Violent protests broke out in China’s Henan province earlier this month after the country’s biggest bank scam saw savers’ money frozen for months. While this scandal shows that corporate governance risks are still very real, we shouldn’t discount the great strides Asia Pacific has made in ESG standards in the past few years.
With ESG assets under management in the region expected to hit $500bn by 2025, momentum is growing. But where are the pressure points, and what will ESG investing look like in Asia in the next few years as the landscape evolves?
The bottom line
Asian businesses are embracing ESG because there is now plenty of research to show that building sustainability into your business model boosts your bottom line, says Kunal Desai, global emerging markets equities fund manager at GIB Asset Management.
“How businesses are perceived from an ESG and sustainability perspective has been a very strong driver of forward returns,” said Desai.
He noted that, since 2018, the top quintile of businesses in emerging Asia that have improved the most on ESG factors have outperformed the laggards by 5.1 percentage points annualised, according to Bernstein.
“So, globally, the businesses in Asia that have improved the most from an ESG perspective have driven the strongest returns for investors.”
Desai also noted the valuation premium for businesses that score higher on ESG is especially pronounced in Asia. A rating of BBB or above from an ESG ratings agency can help a company trade at a 40% premium to the rest of the market, while those rated CCC typically trade on a 30% discount, according to MSCI and Factset.
Low-hanging fruit
Although there is “a long way to go” in emerging Asia compared with other markets because they are starting from a lower base, there is a lot of low-hanging fruit, such as better governance and disclosure, that can have a big impact on profitability, said Desai.
For Alex Chan, head of ESG client strategies, Asia Pacific, at Invesco, better disclosure and transparency is what stands out in terms of major changes in Asia’s ESG landscape over the last few years.
In August, new Securities & Futures Commission (SFC) rules will come in mandating that Hong Kong fund managers disclose and manage climate-related risks, for example.
This year, China’s Ministry of Ecology and Environment also brought in new rules forcing companies to submit annual environmental reports. Stricter governance is already happening, such as the Hong Kong stock exchange mandating gender diverse boards.
There are also improvements happening in terms of the development of taxonomies. The International Sustainability Standards Board (ISSB) is looking at introducing a global set of reporting standards on sustainability-related risks and opportunities, and Chan wondered how this will translate to Asian regulators down the line.
Many countries now have net-zero targets: China has its ‘1+N’ policy framework for carbon neutrality, for example, although it won’t reach net zero until 2060, and India is working even further out at 2070.
Although these targets are distant, these nations also have sector-specific and interim targets to work towards in the meantime, and momentum has increased a lot in the past one or two years, said Chan. “Those interim targets will be helpful in moving momentum along,” he suggested.
There is also progress happening on carbon pricing, he explained. “If we look at the region, Singapore now has a carbon tax, China has launched its national emissions trading scheme and is thinking about further development and expansion.”
Another positive is that carbon goals have funnelled down to the corporate sector, said Chan, and some Chinese companies are aiming to be carbon neutral by 2030 or 2040, far ahead of the government’s target. There are also now 448 Asian signatories to the UN’s PRI goals.
Sector innovation
Innovation is happening that will lift Asia’s green credentials, such as in the renewable energy sector with nascent technologies such as hydrogen and carbon capture.
The agriculture and food industries generate a lot of emissions and are a significant focus for the Chinese government in its Five-Year Plan, with the aim of improving sustainability, supply chains and food security, Chan said.
Some of the hurdles to better ESG in Asia come from the fact there is economic disparity across nations. Some are still very reliant on coal, some are very vulnerable to the physical impact of climate change, and some can’t afford to think about being green right now.
“Economic considerations are critical. Energy transition is important but what does it mean for employment and economic growth, and what climate financing would be required for the transition?” said Chan.
Data availability, transparency and standardisation will all help to counter the wider threat of greenwashing. Chan suggested greater regulatory certainty and clarity will lead to more confidence among investors in future, while growing talent and ESG knowhow in Asia’s workforce will strengthen the ESG investing landscape.
ESG engagement: A case study
Engagement by fund managers will also have a role to play in shaping a more sustainable corporate sector in Asia. Desai meets regularly with the 30 companies he holds in his emerging market equity portfolio, including a steel pipe producer in India.
The company had a dominant market share, great distribution and a strong revenue trajectory, but was trading at a 60% discount to its rivals because of weak perception of its governance, environmental sourcing and disclosure.
Working with management, Desai and his team focused on water and emissions management and corporate governance, and linked key ESG targets to executive pay to incentivise management.
It also pushed to change from a local auditor to one of the Big Four, appoint a head of strategy and launch a new sustainability report. “As a result of our work with the business over the last two or three years, the valuation has re-rated to being in line with its peers in the market,” said Desai.
Solar power and electric cars
Deirdre Cooper (pictured left) is head of sustainable equity within the multi-asset team at Ninety One and manager of the group’s Global Environment Fund.
She agreed Asia Pacific, especially China, is still very reliant on fossil fuels and is continuing to build coal plants. However, she argued “a tonne of carbon saved in an emerging market is just more valuable than a tonne of carbon in a developed market,” while the percentage of coal in the energy mix is going down over time. “Every year the average kilowatt hour in China gets cleaner,” she said.
Cooper’s view is that investors have to look to emerging markets for businesses that are tackling climate change in the world’s most polluting nations. “It would be absolutely extraordinary to invest in solution providers for climate change and ignore emerging markets.”
She noted that emerging markets account for 50% of global carbon emissions, and 95% of emissions growth over the last decade, while China alone accounts for around 30%.
Cooper currently has more than 20% of her portfolio in China, close to its highest ever level due to the strong performance of the green stocks she holds including solar companies and makers of components for electric cars.
The electric vehicle sector stands out in Asia’s ESG landscape, Cooper said, with more than 30% of monthly new car sales in China made up of electric vehicles compared to high teens in Europe and low single digits in the US.
“China is streets ahead of the rest of the world in terms of electrifying its transportation fleet and the companies driving that are not the Volkswagens and the GMs, they’re all domestic Chinese companies.”
Cooper plays this theme through Wuxi Lead Intelligent Equipment, which makes machines that manufacture lithium ion batteries for electric cars, and Sanhua Intelligent Controls, which makes EV heat management systems.
A virtuous circle
Asia’s businesses are working towards being better on ESG from the ground up, and regulators are applying pressure from the top down too.
Over the past five years, 75% of companies in Asia have witnessed at least one ESG improvement, and 37% have seen a two-notch improvement over that period, according to MSCI and Factset.
Investors and companies themselves have so far been driving much of this change, but there is a greater role for regulators and governments from here in a push from voluntary to mandatory disclosures, said Desai.
India’s Securities and Exchange Board, for instance, now makes its top listed companies disclose things like air emissions, waste management, and how much they are spending on ESG initiatives.
“Three things have come together in Asia: low existing ESG scores, increased receptiveness and willingness for companies to improve, and the evidence now in place that once you get ESG improvement, it really is a potent source of shareholder returns. Those three elements reinforce each other to create an environment where there has been a tangible change in emerging markets today,” said Desai.
While the Henan banking crisis should serve as a reminder to investors not to get complacent, the progress Asia Pacific has made on sustainability means it’s already an ESG destination that can’t be ignored.
