Does Better ESG Performance Lower Credit Risk? A Sovereign Credit Perspective

Abstract

In recent years, many economies have launched ESG bonds to demonstrate their commitment to sustainable development and combat the challenges of climate change. Against this backdrop, this study examines how ESG factors have affected sovereign credit risk over time and across economies. We find that investors have generally factored in ESG performance and the development of ESG debt market in pricing sovereign credit risk since the mid-2010s. On comparing emerging market economies (EMEs) with advanced economies (AEs), the still shallow ESG debt market in EMEs has yet to exert material effect on their sovereign credit risks, and investors tend to disregard environmental factors when pricing EMEs’ sovereign credit risk, probably as a sacrifice to economic development. As such, policymakers need to continue to support the ESG-related developments especially in EMEs, for example, by strengthening international cooperation to improve the environmental performance of EMEs, e.g. fostering technology transfer.

Keywords: ESG, Sovereign credit risk, Panel data models