Source: B.M.Khan, KS Advisory, June 1, 2024

Funding Belligerence, War, and Oppression?

Are Institutional Investors Really Adhering to Principles of Ethical Investing? There is a need for a new sovereign rating system and accountability on all fronts.

Ethical investing, also known as socially responsible investing (SRI), has really taken off in recent years. Ethical investors aim to align their portfolios with their values, prioritizing companies and assets that show positive social, environmental, and governance practices. But there's a big gap when it comes to institutional investors who claim to follow strict ethical guidelines yet hold significant assets issued by governments with histories of belligerence, wars, coups, regime change operations, extrajudicial killings, and high death rates of innocent civilians. This contradiction raises questions about the authenticity and consistency of the ethical investing principles many investors purport to follow.

This inconsistency becomes evident when examining portfolios of large investors. Institutional investors hold significant allocations in government bonds due to liquidity, apparent stability, and reliability these investments can provide. Government bonds, particularly those issued by powerful nations, are traditionally seen as risk-free or low-risk investments, offering a safe haven during economic turbulence. However, this approach can be at odds with the ethical guidelines these investors claim to follow, especially when these governments are engaged in actions that directly contravene the principles of peace, human rights, and international law. For instance, investing in the bonds of a country involved in aggressive military campaigns, regime change operations, disregard for international law or internal repression, indirectly supports these activities by providing the government with the capital needed to finance its operations.

Moreover, the issue of accountability becomes critical given the power of institutional investors. Institutional investors wield considerable influence due to the large volumes of assets they manage. By continuing to invest in sovereign assets of belligerent governments, these investors may inadvertently perpetuate cycles of violence and instability and as such can be held accountable.

The current investment practices suggest a selective application of ethical standards, which undermines the credibility of the ethical investment frameworks. Investors who truly want to stick to ethical guidelines should rethink their exposure to such assets, recognizing the broader impact of their investment choices. It's high time to rethink ethical investing and apply strict guidelines consistently, without picking and choosing when to follow honorable ethical standards. There should be a universal application of these standards, without exception.

To stay true to ethical investing principles, investors may shun such assets or demand that each bond issuance clearly state how the funds will be allocated. For example, if a government is selling $10 billion of 10-year bonds, it should be required to specify what percentage is for defense/military, what percentage is for foreign aid, what percentage is for social security, etc. This way, investors can ensure they only participate to the degree the issuance meets their ethical guidelines. Buying government debt indiscriminately from governments with a controversial history in foreign policy and military intervention or disregard for international law is inherently unethical. Unless investors with ethical investment guidelines adjust allocations and demand full disclosure, they are not staying true to the principles they purport and are hypocritical, funding belligerence and bearing responsibility.

Currently, sovereign ratings by agencies such as Fitch, Moody's, and S&P focus primarily on a country's ability to meet its debt obligations, considering factors like economic stability, public finance, and governance effectiveness. However, these ratings do not account for the ethical standards of the government issuing the debt.

Introducing an Ethical Governance Rating (EGR) could fill this gap. This idea of a new rating system would evaluate countries based on criteria such as human rights records, environmental policies, transparency, anti-corruption measures, and social equity. Moreover, it would specifically include assessments of illegal wars, disregard for international law, coups and coup attempts, regime changes, and civilian deaths and destruction of civilian infrastructure. For example, the EGR would provide a clear indication of how well a government adheres to ethical practices, allowing investors to make more informed decisions that align with their values. As such, governments will be under pressure to become better global citizens or risk finding no or few buyers of their debt, with implications that are broad, wide, and seriously consequential.

Investors should consider both the traditional sovereign rating and the EGR when making investment decisions. By incorporating both financial and ethical assessments, investors can ensure their portfolios not only perform well but also contribute to a more just and world where governments are held accountable regardless of their size and might.

Conclusion

While existing ESG frameworks and SRI practices provide a foundation for ethical investing, they do not offer the comprehensive, government-specific evaluation that EGR proposes. This idea of Ethical Governance Ratings introduces a novel approach to holding governments accountable for a wide range of ethical considerations, enhancing the impact of responsible investment practices.

By implementing EGR, investors can gain a clearer and more comprehensive understanding of governments' financial assets from an ethical perspective and understand the implications of their investments, leading to more responsible and impactful investment practices, holding governments accountable and forcing governmental behavior change.

Call to Action

The time has come for ethical governance ratings of governments. A comprehensive, transparent rating system can truly guide ethical investment decisions and hold both investors and issuers accountable. If any entities are willing to collaborate on the idea of EGR, please reach out so we can lay out a roadmap and forge a new way forward.

By addressing these critical aspects, the EGR would not only enhance the accountability of governments but also empower investors to make decisions that align with their ethical values, ultimately fostering a more just and responsible global community.

Initial Proposal for Ethical Governance Ratings (EGR)

Given the gaps in current rating systems, the proposal for an Ethical Governance Rating (EGR) system is timely and necessary. Such a system would evaluate countries based on:

• Accountability for Human Rights Violations: Including extrajudicial killings and civilian harm, both human and infrastructural.
• Adherence to International Law: Evaluating the government's respect for international treaties and conventions, including the imposition of unilateral sanctions and unilateral confiscation of assets.
• Economic Equity: Evaluating policies and practices aimed at reducing income inequality and ensuring fair economic opportunities for all citizens.
• Environmental Stewardship: Assessing the government's efforts in protecting the environment, managing natural resources sustainably, and combating climate change.
• Indigenous Populations: Ensuring the rights of indigenous peoples, including their right to maintain and strengthen their distinct political, legal, economic, social, and cultural institutions, as well as their right to participate fully, if they so choose, in the political, economic, social, and cultural life of the state.
• Nuclear Power: Evaluating unprovoked saber-rattling, usage against populations, and non-disclosure practices.
• Peaceful Governance: Reviewing involvement in wars, illegal wars, coups, regime change operations, cyber warfare, space warfare, and the weaponization of resources.
• Transparency and Corruption: Measuring the level of transparency in government operations and the effectiveness of anti-corruption measures.

Such a rating system would provide a comprehensive and transparent way to guide ethical investment decisions and hold both investors and issuers accountable.

If any entities are willing to collaborate on the idea of Ethical Governance Ratings (EGR), please reach out so we can lay out a roadmap and forge a new way forward.

At best, such a system would pressure governments to become better global citizens or risk finding no or few buyers for their debt, leading to broad, wide, and consequential implications. At worst, the world will have a rating system for governments based on an ethical framework.

The Ethical Governance Rating framework for government and soverign issuers is a win-win proposition.