Grinding Through the Gears

As Asia’s asset owners and managers get to grips with sustainability factors at varying speeds, regulators are pushing the pace of change.

Conspiracy theorists notwithstanding, the vast majority of the world’s population is onboard with the need to play a part in reducing the devastating impact of climate change. The real challenge is how we identify, measure, and report the risk that arises from it.

The institutional investment sector provides a suitable example. The standards being set and the means to monitor whether sustainability targets are really achieved both lack uniformity and transparency. This has led to concerns of window dressing and greenwashing throughout the industry.

And despite some of the world’s largest asset owners and managers waving the flag for better practice and standards, research indicates that progress is patchy, especially in Asia. According to research conducted by the CFA Institute and the Principles for Responsible Investment in 2019, integration of environmental, social and governance (ESG) factors into the investment processes of asset managers is far from systematic across the Asia-Pacific region.

“Respondents believe that fewer than 20% of portfolio managers and analysts systematically include material ESG issues in their analyses and that fewer than 10% adjust their models based on ESG information,”  said the report, titled ‘ESG Integration in Asia Pacific: Markets, Practices, and Data’.

Despite this worrying lack, there are many reasons to be positive. Countries such as China have seen a significant uptake of ESG investing in the last three years. Major drivers include both demand for ESG integration from international investors and regulatory pressure. The inclusion of the China A-share market into major global indices has “improved the data coverage and encouraged local companies to develop databases on ESG information,” the CFA/PRI report noted.

On the one hand, mandatory standards set by regulators would give institutions and companies a clearer idea of what is expected of them. On the other, rules which are not tailored to national and local contexts will fail to address the conditions on the ground.

According to Wai Shin Chan, co-head of ESG research at HSBC: “There [isn’t] a single uniform approach to sustainability and ESG in Asia – what works in one country may not work in another. Local investors, businesses, and regulators are learning to navigate sustainability issues in this diverse region. At the same time, international investors should appreciate the local context and not expect the same standards to be applied everywhere.”

Checklist Vs Principles

Governments across the globe have picked up on these issues and are beginning to act. New Zealand’s government, for example, is aiming to become the first country in the world to compel its financial sector to mandatorily report on climate risks.

If passed through Parliament, around 200 organisations will be required to disclose their exposure to climate risk, operating on a comply-or-explain basis as early as 2023. Effectively any bank, credit union, asset manager and insurer with more than NZD 1 billion in AUM, company with listed debt or equity on the New Zealand’s stock exchange, or incorporated organisation with annual reporting obligations in the country is liable. The rules will be based on the framework established by the Task Force on Climate-related Financial Disclosure.

In June, the Monetary of Singapore (MAS) issued a series of proposed guidelines for environmental risk management by banks, insurers, and asset managers, respectively. The public consultation, which closed in August, focused three broad categories of governance, risk management and disclosure. The underlying principles for each category are:

  • Governance: The board of directors and senior management of financial institutions are expected to incorporate environmental considerations into their strategies, business plans, and product offerings, and maintain effective oversight of the management of environmental risk.
  • Risk Management: financial institutions should put in place policies and processes to assess, monitor, and manage environmental risk.
  • Disclosure: financial institutions should make regular and meaningful disclosure of their environmental risks, to enhance market discipline by investors.

As is typical practice for the MAS, the guidelines are principles based. In other words, the regulator does not set explicit rules detailing requirements of a financial institution, but is more focused on how each institution applies a guideline.

“I think it would be too onerous if you actually require an asset manager to apply very stringent rules  – a checkbox list of things to consider or include within the strategy,” said Grace Chong, counsel for Singapore and Hong Kong at Simmons & Simmons JWS. “It remains a fact that asset manager strategies do vary quite a bit. Many ESG requirements will not necessarily fit in within all those types of different trading strategies.”

For those anxious that such a high level, light-touch approach would effectively leave too much latitude for individual asset managers, experts believe this will be just the first stage of a series of public consultations in this area. The more regulators understand about how the new standards fit into asset managers’ workflows, the higher they will set the bar.

As risk management expectations for institutions increase, so too to the disclosure requirements of listed companies. The International Organization of Securities Commissions (IOSCO), which regulates 95% of global securities markets, has made clear the importance of disclosing ESG information is a top priority, while the vast majority of main exchanges in Asia are now members of the Sustainable Stock Exchange Initiative, which means they are committed to ESG disclosure by the companies listed on their exchanges.

The Hong Kong Securities and Futures Commission (SFC), for example, is a member of the Sustainability Task Force of IOSCO and is working on a various initiatives focused on developing sustainability practices in the financial sector. It has recently set up three workstreams, of which one (in partnership with the Ontario Securities Commission) is dedicated on sustainability-related disclosures for asset managers, green washing consideration and investor protection concerns.

A spokesman for the SFC told ESG Investor: “The purposes of collaborating with overseas counterparts on green and sustainable finance are to foster the development of green and sustainable finance, i.e. to enhance awareness, develop analytical capacity, encourage the industry and investors to consider the financial impact of climate (or broader ESG) risks and reduce greenwashing.’’

Harsh Realities

But how much will all this move the needle? More standardised disclosure is a vital component to improving the ability of asset owners to make investment decisions based on ESG factors. But it is not a silver bullet. Malaysia’s state-owned Khazanah Nasional, for example, is one of only three asset owners in the country to have signed up to the UN’s Principles for Responsible Investment (UN PRI), but recently admitted it is having trouble convincing the companies in which it investment to adopt ESG practices.

Speaking in July, CEO Shahril Ridza Ridzuan admitted the transition to a greener environment is expensive, noting that state companies switching from coal to natural gas would face detrimental short- and medium-term financial implications.

Whether Khazanah is doing enough to drive change is up for debate, but the problem is reflected in the region more broadly. Despite the example set by influential asset owners such as Japan’s Government Pension Investment Fund, the number of ESG mandates handed out, especially by insurers, has been notably low. Remarkably, Nomura Asset Management, Japan’s largest asset manager, with 54 trillion yen (US$500 billion) as of June 2020 of assets under management, only secured its first fixed-income ESG mandate this year on behalf of Japan’s Daido Life.

The ESG approaches adopted by even the more engaged Asian asset owners are considered by today’s standards to be rudimentary. According to research published by Goldman Sachs Asset Management in July, almost two thirds of Asian insurers (64%) use exclusion screening tools for ESG investments, compared to just 32% in the US. More proactive measures are still uncommon.

A reluctance to move to more effective means of measuring and monitoring may reflect anxiety that any overlay will harm the performance of their portfolios, despite recent evidence to the contrary. For example, Harvard Business School revealed in 2015 that companies that scored well on material ESG issues were potentially able to produce 6% annualised alpha performance. Clearly more reassurance is required.

As regulators appreciate, it is extremely hard to force asset managers to apply uniform ESG standards to their investment portfolios, but if the asset owners themselves continue to push for change, accepting some of the risks attached to it, then the market will soon be forced to follow.

For now, expect more consultations from local regulators slowly pushing the ESG agenda. Let’s just hope they are both easy to implement and enforceable and work to universal standards.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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