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ESG Investing
Investors to engage with sovereigns on climate
Australian ESG-focused risk reduction pilot scheme could be expanded to other entities
Jonathan Rogers 6 Sep 2023

The direct engagement of environmental, social and governance (ESG)-focused institutional investors with companies in which they hold equity is a long-established activity, and it is about to extend to engagement with sovereigns by holders of their debt as a pilot scheme focused on Australia gathers speed.

The Collaborative Sovereign Engagement on Climate Change initiative was launched in September 2022 via its coordinator, the London-based United Nations-supported Principles for Responsible Investment (PRI), involving seven organizations. That number has just grown to 25 as more institutional investors sign up, representing around A$12.2 trillion (US$8 trillion) in assets under management.

Those additional 18 investors will join the engagement in 2023-24 with the aim of collaboratively supporting government in Australia – at sovereign and sub-sovereign level – to take the steps required to mitigate climate change in line with the requirements of the Paris agreement.

“There has been an organic rise in engagement from institutional investors, through debt management offices focused on the impact of climate change on sovereign bonds, with an eye on portfolio risk and the ratings dynamic,” says Tom Arup, the PRI’s lead for sovereign engagement stewardship.

“The ESG-focused engagement of investors with corporates in which they hold equity is well established, but collaborative engagement with sovereigns among their debt holders is a relatively new phenomenon,” Arup notes. “This collaborative project focused on Australia is very much a pilot model that could be expanded to other sovereign entities and their government-owned or -linked constituents.”

A primary motivation for the institutional investors is the reduction of risk exposure in sovereign debt portfolios associated with a failure to rapidly transition to a net-zero global economy.

The risk spectrum ranges from the value of sovereign debt investments, through the competitiveness of national economies and investee companies, to the systemic risks involved in exposure to the global economy.

The 18 firms joining the project are Achmea, Ardea Investment Management, Brown Advisory, Candriam, Colchester Global Investors, Fidelity International, First Sentier Investors, IFM Investors, Insight Investment, Jupiter Asset Management, LGPS Central, Morgan Stanley Investment Management, Munich Re, Neuberger Berman, Pendal Group, QIC, Rest and Sumitomo Mitsui Trust Asset Management.

They will collaborate with existing members of the engagement’s advisory committee – Aviva Investors, BNP Paribas Asset Management, Brandywine Global, HESTA, Nordea, Robeco and Schroders.

Direct collaborative sovereign engagement will enhance sovereign climate-change responses to close the gap between current action and a Paris-aligned emissions reduction trajectory.

A key workstream will be to establish detailed, credible and economy-wide net-zero transition plans with supporting policy mechanisms, budget expenditure and investment structures.

The aim is to build greater climate adaptation and resilience across the economy and community to avoid worsening disruption and damage from physical risks. A crucial element of the collaboration will be an improvement in the disclosure of sovereign exposure to climate risks and opportunities in line with international standards.

“There is an evolution occurring in climate risk reporting by sovereigns at the national and local sub-sovereign level,” Arup states. “In Australia, for example, the state of Victoria last year issued a TCFD [Task Force on Climate-related Financial Disclosures]-compliant report and other states have similarly issued sustainability-themed reporting for capital markets. In the Victorian case, it was not specifically linked to debt issuance, but was intended to inform current and potential investors in the state.”

It is expected that such reporting will emerge as the norm in sovereign and sub-sovereign debt markets, including an ever-clearer integration of climate-related factors into fundamental economic statements and forecasts.

“Collaborative sovereign engagement is a relatively new investor practice, and the PRI is excited by the growing signatory interest in joining this initiative,” points out David Atkin, the PRI’s CEO. “Engagement between sovereigns and investors can lead to mutually beneficial outcomes that will help accelerate the necessary transition to net-zero emissions.

“Investors are using increasingly sophisticated measures to assess sovereign climate risk in their investments. Over time, this may affect capital costs for sovereign and other issuers in relevant markets.”

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