Last week marked the end of Renminbi’s twenty-one year old peg with the US dollar as Chinese Yuan fell by 4.4 percent. This move came at the back of weakened Chinese economy due to a drop in industrial production as well as a slackened demand for consumer products. Emerging market currencies as well as stock markets plummeted as uncertaitnity over currency wars indicated a stifling global growth. Commodity prices, oil in specific came under further pressure as well due to the Chinese currency market turmoil adding to the woes of demand for crude oil.
Will billions in bond issuance plug the hole in Saudi Arabia’s shrinking foreign reserves?
On the back of a plunge in oil prices from US $115 a barrel in June 2014 to a six-year low of US $48 last week, the Saudi Arabian government, after an eight year hiatus, made a return to the bond markets issuing sovereign bonds worth SR15 billion ($S4 billion) to local banks to cover its budget deficit. Issuance will have to continue at this rate or higher on a monthly basis to maintain sufficient reserves to cover Saudi Arabia’s imports and defend the currency peg.
The International Monetary Fund has estimated the budget deficit will be about 20 percent of GDP, or approximately $150 billion. According to Jadwa Investment’s chief economist, Fahad Alturki, the Saudi government is expected to fund its deficit by raising SAR 200 billion ($54.5 billion) from the domestic bond market, which will still lead to some draw down of its foreign currency reserves. Other reports put the amount at a more modest SAR 20 billion ($5.3 billion per month) which would represent SAR 115 billion ($30.7 billion) in issuance for 2015 if it continued monthly at this amount through year-end.
Additionally, in order to ensure that it can protect the Saudi riyal’s peg to the US dollar, the Saudi authorities will want to maintain a minimum level of fiscal reserves. The import cover of Saudi Arabia for 18 months works out to approximately $235bn, which is more than twice the cover of most countries. If the oil prices were to stay at the current $50 per barrel level and the deficit remains at current levels during the next two years, Saudi Arabia will breach this level of reserves in 2017.
The analysis adjusts total foreign reserves held at SAMA to be consistent in calculations of months of import coverage for 2010-2013 in the IMF’s International Financial Statistics. We project forward the months-of-import-coverage rate assuming import values reached a peak in 2013 and will remain at the 2012-2014 average levels through 2017. Based on this analysis, we created three scenarios corresponding to no debt issuance after August (a baseline), a low (SR 20 billion per month) and high (SR 200 billion per 6 months) estimate going forward. Under the baseline assumptions months-of-import coverage will fall to 22 months at the end of 2016 and 13 months at the end of 2017.
Using the low (high) continuing debt issuance scenario, our adjusted measure of import coverage will fall to 27 (30) months by the end of 2016 and 21 (27) months by the end of 2017. To remain above 18 months import cover in our baseline estimates, the deficit in 2016 and 2017 would have to be cut by 6pp per year, which will be challenging. This indicates that debt-averse Saudi Arabia will have to continue its sovereign issuance through 2016 and likely 2017 as well. If liquidity in the banking system tightens significantly, the government may also have to consider selling sovereign bond or sukuk into the international market or more widely domestically to non-bank domestic investors.
Saudi Arabia’ public debt stood at US $12 bn at the end of 2014, accounting merely 1.6 percent of its total GDP, indicating that there is room for bond issuances, even to cover huge deficits. Even if Saudi Arabia covered 2015-2017 deficits entirely with bond issuance, it would be able to maintain low debt levels relative to international standards (33.0% by the end of 2017). Regular issuances of sovereign bonds could help create a buoyant Saudi debt market which, if it creates a yield curve across multiple tenors, could spur new corporate debt issues. Creating a robust corporate debt market (most now turn almost exclusively to banks for debt financing) will shift some corporate risks from the banking system and into the capital markets, which will create a robust, stable and well balanced financial system. ■
Editor’s Note: Martina Macpherson, Managing Partner at SI Partners – oekom research UK sees substantial potential for the concepts that are dominating equity investment funds (environmental, social justice and corporate governance) to making their way across the investment spectrum and particularly into areas where only the ‘E’ exists like green bonds. Ms. Macpherson will be speaking at the Global Ethical Finance Forum (GEFF) which will be held on 1-2 September 2015 in Edinburgh, Scotland UK.
Exploring Risks and Opportunities in Sustainable Investment Strategies
by Martina Macpherson, Managing Partner, SI Partners – oekom research UK
Sustainable investment definitions
(Socially) responsible (SRI), sustainable, ‘green’ or ethical investing all possess the same fundamental investment ‘values’: to achieve both a financial return and social good.
