Monday, August 8

Investing and ESG: How it has evolved

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One of the main reasons for ESG integration is recognising that ESG investing can reduce risk and enhance returns as it forces the consideration of additional risks and injects new and forward-looking insights into the investment process. — AFP photo

 

ENVIRONMENTAL, social and governance (ESG) investing is an escalating phenomenon in recent years, amid environmental concerns, and many corporations have now made it an urgent business priority.

Indicators of the past decade’s rapid growth in sustainable or ESG investing are now abundant, according to the research arm of Maybank Investment Bank Bhd (Maybank IB Research) in its Malaysia ESG Compendium “Sustainability: No longer optional”.

“These range from the exponential increase in Principles for Responsible Investment (one of the key responsible investor proponents for whom, per its 2021 Annual Report for the year ending March 2021, the total number of signatories exceeded 3,800 with assets totaling circa US$121 trillion) signatories to the steadily rising share of global sustainable investing assets under management (AUM) versus total managed assets,” it noted in its Malaysia 2H22 Outlook.

And the phenomenon is worldwide. According to the Global Sustainable Investment Alliance, at the start of 2020, global sustainable investment reached US$35.3 trillion in the five major markets (Europe, the US, Canada, Australasia and Japan) covered in the Global Sustainable Investment Review 2020 report, a 15 per cent increase in the past two years (2018 to 2020) and 55 per cent increase in the past four years (2016 to 2020).

“The total professionally managed assets under management during the reporting period has grown to US$98.4 trillion,” the review read.

“Reported sustainable investment assets under management make up a total of 35.9 per cent of total assets under management. This represents a growth from the previous reporting period of 2.5 percentage points.”

Maybank IB Research highlighted that the fact that ESG assets under management across the investment world have seen sharply accelerated growth over the last decade is, most importantly, inextricably linked to the growing weight of evidence that ESG matters when it comes to investment performance.

“One of the main reasons for ESG integration is recognising that ESG investing can reduce risk and enhance returns (namely financial materiality) as it forces the consideration of additional risks and injects new and forward-looking insights into the investment process,” the research arm explained.

“It would be expected that companies scoring well on ESG metrics have performed a much more rigorous assessment of the overall business model to also account for non-financial risk, especially ‘E’ and ‘S’ risks.”

The research arm further highlighted that financial returns would be anticipated from reduced cost and increased efficiencies (for example, better resource and human capital management), reduced risk of regulatory penalties, understanding the risk posed by ‘externalised’ environmental and social costs and recognising the risks and opportunities within sustainability megatrends like climate change, urbanisation and demographic changes.

“Such companies would therefore be expected to be more naturally disposed to longer-term strategic thinking and planning, all of which should deliver better operational performance and hence, valuation premiums that are also reflective of the broader shift to sustainable investments.”

However, Maybank IB Research said against a backdrop of sharply increasing awareness and integration of ESG issues by international fund managers – whether voluntarily or due to pressure from asset owners and an ever-expanding set of sustainability codes and regulations – locally listed companies have generally fared poorly.

“Bursa Malaysia is heavily-weighted in sustainability-challenged sectors such as financials, oil and gas, power utilities and plantations, and many of these, as well as certain foreign labour-dependent exporters like the rubber gloves sector, have attracted negative ESG headlines, with flow-through valuation drag.”

 

Back in 2021, BNM introduced guidelines to help financial institutions categorise economic activities to meet climate objectives and promote the transition to a low-carbon economy. — Bernama photo

 

Syariah and ESG investing

IN the grand scheme of investing terms, some observers commented that syariah and ESG have overlapping qualities.

Dr Aida Othman

 

ZICO syariah advisory services director Dr Aida Othman revealed at the panel that in the investing world, for a few years now, shariah scholars looked at the very fast development of the discourses on ESG and other relevant terms.

“And actually, shariah scholars find that what is being discussed in the ESG world has foundations inside Islamic teachings. It is very easy to find the foundations, but the ESG discourse and criterion and developed methodologies helped to enrich and refine and bring out the discussions out of the vast Islamic heritage corpus basically,” Aida said.

“If you look at, let’s say, when we are students of Islamic law, we will learn Islamic jurisprudence. And one of the first things we will learn is about the concept of public interest.

