ESG in Emerging Markets shifts into top gear

With a number of emerging markets being disproportionately impacted by climate change, the need to tackle carbon emissions has never been greater. In response, issuers, investors and intermediary providers across Asian and Middle Eastern markets are increasingly incorporating ESG (environment, social, governance) into their decision-making processes.

ESG – a critical component in modern-day portfolio construction

The volume of ESG investments in Asia is gathering momentum. According to MSCI, 79% of allocators in the region had either increased their ESG investments “significantly” or “moderately” in response to COVID-19, while a further 57% expected to either “completely” or “to a large extent” integrate ESG factors into their investment analysis by the end of 2021.¹ MSCI continues that $5 billion was invested into sustainable funds in Asia in the final four months of 2020, bringing AuM in the region to $25.4 billion, a 131% year-on-year increase from 2019.²

Although direct ESG investing per se in the Middle East is somewhat lagging relative to other major markets, the region has extensive experience in supporting Islamic finance and Shariah-compliant funds, bonds and insurance. Operators of Shariah funds already have a solid grasp of the S constituent in ESG as their mandates require them to adopt an exclusionary investment approach - eschewing assets likes tobacco, arms and alcohol. The region’s deep rooted expertise of Islamic finance therefore puts it in good shape to develop a wider gamut of ESG products moving forward.

With more investors embracing ESG, corporates in Asia and the Middle East are having to respond. A recent study by international law firm Baker McKenzie found almost 46% of businesses in Asia are taking sustainability more seriously than before the pandemic, while an additional 90% acknowledged they considered ESG issues when making acquisitions.³ Corporates across these emerging markets are also ramping up their ESG reporting - while some are adopting the disclosure guidelines laid out in the FSB’s (Financial Stability Board) TCFD (Task Force on Climate related Financial Disclosures).

Financial Market infrastructures are also keen to promote best practices around ESG. In October 2021, Standard Chartered joined the Singapore Exchange (SGX), DBS and Temasek to develop a joint venture – Climate Impact X (CIX) - a digital global exchange and marketplace for high quality carbon credits. Meanwhile, the Korea Exchange together with the domestic regulator - the FSC (Financial Services Commission) launched an integrated ESG information platform in December 2021, giving investors easy access to ESG data on listed companies. Even in recently liberalised GCC economies such as Saudi Arabia, the country’s Stock Exchange issued ESG reporting guidelines for publicly listed companies. While ESG reporting and adoption in emerging markets is improving - it is not without its challenges.

The main hurdle continues to be data

The barriers impeding ESG adoption across Asia and the Middle East are not unique to these regions but are global problems. Data is perhaps the biggest obstacle facing the ESG market right now. The main issue is that a lot of ESG data – especially when used to measure things like social impact – is subjective and hard to properly quantify. While a number of major issuers in emerging markets are open to publicly sharing ESG data, the reporting standards are varied as a result of these data discrepancies. This will have knock-on effects elsewhere in the investment chain.

Most notably, if the quality of ESG data being published by issuers is inconsistent or unreported, there will be a downstream impact on investors and their ability to report ESG measurables accurately to their own end clients and even regulators. Without material improvements in data quality, substandard reporting and greenwashing – namely when companies or investors make misleading claims about their green credentials – risk becoming more entrenched - thereby undermining the ESG market.

ESG reporting is also inconsistent because of the sheer abundance of ESG data providers and ratings agencies. These data providers assign ESG ratings to issuers - yet their processes are not always aligned – in what can lead to significant dispersions in ESG scores. For example, one rating agency may weight environmental factors heavily in its ESG scoring process yet another might be biased towards governance resulting in different sustainability ratings being awarded to the same company – leading to confusion among investors – especially those who are new to ESG. This is something which merits urgent resolution.

Delivering better data

In order to prevent greenwashing and strengthen ESG reporting, there needs to be better data standardisation and criteria at a local and regional level. Initiatives being led by policymakers and regulators to facilitate this in Asia are already underway. Similar to the EU’s Taxonomy Regulation, the ASEAN Taxonomy is a classification system for sustainable activities.⁴ This benchmark could go a long way in helping companies and investors in ASEAN with their ESG reporting. In addition, China – along with Hong Kong, Japan and Singapore - are working closely with the EU to develop a global taxonomy standard otherwise known as the Common Ground Taxonomy (CGT).⁵ The Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) have already confirmed they will adopt the CGT as and when it is introduced.⁶

Elsewhere, the People’s Bank of China (PBOC) is keen to promote green and sustainable products while it is also taking a lead on the development of mandatory environmental information disclosures. In addition, Hong Kong’s SFC introduced enhanced disclosure requirements for ESG funds and climate focused funds. The authorities in Thailand have been proactive on ESG as well with listed companies and funds now subjected to enhanced sustainability disclosure rules while a taxonomy is also reported to be in the pipeline. And finally, Korea’s FSC is imposing mandatory ESG disclosure obligations on all KOSPI-listed companies beginning in 2025 in an effort to help strengthen sustainability disclosure rules.

A number of regulators are also looking to sharpen ESG data standards through technology and innovation. For instance, the Monetary Authority of Singapore (MAS) is conducting a pilot developing a digital platform for sustainability-linked data in what should help investors access and benchmark ESG information.⁷ MAS is also expected to announce disclosure rules for retail ESG funds later this year.

ESG picks up in emerging markets

Emerging markets in Asia and the Middle East might not be as advanced in terms of their ESG adoption as Europe. However, momentum is gathering pace as investors demand companies globally to tackle climate change and become more transparent about ESG. Moreover, a number of markets in Asia and the Middle East will look to learn from the EU’s ESG experiences and apply those lessons accordingly in the development of their rules. In other words, being a second mover does carry some advantages.