For long-term investors such as asset owners, the evidence increasingly shows merit in sustainable investment approaches practiced within the context of fiduciary duty. These investors, and in particular faith-based investors, aim to reflect their values within their investment strategy.
By doing so, they aim to avoid controversial business areas such as alcohol, tobacco, gambling, biocides, GMOs, pornography, weapons, military or fossil fuel production; some also aim to avoid contraception and abortion. Often, they also aim to ensure that companies’ business practices are in line with international norms and conventions such as the UN Global Compact, Human Rights and/or Labour Rights Principles.
The areas of concern are often referred to ESG issues: environment, social justice, and corporate governance.
Although the strict definition of (S)RI and ESG is still subject to debate, it is clear there is strong upward momentum in sustainable development and investing across the investment value chain:
Source: oekom research, The Impact of SRI (2013)
Sustainable investment strategies
The global sustainable investment market has grown both in absolute and relative terms to US$21.4 trillion at the start of 2014 – equal to approximately 25% of all the world’s financial holdings. US-domiciled assets engaged in sustainable and responsible investment practices totaled USD$3.3 trillion in 2012 and US$6.57 trillion in 2014.
Source: GSIA, ‘Global Sustainable Investment Review 2014’
In the same time, the Principles for Responsible Investment initiative, established in 2005 by UNEP FI, has gained ground: PRI signatories reached 1,387 in July 2015, representing US$59 trillion of assets. According to PRI, the large majority of signatories have now adopted RI policies, and in the latest reporting cycle, 936 signatories reported on their progress in implementing the Six Principles.
Every two years, Eurosif issues a ‘state of the SRI market’ report covering seven SRI approaches:
- Sustainability themed investment
- Best-in-Class investment selection
- Exclusion of holdings from investment universe
- Norms-based screening
- Integration of ESG factors in financial analysis
- Engagement and voting on sustainability matters
- Impact investing
Negative screening, ESG integration and corporate engagement have been identified as the key investment approaches (for market growth and ‘impact’), in Europe and across the globe:
Overall, the definition of best practices in ESG integration is evolving very quickly. A few years ago, being a PRI signatory was considered as advanced; it is now seen as a requirement for asset managers and, instead, the focus has shifted to measuring the effectiveness of ESG factors.
ESG research and ratings
The demand for ESG data and metrics has led to the popularity and growth of (formerly niche) ESG rating houses that can provide quantitative and qualitative data and analysis across asset classes.
ESG ratings agencies such as MSCI ESG Research, Sustainalytics, Eiris, Vigeo and oekom research assess a company’s or a country’s (material) ESG risks and opportunities – at company, security or portfolio level – by using specific ESG indicators, weightings, scores and ratings. These ratings are now used for a broad range of active and passive investment products and benchmarks.
Over the past few years, there has also been increasing interest in another, (mainstream) sustainable investment product: Green Bonds. They are created to fund projects that have positive environmental or climate benefits and have been playing an important role in engaging institutional investors in the transition to a low-carbon economy and, hence, in meeting the UNFCCC’s goal of limiting global warming to 2°C above pre-industrial temperatures.
The European Investment Bank (EIB) introduced the concept of earmarking proceeds for climate investments in 2007, when EIB launched its first ‘Climate Awareness Bond’, a €600 million 5-year equity index-linked bond that was listed in 27 domestic markets in the European Union.
A year later, the World Bank introduced the first bonds with the label ‘Green Bond’, designed in collaboration with SEB and Scandinavian pension funds. The new product allowed investors to benefit from the World Bank’s rigorous environmental and social safeguards in assessing and approving eligible projects, and responded to their request to have their plain vanilla fixed-income investments support World Bank projects with a climate focus.
Since late 2012, demand for Green Bonds has increased significantly and there are now more types of issuers from different rating categories. Investors also have a growing number of choice in terms of bond sizes, structures and currencies. Several supra-nationals, federal and local government agencies, commercial banks and corporates, and now municipalities, have issued Green Bonds totalling US$36.6bn in 2014 – triple the amount issued in 2013, US$11bn. For this year, the Climate Bonds Initiative expects issuances of US$70-100bn.
