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Sovereign carbon footprints – An opportunity for investors and governments to collaborate


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    Discussions at this autumn’s Climate Week and Climate Ambition Summit saw increased scrutiny of the carbon footprints of sovereign bond issuers, with UN Secretary-General António Guterres going so far as to blacklist China, the US, India, and the UK as he prioritised those governments enforcing credible plans and policies to keep the targets of the 2016 Paris Agreement alive.  

    Debate on the carbon footprints of sovereign bond issuers is only likely to heat up, especially amid an intensifying focus on climate reparations, carbon taxes, and national carbon budgets. This sets up an opportunity for investors to engage with governments as they work to decarbonise their portfolios, using carbon footprinting as a tool to support climate reporting and risk assessment.

    Many countries have national net zero plans that will likely require private sector investment. Such funding would give investors leverage to influence a country’s decarbonisation efforts. 

    Measuring sovereign carbon footprints

    Past coverage and reporting frameworks monitoring carbon footprints have focused on carbon emissions by companies. The Partnership for Carbon Accounting Financials (PCAF) aims to help investors assess and disclose the greenhouse gas emissions (GHG) from loans and other investments, which in some cases could concern GHG emissions by sovereign (bond) issuers.

    At BNP Paribas Asset Management, we have chosen to measure national GHG emissions in a similar fashion to those by companies, using Scope 1, 2 and 3 emissions: 

         Companies    Sovereigns  
      Scope 1  Direct emissions from sources owned or controlled by the reporting company  Direct national emissions
      Scope 2  Indirect emissions from the generation of purchased or acquired electricity, steam, heating, or cooling consumed   Electricity imported emissions
      Scope 3  all other indirect emissions not included in Scope 2 that occur in the company’s value chain (upstream emissions in the supply chain, downstream from organisations using its products or services)  Non-electricity imported emissions and exports/ emissions from the use of exported products

    For companies, emissions (known as the ‘carbon intensity’) are set against a company’s market capitalisation or its enterprise value. For emissions by sovereign (bond) issuers, we have opted to use gross domestic product (purchasing power parity-adjusted). 

    Alternative metrics use the population count and outstanding debt. However, both options have more cons than pros. 

    • Using the population count might make sense for highly populated countries, but we need a more holistic view on sovereign carbon footprints.
    • Opting for outstanding debt will favour countries that are highly indebted and countries that can improve their relative ranking by issuing more debt. 

    As yet, there is no standardised basis for comparison.

    The complexities of sovereign emissions accounting

    Although more attention is now being paid to measuring sovereign emissions, there is no consensus on data coverage. Also, different organisations have different approaches. OECD data, for example, only covers 69 countries, including no Scope 3 data for African economies.

    Methodologies used to calculate sovereign emissions totals also differ. For example, some data providers do not consider Land use, land-use change, and forestry (LULUCF) as a Scope 1 metric. The BNP Paribas methodology does include LULUCF in Scope 1 considerations as human activities impact terrestrial sinks and mitigation can be achieved through activities in the LULUCF sector.

    Further complexities stem from the fundamentally multi-faceted nature of sovereign-based national emissions. All sovereigns have emissions from both domestic consumption and outsourced production. They are difficult to track accurately, and weightings can be highly subjective, which limits their usefulness for comparisons.

    How emissions data could evolve in the future

    The finance industry is seeking to respond to these challenges. For instance, Assessing Sovereign Climate-related Opportunities and Risks (ASCOR) is aiming to develop a publicly available, independent tool that assesses countries on climate change and progress on climate change management and the low-carbon transition. Its framework should provide up-to-date, robust data to enable an accurate understanding and assessment of sovereign GHG emissions.

    The Institutional Investors Group on Climate Change (IIGCC) has expanded the scope of its net-zero commitment metrics to include sovereign bonds, while the PCAF Standard for Financed Emissions now includes a framework for sovereign debt.

    Finally, tighter company emissions disclosure requirements and supply chain regulations should improve the transparency of corporate emissions totals, aiding the aggregation of emissions at the sovereign level.

    Improved data integrity should help investors identify the best solutions to decarbonise and reduce sovereign carbon footprints with green, sustainable and sustainability-linked bonds (SLBs).

    Sovereign sustainability-linked bonds could be vital for improving the reliability and transparency on sovereign emissions for two reasons: 

    • Their financial performance hinges on the achievement (or non-achievement) of sustainability objectives such as reducing emissions
    • Designing an SLB requires a set of measurable, time-bound, and ambitious performance indicators. 

    While this bond class has been slow to take off – at present, only Uruguay and Chile have issued SLBs – it is seeing growing demand. The Uruguayan and Chilean SLBs have shown that there is investor appetite for this bond class. It’s hoped the bonds will encourage change at the sovereign level by using clear, climate-focused targets to keep issuers on track given the risk of financial penalties.

    A new portfolio selection method 

    As scrutiny of national GHG emissions grows and the ability of investors to accurately track sovereign carbon footprints improves, we expect sovereign sustainability metrics to play a significant role as a portfolio selection tool.

    The approach of two key net zero milestones in 2030 and 2050 will likely put national governments under pressure to act on climate change. Investors will look for greater transparency not only with a view to investment decisions, but also a dialogue with sovereign issuers.

    This should help build investor confidence in national climate change plans and encourage capital flows into national net zero strategies. 

    As of today, sovereign carbon footprints are not discounted in our sovereign asset allocations, nor do they function as constraints in sovereign debt portfolios or in our investment policies. ESG scores apply only to corporate issuers.


    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
    Environmental, social and governance (ESG) investment risk: The lack of common or harmonised definitions and labels integrating ESG and sustainability criteria at EU level may result in different approaches by managers when setting ESG objectives. This also means that it may be difficult to compare strategies integrating ESG and sustainability criteria to the extent that the selection and weightings applied to select investments may be based on metrics that may share the same name but have different underlying meanings. In evaluating a security based on the ESG and sustainability criteria, the Investment Manager may also use data sources provided by external ESG research providers. Given the evolving nature of ESG, these data sources may for the time being be incomplete, inaccurate or unavailable. Applying responsible business conduct standards in the investment process may lead to the exclusion of securities of certain issuers. Consequently, (the Sub-Fund's) performance may at times be better or worse than the performance of relatable funds that do not apply such standards.

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