2. ESG practices and challenges from a public debt management perspective
Awareness of environmental and social issues has been rising in recent years. The growing integration of ESG factors by investors, corporates and governments has implications for sovereign debt management as it has the potential to noticeably affect investment decisions, investment tools and country credit assessments over time. Public debt management, as an interface between governments and financial markets, can play an important role in supporting government ESG agendas by conveying to investors government commitments to improve environmental and social outcomes and by financing such activities through the issuance of ESG-labelled bonds.
Against this background, this chapter takes the perspective of a public debt manager and discusses approaches to incorporating ESG factors into public debt management. Using survey-based data, it identifies common practices, challenges as well as the key features of emerging leading practices.
Governments, corporates and investors all around the world are increasing their efforts to integrate Environmental, Social and Governance (ESG) factors into their policies and practices to help reduce the carbon intensity of their economies, make them more climate-resilient and reduce social inequalities. This increased ESG focus affects, in turn, government securities markets through investor decisions, investment tools and country credit assessments. In response, public debt management offices are paying greater attention to, and increasingly adapting, their investor engagement, communication practices, and debt instruments to fully benefit from these developments.
This chapter takes the perspective of a sovereign debt manager and discusses the ways in which developments in sustainable finance affect public debt and its management, and country approaches to integrating ESG factors into debt management. It uses survey-based data to identify common practices, challenges and key features of emerging good practices, and market data to analyse the key trends in ESG-labelled sovereign bond markets.
The environmental, social, and governance (ESG)-related risks and opportunities and their consideration by investors, credit rating agencies, regulators and governments have implications for public debt and its management through fiscal balances, investment decisions, sovereign creditworthiness and the cost of borrowing. Public debt management, as an interface between governments and financial markets, can play an important role in supporting government ESG agendas, mainly through communication and issuance strategies.
A growing number of debt management offices are becoming more proactive and transparent in providing information on government initiatives and actions to promote ESG issues. Country practices highlight the importance of leveraging the existing information within government institutions, carrying out investor consultation, ensuring the reliability of data and consistency of definitions with the relevant international standards, and developing institutional technical capacity on sustainable finance.
While still in the early stages of development, the ESG-labelled sovereign bond market grew significantly in recent years. ESG-labelled bond issuance has grown more than threefold since 2019 and exceeded USD 240 billion as of March 2022 and the number of issuers exceeded 30 countries. The yields on sovereign ESG-labelled bonds appear to reflect sovereign creditworthiness, as well as of the high level demand for these bonds in the markets.
The key motivation for issuing an ESG-labelled bond is to align with government ESG policy agendas, followed by catalysing the development of the local sustainable bond market and meeting high levels of investor demand, hence diversifying the investor base.
ESG-labelled bond issuance does, however, raise several challenges for sovereign debt management offices as it requires expertise and information that is not typically found in debt management offices. Further standardisation of ESG products in terms of minimum reporting requirements, and a clear and consistent definition of ‘green spending’, would help facilitate the issuance process and build a robust and liquid ESG bond market.
To date, the leading practices of sovereign ESG-labelled bonds share common features such as stakeholder engagement, including cross-department collaboration and communication with market participants, commitment to transparency and reporting disclosures and to sustaining liquidity through issuance volume and instrument design.
Labelled bonds offer an opportunity for emerging market sovereign issuers to attract international investors by meeting their interest in transparency and ESG issues. However, if issued in foreign currency and left unhedged, this could create further vulnerability for issuers due to the increased currency risk associated with issuing foreign-currency debt.
Awareness of environmental and social issues (e.g. shifting demographics, education, health, housing, poverty, inequality, etc.) has been rising in recent years, with governance issues having greater consideration and understanding for a longer time. Increasing numbers of investors around the world, including central banks, are paying greater attention to sustainable activities, and seeking to integrate ESG factors into their investment portfolios and risk assessment practices. In parallel, a number of alternative investment products with ecological and social benefits have emerged. Many governments have increased their efforts towards the ESG agenda in recent years, as they aim to meet their Paris climate agreement commitments and UN Sustainable Development Goals. They have included environmental, sustainability, and socio-economic equity objectives in their policy packages to help reduce the carbon intensity of their economies, make them more climate-resilient and reduce social inequalities. The integration of ESG factors by investors and governments has implications for sovereign debt management since they have the potential to affect investment decisions, fiscal sustainability and country credit assessments over time.
2.2.1. ESG considerations are high on government agendas
With the Paris Agreement and the United Nations 2030 Agenda for Sustainable Development of 2015, ESG-related policies have made their way up in the governmental agenda all around the world.1 Since then, according to the United Nations (UN), more than 130 countries have set, or are considering, a target of reducing emissions to net zero by mid-century (United Nations, 2021[1]). This group of countries includes both advanced and emerging-market economies. The 2019 mobilisation to a “Decade of Action”, where governments pledged to mobilise financing to meet the UN Sustainable Development Goals (SDGs), will effectively require governments to pick up the pace towards acting on their ESG agenda.2 Moreover, adopting such a perspective is of central importance in the context of economic recovery from the COVID-19 crisis, as stimulus packages could be designed to achieve a profound shift to more sustainable, inclusive, and resilient economic growth.3 Such ‘build back better’ approach requires governments to support and fund investments that lead to a sustained economic recovery, which in turn raises government budget revenues. In this context, growth for build back better policies supports long-term fiscal sustainability.4 Furthermore, the OECD recognises that governments need to focus on reviving hard-hit economies by boosting growth, income and employment while supporting cleaner, more inclusive and sustainable economies (OECD, 2020[2]). With the Glasgow Climate Pact, governments agreed to revisit and strengthen their commitment to achieving a number of climate related targets, and to establishing a new mechanism and standards for international carbon markets in 2021 (UN, 2021[3]).5
Against the background of this policy momentum, government implementation efforts towards green and sustainable growth have been increasingly underpinned by long-term strategies with interim stage objectives, instruments and measures that call for active involvement and co-ordination of a number of different national authorities.6 Clearly, governments are in a unique position to make regulations to combat climate change (e.g. in controlling carbon emissions). The scaling up of environmental and social commitments nationally has also brought with it implications for the role of central budget offices, treasuries and debt management offices (DMOs) that are not responsible for policies on social and environmental policy. For example, a number of OECD governments have adopted green budgeting which aims to integrate climate and environmental perspectives into budgetary processes and decision making, to support the progress of climate and environmental policies (OECD, 2020[4]).7 In this context, national climate change or environmental strategies and plans help to guide taxation and spending decisions that can support the achievement of national objectives.
Given that governmental budgets are already constrained in many countries, additional funding for green budgetary purposes will likely require additional borrowing, in particular in the short-term. This need for additional resources can be met through issuance of conventional bonds as part of general borrowing requirements, or through issuance of labelled bonds such as green bonds. As discussed in Section 2.3.2, in addition to fund social and green spending, ESG-labelled sovereign bonds are issued to support the growth of a local ESG bond market, and to demonstrate government commitments to social, sustainable, low-carbon growth strategies.
2.2.2. Soaring demand for ESG investing fuels new approaches to credit risk assessments and instrument developments
Historically, the evolution of financial markets has been driven by the need to mitigate various challenges and grasp opportunities, and ESG related innovations are no exception to this. A growing number of institutional investors and funds incorporate various ESG investing approaches, to better align between societal values and long-term financial value. For example, pension funds have been increasingly considering ESG risk factors in their portfolio selection and management, as ESG-related issues might present risks and opportunities for their investee assets.
While the definition of sustainable investment varies between countries and over time, and most of the sustainable investing data rely on survey-based approaches, they all indicate a steep rise in ESG-sensitive investing, in particular since the COVID-19 pandemic. For instance, a forthcoming OECD report on climate change and corporate governance estimates that assets under management of the investment funds that label themselves as ESG or sustainable fund increased from about USD 800 billion in 2019 to USD 1.7 trillion in 2021 (OECD, 2022[5]). This surge in ESG investing is commonly attributed to the following factors: i) A more holistic approach to risk management by including ESG considerations into the risk mitigation process ii) A wider awareness about social, environmental and human rights issues and risks for the world; iii) An increasing engagement of the younger population who are relatively more sensitive to environmental and social consequences of their choices, in investment, and iv) Development of new regulations and values.
From an investment strategy perspective, the traditional approach to investing into sovereign debt usually takes into account the macroeconomic outlook of the issuer in order to assess whether sovereign debt risk factors could materialise. To assess these risks, investors have long focused – through sovereign credit ratings – on internal political issues, demography trajectories and the standards of governance as well as on economic indicators, such as the rate of economic growth, levels of external debts and exposure of domestic banks. Hence, except for governance indicators, ESG factors have not been particularly visible in conventional sovereign credit ratings. With a holistic approach, sustainability is increasingly recognised as an important parameter influencing the overall economic performance of a country. By tackling climate risks, improving social cohesion, and supporting good governance, a state can support better economic performance in the long run, and in turn strengthen its creditworthiness. For instance, a recent study by Kahn et al. (2019[6]) finds that persistent changes in climate have a long-term negative impact on economic growth in both advanced and emerging, as well as hot and cold, countries. At the same time, ESG instruments are associated with higher levels of transparency, due to reporting and disclosure, and thus integrating ESG considerations in allocation decisions, provides investors with an enhanced framework to analyse sovereigns from a credit perspective. While no one-size-fits-all investment strategy exists, and the decision of investors to adopt an ESG perspective depends on a variety of factors, different international bodies (among which the OECD, the World Bank, and the Global Sustainable Investment Alliance) have provided a spectrum of investment approaches that seems to apply to the majority of institutional investors (Box 2.1).
Investor appetite towards sustainable investing has been steadily increasing in the last few years, reflecting the fact that investors are paying greater attention to the social and environmental consequences of the decisions that governments make. Sustainable investing strategies in sovereign debt can be summarised as follows:
Traditional investment strategies aim at maximising financial market returns. In such a context there is little to no space for ESG considerations and practices.
Negative screening strategies exclude certain countries from portfolios, based on activities considered not investable (e.g. excessive reliance of the national economy on non-renewable sources of energy).
Positive screening strategies aim to add desirable asset characteristics to a portfolio, by including issuers who are compliant with international norms and standards.
Sustainability-themed strategies aim to select categories of assets who contribute to sustainable development.
Impact investing strategies aim at achieving a positive environmental and/or social impact, while safeguarding long-term financial sustainability.
ESG integration strategies explicitly include ESG factors into financial analysis.
Responsible ownership strategies aim to influence sovereigns’ behaviour, by engaging in stewardship policies with the issuer (OECD, 2019[7]) (World Bank, 2020[8]).
The rise in sustainable investing has implications for sovereign credit assessments, as investors consider the ESG performance of the government, and are not obliged to invest in labelled bonds. In this context, ESG ratings and ESG risk scores have gained consideration as tools to assess the environmental and social impact, as well as to establish environmental, social and governance risks, of specific investment choices. ESG ratings take a perspective of material quantification of the sovereign credit risks linked to environmental, social and governance factors. Therefore, by providing information on the exposure to and management of a country’s ESG risk factors, they are mainly used to assess its sustainability and creditworthiness. On the other hand, ESG scores take a perspective of evaluation of the impact of specific investments, and they aim to gauge a country’s ESG relative performance. Recent studies in this area suggest that the agencies that assign ESG ratings to both bonds and their issuers use different methodologies and are not completely transparent, which may lead to misperceptions about a country’s overall sustainability performance.