Source: Climate Bonds Initiative, 2015
Proceeds from Green Bond issuances are still overwhelmingly used for climate-related projects, but there are more and more ‘Social’, ‘ESG’ and ‘Sustainability’ Bonds that take a broader view on sustainable and societal development and thus focus more for instance on addressing biodiversity and a range of social issues.
Given the strong market interest in sustainable investment products, there is now an industry-wide call for defined ‘green’ standards, more transparency and regular reporting in line with the Green Bond Principles. Second Party Opinions by Cicero, DNV, Sustainalytics, Vigeo and oekom research and Sustainability Bond Ratings by oekom research can help investors to avoid ‘green washing’ and to achieve the (S)RI goal: to grow a sustainable, financial market for the long term. ■
 Source: Mercer / CaIPERS, ‘Responsible Investment’s Second Decade: Summary Report of the state of ESG integration, policy and reporting’, Whitepaper (2011), Link: http://www.calpers.ca.gov/eip-docs/investments/video-center/view-video/mercer-report-second-decade.pdf
 See e.g. Eurosif, ‘European SRI Study 2014’, page 8, Link: http://www.eurosif.org/publication/download/european-sri-study-2014
 Source: GSIA, ‘Global Sustainable Investment Review 2014’, (2014) p. 3, Link: http://www.gsi-alliance.org/
 Source: BSR, ‘Trends in ESG Integration and Investment: Summary of the Latest Research and Recommendations to Attract Long-Term Investors,’ Whitepaper, (2012), p. 3, Link: https://www.bsr.org/reports/BSR_Trends_in_ESG_Integration.pdf
 Source: USSIF, ‘Report on US Sustainable, Responsible and Impact Investing Trends 2014’, (2014), p. 12, Link: http://www.ussif.org/files/publications/sif_trends_14.f.es.pdf
 PRI, ‘Annual Report 2015 – From Awareness to Impact’, (Jul 2015), p. 2 [ff.], 24, Link: http://2xjmlj8428u1a2k5o34l1m71.wpengine.netdna-cdn.com/wp-content/uploads/PRI_AnnualReport2015.pdf
 Source: Eurosif, ‘European SRI Study’, Report (2014): Link: http://www.eurosif.org/publication/download/european-sri-study-2014
 See e.g. a report of more than 100 studies: DB Climate Change Advisors, ‘Sustainable Investing: Establishing Long-Term Value and Performance’, Whitepaper (2012), Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2222740; and a comprehensive guide: Boston College, Centre for Responsible Investment, ‘Handbook on Responsible Investment Across Asset Classes’ (2008), Link: http://www.cof.org/files/images/ExecEd/bcrespinvesthndbk.pdf
 Source: Martina Macpherson, ‘ESG Integration across Asset Classes – a New Approach’, (Oct. 2012), p. 1, Link: https://yoursri.com/responsible-investing/newsletter/topic-of-the-month-october2012-integration-across-assetclasses
 Source: Heike Reichelt, ‘Getting to Know the Green Bond Market’, in Pension Fund Service Local Government – Green Bonds, (Apr 2015), p. 1, Link: http://treasury.worldbank.org/cmd/pdf/GettingtoKnowtheGreenBondMarket_PensionFundService.pdf
 Source: UNFCCC, ‘Copenhagen Accord - U.N. Framework Convention on Climate Change’, United Nations (Dec 2009), Link: http://unfccc.int/resource/docs/2009/cop15/eng/l07.pdf
 Source: EIB, Link: http://www.eib.org/investor_relations/press/2007/2007-042-epos-ii-obligation-sensible-au-climat-la-bei-oeuvre-a-la-protection-du-climat-par-le-biais-de-sonemission-a-l-echelle-de-l-ue.htm?lang=en
 Source: The World Bank, ‘World Bank and SEB partner with Scandinavian Institutional Investors to Finance "Green" Projects’, Press Release, (Nov 2008), Link: http://treasury.worldbank.org/cmd/htm/GreenBond.html
 Source: Climate Bonds Initiative, ‘Market History’, Link: http://www.climatebonds.net/market/history
 Source: oekom research, ‘Corporate Green Bonds: Challenges for a real contribution to sustainability’, in RI Insight: Green Bonds (Sept 2014), p. 22, Link: https://www.responsible-investor.com/reports/download/7af4735d38c3261450fb5a71f4048c2f
 Source: ICMA, ‘Green Bonds’, Link: http://www.icmagroup.org/Regulatory-Policy-and-Market-Practice/green-bonds