“Reactive” compliance-led approach failing to fully account for risks.
Investors are failing to integrate anti-corruption measures into their emerging market investments, a new report from non-profit Transparency International UK (TIUK) has found.
Overlooking corruption in their investment frameworks exposes investors to numerous risks, but also prevents them from raising standards of business integrity and supporting UN Sustainable Development Goals (SDGs).
The report, titled ‘Investing with Integrity’, is aimed at impact investors, and outlines principles for embedding anti-corruption elements into their decision-making processes, to improve development impact and avoid reputational, financial and legal risks.
TIUK said impact investors too often neglect to follow up on pre-investment due diligence, responding only after further events arise to cause concern.
Russia’s invasion of Ukraine recently flagged the difficulties that can arise for investors from a “reactive” compliance-led approach to tackling anti-corruption within developing and emerging portfolios.
Many investors scrambled to divest holdings, leading in some cases to significant financial losses, having failed to heed warnings and indicators that could have alerted them to future risks, including the 2014 annexing of Crimea.
To effectively invest in developing markets and support SDGs, as well as climate mitigation and adaptation, the report, which is based on over 50 interviews with developed and developing market investors, asset owners and investees, highlighted that impact investors must place business integrity at the centre of their mandate, supplanting its current position as a compliance issue.
They must also be proactive in detecting and mitigating risk, and improving coordination of activities on business integrity and ESG.
Ensuring consistency will also be key, according to TIUK, as will collaboration across the impacting investing sector to promote best practice.
Ingrida Kerusauskaite-Palmer, TUIK’s Head of Business Integrity, said impact investors had a particular opportunity as first movers in emerging markets, to set standards for others follow.
“Backing projects that benefit communities and the environment are vital to sustainable development, but unless corruption is addressed in tandem, the potential of an investment can be dramatically undercut,” she said.
SDGs and emerging markets
Emerging market economies require significant investment across infrastructure, technology, and education to meet SDGs by 2030. However, investors using the framework to guide their impact strategies must factor in exposure to countries controlled by oppressive and corrupt regimes.
Asset owners are increasingly expressing an appetite to invest for impact in emerging markets, but have indicated they need better support to direct capital effectively. A coalition of 12 leading UK pension funds convened by the Church of England Pensions Board and representing £400 billion in assets recently committed to exploring how best to support the climate transition across emerging areas.
In April a Principles for Responsible Investment (PRI) report confirmed investing in developing economy transition efforts would be a lever for asset owners to deliver real-world impact.
It cited the UN Conference on Trade and Development figures which emphasised a significant funding gap in emerging countries in financing the SDGs, with annual investment shortfall totalling US$2.5 trillion, a 50% increase since Covid-19 began.
Last year the Impact Taskforce called for G7 governments to take swift action to mobilise capital for a just and inclusive net-zero transition.
Lessons of experience
According to Karen Shackleton, Director of advisory firm Pensions for Purpose, Russia’s invasion of Ukraine exposed a noticeable difference between asset managers which had stringent anti-corruption processes in place and those who did not.
“Those leading the way had analysed the increased risks early on, as the threat of war emerged, and exited holdings. They were on top of the contagion risk in the rest of their portfolio, as well. Those who lagged behind, tended to end up with holdings in Russia that could not be liquidated and were being written off,” she said.
To avoid such issues, investors need to factor corruption into their risk assessments across all markets, not Shackleton said: “I do not see the process for emerging markets being any different to the process for assessing geopolitical risk in any region.
“Asset owners should be challenging their managers robustly, and managers should be taking any lessons learned from the recent experience and adapting their process accordingly.”
Shackleton acknowledged risks can be hard to identify without a physical presence in a local market, particularly in smaller emerging economies, while cost can also be a factor.
“Emerging markets will probably only be around 5% of a pension fund portfolio, at most. There is a fixed governance cost associated with monitoring and due diligence, and this can make it expensive when considering the total expense ratio of investing in emerging markets.”
Private sector eagerness to invest in developing nations has been hindered by a lack access to public sector information, from governments development banks, leaving investors feeling insufficiently insured against the impact of risk.
The UN Net-Zero Asset Owner Alliance (NZAOA) has said that private capital would be able to flow into climate adaption and mitigation projects in emerging markets far better through blended finance solutions.