In 2023, IIGCC launched the Sovereign Bonds and Country Pathways working group to update target setting guidance for this asset class and increase its adoption into net zero investment strategies. This discussion paper is the outcome of that research.
Sovereign bonds are a prominent asset class within institutional investors’ portfolios with ICMA estimating that sovereign bonds made up 50% of the global outstanding bond market in 2020. Integrating this asset class into net zero investment strategies is essential to fulfil individual commitments to net zero alignment.
Download the discussion paper.
This discussion paper provides the building blocks for updated sovereign bond target setting and implementation guidance, written with support from IIGCC's Sovereign Bonds investor working group.
Despite their relevance, there is currently little evidence of adoption of this asset class within investors’ net zero strategies. When it comes to sovereign bonds, investors see challenges in their ability to exercise asset selection to meet net zero commitments, mainly due to:
- Liability management restrictions under which a great portion of sovereign bond holdings operate,
- The limited number of prominent issuers and the concentrated nature of the market means that reducing or removing some sovereigns from the portfolio may force others to be overweighted thereby increasing material risks,
- Persisting flaws in the global policy framework; currently, most NDCs suffer from ambition and/or implementation gaps within a non-binding framework, and;
- A combination of concerns around engagement with sovereigns such as limited engagement opportunities, non-credible ‘exit’, intricate nature of sovereign entities, fairness considerations, lack of metrics to assess success, among others.
As ‘Universal Owners’, holding diversified and long-term portfolios that are representative of global capital markets, institutional investors can play a proactive role in influencing a fair transition to a low-carbon economy. As climate risks increase, they will increasingly affect the credit profiles of sovereign issuers, and ignoring the equity elements of the transition may prevent it from happening altogether, with devastating effects for investment portfolios globally.
Institutional investors and sovereign entities can mutually benefit from their interactions around climate risks and opportunities. Investors can collaborate with sovereign entities to promote policies that address climate risks, and sovereigns can benefit from this interaction to improve their policy environments and foster private investment.
To be able to fulfil their individual net zero commitments, institutional investors can contribute positively to overcoming some of the above-mentioned challenges through their sovereign bond holdings. To that end, this paper encourages investors to take some preliminary steps: