How to tackle sovereign ESG scoring in low-income economies

July 26, 2022

Investors face multiple challenges when evaluating sovereign ESG risks and opportunities.

FTSE Russell highlights one important challenge when evaluating sovereign ESG risks and opportunities, the so-called “Ingrained Income Bias” (IIB), first introduced by the World Bank in its paper “A New Dawn – Rethinking Sovereign ESG”.

It points out that it’s beneficial to look at ESG ratings in the context of a country’s income level and economic strength in order to adjust for biases against developing countries. It is precisely these countries – which in the investment world are grouped together as the emerging markets – that arguably need the majority (over 60% according to UNCTAD) of the USD5–7 trillion per year in investments necessary to achieve the UN Sustainable Development Goals by 2030.

To gain the full picture, this analysis needs to be put into context with the likely future ESG trajectory of sovereign issuers, which ex-post data can shed only limited light on. This is where engagement with sovereign issuers and the forward-looking granular analysis of underlying data needs to step in.

The World Bank draws a similar conclusion, highlighting that simplistic income adjustments of underlying data might lead to overcorrection. It suggests putting greater emphasis on in-country, rather than between-country, comparisons and peer group analysis.

Positively, we believe that sovereign fixed income investors are, to a large extent, already making these income adjustments when evaluating sovereign credit risks – perhaps with the exception of environmental/climate risks, which are yet to be priced in.

The accurate pricing and analysis of environmental risks is further complicated by a lack of consensus around measurement. But at a high level, our analysis showed that once all economic differences are factored out, the spread of the leading ESG performers is approximately 70% lower than the worst performers.

Further dilemmas of sovereign issuers include, to name but a few:

  • How do you offset robust performance within one category (e.g. environmental policies) with a poor track record in another (e.g. human rights) – is performance across E, S & G really additive?
  • What’s the best way of measuring a country’s performance in the environmental dimension?
  • Which sovereign ESG provider ratings do you believe accurately represent reality, given the notoriously low correlations among data providers?
  • Do you factor in ESG risks and opportunities in a same way when investing in short-dated sovereign T-bills vs. 100-year bonds?

Ongoing challenges in ESG sovereign analysis mean it remains more of an art than a science. To give it justice, such analysis needs to be multi-dimensional and quantitative data needs to be overlayed with forward-looking qualitative analysis. This should be supplemented by frequent engagement evaluating the future path of a sovereign. In our view, relying on backwards-looking quantitative data is to the detriment of issuers and investors alike.

Sign up for insights by email

Subscribe now to receive the latest investment and economic insights from our experts, sent straight to your inbox.

This document may be produced and issued by the following entities: in the European Economic Area (EEA), by BlueBay Funds Management Company S.A. (the ManCo), which is regulated by the Commission de Surveillance du Secteur Financier (CSSF). In Germany and Italy, the ManCo is operating under a branch passport pursuant to the Undertakings for Collective Investment in Transferable Securities Directive (2009/65/EC) and the Alternative Investment Fund Managers Directive (2011/61/EU). In the United Kingdom (UK) by BlueBay Asset Management LLP (BBAM LLP), which is authorised and regulated by the UK Financial Conduct Authority (FCA), registered with the US Securities and Exchange Commission (SEC) and is a member of the National Futures Association (NFA) as authorised by the US Commodity Futures Trading Commission (CFTC). In Switzerland, by BlueBay Asset Management AG where the Representative and Paying Agent is BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich, Switzerland. The place of performance is at the registered office of the Representative. The courts of the registered office of the Swiss representative shall have jurisdiction pertaining to claims in connection with the distribution of shares in Switzerland. The Prospectus, the Key Investor Information Documents (KIIDs), where applicable, the Articles of Incorporation and any other applicable documents required, such as the Annual or Semi-Annual Reports, may be obtained free of charge from the Representative in Switzerland. In Japan, by BlueBay Asset Management International Limited which is registered with the Kanto Local Finance Bureau of Ministry of Finance, Japan. In Australia, BlueBay is exempt from the requirement to hold an Australian financial services license under the Corporations Act in respect of financial services as it is regulated by the FCA under the laws of the UK which differ from Australian laws. In Canada, BBAM LLP is not registered under securities laws and is relying on the international dealer exemption under applicable provincial securities legislation, which permits BBAM LLP to carry out certain specified dealer activities for those Canadian residents that qualify as "a Canadian permitted client”, as such term is defined under applicable securities legislation. The BlueBay group entities noted above are collectively referred to as “BlueBay” within this document. The registrations and memberships noted should not be interpreted as an endorsement or approval of BlueBay by the respective licensing or registering authorities. Unless otherwise stated, all data has been sourced by BlueBay. To the best of BlueBay’s knowledge and belief this document is true and accurate at the date hereof. BlueBay makes no express or implied warranties or representations with respect to the information contained in this document and hereby expressly disclaim all warranties of accuracy, completeness or fitness for a particular purpose. Opinions and estimates constitute our judgment and are subject to change without notice. BlueBay does not provide investment or other advice and nothing in this document constitutes any advice, nor should be interpreted as such. This document does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product in any jurisdiction and is for information purposes only. This document is intended only for “professional clients” and “eligible counterparties” (as defined by the Markets in Financial Instruments Directive (“MiFID”) ) or in the US by “accredited investors” (as defined in the Securities Act of 1933) or “qualified purchasers” (as defined in the Investment Company Act of 1940) as applicable and should not be relied upon by any other category of customer. No part of this document may be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, in whole or in part, for any purpose in any manner without the prior written permission of BlueBay. Copyright 2022 © BlueBay, is a wholly-owned subsidiary of RBC and BBAM LLP may be considered to be related and/or connected to RBC and its other affiliates. ® Registered trademark of RBC. RBC GAM is a trademark of RBC. BlueBay Funds Management Company S.A., registered office 4, Boulevard Royal L-2449 Luxembourg, company registered in Luxembourg number B88445. BlueBay Asset Management LLP, registered office 77 Grosvenor Street, London W1K 3JR, partnership registered in England and Wales number OC370085. The term partner refers to a member of the LLP or a BlueBay employee with equivalent standing. Details of members of the BlueBay Group and further important terms which this message is subject to can be obtained at www.bluebay.com. All rights reserved.

Sign up for insights by email

Subscribe now to receive the latest investment and economic insights from our experts, sent straight to your inbox.