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ESG Funds Get ‘Brutal Wake-Up Call’ on Russian Bond Holdings

ESG Funds Get ‘Brutal Wake-Up Call’ on Russian Bond Holdings

  • Asset managers hold the bonds with default risks looming
  • ESG offerings own a fraction of the total $40 billion of debt

Some of the roughly $40 billion in Russian foreign-currency debt now at risk of default is held by a group of ESG funds that are designed to invest in so-called sustainable assets.

The Article 8 funds — a category under Europe’s environmental, social and governance investing rules — hold about $800 million of bonds issued by the government of Vladimir Putin that have a coupon payment due this week, according to data compiled by Bloomberg

The current value of the bonds is likely to be just a fraction of the reported amounts, with no clear roadmap for how investors will be repaid. Like other creditors who financed Putin’s government, which is now 21 days into its war on Ukraine, the ESG funds face deep losses and a protracted legal process as debt markets head into uncharted territory. 

Though ESG funds represent a small share of the total, they’ve still helped “finance the build-up of a war chest in Russia since 2014,” said Sasja Beslik, author of “Where the Money Tree Grows” and a former head of sustainable finance at Bank J Safra Sarasin AG who was recently hired by Denmark’s PFA pension fund.

See Related Article ESG Funds Had $8.3 Billion in Russia Assets Right Before War

It’s “a brutal wake-up call,” he said.

The Bloomberg analysis looked at Russian foreign-currency bonds due  2025, 2027, 2029, 2032, 2035, 2036. The search includes Russia’s sovereign dollar bonds that fall under Regulation S rules — for securities sold outside of the U.S. — and holdings of passive funds, including exchange-traded funds. For ETFs that track bond indexes, there’s little to no choice in what the funds buy or sell.It’s also worth noting that Bloomberg’s data doesn’t include all holdings by investors that aren’t required to disclose their debt transactions. 

If there’s a default on Russia’s foreign obligations, it would be the first time since the Bolsheviks refused to service or recognize the czar’s debts over a century ago.

The holdings of Russian bonds are the latest example of ESG investors holding assets that seem to clash with the label. Bloomberg data show that ESG funds held at least $8.3 billion in Russian assets right before the war, including stakes in state-backed firms such as Gazprom PJSC, Rosneft PJSC and Sberbank PJSC, as well as government bonds.

“In light of current events it is clearly unacceptable that Russian sovereign bonds should be listed in ESG funds,” Peter Uhlenbruch, interim director of financial sector standards at ShareAction, a London-based nonprofit that advocates for responsible investment. “Given that Russia was already under international sanctions for its annexation of Crimea, it’s certainly legitimate to ask why these bonds were in ESG funds in the first place.”

Putin’s government has said that all its debt will be serviced. But it also said investors from countries backing sanctions on Russia will be paid in rubles. If Russia fails to pay — or tries to pay foreign-currency bonds in rubles, which may be treated as a default — the fallout will hit not just the country’s sovereign bond market, but potentially all its corporate issuers as well. The full shock is likely to affect a Russian debt mound of about $150 billion.

“Everybody in the West — financial institutions, businesses, politicians — anticipated and assumed that we and Russia have skin in the game together, given the market’s economic covenant,” Beslik said. “Now it turns out that Russia has broken that covenant…and financial institutions as well as businesses have been taken for a costly ride, while people in Ukraine pay with their lives.”

— With assistance by Amine Haddaoui


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