ESG analysis of govt-issued bonds

At an investor summit in London recently, the Minister of Finance and Investment Promotion, Prof. Mthuli Ncube, announced that the government of Zimbabwe (GoZ) would soon issue catastrophic, green, infrastructure, and diaspora bonds, among others. Bonds are debt securities issued by a company or government to raise capital.

The interest rate paid, or yield of bonds, depends on the financial risk profile of the company or government that is issuing. The yield will be higher for companies or countries that are seen to be at a higher risk of default. Bonds are a major source of government financing, together with tax revenue.

The funds raised from bonds is used to finance government priorities, in this case, mitigation of catastrophic events, building of infrastructure, and climate adaptation and mitigation strategies.

Investors willing to purchase the bonds almost certainly will engage rating agencies or ESG analysts to carry out a thorough ESG analysis of the GoZ so that they are better informed on the financial risks involved.

ESG analysts, munching croissants, cheese and chocolate, and drinking coffee in office cubicles in Zurich, London, New York, Paris and Singapore, will price the environmental, social and governance risks that come with purchasing the bonds.

The ESG analysts endeavor to determine the GoZ’s ability and willingness to pay the periodic interest and the bond value at maturity.

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To a large extent, the ESG analysts’ reports will determine whether the bonds are oversubscribed or undersubscribed. They forecast whether a country will grow fast enough to outpace the rate of debt accumulation. Below is how the ESG analysis would normally be conducted by the rating agencies.

Environmental factors are critical to risk pricing because they substantially affect the rate of economic growth.

Climate change, water stress/drought, flooding, heat waves, hurricanes, pollution, energy access and food security are important environmental factors of GDP growth.

Predictions indicate that sub-Sahara African countries will be disproportionately impacted by climate change although they historically contributed the least to greenhouse gas emissions.

The level of preparedness of a country to withstand the impact of climate change, specifically the mitigation and adaptation strategies, are important when forecasting GDP growth?

The GDP growth of countries that are reliant on fossil fuels for export revenue and power generation may be at risk because of the transition to green energy.

Water stress impacts industrial productivity, especially those whose processes are water-intensive.

Flooding, heat waves and hurricanes, among other catastrophic events, affect productivity by disrupting supply chains and loss of man-hours.

Thus, a country reliant on fossil fuels, and experiences frequent floods, droughts, hurricanes, heat waves and is food insecure, is likely to have a premium imposed on its bonds.

Level of education of citizens, access to affordable housing, healthcare, banking services and internet, social safety nets and labor rights are popular social factors used in ESG analysis.

An educated and skilled citizenry is a prerequisite for economic development. Therefore, amount of money allocated to basic and tertiary education is noted as it affects the level of skills development.

The integrity, competence and dedication of educators are invaluable to develop a skilled citizenry. Access to quality healthcare is important since a population hobbled by disease is less likely to contribute meaningfully to economic growth. Access to internet is likely going to be declared a basic human right sooner rather than later.

Internet and banking services have become indispensable tools for businesses the world over.

The level of internet connectivity and banking are likely to indicate the level of economic activity of a country.

A country where labor rights are respected is less likely to experience strikes, sit-ins, demonstrations and other forms of labor unrests.

Frequent labor unrests will reduce productivity, and inevitably, affect economic growth.

Governance factors provide the basic foundation for economic growth.

Credibility of monetary and fiscal policies, respect for the rule of law, corruption, independence of state institutions, excessive influence of individuals or ethnic groups in government, and the state of participatory democracy are perceived to be important indicators of a government’s ability and willingness to pay periodically and at maturity.

A government that routinely does not follow court orders, applies the laws of the country selectively, and whose monetary and fiscal policies are almost always in flux, will be unfavorably evaluated by ESG analysts.

What guarantee is there that if aggrieved parties take the government to court, they will get a fair judgment? If a judgment goes against the government, will it be effectively implemented?

In short, bonds issued by a government that routinely violates the constitution will find very few or no takers at all.

In contrast, some bonds are oversubscribed because of the perceived mature level of democracy in a country, respect for the rule of law, and independence of government institutions, among several governance factors.    

So, where do ESG analysts get the information they use for the bond analyses? The major source of the information is the government itself.

What government representatives say at local and international fora, in the public and private media and on social media is neatly filed in some office in a western financial capital city.

Non-governmental organizations (NGOs) focused on human rights, environmental justice, labor rights, food provision, and access to education, among an array of sectors, are also a valuable source of information.

NGOs are thought to be independent from the influence of government, and their reports are often regarded as unadulterated and unbiased facts. ESG analysts also closely follow local court judgments, labor unions and political opposition press releases.

Local and international news channels also provide important information regarding climate change, vulnerability to extreme weather events and current state of affairs within a country.

The confluence of ESG factors acting in unison will be gleaned in the final report handed over to potential investors.    

• Jinga is a certified ESG analyst and senior lecturer at Bindura University of Science Education.