What’s to be of ESG?

Global crises have a way of bringing the focus back on sustainable investing. It happened a decade ago during the calamity that was the 2008 Global Financial Crisis, and it is happening again in the midst of the Covid-19 pandemic.

The financial markets today is a whole new playground compared with decades ago when businesses’ main focus is to generate profit and drive the country’s economy.

Aware of the huge impact corporations can make on the environment, governments’ decisions and society, investors now expect businesses to be more transparent and accountable for their operations.

“As more investors embrace “responsible investing”, the degree to which a company observes or fails to observe these non-financial standards in its operations, is increasingly being scrutinised and taken into consideration by the investment community in their investment decision making,” AmBank Equity Research Malaysia’s head Joshua Ng highlighted in a research report.

“The key driving force behind environmental, social and governance (ESG) investing is no longer confined to conscience and philanthropy, but has extended to practicality.

“It has gathered so much momentum in recent years that fund managers who ignore it may risk missing the boat, potentially resulting in underperformance of their portfolios, as the writing has been on the wall for a while,” Ng added.

Considering that ESG factors has become an important part of mainstream investment decision making.

According to Bursa Malaysia, across the globe, asset owners and managers of all sizes and strategies have chosen to incorporate ESG criteria into their investment decision making processes.

The Global Sustainable Investment Alliance reported that approximately US$30.7 trillion dollars of investment is now managed according to ESG investment strategies, making it clear that ESG factors are also driving asset allocation decisions.

“We hold the view that despite potentially reduced returns (lower earnings and cash flow) for a company that observes high ESG standards, its market valuations may not fall, and may rise instead. As more investors embrace ESG investing, they raise the weighting of ESG-compliant stocks in their portfolios.

“This bumps up the demand for ESG-compliant stocks which pushes up their prices based on the simple law of supply and demand.

“The market effectively prices in an “ESG premium”, as reflected in its willingness to accept a higher price per earnings multiple or a lower discount rate in valuing ESG-compliant companies,” Ng noted.

In addition to making a positive contribution to the societies and environment in which they operate, businesses with good ESG performance are often considered to have lower levels of risk than those which have not taken steps to mitigate material ESG risks.

“In emerging markets in particular, strong performance on ESG criteria is often seen as an indicator of quality factors and good management,” Bursa Malaysia highlighted in its recently released FTSE4 Good Bursa Malaysia Index Bulletin.

The local benchmark ESG index, the FTSE4Good Bursa Malaysia or F4GBM, is concerted effort by Bursa Malaysia to offer support to investors who want to incorporate ESG elements into their investment decisions while at the same time, encourage best practice disclosures amongst Malaysian PLCs.

This has enabled companies with leading ESG practices to enhance their profiling and exposure.

While F4GBM has underperformed its benchmark index the FBM Emas persistently, AmBank Research believe the key reason is the under-representation of glove stocks in the index.

“We hold the view that over a longer time horizon, it shall outperform its benchmark index as more investors take to ESG investing, and as the index further expands its constituents, enabling it to better represent and capture ESG-compliant stocks,” it said.

This year, the ESG factor plays an even larger role in the corporate world as investors and the general public weigh in on businesses’ reaction towards the pandemic.

According to Moody’s Investors Service (Moody’s), various corporate business practices have received increased scrutiny during the current Covid-19 crisis, including the ways in which a company protects the health and well-being of its staff, whether it has a propensity to furlough workers or make them redundant, their pay and labour practices, and their shareholder return policies.

“The pandemic may accelerate a shift at companies away from the perspective that shareholders are their leading constituency to a broader view that considers multiple stakeholders, including clients, employees and their communities.

“The acceptance of a stronger social aspect to corporate strategy would underscore the links between a company’s reputation and the way it addresses ESG risk factors,” it added.

As the world begins its slow recovery from the Covid-19 pandemic, BizHive Weekly explores the growing importance of implementing ESG factors into corporate strategies and how it could play a significant role in a company’s recovery post-Covid-19.

Holding corporations responsible

The Covid-19 pandemic has highlighted the importance of financial market risks which has brought focus on ESG factors; namely disaster preparedness and health risks.

Besides ensuring that the corporation safeguards the public’s health safety, investors are now also more aware of how businesses are handling the safety of their own employees amidst the current pandemic and ensuring that their operations remain sustainable.

“Today, businesses are shaken up by Covid-19. The pandemic has amplified the demand for companies to address complex supply chains and become more transparent. And the growing focus now is on how businesses are responding to this pandemic,” AmBank Research’s chief economist Dr Anthony Dass highlighted in a commentary report on ‘Responsible business post-Covid 19’.

“There are growing environmental, political and social pressures for the world to find a more sustainable and responsible path towards development. Organisations are expected not only to apply socially responsible practices but also to become responsible business leaders.

“More organisations are expected to establish and operate ethical value chains and run their processes with integrity. In short, it is all about bringing renewed attention to the importance of corporate transparency on sustainability issues,” he added.

While the ESG issues that investors were looking at prior to Covid-19 still hold, the pandemic has placed a heightened importance and increased scrutiny on how businesses address the “S” in ESG.

