Asia on course to soon overtake the US on ESG adoption

FOR more than a decade, the vanguard of ESG (environmental, social and governance) awareness and adoption has been the Europeans, closely followed by the Americans. In the investment industry, the often main refrain from Asian investors was to "let the Europeans do good". Investors in the Asia-Pacific region took the very pragmatic view that it was not an investor's role to influence or impact society, but rather to achieve the highest possible returns.

That same Asian pragmatism is now one of the major reasons for the acceleration of ESG adoption in the Asia-Pacific. Like their counterparts globally, most investors in the region now realise that ESG is not merely about "doing good", but it is about finding the best companies that have the best chance to excel and succeed - and to do so in a sustainable way.

While ESG is mired in political debate in the US around whether a specific set of social values is being imposed upon asset managers and pension plan sponsors, it is establishing a firm foothold in the Asian investment landscape.

Asian investors, who are deeply rooted in numbers, facts, track records and science, see that ESG factors do, in fact, lead to better downside management and outperformance, and that such paradigms make sense in a region where the dispersion between well and less well managed companies is so much wider.

This is laying the foundations for a stronger set of standards on, and culture of, ESG transparency in Asia-Pacific than in the US. In the not-too-distant future, the region may also catch up with Europe too.

In part, the strengthening ESG culture in Asia reflects trends that are seen in the wider world. It is not merely enough to focus on ensuring fairness in the way companies are run for the benefit of shareholders; and neither is it enough to make bold value judgements on certain industries by excluding them from portfolios. ESG is more than that.

Investors in the region now understand that it provides a comprehensive way to look at the sustainability of companies' performances, their earnings, their business models, their workforce and their management structures - all of which may impact financial results.

Therefore, like the rest of the world, Asia investors are now taking ESG into serious consideration when constructing and weighing portfolios. Based on MSCI index historical data, a series of ESG indices outperformed their non-ESG weighted counterparts over 10 years in both developed and emerging markets. MSCI ACWI ESG Leaders Index which target companies that have the highest ESG ratings in each sector of the parent index, also outperformed its parent index in the past.

This has been quite dramatically illustrated over the last six months when Covid-19 put a lot of stress on the system. Although almost all companies were negatively affected, those that are better managed - ie those that have better planning, better governance and better relations with their labour forces, which ESG tends to lean towards - have fared better during the crisis.

There are trends, however, that are uniquely pushing Asia towards greater ESG adoption and transparency. One is the issue of environmental degradation. The natural assumption many in the investment community have had is that environmental concerns are somehow not of importance. This may have been true in the early years of rapid economic development when many Asian economies prioritised growth at the expense of the environment, but it has got to a point where the environment has become a serious issue in many Asian countries.

The Asia-Pacific experiences more natural disasters than any other region, which in various forms between 2014 and 2017 impacted 650 million people and killed 33,000. Severe environment degradation after years of growth-at-all cost economic policies has left its mark and is visibly exacerbating the natural disasters the region experiences.

A major securities company in China, for example, recently pointed out to me that if an actor pollutes the environment, it gets found out quickly and their misdeeds shared across social media, usually followed by a negative impact on their share price.

The region's ageing population is another important factor. This has increased the importance of attracting and retaining good talent and having a stable workforce. This is most clearly seen in Japan, where the former Abe government's attempts to reinvigorate the economy in the face of a rapidly ageing population includes bolstering women's participation in the workforce.

Despite the enthusiasm, challenges remain in Asia's quest for ESG adoption. The availability of data in the region has been improving over the years, but the reality in some Asian markets is that data and disclosure are not as complete as in developed markets.

Another is the problem of "greenwashing", where certain organisations may wish to rename existing products as ESG which may not meet certain thresholds or standards.

Regulators across the region are working hard on developing consistent disclosure standards, but it will be up to ESG rating agencies and index providers to draw upon a diverse set of reliable information and to remain independent as they provide ESG scores - as ultimately, objectivity will be key to pushing up ESG standards in the region.

This sets the scene for market forces to come into play, with investors using authoritative ESG data and reports to properly scrutinise companies and create a virtuous cycle of engagement on ESG, which will lead to improvements on self-disclosure and self-action.

To ultimately compete with - and exceed - the world on ESG standards, Asia-Pacific will need to embrace and lead on the ESG standards being set globally. Although some countries have sought to come up with their own ESG regimes to suit their own markets, this may not be the most conducive way to attract foreign capital flows. Just like issuer ratings in the bond market, as the world more generally adheres to ESG standards, there is need for a common language so that meaningful comparisons can be made between regional and product performance, giving investors confidence in making the decision whether to allocate their money to this dynamic region.