Sustainable Finance and Sovereign Debt: The Illusion to Govern by Contract

Sovereign debt markets are rapidly venturing into the world of sustainable finance. Sovereign and sub-sovereign borrowers increasingly use ‘green’, ‘social’, and ‘sustainability’ bonds and loans to finance their domestic sustainability agenda. The rationale behind those instruments is to leverage the power of financial markets to incentivize public borrowers to pursue sustainability reforms and projects that would otherwise be difficult to implement. At the same time, given its clear objective to influence domestic policies, some see sovereign sustainable finance as an invasion of national sovereignty and a new form of private conditionality. This article assesses these claims. It sets out a theory of sovereign sustainable bonds that highlights the incentives of the two contractual parties—institutional investors and sovereign borrowers—to use finance as a tool for domestic sustainability reforms. I demonstrate that neither of the two parties has any incentive to use debt instruments to pursue a change in domestic policies and sustainability practices. A lack of financial incentives for investors and constitutional and political limitations on the sovereign borrower’s side make the environmental, social, and governance (ESG) contractual bargain very difficult to negotiate and implement. At the same time, both parties share the common goal of tapping into the ever-expanding ESG market. This results in a sustainable bond structure that only superficially addresses the sustainability objective for which it is marketed to investors.