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By Simon Jessop, Tom Arnold and Karin Strohecker
LONDON, March 23 (Reuters) - When Saudi journalist Jamal
Khashoggi was killed in 2018, London-based hedge fund manager
Dominic Armstrong bet investors would be turned off and the
kingdom's debt would take a beating.
His fund Horatius Capital made a bet worth millions of
dollars through credit default swaps - or insurance against
sovereign default - that Saudi bonds would be hit.
But investors largely stuck with Saudi debt.
When the United States declassified an intelligence report
last month that said de-facto Saudi leader Crown Prince Mohammed
bin Salman approved the operation to capture or kill Khashoggi,
Armstrong again thought investors would act.
"I was expecting to see investors very quietly vote with
their feet," Armstrong told Reuters. "People merely holding
their nose was not enough. But I think the mood has changed.
What will now follow is the actions to back that up."
He's still waiting, though.
In fact, demand for Saudi euro-denominated bonds was so
strong last month that investors paid to lend the kingdom money.
Riyadh rejected the U.S. report as false, while the crown
prince has denied involvement in Khashoggi's killing. Saudi
Arabia is nonetheless the focus of criticism from campaign
groups and some Western politicians over its record on human
rights and civil liberties.
Yet the world's largest oil exporter, which has issued about
$80 billion in international bonds since 2016, has an A-minus
credit rating and pays higher yields than similarly rated peers,
making it hard for investors to stay away.
For all the hype and billions of dollars globally pouring
into investing based on environmental, social and governance
(ESG) factors, it is a niche play in the sovereign bond market.
Some investors say that taking a principled stand on
sovereign debt, and financially penalising countries for their
record on issues such as human rights could prove
counter-productive by constraining modernisation.
"Emerging market debt is full of trade-offs, and taking a
Western lens on that sometimes is relatively difficult as they
are on a different scale of the 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 in the
immediate aftermath of the U.S. report's publication.
Some of the biggest names in ESG investing, including
BlackRock Inc, PIMCO and Ashmore, held a total of nearly $1
billion of Saudi debt, based on the latest data for 2020. They
declined to comment when contacted by Reuters about the impact
of the Khashoggi report.
A Saudi finance ministry spokesman told Reuters that the
kingdom was "going through significant transformation which
provides multiple opportunities for investors around the world".
"Investors are still expressing strong interest in Saudi
Arabia as witnessed by the recent issue of the Eurobond at
negative interest, of which many asset managers have placed
Saudi debt issuances in their ESG funds," he said.
He added Saudi was developing regulations and legislation to
improve ease of doing business, increase transparency and
support its commitment to the U.N. Sustainable Development Goals
as part of its push to improve ESG.
BOND MARKET LAGGARDS
Sovereign debt is part of a fixed-income universe that is a
laggard in the ESG game.
ESG fixed income funds operating across the $130 trillion
debt market have just under $300 billion under management; by
contrast ESG funds across the $88 trillion global equity realm
command nearly $1 trillion, Morningstar data shows.
China, a large A+ rated sovereign market that pays 3%
yields, is another country where increasing Western investment
in sovereign debt is seemingly at odds with European and U.S.
criticism over alleged human rights abuses, which are denied by
Beijing.
Foreign investors hold more than 2 trillion yuan worth of
Chinese government bonds (CGBs) for the first time, with
holdings standing at a record 2.06 trillion yuan ($318.7
billion) at the end of February. That was a 3.1% rise over the
previous month, the slowest rate of growth since last June.
The Chinese foreign ministry did not respond to a Reuters
request for comment.
In a survey last month of dedicated emerging market
investors, JPMorgan analysts found that while most agreed that
engaging with the issuer was a critical principle to any ESG
strategy, more than half of those surveyed had failed to do so
with respective state debt management offices.
Still, some investors said it is possible to take a stand. A
group of fund managers, for example, have in recent months
warned Brazil's government they will divest their investments
unless it halts the destruction of the Amazon rainforest.
Brazil's Foreign Minister Ernesto Araujo acknowledged this
month that there was illegal deforestation occurring, but said
his government was combating it, and that it was 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 fight
deforestation and that further measures were planned, adding
that it had to work within tight budget constraints.
On the other hand, realism prevails for investors; the
United States is one of the world's biggest polluters and
withdrew from the Paris Climate Agreement during the Trump
administration but it is also the world's largest issuer of
debt, making it difficult for fixed income funds to avoid.
'REALMS OF GEOPOLITICS'
Adding to the complex picture, some investors say the "S"
and "G" factors of ESG are far tougher to measure and act upon
in sovereign bonds than in corporate bonds or shares.
Some investors also say that focusing on social and
governance considerations would heavily favour richer countries,
which tend to get a higher ranking than poorer countries because
of stronger markers on political stability, educational
standards, poverty rates and their labour market.
"In terms of risk assessment, the environmental side is
sort of the easy part," said Eric Ollom, head of emerging market
corporate debt strategy at Citi. "The other parts – Social and
Governance – get tricky."
"The Social would be political freedom, and press freedom
and social welfare," he added. "These issues get more difficult
to measure and they also cross into the realms of geopolitics."
Fund managers apply their own weights for working out a
country's ESG score but also factor in the assessment of others.
The JPMorgan ESG fixed index, for example, uses the scoring of
Sustainalytics for part of its assessment.
Sustainalytics ranks Saudi Arabia, an absolute monarchy
which restricts religious, sexual and some other freedoms, 159
out of 172 countries on its ESG scorecard. It had already
factored in the 2018 Khashoggi killing, which it lists as an
example of "State Repression", before the release of the U.S.
report.
European asset manager Candriam does not have Saudi Arabia
in its 882-million-euro sustainable emerging markets fund, which
mainly focuses on the environment, because of the kingdom's
carbon footprint.
But it told Reuters that even significant improvements on
the environmental front would not change its stance because the
country scores in the second percentile on the Human Rights and
Civil Liberties component of the fund's analysis, even lower
than its greenhouse gas emissions score.
(Additional reporting 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)
