LONDON (Reuters) – When Saudi journalist Jamal Khashoggi was killed in 2018, London-based hedge fund manager Dominic Armstrong bet investors would be disabled and the kingdom’s debt would be beaten.
His fund Horatius Capital made a multi-million dollar bet via credit default swaps – or sovereign default insurance – that Saudi bonds would be affected.
But investors have largely stuck to Saudi debt.
When the United States declassified an intelligence report last month that said de facto Saudi leader Crown Prince Mohammed bin Salman had approved the operation to capture or kill Khashoggi, Armstrong again thought investors would act.
“I expected to see investors voting very quietly with their feet,” Armstrong told Reuters. “People just holding their noses was not enough. But I think the mood has changed. What will follow now are actions to support this. “
He’s still waiting, however.
In fact, demand for Saudi Euro-denominated bonds was so strong last month that investors paid to lend money to the kingdom.
Riyadh has dismissed the US report as false, while the crown prince has denied any involvement in Khashoggi’s murder. Saudi Arabia, however, has come under criticism from campaign groups and some Western politicians for its record on human rights and civil liberties.
Yet the world’s largest oil exporter, which has issued around $ 80 billion in international bonds since 2016, has an A minus credit rating and pays higher yields than its similarly rated peers, making difficult for investors to stay away.
Despite all the hype and billions of dollars invested around the world in investments based on environmental, social and governance (ESG) factors, this is a niche game in the sovereign bond market.
According to some investors, taking a principled stance on sovereign debt and financially penalizing countries for their track record on issues such as human rights could prove counterproductive in limiting modernization.
“Emerging market debt is full of tradeoffs, and taking a Western perspective on it is sometimes relatively difficult because they are on a different scale of development,” said Marcin Adamczyk, Head of Emerging Market Debt at NN Investment Partners , which manages 300 billion euros ($ 358 billion).
Adamczyk did not change his holdings of Saudi debt the day after the publication of the US report.
Some of the biggest names in ESG investing, including BlackRock Inc, PIMCO and Ashmore, held a total of nearly $ 1 billion in Saudi debt, based on the latest data for 2020. They declined to comment when they were contacted by Reuters about the impact of the Khashoggi report.
A spokesman for the Saudi finance ministry told Reuters that the kingdom “is going through a significant transformation which offers multiple opportunities for investors around the world.”
“Investors are still showing keen interest in Saudi Arabia, as evidenced by the recent negative interest Eurobond issue, which many asset managers have placed Saudi debt issues in their ESG funds,” a- he declared.
He added that Saudi Arabia is developing regulations and legislation to improve the ease of doing business, increase transparency and support its commitment to the United Nations Sustainable Development Goals as part of its efforts to improve ESG. .
MANDATORY MARKET LAGGARDS
Sovereign debt is part of a bond universe that is lagging behind in the ESG game.
ESG fixed income funds operating in the $ 130 trillion debt market have just under $ 300 billion under management; In contrast, ESG funds in the $ 88 trillion global equity arena command nearly $ 1 trillion, according to Morningstar data.
China, a large A + rated sovereign market that yields 3% returns, is another country where increasing Western investment in sovereign debt seems at odds with European and American criticism of alleged human rights violations. man, which are denied by Beijing.
Foreign investors for the first time hold more than 2 trillion yuan of Chinese government bonds (CGB), with holdings reaching a record 2.06 trillion yuan ($ 318.7 billion) at the end of February. This was up 3.1% from the previous month, the slowest growth rate since last June.
China’s Foreign Ministry did not respond to a request for comment from Reuters.
In a survey last month of dedicated emerging market investors, JPMorgan analysts found that while most agreed that engaging with the issuer is a core tenet of any ESG strategy, more half of those surveyed had not done so with the respective debt management offices.
Still, some investors have said it is possible to take a stand. A group of fund managers, for example, have in recent months warned the Brazilian government that it will divest unless it stops the destruction of the Amazon rainforest.
Brazilian Foreign Minister Ernesto Araujo this month admitted there is illegal deforestation, but said his government is fighting it and is open to international cooperation on sustainable investment in the Amazon. .
Brazilian Vice President Hamilton Mourao said in December that the government had deployed the military to tackle deforestation and that new measures were planned, adding that it had to work within strict budget limits.
On the other hand, realism prevails for investors; the United States is one of the biggest polluters in the world and withdrew from the Paris Climate Agreement under the Trump administration, but it is also the largest debtor in the world, which makes it difficult avoidance of fixed income funds.
“ AREAS OF GEOPOLITICS ”
To add to the complexity of the picture, some investors claim that the “S” and “G” factors of ESG are much more difficult to measure and act on in sovereign bonds than in corporate bonds or stocks.
Some investors also say that focusing on social and governance considerations would strongly favor richer countries, which tend to rank higher than poorer countries due to stronger markers on political stability, education standards, poverty rates and their labor market.
“In terms of risk assessment, the environmental aspect is sort of the easiest part,” said Eric Ollom, head of corporate debt strategy in emerging markets at Citi. “The other parts – social and governance – get tricky.”
“The social would be political freedom, freedom of the press and social well-being,” he added. “These problems are becoming more difficult to measure and they also come under the realm of geopolitics.”
Fund managers apply their own weights to calculate the ESG score of one country, but also take into account the assessment of others. The JPMorgan ESG Fixed Index, for example, uses Sustainalytics’ rating for part of its assessment.
Sustainalytics ranks Saudi Arabia, an absolute monarchy that restricts religious, sexual and certain other freedoms, 159 out of 172 countries on its ESG dashboard. He had already taken into account the assassination of Khashoggi in 2018, which he cites as an example of “state repression”, before the publication of the American report.
European asset manager Candriam does not have Saudi Arabia in its € 882 million sustainable emerging markets fund, which mainly focuses on the environment, due to the kingdom’s carbon footprint.
But he told Reuters that even significant improvements on the environmental front would not change his position as the country ranks in the second percentile of the human rights and civil liberties component of the fund’s analysis, even lower. as its greenhouse gas emissions score.
GRAPHIC: Saudi CDS and oil –
Additional reports by Dhara Ranasinghe, Gwladys Fouche, Essi Lehto, Jacob Gronholt-Pedersen, Colm Fulton, Davide Barbuscia and Marwa Rashad; Editing by Jason Neely, Carmel Crimmins and Pravin Char