ESG-focused fund inflows into Asia are growing, but investing is replete with risk given the region’s diversities and historical inequalities. The lack of universal standards and conflicting development goals among regional governments mean that investors can’t copy-paste their global knowledge, but must develop a more bespoke approach, writes Reema Bhattacharya

Mainstream thinking on the environment and investment has markedly shifted in the space of the past 12 months. Global inflows into environmental, social and governance (ESG) funds reached USD80.5 billion in the third quarter of 2020, with ESG funds in Asia witnessing an inflow of more than USD8.7 billion, and set to grow at a similar pace in the years ahead. US-based Fidelity Investments reported that companies with the highest ESG performance scores had the best financial records in eight of the past nine months.

These figures indicate a shift from the perceived wisdom of recent decades that paying closer attention to ESG issues comes at the expense of a company’s bottom line. Rather, decision-makers now recognise that engaging with a range of ESG issues is crucial to future economic health, not a drag on it. The natural next step would be for governments to implement consistent targets and transparent policies that facilitate sustainable investing. But in Asia’s emerging markets, many with opaque regulatory environments and politicised reform programmes, ESG investment is far from straightforward.

Never a more complicated time

Markets such as China, India, Indonesia and Vietnam have built their value proposition as the world’s factories on the foundation of low-cost manufacturing underpinned by cheap, abundant labour and weak environmental and social protections. Therefore, it is hard to imagine how responsible investment principles could be quickly adopted in the region without a fundamental rethink of what constitutes wealth and value.

ESG
Reema Bhattacharya

In the short term, such an exercise is likely to be unappealing for many crisis-stricken governments, particularly in South and Southeast Asia, which have seen decades of poverty alleviation and socio-economic progress wiped out by the covid-19 pandemic in a few short months. Leaders are more likely to reach for familiar tools in a bid to boost industrial investment and jump-start job creation, such as further easing of workers’ legal protections and corporate governance standards.

Meanwhile, the escalating frequency of climate change-related extreme weather events devastating some of Asia’s most vulnerable communities is triggering heightened public scrutiny of projects and their investors, particularly in countries like India and Bangladesh. In the energy sector, for example, governments will face increasing pressure to reconcile risks related to investor solvency amid increasingly severe climate change-related losses, with rising public anger driven by environmental degradation (when projects are run unsustainably) and extremely high energy tariffs (when power producers are given environmental commitments to meet). With this in mind, investors and multinationals will need to conduct more regular audits of their long-term plans to mitigate climate risks to their portfolios and strategies.

Just tell me how

Asia’s fragmented approach towards legislating on these issues makes things harder. Policymakers and regulators primarily work in isolation, with little in the way of multilateral engagement, thereby limiting the scope for harmonisation of rules that multinationals can adhere to. The ostensibly ESG-focused investments made may not all have been driven by sustainability commitments per se, but rather by broader political opportunism and the disbursal of patronage, driving investments into key sectors such as renewables, green bonds and other sustainable finance instruments.

These challenges in Asia are compounded by the absence of a global green order. Most current global ESG policies lack structure, with no clear definition of what counts as ESG investing, or robust mechanisms to assess companies that claim to be adhering to ESG principles. Although there are several high-profile bodies that act as the key knowledge brokers for green growth in the global economy – such as the US-based Sustainability Accounting Standards Board (SASB), the Netherlands-based Global Reporting Initiative’s (GRI) sustainability reporting standards, and the G20-backed Task Force on Climate-related Financial Disclosures (TCFD) – they each cover different ESG areas, and have varying goals and methods of measurement.

This lack of standardised rules has left investors at a disadvantage when analysing the full opportunities or risks of ESG investment in Asia, while hindering benchmarking exercises across markets. As more companies look to burnish their sustainability credentials, this governance vacuum will ensure that distinguishing between investments that genuinely meet evolving ESG standards and those that only masquerade as such will remain challenging.

However, we anticipate that we are likely in the years ahead to see a proliferation of litigation surrounding false and misleading ESG marketing claims, particularly claims relating to operations or investments in Asia. This also means that companies that do begin to invest in ESG funds and initiatives, perhaps to avoid being considered on the “wrong side” of history, will still face significant reputational risks back home and in Asia.

Leave nothing to chance

A unified approach to metrics and principles is unlikely to materialise in the next few years. In the absence of global standards, it will be critical for investors and companies to understand how ESG issues impact their portfolios and business strategies, who their key stakeholders are, and how they may influence regulators and emerging regulatory frameworks.

This does not mean that companies and investors necessarily need wait for regulations to make good decisions. Ten years ago, the UN published its Guiding Principle on Business and Human Rights as a tool for approaching the kinds of governance gaps that international companies typically face in the jurisdictions where they operate. Since then, industries have been leading the way on its application. For instance, the International Council for Mining and Minerals and the Global Network Initiative (the information and communication technology sector body) have been reliable sources of practical guidance for companies operating in tough jurisdictions.

The principles upon which most industry guidance is grounded tend be undisputed, with a rather straightforward overlap between the environmental, social and governance aspects of an issue. Take an ostensibly environmental issue, such as polluted water discharge. Water pollution is also a human rights

issue, with long-term detrimental effects for society at large. Investors and companies can anticipate ESG regulations if they look to common-sense guidelines and international due diligence frameworks.

Global mindset, local approach

Asia is on the front line of the climate change disaster, but it is also, and will remain, the world’s pre-eminent investment destination. Based on these facts alone, Asia should be at the forefront of a seismic change in global growth patterns. But investors and companies must contend with one of the world’s most fragmented and politicised regulatory landscapes, meaning that detailed pre-investment due diligence, as well as stakeholder, regulatory and compliance risk assessments will be crucial before businesses can make solid claims about investing in a truly sustainable manner.

The sheer diversity of wealth, political systems and levels of stability in the region mean the achievement of ESG principals will also require one final factor – an acknowledgement that costs will be higher. Steps should be taken to educate board members and senior executives on integrating Asia-focused ESG considerations more fully into companies’ strategic outlooks. Rolling out or expanding an ESG strategy based on a purely EU experience, for example, will not be sufficient. This region represents a huge ESG opportunity, as long as investors meet Asia’s challenges on its own terms.

Reema Bhattacharya is a Senior Analyst in Control Risks’ Singapore office. She advises clients on key ESG, political, security and regulatory risks that may affect their operations and exposure to regulatory enforcement in South Asia. To find out more, visit controlrisks.com