April 02, 2009
ESG Trends in Emerging Markets Is Focus of New Study
by Robert Kropp
Report from IFC and Mercer finds growth in sustainable investing in emerging markets, but notes
need for improvement in such areas as active ownership.
Global survey data compiled by Mercer, an
investment consulting firm, indicates that investment in sustainable investment funds in emerging
markets has grown more than fivefold between 2003 and 2008, to more than $300 billion. $50 billion
of this amount reflects funds which are specifically branded as socially responsible or
sustainable, while the remaining amount represent mainstream managers who take environmental,
social, and governance (ESG) issues into account.
Research by Mercer also found
that sustainable investing in emerging markets has been driven by investors in developed markets
seeking to achieve diversification in their investment portfolios.
The above research
results were among the findings included in a report entitled Gaining Ground: Integrating Environmental, Social and
Governance (ESG) Factors into Investment Processes in Emerging Markets, commissioned by the International Finance Corporation (IFC), a member of
the World Bank Group, and written by Mercer.
The report's authors focused their inquiry
into four major emerging markets: China, India, South Korea, and Brazil. In those markets, as in
many emerging markets, rapid economic growth has led to depletion of natural resources and created
challenges to sustainable development. Yet despite such challenges, the authors found that
sustainable investment is gaining a foothold in emerging markets.
Ewan Marshall, Program
Manager for IFC Sustainable Investment, said, "IFC invests $15 billion a year in emerging markets,
and through those investments we hope to influence markets. We believe that good sustainability
management is good investment management."
Specific questions fueled IFC's interest in
sponsoring the report, Marshall said. "What are the best practice sustainable investment strategies
within emerging markets?" he asked. "What are the themes and trends we see as sustainable
investment in emerging markets grows?"
Danyelle Guyatt, a Principal in Mercer's
Responsible Investment team and an author of the report, said, "We found that sustainable
investment is taking hold in emerging markets, including on the local level. In general, standards
of corporate governance are the starting points, although environmental and social issues are
beginning to take hold as well."
While corporate governance was found by the authors to be
a relatively well-understood concept when compared with environmental and social issues, they also
found that investment managers struggle to obtain clarity on companies' governance structures in
emerging markets. Furthermore, active engagement on ESG issues is not commonly pursued by most
investment managers in emerging markets, and short-term investment horizons by managers whose
portfolio turnovers exceed 100% annually tend to inhibit ESG integration in their investments.
"Active ownership has yet to become a first resort for fund managers in emerging markets," said
Guyatt, "And we found few examples where managers felt ESG enhances value. Instead, managers
focused more on ESG as a tool in risk management."
Each of the four countries surveyed in
the report displayed characteristics specific to its cultural and economic trends.
China, the report found, rapid economic development has led to environmental degradation and social
inequality, which could hamper its long-term economic development. In response to the potential for
an environmental crisis, the Chinese government has targeted a 20% reduction in energy consumption
per unit of gross domestic product by 2010.
Also in response to environmental concerns,
China has developed a Green Security Index that requires heavy polluting companies to undergo an
environmental assessment before they seek listing on Chinese stock exchanges.
found that ESG improvements at a business level are challenged by China's position as a world
factory whose pursuit of profits too often excludes consideration of ESG factors. Corporate
regulatory compliance is more often driven by fear of sanction than by a belief in ESG practices.
Guyatt said, "In China, we found a lack of willingness on the part of fund managers to
engage companies, even on governance issues." In large part, the difficulty of such engagement can
be attributed to the Chinese government's dominant share ownership of most large-cap listed
India was found to have the lowest standards of ESG implementation of the
countries surveyed in the report. While some investment managers displayed some awareness of local
social issues, especially regarding poverty reduction, access to clean water, and sanitation,
active ownership of Indian companies was found to be noticeably absent.
On the other hand,
Marshall of IFC pointed out, "The Stock Exchange in Mumbai does have a sustainability index." The
S&P ESG India Index, which was initiated and sponsored by the IFC, comprises 50 Indian companies
that meet ESG criteria.
South Korea has seen the largest increase of sustainable
investment (SI) labeled funds, which grew from two in 2005 to 45 in 2008.The South Korea Exchange
is developing an eco index listing, and plans to establish a socially responsible investment (SRI)
index in the future. In December 2009, South Korea will be re-classified as a developed economy.
"In South Korea, we found a lot of reform in raising governance standards and addressing
climate change." said Guyatt. "But in general there was a lack of good reporting on ESG standards,
and little willingness to engage companies was in evidence."
In Brazil, where the concept
of sustainability led to the creation of an SI labeled fund in 2001, engagement with companies on
the issue of corporate governance has become fairly common, and the practice of proxy voting has
begun to take root as well. However, lack of board independence and insufficient financial
disclosure were found by the report to be common among Brazilian companies.
managers in Brazil tend to offer specialty products, rather than integrating ESG into mainstream
products," said Guyatt. However, she did note that the Principles for Responsible Investment (PRI), a major driver for
global sustainable investment, has 28 signatories in Brazil, including 18 pension funds, 8 asset
managers and 2 professional service providers.
The report recommends a number of steps
that asset managers should take to improve the incorporation of ESG factors in investments. Asset
managers should develop and consistently promote an SI policy, and clarify their expectations
regarding investment in emerging markets. They should integrate ESG and active ownership into their
investment selection criteria.
Also, emerging market asset owners and managers should
consider joining collaborative networks such as the PRI, in order to learn best practice of ESG
activities and improve active ownership practices.