Cover Story: ESG becoming mainstream

This article first appeared in The Edge Malaysia Weekly, on December 7, 2020 - December 13, 2020.
Cover Story: ESG becoming mainstream
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IN recent weeks, while the world’s largest glove maker Top Glove Corp Bhd grappled with a Covid-19 outbreak at its staff accommodations in Klang, which led to investigations by the authorities of the group’s operations in five other states, the investor relations (IR) official at another glove company received various enquiries from fund managers seeking assurances that it did not share the same workers’ problems.

Last week, the Ministry of Human Resources opened 19 investigation papers against six companies related to Top Glove for failure to apply for an accommodation certificate from the authorities, which led to the discovery of other offences, including crowded, uncomfortable accommodation and lack of proper ventilation.

The IR official says ESG (environmental, social and governance) concerns have become the norm, more so following the outbreak at Top Glove’s operations in Klang, which led to scrutiny of the glove maker’s staff quarters.

While the palm oil and forestry industries continue to deal with allegations of deforestation and human rights abuses from NGOs on a regular basis, other sectors are now coming under similar pressures. Is ESG now becoming more mainstream?

ESG investing is not entirely new. After all, the FTSE4Good ESG Index was launched in 2014 by Bursa Malaysia but the movement is still seen as nascent in Malaysia.

“The G component, or governance, is not new. Investors have always prized companies with good governance and the starting point for ESG adoption should continue to be governance. The social aspect, or S, is perhaps newer as investors and the public have come to view corporates as having a responsibility towards society beyond just the short-term bottom line,” says Chris Eng, chief strategy officer at Etiqa Insurance & Takaful.


Hence, news of coerced labour is no longer acceptable to investors or customers and the additional social cost will have to be borne by corporates looking to do business with the developed world, he explains.

As the environmental aspect, or E, Eng says this is the newest aspect among corporates and has emerged perhaps over the last 30 years. Before that, the public had deemed it the government’s responsibility.

“There is still a lot of misinformation in this area and also misdirected information that may arise from lobby groups that are acting in the interests of certain competing industries. Nonetheless, there are no saints in the area of corporates and all need to improve on their environmental credentials,” he explains, adding that the palm oil industry, for example, needs to go beyond its current efforts to ensure that companies are compliant with environmental standards.

Be that as it may, a few things appear to be happening, setting the wheels of ESG investing in motion.

Last month, The Edge reported that the Employees Provident Fund (EPF) would be including, from next month, input from the Sustainable Investment Centre it set up in February as part of the fund’s evaluation of domestic panel brokers. In early November, national oil company Petroliam Nasional Bhd said it aims to become a net zero emitter of greenhouse gases by 2050 and will also increase its investments in renewable energy, making it the first Asian state-owned energy company to announce such a target.

Just last Thursday, Prime Minister Tan Sri Muhyiddin Yassin said the government is preparing to transition to low-carbon energy sources and is drafting a Natural Gas Roadmap as part of the National Energy Policy that will be announced in the first quarter of 2021.

Against this backdrop, reports and conferences on ESG are becoming more frequent.

“[As to] why it’s more topical now, it’s because the pandemic has really made people sit up. That has started the conversation going. Firstly, is our risk register complete and, secondly, was the probability that we attach to these things too low?” asks Datuk Mohammad Faiz Azmi, executive chairman of PwC Malaysia, which launched a report titled “Rethinking ESG in a post-Covid-19 world” last month.


The awareness is occurring across the world as companies react to the pandemic.

“What we’ve been trying to encourage, at least those who are willing to talk about it, is to understand the risks. To manage a business, it’s not just about making money, it’s about saving money. So, understand the risks, understand how those risks apply to your business, and plan to the extent that you can,” Faiz tells The Edge.

However, it is not just about saving money either, although the consequences of not adhering to ESG principles could be costly. The push has been coming from regulators, investors and, increasingly, bankers and financiers as well.

