The power of extending engagement to governments

By Thede Rüst, head of emerging markets debt at Nordea Asset Management

Investor attitudes towards ESG have radically evolved in recent years, with active ownership – the use of engagement and voting to influence companies – now overwhelmingly recognised as a force for good. In addition to fostering progress, constructive dialogue with corporates is increasingly being accepted as a vital element of long-term value creation within both equity and bond markets.

However, as the majority of fixed income assets are issued by countries and government-related agencies, there still remains heavy scepticism surrounding the ability of ESG-aligned asset managers to positively influence sovereign entities – particularly in emerging markets.

There will obviously be instances where engagement efforts are futile, as highlighted by Russia, which was formerly a considerable component of emerging market bond indices. In such cases, there is no substitute for a robust ESG research framework, where human rights and governance factors feature prominently. In the case of Russia, due to mounting evidence of deteriorating governance standards, we put a freeze on all purchases of the country’s government bonds in 2020, before divesting all remaining assets in January 2022.

Encouraging interactions in Brazil

Even though engaging with governments can often be arduous, especially in emerging markets, it is still possible to enact positive change. For example, noting the negative financial materiality of continued rainforest destruction, we at Nordea decided in 2019 to no longer buy Brazilian government bonds for any of our internally managed emerging market debt strategies.

Despite taking this course of action, true responsible investors do not simply divest and disappear. In 2020, Nordea became a founding and advisory member of the Investors Policy Dialogue on Deforestation (IPDD), a collaborative engagement aimed at initiating and coordinating a public policy dialogue on halting deforestation. The Brazil working group was the first formal country workstream of the IPDD, which has since been extended to Indonesia.

The Brazilian government has not done enough yet to make us change our investment stance – but we are encouraged by recent progress. For example, the wide-ranging regulations on ESG announced by the central bank late last year are a good step forward. This includes the requirement that all environmental, social and climate impact is taken into consideration for all financial services and products. It is also preparing to require the country’s banks to account for potential losses from climate change-related phenomena – such as droughts, floods and forest fires.

Social factors also at forefront

While engagement on the climate crisis has accelerated in recent years, responsible investors have also made strong strides forward in positively influencing governments on the ‘S’ in ESG. For example, we continue to engage with Ghana’s government to discuss child labour in the country’s cocoa industry. In cocoa growing areas, 55% of children living in agricultural households were engaged in production and most were also exposed to hazardous work conditions.

Studies on the effectiveness of policy interventions against child labour have shown the most effective measures are not necessarily those designed specifically to prevent child labour. Efforts targeted at increasing school enrolment and retention have proved among the most effective, along with the construction of schools and the upgrading of other infrastructure. In fact, school enrolment and retention has increased across all levels of education in the country, with literacy rates rising from below 60% to almost 80% over the past two decades.

Despite government interventions, child labour remains widespread. In recent discussions with the government, we were informed the number of children involved in cocoa production in Ghana remained stable, even though cocoa production has grown by more than 50% in recent years. We will continue our dialogue with the authorities to highlight the importance of ongoing investment in education and infrastructure, particularly as the Covid-19 pandemic has halted educational progress in many parts of the developing world. In addition, more work needs to be done as cocoa farming expands into new geographical areas in the country, as the infrastructure needed to minimise the likelihood of child labour is less developed in more remote regions.

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