Source: OECD (2019[7]), Social Impact Investment 2019: The Impact Imperative for Sustainable Development, https://doi.org/10.1787/9789264311299-en; World Bank (2020[8]) Engaging with Investors on Environmental, Social, and Governance (ESG) Issues: A World Bank Guide for Sovereign Debt Managers, https://thedocs.worldbank.org/en/doc/375981604591250621-0340022020/original/WorldBankESGGuide2020FINAL.11.5.2020.pdf.
Labelled bonds, which aim to provide investors with sustainable, transparent and high-quality investment opportunities, are becoming an important part of financial markets as they grow not only in size but also in terms of the variety of instruments. Annual green, social and sustainability bond issuance reached over USD 1.1 trillion in 2021, recorded a 45% increase compared to 2020 (CBI, 2021[9]). Despite the record growth, the issuance of ESG bonds is still a modest amount compared to the USD 18 trillion of government borrowing by OECD countries as well as USD 5.9 trillion in corporate bond borrowing in the same year. While corporate sector issuance dominates the ESG debt market, sovereign issuance has been growing rapidly in recent years as discussed in Section 2.3.2.
Going forward, ESG debt market is expected to grow further on the back of increasing funding needs of both private sector and public sector issuers for social projects, climate mitigation and adaptation projects in line with national targets and robust investor demand. Issuers may also be inclined to use labelled bond programs as a means of signalling commitments to ESG aims. The appetite of investors for ESG-labelled bonds on the other hand appears to be motivated by several reasons. First, investors are increasingly influenced by societal values and are characterised by the desire to improve the alignment of financial products with societal and moral considerations. Second, under some circumstances, ESG investing can help improve risk management and lead to returns that are comparable to returns from traditional financial investments. For instance, evidence from primary studies on corporate stocks suggests that socially responsible investing has a positive impact on returns, particularly for portfolios that score well on environmental and diversity dimensions (Galema, Plantinga and Scholtens, 2008[10]). On the other hand, studies on fixed income market resulted in mixed findings: A literature review of over 240 research papers issued between 2016 and 2020 finds that, for fixed income instruments, 33% of the reviewed studies showed a better performance of portfolios with an ESG focus, while 54% found either neutral (performance comparable to traditional portfolios) or mixed effects, and 14% found negative effects (Whelan et al., 2021[11]). Third, significant progress made in regulations and guidelines with respect to ESG labelling, taxonomy and transparency obligations across different jurisdiction has contributed to attract ESG sensitive investors and to the development of the ESG bond market (Box 2.2).
In recent years, sustainable finance has made significant progress from a regulatory and statutory standpoint, as both regulators and market participants sought greater market transparency and more certainty around the long-term sustainability of various types of investments, at a time when ESG considerations were increasingly being incorporated into investment approaches and strategies. The scope of regulations and guidelines is to facilitate investment by giving investors’ confidence and assurance through the clear definition of which investments and financial instruments can be considered sustainable or green, and to allow the easier implementation of policy action by easing the tracking of sustainable finance flows (OECD, 2020[12]). Beside national governments and jurisdictions (where examples include China, France, Japan and the Netherlands), both market associations, such as the International Capital Market Association (ICMA), and supranationals, such as the European Union, have contributed to policy and regulatory making.1
The ICMA plays an important role in the development of sustainable finance by serving as Secretariat for a set of voluntary frameworks known as Principles, which are used as a reference by participants in both international bond markets and sustainable finance markets more broadly. The Principles lay forth best procedures for issuing bonds with social and/or environmental goals, through guidelines and recommendations that enhance transparency and disclosure, thus ensuring market integrity (ICMA, 2022[13]).2 In particular, four macro-categories, one for each bond label, are published under the governance of the ICMA’s Principles: i) the Green Bond Principles, which were first issued in 2014; ii) the Social Bond Principles (SBP); iii) the Sustainability Bond Guidelines (SBG); and iv) the Sustainability-Linked Bond Principles (SLBP). The Green Bond Principles, the SBP and the SBG are all based on four components that determine whether labelled debt instruments are aligned with the relative framework, namely use of proceeds; process for project evaluation and selection; management of proceeds, and reporting. The SLPB, instead, have five core components, that range from the selection of Key Performance Indicators to the process of verification (ICMA, 2021[14]; 2021[15]; 2021[16]; 2020[17]).
On the other hand, the European Union has worked towards the enhancement of the European sustainable finance framework, with the hope of channelling private financial flows into sustainable investment and relevant economic activities and of catalysing mobilisation of capital towards sustainable investment. To do so, in 2018 the European Commission adopted an Action Plan on “Financing Sustainable Growth”, which was built on the introduction of: i) a classification system for sustainable activities; ii) a disclosure framework for financial and non-financial companies; and iii) a set of standards and benchmarks for sustainable investment solutions (European Commission, 2018[18]). The first block is also known as “EU Taxonomy”, a statutory classification system that can be used by financial institutions and investors to establish the sustainability of investments, by evaluating whether a particular economic activity contributes to a series of environmental objectives. In particular, the Taxonomy establishes six environmental objectives, which are climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy, pollution prevention and control; and protection and restoration of biodiversity and ecosystems (European Commission, 2020[19]). The second core block is a mandatory disclosure regime for financial and non-financial companies of the impact of their activities on the environment and the society, to allow financial market participants to have the necessary information to pursue the objective of sustainable investment. The last block is the introduction of a set of benchmarks, standards and labels to facilitate financial markets participants to align their investment strategies with climate and environmental goals. In particular, under this block the Commission is legislating on a voluntary standard for European green bonds (European Commission, 2021[20]). Going forward, the Commission is expected to expand and to develop this framework as part of the European Green Deal (European Commission, 2021[21]).
← 1. The International Capital Market Association (ICMA) is a self-regulatory organisation and a body for capital markets participant, whose mission is that of promoting resilient well-functioning international and globally coherent cross-border debt securities markets. Its market standards and conventions have affected global debt markets in recent decades. (Source: https://www.icmagroup.org/About-ICMA/mission/).
← 2. The Principles also improve financial market players’ knowledge of the relevance of environmental and social impact, with the goal of attracting more finance to support sustainable development. They also aim to raise awareness of the importance of environmental and social impact among market participants, with the aim of attracting more finance to support sustainable development (ICMA, 2022[13]).
2.2.3. The implications of ESG considerations for public debt and its management
The ESG-related risks and opportunities and their consideration by investors, credit rating agencies, regulators and governments, along with related innovations in the financial markets have implications for public debt and its management. This includes the potential for impacts on the fiscal balances, sovereign creditworthiness and cost of borrowing as well as on the role of public debt management in supporting governments’ efforts in achieving the climate goals in the Paris Agreement and the SDG goals by communicating ESG analysis and data and supporting ESG segment of the financial markets.
The first set of effects entail the impact of environmental and social risks on a country’s fiscal sustainability, which, all other things being equal, is the ability of a government to sustain its current spending, tax and other policies in the long run without threatening government solvency or defaulting on any of its debt. Any persistent increase in public expenditures and fall in tax revenues would lead to increased public deficits and debt.8 For example, the health and rebuilding costs of more frequent and severe natural disasters would increase budget expenses. Similarly, the transformation of economies, particularly in the energy sector, is likely to trigger infrastructure costs to the budget, while at the same time energy exporting countries may, over time, suffer from lack of demand for fossil fuels, putting pressure on budget revenues. This fiscal impact ultimately depends on a country’s exposure to the effects of such risks, ability to reduce vulnerability (readiness) and mitigation capacity.
Measurement and reporting of the fiscal impact require conceptual considerations, a comprehensive data, and quantitative and qualitative analyses. While important, these factors can be challenging (OECD, 2021[22]). For example, quantitative estimates of the economic impact of demographic developments and their impact on expenditure on health, social security, education and other demography-related items can be a challenge due to lack of robust projections as well as interconnectedness between the parameters. Similarly, integration of climate related physical and transition risks in public debt sustainability analysis requires different assumptions on the path for greenhouse emissions and magnitude and the persistence of the budgetary consequences of policies aimed at mitigating climate change.9 In this context, data availability is a key challenge for ESG-related analysis (e.g. stress test analysis, scenario analyses as well as scoring and rating analyses). Once the data and methods develop to a point where long-term macro-fiscal implications of climate and social risks can be incorporated in sovereign credit risk analyses properly, sustainability can be expected to become a key macroeconomic variable. While the existing literature on this topic is limited, a few primary studies suggest that climate change vulnerability has adverse effects on sovereign credit ratings, and that countries with greater climate change resilience benefit from higher credit ratings (Cevik and Jalles, 2020[23]).
Assessment of potential fiscal costs will help countries to outline realistic budget targets, develop fiscal strategies and avoid budget risks. Underestimation of structural budget challenges, on the other hand, would risk fiscal credibility and debt sustainability. Already, fiscal impact analyses, for especially climate change scenarios, have been reported by a number of countries either in the form of standalone reports or an annex to budget laws. For example, the UK published the Fiscal Risks Report in 2019 (UK Office for Budget Responsibility, 2019[24]) and Switzerland published the Report on the Long-Term Sustainability of Public Finances in 2016 (FDF, 2016[25]). Australia presented results of climate change impact on level and cost of debt analyses in an annex of the long-term emissions reductions plan of its net-zero by 2050 goals in 2021 (Australian Government, 2021[26]). The European Commission presents the possible impacts on debt trajectories for its member countries in the Debt Sustainability Monitor in 2020 (European Commission, 2021[27]).
The fiscal impact of environmental and social risks has the potential to bear consequences for sovereign creditworthiness and cost of borrowing. The literature in this area is just developing, and therefore the results of primary studies should be interpreted with caution. Nevertheless, some of the empirical analyses present evidence on the link between climate change, social risks and sovereign risk. For instance, Cevik and Tovar Valles (2020[28]), investigating the impact of climate change vulnerability and resilience on sovereign bond yields and spreads in 98 advanced and developing countries over the period 1995-2017, find that exposure to climate risks increases both credit spreads and yields for long-term bonds, in particular for emerging economies (where a 1 percentage point increase in climate exposure increases credit spreads by more than 15 bps in the long-run). Importantly, their findings highlight that the ability of policy makers to enhance climate resilience through mitigation and adaptation strategies can significantly reduce the costs of borrowing in the long-run. Klusak et al. (2021[29]) are able to simulate the effect of climate change on sovereign credit ratings for a sample of 108 countries and find evidence that climate-induced downgrades could be as early as 2030 under a business-as-usual scenario, while the effect would almost be eliminated under a more stringent climate policy. In addition, they are able to assess the material costs of climate change on interest payments, finding that it could increase the annual interest payments on sovereign debt by a range that goes from USD 22 to 33 billion for more positive climate scenarios to USD 137 to 205 billion under high emission scenarios. Finally, the empirical analysis of a sample of 20 OECD countries shows that sovereign bond markets price country ESG factors: countries with good ESG performances are associated with lower default risks and lower yield spreads, suggesting that more sustainable countries are less risky and face lower borrowing costs (Capelle-Blancard et al., 2019[30]). These results therefore have implications for public debt management, which aims to meet the government’s financing needs and payment requirements in the medium-to-long run at the lowest possible cost.
