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I confirm that I am accessing this website for the purpose of acquiring information as, or for, an Institutional Investor (a corporate or other non-retail investor acting for their own account).

I understand the information contained in this website is not directed at, nor is it intended for distribution to, or use by, persons in any jurisdiction in which the dissemination of such investment related information is not permitted. I also understand that the information contained in this site is not directed to any party that may be defined as a ‘retail investor’ by the home regulator of the country in which the website is being accessed. I understand that the information or opinions contained herein should not be construed as an offer to sell or the solicitation of an offer to buy any investment product nor shall any such investment products or services be offered or sold to any person in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful. Fidelity has expressed its own views and opinions on this website, and these may change and there is no obligation to update them. Nothing in this website should be construed as investment, tax, legal or other advice. The information contained herein is subject to change without notice.

This website has been issued by FIL Fund Management Limited, a Bermuda company licensed to conduct investment business by the Bermuda Monetary Authority. Neither FIL Fund Management Limited, its parent company FIL Limited, nor any of their group companies or affiliates makes or gives any warranty or representation that any information contained on this website is accurate, complete, or fit for any particular purpose.

I acknowledge that neither FIL Fund Management Limited, FIL Limited, nor any of their group companies or affiliates will have any liability for any losses arising directly or indirectly from any information accessed from this website. By accepting this representation I also confirm my agreement to the website Terms and Conditions, which I have read and understood.

Please note that FIL Fund Management Limited is not licensed by the Liechtenstein Financial Market Authority (“FMA”) and is not subject to the supervision of the FMA.

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If the above representation is correct, please click 'I agree' below to continue to the site.

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Hiermit bestätige ich, dass ich diese Website zur Informationsbeschaffung als institutioneller Anleger (ein auf eigene Rechnung handelndes Unternehmen oder ein anderer nicht als Privatanleger geltender Investor) bzw. für einen institutionellen Anleger besuche.

Mir ist bewusst, dass sich die Informationen auf dieser Website nicht an Personen richten bzw. für sie bestimmt sind, in deren Land die Verbreitung solcher anlagebezogenen Informationen nicht erlaubt ist. Mir ist ebenfalls bewusst, dass sich die Informationen auf dieser Website nicht an Adressaten richtet, die von der Aufsichtsbehörde in dem Land, von dem aus die Website besucht wird, möglicherweise als „Privatanleger“ klassifiziert werden. Des Weiteren ist mir bewusst, dass die hier zu findenden Informationen oder Meinungen nicht als Aufforderung zum Kauf oder Verkauf eines Anlageprodukts zu verstehen sind. Es sollen auch keine solchen Anlageprodukte oder Dienstleistungen Personen angeboten oder verkauft werden, in deren Land ein entsprechendes Angebot, eine Aufforderung, ein Erwerb oder Verkauf ungesetzlich wäre. Fidelity äußert auf dieser Website seine eigenen Ansichten und Meinungen, die sich jederzeit ändern können, ohne dass eine Verpflichtung zur Aktualisierung besteht. Kein Inhalt dieser Website ist als Beratung in Bezug auf Geldanlagen, Steuern, rechtliche oder sonstige Aspekte zu verstehen. Die hierin enthaltenen Informationen können sich ohne entsprechende Mitteilung jederzeit ändern.

Diese Website wurde von FIL Fund Management Limited eingerichtet, einem Unternehmen mit Sitz auf bzw. nach dem Recht der Bermuda-Inseln, das über eine Genehmigung der Bermuda Monetary Authority zur Ausübung von Investmenttätigkeiten verfügt. Weder FIL Fund Management Limited noch sein Mutterunternehmen FIL Limited oder irgendein anderes Konzernunternehmen oder verbundenes Unternehmen übernimmt die Gewähr dafür oder erklärt, dass die Informationen auf dieser Website zutreffend, vollständig oder für jedwede Zwecke geeignet sind.

Ich erkenne an, dass weder FIL Fund Management Limited noch FIL Limited oder ein anderes Konzernunternehmen bzw. verbundenes Unternehmen für etwaige Verluste haftet, die direkt oder indirekt aus einer auf dieser Website beschafften Information resultieren. Durch Annahme dieser Erklärung bestätige ich auch mein Einverständnis mit den Nutzungs- und Geschäftsbedingungen dieser Website, die ich gelesen und verstanden habe.

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Diese Website präsentiert Informationen in englischer und deutscher Sprache. Als professioneller Anleger akzeptiere ich hiermit, Informationen in mehr als einer Sprache zu erhalten.