“When you are issuing Islamic directions and one of the major jurists who expound the concept of public interest, he said, they must be taken care of (the interest) and you can’t simply do what you want. You must bring the evidence to support the actions that you take in the direction of public interest.

“You’re not looking at the shoring methodologies for investment. But you look at the Islamic principles for commercial law, when you’re signing contracts with one another.

“Oppressive practices, in particular against someone who is a weaker party than you, for example, workers (contract workers, migrant workers) are just not allowed if you look at the Islamic law.

“Of course, you don’t find this inside the methodologies for Islamic investment but the things we’re discussing under ESG is already inherent inside Islamic teachings.

“And they are coming up now, protecting the places you live, the people around you, people who are weaker than you, these are causes that you find being dealt with in the shariah sources.”

Aida highlighted that in the last few years, this discussion and convergence, and this integration between these two methodologies have been welcomed by the shariah scholars in their discussions, adding that funds such as these are definitely welcome.

She further highlighted that when big investors are stating outright that they are going to take into account these factors into their decisions, then hopefully, they expect to make very good steps moving ahead.

“Big institutional investors are saying that ‘we’re going to look at this now seriously, we’re going to revamp the way we choose investments, etc’.

“This sets a chain of things, gets a lot more people to talk. And so for example, let’s say let’s say we look at Malaysia, at overseas, there are similar authorities.

“In Malaysia, we have the Syariah Advisory Council at the Securities Commission for following developments, and say that now we can augment the way we look based on this and support the methodology.

“It has not come out, been extracted and put in a formal fashion but we are moving towards that. And, you know, this is how it came about, positive discourses between different experts.”

As Eastspring Al-Wara’ Investments senior fund manager Chow Kim Seng explained in his insight, both shariah and ESG seek to promote responsible behaviour and as such have overlapping principles.

“This has led to their natural pairing and triggered a growing demand for shariah ESG solutions in Malaysia and around the globe,” Chow noted.

“Malaysia launched its Syariah ESG index, the FTSE 4Good Bursa Malaysia Shariah Index, in 2021 while Nasdaq saw its first listing of shariah-compliant and ESG-aware exchange-traded fund in early 2022.”

As for Malaysia’s regulatory initiatives supportive of syariah ESG solutions, Chow recapped that the two main statutory bodies, Securities Commission Malaysia (SC) and Bank Negara Malaysia (BNM), have been entrusted to support the government’s push in sustainable investments.

To note, the SC introduced the Sustainable and Responsible Investment (SRI) Sukuk framework in 2014 to facilitate the creation of an ecosystem that promotes sustainable and responsible investing for SRI investors and issuers.

“The framework lays the foundation for a conducive and systematic ecosystem for both investors and companies that look to tap the market by aligning definitions and standards to United Nations Sustainable Development Goals, with emphasis on transparent reporting,” Chow noted.

Meanwhile, the Green SRI Sukuk Grant Scheme was established by the SC in 2018 to assist issuers in defraying up to 90 per cent of the external review costs for green SRI sukuk.

The SC later expanded its Green SRI Sukuk Grant Scheme in 2021 to encourage more companies to finance green, social and sustainability projects through SRI sukuk and bonds issuance.

With this expansion, the grant is now renamed as SRI Sukuk and Bond Grant Scheme and applicable to all sukuk issued under the SC’s SRI Sukuk Framework or bonds issued under the Asean Green, Social and Sustainability Bond Standards.

Chow also highlighted that in 2021, BNM introduced guidelines to help financial institutions categorise economic activities to meet climate objectives and promote the transition to a low-carbon economy.

“These guidelines complement the Value-based Intermediation Financing and Investment Impact Assessment Framework (VBIAF) Guidance Document issued by BNM in November 2019.

“The VBIAF is the foundation for ESG considerations in the financial sector, and whilst it is premised on shariah tenets, its framework has universal application for financial institutions targeting to incorporate ESG measures in their operations.”

 

Sunita points out that there are not very many businesses in Malaysia who still have not established their baseline of carbon footprint, who will be able to absorb this sort of carbon prices. — AFP photo

 

Is Malaysia prepared to do its part in the climate emergency?

FROM an environmental standpoint, Malaysia, a nation reliant on fossil fuels, has a long way to go in terms of being a ‘greener’ society by reducing its carbon footprint.

