Ben Sheehan (senior investment specialist – Asia-Pacific equities, Aberdeen Standard Investments)Benjamin Colton (head of Asia-Pacific asset stewardship, State Street Global Advisors)
Michael Cheng (head of corporate governance – APAC, MSCI)
Karine Hirn (partner and chief sustainability officer, East Capital)
Gabriel Wilson-Otto (head of stewardship – Asia, BNP Paribas Asset Management) Funds Global – A recent study found that Asian investors lag behind their global counterparts when it comes to ESG allocation – 10% versus 18% globally. They are, however, optimistic about future allocations. What is your view on asset allocation along ESG factors in Asia and how long do you think it will take to catch up with the global trend? Gabriel Wilson-Otto, BNP Paribas Asset Management – I am optimistic about the direction of travel; magnitude and timing I am a little bit more cautious on. What we have seen across Asia is examples like Japan, which has gone from a very low base to incredible amounts of asset allocation towards ESG and sustainability assets. The drivers were not just down to one simple element, it was quite complex to get everything moving and I am not seeing as concrete evidence that the stars are aligning across the rest of Asia to the same extent. Looking at how higher allocation can be driven, two potential drivers are a shift in demand from retail and institutional investors, or a significant shift in government and state-managed assets trying to change and drive the green ecosystem. I am seeing signs that both are starting to occur in Asia, and we have had some very positive comments in Hong Kong recently. China is definitely starting to ratchet up its focus on ESG and is putting capital behind green finance, but it feels like both the corporates and retail investors are a lot slower to adopt ESG. A lot of that is due to a definition of what ESG is and a legacy view that impact investing, or hard exclusions are the only ways of investing along ESG guidelines. I think we are moving in the right direction in Asia and am optimistic, but the pace of change will vary significantly by market. Benjamin Colton, SSGA – We have seen the amount of ESG assets under management (AuM) increase – globally it accounts for 25% of all professionally managed assets. When you look at the growth rate, more is being allocated to ESG integration strategies, and that is due to the greater availability of data and a longer period of time for which it is available. With more data, it helps to show that ESG really is value-adding and you can see empirical evidence or back-testing demonstrating the value proposition for it. Indeed, there are different levels of sophistication and allocation amongst regions and clients, as everybody is at different stages in their ESG journey, but we have seen a lot of growth in Asia and we continue to see clients being interested. Asian countries have some of the highest growth rates and we would expect this gap will continue to close over time, especially as more quality data becomes available. Karine Hirn, East Capital – Of course regulators in different countries will be insisting on different things, but clearly the trend is there. In some cases, we are still only talking about voluntary, for instance with reporting. It is better just to comply, otherwise you must explain why you are not. What is interesting to consider is China’s internationalisation of its A-shares market. It is still only a tiny weight in the MSCI Emerging Markets index, 1.7% now, and around 4% by the end of 2019, but might grow to 14% in a few years, and foreign investors increase their holdings in line with this increase. Many foreign investors are taking ESG factors into consideration much more than local investors, so it becomes the way that Chinese investors identify stocks that the foreign investors like the most, ask why and realise that maybe it is because they have good ESG. In other Asian markets, further internationalisation of the market is happening, and this is one of the compelling factors for increased ESG focus. Funds Global – Has the fear of missing out has almost crept into the ESG space? Hirn – It probably has, but there is also the greenwashing issue where everybody is seemingly doing it with sometimes hardly any substance about it. There might be cases where asset owners or managers claim that they are signatories of investor-led initiatives, but it is only for a tiny part of their business and the rest remains out of scope. Some statistics such as the number of PRI signatories from Asia might need to be taken with a pinch of salt and it is critical to scratch the surface to realise the real progress behind it. Ben Sheehan, ASI – A number of institutional clients are starting to play catch-up. Outside the markets, such as Australia and Japan where it is more established, we are seeing a lot more clients starting their journey in terms of exploring their options with regards to ESG, sustainable investing, also investing around issues like moral hazard and carbon intensity. Whilst we are definitely getting more enquiries, it is still very nascent, but at some point, assets will follow, and it is important that the asset management industry is ready for this. There is also regulatory support. For example, the Hong Kong Management Authority came out with some measures to support climate change risk and sustainable finance, and one of the measures was to prioritise their capital allocations towards asset managers who can provide ESG solutions. That is certainly a positive signal for the industry. Michael Cheng, MSCI – I see all the different use cases, for example, by capable houses and all the global and regional asset owners. Following the regulatory drift, there have been nine new stewardship codes in the region from 2014 to 2018 from Japan, Malaysia, Hong Kong, Taiwan, Thailand, Singapore, India, Korea and Australia. That increases momentum and the Asia-Pacific region is picking up. Funds Global – How do you quantify the social factor and is it often left behind the environmental and governance aspects? Hirn – Norm-based screening involves looking at companies in your portfolios that might