Faiz notes that the pressure from investors has been growing. “We were talking to the chairman of a bank recently and the comment was that they have had to keep specific information in their sustainability statement just to keep one foreign investor happy. That has been increasing … the questionnaires and questions that our companies get when they go on roadshows … so that pressure has been growing,” he says.

The questionnaires refer to checklists that funds send to investee companies to gauge their ESG compliance.

One of the biggest pushes comes from the world’s largest asset manager BlackRock. It was reported in July that the US$7.3 trillion asset manager had written to 577 companies in Asia-Pacific that represent over 90% of MSCI index constituents (excluding Japan and Australia), saying that it expects greater sustainability disclosures from them.

“Even the local boys are saying that maybe we should be looking at that [ESG] and they have been using risk as the reason why they are looking at it. Meaning, a business that has not at least considered and figured out how to mitigate ESG risks is arguably riskier to invest in,” Faiz says.

Eng says that while institutional funds such as Kumpulan Wang Persaraan (Diperbadankan) (KWAP) and EPF have been instrumental in creating awareness on ESG among analysts and fund managers, for public-listed companies, foreign investors played an early role in pushing the agenda by asking them about their ESG credentials.

“ESG investing is still more prevalent in Europe and the US but given the global nature of investing, it has also impacted Asian companies. Malaysian pension funds have also taken it upon themselves to pursue ESG investing,” he says.

While the trend is still nascent here, interest levels have been growing exponentially, accelerated by regulator support, says Anand Pathmakanthan, head of regional equity research at Maybank Kim Eng. “And client demand for ESG products is also rising, both globally and in Asia, driven by growing awareness and changing demographics.”


He points to the Schroders 2019 Global Investor Survey, which found that 66% of Asian respondents would always consider sustainability factors when selecting an investment product, compared with 57% of global respondents who said they would.

“Clearly, there is plenty of room for growth in Malaysia whether we are late to the game or not, and increasing emphasis on sustainability criteria by key institutional players such as the domestic pension and asset management industries underscore this potential,” Anand adds.

The ESG wave among local institutional funds may be attributable to institutional funds joining the United Nations-supported Principles for Responsible Investment (PRI) network of investors. Khazanah Nasional Bhd signed on in 2017, followed by KWAP in 2018 and the EPF last year.

Established in 2005, the global investor group is committed to a set of investment principles that incorporate ESG issues into investment practice. It launched its six principles in 2006 and believes that the signatories, by implementing them, will contribute to a more sustainable global financial system.

This year, PRI made reporting against the Taskforce on Climate-related Financial Disclosure mandatory for its signatories. PwC notes that this is in line with Bank Negara Malaysia, Securities Commission Malaysia and Bursa Malaysia’s commitment to work towards wider adoption of the recommendations by TCFD among local financial institutions.

Global supply chain factor

Aside from regulators and governments driving the ESG agenda, another major factor is businesses’ global customers.

“We are a trading nation and we are finding that our customers from countries that have endorsed net zero emission targets or have enacted into law decarbonisation, or raised other ethical concerns, such as the use of labour, will increasingly make demands on their suppliers to follow suit,” says Faiz.


“If you have your ultimate client espousing these principles, then it’s difficult to see how they’ll let the supply get away from it. And our biggest trading partner is China,” he adds.

In September, China surprised the world with its pledge to cut its net carbon emissions to zero by 2060. The country is the world’s largest emitter of carbon dioxide, contributing 28% to global emissions.

China is Malaysia’s second-largest trading partner after Singapore. “China has come out with a date, 2060, and we’re a significant component of that supply chain. Do you not think they will be asking us questions?” Faiz says.

Eng of Etiqa agrees, saying that companies in Malaysia need to go above and beyond their peers to prove their ESG credentials if they want to continue enjoying market access in developed markets where ESG awareness is high.

That is something even smaller companies that are not directly exposed to global markets or do not have the resources to incorporate ESG into their operations — especially those struggling during these hard times — will have to think about at some point.

“Companies that survive this are part of a supply chain with larger companies who are their customers, and are demanding for sustainability as they are required to disclose their own ESG performance. ESG may have a role to play at the medium to longer-term recovery stage.

