Sovereign Debt Presents Green Investors With a Predicament

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(Bloomberg) — For the hundreds of investors claiming to target net-zero portfolios, their largest holdings are often their biggest problem. That’s because the $64 trillion global market for sovereign bonds is largely inhospitable to sustainability-minded investing.

Why? There are only a limited number of issuers (fewer than 150 globally compared with more than 70,000 corporate bond issuers), meaning investors risk a much more concentrated portfolio if they seek to avoid climate laggards. Second, some investors have to hold government debt to match their assets with their liabilities, leaving them captive buyers of bonds they might otherwise have shunned.

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Given these and other challenges, UK fund manager Abrdn Plc says the “drive towards net-zero investing has so far left out sovereign bonds.” To illustrate just how hard it is to integrate government bond holdings into climate investment strategies, Abrdn highlights data from the Net Zero Asset Managers Initiative showing that of the 264 signatories in the global investor group with decarbonization targets, only 24 have set a goal for sovereign debt, far fewer than for all other major asset classes. 

Sovereign debt is “almost omnipresent in portfolios,” said Valentina Ramirez, who has overseen the work on government bonds at the Institutional Investors Group on Climate Change (IIGCC). “Some 50% of the global outstanding bond market is sovereign bonds, so if you made a net-zero commitment, it’s the one piece that you need to address.”

To help investors grapple with the challenge, Abrdn, building on tools from the IIGCC, has developed its own framework for assessing the green credentials of sovereign bonds. This took the form of a so-called credibility framework that aims to identify which countries have the most robust climate policies. 

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Such an assessment includes a review of how quickly a country is decarbonizing, whether its climate commitments are strong and legally binding and if they’re supported by a carbon-pricing mechanism and subsidies for clean energy. This is according to Alexandre Popa, a sustainability analyst at Abrdn in London, who says the framework also considers whether climate action is a partisan topic or has broad political support.

Sweden ranks as the most “credible” country based on those parameters, followed by the Netherlands, Germany, France and the UK, according to Nick Gaskell, Edinburgh-based sustainable investment manager at Abrdn.

“There are real challenges for asset owners and investors that have a keen interest in sustainability and supporting the transition,” Gaskell said. “We see fundamental barriers to being able to do that, which has really been the impetus as to why we’ve embarked on developing this framework.”

While declining to provide the current ranking for the US, a spokesperson for Abrdn said the US “performs relatively well” when it comes to climate policy thanks to President Joe Biden’s massive Inflation Reduction Act (IRA) and state-level carbon markets. The nation scores lower, however, in the assessment of decarobnization given that the US “has some of the highest emissions intensity and energy consumption figures.”

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The firm hasn’t updated its assessment of the US since the Nov. 5 election, as it awaits “further details and evidence of material policy changes from the incoming administration” of Donald Trump. The Republican has downplayed the effects of global warming, loudly promoted a wide-ranging expansion of fossil fuel development and pledged to ask Congress to repeal portions of the IRA.

Given the fact that integration of sovereign bonds within net-zero investment strategies is a relatively nascent discipline, insights from Abrdn’s credibility framework are mostly useful in helping investors “see what the lay of the land is,” Gaskell said. A potential second step for bondholders would be engaging directly with countries on their climate ambitions and funding plans, he said.

An obvious way in which this can happen is when governments seek to issue labeled bonds, such as green bonds, according to Gaskell. When sovereign debt management offices run roadshows to sound out potential buyers on frameworks for such instruments, they provide an opportunity for investors to speak up, he said.

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And the market for green government bonds continues to grow. Austria, Indonesia and New Zealand are among countries that have raised $116 billion from selling green notes in the first 10 months of this year, which is on track to at least match the $124 billion sold during all of 2023, a record year for issuance, according to data compiled BloombergNEF.

Labeled bonds “provide the easiest way for institutional investors to access these opportunities to sponsor governments and public authorities in greater investment in climate solutions,” said the IIGCC’s Ramirez. “There is definitely more to gain from issuers issuing labeled bonds, such as the disclosure structures, bolstering country accountability and fostering strong engagement with investors,” she said.

And there’s plenty of room to grow this activity, since labeled debt accounts for roughly 5% of the total global sovereign debt market, Ramirez said.

Sustainable finance in brief

Speaking of Trump, the president-elect’s return to the White House appears to be forcing one of Wall Street’s more jargon-filled corners to rethink its talking points. Investment managers targeting climate change (which a Big Oil-friendly Trump has called a “scam” and a “hoax”) say it’s time to start speaking in terms that don’t alienate his followers. As global warming-induced disasters increase, finance firms nevertheless feel the need to soft-pedal solutions. The consensus view forming among green asset managers is that many of the policies themselves are popular, based on their uptake in many Republican states, but the way ESG professionals tout what they do is polarizing. “We need to change the language we’re using when we talk about climate and the energy transition,” said Joe Sumberg, a former Goldman Sachs Group Inc. managing director who now runs real estate investments at billionaire Tom Steyer’s Galvanize Climate Solutions.  

• ESG fund managers have once again found themselves on the wrong side of a market meltdown, thanks to the US indictment of Indian billionaire Gautum Adani.
• Standard Chartered Plc has wrapped up a $300 million deal that will allow the Bahamas to refinance debt and allocate savings to ocean conservation.
• HSBC Holdings Plc is said to have abandoned plans to build a carbon credits desk as the bank cools to a market awash with allegations of widespread greenwashing.

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