Sustainable finance, with its roots in the early climate work of the 1990s, largely took shape around a ''company-centric'' view of the world. Government debt markets, which represent a major component of the global investable debt universe, were generally lumped together with their corporate counterparts as sustainable markets developed. This includes the development of sustainable financial instruments, where corporate markets led the way, and sovereign debt mostly followed.
Given this progression, its unsurprising that sustainability regulations evolved with more of a focus on businesses and business practices rather than on governments and government policies. But important distinctions exist between sovereign and corporate issuers, which we’ll outline here, and these differences argue for a more nuanced approach going forward.
Companies undertake economic actions directly. Setting sustainability-focused objectives, without also allocating the corresponding resources to achieve those objectives, would make very little sense in a business context. From a reporting perspective, financial accounting standards already require significant transparency of a company’s operations, expenditures and results. At the most basic level, business entities map quite cleanly to a view of sustainability that takes shape around specific, directly undertaken economic activities and the need to measure and report on those activities. The EU’s Sustainable Finance Disclosure Regulation (SFDR) and the corresponding Taxonomy regulation have set the global standard for sustainability disclosures largely on this basis.
Governments play both a direct and indirect role in the economy. Most governments spend some percentage of their country’s annual GDP on wages, social assistance/social security programs, education and other activities, including investment and capital expenditures. But governments’ indirect role—establishing the rules, regulations and institutions that govern economic activity—tends to have a much more meaningful impact on a country’s economy. From a sustainability perspective, this points toward the need to take a ''whole-of-economy'' approach when looking at sovereign debt, which also aligns with the industry standard for assessing financed emissions.
Sustainability at the sovereign level, viewed through this lens, looks fundamentally different from the corporate context. Government issuers need to steer entire economies toward sustainability objectives, primarily via the implementation of good public policies. Direct expenditure (e.g., green capex) may have a role to play, but it’s quite unlikely to match the scale of private sector participation in ''greening'' the economy under well-calibrated policy settings. Sustainability-linked bonds that are built around economy-wide sustainability targets—such as NDC commitments—and that implicitly encourage the adoption of effective public policies, appear to align extremely well with the goal of directing capital in an impactful way.
Yet the issuance of sustainable sovereign instruments tied to policies, or whole-of-economy targets, lags more traditional green, social and sustainability (GSS) issuances, which are generally tied to projects. While we think it’s clearly good to see both markets develop, we also think the asymmetry of this progress limits the potential impact of sustainable sovereign finance. Two key constraints to the development of sustainability-linked sovereign markets have been:
- The difficulty of assessing the ambition of a country’s targets and the credibility of its commitments, and
- The inability of sustainable investment vehicles to allocate to these instruments, given regulatory treatment that generally does not consider them to be ''sustainable investments.''
Addressing some of the constraints inherent in a more ''business-focused'' regulatory environment looks like more of a challenge. But we think it’s well worth the time required, across multiple stakeholders, to see this through. The countries most vulnerable to climate change tend to face fiscal/financial constraints that limit their use of GSS issuances to meet climate and nature challenges. A policy-oriented, whole-of-economy approach can fill the gap and help scale sustainable sovereign finance to a much broader audience, and to much greater impact.