The increasing interest in ESG analysis by investors, researchers and rating agencies raises investor’s demand for greater transparency on this topic. As an interface between a government and its investor base, the ability of DMOs to collect and disseminate information on ESG-related projects and other data, and communicate the national ESG strategy to investors will contribute in shaping the set of financing tools that are available for the central government. In this context, authorities (e.g. debt management offices and budgetary authorities) would benefit from incorporating ESG-related risk scenarios in public debt sustainability analyses, which in turn would necessitate enhancement of risk management capacities and practices. The ability of sovereign debt managers to engage with primary dealers and to monitor secondary markets developments in relation to ESG issues, as well as their ability to adjust their communication strategies to meet the requirements of sensitive investors will contribute to enlarge the investor base and to attract ESG-dedicated investors. At the same time, knowing the composition of the investor base, as well as their geographical location and investment behaviours – for instance, whether domestic institutional pension funds prevail over foreign hedge funds – will reduce the volatility of the debt and will help tilt ESG issuance strategies towards long-term, buy-and-hold investors.
Finally, an important implication of ESG related developments for public debt management is related to the issuance of ESG-labelled sovereign bonds, which supports the development of a domestic market for labelled bonds. From a debt management perspective, the issuance of labelled bonds can help attract those investors who are seeking to support sustainability goals; enhancing the financing capacity, and diversifying funding sources. However, sovereign ESG-labelled bonds bring about new risk management challenges as to selection and effective prioritisation of prospective projects, co-ordination among the various line ministries, legislative changes, special monitoring, reporting and disclosure requirements as well as marketing activities. In addition, labelled bonds, if issued in a foreign currency and not hedged, can be a source of currency risk for issuers. As discussed in Section 2.3.2, this challenge is particularly relevant for EMEs, who may wish to benefit from ESG-labelled bonds to access international capital markets.
In addition to carrying their traditional operational work of managing conventional debt instruments and issuance strategies, DMOs (or other government departments) will have to develop not only new competencies in terms of assessing risks related to climate change and developing and launching new instruments, but also new communication strategies to be able to explain to the investor base the national ESG strategy and the agenda, as well as the commitments, of the government in terms of addressing climate and social risks. Moreover, they will need to be able to co-ordinate with relevant line ministries and to make their part in the development of the broader national strategy. Much of these additional activities have to be sustained regularly, requiring staffing in debt management offices (DMOs). In addition, there is a need to improve knowledge of environmental and social issues, which are not within the DMOs’ area of expertise. Meeting with capacity building needs could be challenging for small debt management offices with limited resources.
Sovereign DMOs can adopt different approaches to incorporating ESG factors into public debt management. This might include i) being more proactive and transparent in providing information to investors, rating agencies and broader public on government initiatives and actions to promote ESG issues; ii) adding ESG-related risk scenarios into debt analysis, and medium- and long-term debt sustainability analyses, and; iii) issuing ESG-labelled bonds.
The development of a strategy for integrating ESG factors in PDM requires an assessment of the potential areas of application (e.g. communication with investors and credit rating agencies, impact analyses on cost of sovereign debt, issuance of labelled bonds) as well as adopting suitable and sound frameworks in terms of roles and responsibilities within and across relevant agencies. To identify DMOs’ view, the challenges encountered and innovative practices concerning different approaches, the OECD conducted a survey on the “Approaches to incorporating Environmental, Social and Governance (ESG) factors into public debt management including issuance of sovereign green bonds” to all OECD member countries in 2021. Following that, a similar survey was extended to a selected number of non-OECD countries in early 2022. This section draws mainly on responses received to these surveys and reflects on countries’ views on different approaches and potential challenges with regard to the integration of ESG factors in PDM practices in terms of communication and transparency practices, as well as debt analysis.
2.3.1. Factoring government’s ESG policies into investor relations and general communication strategy
As discussed in Section 2.2, the ability of debt management offices to communicate the national environmental and social efforts and to engage consistently with their investor base can play an important role in addressing ESG disclosures by increasing transparency and disclosing relevant information/metrics for ESG ratings and accessing market insights. Already, a number of DMOs are factoring government’s ESG policies into investor relations and general communication strategy. The survey results from the OECD countries show that 34% of the responding countries are already taking into account the national-level ESG strategy in their investor relations, and 40% more are either planning to or studying whether to take into account the national-level ESG strategy in their investor engagement. It should be noted that only a few OECD countries including Japan and the United States reported that they do not foresee to take into account ESG factors in their engagement with investors. The responses from non-OECD countries indicated that more than half of the respondents have a strategy to incorporate ESG factors into public debt management and that about one-third of the respondent countries do not have such strategy.10
In terms of the motivations, DMOs commonly highlight that the main aim of the expansion of communication topics towards the ESG-issues is to supplement general information already available to investors and other relevant parties with information from other sources (like a ‘one-stop-shop’) and to use interaction with investors to better understand their decision frameworks for asset allocation (Figure 2.1 and Figure 2.2). Two-way communication with investors enables DMOs to better understand investors’ information requests, their assessment of country’s ESG standing and demand for the ESG-labelled bonds. In countries where the DMO opts not to proceed with thematic issuances, being able to communicate the ESG characteristics of conventional debt instruments still remains important. The aim is to add value to international ESG comparisons by emphasising government’ sustainability priorities and give useful insight to the investors from a national perspective. DMOs also benefit from engagement to influence investor assessments of its country’s ESG performance in favour of increasing or holding allocations into its bonds, and boost country’s ESG credentials. DMOs of non-member countries also cited ‘alignment with international market best practices’ among one of the main motivations.
Source: 2021 survey on Approaches to incorporating Environmental, Social and Governance (ESG) factors into public debt management including issuance of sovereign green bonds.
Source: 2022 survey on Approaches to incorporating Environmental, Social and Governance (ESG) factors into public debt management including issuance of sovereign ESG-labelled bonds by the OECD Public Debt Management Unit.
Note: Sovereign’s ESG performance intended as a country’s rank with respect to its environmental performance, OECD’s better life index, UN Sustainable goals, World Bank Governance Indicators and reporting arrangements intended as reporting on allocation of proceeds and/or impact reporting. The “Others” category mostly included countries reporting that they were at the beginning of the process, and that no information was shared.
Source: 2021 survey on Approaches to incorporating ESG factors into public debt management including issuance of sovereign green bonds and 2022 survey on Approaches to incorporating ESG factors into public debt management including issuance of sovereign ESG-labelled bonds.
In terms of the topics, DMOs often share information on the ESG aspects on labelled bonds including reporting on allocation of proceeds and/or impact of spending on green projects, and government’s ESG-related targets and projects. The survey results indicated that some DMOs, rather than communicating to their investor base the whole spectrum of ESG issues and strategies, focus exclusively on its environmental dimension in the context of their thematic issuances (Figure 2.3). This is, for instance, the case of the German DMO, which currently takes the national-level ESG strategy into account in its investor engagement in the context of their green bond issuance, and its currently analysing the possibility to pursue this on a more general level, and of Colombia, which provides investors with relevant information on the National Development Plan (NDP).
Sovereign DMOs use various tools to engage with investors, rating agencies and broader public including regular and ad-hoc meetings with investors, information presented on websites and annual reports. The pandemic has forced sovereign issuers to shift rapidly towards digital communication tools such as email distribution lists, publishing market notices on their websites, and virtual meetings. ESG-related information is most frequently disseminated through investor presentations, e-newsletters and meetings (e.g. Chile, France, Germany and the United Kingdom) (Figure 2.4). Some countries also launched dedicated websites to share various reports and analyses on sustainability performances. Information in the form of data, reports, analyses on a wide range of issues from progress on climate change mitigation plans, social equality and well-being, ageing population, as well as country’s ranking in OECD’s Better Life Index, WB’s Governance Indicators, progress on implementing the UN SDGs are shared through websites. Examples of this approach include Finnish Treasury’s website on ‘Sustainability and Finnish Government Bonds’ and Benin’s website on Sustainable Development Goals targeted by Benin.11
Source: 2022 survey on Approaches to incorporating Environmental, Social and Governance (ESG) factors into public debt management including issuance of sovereign ESG-labelled bonds.
Major challenges draw on issuers’ ESG-related communication practices as follows:
Identification of relevant information for investors and credit rating agencies
Co-ordination among the relevant public institutions, difficulty in accessing existing data
The main challenges with communicating ESG-related issues source from the fact that DMOs may not have the necessary expertise and information related to ESG policies nor have any influence/say on the policies that are implemented. Often, DMO staff in EMs lack the necessary knowledge to address question related to ESG-policies that are posed by investors, and can’t quality check the reliability of the information (Figure 2.5). In this context, the perception of greenwashing could pose a challenge in sovereign sustainable finance.12
The survey results highlight the importance of strengthening the co-ordination between DMOs and the respective line ministries to ensure access to all the necessary information in a timely and efficient manner. In addition, raising awareness among the DMO staff about the ESG risks, country’s vulnerability and the way these risks are addressed by the national government is stated as an important factor for improving communication. DMOs of EMEs particularly highlighted the need for capacity building activities with respect to issuance of labelled bonds; how to analyse fiscal impact of environmental and social risks, and; how to improve ESG related communications strategy.
Note: In Panel A the Yes options were “Yes, limited expertise/knowledge in the DMO” and “Yes, deep expertise/knowledge among several staff” In Panel B, no country selected the “Not at all aware” option.
Source: 2022 survey on Approaches to incorporating Environmental, Social and Governance (ESG) factors into public debt management including issuance of sovereign ESG-labelled bonds.
Source: 2022 survey on Approaches to incorporating Environmental, Social and Governance (ESG) factors into public debt management including issuance of sovereign ESG-labelled bonds.
Common features of leading practices
Drawing on the key points from the implementation experiences of OECD countries, which are still evolving, this section proposes common features of leading practices on integrating ESG factors in PDM practices in terms of communication and transparency practices. These features focus on the coverage, debt management offices in the surveyed countries, and are intended to support the ongoing development and implementation of incorporation of ESG factors into public debt management.
Leverage existing information collected by the relevant ministries/agencies: ESG covers a wide set of cross cutting issues from demographics to greenhouse emission targets, most of which do not fall under DMOs area of responsibilities. At the same time, the reliability and timeliness of the ESG information shared is very important in terms of credibility and reliability of sovereigns. Hence, it is important to establish a robust co-ordination mechanism for co-ordinating with the relevant national authorities such as ministries/agencies of environment, energy, health and housing such as through high-level committees, and avoid a duplication of resources.
Consider the preferences of both foreign and domestic investors regarding areas and metrics as well as tools of ESG communication: Expansion of communication of relevant ESG issues requires an assessment of the potential ESG related targets and indicators (e.g. how country is ranked or rated vis-à-vis international standards, progress reports etc.), and communication tools (e.g. newsletters, websites, investor presentations, regular and ad-hoc meetings including overseas roadshows). DMOs should prioritise areas, and metrics considering investors and other relevant parties’ interest as well as government commitments with respect to ESG issues.
Ensure reliability and quality of data and consistency of definitions with the relevant international guidelines/standards on sustainable finance: As environmentally and socially responsible investment is a new segment of the financial markets, relevant taxonomy and definitions are still at development stage. At the same time, ESG-sensitive investors’ confidence in data and other analysis is key for its long-term development. In this regard, sovereign debt management offices should attach great importance to the accountability and transparency principles when interpreting the relevant taxonomy, disseminating the information collected from other sources, and ensure consistency of definitions with the existing international guidelines/standards on sustainable finance. Failing to adhere to these principles would lead to ‘greenwashing’ concerns and deteriorate development of sustainable finance and credibility of government.
Enhance institutional capacity with respects to number and knowledge of staff: Given that DMOs do not have the competence in ESG-related policies and/or activities, capacity development is key for the collection, analysis and dissemination of ESG related information. Authorities should adopt suitable and sound frameworks in terms of roles and responsibilities within and across relevant agencies, and support the responsible staff in the development of ESG expertise. They can benefit from using their networks and contacts within the financial market community and beyond to understand best practice, emerging trends, investor preferences.
2.3.2. Launch of ESG-labelled sovereign bond programmes
In recent years, a number of sovereign debt management offices have expanded their borrowing instruments with ESG-labelled debt securities. From a debt management perspective, issuing a new instrument helps to enhance the financing capacity of sovereigns and to diversify their funding sources. In addition, sovereign ESG-labelled bonds feature broader benefits to the overall economy and the financial market by supporting governments’ efforts in financing green and social projects and promoting the development of a domestic market for labelled bonds (OECD, 2022[31]). On the demand side, the number of investors who are committed to responsible investment and integrating ESG factors into their investment processes is increasing quite rapidly (e.g. Norwegian Global Fund, Denmark’s ATP Pension Fund, Swedish National Pension Fund and The California State Teachers' Retirement System etc.) which, in turn, supports portfolio investments in ESG-labelled securities.
The labelled bond market has seen rapid growth in issuance across four primary categories: green bonds, social bonds, sustainability bonds, and sustainability-linked bonds (Box 2.3). Since 2016, when Poland was the first sovereign to issue a green bond, sovereign ESG bond issuance in both advanced and emerging market economies has grown exponentially, reaching more than USD 240 billion at the end of March 2022. The survey results from OECD debt management offices indicate that more than one-third of respondents is planning or studying whether to incorporate ESG factors into its issuance decisions, with more than a quarter of countries currently doing so.
The responses to the OECD surveys suggest that the motivations behind such momentum are varied and dependent on the national context. Of 30 respondents, 25 emphasised that the key motivation for issuing an ESG-labelled bond was that of aligning with the existing ESG policy agenda as a way to finance the government’s environmental and social strategy.13 Country experiences suggest that the issuance of labelled bonds brings about a positive market story with supportive news flows, which in turn help issuer countries to communicate their sustainability strategies. For some of the respondents an important motivation is that of meeting the increased investors’ demand (15 out of 30 respondents) and that of strengthening the development of sustainable finance (12 respondents out of 30). Another key driver, as highlighted by 13 of the respondents, was that of diversification of the investor base, which remains important for many issuers, in particular for the EM issuers. For instance, Slovenia allocated 48% of its EUR 1 billion green bond to ESG-focused investors, while this percentage stands between 50% and 80% for both Benin and Indonesia and at 77% for Mexico’s specific SDG bond issuance. Nevertheless, this investor diversification benefit exists as well for advanced economies: for instance, Italy and Spain allocated respectively more than half and more than two thirds of their initial ESG issuances to sensitive investors.
The findings of the survey with regard to motivations imply that the pricing advantage (‘greenium’) is not one of the main determinants of ESG-labelled sovereign bond issuance. While securing funding at a lower cost surely is an additional benefit that sovereign debt managers take into account in their issuance strategies, the results of the OECD surveys suggest that this is not the main reason why they do so.
Against this background, this section first present issuance trends in sovereign ESG bond market, then discuss issuers’ experience and views on the motivations behind and the challenges with labelled bond issuance. Following that it proposes a set of common features of leading practices in ESG-labelled bond issuance and provides a brief discussion about the outlook for labelled bonds.
Specific bond labels are defined and distinguished by the ICMA’s Principles, but national regulations or standards might apply as well. The main difference between green, social and sustainability instruments and sustainability-linked instruments is that the former are project-based, while the latter are target-based. Project-based instruments are those whose proceeds are earmarked to specific projects: green, social and sustainable instruments are a form of financial instruments whose proceeds are exclusively earmarked to fund green projects, social projects or a combination of the two. Green projects include activities that deliver benefits to efforts related to climate change mitigation or adaptation; natural resource depletion; loss of biodiversity; air, water or soil pollution. Social projects include the promotion of sustainable social infrastructures, essential services and of socio-economic improvement, as well as the generation of employment and the alleviation of unemployment. Finally, proceeds from sustainability bonds must finance a combination of green and social projects, with the aim of promoting the social co-benefits associated with green, and the green co-benefits associated with social, benefits. On the other hand, target-based instruments are those whose financial and/or structural characteristics can vary depending on whether the issuer achieves predefined ESG objectives, but whose proceeds can be used for general purposes.
Project-based and target-based instruments also differ in terms of reporting requirements and external review processes. The structure of sustainability-linked bonds implies that the issuer makes an explicit and formal commitment towards future improvements in the predefined ESG objectives. As such, this commitment will be included in the instrument documentation and will rest on the selection of key performance indicators (KPIs) and of sustainable performance targets (SPTs), which are used to gauge the issuer’s performance in terms of KPIs. Hence, issuers of sustainability-linked instruments must mandatorily seek independent and external verification by a qualified external third party of the performance of each KPI with respect to the related SPTs. In addition, they should provide a reporting document with up-to-date information on the performance of KPIs with respect to the baselines and a verification assurance report that outlines the performance against SPTs and the related impact on the bond’s financial and/or structural characteristics; as well as a set of information that enables investors to analyse the performance of the issuer with respect to SPTs. Reporting documents and external reviews are not mandatory for issuers of project-based instruments. However, they are strongly recommended, given that a commitment to transparency helps investors to better assess the impact of each project. In practice, the issuance of project-based bonds has in most cases been accompanied by the publication of allocation reports and by third party reviews, suggesting that this has become a standard practice among debt management offices.
Source: Stylised adaptation from the ICMA Principles; for illustrative purposes only.
Trends in issuance of sovereign ESG-labelled bonds
Although the number of issuers is evenly spread across advanced and emerging market economies, large ESG-thematic financing programs are most common among advanced economies, which account for around 75% of the total ESG-labelled bond issuance. Nevertheless, issuers from emerging market economies have gained importance from 2018 onwards and some of them fare particularly well in terms of volume. As a result, the share of gross annual ESG-labelled bond issuance by EMEs has increased from 14% in 2018 to 43% in the first quarter 2022. While the issuance trend has been upward for all issuers, between 2019 and 2021 the sovereign ESG bond market has grown faster across emerging market economies than advanced economies by around 30%.
Note: Calculations include ESG-labelled bonds (with green, social, sustainability, and sustainability-linked labels) issued by sovereigns in the period from 1 December 2016 to 31 March 2022. Further details on the analytical methodology can be found in Annex 2.A.
Source: OECD calculations based on data from Refinitiv.
This growing issuance momentum has been sustained over the last five years, with a tenfold increase in gross amounts between 2017 and 2021, and has accelerated particularly in the wake of the COVID-19 pandemic. This could be explained by both the sudden increase in borrowing needs prompted by the pandemic and by the financial community’s newfound understanding of its role in promoting a green and long-term recovery. Hence, the market reached record levels in 2020 and 2021, with annual issuances of around USD 44 and 122 billion, and year-over-year growth rates of 69% and 178%, respectively. In particular, 2020 has seen nine debut issuances – by countries including Germany, Indonesia, Mexico, Sweden and Thailand – which altogether amount to approximately 42% of the yearly gross issuance. Similarly 2021, which alone accounts for more than 50% of the total outstanding amount over the whole period, has seen the entrance to the market of 11 first-time issuers, which account for 31% of the yearly total gross issuance, including Benin, Colombia, Italy, Peru, Spain and the United Kingdom.
Note: The “After Pandemic” category contains all issuances made in 2020 and 2021. Issuance in the first quarter of 2020 amounted to 4% (USD 7.5 billion) of the total post pandemic issuance approximately, and was mostly concentrated in February and March, when COVID-19 cases started surging.
Source: OECD calculations based on data from Refinitiv.
The five largest issuers (Chile, France, Germany, Italy and the United Kingdom) make up for a little over 60% of the total amount issued, while the remaining 31 countries only account for less than 40% of the market. Among the 36 issuers, France is by far the most active issuer of green bonds with a little over USD 50 billion already on the market, almost double than any other sovereign. Germany, Italy and the United Kingdom are the next largest advanced economies issuers, with issuances of around USD 30, 16 and 22 billion respectively. Among these issuers, Chile is both the largest issuer among EMEs and the only sovereign to have issued all categories of thematic bonds (Box 2.4).
The recent OECD surveys revealed that the issuance momentum is expected to continue in coming years, both among OECD members, where perspective debut issuers include Austria, Greece, Iceland, and in a wide range of emerging market economies, where perspective debut issuers for the next 12 months include the United Arab Emirates and Uruguay. In addition, a few countries, such as Brazil, are in the initial process of setting up the ESG framework to issue thematic bonds.
Issuance strategies and annual borrowing programs of large issuers of labelled bonds (e.g. Chile, France, Germany, Italy and the United Kingdom) suggest that there is a willingness to fully integrate ESG-thematic issuance in annual issuance strategies. This also applies to emerging market economies, where several countries, in particular Asian and Latin American countries, have already allocated an important part of their annual strategy to environmental and social borrowing (i.e. Indonesia and Thailand). While the market is still in its early development stage, most of the large thematic bond issuers are committed in terms of mainstreaming ESG issuance in their annual strategy and sustaining the liquidity of debt securities on both primary and secondary markets. If these commitments were to translate into a regularity of thematic issuances in the years to come, this would support deepening of the market and ensure the entrance of new issuers, influenced by leading examples. To date, cumulative sovereign volumes account for a small fraction of the outstanding cumulative ESG volumes, suggesting that sovereign issuers are yet to fully exploit their potential to scale up the size of the market. Despite recent developments there remains a scope for sovereign issuers to channel capital flows to social and environmental expenditures. Doing so would generate positive spillovers to the private sector, especially by setting up a benchmark for private issuers, and could generate crowding in effects.
