Despite sovereign bonds comprising around half of the global bond market, index options for ESG investors remain limited. 

Indices play an important part in shaping investment decisions, whether investors use active or passive strategies. Investors seeking to incorporate environmental, social and governance (ESG) factors are therefore paying increasing attention to the growing number of ESG indices. In the sovereign debt market, constructing such indices can present unique challenges and opportunities compared with corporate indices. To explore these factors and better understand the building blocks of such indices, the Principles for Responsible Investment (PRI) convened a group of sovereign bond investors and six index providers in November 2021.

Workshop participants

Index providers[1]


JP Morgan

FTSE Russell


Intercontinental Exchange (ICE)


Investment organisations[2]


Manulife Investment Management


Neuberger Berman

BlueBay Asset Management

Ninety One

Colchester Global Investors

Nordea Asset Management

Danske Bank Asset Management


Fim Partners


Franklin Templeton



Western Asset Management

Global Footprint Network

William Blair

Lazard Asset Management


The workshop was a unique opportunity to engage collaboratively, as meetings between index providers and investors often take place on a bilateral basis. It gave the investors an opportunity to ask questions of different providers, while the index providers could better gauge how investor demand is evolving.[3]  

The discussion followed four themes and produced a list of ideas for next steps, including new approaches to index construction that offer alternative ways of capturing ESG themes. 

ESG incorporation and sovereign bond indices

Index providers design and calculate broad market indices then license (sell) the right to use their designs and calculations to investors for funds and products. Providers set the rules that decide which securities to include in an index, how the index is managed, and how securities will be added and removed from the index over time. Indices are used for passive products (where the index is replicated as closely as possible) or as a benchmark for active products to measure relative performance. They can be developed for multiple asset classes, including equities and fixed income.

Indices tracking the fixed income market are generally limited to issuers or securities meeting certain characteristics, based on factors such as:

  • Type of issuer (for example corporate, sovereign or government-related)
  • Credit quality (high yield or investment grade)
  • Maturity (short or long term)

ESG indices, meanwhile, normally derive from parent, non-ESG indices, with modifications made to factor in ESG criteria. However, the data and methodology (for example whether to exclude securities or tilt their weighting) used to construct ESG indices can vary, with important implications for asset allocation.

ESG indices were originally conceived for equity investors, with the first dating back to 1990 and focusing on US companies.[4]   But they have expanded to cover other asset classes and regions since then and the suite of fixed income indices applying some form of ESG criteria or methodology is growing.

Index providers have broadened the range of tailored fixed income ESG indices that they offer in response to different investor objectives and preferences. Where possible, for commercial reasons, they seek to encompass common interests among different investors, resulting in semi-customised indices.

ESG indices are not the only way to incorporate ESG factors in investment decisions. Active investors using traditional indices as benchmarks may outperform by incorporating ESG factors they believe are not adequately priced. However, ESG indices can be used as a starting point for active management or for passive strategies (which are less common in fixed income than in equity). These indices are particularly useful where investors’ ESG choices and constraints create so much divergence that comparison with traditional benchmarks is inappropriate.

Conventional (non-ESG) indices versus ESG indicies

During the workshop, index providers and investors discussed how index products are constructed. When deciding to launch an ESG sovereign index, providers shared that they make decisions on at least three main criteria (see Figure 1).

Figure 1: Criteria for index construction

CriteriaExamples of different options


  • Focused on a single ESG factor
  • Including multiple ESG factors (with providers deciding on factor weights)


  • Blended (corporates and sovereigns)
  • Focused on labelled bonds
  • Themed, e.g., climate


  • Excluding or screening countries
  • Tilting, e.g., assigning bonds a greater or smaller weighting relative to traditional indices

The more limited universe of sovereign debt issuers, compared with the corporate market, makes a screening approach harder for sovereign indices without constraining diversification. Therefore, providers often prefer to use a tilting approach, although some clients may desire hard exclusions.

Data and methodology

The index providers explained that there are also specific data and methodological considerations that need to be weighed when designing ESG indices. The main ones mentioned were:

Coverage and time series: The availability and timeliness of data across issuers affect which ESG factors an index can take into account. For the purposes of back-testing, the more historical data on the ESG factors, the better. Yet data may be lacking for some countries, particularly in emerging or frontier markets.

Reliability and objectiveness: The data series used to construct the index need to be updated regularly and not go out of production. Providers also need to have confidence in the objectivity of the data.

Costs: Open-source data (such as that provided by the World Bank or the Social Progress Index) is free but may have limitations, such as time lags and data gaps. Some index providers have the advantage of being part of wider organisations that are also ESG information providers (i.e., they collect and sell ESG data through a different division), and for them using in-house data may be cheaper.

Control: Using in-house data can bring more methodological clarity, consistency and control for providers. However, opting for third-party datasets offers more choice and may be aligned with what clients use.

Eligibility criteria to enable replication: Effective indices need the underlying bonds to be liquid, facilitating the trading needed to replicate the index. Furthermore, providers set caps and thresholds on factors such as credit ratings either at an issuer or bond level. For ESG indices, such restrictions may need to be eased to avoid limiting the investable universe too much. In particular:

  • The standard minimum issuance size for bond inclusion may be too high for some ESG labelled bonds.
  • The liquidity of sovereign bonds is often a function of the amount of a government’s outstanding debt, which can give indices a bias towards larger issuers.

Climate-focused sovereign debt indices

Trade-offs on data and methodology are apparent when building climate indices. Index providers can choose between different ways to measure emissions. Production-based (or territorial) emissions data accounts for all emissions generated within a country’s borders. In contrast, consumption-based emissions data is adjusted for trade (i.e., emissions better reflect where products are consumed).

Production-based data is often used when countries report and set targets for emissions; as such, indices using this metric are aligned with how issuers assess their emissions. However, consumption-based data captures “carbon leakage” (e.g., where highly regulated countries import carbon-intensive products from countries with less stringent regulations) and so may be a better gauge of a country’s contribution to emissions.

For index construction purposes, emissions can also be weighted by GDP or other factors, but this can pose challenges. First, if GDP or another denominator changes rapidly from one year to the next, index constituent weights can fluctuate significantly. Second, weighting by GDP gives richer countries greater room to emit carbon, raising questions of fairness.

Investors asked providers about plans to build indices based on climate policies, which could reflect the trajectory of a country’s emissions and its exposure to transition risk. But providers observed that many policies are yet to be implemented, with the targets far off on the horizon, making measurement of progress difficult. In addition, for the purposes of constructing a climate policy index, providers highlighted the following challenges:

  • It can be difficult to find the right numerical measure: for example, simply counting the number of policies a country has introduced is not likely to be an effective way to measure commitment.
  • Policies can change from one year to the next when a new government takes office, causing volatility in the metric used.

The response to climate change does not come from central government alone. The provider would also have to decide how to incorporate responses from the private sector and sub-national administrations.

Engagement with issuers

When asked by participating investors if they engaged with sovereign entities, index providers replied that they do not routinely communicate with government bodies.

They highlighted some challenges: finding the right person or department to engage with on ESG-related matters, and retaining independence (i.e., avoiding the risk of a government receiving favourable treatment if it is more conducive to engagement).

Investors themselves face some of these challenges when engaging with sovereigns, as the PRI highlighted in previous work.[5]  Yet they observed that engagement between index providers and sovereigns could be beneficial on a number of levels, as it could:

  • improve information disclosure, helping with the construction and maintenance of ESG indices.
  • spur issuers to improve their performance on ESG criteria in order to be included in indices. This would in turn increase structural demand for their debt and reduce their funding costs.

Next steps

Despite the proliferation of ESG indices, they remain lacking for sovereign bonds, which comprise around half of the global bond market.[6]  Demand is evolving quickly as investors seek to consider new ESG factors, incorporate existing ones more comprehensively, and adapt to new regulations such as the European Union’s Sustainable Finance Disclosure Regulation (SFDR), which requires them to show the extent to which their investments consider ESG factors. Other regulations are directed at index providers themselves, such as those relating to the EU labels for benchmarks and benchmarks’ ESG disclosures.