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Illustration: Michael Morgenstern

The challenge of investing sustainably in sovereign debt

von Jan Berthold, Martin Dropkin und George Watson

Veröffentlicht am 15 April 2019

ESGFixed IncomeSovereign debt

Engaging with governments on sustainability issues is much harder for investors than engaging with companies. But despite the challenges, doing it well can lead to stronger economic growth for the issuing sovereign and positive alpha for investors.

Sustainable investing is never straightforward. Opinion differs on the best way to do good with your money. However, one asset class stands out as particularly difficult: sovereign bonds.

It’s a world away from companies. Investors are much more familiar with - and vocal advocates of - corporate sustainability. Environmental issues grab the headlines, but governance and the impact of business practices on the wider society are also receiving more attention from asset owners. The relationship between a company and the investors who provide it with capital is clearly defined. Holders of company equity can take the ultimate step in engagement, shareholder voting. Even corporate bond investors enjoy regular access to senior management and a reasonable level of influence over sustainable goals.

But for investors in sovereign bonds the situation is far from straightforward. While companies act in a world where the lines between right and wrong, or at least what is legal and illegal, are relatively clear, sovereign states can define their own rules. A government’s approach to issues such as corruption, pollution and human rights might fall short of international standards yet still be legal or even state-sponsored by the issuing country.

So simply taking the model used for corporate engagement and applying it to governments will not work.

The challenges facing sovereign bond investors

Firstly, multiple parties with conflicting demands interact with government policy makers, including industry, trades unions, non-governmental organisations, and of course the electorate. Bond investors can find themselves lower down the priority list.

Furthermore, it is not always clear where power resides. Each country has its own formal and informal processes for policy decisions. Would-be engagers must navigate the corridors of power to find the appropriate ear to bend. Companies, on the other hand, have defined power hierarchies and clear reasons for issuing debt, making engagement more straightforward.

Then there is the question of how much influence an investor might hold. It’s often not very much. A significant proportion of the holders of sovereign debt, such as central banks, foreign governments, and domestic institutional investors are ‘insensitive’ buyers. Whether for regulatory reasons or other obligations, these parties buy sovereign debt regardless, reducing their incentive to engage compared to discretionary investors.

Even discretionary investors may not equally share an interest in sustainable issues. This lack of alignment among sovereign bond investors means those that do wish to raise issues often have little clout. One obvious way to mitigate this would be for discretionary investors to group together to raise pre-agreed issues. However even this is harder than it sounds as asset managers have a responsibility to execute their clients’ mandates, which have a range of priorities and sustainability goals.

Election cycles too pose problems for engagement. Even though CEOs change from time to time, company strategy evolves relatively slowly. In any case, it is highly unlikely that the entire senior management needs replacing at the same time as the boss. But when a government is voted out, it can leave investors to engage with policies and personnel that have changed overnight.

Another difference is that corporate bonds also typically come with covenants: a legal contract to protect both parties. Bond covenants often help investors by limiting the amount of debt a company can issue in the future. But they can also be used to compel companies to embrace better governance and reporting standards.

Sovereign bonds come with no such legally-binding agreements. In any case, there are moral implications of any strict covenants. A government obliged to differ from its election promises to honour bond covenants agreed with its predecessors would make many parties uneasy no matter the how virtuous the intentions.

Sovereign engagement can be beneficial to both sides

This long list of the challenges involved might put many off engaging with sovereigns. But this would be a mistake. Raising standards, especially around governance, can boost macroeconomic growth, boosting living standards, increasing expected tax receipts and lowering the probability a country will be unable to honour its debt obligations.1 This reduction of sovereign default risk not only increases returns for existing bond holders, but also reduces the cost of borrowing in the future, giving governments more opportunities to finance growth-friendly policies in a positive feedback loop.2,3

It is in the interest of both governments and their investors to take sustainable growth policies seriously.

Governance for growth

Governance is the sustainable issue with the biggest influence on economic growth and therefore sovereign bonds. For example, reducing the level of bribery and corruption opens up markets to new investors and reduces the cost of doing business for private companies, boosting growth throughout the economy. Governance also covers more mundane topics such as data transparency, but even that can significantly reduce the perceived risk of sovereign bonds according to a recent IMF paper. By adopting the IMF’s Data Standards Initiatives, emerging markets could reduce their sovereign bond spreads by 15 per cent in a year.4

Georgia case study

A good example of the positive reinforcement cycle of better governance leading to higher economic growth, and then to cheaper financing is Georgia. The real economic output of Georgia has increased by around five per cent every year for the past decade. This is impressive for any country in the post-financial-crisis era. But for an emerging economy walled in by the Caucasus mountains, bereft of natural resources, and one-fifth occupied by the Russian military, it is remarkable.