In terms of labels, green bonds still represent the vast majority of the instruments issued on the market and account for four-fifths of the overall ESG sovereign labelled volume. Nonetheless, the COVID-19 pandemic has shed a light on the interlinks between economic and social crises, thus galvanising the issuance of social and sustainable bonds, as they allowed governments to raise financing for project that helped in the alleviation of the effects of the pandemic, such as health care and job preservation spending. As a consequence, since Seychelles’ first sovereign social bond issuance in 2018, the market has jumped more than ten-fold, reaching USD 49 billion across both advanced and emerging market economies at the end of March 2022. In particular, this trend was particularly marked during the years of the onset of the COVID-19 pandemic. From 2020 to 2021, the issuance of social and sustainable thematic bonds has more than tripled from USD 9 to USD 30 billion. Almost all of the total amount was issued from the second quarter of 2020 onwards, but the largest volume issuance was concentrated between September 2020 and November 2021, period in which the volume issuance accounts for almost 70% of the whole issuance and which has marked the entrance to the social and sustainable bond market of large issuers such as Chile, Luxembourg and Peru. This suggests that, as countries started to exit from the acute phase of the COVID-19 pandemic, they recurred to social and sustainable borrowing to fund future expenditures aiming at preventing new health and social crises of such a magnitude. This increasing trend is expected to continue in 2022. In the first quarter the share of social and sustainable bonds accounted for 43% of the total ESG issuance, driven in particular by Chile, which has issued sustainable bonds for USD 4 billion in January 2022 as well as the first sovereign sustainability-linked bond, for an amount of USD 2 billion, in March 2022 (Box 2.4).
Source: OECD calculation based on Refinitiv data.
In order to contribute to Chile’s climatic and social challenges, necessary to achieve sustainable development, the Ministry of Finance has incorporated since 2019, in its usual policy of sovereign debt plan, the issuance of thematic instruments. These instruments commit public spending on projects that contribute substantially to the economic, social, and environmental development objectives of the country and aligns incentives for the market to advance sustainable practices.
In 2019, the Ministry of Finance published its Green Bond Framework to subsequently extend it to the current framework for Sustainable Bond Framework in 2020, which includes the guidelines for the issuance of green, social, and sustainable bonds (that funds green and social projects). After the publication of its Sustainability-linked bond (SLB) framework, in March 2022 Chile issued the first sovereign SLB, achieving a new milestone in the development of sustainable financial instruments. To make a document with credible standards and recognised by the market, it must be verified by an independent third party. In the case of Chile, these Frameworks are aligned with ICMA’s principles and received a favourable opinion from Vigeo Eiris and Sustainalytics, in the case of Sustainable Bond Framework and SLB Framework, respectively. On the other hand, the green portfolios are certified under CBI standards.
The Sustainable Bond Framework aims to provide clear guidelines on the type of projects that would be financed through these instruments, the reports that will be published ex post, and the project selection and exclusion system. Once the financial conditions of the bond have been settled and the portfolio of projects to be financed has been communicated transparently, a fundamental step is the ex-post annual report on the progress in the disbursement of the projects, the eligibility of these according to the standards established in the framework and the environmental and/or social impact of the projects.
On the other hand, the SLB Framework aims to provide transparency on the selected key performance indicators (KPIs) as well as the sustainability performance targets (SPTs) as well as the verification and subsequent reports.
At the end of March 2022, 28.7% of the Treasury's total debt stock corresponds to thematic bonds. This is equivalent to a total USD 33 billion in thematic bonds, of which USD 17.8 billion correspond to social bonds, USD 7.7 billion to green bonds, USD 5.5 billion to sustainable bonds and USD 2 billion to SLB. In 2021, 66% of the total issuances were in ESG related bonds. During the issuances of these instruments, among the main financial highlights of these transactions are a greenium of approximately 10 basis points in the first green bond issues in euros; an average oversubscription of 3.5 times and an expansion in the investor base, reaching a peak participation of investors with ESG mandates of 71% in the transaction in euros in 2019.
Among the main challenges that arise in the issuance of these instruments are the preparation of the project portfolio, along with the elaboration of the Framework, and the reporting system, as well as the coordination of the various actors involved in both project management and resource disbursement.
A fundamental initial step in the process of issuing thematic bonds has been the strengthening of the capacities of the DMO on different climate and ESG concepts, to later explain them to investors specialised in ESG investing. In line with the latter, the DMO have added a specific section in its website with Q&A about the main elements of its thematic bonds and an explanatory video of the Framework. Thus, the permanent updating of the information channels is fundamental.
Although the construction of the portfolio of both social and green projects as well as the preparation of ex-post reports suppose an extra effort, the benefits of obtaining better conditions of financing and an expansion of the investor base, together with the visibility of the State's efforts, have been essential to insist on this type of issuance. For the future, Chile expects to increase the ESG composition in its stock of debt, combining traditional ESG bonds associated to certain projects, with other SLBs, issued under the SLB Framework.
Given that the majority of ESG sovereign bond issuers are European countries, the main currency of issuance is the Euro, which alone accounts for almost 70% of the total issuance. The share of dollar denominated ESG sovereign bonds is 14% of the total issuance and the British Pound accounts for a little less than 10% of the total issuance. Other currencies, including the Canadian Dollar, Krona, Peso, Yen, and Yuan make up for the remaining 8% of the total issuance. These peculiarities are of particular importance for emerging market economies: among the total EME issuance, the share of foreign currency denominated debt stands at around three-fourths of the whole issuance over the period between 2016 and March 2022. Labelled bonds offer an opportunity for these issuers, in particular for those with large financing needs and shallow domestic debt markets, to attract international investors by meeting their interest in transparency and ESG issues. In this context, ESG-labelled instruments could entail further vulnerabilities for these issuers due to currency risks, considering that it often remains unhedged. Among the EME issuers that responded to the OECD survey on ESG considerations in PDM, only Indonesia has hedged bond related cash flows against such currency risks. Other countries, instead, do not envisage to do so or, as is the case for the Seychelles. It should be noted that the lack of hedging of foreign currency ESG-labelled bonds adds vulnerabilities and reduces transparency in terms of fiscal trajectory.
Note: The “Other currencies” category includes Canadian Dollar, Chilean Peso, Chinese Yuan, Colombian Peso, Danish Krone, Fijian Dollar, Hungarian Forint, Indonesian Rupiah, Japanese Yen, Nigerian Naira, Swedish Krona, Thai Baht, and Uzbekistani Sum.
Source: OECD calculation based on data from Refinitiv.
The cost of ESG-labelled sovereign bonds is generally in line with that of comparable conventional bonds, in some cases lower than that of a similar maturity conventional bond. In the primary market, between 2016 and March 2022, 13% of the total ESG-labelled bonds were issued with negative yield, 67% with a yield lower than 2%; 16% of the issued debt had a yield between 2% and 4%, and 4% of the total debt had a yield that was higher than 4% (Figure 2.12). This yield composition is a reflection of the creditworthiness of issuers and is particularly driven by the fact that volumes issued by highly rated countries are significantly larger than volumes issued by countries whose credit ratings are lower. In line with cost trajectories for conventional securities, issuers classified as investment grade face the lower issuance costs. Luxembourg, the sovereign that as benefitted from the lower issuance cost, has an AAA rating.14 Similarly, countries whose labelled debt was issued with a yield lower than 1%, such as Belgium, France, Germany and the United Kingdom, benefit from an investment grade status and have high credit ratings. When the sample of countries is restricted to EMEs, the issuers that have issued securities with a yield lower than 1% are those whose credit ratings fare better in comparison. For example, both Chile, which has had multiple issuances with a yield smaller than 1%, the lowest being 0.39%, and Poland, which has been able to issue a bond with a 0.63% yield, had an A- rating. On the other hand, countries that have faced the highest borrowing costs (with yields larger than 4%) are all classified as non-investment grade. This is the case of Benin (5.2% yield and B+ rating), Colombia (yields ranging between 7.5% and 7.9% and BB+ rating), Fiji (6.3% yield and B+ rating), Guatemala (5.375% yield and BB- rating), Seychelles (6.5% yield approximately and B+), and Uzbekistan (14% yield and BB-). Egypt, the largest volume issuer in this group, with a total issuance of USD 750 million, still faced a 5.25% yield, in line with its B+ rating. Hence, yields of labelled securities are influenced by the issuer’s creditworthiness, rather than being a direct consequence of the ESG nature of such securities.
Nevertheless, the responses to the OECD surveys suggest that while cost of labelled securities are in line with conventional one, the former tend to exhibit a moderate ‘greenium’ – the negative spread between yields on conventional and green bonds of a similar maturity. The existing literature on the greenium is mixed. On the one hand, some researchers find a statistically significant greenium on certain types of stocks and portfolios (Alessi, Ossola and Panzica, 2020[32]).On the other hand, a study by the IMF finds that no significant greenium at issuance exists for sovereign green and non-green securities (IMF, 2019[33]). This premium might simply be a consequence of supply and demand dynamics. Survey results highlight, as a potential reason underpinning the greenium, a relative scarcity effect induced by a demand higher than the supply of ESG-labelled instruments on the market. Hence, when ESG-labelled securities on the market will be less scarce, the yield differential between conventional and sustainable securities may not persist.
In terms of maturity structure and size, sovereign labelled bonds vary significantly. The maturity of ESG sovereign debt varies from country to country, ranging from two years for Indonesia’s Green Sukuks to 50 years for bonds issued by both Chile and Peru and the average time to maturity of the total debt stock is slightly over 13 years, which highlights the long-term dimension of environmental and social spending and funding.
Key challenges in issuing sovereign ESG-labelled bonds
Lack of – or limited – eligible government expenditures can be a potential barrier to sovereign green and social bond issuance as issuing a new instrument requires a long-term commitment to create and maintain liquidity, and to lower issuance cost. Responses to the survey also highlight that low levels of liquidity and limited trading activity in secondary markets are sources of concern for many sovereign issuers. It should be noted that governmental budgets are constrained and governments in many countries face competing pressures when prioritising the use of resources. Against this backdrop, the survey results revealed that issuers with limited funding requirements prefer to allocate their scarce activities in nominal bonds to secure their liquid sovereign curve. Some issuers do not view earmarked project bonds as a perfect match to fund the general government budget deficit. As well, issuing a green bond may create a fragmentation in sovereign issuance structures and increase funding costs due to illiquidity premium. In response to such difficulties, sovereign issuers may consider issuing sustainability bonds, which include both social and green expenditures and sustainability-linked bonds which consider issuer’s strategy towards achieving predefined sustainability objectives within a set timeline, and their proceeds do not need to be allocated to specific projects.
Issuance process of an ESG-labelled bond is different from that of a conventional bond as it requires a number of ex-ante reviews and ex-post reporting as well as additional marketing activities. The issuance process for ESG bonds is far more onerous than it is for conventional bonds First of all, a governing framework that includes detailed information on eligible expenditures (or Key Performance Indicators for SLBs), management of proceeds, allocation and impact reporting and external reviews, needs to be published. Setting up such a framework requires co-ordination with other relevant government departments whose budgets include eligible expenditures, consultation with investors, and communication with external reviewers. The survey results indicate that sovereign issuers find evaluation and selection of eligible expenditures challenging, due for example to a lack of a clear and consistent definition of ‘green spending’.
In addition to preparation, implementation of the framework throughout the bond’s lifetime entails various operational and financial costs that can deter many sovereign issuers with limited resources and capacity from issuing ESG-labelled bonds. For example, labelled bonds often require issuers to perform distinctive monitoring and reporting activities in order to respect internationally recognised guidelines and adhere to best market practices. Country practices highlight the complexity with interpreting taxonomies and measuring the environmental and social value generated by the underlying projects for a clear impact reporting. Such difficulties could be even more acute in countries with limited public debt expertise and capacity. Some countries benefit from services of advisory/consultant companies to produce frameworks, reviews and reports in addition to third-party verification of frameworks and impact reports. This in turn affects not only operational cost but also financial cost of the bond issuance to the sovereign issuers.
