It was James Carville, President Bill Clinton’s political adviser, who famously said he would like to be reincarnated as the bond market because “you can intimidate anybody”. He was speaking in 1994, in the wake of investors sending US Treasury yields soaring over concerns about federal spending. Investors can still exert influence over sovereign issuers, but a growing number of them are using their power for good — to encourage improved ESG outcomes.

A recent example was an online meeting between a group of investors, led by Norway’s Storebrand, and Brazilian ministers and central bankers to discuss the investors’ concerns over deforestation.

It followed a letter sent in June from 34 institutional investors expressing worries about “the financial impact that deforestation and the violation of the rights of indigenous peoples may have on our clients and investee companies,” noting that Brazilian companies exposed to deforestation in their operations and supply chains might find themselves locked out of international markets.

Crucially, they also noted that: “Brazilian sovereign bonds are also likely to be deemed high risk if deforestation continues.”

Examples such as this illustrates the value to investors of engaging with governments on ESG issues. The World Bank has been working in this area, including partnering with the Government Pension Investment Fund of Japan and Dutch pension fund APG to host a roundtable “to promote dialogue between institutional investors and sovereign bond issuers on ESG risks and opportunities”.

The key messages that emerged from the roundtable — which included both investors and sovereign issuers — included that investors are including sovereign bonds in their ESG integration processes, with investors seeing “a strong link between an issuer’s ESG performance and the consistency of financial returns for its bonds”.

Engagement trumps exclusion

Investors also value the engagement process, noting that they would rather engage than exclude particular issuers. Engagement is important for “building trust and understanding a country’s story and ESG ambitions beyond what the data shows.”

While engagement between investors and corporates is widely practiced, through voting at annual shareholder meetings or via direct meetings, the channels for engagement with sovereigns are less clear. A country’s debt management office is typically the gatekeeper, but facilitating the engagement throughout the various public institutions and ministries can be a challenge. Initiatives like the one from the World Bank that bring more transparency and efficiency to sovereign engagement are very much needed.

Crucially, the investors at the roundtable also noted that “data lags remain a challenge”, particularly for emerging market sovereign issuers. “A better understanding of sustainability and guidance on the relevance of indicators on performance and impact are needed,” the World Bank said.

The good news is that government debt offices seem to have got the memo. Despite representing a government led by populist climate denier Jair Bolsonaro, the meeting with investors went smoothly, according to participants.

Jan Erik Saugestad, chief executive officer of Storebrand, expressed himself “encouraged by the initial response and dialogue with the Brazilian government representatives and [we] look forward to its continuation and results on the ground.”

Rules of engagement

The case of Brazil seems to be an easy one, as speaking up against deforestation and the trampling of the rights of indigenous people is not controversial. It will be interesting to see whether large asset managers and asset owners exert their influence on more controversial topics, such as renewable energy versus nuclear power, or homosexual rights in conservative societies.

Sovereign engagement also creates an interesting dynamic. A government’s policies are, at least in democratic countries, the result of a political process where the electorate chooses a government to deliver on election promises. Global investors are powerful but unelected stakeholders, seeking to promote certain interests that may not necessarily be supported by a country’s voters. In today’s world, where populism and nationalism are rampant, this offers potential for conflict.

Investor engagement has the potential to steer government policies onto the right direction, but the rules of that engagement also need to be given some consideration.

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