A significant proportion of that economic growth is down to the government’s business-friendly policies and focus on climbing the World Bank’s ‘Doing-Business’ rankings, a composite measure that includes metrics such as the ease of starting a business, registering property, enforcing contracts and getting credit. For instance, the government has established sophisticated centralised ‘investor relations’ departments, which help foreign investors find fast and pragmatic solutions to their queries. Georgia now sits in sixth place in the rankings, just ahead of Norway, the US and the UK, and well ahead of Germany and Japan languishing in 26th and 39th place respectively.

We found that engaging with Georgia’s top policymakers was a crucial step in assessing the sovereign bonds. Our analyst met with the Prime Minister and his key advisers to probe the resilience of the government agenda and judge how committed it was to its strategy. It was also an opportunity to give the government an investor perspective, so they could make more informed decisions. Before we invested, we also spoke with sovereign-related corporations in financial services, energy and transportation to get a sense of whether the policies were making a difference to the business environment of key industries. We continue to follow up with policy-makers in Georgia and elsewhere to cultivate the dialogue and encourage a transparent and rule-based business climate.

World Bank governance indicators for Georgia on a scale of -2.5 (weak) to +2.5 (strong). Georgia GDP at US dollar 2010 constant prices. Source: World Bank, Fidelity International, April 2019.

Social and environmental factors

Aside from the obvious benefits to wellbeing, there is less evidence that improvements in social and environmental conditions have such a strong correlation with economic growth. But there is no question that they can harm growth prospects if governments ignore them. Investors often engage on these topics if it becomes apparent that they threaten stability.

For example, the mismanagement of natural resource extraction and the resulting environmental devastation in the Niger Delta has been a major source of social grievance in Nigeria for some time. The gravity of the situation and the apparent lack of action by policy makers has incited militancy and pipeline vandalism by locals, in part to raise awareness and force the government into action. While hydrocarbon extraction represents only around 10 per cent of GDP, it accounts for nearly two thirds of all government revenue.5 Dissident action that threatens this has significant implications for both economic growth and sovereign default risk.

Social indicators too can prove a risk to an economy. Injustice or the treatment of ethnic minorities can lead to unrest that can impact growth. For example, despite the near-disappearance of ISIS in Iraq, substantial progress is needed to heal the divisions in society for the economy to grow and realise the full potential of the country’s natural resources. Not all investors have the risk tolerance needed to hold such sovereign debt, which greatly limits the government’s access to funding to invest in development.

Framework to investigate sustainability in sovereigns

Each country is unique but there are certain actions investors can do to help them make more informed judgements about sovereign bonds:

  • The starting point is analysing the data. The World Bank, IMF and other supranational organisations produce statistics which act as a benchmark when analysing a specific country. The data tends to be stronger for governance-related factors, so for environmental and social issues its often best to supplement with case studies.
  • Evidence gathering. Each country has its own history and culture requiring a flexible and responsive approach. It’s often best to concentrate efforts on the weakest aspects of a country’s business structure because that is where the marginal gains are most likely to be made. For South Africa this includes its labour unions, for Kazakhstan the independence of courts to enforce property rights, and for Angola corruption. Sources that can help with collecting information about a country’s fault-lines include think tanks, journalists and opposition political parties.
  • Active engagement. Creating a dialogue with key policymakers helps to understand the long-term goals and commitment of a country’s leaders. In many cases it’s best to engage with the most influential members of the government who have broad mandates, rather than just specific departments such as the finance ministry or central bank, which are limited in their scope.
  • Modelling, analysis and investment recommendation. Sustainability factors can make a difference in the final investment recommendation. In particular, a country with an improving sustainability profile, which the broader market has not yet spotted, can offer mispriced securities from which to generate alpha.
  • Follow up. As investors, we want to see governments implementing positive business policies, and not drift from their stated objectives. There should be steady progress, and any stalling should be examined. Engaging with policy-makers is ideally a long-term endeavour so that the relationship develops, and policy improvements can be continually made.

The rewards are there for both sovereigns and investors

Sustainability is a broad and complex topic and it would be wrong to assume there is or will ever be a widely accepted set of boxes for sovereign engagement that investors can simply tick off. Engagement is difficult to assess, and the ambiguous, changing and unique circumstances of each country mean that it will always be a challenge.

But sovereign engagement can be rewarding for both issuers and investors despite the complexities involved. It’s true that sustainable issues can pose risks for governments, but they also present a huge opportunity for long-term growth, cheaper financing and a higher standard of living for citizens.

For investors to gain the influence needed to encourage change, it could take something asset managers might regard as radical but that a five-year old would intrinsically understand. They might have to work together.

Worauf sollten wir als Nächstes eingehen?

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