In view of challenges with regard to the issuing process and the capacity gap, potential EM issuers may benefit from other countries’ experiences as well as international financial organisations such as the World Bank Group and UNDP regarding different aspects of the labelled bonds including preparation of the most suitable policy framework, leveraging media interest, market intelligence and project screening activities.
Common features of leading practices
The considerable market demand for ESG-labelled bonds, especially among institutional investors committed to this market segment, makes them a potentially helpful tool for public debt management operations. In the current context of high levels of debt servicing combined with significant borrowing needs required to rebuild out of the COVID-19 pandemic in a more sustainable and resilient way, issuance of labelled bonds present opportunities. This can be particularly helpful for EME issuers by facilitating their access to international capital markets. At the same time, it is important to meet with investors’ demand for and consistency with standards of clarity in the use of proceeds, quality in impact reporting and benchmark size issuance for successful growth of this asset class. In this regard, sovereign issuers could strengthen the sustainable finance market development only by implementing sound practices in ESG-thematic public debt management in terms of transparency and liquidity. Moreover, failure to adhere to commitments would harm investors’ confidence and deter the development of this newly emerging asset class.
Despite the relative novelty of such an approach to sovereign borrowing, some common features of leading practices on issuance of ESG-labelled bonds have already been emerged. They are as follows:
Strong interaction and collaboration with stakeholders throughout the life of the bond
The issuance of an ESG-labelled sovereign bond requires important efforts in terms of cross-collaboration between different ministries over its entire period of existence, from the initial structuring decisions to the final repayment at maturity. Receiving a clear mandate from the national government is a critical first step for debt management agencies since it ensures co-ordination amongst participating line ministries. A standard step for labelled bond process is to establish a framework, which aims to determine eligible sectors and establish a monitoring and reporting practice. This has been the case across sovereign issuers: it is, for instance, the case of the United Kingdom where the Chancellor of the Exchequer announced the national plan to issue Green Gilts in 2020. This then ensured the UK DMO and Treasury with the necessary authority to promptly publish the national Green Framework in June 2021 and to issue the first green bond in September 2021 (HM Treasury, 2021[34]).
Moreover, the issuance of labelled bonds requires the policy collaboration between the DMO and the Ministry of Finance, given its budgetary responsibilities, and with other line ministries (i.e. agriculture, transport, infrastructure, environment, energy, etc.) in order to identify eligible expenditures and their size. This is critical because translating theoretical environmental goals into practical initiatives necessitates knowledge and a domain of competence that neither the Ministry of Finance nor the DMO alone possess. After the issuance of the bond on the market, collaboration between different stakeholders remains necessary, as various parties involved will have to contribute to the preparation of the required reports on the allocation and impact of bond proceeds. Coordination issues can be addressed by either establishing contact points at each institution or establishing a committee involving government ministries / agencies that are involved. The survey results revealed that a number of sovereign DMOs established an intergovernmental committee to support the establishment of an ESG-labelled bond programme. This includes, for example Canada’s Interdepartmental Green Bond Committee, consisting of representatives from multiple departments that are involved in implementing the government’s climate and environment plan.15 Another prominent example is Germany, where an Inter-Ministerial Working Group, was established to oversee and validate key decisions about the Green German Federal securities. Under the responsibility of the Federal Ministry of Finance, this Working Group pools the expertise needed for a thorough and robust selection and evaluation of Eligible Green Expenditures. 16
This collaboration can be expanded to supranational organisations, which can provide effective technical assistance with the issuance process. For instance, Seychelles benefited from the assistance of the World Bank with the structuring and placement on international markets of its USD 15 million blue bond (a bond whose proceeds are earmarked for marine and oceanic projects) issued in 2018 (World Bank, 2019[35]).
In addition, sovereign issuers should conduct investor consultations to inform their decision-making process and analysis. Such consultation with primary dealers and broader market participants about potential demand for different types of ESG-labelled bonds, as well as other design features such as preference about maturity segment and issuance methods could be valuable for successful management of the issuance process.
Commitment to transparency and reporting disclosures
The process of issuing a sovereign labelled-bonds typically involves a budget tagging exercise and commitments to report on the allocation of proceeds and their impact, which greatly increases transparency and accountability on public spending. This greater transparency should also encourage greater investor demand, in particular for EM issuers, since it helps strengthening trust between investors and issuers.
Investors attach great importance to the environmental and social efficiency of their investments, as well as the financial stability and risk resilience features, and a cursory reporting process can seriously affect the success of future issuances. The quality of pre- and post-issuance reporting metrics and external independent review and verification provides transparency, ensures accountability and underpins the credibility of labelled bonds. Sovereign issuers must adhere strongly to the principles of transparency and reporting established by international guidelines. France sets a good example of high commitment to transparency with its commitment to deliver ex-ante and ex-post reporting as well as evaluation reports for green bonds (also referred to as Green OATs ‘Obligation Assimilable du Trésor’) (Box 2.5).
In its 2021 Budget, the French Government introduced a “Green budget” – a new classification of its budgetary and fiscal expenditures based on their environmental impact – as a way to improve its reporting of the impact of public finance initiatives on the ecological transition (OECD, 2021[36]).
Furthermore, the French DMO (Agence France Trésor, AFT) developed a comprehensive framework based on the “Green Bond Principles” and the “Transition Energétique et Ecologique pour le Climat” (TEEC) label in order to issue green bonds. This framework includes key features both in terms of project selection and reporting. An inter-ministerial working group managed by the Ministry of Finance and the Ministry of Environment, and overseen by the Prime Minister, conducts the screening for the evaluation and selection of projects. Then, a ‘Green OAT Evaluation Council’, made up of independent scientists and economists, evaluates ex-post the environmental performance of France’s Eligible Green Expenditures.
In terms of reporting, until the funds are fully allocated, two yearly reports will be released for investors: (i) a report on the use of proceeds and (ii) a report on the performance of ‘Eligible Green Expenditure’. In addition, under the supervision of the Green OAT Evaluation Council, the ex-post environmental effect of ‘Eligible Green Expenditure’ will be examined in a special report at regular intervals. This contributes to maintaining a high level of transparency in both the selection of projects and in the allocation of proceeds, as well as in holding the government accountable for how green bonds are used, ultimately contributing to setting high standards in green bond market (Agence France Trésor, 2021[37]).
Commitment to sustain liquidity through issuance volume and instrument design
While ESG-labelled sovereign bonds benefit from a considerable investor appetite, some peculiarities of thematic market segments can negatively affect their liquidity. Usually, an instrument is said to be liquid if transactions in it can happen rapidly without reducing its price to a significant degree.
Given that the only difference of green bonds is that their proceeds are earmarked to specific social and environmental projects, their potential to be sold on secondary markets is comparable to conventional bonds. However, on the buy side, there may be some concerns about the liquidity of labelled bonds. First, the stock of instruments accessible for investment remains limited. While ESG sovereign markets have expanded in size and diversity, they still account for a small fraction of the sovereign bond market and outstanding amounts of thematic bonds remain modest in comparison to conventional ones. Furthermore, sovereign ESG-labelled bonds are largely oversubscribed on the primary market. While this could mean that it would be easy for investors to offload their bonds if the demand for such instrument remains robust, it also means that the accessibility of ESG bonds in the secondary market will remain limited. Second, thematic bonds investors are mostly buy-and-hold institutional investors and/or ethical investors, who hold their purchases until maturity. While this could mean that, in times of crisis, green bonds will experience more stability, it also means that the amount of free float available in the market is limited.
Ensuring the liquidity of sovereign ESG markets is crucial for debt management offices. If the liquidity of labelled government securities was reduced, the price discovery process in the secondary market would be impaired and it would translate into higher yields through a liquidity premium in primary markets (OECD, 2018[38]). Ultimately, this would increase the costs of funding green and social projects for sovereigns. Given that even small changes in the interest rate paid on a sovereign bond can result in significant additional costs or savings and that sovereigns have an interest to catalyse ESG investments at a low cost to finance the environmental and social transition, DMOs have a great responsibility to maintain well-functioning social and sustainable markets.
There are several market practices that can help to ensure the liquidity of environmental and sustainable debt securities. An important contributor to market liquidity is the size of issuances, as it determines the amount that is available for trading. Usually, sovereign debt managers pursue a benchmark bond issuance policy to reach a significant issue size for a bond, which in turn allows them to benefit from a liquidity premium. As a rule of thumb, larger securities tend to be more liquid because they allow for a reduction of transaction and information costs. As information about the security is broadly disseminated among investors (because of a large pool of investors that own it or that have analysed its features), it will remain in dealers’ inventories for a shorter period of time. For ESG-labelled bonds this is achieved by making sure that the size of the inaugural issuance is comparable to that of conventional issues. To date, the largest inaugural sovereign ESG issues are the GBP 10 billion Green Gilt issued by the United Kingdom in September 2021 and the EUR 8.5 billion green BTP issued by Italy in March 2021. For small issuers, however, ensuring liquidity of an ESG-labelled bond through issuance of large volumes can be a challenge given their limited financing needs.
Re-opening existing issues, in which DMOs place additional quantities of previously issued bonds on the market, is another popular approach employed by sovereign debt managers to support the liquidity of thematic bonds. Depending on whether they want to issue these additional amounts via auction, DMOs have two main policy tools for primary market operations. They can reopen the issue through an auction. Using this process, re-openings have a different price and issue date than the initial issue of the security. This enables issuers to build larger supply in existing lines in markets and to limit fragmentation which impedes market liquidity. In addition, tap issues can also be used to provide additional amounts, where bonds are issued at their original face value, maturity and coupon rate.
France has achieved its large issuance volume of more than USD 50 billion – which makes it the largest sovereign issuer in the world – by regularly taping its two Green OATs (issued in September 2017 and in March 2021). In particular, the outstanding amount of the 2017 Green OAT has been more than quadrupled from the original EUR 7 billion at issuance to the approximately EUR 31 billion that are currently outstanding, while the amount of the 2021 issuance has been doubled to EUR 14 billion. Specifically, in order to comply with common practices on thematic bond issuance, the proceeds from tap issues are also matched to Green Eligible Expenditures, as the cumulative amount of such expenditures has risen over the years (Agence France Trésor, 2021[39]). Other countries, such as Chile, Hungary and Thailand, have chosen to reopen or tap their existing bonds, as a way to raise their total liability on ESG markets.
In addition to actual issuance, issuers can indicate their commitment to issuing further amounts as well as to building out a yield curve in the coming years. For example, the German Finance Agency is committed to the green market, which means that green bond issuance will be a regular component of its issuance programme in the future, and it additionally intends to establish a benchmark green curve for other issuers. Similarly, the UK Debt Management Office has committed to issuing at least GBP 15 billion of green gilts in financial year 2021-22, as well as to building out a green curve in the coming years.
Lastly, market-oriented bond innovations can be used to ensure liquidity in ESG securities, which are usually smaller in size than conventional bonds. For example, the German Finance Agency successfully introduced a twin bond framework in 2020, which was also followed by Denmark in 2022. Under this twin bond framework, any new green German bond will always be issued alongside an existing conventional bond, which sets a good example in terms of: i) introducing an empirically accurate measure of the “greenium” – the spread between yields on conventional and green bonds of a similar maturity –; and ii) ensuring the liquidity on the market by allowing investors to switch between the conventional and the green bond (Box 2.6).
