ESG moves up on sovereign wealth funds' priority list

Sovereign wealth and investment funds are increasingly adopting ESG policies that encourage institutional investors as they work toward their own sustainability goals and push for greater transparency all around.

The COVID-19 pandemic is part of the impetus for more attention on ESG from sovereign wealth funds, along with a global consensus on addressing climate change and other issues for financial as well as more virtuous goals.

"There has been rapid uptake on ways to approach climate change ... and we have generally seen an improvement in transparency and governance" on other ESG issues, said Victoria Barbary, director of strategy and communications for the London- based International Forum of Sovereign Wealth Funds, which tracks roughly 60 funds.

There has also been "a push from outside," she said. With sovereign wealth funds seen as representatives of their governments, "they have become more mainstream, and there is a better understanding of what they can do" on the ESG front, particularly as the energy transition becomes a more pressing need, and pressure mounts for all types of investors to align with the goals of the Paris Agreement on climate change, Ms. Barbary said.

"There's been a real change in terms of thinking about risks and opportunities," Ms. Barbary said.

Invesco Ltd. found in its 2022 Global Sovereign Asset Management Study that 75% of sovereign investment funds now have an ESG policy in place, compared with 46% in 2017.

Invesco questioned 139 chief investment officers, heads of asset classes and senior portfolio strategists from 81 sovereign wealth funds and 58 central banks, altogether responsible for €22.6 trillion ($24.3 trillion) in assets. Large public pension funds were included "because they are all long-term investors," said Rod Ringrow, head of official institutions at Invesco in London.

Invesco's study found regional variations in ESG-policy adoption, with 77% of Western sovereign wealth funds and central banks having an ESG policy, followed by Asia at 68%, the Middle East at 55% and emerging markets at 30%.

For those without an ESG policy, significant challenges included the slow pace of organizational change, lack of government leadership or clear regulatory standards, and a lack of quality data, including ESG ratings, the Invesco study found.

While noting that sovereign wealth funds and central banks aren't a homogeneous group, the report saw several common themes emerge, including a more challenging geopolitical environment, more public awareness of ESG and the role of sovereign investors in driving the energy transition.

When it comes to integrating ESG into their investment process, sovereign investors "have all been on a journey," Mr. Ringrow said. He sees them preferring engagement over divestment, and "some have been pretty vocal about requiring their managers" to engage as well, he said.

The terms sovereign or state-owned investors can refer to sovereign wealth funds and public pension funds, with central banks also thrown into the mix.

A sovereign wealth fund is an investment vehicle owned by a national or regional government that falls into one of three basic categories: stabilization or "rainy day" funds; funds that save for future generations, like Singapore's GIC established in 1981 to manage the country's foreign assets; and strategic or development funds designed to boost the domestic economy or attract foreign capital.

The world's largest sovereign wealth fund, the $1.37 trillion Government Pension Fund Global, Oslo, whose assets are managed by Norges Bank Investment Management, collects revenues generated by the sale of North Sea oil, and its assets support Norway's pension system.

In its recently released strategy through 2025, NBIM said it wants to develop an ESG database and analytical tools, "to make ESG information more relevant, reliable, and available to the organization," and make the buildings it owns more energy efficient.

Public pension funds are often included in the sovereign investor picture. According to New York-based research organization Global SWF, sovereign or state-owned investors represented $32.8 trillion in assets in 2022, with $21.3 trillion in public pension funds and $11.5 trillion in sovereign wealth funds.

A July report from Global SWF found sovereign wealth funds focusing more on sustainability and climate issues, although public pension funds were further ahead.

In its report, Global SWF said that despite 2022 being a very challenging year — the first in history where the industry shrunk from $33.6 trillion in 2021 — sovereign investors deployed more capital than ever. The 176 sovereign wealth funds it studied deployed $152.5 billion, 38% more than the previous year, while the 281 public pension funds it tracks saw investments dip in 2022, down 9% by value and 16% by volume, with the average deal ticket relatively stable at $340 million.

Ms. Barbary and others credit the One Planet Sovereign Wealth Funds Network for helping to advance work on the energy transition. The network, with 45 sovereign wealth funds and other institutional investors with a collective $37 trillion, has issued guidance on climate data, clean hydrogen and renewables in emerging markets.

While the need to fund the energy transition has made environmental issues the easiest ESG goal to deal with, "there has been dramatic improvement" on governance issues, Ms. Barbary said, including forthcoming updates to the Santiago Principles — 24 generally accepted principles and practices endorsed by members of the International Forum of Sovereign Wealth Funds to promote transparency, good governance, accountability and prudent investment practices.

Social issues like a sovereign country's human rights record "is hardest, because it varies over time and geography," but should improve as more research is devoted to it, Ms. Barbary said.

Other sovereign wealth funds are taking a more visible role in ESG issues. Singapore's GIC, with $690 billion according to Global SWF, recently provided feedback on climate- and sustainability-related disclosure requirements being developed by the International Sustainability Standards Board.

"As Singapore's sovereign wealth fund, sustainability is integral to GIC's mandate, which is to preserve and enhance the international purchasing power of the funds placed in our care. Creating a global set of standards for sustainability disclosures will be key to enabling long-term investors such as GIC to improve our assessment of sustainability-related risks and opportunities, and we believe that the work ISSB is undertaking is critical to this endeavor," GIC said in its comment letter.

To see how issuer countries are dealing with climate change, investors in sovereign debt on Feb. 7 announced the ASCOR Project — Assessing Sovereign Climate-related Opportunities and Risks. It is expected to be the first publicly available, independent, and open-source investor framework and database assessing the climate action and alignment of sovereign bonds, according to officials with the project representing international institutional investors with a collective $5 trillion in assets, including BT Pension Scheme, London; Church of England Pensions Board, London; asset managers, green finance organizations and academics.

Many institutional investors hold sovereign debt but there is little information on how it is or could be impacted by climate change, said Victoria Barron, head of sustainable investment at the £46.9 billion ($57.2 billion) BT Pension Scheme and vice chairwoman of the ASCOR Project, in an interview. "There is a really big demand for it," Ms. Barron said.

The timing is right, as large sovereign funds join the green bond movement, including Saudi Arabia's Public Investment Fund, which in October offered a green bond on the London Stock Exchange. With $607.4 billion in assets according to Global SWF, PIF plans to invest more than $10 billion by 2026 in green projects like lower carbon transportation and sustainable water management.

According to Global SWF, state-owned investors are increasingly attracted to renewable energy investments, which in 2022 totaled $18.7 billion. North America and Western Europe were the most popular destinations thanks to opportunity and a positive regulatory environment, it found, while developed Asia and Pacific investments more than doubled to $4.7 billion.

GIC was the largest single investor in renewables, while Canadian funds accounted for 33% of the total and Persian Gulf investors contributed 29%, Global SWF said. It expects to see more renewable investment by the Persian Gulf funds, which are focused on diversifying their economies and making progress on net-zero goals.