have been either accused of or have issues of confirmed violations of the Global Compact Principles, and quite a few of them are related to social issues. In our proprietary ESG scorecards, we do have questions on social practices and standards, but it is true that the ‘S’ accounts for much less in the final score. Governance is 75% of the score and then the rest is split between ‘S’ and ‘E’. It does not mean that social is not important, but we only invest in emerging and frontier markets and we know for a fact, from our own experience of doing this for more than 20 years, that if you have corporate governance right, you will probably have less risk on the social and environmental side. That is why to us it is more important to look into the way the company is being owned (responsible owners), led (board composition) and managed (management structure, practices etc). Many social issues actually derive from the corporate governance side. Social factor also varies greatly, depending on the country and sectors and that can also make it a bit more difficult to quantify. Colton – We have created a proprietary scoring system for looking at ESG factors, and when quantifying these factors, it is essential to think about financial materiality. So, what is actually important? As Karine mentioned, it varies amongst sectors and countries. When you think about environmental and social issues, those transcend geographical boundaries: human rights, climate change and carbon emissions. The financial impact of these issues is often industry-specific but market-agnostic, whereas governance on the other hand is market-specific and industry-agnostic. We utilise the Sustainability Accounting Standards Board’s (SASB) materiality map as a framework because it focuses on financial materiality, is industry-specific and is very transparent, so it allows companies and investors to understand what is important in my industry, and that is how we are looking at social factors. On the stewardship front, we are also addressing social issues. Let’s take gender diversity, for example. We are seeing really robust empirical evidence that more diversity leads to more innovative thinking, less groupthink and better business outcomes. MSCI also published a report showing companies with more gender diversity on the board and at executive management level have a higher return on equity (ROE). But despite this evidence, still many companies did not have a single female on their board. With this in mind, we thought is there something that we can do as asset managers? We launched our Fearless Girl campaign, which really raised the awareness and we also started addressing the issues with our voice and vote. For example, we became the first large US asset manager to start voting against companies with no women on their board. We are also focusing on corporate culture, which is closely tied to human capital management. Corporate culture encompasses a variety of social issues and we are starting to ask boards how they are aligning their corporate culture with strategy and whether there are KPIs to monitor progress. Sheehan – The issues around measurability and quantifying do present challenges, but it is also important to identify what the social issues are and not just focus on the measurement aspect. We have invested significant resources to help identify social issues. In addition to a dedicated team of 20 ESG professionals, we have a team of 30 ESG specialists who conduct thematic and sector research across asset classes, and that really puts us in a good position to stay ahead of emerging issues and identify what the social issues could be. Examples include changing demographics, an ageing society and cyber security, so there are some issues and themes that we have identified, and we incorporate them in our engagement agenda with the companies that we are looking at or investing in. Wilson-Otto – We have a similar structure around our own proprietary ESG framework for evaluating the issues based off SASB’s Materiality Matrix with financial materiality as the starting point, but we also have a screening system. When we approach quantifying social factors, the first step is norms-based screening based on the UN Global Compact which includes instances where companies have a track record of violations of norms and human rights. From there, we also combine more of a thematic lens around shifting, growing or shrinking profit pools as a result of social impacts, and this is where the demographic and some of those thematic trends start moving into the picture. Finally, in actual stock selection, analysis and implementation, this is where more of the quantifiable data comes into it where, if we are looking at a company that is heavily labour-intensive, how is the labour force being treated? What is the turnover rate? What is the injury and fatality rates within that specific industry? If you are in a sector which relies on quality researchers, how much are you paying? What is your reputation within the market as a hirer and employer? Can we get data to quantify any of these metrics so that we can make an objective statement about your ability to attract and retain talent within that industry? Cheng – As a service provider, I would echo the theme of materiality – especially from the financial perspective. MSCI’s ratings model is done by dividing the 7,000-plus issues we cover into around 156 industries, and then we apply from a list of 37 key issues what is material, ranging from about three to seven. For a semiconductor company, it would be opportunities in cleantech and water stress, which would be environmental and human capital development and controversial sourcing would be social. We then conduct a mandatory governance assessment which we believe should run through the whole analysis. There could be emerging issues which become more important, like privacy and data security with all the use of social media, the recent incidents with Boeing and bad vaccines in China, so product safety and quality. The social list of key issues should move with the times and that is why we constantly engage with clients and peers – to upgrade and enhance our