The ESG Interview: Asia Plots its Own Path

Mercer’s Alexis Cheang sees parallels and differences in the approaches of the region’s asset owners and policy-makers.

As Head of Responsible Investment for the Pacific region at investment consultants Mercer, Alexis Cheang spends a lot of time working with asset owners, helping to turn their beliefs and priorities around ESG issues into investment processes and practices. Based in Sydney, many of her clients are Australian superannuation funds, some of which are among the most proactive in demanding rapid action from investee companies, with fossil fuel finance and transgression of indigenous rights in the mining sector being particular flashpoints.

However, taking Asia-Pacific as a whole, Cheang says engagement on climate and other ESG issues is less direct than in Europe or her native United States. This is partly because Asia-Pacific asset owners are typically one or two steps behind western hemisphere peers in fully integrating their ESG beliefs into processes such as manager selection, proxy voting and engagement. But there is also a cultural element.

“In the US, engagement is very public. Asset managers or owners will file a shareholder proposal and tell companies what they want. It’s fairly forthright,” she says. “But that approach is not culturally appropriate in Asia. You need to come to the table as an investor with the skin in the game, looking to create value for all shareholders. You need to explain why, for example, water risk is material for a semiconductor manufacturer – and listen too.”

The approach may be slower, she says, but it is effective. “Calm conversations behind closed doors in a setting of trust lead to good outcomes. It doesn’t make for great headlines, but it does make for sustainable companies.”

Different drivers

Cheang also notes a contrast between the key factors shaping the ESG priorities of asset owners in Asian markets compared to the approaches in Europe and her adopted home of Australia.

“Beliefs will be shaped by regulation, competition, risk and return profiles, and the cultural norms of employees, stakeholders and customers,” she says, but the precise mix of these factors can lead to different emphases.

“In Australia, competition plays quite a big role in forming those beliefs and driving the ESG strategy of superannuation funds,” she explains. “Because regulation around sustainable investing is more clear cut in Europe, it may be a bigger driver than competition.”

With regulation and competition playing a limited role in many Asian markets, corporate values can be significant motivating factors. “An Asian insurer, for example, may have a strong belief that climate change presents a business risk to their organisation. It’s natural that their responsible investment policy would have a strong focus on climate change, because it’s consistent with the way they think about the risks to the wider business,” explains Cheang.

Although hard to quantify across such a diverse region, the pace of change appears to be accelerating in Asia. A survey by the Asia Investor Group on Climate Change found that 40% of large asset owners and managers in the region had already adopted decarbonisation strategies in the management of their portfolios, while more than 35% said they were using tilting to actively pivot away from assets with climate risks.

The survey also reported a sharp increase in asset owners conducting carbon footprint analysis in listed equities and fixed income assets versus 12 months previously. Around half of survey respondents are disclosing against the emissions reporting framework set out by Task Force for Climate-related Financial Disclosures (TCFD), with 30% actively considering doing so.

The path to integration

While asset owners inevitably have different perspectives, Cheang says the process for building out policies is more consistent, with beliefs being identified, discussed and formalised, before policies and procedures are drawn up and embedded. There is a stronger need for this in Asia, she says, as fewer firms have signed up to the UN Principles for Responsible Investment.

“Getting beliefs clear in the minds of the leadership team and board is really critical. We spend quite a lot of time surveying leadership teams and boards around what they think they believe around ESG and how consistent that is across the organisation and where there are differences of opinion,” explains Cheang.

This reliance on values as an engine for ESG-informed change – as opposed to competitive or regulator drivers – may be one factor behind the mixed pace of ESG integration in the Asia-Pacific region.

“Asset owners consistently say they believe integrating ESG into the investment process can lead to better long-term risk-adjusted returns and that it’s part of good governance practice. But sometimes it’s not actually embedded into the investment policy statement or manager selection guidelines or how portfolios are assessed,” she says.

In several respects, a key purpose of revised investment processes and policies is to help the asset owner to identify asset managers with compatible approaches and beliefs around ESG, reflected in their engagement policies and voting records for example. Cheang likens it to establishing any new relationship with a view to the long haul.

“Fundamentally, if your investment manager doesn’t believe ESG can add value, and you do, they’re probably not the right manager for you,” she says. “But you can both believe in ESG and have different ways of pursuing it. So, you need to find out about the role of proxy voting in their ESG strategy, for example, or how they use engagement as a tool to improve performance. Going slowly and asking those questions to understand managers better is time well spent.”.

Exclusion versus engagement

The choice of tactics by investors to enact change at investee firms is a source of contention, because they can have consequences beyond the oversight role taken by shareholders in recent decades, and because processes for escalation rarely well defined.