 

Datin Seri Sunita Rajakumar

 

According to Climate Governance Malaysia chairperson and director Datin Seri Sunita Rajakumar at a panel during the Nomura Asset Management Malaysia Global Shariah Sustainable Equity Fund launch, what is happening in the Arctic and the Antarctic may seem many miles away from us, but it is going to affect how we live.

“And part of the reason why we’re so detached is because we’re almost 80 per cent urbanised,” she explained.

“We do not price in these externalities, negative externalities are not priced in, public good is not priced in, such as clean and fresh water.

“We are a net exporting nation, where exports are 70 per cent of our gross domestic product (GDP). We’re not only extracting from our environment for ourselves, but we are extracting it for customers beyond our borders, who are not paying full price for this.

“We are addicted to fossil fuels, and addicted in a very wasteful way. All of this lights and cooling means that between 70 to 90 per cent of the power that was generated and distributed is lost enroute.

“There’s no circularity with our products – we buy things, we use them for a short while, and then we throw it away. We don’t understand how to recycle and reuse. There is a misalignment of policies and priorities.

“The World Meteorological Organisation says that we are going to hit 1.5 degrees of warming in the next few years. We are on track for that, this is not an end of century result that we’re looking at.

“Collective commitments that all governments have made are going to lead to 2.7 degrees of warming. We’re going to see increased cases of flash flooding.

“We understand that in Japan, they’re at the highest heat levels in 150 years. We’re going to have rain bombs, which cities are not built for.

“We’re going to have extreme heat days where you won’t be able to stay out of doors in the shade for more than three hours at a time without suffering from heatstroke.

“How is this going to affect huge sectors of the economy and emergency first responders such as your policemen and your firemen?”

Sunita said that capital markets are forward looking: While this transition is going to take place, businesses are going to take a while to be able to embed sustainability into their DNA.

However, when these risks are pulled forward, there are whole squads of businesses, industries, economies, regions, countries, that will not be able to make a smooth transition.

“We need to be part of the solution, this ecosystem of solutions, to ensure that we have as many possible options available to us for adaptation,” she affirmed.

On the risks and threats that climate change poses to the economy and whether this has evolved during the pandemic, Sunita opined that the pandemic has shown that it is not just about facing a climate emergency – it is a triple crisis, including biodiversity and pollution.

“This is supposed to be the century of pandemics, this is just the beginning. Get ready for many more instances, because Earth is not able to sustain population growth, and the extraction of resources that we are demanding to maintain our lifestyles.

“Be prepared also – and I think it’s been instructive – that although there’s this idea that we have a common responsibility for how we’re polluting the environment, notably emissions, but it is differentiated.

“And so developed countries aren’t necessarily going to come to the rescue of developing countries. And we saw this very clearly, with the pandemic, where Western countries refused to waive intellectual property rights, for example.

“It was okay for a global multinational pharmaceutical company to make US$22 billion of profits, even though this is directly correlated to vaccines and saving lives, for example.

“I don’t think there’s going to be any white knight on a white horse coming to rescue anybody. And this also means that we need to take responsibility as a net exporting region, addicted to fossil fuels, for our own mitigation and adaptation strategies.”

Sunita noted that if a lot of the climate emergency is linked back to emissions, then there is a need to manage our carbon footprint.

“The prices that we are seeing nowadays, the IEA, the IMF, estimating carbon prices of US$130 to US$160 per metric tonne.

“In EU and the UK, the emissions trading schemes, the futures markets are looking at between US$70 to US$100 per tonne.

“Today, the G7 said that they want to synchronise all the trade, non trade tariffs, or any barriers that they might have. They want to synchronise that between themselves, so they’re not unduly penalising, everyone’s headed in the same direction.”

Sunita went on to point out that there are not very many businesses in Malaysia who still have not established their baseline of carbon footprint, who will be able to absorb this sort of carbon prices.

“A lot of technologies, for example, for carbon capture and storage, don’t come from this part of the world so we also need to recognise that. A lot of adaptation solutions are going to be difficult if we don’t have the data to be able to make informed decisions.

“For example, there’s publicly available information showing that rising sea levels, plus normal flood heights are going to come all the way into areas well past Kota Kemuning, to the borders of Subang Jaya. This is publicly available information, but it’s done on a global level.