“The focus is on the treatment towards its employees, suppliers and the communities in which they operate while naming and shaming good and bad actors along the way,” he pointed out.

Heightened public attention on corporate responses to the pandemic has also already shown signs of influencing behavior.

As can be seen in the case of Top Glove and the recent spike in Covid-19 cases amongst its workers from one its dormitories, which has caused heavy public scrutiny on the way the company handled the health safety of their employees amidst the current pandemic.

According to news reports, Top Glove would likely be charged for its cramped dorms. It has been reported that the government has opened investigation papers on Top Glove, which has been linked to the Teratai cluster in Selangor.

A report by The Edge Markets said that Human Resources Ministry had opened 19 investigation papers into six subsidiaries of Top Glove, after enforcement operations found that they did not comply with the minimum standards for workers housing and amenities, as provided under the law.

Citing the ministry’s statement, it reported that the main offence was the firms’ failure to apply for an accommodation certificate from the director-general of the Peninsular Malaysia Labour Department, which led to the discovery of other offences, including congested and uncomfortable accommodations that lacked proper ventilation.

Operating under the new norm

Since the pandemic has raised the need for businesses to address complex supply chains and become more transparent, the growing focus now is on how businesses are responding to this pandemic, Dr Anthony pointed out.

“The emphasis is on board composition and quality, environmental risks and opportunities, corporate strategy and capital allocation, compensation that promotes long-term growth, and human capital management.

“In short, it is all about bringing renewed attention to the importance of corporate transparency on sustainability issues. It is time to relook at business models. The model should focus on “sustainability” which then looks at resilience, reforms and reimagination,” he added.

While managing Covid-19’s immediate impacts will be the top priority for businesses, reporting historical environment, ESG data and performance remains essential.

“A slight delay of this year’s reporting is understandable, yet businesses must still strive for the same level of coverage as previous years and continue to improve their disclosures, moving forward, with the aim of ensuring their performance on key social issues are even more thoroughly examined than usual.

“Besides, accountability is vital in this new reality. Reports should provide sustaining account as to how businesses are responding to the pandemic. The degree to which companies do this now or in the future will depend on which part they are in their reporting cycle,” he advised.

Going forward, Dr Anthony pointed out that it would be essential for businesses to provide a narrative that identifies what change in historical performance relates to Covid-19 factors and what change results from previously existing plans – numbers on their own will be impossible for readers to interpret.

“It will also be important to provide a forward-looking narrative explaining their potential trajectory once Covid-19 is behind us.

“While reputation is an important driver of focus, business continuity, economic inclusion and public safety considerations are also critical. Given the growing attention across the board from investors to media, companies will need to increasingly focus on social issues to demonstrate their responsiveness to the top priorities of the day. Collaborations with industry peers to ensure comparable Covid-19 disclosures is vital,” he explained.

Balancing costs and social responsibilities

New safety requirements will profoundly affect the way companies, employees, customers and governments interact in the wake of the coronavirus pandemic, Moody’s Investors Service said in a report published recently.

For the companies themselves, these requirements likely will add costs and reduce capacity, and in turn curb revenue and profitability long after the pandemic recedes.

“Perhaps the most profound and long-lasting impact of the Covid-19 pandemic will be concern about contracting the virus,” said Moody’s vice president Edmond DeForest.

“Employees returning to shared workplaces will demand that companies invest in safety measures and customers will demand more digital products and services, while governments likely will insist on increased engagement with corporate management, with these changes affecting a company’s growth and possibly also its credit quality.”

Even if Covid-19 wanes, Moody’s pointed out that the lingering risk of contagion will impact profoundly the way corporations, employees, customers and governments interact with one another.

“Safety from infection will become a burden assumed by corporations as employees, customers and society at large make new – and expensive – demands on them,” it stated in a recent report.

It added that in order to address these demands, many corporations would need to make substantial and costly changes to, and investments in, their operations.

“Some will need to invest large sums in new technologies and capabilities, including robotics, artificial intelligence and videoconferencing, not only to address safety concerns, but in some cases to compensate for the higher costs associated with lower capacity utilisation.

“Others will need to implement safety-oriented policies and procedures to forestall regulatory requirements, only to find that the political pressure to “get tough” on safety leaves them subject to burdensome or conflicting laws, rules and standards,” it said.

But on whether these ESG-focused measures would reduce profitability for a company, AmBank Research disagrees.

AmBank Equity Research Malaysia head Joshua Ng explained: “Our main contention is that, as far as valuations of a company are concerned, ‘returns’ (as reflected in earnings, cash flow, and others) are only half the equation, with the other half being a ‘factor’ (such as P/E multiple, cash flow discount rate) to be decided by the market based on the market’s perception on the company’s prospects and risks.

“We are of the view that despite potentially reduced returns (lower earnings and cash flow) for a company that observes high ESG standards, its market valuations may not fall, and may rise instead.

There are plenty of tell-tale signs that more investors are taking to ESG investing.

“When they do so, they raise the weighting of ESG-compliant stocks in their portfolios. This bumps up the demand for ESG-compliant stocks which pushes up their prices based on the simple law of supply and demand.

