Emerging Markets Unveiled: Uncovering Opportunities for Impact in Emerging Markets
Assessing sovereigns on their ESG impacts is no easy feat. In comparison to companies, governments have a much wider array of responsibilities and impacts, both within and beyond their borders. And no sovereign issuers are perfect – conflicting priorities, a lack of political will, and insufficient resources are a few of the many challenges that prevent them from making the necessary investments needed to improve on ESG. Despite this, sovereigns have unique potential to generate immensely positive impacts on the environment and society.
In the corporate world, investors concerned with ESG impact can divest from ESG laggards and overweight leaders. If all investors followed this path, only companies with strong ESG performance would be able to raise capital; the laggards would be forced to close. But countries cannot shut down. And while it would be simpler to lend only to countries that already have the best metrics, this may not be the best way to generate real world impact.
Therefore, investors seeking to maximize ESG impact should use an ESG ratings framework with the explicit aim of identifying countries where added capital is most likely to improve outcomes. Unfortunately, due to a number of methodological shortcomings common to many sovereign ESG ratings, this is often not the case. Such shortcomings can be a particular problem for ESG assessments in emerging markets due to issues such as ingrained income bias, overdependence on quantitative metrics, and a bias towards certain governance structures.
In PGIM Fixed Income’s current sovereign ESG ratings framework, we attempted to tackle these issues head on. The following focuses on the main methodological challenges we faced in that endeavor and how we addressed them.