Integrating ESG criteria in government debt

Why have we created a sovereign risk ESG framework?

Investors seeking environmental, social and governance (ESG) integration in their equity and corporate bond exposures are today well equipped with a wide range of solutions. Historically, ESG integration in index government debt strategies has typically been limited compared with corporate debt and equity markets.

LGIM’s proprietary sovereign risk ESG framework represents a meaningful step forward in expanding ESG integration in index strategies investing in government debt markets, particularly taking into account geopolitical risk and stability as an enhancement to sovereign ESG assessment.

This framework will complement the work we have already undertaken to assess sovereign ESG credentials in our active and multi-asset funds, and our success in creating and maintaining the LGIM Corporate ESG framework for more than half a decade.

Which ESG goals does the framework support?

The framework draws on the objectives of the United Nations Global Compact, the Climate Change Initiative, UN Sustainable Development goals, the Organisation for Economic Co-operation and Development, and labour and human rights factors to assess ESG factors that relate to sovereigns.  

As we have seen through our experience with the LGIM Corporate ESG framework, sustainability-related themes and topics evolve, and as such it is critical that the underlying assessment framework remains dynamic and can adapt and evolve to such changes.

LGIM continually reviews the impact of the framework, and by staying abreast of market themes fed in from multiple areas of the business we are able to adapt our framework to ensure the integrity of our initial design holds true.

More formally, we meet on a quarterly basis to discuss any changes, which then flow through our existing governance review processes to the point at which a change to the framework is made.

How is the score calculated?

The framework currently consists of 52 underlying sovereign ESG metrics, covering 11 ESG themes (see the boxed wording in the chart above), spread across four equally weighted pillars of environment, social, governance and geopolitical risk/stability.

All data is sourced from third-party ESG providers. We believe this is important as it means we don’t calculate or impose institutional bias on the scoring of any metrics. To create the framework we partnered with Verisk Maplecroft, an industry leader in sovereign data analytics.

LGIM sovereign risk ESG scores are currently produced for around 200 countries, spanning all markets. Scores are refreshed on a quarterly cycle.

Why does the framework include the fourth pillar of geopolitical risk/stability?

The inclusion of the proprietary ‘r’ pillar of geopolitical risk/stability aims to identify risks beyond the standard headline sustainability metrics, which we believe provides a more comprehensive risk assessment when investing in government debt.

By assessing topics including interstate tensions, trade sanctions, conflict intensity, exposure to regional conflict and civil unrest, the ‘r’ pillar aims to preserve capital for investors by flagging potentially material risks to a sovereign’s ability to service its debt.

We believe this pillar is important when assessing sovereigns as it adds a structural risk-mitigating element into the sovereign scoring framework – something we believe is often overlooked within the sovereign ESG sphere. 

How might LGIM potentially use the framework longer term?

The scores provided by the framework are designed to be used across asset classes for clients seeking integration of ESG criteria in government debt investment. Beyond fixed income, the scores are also relevant for equities and may also be used to help inform asset allocation decisions.  

Whilst we have incorporated ESG information into investment decision making and stewardship practices, there can be no assurance that any responsible investing goals will be met.

Key Risk Warnings

Past performance is not a guide to future performance. For professional investors only. The value of investments and the income from them can go down as well as up and you may not get back the amount invested. The details contained here are for information purposes only and do not constitute investment advice or a recommendation or offer to buy or sell any security. The information above is provided on a general basis and does not take into account any individual investor’s circumstances. Any views expressed are those of LGIM as at the date of publication. Not for distribution to any person resident in any jurisdiction where such distribution would be contrary to local law or regulation.

This financial promotion is issued by Legal & General Investment Management Ltd. Registered in England and Wales No. 02091894. Registered office: One Coleman Street, London EC2R 5AA. Authorised and regulated by the Financial Conduct Authority.