Insight Investment, the big funds management subsidiary of BNY Mellon, has launched a global sustainability model which dissects the risks in each country for sovereign debt investors. In its first unveiling today, the model shows Australia to be “generally strong” on ESG scores, although it is dragged down by environmental issues. New Zealand comes out as number one in the world.
Australia is used as a case study in the first report, ‘Sovereigns And Sustainability’, from the new model. Apart from environmental issues, the political instability – with six prime ministers in 10 years – also held back Australia’s overall ESG score for bonds. The model assesses not only the current state of all ESG factors, it also estimates momentum, either negative or positive.
Bruce Murphy, Insight Investment’s managing director for Australia and New Zealand, said: “We believe investing effectively in sovereign debt requires in-depth analysis of environmental, social and governance (ESG) matters, especially in emerging markets. However, most ESG analysis and research focuses on corporates – not countries. We have therefore built a proprietary model to help us better understand the ESG risks at the country level across our portfolios.”
ESG factors have been understood as potentially material for sovereigns, but systematic processes and research methods to build these factors into credit ratings and evaluations have only been established relatively recently.
Murphy said: “Insight’s proprietary ratings and momentum scores complement our existing tools for evaluating sovereign and sovereign-related debt. Insight has shown that building a country sustainability risk model not only is possible and credible but can complement and reinforce traditional evaluations of sovereign issuers.
“The model results are in many ways unsurprising: for example, better-governed countries exhibit stronger economic and credit performance. The relationship between the model’s ESG results and economic or credit indicators are more clearly visible in emerging markets where these factors tend to be more material.
“Developed markets, according to the model, are less materially impacted by ESG issues on a systemic basis. However, the momentum scores often align with our portfolio managers’ views on the direction of individual countries.”
Initial observations include:
- Countries with higher GDP per capita typically have better ESG scores. This is generally driven by governance and social factors, not environmental scores
- More countries are deteriorating on ESG than improving – with the majority of developed markets receiving a negative ESG momentum score, and
- ESG momentum has a weak relationship overall with standard industry measures of sovereign credit risk, but there are outliers.
As the best performer in the world, New Zealand boasts robust institutions and governance, stable social relations with a broad acknowledgement of human rights based on the rule of law, and limited exposure to environmental risks.
As the worst performer, Afghanistan has suffered after many years of conflict. Politically and socially unstable, little data is available on environmental factors.
Australia was used as a developed market case study. Australia’s ESG performance is generally strong, driven by social and governance scores, though its environmental score is average, the initial report says. In terms of momentum, its environmental performance has slightly improved and its social performance has deteriorated somewhat – but momentum of its governance score is materially negative.
“Australia has experienced a long period of political change. The country’s 2007 election led to the defeat of Prime Minister John Howard, who had been in power for over a decade. Since then, the country has been led by six prime ministers. This political instability has meant there is little direction on some fundamental environmental and social issues facing the country, with the influence of independent and minority-interest politicians limiting progress in political discourse,” the report says.
“In short, policymaking has become less effective. For example, in recent years, access to housing has become more limited, but the political sensitivities around the issue have led politicians to avoid discussing potential solutions.”
Aside from politics, the Australian economy has an impressive record, with almost three decades of continuous growth. This was in part enabled by a sizeable boom in the mining sector, driven by China’s continued near-double-digit growth during the global financial crisis. This more than mitigated the negative impact of the global financial crisis, making Australia somewhat unique among developed economies.
However, the mining boom has had consequences. The majority of mines are foreign-owned – about 80 per cent according to the report – resulting in income flowing out of the country. Also, workers in the industry have been somewhat reluctant to take jobs in other generally lower-paying sectors.
“As a result, levels of underemployment have risen. The dominance of mining has also led to division over environmental issues. There is concern that legislation to protect the environment will add to pressure on the mining industry at a time when momentum is slowing, and so some politicians are looking to change previous environmental commitments, which would mean reducing enforcement of environmental regulations and reneging on previous laws,” the report says.
“Despite these political, social and environmental risks, Australia retains an AAA rating, although agencies have kept the country on negative watch. For example, in May 2018, S&P Global Ratings reaffirmed its negative outlook.”
Insight’s country sustainability risk model shows that while Australia’s governance score remains among the highest in the world, it has notable negative momentum, which reflects the challenging political environment.
“It also aligns with our view that the country is likely to underperform on ESG performance at least in the near term, as government policymaking is unlikely to be effective; social issues – such as underemployment and deteriorating social cohesion – are likely to have a negative impact; and the lack of enthusiasm for environmental regulations suggests little will happen to support an improvement in environmental risks. We do not currently expect economic indicators or the markets to reflect Australia’s ESG performance,” the report says.
Insight Investments has about US$780 billion (A$1.075 trillion) under management across a range of equity, fixed income and multi-asset strategies globally. Its parent, BNY Mellon, has about $US1.8 trillion under management.