FINANCE FINANCE EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT The Potential Implications of Economic and Social Rights for Sovereign Debt Investing Ekaterina Gratcheva, Bryan Gurhy, Dieter Wang, Anne-Marie Brook, K. Chad Clay, Susan Randolph © 2023 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of of The World Bank and the Human Rights Measurement Initiative Charitable Trust (HRMI). The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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If you wish to re-use a component of the work, it is your responsibility to determine whether permission is needed for that re-use and to obtain permission from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. This paper forms part of a series of publications under the Global in collaboration with World Bank Treasury, Development Program on Sustainability (GPS). The series is a knowledge Economics Vice Presidency, and other global practices. product of GPS Pillar 3 with the objective to promote the use Focusing on environmental, social, and governance (ESG) of high-quality data and analysis of sustainability to better issues in sovereign investing, the series disseminates practical, inform decisions made by governments, the private sector, and evidence-based recommendations for market participants, financial institutions. GPS Pillar 3 is led by the World Bank’s including institutional investors, sovereign issuers, credit rating Finance, Competitiveness and Innovation (FCI) Global Practice agencies, ESG data and service providers, among others. “A New Dawn - Rethinking Sovereign “Demystifying Sovereign ESG” ESG” proposes improvements to the focuses on comparing sovereign ESG sovereign ESG framework and builds on methodologies of leading sovereign findings and recommendations discussed ESG providers and presents structural in other papers in the series. challenges with the current sovereign ESG framework. “Riding the Wave: Navigating the ESG “Paving the Path: Lessons from Chile’s Landscape for Sovereign Debt Managers” Experiences as a Sovereign Issuer for provides a thorough discussion of Sustainable Finance Action” provides sovereign ESG from a debt management a focused study of Chile’s ESG focused office perspective. issuances to date and relevant lessons. “Spatial Finance: Challenges and “Credit Worthy: ESG Considerations in Opportunities in a Changing World” Sovereign Credit Ratings” demystifies in partnership with WWF discussed the role of ESG factors in country credit challenges with the E data, including at ratings and highlights the potential the sovereign level, and explores the use ESG impact on the creditworthiness of of satellite data to address the quality and countries with the application of the World availability of E data. Bank’s wealth and stranded asset data. The chapter “Natural Allies: Wealth “Natural Capital and Sovereign Bonds” and Sovereign ESG” from the book introduces the concept of ingrained “The Changing Wealth of Nations income bias and presents evidence that 2021: Managing Assets for the Future” sovereign bond yields reflect a country’s focuses on challenges in ESG data, and various types of natural capital. discusses solutions with the application of the World Bank Wealth data. Contents Abbreviations 4 Acknowledgments 5 Executive Summary 7 Relevance of Economic and Social Rights to Sovereign Debt Investors 8 Measuring Country Performance on ESRs 8 What insights can the ESR dataset provide for sovereign debt investors? 9 Operationalizing the dataset: Investing in economic and social rights 11 Next Steps 11 1. Introduction 13 Why Are Economic and Social Rights Relevant 2.  for Sovereign Debt Investors? 16 3. The Importance of Addressing the Income Bias in Sovereign ESG Data 21 What Insights Can the ESR Dataset Provide 4.  for Sovereign Debt Investors? 24 5. Sovereign Debt: Investing in Economic and Social Rights 28 6. Next Steps 35 References 36 Appendix A: Extended History of Credit Rating Agencies 39 Appendix B: Index Weight Reallocations and Tilt Strength, by Income Classification 40 Appendix C: Index Weight Reallocations and Tilt Strength, by Geographic Region 41 Appendix D: Beyond Income and Credit Ratings—What ESRs Can Teach Us about Individual Countries. Case Study: South Africa and Brazil 42 Appendix E: Detailed Methodology of the ESR Dataset 43 Appendix F: Bayesian Measurement Model 47 Appendix G: Data Collection Challenges 48 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 3 Abbreviations APF achievement possibility frontier CPRs civil and political rights EAP East Asia and Pacific ECA Europe and Central Asia EMBI Emerging Market Bond Index (J.P. Morgan) EPI Environmental Performance Index (Yale) ESG environmental, social, and governance ESRs economic and social rights FAO Food and Agriculture Organization of the United Nations GDP gross domestic product GPS Global Program on Sustainability HRMI Human Rights Measurement Initiative JME joint child malnutrition estimates JMP Joint Monitoring Programme LAC Latin America and Caribbean LMIC lower-middle-income country MENA Middle East and North Africa ND-GAIN Notre Dame Global Adaptation Initiative (country index) OECD Organisation for Economic Co-operation and Development OHCHR Office of the High Commissioner for Human Rights PISA Program for International Student Assessment PPP purchasing power parity SA South Asia SDG Sustainability Development Goal SERF Social and Economic Rights Fulfillment (index and project) SSA Sub-Saharan Africa UMIC upper-middle-income country UNESCO United Nations Educational, Scientific and Cultural Organization UNICEF United Nations Children’s Fund UN PRI United Nations Principles for Responsible Investment 4 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT Acknowledgments This publication was produced by a team consisting of Ekaterina Gratcheva; Bryan Gurhy and Dieter Wang from the World Bank Group; Anne-Marie Brook, Human Rights Measurement Initiative (HRMI); K. Chad Clay, HRMI and GLOBIS Center, University of Georgia; Susan Randolph, HRMI and the Social and Economic Rights Fulfillment (SERF) Project, University of Connecticut. The team would like to thank the following individuals for comments received during the review process: Aart C. Kraay (Development Economics Vice-Presidency, World Bank); Sophie Logan (Finance, Competitiveness, and Innovation (FCI) Global Practice, World Bank); Ruth Hill (Poverty and Equity Global Practice, World Bank); Heike Reichelt, Ivana Pavlovic, Rodrigo Cabral and Tapiwa Sikipa (World Bank Treasury); J. Clifford Frazier, Siobhan McInerney-Lankford, and Victor Bundi Mosoti (Legal Vice-Presidency, World Bank); Rekha Reddy (FCI Global Practice, World Bank); Rachel Mok (Climate Change Global Practice, World Bank); Sara Grut (Goldman Sachs); Lee Clements and Julien Moussavi (FTSE Russell); Nick Polowchena (J.P. Morgan); Ashley Schulten (BlackRock); Fergus McCormick (Emerging Markets Investors Alliance); Carmen Nuzzo and Jasper Cox (United Nations Principles for Responsible Investment); David Lubin (Citi Group); Layna Mosley (Princeton University); and Jarrad Linzie (MSCI). A special thank you to Jean Pesme (global director of the FCI Global Practice of the World Bank Group); Niraj Verma and Anderson Silva (FCI managers); Elizabeth Price (senior external affairs officer, FCI communications); Nandita Roy (external affairs officer, FCI communications); and Siobhan McInerney- Lankford (Legal Vice-Presidency, World Bank) for their stellar support and guidance. The views expressed herein are solely those of the authors and should not be attributed to the World Bank. The report was edited by Daryl Martin and Marcy Gessel, Publications Professionals LLC and designed by Hanna Chang We thank them all. Authors’ E-Mail Addresses: egratcheva@imf.org; bgurhy@worldbank.org; dwang5@worldbank.org; anne-marie.brook@hrmi.ngo; susan.m.randolph@gmail.com; kcclay@uga.edu PHOTO CREDITS Cover: Robert Boyer, Unsplash Page 20: Google Earth Page 2: Pixabay Page 23: Pixabay Page 6: Pixabay Page 24: Pixabay Page 11: Pixabay Page 28: Ihor Oinua, Unsplash Page 12: Khasar Sandag / World Bank Page 34: Mike Von, Unsplash Page 14: Kostiantyn Stupak, Pexels Page 47: Simone D. McCourtie / World Bank Page 16: Clodagh Da Paixao, Unsplash Page 48: Climate Investment Funds Page 17: Climate Investment Funds THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 5 >>> Executive Summary This paper, written jointly with the Human Rights Measurement Initiative (HRMI), discusses one branch of human rights—namely economic and social rights (ESRs), which are fundamental to countries’ long-run sustainability. While human rights are universal, inalienable, indivisible, interdependent, and interrelated, they can be realized on different time horizons. For instance, the obligations underpinning economic, social, and cultural rights are subject to the principle of progressive realization, which means that better performance is expected as countries grow their resources. It is common for countries to progress more on their obligations under one set of rights and less under another. Nevertheless, in the overall goal for all people to lead a life of dignity and to contribute to a country’s long-run sustainability, countries displaying weaknesses in specific areas of human rights ultimately have a weaker foundation than countries that do not. This publication is the product of the World Bank’s ongoing proactive engagement with the finance industry on pertinent sovereign environmental, social, and governance (ESG) issues. It forms part of a series disseminating practical, evidence-based recommendations for market participants.1 Our active dialogue with the industry reveals that investors seek evidence- based ways to reflect various aspects of sovereign sustainability in the investment process. Our previous publications identified structural issues in prevailing sovereign ESG approaches, such as the lack of clarity in objectives in developing sovereign ESG frameworks, the conflation of risk management and sustainability in the application of sovereign ESG methodologies in the investment process, difficulty with measuring investment impact at the sovereign level, and the perverse impact of an ingrained income bias that adversely affects many sovereign ESG metrics and industry practices (Gratcheva et al. 2021). The World Bank’s ongoing engagement in sovereign ESG investing with market participants recalls the fact that human rights issues are complex. While the World Bank’s development mandate, derived from its Articles of Agreement, does not directly or explicitly relate to human rights, there are links between human rights and development. Subject to the limits of the World Bank’s mandate and the constraints imposed by the Articles on the organization’s decision-making with respect to political considerations, the World Bank can support its member countries in fulfilling their human rights obligations through the financial and technical support that it provides. 1 The series is published under the auspices of the Global Program on Sustainability (GPS), which is funded by the GPS. HRMI’s contributions to this research were part-funded by the Open Society Foundations and the University of Connecticut. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 7 Certain investors in sovereign debt are beginning to pay have strong institutional settings and governance processes, more attention to human rights issues when designing indicating a robust public policy,4 which helps create the their investment mandates. While some investors are conditions for quality economic policies and institutions that can legally mandated to consider human rights in their investment help lower a government’s financing costs (Abate et al. 2021). process either as part of an ESG framework or otherwise, others are not. Various international guidelines and principles may also have a bearing on this issue.2 In recent years, many M EAS U RING CO U NTRY in the investment industry have highlighted the potential role PERFO RM ANCE O N ES RS that investors can play in influencing a country’s decisions on environmental and social issues, including human rights Reducing inequalities and ensuring no one is left behind (United Nations Principles for Responsible Investment [UN are integral to a country’s longer run sustainability. PRI] 2020, 2022). This potential to influence a sovereign’s Research has found that many of the ESG metrics, including actions is very pertinent to social issues, given a state’s direct the SDGs, the Notre Dame Global Adaptation Initiative (ND- role in providing social entitlements and benefits to its citizens. GAIN), Yale’s Environmental Performance Index (EPI), and other indices widely used in the industry, are marred by an ingrained income bias that leads to perverse incentives to divert RELEVA N C E O F EC O N O M I C A ND capital from lower-income countries toward higher-income countries (Gratcheva, Emery, and Wang 2021; Gratcheva, SO C IA L R IG H TS TO S OV E R E I GN Gurhy, Emery et al. 2021). It is therefore essential for investors DEBT IN VESTO R S who want to align their portfolios with sustainability to focus The realization of ESRs is intrinsic to sustainable on factors that contribute to sustainability adjusted for where development, overlaps with several Sustainable a country is in its economic development. This approach Development Goals (SDGs), and forms a core pillar of enables investors to direct more capital to the countries that a sovereign’s social fabric. Sustainable development,3 the are most effective in achieving social and other nonfinancial process by which a country reaches the goal of sustainability, goals within their specific level of development. focuses on meeting the present’s needs without compromising This paper draws on a country-level dataset (“the ESR the ability of future generations to meet their own needs. ESRs, dataset”) developed by the Human Rights Measurement as well as civil and political rights (CPRs), provide a legal Initiative (HRMI) that is a variant of the HRMI/SERF basis for many of the commitments in the SDGs, which are Economic and Economic Rights Fulfillment dataset and not themselves legally binding. ESRs ensure that everyone measures a country’s performance on ESRs adjusted for has access to the basic goods, services, and opportunities that country’s stage of development. While the World Bank necessary to survive and thrive. has had no role in the methodology or design of this dataset, The rationale for sovereign debt investors to focus more we highlight its relevance for ESG investors in sovereign debt. explicitly on ESRs is strong. Empirical evidence suggests A key reason for this is the income adjustment which means that there is a complementary relationship between policies that that the ESR dataset assesses how well countries are using support the fulfillment of ESRs and the enjoyment of economic their resources to bring about good outcomes for people in five growth in the future (Aghion, Caroli, and García-Peñalosa distinct areas: (a) education, (b) food, (c) health, (d) housing, 1999; Hamoudi and Sachs 1999; Krueger and Lindahl 2001; and (e) work. Countries that do this well within their level of Perry et al. 2006; Randolph and Guyer 2012; Ranis, Stewart, economic and financial resources attain high ESR scores and and Ramirez 2000). Countries that invest in universal education can be seen as efficiently promoting sustainable development and health care build the foundations for a productive economy through their institutions, laws, and public policies. The and future innovation, which may boost their ability to service ESR dataset has recently been added to the World Bank’s their debt obligations. Countries with better ESRs generally Sovereign ESG Data Portal.5 2 Examples of these guidelines and principles include national laws in France, the Netherlands, and Norway; the European Commission’s adoption of a proposal for a directive on corporate sustainability due diligence, including human rights (European Commission, n.d.); “Guidelines for Multinational Enterprises” (OECD 2012); and “Responsible Business Conduct for Institutional Investors” (OECD 2017). 3 Sustainable development focuses on two key concepts: (a) needs, particularly the essential needs of the world’s poor, to which overriding priority should be given, and (b) the idea of limitations imposed by the state of technology and social organization on the environment’s ability to meet present and future needs (Brundtland Report 1987). 4 There is substantial overlap between the ESRs and the Governance pillar of sovereign ESG ratings. 5 The Economic and Social Rights Performance Score is available on the Sovereign ESG Data Portal with a lag of one year. A more up-to-date version of this score is available from HRMI. The ESR dataset which serves as an input to the calculation of the Economic and Social Rights Performance Scores is HRMI’s income-adjusted country scores, which are the same as the SERF Index data and are available for download on the HRMI website at https://humanrightsmeasurement.org/download-the-dataset/ (see data files: LMY_YAdj_file.xlsx and HiY_YAdj_file.xlsx) or https://serfindex.uconn.edu/2021-update-international-serf-index-data/ (see data files: LMY_SERF_Data and HiY_SERF_Data). 8 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT WHAT IN SIG H TS CA N T H E we move down the income spectrum into non–investment grade ratings because sovereign credit assessments for ES R DATASE T P ROV I DE FO R these countries focus on traditional credit metrics, such as SOVERE IG N DE BT I N V ES TO R S? fiscal and debt measures (Gratcheva, Gurhy, Skarnulis et al., The ESR dataset can provide insights for sovereign 2021). Nevertheless, because ESRs contribute to sovereign debt investors for two primary reasons. First, ESR scores sustainability (financially and otherwise), one would expect a provide additional information to sovereign credit ratings, closer link between a country’s performance on these rights especially for lower-income countries. As illustrated in and its sovereign credit rating. This highlights the additional figure ES.1, high-income countries with better ESR scores insights for sustainability-focused investors, in addition tend to have a lower sovereign credit risk (that is, a higher to traditional sovereign credit rating assessments- which investment-grade rating). However, this is not the case as invariably focuses on short-term dynamics. FIGURE ES1 - ESR scores offer a distinct perspective when compared with sovereign credit ratings for countries at low and middle income levels Sources: HRMI/Social and Economic Rights Fulfillment (SERF) Index; Fitch Ratings; S&P Global Ratings; Moody’s Investor Services. Note: The average correlation between ESR and sovereign credit ratings is 0.53 for all countries, 0.47 for high-income countries, −0.13 for upper- middle-income countries, 0.13 for lower-middle-income countries, and −0.08 for low-income countries. ESR = economic and social rights. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 9 Second, ESR scores are particularly useful for sovereign this indicator could also be supplemented with additional debt investors who focus more explicitly on sustainability insight into the current government policies and overall quality outcomes. For investors focusing on their investment impact of governance to account for the lagged nature of the dataset. (in terms of environmental, social, or SDGs), ESR scores are Figure ES.2 shows that ESR scores and average ESG scores useful, as they measure how well countries are performing on (standardized) show strong correlations for high-income ESRs given their level of development and the dataset reflects countries only, again highlighting the additionality of the ESR the effectiveness of governance and the quality of social dataset compared with sovereign ESG scores, particularly for policies up to a given moment in time. For impact investors, lower-rated sovereigns. FIGURE ES2 - ESR scores and average ESG scores (standardized) are strongly correlated for high-income countries only Source: HRMI/Social and Economic Rights Fulfillment Index, Fitch Ratings, S&P Global Ratings, Moody’s Investor Services. Note: The average correlation between ESR and ESG scores is 0.70 for all countries, 0.72 for high-income countries, 0.01 for upper-middle- income countries, 0.58 for lower-middle-income countries, and 0.35 for low-income countries. ESR = economic and social rights. 10 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT OP E RAT ION AL I ZI N G T H E NEXT S TEPS DATASE T: IN V ES T I N G I N This paper describes how investors can already start EC ON OM IC AN D S O C I A L R I G HTS to incorporate a specific category of human rights— ESRs—into their investment process, thus focusing We explore one potential use case of the ESR dataset more explicitly on a country’s longer-term sustainability. by tilting an existing government bond index toward While the ESR dataset is naturally slow moving in acquiring countries with better ESR scores. The ESR-tilted index information (and it lags), it provides empirical evidence for a reallocates index weights toward countries with better ESR country’s longer-run growth potential, making it both relevant scores (adjusted for their level of development), thus allowing and forward looking. investors to better align their sovereign bond portfolio with a country’s performance on ESRs. More work is needed to understand the relationship between a country’s performance on ESRs and Investors often prefer tilting rather than excluding other measures of sovereign sustainability, such as certain issuers from their investment portfolios, creditworthiness over time or advancement toward the because the more limited universe of issuers in SDGs. It is only when the dynamics of these relationships sovereign debt (compared with a much larger universe are clear that the full potential of analyzing a country’s of corporate issuers) is challenging in terms of portfolio performance on ESRs will be appreciated. diversification. (Nevertheless, exclusions may be preferred for certain themes, such as CPRs). However, we emphasize Finally, while this paper presents one potential the fact that investors who are more focused on sustainability application of the ESR dataset, it also has potential both do not always favor the index-tilting approach, as it is more as a key performance indicator for the sustainability-linked challenging with respect to measuring positive outcomes and bond market and in the investment process as a measure attributing the impact of an investment.6 of the ex-post investment impact. Continued work on both applications with market practitioners is necessary to realizing the dataset’s full potential. 6 As shown in figure 5.2 and appendix B, repeated tilts can boost the effect on the index or portfolio. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 11 1. 12 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT >>> Introduction This paper discusses both the relevance of economic and social rights (ESRs) for environmental, social, and governance (ESG) investing in the sovereign debt asset class and how to start incorporating these rights into the investment process in a practical way. Many in the investment industry recognize the potential role that investors can play in influencing a country’s decisions on environmental and social issues, including human rights (UN PRI, 2020, 2022). Investors are also increasingly acknowledging the potential to influence a sovereign’s actions on social issues, such as ESRs, given the state’s direct role in providing a pathway to social advancement for its citizens. This publication, written jointly with the Human Rights Measurement Initiative (HRMI), is the product of the World Bank’s proactive engagement on pertinent sovereign ESG issues with the industry.7 Our previous research highlights the lack of clarity around sovereign ESG frameworks, the difficulty in measuring investment impact, and the concerns around the ingrained income bias that mars many sovereign ESG metrics and industry practices. The result of this bias means that 90 percent of a country’s ESG performance can be explained by that country’s level of income (Gratcheva et al. 2021). This paper draws on a country-level dataset (“the ESR dataset”) developed by HRMI that measures a country’s performance on ESRs adjusted for that country’s stage of development. The World Bank has no role in the development of the methodology behind, or in the production of, this dataset and does not use it for its own investment purposes. Sovereign debt investors are at different stages in their ESG investment journeys. Sovereign debt as an asset class has been the most challenging to fit into an existing set of ESG frameworks/methodologies given the complexities in defining sovereign sustainability and its metrics. Nevertheless, some investors, driven by asset owners and regulatory pressures,8 are beginning to focus on ESG factors as an “output”—or impact—of the investment process rather than as “input” parameters in their investment decisions. In this output approach, ESG factors may influence the financial value of an investment and reflect its impact on broader, nonfinancial systems. This changing shift in investor perspective is observable in a recent J.P. Morgan Investor survey (J.P. Morgan 2022), in which 30 percent of respondents said that sustainability is integral 7 This publication is part of a series produced under the auspices of the Global Program on Sustainability (GPS). 8 Regulation (EU) 2019/2088 of the European Parliament and the Council of 27 November 2019 on Sustainability- Related Disclosures in the Financial Services Sector, document 32019R2088, https://eur-lex.europa.eu/legal-content/EN/ TXT/?uri=celex%3A32019R2088. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 13 to their sovereign ESG framework, while 60 percent have a separate but complementary Sustainable Development Goal (SDG) framework and 10 percent assess sustainability apart from the ESG framework. However, a continuous challenge for investors who wish to use the output approach has been how to attribute an impact or a positive outcome to an investment (Gratcheva, Gurhy, Emery et al. 2021). Our engagement with the industry revealed that investors are looking for evidence-based ways to reflect various aspects of sovereign sustainability in their investment processes. We present one possible mechanism for aligning sovereign debt investment portfolios with specific objectives to contribute to more sustainable outcomes by drawing on new country-level data on ESRs: the HRMI/SERF Economic and Social Rights Dataset. While the World Bank does not endorse this particular dataset or methodology, previous A note on the World Bank’s engagement with ESRs. While World Bank research highlights the attractiveness of this the World Bank’s development mandate, derived from its dataset for ESG investors in the sovereign debt asset class Articles of Agreement, does not directly or explicitly relate to (Gratcheva et al. 2021). The dataset is relevant for investors human rights, there are linkages between human rights and focused on traditional sovereign debt mandates and for those development, including those in the World Bank’s work. The focused on return on investment and sustainable outcomes. organization can support its member countries in fulfilling their A variant of this dataset, the Economic and Social Rights human rights obligations through the financial and technical Performance Score, has recently been added to the World support it provides, subject to the limits of its mandate and Bank’s Sovereign ESG Data Portal.9 the constraints imposed by the Articles on its decision-making While this publication focuses solely on ESRs, it is with respect to political considerations. In addition, the World important to acknowledge that civil and political rights Bank’s continued work on sustainable finance, particularly (CPRs) are also considered central to sustainability.10 on ESG investing in the sovereign debt asset class, shows ESRs ensure that all people have access to the basic that human rights are an issue that increasingly arises among goods, services, and opportunities necessary to survive investors and end-asset owners. and thrive, which includes discrimination-free access to an The rest of this paper is organized as follows. Section 2 adequate standard of living, the right to work, fair wages explains the relevance of ESRs to the sovereign debt asset and equal remuneration for work of equal value, the right to class. Section 3 introduces the income adjusted ESR dataset, the enjoyment of the highest attainable standard of physical and section 4 illustrates the insights that this dataset can and mental health, and the right to education. Empirical provide for sovereign debt investors. Section 5 provides one evidence suggests that policies that support the fulfilment of practical example of how sovereign debt investors could use ESRs and sustainable economic growth in the future strongly such a dataset in practice. Section 6 presents our conclusions. complement one another (Randolph and Guyer 2012). The appendix presents further background on, and the Figure 1.1 illustrates how the ESR dataset relates to current methodology for, the ESR dataset. measures of attainment of the SDGs. 9 The Economic and Social Rights Performance Score is available on the Sovereign ESG Data Portal with a lag of one year. A more up-to-date version of this score is available from HRMI. The ESR dataset which serves as an input to the calculation of the Economic and Social Rights Performance Scores is HRMI’s income-adjusted country scores, which are the same as the SERF Index data and are available for download on the HRMI website at https://humanrightsmeasurement.org/download-the- dataset/ (see data files: LMY_YAdj_file.xlsx and HiY_YAdj_file.xlsx) or https://serfindex.uconn.edu/2021-update-international-serf-index-data/ (see data files: LMY_SERF_ Data and HiY_SERF_Data).. 10 Indeed, a key advance of the SDGs over the Millennium Development Goals was that they not only included features that relate to CPRs but also recognized the importance of participation, accountability, inclusion, and institutions. 14 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT FIGURE 1 - Linking the ESR dataset with the SDGs SDGs ESRs Source: World Bank and HRMI staff illustration. Note: The ESR dataset (illustrated above by the five icons in the inner circle) complements SDG monitoring by distinguishing between countries that fail to meet the goals because of resource constraints as opposed to those that fail to meet the goals because they are not effectively marshaling their resources to do so (Randolph and Brook 2019). The graphic shows the main links between ESRs and SDGs and illustrates that the five ESRs are linked to all of the SDGs, either directly or indirectly, through various transmission channels. ESRs = Economic and Social Rights; SDGs = Sustainable Development Goals. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 15 2. >>> Why Are Economic and Social Rights Relevant for Sovereign Debt Investors? ESRs have not often to date been explicitly considered as part of the investment process for sovereign debt investors because other headline issues have been dominant. While there is growing awareness of and an interest in considering human rights in the investment process (box 2.1),11 sovereign bond investors typically focus on civil and political rights (CPRs),12 and they have been dealing with this issue primarily by excluding specific issuers from their investment portfolios (Financial Times 2021). While some aspects of human rights issues are often included in the governance and social pillars of sovereign ESG frameworks, these rights have always been a sensitive issue for several reasons, so they have not taken their proper place in sovereign ESG frameworks. Recently, there has also been increased discussion about the ethics that fund managers face in managing the assets of more authoritarian states (Nangle 2023). 11 The recently established Shift Project is intended to examine investor needs and challenges concerning the management of human rights issues: https:// shiftproject.org/. 12 We note that in addition to the ESR dataset introduced here, a second HRMI dataset uses an expert survey methodology to produce a CPR dataset for a smaller number of countries that is growing each year (Brook et al., 2020; Clay et al. 2020; Clay et al. 2021). To address the incomplete country coverage in this dataset, the HRMI team have also developed a more complete dataset by also drawing on other publicly available civil and political rights data. 16 The realization of ESRs is intrinsic to sustainable The rationale for sovereign debt investors to focus more development and provides a strong foundation for on ESRs is strong. Empirical evidence suggests that the specific components of the UN’s SDGs. Sustainable policies that support the fulfilment of ESRs and the enjoyment development is an inclusive, participatory process by which of economic growth in the future complement one another a country reaches the goal of sustainability; 13 it focuses on (Aghion et al. 1999; Hamoudi and Sachs 1999; Krueger and meeting the present’s needs without compromising the ability Lindahl 2001; Perry et al. 2006; Randolph and Guyer 2012; of future generations to meet their own needs. The renewed EU Ranis, Stewart, and Ramirez 2000). Countries that invest in Sustainable Development Strategy (Council of the European universal education and health care build the foundations for Union 2006), articulates that sustainable development aims a productive economy and future innovation. Improvements in “at the continuous improvement of the quality of life and well- a country’s ESRs foster access to education, the right to work, being on Earth for present and future generations.” and the alleviation of poverty. These determinants of economic growth and prosperity may boost a country’s ability to service It is important to distinguish between the effects its debts while helping to ensure that all people have access of different aspects of human rights on a country’s to the basic goods, services, and opportunities necessary to sustainable development and the time horizon over survive and thrive in an equal and sustainable society. which they occur. ESRs as well as CPRs provide a legal basis for many of the commitments in the SDGs, which are Countries with better ESRs generally have strong not themselves legally binding. Indeed, a key advance of the institutional settings and governance processes, SDGs over the Millennium Development Goals is that they not indicating robust public policy.14 Countries where only include features that relate to CPRs but also recognize institutional frameworks are weak, corruption is high, and the importance of participation, accountability, inclusion, and public funds may be misused are generally associated with institutions. a higher credit risk and weaker performance on ESRs than are other countries at similar income levels. On the other ESRs ensure that all people have access to the basic hand, countries with strong institutions and governance goods, services, and opportunities necessary to survive frameworks are generally associated with a lower credit risk and thrive. In international law, these rights can be defined as and stronger performance on ESRs. The main reason for the discrimination-free access to an adequate standard of living; difference is that strong institutions and governance play a the right to work, fair wages, and equal remuneration for key role in enabling public policy to foster better ESRs and work of equal value; the right to the enjoyment of the highest quality economic policies that can help lower a government’s attainable standard of physical and mental health; and the financing costs (Abate et al. 2021). right to education. 13 Sustainable development focuses on two key concepts: (a) needs, particularly the essential needs of the world’s poor to which overriding priority should be given, and (b) the idea of limitations on technology and social organization imposed by the state on the environment’s ability to meet present and future needs (Brundtland 1987). 14 There is substantial overlap between the ESRs and the Governance pillar of sovereign ESG ratings. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 17 > > > BOX 2.1 - How economic and social rights fit into the broader area of human rights and their relevance to investors WHAT ARE HUMAN RIGHTS? Human rights are universal legal guarantees that protect individuals and groups against actions and omissions that interfere with fundamental freedoms, entitlements, and human dignity (OHCHR 2006). Human rights are the subject of legal obligations, which are obligations that have their source in the United Nations (UN) Charter, treaties,a customs, and general principles of law. Investors in sovereign debt have varying mandates that largely dictate their investment activities in this asset class. While some investors are legally mandated to consider human rights in their investment process, either as part of an environmental, social, and governance framework or otherwise, others are not. Various international guidelines and principles may also have a bearing on whether and the extent to which investors consider human rights in their processes.b While the human rights agenda has been formalized for many decades, it is only recently that human rights have become a focus for investors (figure B.2.1.1). Since the UN Guiding Principles on Business and Human Rights were adopted in 2011, they have been integrated into global standards, laws, and initiatives relevant to business and to human rights. Numerous public and private sector alliances, announcements, and product offerings complement these initiatives. More recently, two UN-supported Principles for Responsible Investing (PRI) initiative reports on human rights not only highlight the deep connectedness of sovereign debt and human rights but also encourage investors to engage with governments (UN PRI 2020, 2022). FIGURE B2.1.1 - Human rights and investing 1922 International Federation for Human Rights 1948 Universal Declaration of Human Rights 1965 International Convention on the Elimination of All Forms of Racial Discrimination 1966 International Covenant on Civil and Political Rights International Covenant on Economic, Social and Cultural Rights 1979 Convention on the Elimination of All Forms of Discrimination against Women 1984 Convention against Torture and Other Cruel, Inhuman or Degrading Treatment or Punishment 1989 Convention on the Rights of the Child 1990 International Convention on the Protection of the Rights of All Migrant Workers and Members of Their Families 1999 World Bank: Worldwide Governance Indicators 2000 OECD Guidelines for Multinational Enterprises 2006 United Nations Human Rights Council International Convention for the Protection of All Persons from Enforced Disappearance Convention on the Rights of Persons with Disabilities 2008 UN Protect, Respect and Remedy Framework 2011 UN Guiding Principles on Business in Human Rights I OECD Guidelines for Multinational Enterprises, revised 2017 OECD Responsible Business Conduct for Institutional Investors 2019 World Bank: Sovereign ESG Data Portal 2020 UN PRI report "Why and how investors should act on human rights" 2022 UN PRI report "Human rights in sovereign debt: the role of investors" 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 Source: World Bank, HRMI Continue on next page 18 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT Continued from previous page HOW DO ESRS FIT UNDER THE HUMAN RIGHTS UMBRELLA? Economic and social rights (ESRs) are a key part of the human rights family, as illustrated in table B.2.1.1.c Human rights are universal, inalienable, interdependent, interrelated, and indivisible (OHCHR 2012), which means that their status and value are equal, not hierarchical (Donnelly 2013).d For example, it would be impossible to fully enjoy one’s right to political participation without also enjoying one’s right to education. Likewise, a right to food without the right to freedom from extrajudicial killing, or vice versa, would largely be meaningless; the two sets of rights mean more together than they do apart. TABLE B2.1.1 - A non-exhaustive overview of human rights: What’s the difference between economic, social, civil, and political rights? ECONOMIC AND SOCIAL RIGHTS CIVIL AND POLITICAL RIGHTS ● the right to education ● the right to freedom from arbitrary arrest ● the right to food ● the right to freedom from forced disappearance ● the right to health ● the right to freedom from the death penalty ● the right to housing ● the right to freedom from extrajudicial execution ● the right to work ● the right to freedom from torture and ill-treatment ● the right to assembly and association ● the right to opinion and expression ● the right to participate in government Source: Adapted from UN PRI 2021. Note: Under Article 2(1) of the International Covenant on Economic, Social and Cultural Rights, economic and social rights (ESRs) are subject to the principle of progressive realization, while civil and political rights (CPRs) are not. The topic of human rights is complex. While human rights are indivisible, interdependent, and interrelated, they can be realized on different trajectories. For instance, fulfilling economic, social, and cultural rights is subject to the principle of progressive realization, while states are obligated to immediately fulfill civil and political rights. Moreover, it is possible for a country to improve its performance on one set of rights (say, ESRs) without simultaneously improving its performance on civil and political rights, and vice versa. In this context, one way to conceptualize human rights is as an interconnected net, pieced together to ensure that it can catch people before they fall below a life of dignity. If one of the ropes that make up the net is broken, it is much easier for someone to fall through the hole it leaves behind. This implies that countries that are weak in certain areas of human rights ultimately have a weaker foundation than countries that are not weak in these areas—in the overall goal for all people to lead a life of dignity. a. According to OHCHR (n.d.), there are nine core international human rights instruments. Each of these instruments has established a committee of experts to monitor implementation of the treaty provisions by its states’ parties. Some of the treaties are supplemented by optional protocols dealing with specific concerns, whereas the Optional Protocol to the Convention against Torture establishes a committee of experts.” b. Examples of these guidelines and principles include national laws in France, the Netherlands, and Norway; the European Commission’s adoption of a proposal for a directive on corporate sustainability due diligence, including human rights (European Commission, n.d.); the Organisation for Economic Co-operation and Development’s “Guidelines for Multinational Enterprises” (OECD 2012); and “Responsible Business Conduct for Institutional Investors” (OECD 2017). c. Table B.2.1.1 provides specific examples of the rights in the two distinct categories of human rights. However, it does not provide a comprehensive overview, because it excludes not only several rights in each category but also some categories of rights, particularly cultural rights (and the various anti-discrimination rights if they are considered separately). d. This view reflects the fundamental unity of all human rights in the Universal Declaration of Human Rights even though they are reflected in two treaties: the International Covenant on Economic, Social and Cultural Rights and the International Covenant on Civil and Political Rights. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 19 3. 20 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT >>> The Importance of Addressing the Income Bias in Sovereign ESG Data Reducing inequalities and ensuring that no one is left behind are integral to achieving a country’s longer run sustainability. Research has found that many of the ESG metrics, including the SDGs, Notre Dame Global Adaptation Initiative (ND-GAIN), Environmental Performance Index (EPI), and other indices widely used in the industry, are marred by an ingrained income bias that leads to perverse incentives to divert capital from lower-income countries toward higher-income countries (Gratcheva, Emery, and Wang 2021; Gratcheva, Gurhy, Emery et al. 2021; Gratcheva, Gurhy, Skarnulis et al. 2021). It is therefore essential for investors who want to align their portfolios with sustainability to focus on factors that contribute to sustainability adjusted for where the country is in its economic development. This approach would enable investors to direct more capital to the countries that are most effective in achieving social and other nonfinancial goals within their specific level of development. The ESR dataset is constructed to address the ingrained income bias. The dataset is derived from socioeconomic indicators that are comparable across countries.15 By adjusting for a country’s level of income, the ESR dataset assesses how well that country is using its resources to bring about good outcomes for people in five distinct areas: (a) education, (b) food, (c) health, (d) housing, and (e) work. Countries that do this well within their level of economic and financial resources attain high ESR scores and can be seen as efficiently promoting sustainable development through their institutions, laws, and public policies. In higher-income countries, a larger percentage of the population typically enjoys ESRs than does the share of the population in lower-income countries because it takes resources to fulfill these rights. Consistent with capturing country obligations as set out in international human rights law, the ESR dataset benchmarks these obligations according to historical evidence on what countries have shown it is possible to achieve at different per capita income levels. 15 Indicators are selected not only on the basis of data availability and cross-country comparability but also on the basis of the extent to which they can act as bellwethers that capture high-level trends and that cannot easily be gamed by governments. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 21 The Achievement Possibility Frontier (APF) benchmarks The scatter plot in figure 3.1 illustrates how the income- are at the heart of the income adjustment. The APF adjustment methodology works by using the example of identifies what the best-performing countries have shown is secondary school enrollment rates. Each dot represents a achievable at each income level (figure 3.1). This measure country’s performance in a particular year plotted against its per is conceptually similar to the Markowitz efficient frontier for capita gross domestic product (GDP) in 2017 purchasing power investment portfolios. Even in the absence of any government parity (PPP) dollars. The APF, the red curve in the diagram, effort, some percentage of the population would enjoy many forms the outer envelope of the scatter plot, defining what of the rights, and this percentage reflects a natural minimum. enrollment rates can be achieved at each income level. This This natural minimum threshold differs by right and reflects example shows that Tajikistan is performing significantly better a country’s expected achievement on a given right in the (that is, closer to the 100 percent target line) than Guatemala absence of any effort by the government. The threshold is in terms of converting its resources into good secondary school specified as the lowest value of a right’s indicator observed participation rates even though Tajikistan’s GDP per capita (at in the last quarter century. A country’s score is calculated as $2,317 in 2017 PPP) is significantly lower than Guatemala’s the percentage of the benchmark achieved beyond the natural ($8,448 in 2017 PPP). In contrast with Guatemala, Malaysia is minimum. Additionally, for countries that have more than not doing too badly. However, it has more than enough income enough income to ensure that all of their people enjoy a given to ensure that 100 percent of its secondary-school-age children aspect of a right but fail to do so, a penalty is deducted from are enrolled in secondary school. Thus, a penalty would be their ESR score. The greater the country’s income, the higher applied to Malaysia’s ESR score. the penalty and the lower the country’s actual achievement. FIGURE 3.1 - Achievement Possibility Frontier 100% 100% net secondary school enrollment 90% Tajikistan TARGET 80% Malaysia 70% 60% A LONG 50% WAY BEHIND Guatemala 40% 30% 20% 10% 2,000 6,000 10,000 14,000 18,000 22,000 26,000 30,000 per capita income Source: HRMI. Note: The natural minimum for secondary school is set at 0 and so is not shown here. 22 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT The five rights-specific scores are combined into an credible intervals to reflect the uncertainty associated with this overall country ESR score via a Bayesian latent variable estimation strategy. Appendix A provides a complete set of model. Because some countries are missing scores for one indicators while Appendixes E and F provide an overview of the or more components, country coverage of the ESR dataset is dataset, the scoring methodology, and the modeling. Appendix expanded by using the HRMI/SERF income-adjusted indicator D highlights the importance of understanding country context scores as inputs into a Bayesian latent variable model. This when interpreting data and Appendix G discusses some of the model provides an overall ESR score, the Economic and challenges posed by the underlying data collection. Social Rights Performance Score, for all countries and with THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 23 4. >>> What Insights Can the ESR Dataset Provide for Sovereign Debt Investors? The ESR dataset can provide insights for sovereign debt investors for two primary reasons regardless of whether the investors follow traditional or more impact-orientated investment mandates. First, ESRs scores provide additional information to sovereign credit ratings, especially for lower-income countries. Figure 4.1 plots the ESR scores of individual countries against sovereign credit ratings. For high-income countries, there is a strong correlation between the two variables; countries with better ESR scores tend to have a lower sovereign credit risk. However, this relationship becomes weaker as we move down the income spectrum into non–investment grade ratings. This shift is likely tied to the fact that sovereign credit assessments for lower-income countries tend to focus on traditional metrics, such as fiscal and debt measures (Gratcheva, Gurhy, Skarnulis et al. 2021). However, because ESRs contribute to sovereign sustainability, one would expect a closer link between a country’s performance on these rights and its sovereign credit rating. Indeed, many in the investor community also believe this to be true. For example, in a recent investor survey of emerging market investors, nearly 80 percent of respondents said that they believe that “improving ESG fundamentals will lead to lower sovereign credit risk” (J.P. Morgan 2022). Our research shows that ESR scores may offer insights for sustainability- focused investors over and above the information provided by traditional sovereign credit rating assessments, which invariably focus on shorter-term dynamics. 24 FIGURE 4.1 - ESR scores offer a distinct perspective when compared with sovereign credit ratings for countries at low and middle income levels Sources: HRMI/SERF, Fitch Ratings, S&P Global Ratings, Moody’s Investor Services. Note: The average correlation between ESR and sovereign credit ratings is 0.53 for all countries, 0.47 for high-income countries, −0.13 for upper- middle-income countries, 0.13 for lower-middle-income countries, and −0.08 for low-income countries. ESR = economic and social rights. Second, ESR scores are particularly useful for sovereign outcomes. ESR scores also reflect the effectiveness of debt investors who focus more on sustainability governance and the quality of social policies up to a given outcomes. For such investors, ESR scores are useful moment in time (which results in certain statistics captured because they measure how well countries are performing on by a score). For investors interested in impacts, this score these rights given their level of development. As a result, the could also be supplemented by additional insight into current scores can provide insight into how one US dollar invested government policies and the overall quality of governance to today will improve one or more SDG/environmental/social account for the lagged nature of the dataset. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 25 ESRs scores are weakly correlated with income, indicating scores and national income are weakly correlated across the relative additionality of the ESR dataset over existing all income groups, as indicated by the flat regression lines. measures to align sovereign debt portfolios with certain Similarly, figure 4.3 shows that ESR and average ESG components of the SDGs. Sovereign ESG scores, which scores (standardized) are strongly correlated for high-income are generally thought to measure a country’s sustainability, countries only, again highlighting the additionality of the ESR are highly correlated with countries’ level of income,16 so their dataset compared with sovereign ESG scores, particularly for ability to measure a country’s performance on sustainability lower-rated sovereigns. is questionable. In contrast, and as shown in figure 4.2, ESR FIGURE 4.2 - ESR scores and gross national income per capita are weakly correlated Source: HRMI/SERF; World Bank staff illustration. Note: The average correlation between ESRs and per capita GDP is 0.57 for all countries, 0.29 for high-income countries, 0.10 for upper-middle-income countries, 0.33 for lower-middle-income countries, and -0.30 for low-income countries. ESR = economic and social rights. 16 Sovereign ESG scores have an average correlation of 83.2 percent with gross national income per capita, with the Social pillar having the highest correlation among the pillars of 85.2 percent (Gratcheva, Emery, and Wang 2021). 26 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT FIGURE 4.3 - ESR scores and average ESG scores (standardized) are strongly correlated for high-income countries only Sources: HRMI/SERF; World Bank staff illustration. Note: The average correlation between ESR and ESG scores is 0.70 for all countries, 0.72 for high-income countries, 0.01 for upper- middle-income countries, 0.58 for lower-middle-income countries, and 0.35 for low-income countries. ESR = economic and social rights. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 27 5. >>> Sovereign Debt: Investing in Economic and Social Rights This section proposes one potential use case of the ESR dataset in which an existing government bond index is tilted toward countries with better ESR scores. Indices play an important role in forming investment decisions (Arslanalp et al. 2020),17 and the increasing interest in ESG investing has also seen a rise in ESG-focused index products. The trend is driven by asset-owner demand and an increasing regulatory focus, particularly in Europe (UN PRI 2022). In 2018, J.P. Morgan, the dominant provider of fixed-income benchmarks that measure sovereign debt in emerging markets, introduced ESG-tilted versions of its sovereign debt indices for local currency and hard currency in emerging markets, while more recently, FTSE Russell and Bloomberg introduced the Climate Risk-Adjusted Global Government Bond Index and a carbon score index, respectively. Inclusion in such indices generates strong and sustained investor demand, demonstrated by the US$45 billion of assets under management18 as of January 2023 for all of J.P. Morgan’s fixed-income ESG indices for emerging markets. Tilting refers to increasing the exposure of an index or portfolio toward a specific factor. This approach has become popular in the sustainable investing space (Hamill and Hampden-Turner 2022; MSCI 2017; Ross, Song, and Pearce 2014; S&P Dow Jones Indices 2023) mainly because of its practical considerations and the already widespread use of index investing in the industry. Tilting a bond index differs from impact-oriented investing in its core objective as it rewards the good ESR performers and intends to reward the investor 17 For example, Raddatz et al. (2017) found that 70 percent of country allocations to investment mutual funds are influenced by benchmark indices. 18 This amount has increased from US$18 billion in October 2020. 28 FIGURE 5.1 - Tilting toward ESRs, by income classification Panel a shows how the baseline index weights from the J.P. Morgan EMBI (see footnote 13) would change if the index were tilted toward the income-adjusted economic and social rights (ESR) scores; that is, the index would be adjusted by allocating index weight away from countries with lower ESR scores toward countries with higher ESR scores. Because the ESR scores are income adjusted, only 1.3 percent of index weight is affected. Panel b repeats the same exercise but uses the raw input data for ESR scores, which are not income adjusted. As a result, 6.4 percent of the index weight would have been shifted toward higher-income countries. a. Tilting with ESR weights (income adjusted) Baseline weights Net change weights Net change Tilted weights Baseline weights Net change Net change Tilted weights weights Net change Tilted weights Continue on next page Net change Tilted weights THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 29 Continued from previous page FIGURE 5.1 - Tilting toward ESRs, by income classification b. Tilting using raw input data (not income adjusted) weights Net change Tilted weights Baseline weights Net chang Net change Tilted weights weights Net change Tilted weights Net change Tilted weights Sources: Bloomberg, HRMI/SERF, World Bank calculations. Note: The distributions show the uncertainty associated with estimating ESR scores. The whiskers and dots are the 50% and 90% confidence intervals. GNI = gross national income; HIC = high-income countries; LIC = low-income countries; LMIC = lower-middle-income countries; UMIC = upper-middle-income countries. 30 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT with a better-expected return for a given level of risk in the adjustment, low- and lower-middle-income countries would long run. On the other hand, tilting an index generally does not lose 6.3 percent in favor of upper-middle-income and high- funnel capital into boosting the performance of lower-scored income countries, as shown in figure 5.1. Figure 5.2 illustrates countries (those that have already performed well would have this approach from a regional allocation perspective. better scores today and therefore receive greater weight in Repeated tilts can achieve indices that have stronger the index). Moreover, the underlying tilt variable used by most alignment with ESR scores, but this comes at the cost index providers is mostly based on ESG scores, which often of a less diversified portfolio. Figures 5.1 and 5.2 show the favor higher-income countries. results of a single tilt. We can repeat the tilting exercise over Given the potential shortcomings of the tilting approach, multiple iterations to increase the exposure to ESR scores it is important to use an underlying tilt variable that (see appendixes B and C). However, stronger ESR alignment considers a country’s income level. In our case, we adjust also makes portfolios more concentrated (Amenc et al. 2016; the weights of a bond index by allocating weights away from FTSE Russell 2017a). The geographic breakdown in figure countries with low ESR scores toward countries with high 5.2a shows that Sub-Saharan Africa’s index weight dropped ESR scores. Investors often prefer tilting rather than excluding from 9.3 percent to 7.3 percent after a single tilt. Repeated certain issuers from their investment portfolios, as the more tilts would continually shift weights away until Sub-Saharan limited universe of issuers in sovereign debt (compared with Africa’s weight would constitute only a minor fraction of the a much larger universe of corporate issuers) is challenging index, while countries in Latin American and the Caribbean, in terms of portfolio diversification. Nevertheless, exclusions and in Europe and Central Asia would make up more than 55 may be preferred for certain themes, such as CPRs. However, percent of the index weight (appendix C). tilting alone may not always be enough for more sustainability- The tilted portfolio results in an improved average ESR focused investors who want to ascribe positive outcomes and score22 and slightly increases portfolio concentration.23 impacts to their investments.19 Investors are likely to combine This result is brought about by shifting the index weight between the tilting approach with other approaches, depending on their member countries. The extent to which this shift affects individual investment objectives and where they are in their ESG journey. countries depends on the initial weights in the baseline index. We used the J.P. Morgan Emerging Market Bond Index To illustrate, recall that the original index generally allocates (EMBI) as the baseline and compared it to an ESR-tilted more weight toward countries with more marketable and liquid version.20 The EMBI is well suited as a baseline given its status debt outstanding. This has two implications. While countries as the industry standard for investors in emerging markets, with higher initial weights stand to change more in absolute with about US$415 billion in assets tracking the index suite.21 weight terms, countries with lower initial index weights stand to For government bonds to be eligible for the EMBI, they must change more on a relative basis. These countries are ones that meet several investability requirements that ensure sufficient were just adopted into the index or that have been struggling liquidity and capacity. Tilted versions of the EMBI also benefit to fulfil the minimum requirements to remain in the index. They from these requirements. are also most likely to be lower-middle or low-income countries (figure 5.1) in Sub-Saharan Africa or South Asia (figure 5.2). The ESR tilted index reallocates index weights toward In addition, figure 5.2a, shows that on a relative basis, even countries with better ESR scores adjusted for their level of after adjusting for income, Sub-Saharan Africa underperforms development, thus allowing investors to better align their on ESRs (Fukuda-Parr et al, 2015). sovereign bond portfolio with a country’s performance on fulfilling ESRs. We found that index weights shift away The income-adjusted tilt rewards countries by increasing from lower-middle–income countries (−1.3 percent) toward the index allocation for good ESR performance rather upper-middle- (+0.7 percent) and high-income countries (+0.6 than for having a higher income, which would have percent). If investors were to base their allocation decisions been the case with traditional ESG scores. Better ESRs on the underlying ESR indicator scores without the income can benefit a country both financially and otherwise either 19 As shown in figure 5.2 and appendix B, repeated tilts can boost the effect on the index or portfolio. 20 For the calculations in this application, we used the index weights from the iShares J.P. Morgan USD Emerging Markets Bond ETF, which tracks the J.P. Morgan EMBI Global Core Index. The country weights were obtained from Bloomberg. We follow the tilting method outlined in Bender et al. (2013) and in FTSE Russell (2017b). First, we transformed the ESR scores to have a mean of zero and to fall within three standard deviations. Next, we mapped the resulting scores using the standard normal cumulative distribution function into the unit interval. We then used the resulting scores as tilting weights and multiplied them element-wise with the baseline index weights. Finally, we ensured that the tilted weights summed to 100 percent. 21 While we use the EMBI as an example, this approach could be implemented for a wide variety of fixed-income indices, including local currency. 22 The tilted portfolio improved the average ESR score 5.2 percentile ranks. To measure how much the average ESR score of the index changed, we related the average ESR score to all individual ESR country scores in terms of percentile ranks. The country with the best ESR scores has a percentile rank of 100, meaning that 100 percent of the remaining countries have a lower score. For the original index, the average ESR score corresponded to a percentile rank of 37.9, which increased to 43.1 for the tilted index. 23 Gini coefficient for the baseline index was 50.6 percent, which grew to 51.1 percent in the ESR-tilted version. An equally weighted index would have a coefficient of zero. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 31 directly through stronger institutions or indirectly by fostering these rights. This is why only 1.3 percentage points of index economic prosperity. By adjusting for income, the ESR tilt weight were shifted between income groups (Figure 5.1a helps to isolate the direct effect of better ESRs and rewards and Appendix B). countries that, given their current resources, perform well on FIGURE 5.2 - Tilting toward ESRs, by geographic region Panel a shows how the baseline index weights from the J.P. Morgan EMBI (see footnote 13) would change if it were tilted toward ESR scores; that is, the index would be adjusted by allocating the index weight away from countries with lower ESR scores toward countries with higher ESR scores. Similar to figure 4.3, about 1.5 percent of the index weight is reallocated. a. Tilting with ESR weights (income adjusted) Baseline weights Net change Baseline weights Net change Baseline weights Net change Tilted weights Baseline weights Net change Tilted weights s Net change Tilted weights s Net change Tilted weights Continue on next page 32 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT Continued from previous page FIGURE 5.2 - Tilting toward ESRs, by geographic region b. Tilting using raw input data (not income adjusted) Baseline weights Net change Baseline weights Net change Tilted weights Baseline weights Net change Tilted weights ights Net change Tilted weights ights Net change Tilted weights The income adjustment reduces the magnitude of the index reallocation away from Sub-Saharan African countries. If the index were aligned with raw ESR input data without adjusting for income, 6.7 percent index weight would have been reallocated between regions (figure 5.1, panel b), with Sub-Saharan Africa standing to lose the most (−6.0 percent) along with South Asia (−0.7 percent). In contrast, a tilt using the ESR scores (figure 5.1, panel a) moves only −1.5 percent index weight away from Sub-Saharan Africa to the benefit of Latin America and the Caribbean (+0.6 percent), the Middle East and North Africa (+0.5 percent), Europe and Central Asia (+0.3 percent), and East Asia and the Pacific (+0.1 percent). These discrepancies are also related to the fact that the sovereign investable universe is more limited in some regions than others. Sources: Bloomberg, HRMI/SERF, WB staff calculations. Note: The distributions show the uncertainty in the estimates of ESR scores. The whiskers and dots are the 50% and 90% confidence intervals. LAC = Latin America & Caribbean; MENA = Middle East & North Africa; EAP = East Asia & Pacific; ECA = Europe & Central Asia; SSA = Sub-Saharan Africa; SA = South Asia. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 33 6. 34 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT >>> Next Steps ESG investing continues to evolve, and its application in the sovereign debt context has been particularly challenging. Investors and other stakeholders continue to enhance their sovereign ESG frameworks, but there is an increasing realization that no single framework addresses all the complexities a sovereign issuer faces or meets the large variety of investors’ objectives. The difference between investment value and ethical values is at the core of this evolving landscape of sustainable finance. A less stable international order will likely change investors’ perspectives on a host of ESG-related issues, from national security to climate change, to the energy transition, to human rights. In such an environment, clear investment objectives, transparent methods, and improved data are critical (Gratcheva et al. 2021a). ESG investors are clearly at different stages in their journey, and many methodological issues are yet to be fully addressed at the sovereign level. These issues include comprehensively measuring the performance of countries on CPRs, managing the trade-offs across important ESG issues, and implementing a holistic sovereign ESG framework. Human rights issues are likely to continue to gain traction as an important tenet of ESG investing in the sovereign debt asset class. Sovereign debt investors have made progress on their ESG journey, leading to greater focus on achieving sustainability outcomes. These investors will face questions about the countries where they should focus their impact-oriented investment mandates and the associated tradeoffs between sustainability metrics. For example, should investors focus on countries where the marginal impact is highest, or is this not important? In addition, which metrics are more relevant and should take precedence? Other questions that need to be explored revolve around the processes and relevance of chosen metrics in improving a country’s sustainability and the measurement of sustainability outcomes on a cumulative basis. Finally, measuring CPRs is an area that requires additional investment. The HRMI initiative will continue its efforts to develop a comprehensive dataset on this important branch of the human rights family. This paper explained how investors can already start incorporating a specific human rights category—ESRs—into their investment process, thus focusing more explicitly on countries’ longer-term sustainability. While the ESR dataset is naturally slow moving in acquiring information (and lagged), it provides empirical evidence for a country’s longer-run growth potential, making it both relevant and forward looking. The dataset also offers potential as a key performance indicator for the sustainability-linked bond market and as a measure of the ex-post monitoring of impact-oriented investments. The trend in a country’s ESR score coupled with current governance indicators and policy directions, may provide a valuable tool in attributing the expected, positive, long-term impact to today’s investment. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 35 References Abate, Girum Dagnachew, Michael Andrew Brown, Alex Clay, K. C., R. Bakker, A. Brook, D. W. Hill, and A. Murdie. 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UN PRI (United Nations Principles for Responsible Investment). 2020. “Why and How Investors Should Act on Human Rights.” United Nations, Geneva. 38 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT Appendix A Indicators Used in Constructing the ESR Dataset INCOME ASSESSMENT STANDARD USED LOW & AREA INDICATORS MIDDLE HIGH DATA SOURCE Net primary school enrolment rate ✓ UNESCO Net secondary school enrolment rate ✓ ✓ UNESCO Education Education achievement: math percent > level 2 ✓ OECD PISA Education achievement: science percent > level 2 ✓ OECD PISA Education achievement: reading percent > level 2 ✓ OECD PISA Percent of children (under 5) not stunted ✓ UNICEF-WHO-World Bank JME Food Percent of population not food insecure ✓ FAO Modern contraceptive use rate ✓ UNPD UNICEF, WHO, UN, World Bank Child under five survival rate ✓ ✓ (UN IGME) Health Adult survival rate ✓ ✓ UNPD, Max Planck Inst. Percent of babies at healthy birth weight ✓ OECD, World Bank Percent of population with access to water on ✓ WHO, UNICEF JMP premises Percent of population with at least basic ✓ WHO, UNICEF JMP sanitation Housing Percent of population with safely managed ✓ WHO, UNICEF JMP sanitation Percent of poorest income quintile with access ✓ Eurostat to affordable housing Percent of population not absolutely poor ✓ World Bank (income>$3.20 per day (2011 PPP$)) Work and Percent of population not relatively poor Luxembourg Income Study, decent ✓ (income > 50% of median income) OECD income Percent of unemployed not long-term ✓ OECD unemployed Source: HRMI. Note: FAO = Food and Agricultural Organization; JME = Joint Child Malnutrition Estimates; JMP = Joint Monitoring Programme; LIS = Luxembourg Income Study; OECD = Organisation for Economic Co-operation and Development; PISA = Program for International Student Assessment; UNESCO = United Nations Educational, Scientific and Cultural Organization; UNICEF = United Nations International Children’s Emergency Fund; UN IGME = United Nations Inter-agency Group for Child Mortality Estimation; UNDP = United Nations Development Programme; UNPD = United Nations Procurement Division; WHO = World Health Organization. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 39 Appendix B Index Weight Reallocations and Tilt Strength, by Income Classification FIGURE B.1 In this figure, panels a and b demonstrate the evolution of index weights when the tilt strength is increased (FTSE Russell 2017a). When the tilt strength is zero (squares), the allocations correspond to the baseline. When the tilt strength is one (triangles), the allocations correspond to those in figure 5.1. Panel a shows how the index weights following multiple ESR tilts remain largely stable, while in panel b, the ingrained income bias intensifies. a. Tilting with ESR weights (income adjusted) b. Tilting using raw input data (not income adjusted) Sources: Bloomberg, HRMI/SERF, World Bank staff calculations. 40 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT Appendix C Index Weight Reallocations and Tilt Strength, by Geographic Region FIGURE C.1 Panels a and b demonstrate the evolution of index weights when the tilt strength is increased (FTSE Russell 2017a). When the tilt strength is zero (squares), the allocations correspond to the baseline. When the tilt strength is one (triangles), the allocations correspond to those in figure 5.2. Panel a shows how the index weights following multiple ESR tilts magnify the shifts in weight away from Sub-Saharan Africa. In panel b, Sub-Saharan Africa, East Asia and the Pacific, and Latin America and the Caribbean become more and more disadvantaged as the tilt strength increases. a. Tilting with ESR weights (income adjusted) b. Tilting with raw input data (not income adjusted) Sources: Bloomberg, HRMI/SERF, World Bank staff calculations. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 41 Appendix D Beyond Income and Credit Ratings—What ESRs Can Teach Us about Individual Countries. Case Study: South Africa and Brazil Interpreting a country’s economic and social rights It is useful to compare a country’s ESR trends over time. (ESR) performance is not a trivial effort, and users of In the context of per capita income growth, a country’s ESR the ESR dataset should become knowledgeable about score rises to the extent that it transforms income gains into a country’s specifics and its historical context—both the enjoyment of expanded rights more rapidly than the rate of which are often key drivers of a country’s performance at which the Achievement Possibility Frontier (APF) increases on ESRs. We use the examples of South Africa and Brazil, over the same income range. Generally, countries with lower which, despite having similar income levels and sovereign ESR scores at the start of a time period have the potential to credit rating paths, differ notably in their performance on achieve a greater increase in their scores than can countries ESRs. South Africa’s legacy of apartheid and Brazil’s legacy with higher initial scores, as they adopt more effective policies of military rule provide different foundations for development. and expenditure practices. For example, the gain in South Assessments of their performance should reflect these Africa’s score from 2007 to 2018 was higher than Brazil’s gain different contexts. in the areas of health and work, but this was largely offset by South Africa’s performance on the right to education. Overall, Both countries have explicit provisions in their if we average across the four rights, the gains in the two constitutions that foster ESRs. Brazil’s current constitution countries’ ESR scores were similar: 7.3 percentage points for took effect in 1988 as the first step in its re-democratization Brazil and 8 percentage points for South Africa, but it should after years of military rule. It invokes “the dignity of the human be noted that given Brazil’s considerably higher ESR scores in person” and the “primacy of human rights” as two of its essential 2007, its scope for improvement was more limited. principles. The current South African constitution, signed into law in 1996, explicitly protects the rights to housing, health The key feature of the HRMI/SERF methodology is that care, food, water, social security, and education. As noted by because it adjusts for differences in per capita income Sunstein (2001, 4), the constitution is “transformative” in that levels, it allows valid comparisons of countries across different it recognizes that the “apartheid system could not plausibly be parts of the world (such as Brazil and South Africa). Even so, separated from the problem of persistent social and economic it can still be useful to conduct within-region comparisons. deprivation.” After adopting their current constitutions, both For example, the ESR performance of Latin American and Brazil and South Africa implemented a series of social Caribbean countries tends to be better than that of Sub- policies aimed at expanding the enjoyment of ESRs. Brazil Saharan African countries, perhaps reflecting Sub-Saharan implemented a range of policy approaches that included Africa’s more recent experience with colonialism. decentralization, measures strengthening family farming, and conditional cash assistance programs, while South Africa’s policies focused more narrowly on cash assistance programs. 42 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT Appendix E Detailed Methodology of the ESR Dataset The HRMI/SERF economic and social rights (ESR) dataset IND ICATO R S EL ECTIO N measures the extent to which countries fulfill their economic and social rights obligations. The dataset, first A limited number of indicators for each of the five rights known as the International SERF Index, was developed for are selected to reflect key features of the rights as defined the Social and Economic Rights Fulfillment (SERF) Project by the General Comments of the Committee on Economic, (serfindex.org) by Sakiko Fukuda-Parr, Terra Lawson-Remer, Social, and Cultural Rights, the treaty-monitoring body of and Susan Randolph, funded in part by National Science the International Covenant on Economic, Social and Cultural Foundation grant 1061457. It was adopted by the Human Rights. When possible, bellwether indicators reflecting multiple Rights Measurement Initiative (HRMI) as its income-adjusted aspects of a right are selected. Beyond concept validity, quality of life index (humanrightsmeasurement.org and indicators are selected to be internationally and intertemporally rightstracker.org). The motivation for and the construction of comparable, reliable, based on objective information and on the ESR dataset are described in Fukuda-Parr et al, (2015) a transparent methodology, and publicly accessible from and in a number of other journal articles and methodology authoritative international institutions such as the World manuals.24 Bank’s World Development Indicators and the World Health Organization’s Statistical Information System. In addition, The dataset scores countries on how effectively they indicators are selected such that they measure the percentage use their resources to put in place policies, programs, of the population that enjoys key aspects of each of the five and measures that ensure that those who live in rights. For example, three indicators are used to measure their jurisdiction enjoy five ESRs: the rights to health, the right to health, one each for child health, adult health, education, food, housing (including water and sanitation), and reproductive health. Indicators updated with reasonable and productive work. frequency are preferred over those updated less frequently, and flow indicators (such as school enrollment rates) are The methodology for scoring countries does the following: prioritized over stock indicators (such as literacy rates). ● Draws on socioeconomic indicators, comparable across Data availability poses serious constraints on the rights for many countries which indicators can be selected. The right to social security, ● Estimates the Achievement Possibilities Frontier, which one of the rights enumerated in the International Covenant benchmarks what the best-performing countries have for Economic, Social and Cultural Rights, is excluded given shown is achievable at each income level the limitations in the availability of comparable data on social security for most countries around the globe. However, several ● Establishes a minimum level at which some percentage of the indicators used to measure the right to productive work of a country’s population would enjoy many ESRs; that and a decent income (absolute and relative poverty indicators) is, a country’s ESR performance must exceed a “natural partly address the right to social security. It was not possible to minimum” threshold before its performance is formally define “universal” indicators that are relevant to all countries. recognized Some indicators that are widely available and relevant to low- ● Applies a penalty to countries whose income is more than and middle- income countries, such as access to primary sufficient to ensure that all people in their country enjoy school, are either not available for, or not particularly relevant to, a given right or a given aspect of a right but fail to do so. high-income countries. Similarly, some indicators particularly relevant to high-income countries are either not available or Each of these components of the methodology is explained in not relevant to low- and middle-income countries. As a result, some detail below. indicator sets that reflect two assessment standards—one 24 See, for example, Fukuda-Parr et al, (2009); Randolph et al, (2010); Randolph et al, (2022); and Randolph and Kehoe-Rowden (2022). THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 43 for high-income countries and the other for low- and middle- power parity dollars) for the same year. For India, the most income countries—are used. Appendix A shows the indicators recent observation on the percentage of children ages five selected for each right and each assessment standard. Each and younger who are not stunted is well below what other country is evaluated on both assessment standards to the countries have demonstrated is possible at India’s per capita extent that data are available, and both sets of indicators feed income level. A separate APF is constructed for each indicator. into the Bayesian measurement model (see appendix F) that produces the Economic and Social Rights Performance Score used for the analysis in this paper. NATU RAL M INIM U M THRESHOLD Even in the absence of any organized government effort, the lowest value of an indicator would exceed zero for many BEN C HM A RK I N G S TAT E indicators, including the percentage of children who are not OBLIGAT ION S : AC H I E V E M E N T stunted. This value is known as the natural minimum threshold, POS SIB ILIT Y F RO N T I E R and it is approximated as the lowest value observed over the past 25 years. The natural minimum threshold varies from The Achievement Possibility Frontier (APF) benchmarks indicator to indicator. For example, the lowest value observed what the best performing countries have achieved, and for the child survival rate (where child is defined as younger that can be achieved, at different per capita income than five) over the past quarter century is 66.9 percent, levels. The red curve in figure E.1 represents the APF (the whereas the value is much lower, at 24.6 percent, for the adult outer envelope of the plot). Each dot in the figure shows the survival rate (where adult is defined as ages 15 to 60). The percentage of children who are not moderately or severely lowest share of households without basic sanitation observed stunted in a given year for a given country, plotted against over the past quarter century is 3.4 percent. the country’s GDP per capita (measured in 2017 purchasing FIGURE E.1 - Achievement Possibility Frontier % Children (under 5) Not Moderately or Severely Stunted 100 Achievement Possibilities Frontier 80 60 India 40 20 0 0 4,000 8,000 12,000 GDP per Capita (2017 PPP) Source: Randolph et al. 2022, 1, figure 1. Note: GDP = gross domestic product; PPP$ = purchasing power parity dollars. 44 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT FIGURE E.2 - Natural minimum threshold and indicator score % Children (under 5) Not Moderately or Severely Stunted 100 Achievement Possibilities Frontier 80 India 60 40 20 0 0 4,000 8,000 12,000 GDP per Capita (2017 PPP) Source: Randolph et al. 2022, 19, figure 2. Note: GDP = gross domestic product; PPP$ = purchasing power parity dollars. For the percentage of children who are not moderately or income to ensure that no children are stunted, yet they failed severely stunted, figure E.2 shows that the natural minimum to do so. For countries like Mexico and Oman, a penalty is threshold is 26 percent. For countries without the resources applied to the calculated score shown above. Both Mexico needed to ensure the maximum value of a given indicator, the and Oman have similar percentages of children who are not score is calculated as the percentage of the frontier achieved stunted, but Oman’s per capita income is about one and a above the natural minimum. For India, therefore, on the half times Mexico’s, so accordingly, the penalty imposed is percentage of children not stunted, this score is represented higher for Oman than it is for Mexico. Similarly, for countries by the height of the blue arrow relative to the height of the red with an income above Yp and the same per capita income arrow in Figure E.2. level, the lower the percentage of the frontier achieved, the higher the penalty. PENA LT Y Figure E.4 plots the impact of the penalty on a country’s indicator score as calculated in figure E.2. Each curve in Some countries have more than enough income to ensure the figure shows how a country’s indicator score decreases that all people enjoy an aspect of a given right measured with the penalty as the country’s income rises as a multiple by a particular indicator. This concept is illustrated in figure of Yp. A country whose indicator score is 95 percent of the E.3, which fills out the graph of the percentage of children distance between the natural minimum and the maximum who are not moderately or severely stunted across higher frontier value sees its score fall to 85 percent as its income per capita income levels (figure E.2). It becomes possible increases to 10 times Yp. A country whose indicator score is to ensure that no children are stunted at the income level 60 percent of the distance between the natural minimum and labeled as Yp, which is the peak of the APF. As shown in the maximum frontier value sees its score fall from 60 percent the figure, both Mexico and Oman have more than enough to 20 percent as its income increases to 10 times Yp. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 45 FIGURE E.3 - Applying the penalty % Children (under 5) Not Moderately or Severely Stunted 100 Mexico Oman 80 60 40 20 0 Yp 15,000 0 5,000 10,000 20,000 25,000 30,000 35,000 GDP per Capita (2017 PPP) Source: Randolph et al. 2022, 21, Figure 3. Note: GDP = gross domestic product; PPP$ = purchasing power parity dollars. FIGURE E.4 - Size of the penalty 100 Ninety five percent 80 Ninety percent Score with Penalty 60 Eighty percent 40 Sixty percent 20 Forty percent 0 1 2 3 4 5 6 7 8 9 10 No Y / Yp Penalty Source: Adapted from Randolph et. al. 2022, 23, figure 5. 46 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT Appendix F Bayesian Measurement Model We used each of the 18 HRMI/SERF income-adjusted indicator The resulting posterior distributions for the ESR latent variable scores to create an overarching measure of ESRs for every have means ranging from 0.796 to 2.632 and standard country-year, with at least three indicator scores in the ESR deviations ranging from 0.100 to 0.334. The means and dataset for that year. The 18 scores are shown in appendix A. standard deviations of each of the posterior distributions, The overarching measure is called the Economic and Social along with the indicator-level scores used to generate them, Rights Performance Score, which is available (lagged by one are available in the ESR dataset. For many of the analyses year) on the World Bank’s Sovereign ESG Data Portal. in this report, we relied on a dataset of 1,000 independent draws taken from the posterior distribution associated with Following HRMI’s approach with its metrics for civil and political each country-year. rights (Clay et al. 2021), we used a Bayesian measurement model to estimate our latent concept of a state’s fulfillment of its ESR obligations. We treated each of the 18 indicator scores as caused by the latent ESR variable. Following Bakker et al. (2016); Clay et al (2021); and Justwan, Bakker, and Berejikian (2018), our model can be written as follows: In this framework, y represents the observed value for country-year i on SERF indicator j, while X represents the latent ESR measure. As displayed in the model, we assumed that the continuous indicator-level SERF scores are normally distributed. For the latent ESR variable, we assigned standard normal prior distributions. The β parameters were assigned normal prior distributions with a mean of 1 and a variance of 2. We also placed some restrictions on the β parameters to be greater than or equal to 0 in order to ensure that the latent scale ran in an intuitive direction—that is, that higher scores represented better ESR performance. The σ parameters were assigned a Gamma prior distribution with scale and shape parameters of 1. Using the Markov chain Monte Carlo method in Just Another Gibbs Sampler, our model ran for 105,000 iterations, and we saved the last 5,000 iterations to summarize the parameters. All models showed strong evidence of convergence. THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT 47 Appendix G Data Collection Challenges Environmental, social, and governance (ESG) analysis ● New data collection efforts that are not conducted by often requires data disaggregated by different population government entities but by organizations such as HRMI, groups. While some economic and social rights (ESR) data which uses an expert survey methodology to collect are available disaggregated by gender, they are often not information on civil and political rights violations disaggregated by race, income quintile, rural/urban location, ● Data aggregation methodologies that draw on different or other population subgroups. As long as decisions about data sources, allowing estimates to be computed from an data collection are left to national authorities, and as long incomplete dataset. as they rely on national funding, such gaps in the data are likely to persist. Some of the reasons for this and other data Finally, users of the ESR dataset should understand the collection challenges are discussed in Box G.1. It is also likely specifics of a country and its historical context, which can often that efforts to fill these gaps will further develop, including the explain different dynamics within the same income levels. following: 48 THE POTENTIAL IMPLICATIONS OF ECONOMIC AND SOCIAL RIGHTS FOR INVESTING IN SOVEREIGN DEBT > > > BOX G.1 - The challenges in collecting data: Context is important The economic and social rights (ESR) dataset draws on publicly available economic and social statistics, collected by using internationally agreed-upon standards and harmonized into publicly accessible databases managed by organizations such as UNESCO, FAO, and the World Bank (see the data sources in appendix A). Unfortunately, not all countries produce all potential indicators of interest for the following reasons: ● Not all statistics are equally relevant for every country.a For example: ◗ Child stunting rates from the UNICEF-WHO-World Bank Joint Childhood Malnutrition Estimates database are an excellent measure of access to sufficient healthy food. But these data are typically not collected in high-income countries where malnutrition is relatively rare. ◗ Higher-income countries tend to emphasize indicators such as the OECD PISA, which measures the quality of education, in contrast to lower-income countries, which are more focused on boosting school enrollment rates. ● Accurate statistics are costly to produce. For budgetary reasons, countries with smaller populations often need to more strictly prioritize which data series to produce. A useful resource for seeing the progress that countries are making in producing a full set of statistics is the World Bank’s Statistical Capacity Indicator Dashboard There are also political reasons for why some data series are not produced and for why data on some population subgroups are not collected. For example: ● In the European Union, most countries do not use the concept of race or ethnic origin in data collection via the national census, surveys, or administrative registries (European Commission, Directorate General for Justice and Consumers 2017) even though this is standard practice in other parts of the world. This decision may reflect the legacy of persecution on the grounds of ethnic or racial identity, which prevailed during the Holocaust. Some countries may choose not to collect particular statistics (or not to ensure that the statistics are representative) because of a concern that the data may reflect badly on them or on their political leadership. For example, it has been argued that China’s 2018 PISA results are not representative because they consider Beijing, Shanghai, Jiangsu, and Zhejiang only, the four wealthiest states in the country (Gruijters 2020). This finding is also supported by Patrinos and Angrist (2018), who note that the 2015 PISA results, which reflect the participation of Beijing, Shanghai, Jiangsu, and Guangdong, are unlikely to be representative for the whole country even though the latter two cities are relatively less affluent compared with Shanghai. Note: FAO = Food and Agriculture Organization of the United Nations; OECD = Organisation for Economic Cooperation and Development; PISA = Programme for International Student Assessment; UNESCO = United Nations Educational, Scientific and Cultural Organization; UNICEF = United Nations International Children’s Emergency Fund; WHO = World Health Organization. a.  For this reason, HRMI publishes the ESR data by using two assessment standards, each of which represents a different collection of indicators. The low- and middle-income assessment standard uses statistical indicators that are available for most countries in the world, particularly low- and middle-income countries. The high-income assessment standard uses some indicators that are available primarily for high-income countries and that better reflect the human rights challenges of high-income countries. For more information, see HRMI’s Rights Tracker at https://rightstracker.org/en.