Credit agencies called to account on ESG in sovereign debt ratings

Investors want credit rating agencies to take on qualitative and quantitative environmental, social and governance (ESG) analysis when determining sovereign debt ratings to avoid another crisis in the $47 trillion sovereign debt market, according to the Principles of Responsible Investment (PRI).

Sovereign credit risk can be better understood by investors if ESG factors are taken into account, according to a new PRI research paper.

Research showed that sovereign debt issued by countries with higher ESG scores outperformed during the euro crisis, PRI said, and multiple studies had pointed to the correlation between ESG factors and creditworthiness and investment performance.

Florian Summer, chair of PRI's Sovereign Fixed Income Working Group, said ESG factors influenced the economic development of countries and played a role in the current sovereign debt crisis, particularly with regards to corruption where developing and transition economies take in bribes worth US$20-40 billion per year according to the World Bank.

VIEW ALL

View all

"Investment research today still largely fails to make the link between ESG and credit risk," she said.

Although some institutional investors now applied ESG analysis to their sovereign bond portfolios and incorporated it into asset manager selection, working group members said there was a lack of quantitative analysis of qualitative data. Some expressed an interest in research which combined ESG and financial data to produce one valuation or buy/sell recommendation.

One member said investors felt more comfortable with data they could input into a spreadsheet.

"Given the sheer size of the sovereign bond market and compelling evidence that these factors are material to both creditworthiness and investment performance, the challenge is now on others to act," said PRI executive director James Gifford.