ESG risks in sovereign debt analysis. We have seen that investors in sovereign debt increasingly incorporate ESG issues into their analysis and it's based on the belief that ESG factors will influence the country's economic performance and in turn the ability of the country to service its debt. A closer look at the relevant factors reveals that the environmental, social and governance factors relevant to sovereign debt investors are different in many ways from the factors that analysts consider when they're looking at corporate issuers' debt securities. For example, the governance factors relevant to sovereign bonds concern the country's overall rule of law, corruption risk, and regulatory framework. Factors that are very different from company specific corporate governance structures and issues, such as board structure or accountability. Corruption risk, for example reduces tax revenues and hinders economic growth in turn impacting on future tax revenues. With regard to the environmental factors and the impact of climate change, some countries will be impacted by rising sea levels and more frequent droughts or excessive rain leading to economic disruption. And in turn, this may impact the country's corporate performance and economic growth leading to weaker tax revenues and an inability to service its debt.

Investors are asking themselves the following questions. Does the country have enough fiscal capacity to deal with drought and help farmers? Does the country have enough fiscal capacity to build defenses against rising sea levels? Does the country have enough fiscal capacity to deal with locus plagues destroying agriculture, a sector that may account for a large share of a country's GDP? So analysts will consider different physical climate related risks that can manifest themselves through different channels. The increasing weather volatility in extremes threatens to disrupt infrastructure, agriculture, tourism and water supply with potentially material implications for national economies and public accounts. These risks have implications at the sovereign issuer level but also for individual bond issues with different maturities and denominations in local or hard currency. Social factors, such as the level of education and demographic changes also impact the country's prospects for economic growth and ability to honor its obligations to bond holders. Measuring these factors is not an exact science. Analysts and investors rely heavily on data from ESG data providers, which they then combine with data from institutions such as the IMF or the World Bank. The information obtained is then used as inputs into their own proprietary analysis. Analysts also focus on the dynamics of the ESG data. That's the trend to indicate how some of the ESG factors evolve and in which direction they're heading.

A challenge to consider when trying to identify material ESG factors is that such factors are often interrelated. A country's governance characteristics can help mitigate, prevent, or exacerbate social and environmental shocks. There is also overlap between environmental factors and social factors. For example, projects and initiatives, which aim to improve environmental conditions can directly impact social conditions.