Germany, the largest economy in Europe, has taken an innovative stance on its green debt issuance process, by choosing to enter the market under a “twin” bond structure. This means that all green German Federal securities will have a conventional traditional Federal security on the side, with which they will share some characteristics. In particular, the twins will have the same characteristics in terms of coupon, interest payment dates and rhythm, and maturity date – which results in an identical tenor for both securities. Nonetheless, they will present differences in terms of i) issuance volumes, with the conventional twins that will be placed at a larger volume than their green counterparts; ii) pricing dates, with the conventional twin that is issued earlier than the green security; and iii) ISIN codes, so that the two securities are separate in nature and can be held or traded separately from each other. The maturity segments for the green issues will be predefined by the standard tenor of the medium and long-term federal securities, with the German DMO that plans to target 2-, 5-, 10-, and 30-years maturities, with the aim of building a green yield curve in the medium term, and to fully integrate green issuance in its issuance schedule.
Two major reasons motivated the selection of this instrument design. The first aim of the German DMO was that of having access to an accurate measure of the “greenium”, the yield difference that investor are willing to pay to hold green bonds. The second reason was to ensure the liquidity of green Federal securities on both primary and secondary markets. In order to execute this twin concept on the primary market, the German DMO takes several steps in terms of issuance timing. As a matter of fact, the conventional twins is always issued first, usually by an auction process (which is the established procedure for German Federal Government securities). When the associated Green Federal security is born on the market (which can happen either via auction or syndication), an analogous stock of the conventional bond is issued into the own stock of the Federal Government at the same time. On the other hand, with regards to the secondary market the German Finance agency intends to ensure the secondary market tradability and to sustain the liquidity of the green twins. In particular the twin instrument design and the German DMO’s additional amount of own holdings in the conventional bond in its portfolio facilitate combined and debt neutral sale and purchase transactions between both bonds, the so-called switch trades that allow investors to exchange the green twin with the conventional one at any time. Moreover, the German finance Agency can also recur to outright purchase/sale and securities lending programmes, as well as getting into repurchase agreements. This commitment should result in a liquid green curve and, consequently, in a pricing reference for other euro-denominated green bonds.
The aim of the German Government was that of setting an example in the green bond markets, especially in Europe. Germany’s traditional debt is regarded as the safest in Europe and serves as a risk-free benchmark. This function might possibly be reproduced in the green sector as well. In the meantime, its example has started to gain following in Europe. On the 19th of January 2022 Denmark has had its debut issuance of 5 a billion Danish crowns (EUR 762 million) green bond, paired to its benchmark 10-year benchmark bond, 0.00 percent 2031. Investor in Danish green bonds will only be able to switch from the green twin to the corresponding conventional twin. Exchanges from the conventional to the green twin will not be possible.
Note: Updated as of the 23rd of March 2022. Any missing yield data were estimated as the average of the previous and successive yields.
Source: OECD staff calculation based on data from Refinitiv.
Box source: German Finanzagentur’s dedicated webpage and related videos (2021) available at https://www.deutsche-finanzagentur.de/en/institutional-investors/federal-securities/green-federal-securities and Danmarks Nationalbank (2022), available at Green bonds (nationalbanken.dk).
The outlook for ESG-labelled bonds
Building on the recent years’ momentum, ESG-labelled bonds have great potential to grow further and become a distinct asset class. The outlook depends on various factors concerning investors’ demand and issuers’ supply. The survey results suggest that sovereign issuers expect sustained growing investor demand for sustainable investing, and that investors are becoming more sophisticated (e.g. demanding quality impact analysis and more quantitative comparable data). To the extent that these demands are met, this can support maturity across different sustainable finance products and assets. However, there are some pitfalls to watch out for and issues to be considered carefully both for the robust growth of sustainable finance market segment, and efficient management of public debt.
Going forward, it is important to address the implementation challenges that sovereign issuers are currently experiencing with regard to relevant resources and expertise within debt management office, availability of eligible projects in budgets, co-ordination among the relevant ministries and agencies, as well as scaling up the quality and supervision of impact and other reporting. In this context, growing commitments of governments towards building a better and more sustainable future, and wider implementation of OECD’s green budgeting principles, would help addressing the challenges related to availability and identification of eligible projects in budgets. It should also be noted that given the complexities and additional financial and operational costs of labelled bonds due to idiosyncratic requirements (e.g. payments to external services), a decrease in operational and additional financial costs in the future will further encourage the number of sovereign issuers and bonds. In this context, further standardisation of ESG products would not only help facilitate the issuance process, but also build a robust and liquid ESG bond market. Amongst the most important areas for standardisation will be: (i) minimum reporting requirements; (ii) a clear and consistent definition of what constitutes ‘green spending’; and (iii) an agreed mechanism to deal with issuers that do not allocate funds raised in accordance with these standards.
Investors’ confidence is pre-requisite for sustaining demand and achieving low cost of borrowing for any issuer. This is particularly relevant for ESG-sensitive investors. The process of issuing a labelled bond encourages issuers to disclose information about sustainable practices, helping investors evaluate the ESG performance of the project. On the other hand, greenwashing, which can occur throughout the budgetary process and through the bonds lifetime potentially damages the issuer’s reputation and could cause a loss of credibility, which can have a significant detrimental impact on access to sustainable finance sources. Therefore, paramount importance should be given to compliance with regulatory landscape in respect of ESG disclosures and recommends; providing investors with quality, comparable and digestible data; avoiding potential misinformation, and double counting of expenditures. In this regard, public debt managers’ role in communicating information about government’s sustainable practices, helping investors evaluate the ESG credentials of the overall country is pertinent. ESG-related capacity challenges in public debt management offices as well as budget office and other relevant line-ministries, oversight institutions and the preparers of the financial statements of government should be addressed.
Foreign-currency denominated labelled bonds, which have attracted both investors and issuers in EMEs, should be handled with care. This can pose a challenge for debt management offices that lack the technical capacities to properly assess and manage the currency risk exposure of a debt portfolio. If not managed properly, increasing share of foreign-currency denominated debt can be a source of external vulnerability for issuers. Sovereign debt management offices should consider currency risk attached and look into hedging options while benefiting from growing demand for labelled bonds from international investors.
In terms of cost effectiveness, as supply of sovereign ESG-labelled bonds increases and meet the investor demand in the future, ‘greenium’ on sovereign bonds may fall or completely disappear. The survey results highlight that sovereign debt managers observe that issuer credentials – including sustainability credentials – are more important for cost of borrowing than the choice of specific financing instruments. This in turn raises an important question for policy makers as to what extent project-based bond issuance is making a real difference in climate and social change that could not be achieved by other means. Having said that, other motivations for issuing labelled bonds such as catalysing the development of local sustainable bond market, and meeting growing demand from ESG-sensitive investors are expected to remain relevant in the future.
References
[39] Agence France Trésor (2021), Green OAT: Announcement of the Amount of Green Eligible Expenditures For 2021, https://www.aft.gouv.fr/en/publications/communiques-presse/20210125-green-oat-eligible-green-expenditure.
[37] Agence France Trésor (2021), Green OATs, https://www.aft.gouv.fr/en/green-oat.
[32] Alessi, L., E. Ossola and R. Panzica (2020), The Greenium matters: greenhouse gas emissions, environmental disclosures, and stock prices, Publications Office of the European Union, Luxembourg, https://doi.org/10.2760/49586.
[26] Australian Government (2021), Australia’s Long-term Emissions Reduction Plan, Commonwealth of Australia 2021, https://www.industry.gov.au/sites/default/files/October%202021/document/australias-long-term-emissions-reduction-plan.pdf.
[30] Capelle-Blancard, G. et al. (2019), “Sovereign bond yield spreads and sustainability: An empirical analysis of OECD countries”, Journal of Banking & Finance, Vol. 98, pp. 156-169, https://doi.org/10.1016/j.jbankfin.2018.11.011.
[9] CBI (2021), Sustainable Debt: GLobal State of the Market, https://www.climatebonds.net/files/reports/climate_bonds_initiative_sustainable_debt_global_state_of_the_market_2021.pdf.
[23] Cevik, S. and J. Jalles (2020), “Feeling the Heat: Climate Shocks and Credit Ratings” WP No. 2020/286, https://www.imf.org/en/Publications/WP/Issues/2020/12/18/Feeling-the-Heat-Climate-Shocks-and-Credit-Ratings-49945.
[28] Cevik, S. and J. Jalles (2020), This Changes Everything: Climate Shocks and Sovereign Bonds, p. 24, https://www.imf.org/en/Publications/WP/Issues/2020/06/05/This-Changes-Everything-Climate-Shocks-and-Sovereign-Bonds-49476.
[21] European Commission (2021), “Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions. Strategy for Financing the Transition to a Sustainable Economy”, COM(2021) 390 final, https://eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX:52021DC0390.
[27] European Commission (2021), Debt Sustainability Monitor 2020, Publications Office of the European Union, https://ec.europa.eu/info/sites/default/files/economy-finance/ip143_en.pdf.
[20] European Commission (2021), “Proposal for a Regulation of the European Parliament and of the Council on European green bonds”, COM/2021/391 final, https://eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX:52021PC0391.
[19] European Commission (2020), “Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088”, Official Journal, L 198, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32020R0852.
[18] European Commission (2018), Action Plan: Financing Sustainable Growth, https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52018DC0097&from=EN.
[25] FDF (2016), Report on the Long-Term Sustainability of Public Finances in Switzerland, Federal Department of Finance.
[10] Galema, R., A. Plantinga and B. Scholtens (2008), “The stocks at stake: Return and risk in socially responsible investment”, Journal of Banking & Finance, Vol. 32/12, pp. 2646-2654, https://doi.org/10.1016/j.jbankfin.2008.06.002.
[34] HM Treasury (2021), UK Government Green Financing, https://www.gov.uk/government/publications/uk-government-green-financing.
[13] ICMA (2022), Sustainable Finance, https://www.icmagroup.org/sustainable-finance/.
[14] ICMA (2021), Green Bond Principles, https://www.icmagroup.org/assets/documents/Sustainable-finance/2021-updates/Green-Bond-Principles-June-2021-140621.pdf.
[15] ICMA (2021), Social Bond Principles, https://www.icmagroup.org/assets/documents/Sustainable-finance/2021-updates/Social-Bond-Principles-June-2021-140621.pdf.
[16] ICMA (2021), Sustainability Bond Guidelines, https://www.icmagroup.org/assets/documents/Sustainable-finance/2021-updates/Sustainability-Bond-Guidelines-June-2021-140621.pdf.
[17] ICMA (2020), Sustainability-Linked Bond Principles, https://www.icmagroup.org/assets/documents/Regulatory/Green-Bonds/June-2020/Sustainability-Linked-Bond-Principles-June-2020-171120.pdf.
[40] IEA (2022), Oil Market Report - March 2022, IEA, Paris, https://www.iea.org/reports/oil-market-report-march-2022.
[33] IMF (2019), Global Financial Stability Report: Lower for Longer, https://www.imf.org/en/Publications/GFSR/Issues/2019/10/01/global-financial-stability-report-october-2019.
