How do investors gauge the degree of state-level sin?

Refinitiv Lipper's Dewi John looks at how investors can analyse ESG credentials of sovereign debt in countries that lack high levels of transparency

There’s an old saying all money is dirty. You could justifiably add, “particularly when it comes to governments”.

Take China—an easy target: largest total greenhouse gas (GHG) emission, persecution of minorities, general civil rights violations. Surely not a candidate for ESG investments.

Which begs the question, when it comes to sovereign debt, what is acceptable and why? How do investors gauge the degree of state-level sin: who has the mote and who the beam in their eyes?

By way of example, let’s focus on the E in China’s ESG. At this year’s COP26, former US president Barack Obama criticises Russia and China for their “absence of urgency” on climate targets. That these countries are behind the curve is certainly true. Meanwhile, US drilling approvals hit a 20-year high. What’s more, per capita CO2 emissions for China are 7.5 tonnes; for the US that figure is 16.5, and for high income countries overall, it’s 10.7 (World Bank, 2014).

Chinese development, and with it Chinese GHG emissions, has been driven by the offshoring of production from many developed nations to China and other developing nations. Western governments cannot have it both ways—trumpeting their falling emissions, decrying China’s rising ones, while conveniently missing the link between the two.

We want all the things these countries make for consumption outside of their borders, but we don’t want to consider the results of these choices. But GHGs don’t stop at borders.

Atmospheric greenhouse gasses are not simply—even predominantly—an issue of current emissions (flow); the bigger climate impact is a result of historic emissions (stock). A 2020 paper published in British medical journal The Lancet, titled Quantifying national responsibility for climate breakdown, claimed as of 2015, the G8 nations were together responsible for 85% of excess C02 emissions. And, while the Global North was responsible for 92%, most countries in the Global South were within their boundary “fair shares”, including India and China, although it added that “China will overshoot soon”.

While we’re throwing proverbs around, there’s that whole “let he who is without sin…” thing, to continue with the biblical theme. Which isn’t particularly helpful, as clearly someone has to make an investment decision. Which brings us to how.

Hypocrisy-hunting in governments, whether east or west, north or south, is slightly less difficult than shooting fish in a barrel. But where does it get us? Capital needs to be deployed in ways that take us closer to realising the goals of the Paris Agreement. For that, investors need reliable and standardised information. For example, the World Bank, which pioneered green bonds from their origins as sovereign debt instruments, provides high-level data by which investors can gauge the credentials of sovereign issuers.

Tackling the lack of such data, and the resultant greenwashing, has moved up the agenda. International Organisation of Securities Commissions (IOSCO) chair Ian Alder has said that “greenwashing is climbing up the agenda as an issue” for regulators, identifying data gaps and an absence of standardised indicators for sustainability as the core challenge.

This year’s IMF Global Financial Stability Report stressed the “increasing importance” of sustainability labels as drivers of investment fund flows, alongside challenges faced by fund managers including “data gaps, risk of corporate greenwashing, multiple disclosure standards, and a lack of globally accepted taxonomies”. The IMF says policymakers should “urgently strengthen the global climate information architecture” through data, disclosures, and taxonomies for companies and investment funds.

Meanwhile, the Organisation for Economic Cooperation and Development (OECD) has encouraged G20 economies to consider introducing policies to strengthen ESG investment practices, such as greater comparability and alignment of environmental metrics in ESG ratings. The OECD also warns that greater international cooperation is needed to address “the current market fragmentation” of practices to assess ESG-related investments.

I’m certainly not arguing that, when it comes to China (or anywhere else), it should be a case of “give them your money and hope for the best”. Quite the reverse: greenwashing can only be countered by investors being able to measure the ESG effects of their investments, and to ensure that a positive impact with one project isn’t overwhelmed by negative impacts by the entity as a whole—a classic example of greenwashing, whether state or corporate, which has been flagged as a concern with green bonds.

Not investing in China or Chinese enterprises because their governance is dubious, and so the deployment of capital in a sustainable way questionable, makes sense. That’s far from being a problem unique to China. How the world’s largest GHG emitter transitions is of vital importance, and that will be driven, in part, by greater global transparency.


Natalie Kenway

Natalie is editor in chief at MA Financial covering ESG Clarity, Portfolio Adviser and International Adviser. She was previously global head of ESG insight for ESG Clarity and has been an investment journalist...