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December 10, 2010
ESG Transparency and Performance Improves Among Emerging Market Companies
    by Robert Kropp

A Eurosif report on emerging markets finds an increase in the uptake of sustainability issues by companies, and recommends that investors encourage continual improvement.


In the latest of a series of trends reports on sustainable investment in various regions of the world, Eurosif has published this week its updated study of the integration of environmental, social, and corporate governance (ESG) factors into the business practices of companies in emerging markets.

The findings of the report, which is the fifth in a series on emerging markets published by Eurosif, are based on research provided by
Inrate, a Swiss-based sustainability rating agency. The report analyzes the ESG performances of 721 companies headquartered in four emerging market regions: Asia, Eastern Europe, Latin America, and Africa and the Middle East. The ESG performance of the companies is then compared to that of 1,605 companies in the MSCI Developed Market Index.

Referring to the
2010 World Economic Outlook, published in April by the International Monetary Fund (IMF), the report observes, "Over the last decade, the growth rates of emerging markets have been systematically greater than in developed countries and forecasts confirm a similar trend for the future."

The observation above is borne out both by the outperformance of the MSCI Emerging Markets Index over most of the last decade when compared to its benchmark of the MSCI World, and by growth in Gross Domestic Product (GDP) over the same time period. As a result of such growth and other factors, "poverty rates dropped from 46% to 27% in developing regions in the first half of the decade."

Yet, such growth is accompanied by significant risks, "including, but not limited to, overexploitation of natural resources, environmental pollution and unequal distribution of income," according to the report. Therefore, "Investors who are willing to take advantage of the economic growth and direct capital towards more sustainable businesses in emerging market regions need to understand how local companies manage sustainability challenges."

"A precondition for that to happen is clearly ESG transparency," the report continues. While corporate disclosure of ESG factors in emerging markets continues to lag behind that of companies in developed economies, it has improved in recent years, and the 2010 report finds that approximately 90% of emerging market companies provide "some sort of disclosures on environmental and/or social issues in their public reporting." A factor driving the incorporation of ESG factors in some countries has been their stock exchanges.

In June of this year, for instance, the
Johannesburg Stock Exchange (JSE) began requiring its more than 450 companies to produce integrated reports, and also announced a collaboration with four other South African organizations in forming the Integrated Reporting Committee (IRC) to issue guidelines on best practice in integrated reporting. In 2002, the national stock exchange of Brazil created a sustainability index, and as a result, "100% of Brazilian companies in the sample disclose information on ESG issues," the report found.

On the other hand, "external verification or the adoption of recognized reporting guidelines" remains insufficient. Investors can play an important role in bridging the verification gap, by signing on to the United Nations'
Principles for Responsible Investment (PRI), and by supporting such reporting initiatives as the Carbon Disclosure Project (CDP) and the Global Reporting Initiative (GRI).

Analyzing the three pillars of ESG separately, the report finds that on environmental issues, "42% of emerging market companies support environmental commitments in the form of policies or statements;" however, the report continues, the companies "remain weaker on implementation and progress tracking." Largely because of the listing requirements of the JSA, South African companies are strongest in reporting and in establishing climate change mitigation strategies such as setting targets for greenhouse gas (GHG) emissions reductions.

"Some Asian countries," the report continues, "Such as Korea or Taiwan, stand out on specific environmental issues because of their business culture." On the other hand, Chinese companies scored lowest on environmental reporting and performance; pressure on the fast-growing economy of China to improve its performance will certainly grow, the report observes, as it begins "to play a bigger role in the international climate change regime."

If companies ignore the importance of engaging key stakeholders on social issues, the report warns, it can weaken "competitive positions due to increased external costs, loss of license to operate, boycott, or community opposition." Latin American and South African companies scored above average on social issues, while "Chinese companies underperform significantly in this area, with below average performances on labor and corruption policies, poor coverage of employees by collective labor agreements as well as a lack of disclosure on health and safety data."

Many asset managers consider corporate governance issues to be "the most important criterion when assessing their emerging market investment strategy," the report finds. While governance scores were significantly higher than those of environmental or social issues, the report alerts investors to the fact that "ESG practices are differently perceived and implemented by companies in emerging markets due to the different policies and business cultures." Investors would do well, the report advises, "by monitoring ESG regulatory developments and gaining local market information in order to set-up effective sustainability investment strategies."

Observing that "sustainable investment in emerging markets has increased above $300 billion in assets under management in the past five years," the report concludes with a number of recommendations for investors. They include investment in companies with a commitment to sustainability, and monitoring unsustainable corporate practices to encourage improvement. To help catalyze sustainable development, investors should identify cleantech companies that can help address the significant environmental challenges that the regions face.

Finally, because many multinational corporations with headquarters in developed companies have operations in emerging markets, investors can choose to engage with such companies, to "facilitate and inspire local companies."

 

 
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