Warming waters in the tropical North Atlantic Ocean contributed to a record-setting fire season across the Brazilian Amazon, with nearly 30,000 fires set this year. In Australia, scorching temperatures and severe droughts contributed to the burning of over 11 million hectares in January of this year alone. And, of course, the novel coronavirus pandemic has gripped the world, infecting more than 43 million people and contributing to the deaths of more than 1 million globally.
There is now little doubt that the world is seeing increasing threats to its climate, ecological, social, and political systems—and that there’s growing appetite for change. The financial sector has taken note of this evolving landscape as Environmental, Social and Governance (ESG) factors are increasingly integrated into investment mandates. Unsurprisingly, demand for financial assets that can contribute to positive impacts and a more sustainable future is skyrocketing. One recent study by PricewaterhouseCoopers suggests that ESG-dedicated funds will experience a more than threefold jump in assets under management by 2025.
But what do these developments mean for the largest fixed-income asset class—sovereign debt—and the people tasked with issuing, managing and repaying a country’s debt, the debt management offices (DMOs)?
In a recently launched World Bank report, we argue that sovereign debt issuers should take note of this evolving investor landscape and course-correct accordingly. The paper aims to help DMOs and those involved in public debt management formalize thinking and strategy on ESG issues. In addition, the report provides investors, academics, and non-financial market participants with insights on the constraints and issues that DMOs must contend with when engaging on ESG issues.
ESG investing in sovereign debt is hampered by many challenges, such as lack of data availability and disclosure, and lack of harmonization and standardization, although the area is quickly evolving. ESG investing in the sovereign debt of emerging markets and developing economies (EMDE) remains focused on the impact of ESG factors on a country’s creditworthiness, with governance seen as the main driver.
What does this mean for the activities of a DMO?
Our report outlines how a country’s DMO can play an important role in supporting a country’s transition to a sustainable economy while working within its core public debt management mandate—meeting its financing needs and payment obligations at the lowest possible cost over the medium to long run, consistent with a prudent degree of risk.
There are three main approaches that DMOs can take to engage in ESG activities:
- First, they can issue ESG-related borrowing instruments to fund the government,
- Second, they can use their convening power and investor-relations expertise with market participants to channel information on ESG issues and increase the visibility of government initiatives, and
- Third, they can leverage their financial expertise to execute ESG transactions or implement ESG policies that are linked to capital markets.
Decisions on pursuing ESG activities will depend on a number of factors, including the broader context of each respective sovereign debt market. In the report, we term these factors as “ESG market readiness factors”, which should ideally be in place to “ready” a market for each activity pursued (Figure 1). As with any additional responsibilities, the DMO should ensure that any new ESG activities do not interfere with the fulfillment of its core mandate.
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Figure 1: ESG market readiness factors: relative importance for different ESG activities
The stage of market development will be an important consideration for a DMO when deciding on ESG activities. Although each sovereign can rightly aspire to engage on ESG issues, it is important to understand that the existence of “ESG market readiness factors” may affect the success of various approaches. For certain sovereigns whose weaknesses in these factors have not been addressed, it may still make sense to pursue specific ESG activities for other reasons, such as sending a clear political message. However, in most countries, where the local currency bond market is still incipient, formal DMO ESG activities will likely play a limited role, especially given financial and human-resource constraints. Countries that are at a more advanced stage of market development could experiment with the suite of ESG activities in a more flexible way.
The Public Debt Management (PDM) ESG framework
The report formalizes a PDM ESG framework that can be used as a roadmap to support the debt manager’s cost-benefit analysis of various ESG activities. It recommends that the DMO assess the ESG landscape using the identified “ESG market readiness factors” as a checklist. Any bottlenecks should be identified and addressed as needed. In some instances, this could form part of a government bond market development plan.
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Figure 2: Public debt management: environmental, social, and governance framework
The time for sovereign debt managers to act is now. As the ESG landscape continues to evolve, it is important that the managers of the largest pool of fixed-income assets respond in turn. It is our hope that this report can contribute to debt managers’ understanding of the actions that they can take now to contribute to a more sustainable future.