[6] Kahn, M. et al. (2019), “Long-Term Macroeconomic Effects of Climate Change: A Cross-Country Analysis” NBER Working Paper No. 26167, https://doi.org/10.3386/w26167.
[29] Klusak, P. et al. (2021), “Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness”, SSRN Electronic Journal, https://doi.org/10.2139/ssrn.3811958.
[5] OECD (2022), Climate Change and Corporate Governance, Corporate Governance, OECD Publishing, Paris, https://doi.org/10.1787/272d85c3-en.
[31] OECD (2022), OECD Sovereign Borrowing Outlook 2022, OECD Publishing, Paris, https://doi.org/10.1787/b2d85ea7-en.
[22] OECD (2021), Climate Change and Long-term Fiscal Sustainability, OECD Publishing, https://www.oecd.org/gov/budgeting/scoping-paper-on-fiscal-sustainability-and-climate-change.pdf.
[41] OECD (2021), Government at a Glance 2021, OECD Publishing, Paris, https://doi.org/10.1787/1c258f55-en.
[36] OECD (2021), Green Budget Tagging: Introductory Guidance & Principles, OECD Publishing, Paris, https://doi.org/10.1787/fe7bfcc4-en.
[12] OECD (2020), Developing Sustainable Finance Definitions and Taxonomies, Green Finance and Investment, OECD Publishing, Paris, https://doi.org/10.1787/134a2dbe-en.
[4] OECD (2020), OECD Green Budgeting Framework Highlights, http://www.oecd.org/environment/green-budgeting/OECD-Green-Budgeting-Framework-Highlights.pdf.
[2] OECD (2020), The 2020 OECD Ministerial Council Statement recognised the need for governments to focus on restarting hard-hit economies by boosting growth, income and employment while promoting cleaner, more inclusive and sustainable economies, http://www.oecd.org/coronavirus/policy-responses/a-debt-standstill-for-the-poorest-countries-how-much-is-at-stake-462eabd8/.
[7] OECD (2019), Social Impact Investment 2019: The Impact Imperative for Sustainable Development, OECD Publishing, Paris, https://doi.org/10.1787/9789264311299-en.
[38] OECD (2018), OECD Sovereign Borrowing Outlook 2018, OECD Publishing, Paris, https://doi.org/10.1787/sov_b_outlk-2018-en.
[24] UK Office for Budget Responsibility (2019), Fiscal risks report - July 2019, https://obr.uk//docs/dlm_uploads/Fiscalrisksreport2019.pdf.
[3] UN (2021), The Glasgow Climate Pact – Key Outcomes from COP26, https://ukcop26.org/wp-content/uploads/2021/11/COP26-Presidency-Outcomes-The-Climate-Pact.pdf.
[1] United Nations (2021), United Nation | Climate Action, https://www.un.org/en/climatechange/net-zero-coalition.
[11] Whelan, T. et al. (2021), ESG and Financial Performance: Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published between 2015 – 2020, https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021.pdf (accessed on April 2022).
[8] World Bank (2020), Engaging with Investors on Environmental, Social, and Governance (ESG) Issues: A World Bank Guide for Sovereign Debt Managers, https://thedocs.worldbank.org/en/doc/375981604591250621-0340022020/original/WorldBankESGGuide2020FINAL.11.5.2020.pdf.
[35] World Bank (2019), Seychelles: Introducing the World’s First Sovereign Blue Bond - Mobilizing Private Sector Investment to Support the Ocean Economy, https://thedocs.worldbank.org/en/doc/242151559930961454-0340022019/original/CasestudyBlueBondSeychellesfinal6.7.2019.pdf.
Primary sovereign bond market data are based on original OECD calculations using data obtained from Refinitiv that provides international security-level data on new issues of sovereign bonds. The ESG data set covers ESG-labelled bonds issued by sovereigns in the period from 1 December 2016 to 31 March 2022 and includes long-term debt only. Long-term debt is defined as any security with a maturity longer than 365 days. Securities with maturity less than 365 days issued by sovereigns are excluded from the dataset. The database provides a detailed set of information for each bond issue, including the proceeds, maturity date, interest rate and interest rate structure.
Refinitiv provides bond type information for most of its government securities entries. ESG-labelled securities are those classified under ESG in the database. In addition, Refinitiv provides a categorical indicator variable to specify whether an ESG issue is a green bond. Hence, to further subset the data according to the specific bond label (“Green” and “Social and Sustainable”), securities that were classified as being ESG-labelled but not green were considered to be part of the “Social and Sustainable” category.
The definition of emerging markets used in this report is consistent with the IMF’s classification of Emerging and Developing Economies used in its World Economic Outlook. The regional definitions are also those used by the IMF, while the income categories used (high income, low income, lower middle income, upper middle income) are defined by the World Bank according to GNI per capita levels.
A number of bonds have been subject to reopening. For these bonds the initial data only provide the total amount (original issuance plus reopening). To retrieve the issuance amount for such reopened bonds, specific data on the outstanding amount on each reopening date for the concerned bonds have been downloaded separately from Refinitiv. As the reopening data only provide amounts outstanding in order to obtain the issuance amount on each relevant date, the outstanding amount on the previous date is subtracted from the outstanding amount on that given date. These calculated issuance amounts are converted on the transaction date using USD foreign exchange data from Refinitiv. To ensure consistency and comparability, the same method is used for all bonds, including those which have not been subject to reopening.
Exchange offers and certain bonds in the dataset have been manually excluded when they did not have any identifier (ISIN, RIC or CUSIP) and when they have not been able to be manually confirmed by comparing with official government data.
The issuance amounts are presented in USD, converted on the transaction date.
Calculations excluded a series of bonds issued by countries that are part of the CFA franc zone. These bonds, issued in West African CFA, amount to a total of USD 6.29 billion and were issued between 2020 and 2021. Issuer countries were: Benin, Burkina Faso, Côte D’Ivoire, Guinea Bissau, Mali, Niger, Senegal, and Togo. Maturities ranged from 27 days to 15 years. None of these securities was classified as being green and, under use of proceeds, Refinitiv classified the proceeds from these securities as being used for “pandemic” purposes.
The survey on “Approaches to incorporating ESG factors into public debt management, including the issuance of sovereign green bonds,” was circulated to Delegates to the OECD Working Party on Debt Management in the third quarter of 2021. Thirty-four of the 38 OECD countries responded to the survey. Ireland, Korea, Norway and the Czech Republic did not take part.
The survey on “Approaches to incorporating ESG factors into public debt management including issuance of sovereign ESG-labelled bonds” was circulated to a sample of selected non-OECD countries, with a particular focus on emerging market economies in February 2022. Tthe following 17 countries responded to this survey: Argentina, Benin, Brazil, Bulgaria, Cambodia, Cameroon, Croatia, Ghana, Indonesia, Jamaica, Morocco, Philippines, Rwanda, Seychelles, Thailand, the United Arab Emirates and Uruguay.
Notes
← 1. The Paris Agreement is developed under the United Nations Framework Convention on Climate Change (UNFCCC) to combat climate change. The agreement’s main goal is to limit the global temperature increase in this century to below 2 degrees Celsius above pre industrial levels, and to work towards limiting the increase to 1.5 degrees. The Paris Agreement was drafted in December 2015, and went into effect as of November 2016. Currently, there are 189 countries that are party to the agreement, and 195 signatory countries. Many companies set their climate related targets to be in line with the goals of the Paris Agreement (Source: https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement).
← 2. The United Nations Sustainable Development Goals were adopted in September 2015, with the aim to protect the planet and improve quality of life globally. The UN SDGs refer to the 17 categories of targets to achieve a broad range of aspirational goals, including ending poverty and hunger, improving education, and protecting the environment (https://www.undp.org/sustainable-development-goals).
← 3. More recently, the war in Ukraine has raised energy security concerns and therefore reinforced the need to accelerate the transition away from fossil fuels, especially in Europe. This could in turn provide additional impetus for countries’ climate policies and sustainable finance (IEA, 2022[40]).
← 4. Despite strong policy advices and commitments towards ‘build back better’, progress so far has been limited. For example, the 2021 OECD Government at a Glance report highlights that as of July 2021 only 17% of the pandemic-related recovery spending of OECD countries and key partner economies has been allocated to environmentally positive spending, while the remaining 83% will either have no environmental impact or, worse, a negative impact (OECD, 2021[41]).
← 5. In the Glasgow Climate Pact, 190 countries agreed to phase down unabated coal power, 137 countries committed to halt and reverse forest loss and land degradation by 2030, and over 100 countries pledged to reduce methane emissions by 30% by 2030 (UN, 2021[3]).
← 6. In a number of countries, governments have established various high level bodies to lead these efforts across government. They are often tasked with developing and implementing policies to tackle with the risks from climate change, from under-investment or poor treatment of the workforce, from poor executive behaviour. For example, in the United Kingdom National Economy and Recovery Taskforce was established on public sector recovery and the Better Regulation Committee was established to co-ordinate a regulatory reform agenda. At the same time, non-profit initiatives such as Green Building Councils have been launched to bring together business leaders from a cross-section of industries and sectors to advise governments on green and green growth policies such as infrastructure, innovation and investment.
← 7. As of 2020, more than a third of OECD countries (14) practice some form of green budgeting, with an additional 5 countries (Chile, Greece, Latvia, Poland and Slovenia) indicating plans to introduce green budgeting in the future. Furthermore, initiatives such as the European Green Deal by the European Union and other political commitments across the OECD suggest that interest in green budgeting will continue to grow in the near future (OECD, 2020[4]).
← 8. Beyond the direct impacts, there are a range of other ways that climate change and social issues will affect government finances such as the impact of uncertainties on business and social unrest.
← 9. The impact of climate change on the economy is classified under “physical risks”, which express the consequences of environmental impact, and “transition risks”, which are the results of policies aimed at reducing climate change.
← 10. In addition, some countries specified that if they do not have such a strategy yet, this is because they are at the beginning of the process that will allow them to include ESG factors in their debt management practices. Brazil and the United Arab Emirates reported being in the process of building the ESG framework.
← 11. Relevant websites are as follows: Central government debt management - Sustainability and Finnish Government Bonds (treasuryfinland.fi) and les Objectifs du Développement Durable visés par le Bénin - République du Bénin (odd.gouv.bj).
← 12. ‘Greenwashing’ refers to conveying a false impression or providing misleading information about an economic activity regarding its contributing to a climate or environmental objective.
← 13. At the time of the surveys, 30 out of 51 countries issued or were in the process of issuing a form of ESG-labelled bond and were able to answer this question.
← 14. All ratings in this section are from Fitch Ratings, updated as of December 2021.
← 15. This committee is co-chaired by Finance Canada as well as Environment and Climate Change Canada. Several other departments (e.g. Natural Resources Canada, Transport Canada, and Infrastructure Canada) are also part of this committee given their important roles in delivering on the government’s environmental priorities.
← 16. German’s Inter-Ministerial Working Group includes: the Federal Ministry of the Interior, Building and Community, the Federal Ministry for Economic Affairs and Energy, the Federal Ministry of Food and Agriculture, the Federal Ministry of Transport and Digital Infrastructure, the Federal Ministry for the Environment, Nature Conservation and Nuclear Safety, the Federal Ministry of Education and Research and the Federal Ministry for Economic Cooperation and Development.