ESG and Currency

  • Published: 11/09/2019
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Co-authored with Aaron Cantrell. This article first appeared on

The advancement of ESG data access and analysis gives investors the chance to expand the scope of their sustainability objectives and investment programs, including in new asset classes. Record Currency Management has been building the research and investment infrastructure for ESG integration in currency.

The motivation for integrating ESG analysis into currency investment is threefold. First, we acknowledge the nature of risks in the 21st century, many of them deriving from social or environmental boundaries, as well as governance fault lines. This is especially true for a nation-level instrument such as currency. Second, we aim to expand the scope of our economic and financial models, using new data and techniques to better identify sustainable opportunities. Third, we are paying closer attention to the consequences, positive and negative, of investment activity. Currency is a versatile asset class which accommodates ESG integration for better investment outcomes, while also enabling investors to express their sustainability objectives through a market that offers direct access to local economies.

There are no existing methods of ESG incorporation that can be grafted directly onto currency investment, but many of them offer lessons for it. As with government bonds, currency exposure entails an exposure to the sovereign, though more to its monetary institutions and policies than to its fiscal authorities. In addition to conventional measures on central bank independence, central bank mandate, and inflation (target and surprise), we integrate metrics on corruption, regulatory changes, and judicial independence. This helps us to generate a more comprehensive picture of governance culture.

In common with global strategies which take explicit country-based positions, we also monitor developments at the national level (distinct from the sovereign). We expect non-financial data to anticipate risks that have not yet appeared in financial data. Additionally, we analyze social and environmental factors such as education, integration to global trade, and energy efficiency. Factors like these contribute to those macroeconomic variables that support a currency’s intrinsic value: particularly productivity growth and interest rates.

When it comes to understanding the effects of an investment, currency differs substantially from other assets. Especially in equities, and to a lesser degree also in fixed income, the effects of investment activity are relatively straightforward. Investors can and do use a carrot-and-stick logic of capital provision with corporations and sovereigns to encourage their growth and investment capabilities, or to limit them. This action operates through two channels: by modifying the financial incentive structure in which that entity operates and by directly reducing their capacities in order to reduce the risk they may represent to the environment and society.

In currency, this mechanism is much more complex. For one, in contrast with a corporate equity or debt investment, which affects primarily the counterparties of investor and investee, there are numerous stakeholders in a currency investment. It is a sovereign instrument, yes, but it is also a nation-level instrument which implicates local debt market participants in both the public and private sectors, all parties engaged in import and export, foreign investors, not to mention the purchasing power of citizens. Second, the incentive that currency investment can create does not always go in one direction. Although currency investment (especially with some duration) can lower the cost of capital in the local economy, supporting investment capacity for the nation and state, it may also support the exchange rate. The ‘currency wars’ teach us that for a country willing to use policies which directly aim to lower the exchange rate, currency investment which can cause appreciation is no incentive. Therefore the integration of sustainability objectives requires a nuanced approach. In this example, that means considering dependence on exports, net international investment position, and fiscal balances in order to understand the effects of currency investment.

To inform our analysis, Record has compiled one of the largest sets of country-level ESG data built to date. The database includes approximately 200 countries, with more than 1,600 separate series, dating in some cases as far back as 1960, and has been derived from multiple sources including World Bank, United Nations, and Fraser Institute. We also engage ESG research providers in order to understand the data from both its primary and secondary sources. This database has been used to map quantitative relationships between the non-financial factors and currency returns. This lends itself to systematic incorporation of ESG data, alongside more timely and discretionary ESG risk management. Record has incorporated these decision criteria into its own portfolio where we co-invest alongside our clients. This is done not just as part of our in-house research and investment efforts, but also as a contribution to ESG investment around the globe.

Indeed, the process of engineering an ESG understanding in currency is still underway. We welcome collaboration with investors and research institutes, including sharing the data we have collected, to widen currency’s role as an asset class in achieving responsible investment objectives.