“The hypothetical question with which ESG [environmental, social and governance] investment in sovereign debt is challenged is: are you prepared to not own US Treasuries if you think the US does not pass a certain scoring threshold or equivalent? Inevitably, the answer has been ‘no’. But unless a commitment to withhold capital is credible, investors cannot really expect market discipline to drive a change in behaviour,” says Tamar Hamlyn, principal and portfolio manager, interest rate strategies and macroeconomics at Ardea Investment Management.

This is not a purely theoretical point. Six months after his inauguration as US president in 2017, Donald Trump set the clock running on the US’s withdrawal from the Paris Agreement. Given a credible track to Paris goals is perhaps the single most commonly used baseline for environmental scoring, a country abandoning even lip service to the end goal would under normal circumstances surely have set off flashing red alarms for ESG screens.

In fact, there was little or no impact on the US Treasury market and it almost goes without saying that investors did not pull out en masse. This may not just have been for technical, market access reasons. For one thing, while the US’s environmental policy may have taken a catastrophic turn for the worse, the same could not necessarily be said for its own domestic outlook.

Ultimately, investors say, from an ESG perspective we would have had to ask whether the US’s environmental or social risks changed because it was not operating a net zero policy. The conclusion many come to is ‘probably not’ – and certainly not right away. This remains the case even though the same investors freely admit the rest of the world was impaired by the decision and that is is obviously self-defeating in the long term. Exiting the Paris Agreement was clearly a misstep ethically, in other words, but perhaps not from a risk perspective.

There has yet to be evidence of genuine market-moving flows on the back of investor assessments of sovereign environmental policy, with most headlines to date reflecting shots across the bow by individual investors rather than market-wide responses. But some believe more widespread reallocation of capital is on the horizon in the sovereign space, and that when it arrives the first countries to feel its impact will be peripheral nations in the developed world.

“There is a category of nations developed enough that investors may not feel unreasonable when making demands regarding the competency of climate policy, but that also aren’t so large or so central to interest rate or currency management exercises that they cannot be divested,” suggests Zoe Whitton, managing director at Pollination Group.

Australia is likely in this category, she adds: it is not a huge portion of the international market but it is sufficiently developed to be expected to have progressive climate policy. Whitton says some European nations and countries such as Singapore may also fall into this category.

Carl Shepherd, portfolio manager, fixed income at Newton Investment Management, adds: “Issuance by the biggest global sovereigns effectively creates its own demand as there is a massive pool of liquidity in the reserve currencies that is very benchmark aware. I can see ESG considerations having a much bigger impact on the peripheral index members like Australia, Canada, Denmark and the like.”

Some investors say it is important to try to manage around the challenges of sovereign bond market realities. For instance, while Shepherd admits that it is very difficult to omit US Treasuries from a sovereign portfolio mix, he says in the case of a situation like the US bein out of the Paris Agreement, where possible Newton would seek to buy product like state debt or alternative US dollar, triple-A rated securities other than US Treasuries.

Ryan Myerberg, partner, portfolio manager and co-head of global taxable fixed income at Brown Advisory, adds: “It is important to assess every investment we make without fear or favour – to have the same framework and make the same assessment. We can’t say we are just not going to scrutinise the liquid markets we use for traditional duration management as critically as we do an emerging market.”