ESG Opportunities and Challenges in Asia
Introduction
ESG investments have evolved over the years in Asia from a trend to a more sustainable approach to investing. Despite the recent global macro and geopolitical events, investors in Asia continue to show interest in national climate and development policies, energy security and sustainable finance. As with all investments, there are risks. In ESG investments, these include divergent country standards, data security challenges and sustainability risk implications. Still, we are positive on certain sectors such as climate and sustainable thematics since these should experience strong growth tailwinds. As investor sentiment pivots towards a more sustainable way of investing in Asia, we think the future is bright for ESG investments.
Growth of ESG investing in Asia
Global ESG AUM is forecasted to triple between 2020 and 2025 to $6.5T USD. Of which, Asia is expected to be a key driver of growth, with ESG AUM forecasted to quintuple from $90B in 2021Q3 to more than $500B by 2025. The robust AUM growth can be attributed to a wider societal pivot towards sustainability, a greater demand from asset owners and managers as well as a sense of urgency from policymakers to enact policies and regulations that promote sustainable investments.
In addition, there have been a few important developments in recent years. First, the UN’s latest 2022 Intergovernmental Panel on Climate Change (IPCC) report highlights dire consequences if policymakers do not act quickly enough. The report’s findings show that inaction would lead to a global temperature rise of 1.1 degrees and sea levels rise of 9 inches. That means that urgent decarbonization is required to limit the temperature rise in order to prevent adverse climate impacts, with corresponding risks for many Asian countries including forced migrations and displaced populations. Outside of climate, there are also wider trends in ethical consumption and increased attention on other sustainability factors like diversity and governance driving ESG interest. Second, more asset owners and managers are actively considering ESG investing approaches. There are now over 4000 UN Principles for Responsible Investment signatories with much of the growth coming from Asia investors with over 100 ESG funds launched in Asia in 2021. Third, government policies like China and India’s net zero commitments or the mandatory ESG reporting regulations coming out of Singapore and Hong Kong (as covered in our previous piece on Greenwashing in Asia) have also helped to create interest in ESG investing.
ESG investing opportunities in Asia
Greater interest in ESG investing has created corresponding investment opportunities including ESG integration, climate investing and broader sustainability and social themes. ESG integration helps investors consider potential sustainability risks that have material impacts on portfolio value including climate transition or physical risks like stranded assets and potential supply chain liabilities often arising from regulations or legislations (such as Modern Slavery Act in Australia or Canada resulting in Asian suppliers being dropped or excluded by end producers and retailers). Active ownership also helps enhance portfolio value through engagements improving ESG outcomes in companies.
Second, the global climate agenda will continue to create opportunities given investments required for economies to decarbonize. Implementation of net zero pathways will create demand for climate technologies including renewables alongside electrification and energy storage. This also implies opportunities in broader supply chain of climate solutions such as solar and wind component manufacturers or new innovations in battery cell manufacturing or semiconductor technologies. There are also opportunities to invest in climate transition leaders in heavy-emitting sectors who have made substantial progress to decarbonize. Europe’s upcoming cross-border adjustment mechanism will also exert cost competitiveness pressure that will drive quicker decarbonization amongst export focused Chinese industries like steel to remain competitive.
Third, broader sustainability themes like natural capital and biodiversity are expected to grow in interest. The World Economic Forum identified biodiversity loss as a top five global risk for the next decade in 2020 and 2022 would see the launch of TNFD’s framework (Taskforce on Nature-related Financial Disclosures). The bigger focus on natural capital may create opportunities in areas like water, agriculture and food. There’s also an increasing priority to balance economic growth with sustainability. Businesses that are able to create inclusive economics such as increasing healthcare or financial access will play well to this shift.
ESG challenges and developments in Asia
While ESG uptake can provide opportunities for investors, by the same measure there are still areas which could pose challenges and risks to the implementation of ESG strategies. In Asia there has been a jump in ESG data disclosures though the diversity of development models across the region means differing stages of regulatory maturity. For example, some Asian economies have set in place greater disclosure consistency and transparency, this includes TCFD-aligned (Taskforce on Climate-Related Financial Disclosures) regulations in Singapore, Hong Kong and Malaysia or sustainability reporting and stewardship codes in Taiwan and Japan. China has also made progress especially in environmental reporting requirements such as releasing the Environmental Information Disclosure Guidelines for Financial Institutions and India’s Securities and Exchange Board of India (SEBI) has also been having ongoing consultations on ESG regulations. Individual country standards vary widely from one another – the lack of a unified set of rules across the region opens the door for inconsistent data disclosures that could make it hard for investors to make like-for-like comparisons.
Investors in these markets should be aware of potential information asymmetry and data inconsistencies when considering potential ESG and climate risks businesses face relative to industry peers.
Currently, the primary use of green taxonomies emerging in Asia is for sustainable financing and is based on Europe’s framework. Many existing taxonomies in Asia – and even those under development – are only voluntary disclosures, with the exception of China which uses these taxonomies for green bonds. A mandatory transition could close these gaps. Ideally, a green taxonomy would define what is termed as sustainable and offer reference metrics for companies to report on. This is not only important for coherence but also helps mitigate against corporate greenwashing. Additionally, there is scope for expansion of green taxonomy applications in Asia to equity investing and other forms of financing.
It’s possible that the establishment of supply chain-related legislation such as the EU due diligence rules will bring supply chain ESG issues in Asia to the fore. Many Asia corporates remain ill-equipped for potential upcoming international supply chain due diligence requirements and may be affected by the regulation. As a key manufacturing and supply chain hub, Asia is disproportionally exposed to environmental and social risks. The International Labor Organization’s latest data suggests Asia Pacific region make up well over half of the global estimated number of 21 million people affected by force labor. Corporates and investors could benefit from greater transparency and more proactive consideration of potential supply chain risks.
Path Forward
Global ESG standards developed by the ISSB (International Sustainability Standards Board) are to launch this year, setting a new global baseline for sustainability disclosure. Certainly, the participation of many Asian countries will be critical to enabling consistent and purposeful comparisons of sustainability reporting across sectors and geographies.
As ESG reporting matures across Asia, corporations are likely to increasingly integrate sustainability related issues into strategy and financial planning. Investors should keep an eye out for developments in the fast-transitioning Asian ESG scene. Already, Asia leads the global energy transition with China alone accounting for 35.2% of energy transition investment in 2021.
It is important to remember that ESG is a longer-term calculus, and we may see a bit of confusion as investors try to parse through some of the challenges. Undoubtedly, these risks should continue to evolve, especially in a more nascent ESG market such as Asia. Against that backdrop, it would be worthwhile for corporates and investors to invest in ESG data and analytical tools along with continued considerations of ESG risks and opportunities. The transition for businesses will take time and upfront capex – those which address ESG risks early in corporate strategy stand out to be future leaders.