Index providers

Investors acknowledged the challenges in ESG index construction that providers face but maintained that providers have scope to be more thoughtful and creative in how they incorporate ESG criteria. As sovereign issuers adapt to investors’ growing expectations on ESG factors, and as the ESG labelled bond market continues to expand, this scope is likely to increase.

Investors suggested that providers could focus on the following:

  • Adapting to evolving demands for thematic ESG indices. For example, these could better capture a country’s progress in meeting the UN Sustainable Development Goals (SDGs) or meet investors’ specific environmental or social goals (such as protecting biodiversity or human rights). In doing so, they should also take into account the starting point of a country because that may affect its ESG performance trajectory.
  • Developing more indices for labelled sustainable sovereign bonds. Many sovereigns have now issued green bonds, making indices based on these more feasible. In the future, there may be enough issuance of other types, like social bonds or sustainability-linked bonds, to create a wider array of labelled sovereign indices (see Figure 2). Index providers could ease liquidity requirements to allow more securities to be included in these indices.

Figure 2: Issuance volume of sovereign green, social and sustainability bonds (US$bn). Source: Climate Bonds Initiative*


*In 2016 there was $800m of issuance from emerging markets and none from developed market

  • Exploring creating indices aligned with ESG regulations. Sovereign debt investors are trying to find ways to meet emerging ESG regulations and norms. In Europe, SFDR, sustainability preference requirements under the Markets in Financial Instruments Directive (MiFID) and the taxonomy for sustainable activities are increasing the need to align with standards. Other jurisdictions are looking to develop sustainable finance regulations too. Most regulation so far is focused on investments in corporates, or at least is harder to navigate for sovereign debt investors. New ESG sovereign debt indices could help investors match their holdings in this asset class with regulatory standards. In the context of SFDR, investors may be better able to show credible evidence that they are managing their financial products as Article 8 or 9.
  • Engaging with sovereign issuers on ESG topics. This may not always be possible, but where it is, engagement can help sovereigns understand how they can be included in ESG indices
  • Ensuring transparency of data and methodology. This is particularly pertinent when making methodological changes, either due to regulatory changes or because data and best practice change quickly in ESG finance. When proposing methodological changes, some providers seek feedback from investors through opening a consultation process or arranging individual meetings; more should do so. Moreover, they should better explain whether they use third-party data and then apply their own modelling, as this does not always seem clear to investors. Transparency here is additionally helpful for the purpose of SFDR disclosure.


Provider feedback indicated that investors need to be clear about why they want to use ESG sovereign debt indices. Questions investors should consider:

  • Are they seeking an index that outperforms conventional indices by integrating underappreciated ESG factors, or is the purpose of the index to re-allocate capital to countries in order to pursue positive ESG outcomes and avoid negative ones?
  • If the latter is true, do they want to reward countries already scoring highly on ESG factors, countries with the greatest potential to score more highly, or countries most in need of funding to tackle ESG challenges?
  • Are asset owners prepared to revisit risk and return expectations in order to use an ESG sovereign bond index that may perform less well?

Investors also noted that using an ESG index should not be an excuse to avoid trying to engage with sovereigns where this is possible.

Within the investment chain, asset owners have a unique role to play in incorporating ESG factors. If they use an ESG index (standard or customised) to track performance, they give asset managers greater scope to consider these factors. (A case study from AkademikerPension offers an example of active asset management against a customised index that excludes sovereign issuers on human rights grounds.)


The PRI will continue to use its convening power to bring together sovereign debt investors, asset owners, consultants and index providers in order to foster ongoing dialogue and move the market forward. It is also broadening the outreach to ESG information providers, whose offerings can help investors and index providers alike. The workshop format allows participants to discuss common challenges and opportunities in a more comprehensive way than during standard bilateral client meetings.

Beyond these stakeholders, we will also explore opportunities to bring sovereign issuers themselves into the conversation.