The market effectively prices in an “ESG premium”, as reflected in its willingness to accept a higher P/E multiple or a lower discount rate in valuing ESG-compliant companies.”

Building a more ESG-conscious Corporate Malaysia

Corporate Malaysia is rapidly becoming aware of the importance of ESG practices into their companies’ growth strategies as can be seen by the growing number of corporations eligible for the FTSE4Good Bursa Malaysia index.

Since the FTSE4Good Bursa Malaysia index was launched in 2014, Bursa Malaysia noted that Malaysian companies eligible for inclusion in the FTSE4Good Bursa Malaysia (F4GBM) have increased year on year.

“This indicates that the ESG scores of Malaysian companies has shown consistent improvement over time.

“In the area of corporate governance, Malaysian companies demonstrate some of the highest levels of performance in relation to other companies operating in Emerging Markets and in term of overall ESG ratings,” it said in its recently published F4GBM bulletin.

It noted that the number of F4GBM Index constituents has grown three-fold since 2014, increasing from 24 to 73 as of the latest review in June 2020.

“Investors and shareholders now expect greater transparency and accountability from their investee companies, as they take greater interest in the social and environmental impact of their investment decisions,” said Bursa Malaysia chief executive officer Datuk Muhamad Umar Swift.

“As a frontline regulator and market operator, we want to provide an environment that encourages sustainable practices among our market participants.”

FTSE Russell Asia Pacific head of Sustainable Investment Helena Fung said, “Bursa Malaysia has been a valued partner of FTSE Russell since 2006, and we are delighted to collaborate with Bursa on their new ESG Initiative.

“This is a mark of our ongoing commitment to markets in Malaysia and across the Asia Pacific region. FTSE Russell’s ESG Ratings and data model provide globally recognised standards for market participants and companies to utilise as they incorporate sustainability approaches into their investment strategies.”

Bursa Malaysia has also made the PLCs’ ESG ratings available to the public to offer a good point of reference for investors looking for PLCs with good ESG performance.

It also provides PLCs with a view of their peers’ ESG performance. In addition, the ESG ratings can be used as building blocks for integrating ESG into investments in a variety of ways, including active portfolio management, benchmark construction and company engagement.

Beyond the stock market, Malaysia’s government is also setting the benchmark for corporate Malaysia by emphasising on socio-economic and environmental sustainability, with focus on ESG measures and green technological innovation.

In the recently approved Budget 2021, one of measures announced in its strategy to ensure resource sustainability is the sustainable development agenda.

The government through cooperation with the UN will establish the Malaysia-SDG Trust Fund or MySDG Trust Fund with an initial allocation of RM20 million. The fund will coordinate financing from various public and private sources systematically. Thus, various parties can contribute and be involved in efforts to ensure the SDG is achieved by 2030.

In addition, the government also supports the SDG programmes implemented by the Malaysian Parliamentary Party Cross Group with an allocation of RM5 million.

The government also aims to create a sustainable financial hub, with the issuance of its first Sustainability Bond in Malaysia for environmental and social initiatives in 2021.

In addition, to further encourage the issuance of Sustainable and Responsible Investment (SRI) products and bonds that achieve green, social and sustainable standards in Malaysia, the existing income tax exemption for SRI green sukuk grant is extended to all types of sukuk and bonds and this exemption is extended until 2025.

Furthermore, the government also announced that it will also continue the Green Technology Financing Scheme 3.0 or GTFS3.0 with a fund size of RM2 billion for two years up to 2022 which will be guaranteed by Danajamin to encourage the issuance of SRI sukuk.

These efforts were put in place in the hope that more companies will be encouraged to take up more effort to be environmentally and socially responsible.

And companies are fast to show that they are focused on this: Consumer giant Nestle Global on Friday pledged to invest 3.2 billion Swiss Franc (RM14.49 billion) in its newly-launched roadmap to halve its carbon emission by 2030 and achieve net zero by 2050.

In Malaysia, Petroliam Nasional Bhd (Petronas) said it has joined forces with United Nations Global Compact Network Malaysia and Brunei UNGCMY&B at the recent GO ESG Asean Corporate Sustainability Virtual Summit 2020 to position sustainability at the core of business recovery efforts in Asean.

This came on the back of its Net Zero Carbon Emissions 2050 announced in October this year.

Petronas group vice president (Health, Safety, Security and Environment) Dzafri Sham Ahmad said Petronas’ strategy was to continue minimising the impact of its carbon footprint in existing and future operations and deploy more low carbon solutions technologies.

“We believe there are opportunities in growing our low-carbon portfolio and increasing circularity in our resource consumption to optimise costs,” he said during the GO ESG Asean Corporate Sustainability Virtual Summit 2020 earlier this week.

“We are already seeing positive results through efforts that we have put in two decades ago to reduce emissions. Over the same period, our technology strategy also delivered improved efficiencies,” he said.

In order to achieve the 2050 aspiration, Dzafri said a concerted effort and collaboration was required between policy makers, industries, consumers and other key stakeholders.

“Collaborations will be the key driver for Petronas to grow our businesses and support a green and clean agenda together with our partners,” he added.