Responsible investing: ESG factors set to alter the investment landscape

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on January 8, 2018 - January 14, 2018.

As Asia-Pacific undergoes dramatic change and disruption in the coming years, the three little letters E, S and G will bring significant challenges and opportunities for investors and corporates alike. > Madhu

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Environmental, social and corporate governance (ESG) and sustainable investing (SI) are central topics for policymakers, institutional investors and corporates. Related stories - be it human rights, board diversity or climate change - appear daily in the media. Major institutions and, increasingly, younger retail investors are keenly focused on these issues and managers are factoring the concepts into their investment strategies. In short, ESG and SI are no longer outliers to the portfolio selection and investment process.

The investment landscape has been rewritten of late, with all the players in the investment value chain shifting their focus to long-term, sustainable, risk-adjusted returns. This is a key global trend, with worldwide responsible investment assets as at the end of 2016 amounting to nearly US$23 trillion, says the 2016 Global Sustainable Investment Review. In Asia-Pacific, the responsible investment trend has seen spectacular growth, with China and India’s doubling between 2014 and 2016. Indeed, China has grown rapidly to become the largest issuer of green bonds globally, accounting for 40% of all new green bonds.

In 2017, BNP Paribas conducted a study on ESG practices in Asia-Pacific and globally with over 450 investors, accounting for over US$5.4 trillion in assets under management. The results underline the importance of ESG — in the next two years, 46% of asset owners plan to have 50% or more of their investments in funds that incorporate ESG or responsible investing, and 54% of asset managers plan to market 50% or more of their funds as ESG or responsible investing funds. We also found that investors are increasingly investing based on the ESG profiles of the investee companies (57% of respondents) and using green, sustainable bonds (52%).

Asia-Pacific investors are leapfrogging their regional counterparts, with the Paris Agreement of 2015 hugely important in focusing attention on Asia on green and low-carbon growth and in spurring environmental and social investing.

“In many Asian countries, it is no longer regarded as something that is ‘nice to have’, but instead, regulation and policy development is placing the region on a trajectory that will see it soon overtake other parts of the world,” states the Responsible Investment Market Update: A Snapshot of Signatory Action, Principles for Responsible Investment. Asia-Pacific respondents in our survey were particularly positive about ESG. They are more likely to have an ESG policy as part of their strategy (92%) and incorporate ESG factors into decision making (84%).

Despite these positive developments, there is still much work to do and challenges to overcome. Action is required in three key areas:

Smarter data, better analytics

Our respondents noted that a lack of robust ESG data is the biggest issue for asset owners and asset managers, with over 55% of them citing this as the biggest challenge. ESG and long-term sustainable value creation is not just about the past and the present, but about the future as well; the emphasis has to be on developing more rigorous and granular analytics and stress-testing capabilities. This will assist the investment decision-making processes, bolster risk management practices and demonstrate long-term performance benefits.

A common language

If investors are to make more informed and transparent decisions, they need to understand every ESG-related risk and opportunity associated with the companies and sectors in which they invest. According to our survey, the biggest reason why ESG is not part of investment decision-making today is a lack of clarity over how to define it — an obstacle for 38% of the respondents who do not currently incorporate ESG into their investment decisions. Hence, a common language to enable richer, deeper and more comprehensive reporting of the risks and the opportunities is something the industry at large is working towards. In November last year, with the rapid growth of the green bond market, the European Investment Bank and the China Green Finance Committee presented the initial conclusions of a project that ultimately seeks to facilitate the establishment of a common language in green finance. The organisation’s study looked in detail at the green bond standards in China and the European Union, finding that they use different categories to classify underlying assets.

Governance and standards

ESG goes beyond just the investor or the corporate. It impacts all aspects of the investment value chain. Regulators and industry bodies as well have a strong role to play, be it in the realm of governance codes, Stewardship codes, the UN-backed Principles for Responsible Investment (PRI) guides, the Global Reporting Initiative (GRI) standards or with standards on green bonds. With the launch of the Asean Green Bond Standards in November last year, the Asean nations have a strong base from which to provide incentives for both corporates and investors to consider green bond investments in the region. It is also a key enabler of business, potentially attracting investor capital to the region and allowing Asean issuers wider and greater access to investors.

As Asia-Pacific undergoes dramatic change and disruption in the coming years, the three little letters E, S and G will bring significant challenges and opportunities for investors and corporates alike. Harnessing the opportunities, managing the risks and overcoming the challenges in a coordinated, holistic manner will be the key to success.

Madhu Gayer is the head of investment analytics and sustainability, Asia-Pacific at BNP Paribas Securities Services