Recently, on 11th November, I moderated an event hosted by the Developing Markets Society at the London School of Economics. It was on ESG risks to emerging markets. The guest speaker was Dr Atsi Sheth, Managing Director and Head of Credit Strategy and Research Group at Moody’s, the global ratings agency. She spoke on how ESG factors influence sovereign credit ratings, with roughly 60% of developing countries’ credit ratings negatively affected by ESG factors. So, how is Nigeria performing on the ESG front?
First, what is ESG? Well, it stands for Environmental, Social and Governance. It’s a set of standards by which companies and countries are judged on environmental, social and governance issues. Asset managers and investors routinely factor ESG considerations into their decision-making and rely on ESG rating agencies to assess the ESG performance of a company or sovereign.
Historically, ESG ratings have focused on equities and corporate bonds, where asset managers and institutional investors put pressure on companies to improve their ESG performance, such as on climate change mitigation, or suffer a downgrade in valuation. According to a recent report in the Financial Times, equity funds with ESG mandates attract twice as much money as those without such mandates. As a result, ESG sensitivity and consideration have grown significantly in the corporate world.
But, recently, the focus of ESG ratings has also shifted to sovereigns, that is, countries’ ESG performance. How is a country doing on environmental, social and governance issues? If a country has a high exposure to environmental, social and governance risks, its credit impact scores will be negative, which would affect its credit rating and economic potential. Truth is, better ESG scores reduce investment risks; poor ESG scores increase them!
Some ESG ratings agencies, such as Refinitiv, take a broader view of ESG criteria and base their scores on a country’s relative performance across the United Nations Sustainable Development Goals (SDGs). They map sovereign ESG performance to the 17 UN SDGs, such as poverty eradication, zero hunger, good health and wellbeing, quality education, gender equality, clean water and sanitation, affordable and clean energy, reduced inequalities, climate action as well as peace, justice and strong institutions.
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But most ESG ratings agencies, such as Moody’s and Fitch, focus specifically on key elements of the three ESG pillars: environmental, social and governance. The environmental pillar typically includes factors such as climate change and environmental sustainability; the social pillar includes factors like human capital, gender and diversity; and the governance pillar encompasses a wide range of political governance and institutional issues, such as the rule of law and government effectiveness.
So, back to our question: How is Nigeria performing on the ESG front? Well, it would not surprise many readers that Nigeria has an appalling ESG record. This country is a world laggard on ESG issues, and thus its exposure to ESG risk factors is exceedingly high.
Take the 17 UN SDGs. Even the minister of education, Adamu Adamu, recently admitted that Nigeria has failed to meet the expectations of the SDGs. Is it poverty reduction? Nigeria is the poverty capital of the world. Is it quality education or gender equality? What about clean water and sanitation? Only 29 per cent of Nigerians have access to sanitation, with Nigeria recently ranked as the worst open defecation country in the world. Or is it on peace, justice and strong institutions? Truth is, if Nigeria’s ESG rating was based on the UN SDGs, it scores would be highly negative!
Similarly, Nigeria has an appalling record on each of the traditional ESG pillars – environmental, social and governance – always at the bottom of world league tables. And this has fed into its credit ratings, where it often receives a rating action of downgrade or negative outlook from ratings agencies such as Moody’s, Fitch and Standard & Poor’s.
Let’s take each of the pillars, starting with the environmental. Nigeria is known for environmental degradation like massive oil spills and excessive gas flaring. An estimated 7.4bn cubic feet of gas was flared in 2018, making Nigeria the world’s seventh largest gas flarer. Although the Petroleum Industry Act 2021 bans gas flaring, it allows the practice under specified conditions: (i) emergency; (ii) exemption expressly granted by the Commission; and (iii) acceptable safety requirements under established regulations. So, there’s no total, unconditional, prohibition of gas flaring!
Of course, the impacts of climate change are also felt throughout the country with the devastating effects of desertification, floods, pollution and soil erosion. Yet, greenhouse gas emissions from fossil fuel production and use have increased by 16% since 2015, according to the International Energy Agency, and grow by about 6% annually.
To be fair, Nigeria has recently taken some symbolically important steps on climate change. It committed to reach net zero carbon by 2060 at the recently-concluded UN climate change conference, COP26, in the UK, and, last week, President Muhammadu Buhari signed the Climate Change Bill into law. According to the 2021 sovereign green, social and sustainability bond survey, Nigeria is one of only three African countries, so far, to have issued a green bond to finance green projects. Nigeria first issued its green bond in 2017, repeated it in 2020 and has indicated a future intention to repeat the green bond issuance.
Yet, despite these seeming pro-green intentions, Nigeria has made little progress on renewable energy generation. What’s more, despite its net zero pledge, Nigeria has said it would continue to burn fossil fuels – oil, gas and coal – and has, in fact, legally set aside 30% of NNPC’s profits for further oil and gas exploration. None of these will inspire confidence in ESG ratings agencies about Nigeria’s performance in the environmental pillar of the ESG.
What about the social pillar? Well, everyone knows that Nigeria has appalling human development and human capital indexes. It ranks 161st out of 189 countries in the 2020 UN Human Development Index. Whereas most countries spend their budget on social security, healthcare, education and administrative support, Nigeria spends its own on governance and paying debt, while borrowing heavily for physical infrastructure. Widespread poverty, inequalities, including gender inequality, and, of course, insecurity worsen the social conditions in Nigeria. The government’s inability to tackle the problems is a major ESG risk that negatively affects Nigeria’s creditworthiness and attractiveness to foreign investors.
Of course, on the governance pillar, Nigeria has some of the worst governance indicators in the world, be it on the rule of law, control of corruption, regulatory quality and government effectiveness. For instance, as I wrote in my Vanguard column last week, Nigeria has one of the weakest anti-corruption regimes in the world, with a lax asset declaration and disclosure system, with the absence of Unexplained Wealth Order (UWO) and with anti-corruption agencies that lack sophisticated investigatory and prosecutorial abilities. The result is that Nigeria retains its reputation as a “fantastically corrupt” country.
In 2019, Sustainalytics, an ESG ratings company, published a report titled “New Frontier: African Sovereign Debt and ESG Risk”. Using mainly institutional factors, the study found that, of Africa’s top 7 bond sellers in 2019, Nigeria was one of the five with high ESG risk. On governance indicators, Nigeria scored 9 out of 25 points, coming second from the bottom after Cote ’Ivoire. Even Lesotho leads Nigeria on most measures of institutional capital. In a separate analysis by Lazard, using RAG (Red-Amber-Green) ratings, Nigeria was on red in all the indicators, not a single green!
Of course, a poor ESG rating doesn’t mean investors would not buy a country’s sovereign bonds. But the spread or yield would be high, and Nigeria, Africa’s highest bond issuer, always crosses the threshold. That raises the debt-servicing cost and undermines economic prosperity. Sadly, that’s the price Nigeria pays for its abysmal ESG performance.
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