ESG in Emerging Markets Sovereign Debt

In 2025, the financial industry is seeing a significant shift towards a more nuanced approach to evaluating environmental, social, and governance (ESG) factors in sovereign debt analysis, particularly for emerging markets. Unlike corporate entities, sovereign states have unique factual and ethical differences that necessitate a tailored ESG assessment. For example, social and governance scores for sovereigns correlate with credit quality, whereas corporate ESG scores do not. Additionally, while it is acceptable for corporations to fail, the collapse of sovereign states can lead to significant socioeconomic costs. As a result, models have been developed to adjust social and governance scores based on a country's level of development and consider changes in income-adjusted ESG scores as reflections of effort, ensuring that poorer countries are not penalized for low environmental scores. 
  
Our team’s new approach to sovereign ESG aims to provide better investment insights and create more ethical portfolios. By excluding the bottom quartile of countries based on their income-adjusted ESG scores, investment strategies can adhere to rigorous ESG standards. This method aligns with global sustainable finance regulations and addresses the divergence in sovereign ESG scores noted by various studies. The argument is that a thoughtful consideration of the factual and ethical differences between sovereigns and corporates can lead to more accurate assessments and ultimately, better investment outcomes. This shift reflects a broader trend towards integrating ESG factors into all areas of investment, recognizing the unique challenges and responsibilities associated with sovereign debt.

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[4526710] 5/2025 
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