In the realm of Environmental, Social and Governance (ESG) investment, Asia has lagged behind. While Europe accounts for about half of the global ESG assets under management, until recently Asia ex-Japan barely registered on the ESG fund-flow charts.
The 2020 pandemic proved to be an accelerant for change in the region’s investment trends, as the crisis threw a spotlight on issues such as corporate governance and sustainability. At the end of 2019, ESG AUM in Asia ex-Japan totalled only US$810 million. A year later, that figure had surged to US$24.5 billion.
ESG funds have accounted for 84% of equity-fund investments over the past two years, according to our global fund flow report. Net inflows have surged seven-fold over that period, accounting for US$15.1 billion of the US$18.1 billion.
In our report, Asia is now forecast to be only two or three years behind Europe, the global leaders in ESG investment. But will the region’s ESG investment growth continue to accelerate? And what are some of the major challenges still facing the region? At our recent webinar – ESG funds popularity explosion goes global: Where does Asia stand on ESG? – held in May, experts gave their views on the current environment and future trends in the Asian ESG landscape.
The acceleration of ESG investment in Asia is now on a strong uptrend. Where even a few years ago companies offered little or no disclosure, and showed no interest in ESG metrics, many are now committing to sustainability. Companies are establishing ESG departments, or injecting a level of ESG competence into their investor relations teams, and ESG matters are increasingly a matter for C-suite discussion, noted Karine Hirn, Partner, Co-Founder and Chief Sustainability Officer at East Capital.
This breakthrough in awareness has coincided not just with record inflows into sustainable investments but also with a growing political consensus on tackling climate change and other pressing issues. Even among the region’s frontier markets such as Sri Lanka and Vietnam, governments are setting long-term de-carbonization and net-zero emissions targets. This is an important step, because though some of the recent progress can be attributed to investor pressure, companies in Asia tend to be guided by government policy more than their European counterparts, said Sachi Suzuki, Engagement Professional at Federated Hermes.
“It’s great to have long-term targets, but we need mid-term targets too, and we need companies [to get onboard], because they are the ones producing emissions,” Karine said.
The twin forces of governments and investors are critical to drive change. Government influence on companies in Asia is typically stronger, in part because many companies are at least partially state-owned, and “even without ownership influence they tend to follow government guidance,” noted Sachi. The commitments of China, Japan and South Korea to net-zero targets are therefore highly significant.
Equally, governments have an important role to play in providing a robust regulatory environment and reducing the prevalence of greenwashing.
Even outside the region, legislative action will become increasingly influential, placing renewed pressure on companies in Asia to meet ESG standards. The implementation of rules such as the Non-Financial Reporting Directive (NFRD) in the EU will affect not just European companies, but any business with operations in the region. The NFRD already makes it mandatory for large companies to disclose information on their sustainability risks and impacts, and its scope will soon be expanded to more companies and includes information to understand climate transition plans and human rights and environmental risks in their value chain- Complying with these EU rules will become a “huge challenge” for many businesses, Karine said.
“We will definitely see more focus on these topics than in the past, which makes a lot of sense, especially when you have lots of companies with transformed business models in which a lot of operations are outsourced,” Karine said. “So it’s not enough now just to say ‘well, I’m fine with my own operation’. You also have to think in terms of your actual impact in terms of sustainability across your value chain. That’s really important.”
However, the perception that government intervention is indispensable to the progress of ESG investment in Asia is misplaced, according to Sachi and Karine.
“Of course, you need to have the regulatory environment that puts rules in place in terms of what must be disclosed – that makes our job easier,” Karine said. “I don’t necessarily think you need to have the legislator involved again [post-regulation].”
Investor engagement is an equally important responsibility. There is now a growing trend in Asia of investors wanting information on the actual impact of their investments. Karine said her company is actively involved in global and regional initiatives encouraging shareholders work together to ensure companies follow the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), for example.
The emergence of a more active brand of shareholder in Asia will be more influential in persuading companies to cut emissions than the “ESG 1.0” approach of refusing to invest at all in certain sectors and companies, she added.
There are still significant challenges to overcome, however.
In terms of getting asset-owners behind the sustainability agenda, Asia is still lagging, with the exception of Japan. Though the number of Asian signatories to the UN’s Principles for Responsible Investment is climbing rapidly, only two asset owners in China have signed up, and only 10 in the rest of Asia ex-Japan combined. That compares with 24 in Japan, where the proactive ESG approach of the Government Pension Investment Fund, the world’s largest pool of retirement savings, has encouraged a surge of interest.
The issue of minority shareholder rights is another difficult area. Given the predominance of family-owned businesses in Southeast Asia in particular, minority views on company boards have minimal leverage, making it difficult to effect change. In theory, independent directors are supposed to represent those views but the reality is often different.
“Obviously a board is a requirement if you’re a listed company, but if the independent directors on the board have been there for a very long time and get very well paid, on the day decisions get made they’re not going to be a champion for minority shareholders,” Karine said. “That’s really an issue.”
As a result, the level of disclosure of ESG risks and targets and KPIs in many cases is weak, partly because of a lack of clear disclosure requirements or, as in China’s case, because the market has been waiting a considerable time for new rules to be introduced and implemented. According to a recent report from the Asian Corporate Governance Association, some companies have been outsourcing their ESG reports to consultants, and boards are not even seeing the results.
Despite the profusion of “different realities” around the region, the overall trend is positive. Almost 80% of Asian investors increased their ESG investments last year, while about two-thirds expect to have ESG issues mostly or fully incorporated into their investment decision-making processes this year. In short, ESG in Asia is here to stay.
“As in many things, Asia sometimes starts a bit later but catches up very fast,” Sachi said.
 Source: Bloomberg
 Source: Morningstar
 Source: MSCI