Derivatives Vigilantes Are Punishing the Badly Behaved Nations

(Bloomberg Opinion) -- Asset managers are increasingly using their financial clout to persuade companies to be friendlier to the planet, wielding a combination of the stick of disinvestment and the carrot of engagement. But can the financial world do more to ensure countries and their central banks are also meeting their environmental, social and governance responsibilities?

Travel platform fromAtoB.com scrutinized the 2018 flight statistics for leaders of the Group of 20 nations to work out who emitted the most carbon dioxide. Of the 15 leaders examined, Japan’s Shinzo Abe was responsible for the most emissions, taking 38 flights covering 128,000 miles (207,000 kilometers) and emitting almost 14,500 tons of CO2 gases.

It may seem like a slightly frivolous exercise; we don’t expect our national leaders to forgo airplanes in favor of slower but greener modes of transport. (Well, not yet, anyway). But it is indicative of how the climate crisis is prompting increased scrutiny of many of the activities we take for granted, including long-haul flights.

And a new study published this week by Hermes Investment Management suggests that the weaker a nation’s commitment to ESG, the higher its financing costs are likely to be.

Hermes studied 59 countries, using ESG scores generated by London Stock Exchange Group Plc’s Beyond Ratings unit, and compared those rankings with prices in the credit-default swap market for the years from 2009 to 2018.

Countries with higher default-swap prices typically pay more to borrow in the bond market than those with lower CDS values. So there’s a connection between a nation’s likely funding cost and how its ESG ranking compares to its peers.

The Beyond Ratings ESG scores are weighted, with 30 percent derived from a country’s environmental record (including energy policies and natural resources stewardship), 30 percent for social policies (such as health, equality, political freedom) and 40 percent for governance (corruption, political stability, rule of law). Individually, the study found that governance had the closest correlation with credit-default swap prices.

Hermes suggested that environmental risks may not be reflected in sovereign CDS prices. Moreover, “the risks associated with environmental issues, in particular climate change, are difficult to quantify (whether in terms of transition risk or physical climate risk) and their time horizon is even more uncertain,” the fund management firm said. Bloomberg LP competes in the market for ESG data. 

A separate report published this week by Swiss bank UBS AG suggests that the world’s central banks are lagging behind in taking ESG factors into account when managing their portfolios. The study, based on a survey of reserve managers taken earlier this year, showed only 9% of central banks are taking measures that go beyond the broad ESG frameworks that UBS reckons most public agencies have already put in place.

That’s probably because central banks don’t answer to any particular constituency. Only 19% said they were taking climate risks into account “in anticipation of increased pressure from stakeholders,” while just 6% said they’d experienced “increased scrutiny” from politicians and supervisory bodies. Some two-thirds cited the lack of reliable benchmarks and data as an obstacle to reflecting environmental issues in portfolio management.

That lack of standardized data is recognized as an important impediment to the sustainable finance movement. So the recent moves by the European Union to create a taxonomy to help asset managers identify investment opportunities is to be welcomed, as is the U.K. Treasury’s announcement this week that it’s considering making it mandatory for companies to disclose their exposure to climate risks.

UBS calculates that even just the world’s five major central banks – those representing the U.S., China, Japan, the euro zone, Switzerland and the U.K. – control more than $21 trillion of assets between them. With the rest of the world waking up to the need to go green, it would be a shame if the financial firepower of central banks wasn’t similarly harnessed in defense of the planet.

To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable."

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