Worsening human rights records among emerging market issuers a cause for concern for sovereign bondholders.
Deteriorating human rights across emerging market economies pose a material risk to sovereign bondholders and are reaffirming the need to establish engagement best practice for fixed income investments distinct from equities.
According to a new report from sovereign ESG ratings provider Verisk Maplecroft, human rights risks are rising in key constituents of government debt portfolios, including several of the largest emerging markets issuers such as Brazil, Mexico, Indonesia and South Africa, where institutions have weakened and violations have increased since 2020.
“What is or isn’t happening within the domain of human rights is informative and material from an investment perspective,” said James Lockhart Smith, VP of Markets at Verisk Maplecroft. “There is a direct, causal link between ESG performance and credit risk outcomes.”
A weakening of human rights is an early leading indicator of potential political instability and widening future risks, Lockhart Smith told ESG Investor, adding that human and labour rights embody the nature of the “social contract between rulers and ruled”.
The report said sovereign bondholders should press governments in relevant jurisdictions on “policy areas that have unravelled and bring human rights back up the agenda” as part of their ESG integration strategies.
“While investors should be frank about violations when engaging with governments, driving implementation of processes in key institutions to facilitate change should be a key area of focus,” said Lockhart Smith.
He did acknowledge, however, that bondholder engagement, particularly on human rights risk, is still an “emerging area”.
“You don’t see anything like the degree of activity and attention [on human rights] that you see on climate,” he said. “Various asset managers have taken strides to engage on human rights-related issues with sovereign issuers but there is not a strong collective voice.”
Collaborative investor initiatives targeting sovereigns on environmental themes include the Investors Policy Dialogue on Deforestation, which is widening its remit from engaging with governments on supply side to those on the demand side, including Europe, the UK and US.
According to Peter Eerdmans, Head of Fixed Income at Ninety One, the global investment manager is engaging strategically with sovereigns on budget transparency and climate, but not yet on human rights.
Ninety One has created a Climate and Nature Sovereign Index which introduces a framework for assessment of environmental and sustainability risk on a country-by-country basis. But the firm is yet to create a similar framework for the assessment of human rights risk in the sovereign debt market, noting that it is regarded as a “sensitive topic”.
However, that does not mean that human rights-related risks are never discussed with sovereign issuers.
“When human rights begin to meaningfully deteriorate, we will raise the issue with sovereign issuers, often in tandem with other investors and NGOs,” said Eerdemans, noting that such risks are a concern to bondholders and potentially material to the market pricing of a sovereign debt.
Ninety One uses its own scoring process to track the human rights performance of sovereigns, which has registered improvements in Latin America as bondholders have taken comfort in the presidential elections of Luiz Inácio Lula da Silva in Brazil and Gustavo Petro in Columbia – two leftist leaders – in the past 12 months.
Human rights abuses were worse under the Jair Bolsonaro and Iván Duque’s administrations, said Eerdmans, noting that Ninety One’s ESG scores are reflective of a more positive outlook under new leadership.
Both ‘Lula’ and Petro have expressed willingness to cooperate on protecting the Amazon rainforest, establish an integrated electric power grid and set non-violent anti-drug policy.
“There are human rights issues in some countries, corruption or deforestation issues in others. But to simply brush them aside and not invest in emerging markets is probably the worst thing that you can do from a sustainability perspective,” said Eerdmans.
“If you deprive [emerging market] economies from funding […] it will become even tougher for isolated countries to address the underlying issues – it’s always a bit more nuanced when you think about sovereigns.”
Channels for engagement
The Verisk Maplecroft report found a range of issues driving deteriorations in emerging market performance, but a unifying trend was a weakening of the institutions and processes protecting human rights.
Where government expenditure and attention on protecting rights has decreased, violations during the 2020-2023 period have become more severe and frequent, the report noted. Key examples include Brazil, Mexico, the Philippines, Indonesia and Colombia where rollbacks on freedom of assembly have occurred.
Lockhart Smith said a key challenge for asset managers when engaging on human rights issues is finding a “credible path” to making a meaningful difference on underlying factors.
“A lot of countries have signed human rights conventions and have related laws in place – they’re just not being implemented,” he said, noting that engaging with sovereign issuers on implementation of processes in key institutions is a potentially productive channel for engagement.
“It’s easy for an asset manager and issuer to engage on social risk and both come away and feel like they have made a difference, but in reality little impact has been made on the underlying human rights guarantees,” he added.