This article – Integrating ESG Factors Into Sovereign Debt Analysis – is the fifth of an eight-article series from the CFA Institute that recaps their ongoing research into the application of Environmental, Social and Governance standards to investment analysis and selection.

The CFA institute is a global think tank with more than 150,000 CFA charterholders globally. The Chartered Financial Analyst® designation is the most respected and recognized investment management designation in the world. The author of this article, Matt Orsagh, CFA, CIPM, is one of a team of analysts studying the practical and policy implications of deploying ESG standards around the world.

by Matt Orsagh, CFA, CIPM

The integration of environmental, social and governance factors into investment analysis is easy to define. It is the explicit and systematic inclusion of ESG factors in investment analysis and investment decisions

However ESG integration in practice, is much more difficult to understand. To do so, CFA Institute and Principles for Responsible Investment (PRI) surveyed 1,100 financial professionals, predominantly CFA members, around the world; ran 23 workshops; interviewed practitioners and stakeholders and published more than 30 case studies

This effort resulted in the publication of Guidance and Case studies for Integration: Equities & Fixed Income by CFA Institute and Principles For Responsible Investment

This article concerns our findings about ESG integration with respect to sovereign debt. In the previous column we covered ESG integration for corporate bond analysis. In subsequent articles we’ll cover ESG integration for municipal bonds and structured credits

Low Adoption

The current low adoption of ESG integration by sovereign-debt practitioners is due in part to the lack of understanding of how to integrate ESG issues into sovereign debt issues. Unlike some corporate bond practitioners, sovereign-debt practitioners are not able to simply borrow techniques and materiality/sustainability frameworks from their fellow equity practitioners, which might speed up the integration process. Extensions to existing frameworks or new frameworks for country-specific factors are likely needed.

The lack of understanding may be exacerbated by the difficulties of sourcing ESG data on countries as compared companies, especially environmental data. This makes it more difficult for practitioners to assess the absolute and relative ESG performance of a country and in turn, convert the ESG data/analysis into meaningful indicators to support their ESG integration practices.

ESG Data Sources For Sovereign Credit Analysis

Freedom House—Freedom in the World survey
Reporters without Borders—World Press Freedom Index
Forum for a new World Governance—Worldwide Governance Index
Bündnis Entwicklung Hilft—The World Risk Index
Transparency International—Corruption Perceptions Index
World Bank—Ease of Doing Business Index
United Nations Development Program—Human Development Index
Fund for Peace—Fragile State Index
Organisation for Economic Co-operation and Development—Better Life Index International
International Labour Organization—labor and health and safety statistics
Access Initiative and World Resources Institute—Environmental Democracy Index Natural
Natural Resource Governance Institute—Resource Governance Index
Yale University—Environmental Performance Index
World Energy Council—Energy Trilemma Index
International Monetary Fund—country reports
EU—country reports
US Central Intelligence Agency—World Factbook
• ESG research providers
• Credit rating agencies

Another reason for the lower usage of ESG in sovereign credit analysis relates to the CFA-PRI survey finding suggesting that ESG issues are generally less material for sovereign debt compared to their impact on shares and corporate bonds (see table below). Practitioners may believe that ESG issues do not impact sovereign debt prices and therefore ESG integration is not applicable. However, the CFA-PRI survey did indicate that governance issues, social issues, and environmental issues are impacting prices.

The Impact Of ESG Issues on Corporate Bond and Sovereign Debt Yields


As indicated by the table, the respondents believe that social issues more frequently affect sovereign debt prices than environmental issues. Practitioners are more likely to analyze social information on a country than environmental information, especially as the time horizon of social issues is more aligned with the investment horizon for sovereign debt. The more-readily available social data also makes it easier for practitioners to integrate social issues into their sovereign credit analysis.

Examples of ESG Issues Analyzed By Sovereign Debt Investors

Institutional strength
Regime stability
Rule of law
Regulatory effectiveness and quality
Accounting standards
Freedom of the press
Political and civil liberties

Human rights
Education and human capital
Health levels
Political freedoms
Demographic change
Employment levels
Life expectancy
Social exclusion and poverty/ income disparity
Trust in society/institutions
Crime and safety
Food security

Effects of climate change
Water resources and pollution
Energy resources and management
Biocapacity and ecosystem quality
Air pollution
Natural disasters
Natural resources

Despite these challenges, practitioners are integrating ESG issues into their sovereign credit analysis. The majority are making qualitative assessments of ESG issues through the use of third-party research and/or internal research and these assessments then inform their investment decisions. Quantifying ESG issues in sovereign credit analysis is not widespread and is practiced less than with corporate credit analysis. With sovereign debt analysis, it tends to be performed by feeding ESG research and/or scores into the credit analysis of an issuer, which can cause adjustments to credit ratings or internal credit assessments.

Another common approach to sovereign credit analysis is to analyze ESG issues through portfolio construction tools. ESG issues can then influence allocations to regions and countries, providing underweight, neutral, and overweight signals.

As well as analyzing the impact of ESG on a country’s ability to pay its debt obligations, practitioners have used ESG information to assess a country’s willingness to pay its debt obligation. For example, an investment manager who believes a link is present between a country’s level of corruption and its willingness to pay might use that link as justification to adjust country credit ratings and outlooks that they believe do not reflect the level of corruption in those countries.

While the integration of ESG factors into sovereign debt analysis is in its infancy, adoption is growing. As noted fully 44% of practitioners anticipate that ESG factors will impact sovereign debt yields in 2022, a material increase from 2017’s 35%. One factor which could accelerate adoption is greater availability and standardization of ESG data, which would provide practitioners with more options for integration than they now have.

Matt Orsagh, CFA, CIPM is a director of capital markets policy at CFA Institute, where he focuses on corporate governance issues. He was named one of the 2008 “Rising Stars of Corporate Governance” by the Millstein Center for Corporate Governance and Performance at the Yale School of Management.

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