The European Commission has developed a comprehensive European Union (EU) roadmap on sustainable finance, to be presented at today’s high-level conference, bringing together European leaders to foster transparency and long-term-thinking in financial activities. Scope believes that this initiative, which also targets a unified classification system for sustainable activities, standards and labelling in the context of financial products, and support for green assets, has the potential to direct capital flows towards sustainable investing, ultimately enhancing the importance of ESG in risk management.
Multiple initiatives have acted as a catalyst to make ESG an intrinsic part of the institutional investment process. However, Scope observes that the rules, regulation and taxonomy surrounding ESG remain in motion while ESG-specialised investment products are still at an early and evolving stage.
Individual ESG factors impact the likelihood of sovereign debt repayment to varying degrees. An ESG factor may have a negligible impact on a sovereign rating, or it can have an impact in the very near term; in addition, many ESG factors become increasingly material over the long run. In the case of sovereign issuers, the weight of governance factors normally dominates (50% in some ESG scores), followed by social factors (35% in some ESG scores).
Scope Public Finance believes that, while sovereign credit risk and ESG are distinct concepts, there are areas of overlap, ranging from influences on potential growth to long-run healthcare costs (when evaluating public debt sustainability) to political stability and governance effectiveness to financing rates and financing availability (evidenced in the inception of ESG investment benchmarks).
There is a relationship between Scope’s sovereign ratings and sustainability, reflecting we believe two broad influences: i) an area of overlap in Scope’s methodology with some ESG risks, alongside ii) a correlation between some factors in Scope’s sovereign methodology and some ESG factors, without direct inclusion in Scope’s framework.
Although Scope’s sovereign ratings methodology includes elements of ESG, it is Scope’s view that there are two avenues on how sustainability risks can be further evaluated in our sovereign approach: i) an “add-on” approach or ii) a further partial integration approach.
Acknowledging the inherent challenges, Scope views the further exploration of sustainability in sovereign risk as, nonetheless, an important area of research in developing a more holistic view on areas where there’s overlap, from the perspective of a European rating agency.