“Many smaller players are suppliers for larger companies. Large companies may have the resources for ESG, but they cannot achieve their ESG goals without support from the smaller companies in their supply chain,” says Andrew Chan, PwC’s Sustainability and Climate Change Leader.

He adds there is increasing recognition that SMEs have a key role to play. “But it’s not putting all the responsibility on the SMEs. For context, some studies have highlighted that SMEs and companies in the supply chain can have a total environmental footprint five times that of the main company.”

On the issue of smaller companies finding it hard to bear the cost of ESG monitoring and reporting, Anand is hopeful that technology and regulator support for this group will bridge the gap.

PwC in its report identified palm oil producers and glove makers as among Malaysian exports that are subject to ESG risks. For palm oil producers, the concerns are environmental and labour practices while for glove makers, it is forced labour. Why are these two sectors getting so much attention?

“They are highly visible industries that generate significant economic value from natural resources and require a large manual workforce. They also operate across global markets, across countries with different standards to adhere to,” says Chan.

While companies in these sectors must incorporate ESG into every aspect of their business and engage stakeholders to build trust, they have more control over their sustainability narrative than they realise, he adds.

“It’s important that companies are able to show that they have a clear plan in place to address any gaps in ESG practices, chart their progress regularly and communicate in a balanced manner,” Chan says, adding that when investors and analysts cannot find sufficient and credible information from the company itself, they look towards informal, or third-party sources, which may not be accurate.

“When this happens, companies then have to spend more time and resources reshaping the narrative of themselves, which may be damaging to their brand or reputation,” he warns.

Nevertheless Faiz commends the palm oil industry for its response to the pressure from the NGOs, saying: “The industry has done a lot to try and address these concerns, the creation of the Roundtable on Sustainable Palm Oil was one such thing. Now, imagine, we have to somehow replicate this across other industries.”

Scepticism

Although more people are chanting the ESG mantra more frequently these days, sceptics who question its genuine adoption by companies are equally as many.

PwC SDG Reporting Challenge 2019 highlighted that 73% of Malaysian companies mentioned the United Nation’s Sustainable Development Goals (SDG) in their reporting. Although 20% had SDG in their published business strategy, only 11% had specific SDG targets.

Anecdotes abound over “greenwashing” by companies as well as CEOs saying in private that they would worry about the planet once they had made enough money.

The question is, has the ESG pressure from investors and other stakeholders led to sustainable practices in corporations that contribute to a cleaner environment and a better society.

“The answer is an unequivocal yes. With the rapid growth in ESG-themed investment funds, and more and more large institutional funds adopting sustainability frameworks regarding their investment decisions, companies are, in our view, clearly responding with better ESG reporting and standards,” says Maybank Kim Eng’s Anand.

From his experience covering Malaysian companies, he says they have come a long way in the past few years regarding sustainability reporting and articulating ESG concerns related to their operations.

“Many are now setting targets in areas like emissions, gender representation and energy efficiency, with stated benchmarks that they can be held accountable against (that is, opening themselves up to monitoring by external parties, including shareholders),” he adds.

Chan adds that the danger of companies merely paying lip service to the ESG agenda in this digital era is that nothing remains a secret and they run the risk of incurring severe reputational damage by not walking the talk.

For PwC, which was the first among the Big Four firms to set up a sustainability unit way back in 2007, it has seen interest in ESG grow over the years.

Faiz recalls setting up the unit after watching the 2006 documentary on global warming, An Inconvenient Truth, with his daughter and being asked what he was “personally doing about it”. What followed was a session with clients on the subject held by a PwC colleague from London in Kuala Lumpur.

“We pretty much won our first assignment after that briefing. We didn’t realise that a number of our clients were facing these problems with NGOs. Now, 13 years on, the pressure is across the board, whether you’re a bank, construction company, car company or food company. Because we’re part of the supply chain, what we do matters to the principal that we’re selling to,” he says.

 

 

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