“We don’t have micro, local information to make informed decisions. We don’t have scenarios.”

She gathered that the Intergovernmental Panel on Climate Change (IPCC)-Network for Greening the Financial System (NGFS) have six scenarios, all global scenarios of what the transition is going to look like.

“All of these scenarios include nuclear power in the mix, it’s not applicable here. We need to craft our our own scenarios. There’s so much work to be done for a region, which is going to be disproportionately affected by the climate emergency.

“I understand the sustainable development goals (SDGs) are all important, the climate emergency, loss of biodiversity, the pollution crisis, is critical.”

 

There has been a large number of sustainable outflows into sustainable strategies and there has also been a high number of new launches of sustainable funds. — AFP photo

 

Concerns over greenwashing

HOWEVER, there are concerns of greenwashing occurring, particularly in the world of sustainable funds.

The term greenwashing, as defined by Cambridge Dictionary, is the “behaviour or activities that make people believe that a company is doing more to protect the environment than it really is”.

 

Alex Rowe

 

Nomura Asset Management UK’s executive director of sustainable equity portfolio manager Alex Rowe highlighted that there has been a large number of sustainable outflows into sustainable strategies and there has also been a high number of new launches of sustainable funds.

“At one point, there were 800 sustainable funds launched within just one year and actually 60 to 70 per cent of them were just rebranded,” he commented at the same panel.

“All these different funds that have launched, all doing very different things. We have the rating agencies that all provide very different scores that can be sometimes exceptionally low in correlation between what one provider is saying of another provider.

“And so rightly, we have had concerns over greenwashing really, being that the fund is not as sustainable as it might appear. And what we strongly believe is that impact awareness really cuts through all of the noise and it really helps to articulate what sustainable action means.

“When I say impact awareness, first of all, public equities have not typically been associated with that. It’s really been something that’s more seen in the private equity or private debt space.

“But if you look back at the Covid-19 pandemic, it was actually large public companies that had the investment firepower, the human resources, the management capabilities, intellectual property, to deliver vaccines in record time.

“And in addition to that, we as the investing community, have done a huge amount of engagement with these companies to try and support access to vaccine. There are very poor access to vaccines in Africa and in Southeast Asia.

“That’s just one very strong example of why impact should be at the forefront of everyone’s mind when they invest in a sustainable strategy.

“Of course, there was also mention of climate change. We all know that huge amounts of capital needs to be mobilised if we have any chance of meeting our targets globally.

“There are many estimates, you have between US3 trillion and US$5 trillion annually, we’re going to have to mobilise the capital of large public companies.

“This is why impact awareness is incredibly important for us as sustainable investors and should be important to anyone who has invested in a sustainable strategy.”

On how to prevent greenwashing from occurring, Rowe opined that it all comes down to impact awareness and really understanding what a company does and its total impact.

“It’s not what the industry does, in general, the industry focuses more on financial materiality, and really focuses more on the ability of the company to continue to operate more so than what the impact of the company actually is.

“In terms of what we do, we just really try and focus on what are the core impact metrics that are really showing what are companies doing, engaging with companies to really try and report better impact data.

“An anecdote which I always find amazing is that you can have companies doing fantastic things, small companies in emerging markets that are doing fantastic things on micro financing or on building up renewables but they’ve terrible ESG scores because they don’t have policies in place or they haven’t got the resources to respond to the ESG rating agencies.

“This is absolutely nonsense and it really shows the industry’s gone the wrong way. So what we do is we really focus on the impact of the companies and really try and understand it.

“Because of the greenwashing of funds themselves, what we do is we try to articulate the impact of both our investments and our engagement activity and just be brutally transparent.

“We produce an impact report every year on all of our holdings and why we hold these companies, what are the impact metrics we’re tracking and we try and be brutally transparent about what impact we’ve had through our engagement, where we haven’t had success.

“For example, some of the tech companies have been very disappointing, whereas with other companies we have had success.”

Overall, Rowe advised investors to ask and demand from their fund managers to really articulate what is the actual impact of the underlying holdings.

“Why’d you hold it? What was the impact of your own activity on our behalf, we’re entrusting you with our capital, we expect you to spend a lot of time engaging with companies and achieving certain impacts.

“There’s got to be a lot more nuanced thinking. And so really, this focus on impact awareness really cuts through greenwashing.”