“The areas where there tends to be a little bit more discussion and deliberation are often around the role of exclusion versus engagement,” says Cheang, implying a vigorous debate within the region’s asset owners and perhaps an overall preference for “keeping a seat at the table” to drive change from within.

“Both are valid and are used in different ways, but it’s an area of tension between different parties within an organisation. We try to work it through, asking, ‘If you were to divest, what would that mean for your tracking error, volatility, risk and return? Where would you reallocate that capital? Also, how capable is the company of changing’,” she continues, noting that firms in certain sectors face significantly steeper risks and challenges from climate change than others.

Nevertheless, net-zero commitments are firmly on the agenda. The AIGCC survey found that approximately 70% of Asian institutional investors are considering portfolio-wide decarbonisation targets for 2050. Recently, the UN-convened Net-Zero Asset Owners Alliance recruited its first member in the region, Dai-ichi Life Insurance of Japan. Mercer itself has committed to a net-zero absolute carbon emissions target for 2050 for its Australian funds and the Mercer-managed funds withing the Mercer Super.

“In Asia, we’ve started to see more companies and investors make net-zero commitments,” says Cheang. “And more are willing to do so, given the government commitments we’ve seen across the region. When government set those targets, it’s much easier for investors to follow.”

Cheang says net-zero commitments should be regarded as “aspirational” at this stage. “Investors aren’t completely sure how they’re going to meet those targets, particularly once you’ve captured the low-hanging fruit, and you’re left with the hard-to-abate sectors,” she says. “It’s a question that most investors won’t get to for a little while, because there’s a lot to be done in the first couple of years to reduce emissions from the high emitting industries they’re exposed to.”

As well as sectors such as steel, cement, and real estate, Cheang flags agriculture as a “challenging” sector.

The broader data challenge

Universally challenging issues – such as the availability and comparability of decision useful data – can also have a regional twist. ESG-related metrics are more advanced in public equities than other asset classes, but this can have different implications depending on the proportion of overall investments represented by listed equities. Some of the most significant ESG risks can lie outside an investor’s equity exposures, notes Cheang. Equally, it is in the non-public markets where access to data can be most difficult.

“It’s important to ask questions about how risks around climate change – transition and physical – but also issues such as modern slavery are managed by portfolio investment managers in those asset classes,” she says. “But when you’ve got a number of different managers for your private markets portfolio, there is no database where you can compare apples to apples, and many private equity managers don’t provide the data in the first place.”

In the absence of regulatory drivers of reporting standards, says Cheang, one possible remedy for asset owners is to design manager surveys and reporting requirements in order to collect the data needed to assess total portfolio exposure to transition risk, for example.

“We’ve found this to be really useful, because it empowers asset owners to have a more meaningful conversation with managers,” she says.

Asia’s ESG evolution

Asia’s asset owners must appoint managers and track ESG risks across jurisdictions at very different stages of development, from a sustainable investment perspective. Reporting, disclosure and risk management requirements vary by jurisdiction, institution and asset class.

Traditional finance hubs such as Singapore and Hong Kong have been making the running in adopting policy frameworks to facilitate sustainable investment strategies, but the whole region is reforming its existing practices. Often, regulators are looking to first movers, such as the European Commission, aligning their taxonomies, but reserving the ability to accommodate local realities.

“The proposed taxonomies being developed are going to be very useful, although it’s going to be a little bit painful to get there. Markets developing their own taxonomies will be looking very closely towards the European taxonomy for consistency,” says Cheang, who sat on the Australian Sustainable Finance Initiative (ASFI), co-chairing a technical working group on embedding sustainability in financial markets, products and services.

“Over time, there will be harmonisation across those taxonomies, but it’s going to take a little while because they’ve been developed embryonically in their own local markets,” she says.

The evolution of China’s policies, such as the recent launch of its emissions trading regime, will be watched particularly closely, says Cheang, who expects the country to beat its 2060 net-zero target “by some margin”.

China’s progress will inevitably have impact way beyond its borders, influencing trading partners, including Australia.

The severe drought and wildfires that devastated great swathes of the Australian landscape toward the end of 2019 and the beginning of 2020 had a profound impact on the view of climate change among individuals, and investors, but also at a national government level, confirms Cheang.

Although the pandemic has taken policy-makers’ attention for much of the period since, Cheang says efforts by China to wean themselves off fossil fuel will have a significant effect on Australia’s economic outlook and hence government policy. “If those markets are drying up, that is not the stable export basis for the Australian companies,” she says, suggesting the country will need to accelerate its pivot to renewable energy resources.

“It’s been interesting to see the discussion around whether there’s a future in a hydrogen-based economy where Australia could be an exporter of hydrogen to fuel the clean energy transition,” says Cheang.

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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