Asia's Path to ESG Integration

The article below is from our BRIEFINGS newsletter of 22 July 2019

Across Asia, companies are getting more serious about sustainability. We sat down with Goldman Sachs Research’s Sharmini Chetwode, who shared how companies are increasing their disclosures around environmental, social and governance (ESG) factors and how investors are integrating ESG into their investing framework.

Sharmini, how is the global landscape for ESG investing evolving?

Sharmini Chetwode: Globally, investors are facing pressure to invest in a socially responsible way. Currently, about $17 trillion – or 20% of global assets under management -- is labelled as ESG integrated and is invested according to the UN-sponsored Principles for Responsible Investing. That percentage is likely to increase given that the UNPRI has recommended that asset managers integrate ESG in at least 50% of their AUM. What was once considered optional for companies to report is now shifting to mandatory. More broadly, integrated ESG reporting – the new normal in Europe – is gradually becoming part of financial reporting in Asia. Excluding China A shares, Asia's Environmental and Social performance is on par with that of the US. However, conclusions on E&S performance from frameworks alone can be erroneous.

How do Asian companies compare to their global peers in disclosing ESG progress?

SC: Asia is keeping pace with – and, in some jurisdictions, outpacing – global averages for disclosures around E&S risks with environmental metrics featuring most prominently in the rise. The drivers for this rise include the UNPRI and the Sustainable Development Goals, set by the United Nations General Assembly in 2015. We're also seeing an increasing regulatory push toward ESG disclosure in the region. Over the last three years, for example, we've seen a flurry of initiatives in Hong Kong, underscoring its commitment to ESG and a desire to remain at the forefront of global standards. Japan's implementation of the Stewardship Code – which was published in 2014 and revised in 2017 – and the 2015 Corporate Governance Code – which was revised in 2018 -- has forced investors to actively engage with companies to achieve higher returns on equity, capital efficiency and transparency. In India, the Securities and Exchange Board made it mandatory for the country's largest companies to prepare business responsibility reports. Meanwhile, the China Securities Regulatory Commission is requiring heavy polluters to give more detail on emissions and encouraged all listed companies to voluntarily disclose E&S information by the end of 2020.

You’ve said that ESG data alone is not enough for ESG insight. Why?

SC: The perception that large data sets can reveal ESG risks is different from the reality. We need a deeper understanding of a company’s business model, geography and strategy. Whether a company is vertically integrated or has a capital intensive business model can influence its E&S performance. High-level sector-relative analysis can be either punitive or flattering for a given company, so the choice of a peer set is important in forming conclusions about E&S performance and longer-term risks. The same is true for the company’s geographic location and what that implies for access to water, renewable energy and vulnerability to emissions regulation. This is why digging beyond headline numbers is crucial.

What other challenges do investors face in integrating ESG?

SC: The most challenging obstacle is the amount and quality of data. More than 450 ESG metrics are available from major data providers for investors to analyze. Deciding which metrics have the greatest potential to impact the company’s financial performance is the starting point. From there, investors have to navigate holes in data availability, lagging data, varied reporting nomenclature and inconsistent levels of data assurance. Analyzing the data in the context of the company’s business model and location can provide a better snapshot of its ESG risks. However, understanding longer-term risks requires an understanding of a company’s strategy and goals, potential scenarios of environmental and climatic threats, and is also dependent on whether the company has the tools – such as the appropriate skill sets, Board of Directors support and ESG-linked compensation – to integrate ESG into their business. These are key areas of future progress in Asia.