Asia in transition: How the region’s most influential investors are shifting the ESG story______

Leo Chen, Managing Director - Head of Asia

Appetite for environment, social, and governance (ESG) investment products within Asia Pacific has increased dramatically in recent years, driven largely by influential institutional investors and regulators keen to put sustainability higher up the agenda. However, Asia is still behind the curve due to a lack of awareness of the financial and sustainable benefits of incorporating it into the investment framework.

The assets of Asia Pacific-based ESG funds topped US$62.8 billion by June 2020, while assets in ESG ETFs domiciled in the region increased remarkably from US$1.56 billion in the first quarter of 2018 to US$7.01 billion in the same quarter of 2020, according to data sourced by UBS, a Swiss investment bank.

Slow take up in Asia

Asset owners in Japan are leading the ethical charge in the region, presently accounting for 23 out of a total of 34 asset owners in Asia-Pacific (ex-Australia and New Zealand) who have signed up for the UN Principles for Responsible Investment (UN PRI). However, outside of the far-East Asian nation, traction is less pronounced. Malaysia comes a distant second to Japan with three asset owner signatories, while China and Hong Kong have two, respectively. In contrast, the UK alone has 66 asset owner signatories.

The reasons for the low take up from asset owners are varied (Asia is not a single entity), but according to consultant Oliver Wyman it nonetheless “indicative of a less mature ESG Investing environment, [and] attributed to legacy issues, short-termism, lack of awareness, and talent gap.”

While clearly more commitment from asset owners elsewhere in Asia is required, the general direction of travel for ESG is positive. According to the UN PRI’s 2018-2019 annual report, the numbers of institutions (which includes asset owners, investment managers and service providers) to have signed up in the year was up. In China alone the number of those committing to UN PRI increased 64% year-on-year to 22, for example.

And despite the turmoil wrought by the global pandemic, Government-led initiatives to spur investment into ESG-related activities continues at a healthy pace. In May last year, the Hong Kong Monetary Authority and Securities Futures Commission teamed up to create the Green and Sustainable Finance Cross-Agency Steering Group to examine policy and regulatory issues and facilitate policy direction and coordination between the two regulators.

Likewise, the Monetary Authority of Singapore (MAS) recently revealed its plans to further develop its green finance credentials. In a speech made in October, Ravi Menon, the MAS’ managing director announced the central bank would soon incorporate climate-related scenarios in their annual stress tests for the financial industry.

The development comes on the back of published guidelines published this year to assess how financial institutions incorporate environmental risk management in their business operations. The guidelines for banks included the development of capabilities in scenario analysis and stress testing to assess the impacts of environmental risk to their risk profiles and business strategies.

Stock exchanges are also getting into the act. Effective from July this year, the Hong Kong Stock Exchange now requires listed entities to disclose how climate change will affect their business. They must also have policies on identification and mitigation of significant climate-related issues that may impact their business. Boards of directors are also now responsible for ESG, instead of leaving it to a small team led by mid-level executives which was previously the case.

Influence from the top

Such initiatives are important as they push the conversation of managing ESG issues higher up the agenda. Despite a need for more formal commitment from asset owners in Asia, there is plenty of evidence to suggest that they are taking it more seriously too. This behaviour naturally drives asset managers to launch more ESG-focused products and services.

According to fresh research conducted by Cerulli Associates, most sizeable asset owners (e.g., pension funds, insurance companies, sovereign wealth funds etc.) in Asia have introduced ESG considerations into their investment processes.

The majority of these owners are typically government-run, such as Japan’s GPIF – Government Pension Investment Fund – the largest fund in the world by assets under management, and these are institutions which hold a lot of influence on smaller funds who look to them for investment guidance. A major driver for change in Asia is policy and leadership. The filter down effect of huge political commitments such as the 2015 Paris Agreement has placed pressure on institutions to act.

The report, titled ‘Responsible Investing in Asia 2020’, paints a picture of a region in positive transition. Approximately two-thirds of asset owners follow a documented approach for ESG integration, while almost two thirds expect managers to document their ESG integration approach, with a similar percentage (62%) of asset owners saying they seek information about ESG integration from managers, but, as yet, do not make it a requirement.

Sophisticated pressure

More importantly, the research discovered that Asia’s asset owners are moving from rather basic practices of negative screening securities to invest in, to proactive ESG integration within the investment decision-making process. According to Cerulli’s data, slightly more respondents chose ESG integration (69%) as opposed to those who chose negative screening practice (65%). This shift represents a maturing of the market that is more prevalent within Europe and North America.

But despite the increasing pressure brought about from asset owners such as GPIF , governments and regulators, the supply side of the story is still a complicated one. According to report titled ‘Climate Change and Corporate Value’ and co-published by KPMG and law practice Eversheds Sutherland, corporate executives are not prepared for the decarbonisation in their business models and lack the required expertise and resources to address issues such as climate risk.

According to the survey findings, only one in four companies offer remunerative incentives for directors to achieve decarbonisation targets. Slightly more (27%) admitted their companies have yet to set decarbonisation targets. Without these in place, it’s hard to see how management will effect real change.

Transparency is key

This lack of consistency in c-suite commitments to decarbonisation should be viewed as an opportunity. Firstly, it is a chance for asset managers and investors in Asia to take a global lead and support those companies who are taking a proactive stance on ESG, such as decarbonisation; this will push other influential corporates to look at the issues more seriously. Investors who make clear their investment goals and targets can pressure companies into providing more transparency on their sustainable commitments. Should a lack of transparency be a problem, then investors need to make clear they may not continue to provide financial backing or own their stock.

Other investors and asset managers may choose to take an “activist” approach by forcing the hand of companies via shareholder actions. A recent example of this is Exxon Mobil and BlackRock where the latter has committed to flagging publicly its concerns about the oil company’s progress on climate change.

Where resources and skillsets are a real concern, asset managers should look to share knowledge they have gleaned from working and investing in similar companies who are making headway – the dissemination of knowledge is vital.

Joining prominent industry group to both apply pressure on companies can be highly effective, but it is also a vital way to share market knowledge. With 545 investors on its books, the Climate Action 100+ is one example; the Asia Investor Group on Climate Change is another. The UN PRI, for example, provides invaluable case studies of how asset managers grapple with quantifying ESG within their portfolios.

The reality is there should be no room to ignore the subject of sustainability. Increasingly at the top of the corporate agenda, as is the role capital plays in influencing in, it is a sector awash with information but currently lacking in coherence for many who are now being made responsible internally for incorporating ESG into their company workstreams. But change comes from the top and without setting the right incentives to change, asset managers will soon find their clients will park capital elsewhere.

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