model. Funds Global – How do you manage conflicting data? Colton – When we looked at the different data providers we found there is little correlation between their ESG scores and methodologies, or there might be coverage for one data provider whereas it is limited for others. When we went through and created the scoring system, we built a data architecture that is taking in multiple sources of best-in-class data. Using multiple sources of data is a good way to balance the scores, reducing the risk of relying on a single data source. Cheng – There is a challenge for data users on consistency and maybe in some cases, transparency among the data providers, but we are moving towards a common language. We are very motivated and excited by all the different use cases. We often positively encourage our clients to go beyond the score, or just a letter rating, and use their material data from their own use case and investment process. It is only when ESG data is integrated into the investment ecosystem that it makes sense. While easier said than done, ESG service providers must constantly up their game and ultimately enhance the whole ecosystem of data, including data quality, consistency and availability. There is a fair bit of pressure on everybody so that we achieve materiality, quality, consistency and transparency. Wilson-Otto – The key barriers to ESG integration are really around data, capability and culture. The availability of data is one thing, but transparency, traceability and comparability are another. If we dig into commonly used data metrics, it is not directly clear if you are comparing two companies within a sector that have reported the metric covering the same scope of their operations and on the same basis, so it becomes very difficult to get a granular understanding of the genuine performance of a company on these metrics. If we look at capability, there is often a bit of confusion around what ESG integration is or isn’t, or could be, and there is an entire spectrum of ESG integration. Hypothetically, you could say that a fund is ESG integrated if all you do is speak to management about governance because you are using ESG, and cutting through this is one of the problems, or for an external party it becomes more difficult to evaluate whether ESG integration is genuine. One of the common problems is trying to take a third-party dataset or approach to integration that was not tailored to the specific fund or the specific operations of the business, resulting in sub-standard outcomes. Funds Global – Global calls to address the climate crisis are growing, and 22% of investors have ranked it as the most important sustainability issue according to a survey last year. How are you addressing this in your portfolios, especially with the push from the younger generation? Hirn – The push from the younger generation is definitely here. I am the mum of somebody who has been called the Finnish Greta Thunberg, because she organised the student-led March for Climate in Hong Kong, got an authorisation by the police and started discussions with the local government. There is huge pressure and we will see more. While Sustainable Development Goals (SDGs) are all very important, if you don’t reach the climate goal then there will be so many objectives that will not be met and social and environmental challenges which will most probably get worse. So, you start with the one that might matter the most and there is a time urgency that we all know, we have seen enough of these statistics and graphs of what could happen. Emerging and frontier markets have a crucial issue related to data. For instance, only 20% of our portfolio holdings disclose information to the Carbon Disclosure Project (CDP). We are supporting organisations like the CDP by helping with the disclosure campaign and holding workshops for issuers. We also have an SDG model in our ESG score card where we address SDG 13 (climate action) and analyse which companies will be either benefiting in terms of increased or decreased revenues deriving from climate change mitigation and adaptation. Wilson-Otto – The way that we are thinking about integrating climate change concerns into our portfolios and investment processes is outlined under our global sustainability strategy that was released in March 2019, which enhanced and extended our commitment to sustainability. The first is around our coal policy and the way that we deal with thermal coal production, as well as mining. Our approach is around trying to support an energy transition where we are looking at the carbon intensity of a company’s energy or power production portfolio and essentially our exclusion is based on companies that are not consistent with a sustainable development scenario. What we are saying is that if you are a large coal thermal-powered power company that is not undertaking a transition to cleaner energy, then that is not a company we will consider within our investments. The other areas that we look at where climate change impacts filter through is on deforestation and our approach to managing companies with that style of risk. Another is around physical risk from climate change and the way it can impact already scarce water resources within specific environments, contribute to contamination, contribute to flooding and destruction of physical assets. Sheehan – As investors we have a critical role to play in financing the transition to a lower-carbon economy. We also have a responsibility to our investors to let them know how climate change issues will impact the value of investments. We have a climate change policy which sets out how we engage on a range of issues related to climate change and influences our research agenda. We prioritise engagement with high-emitting companies or enablers of emissions and make sure that they are transitioning towards global best practice. Perversely, the higher emitters and enablers of carbon emission are best placed to make that transition, so in the case of energy companies, they have the means and ability to fund and capex that transition versus a start-up that just does not have the cash flow. Screening out high-emission companies or enablers is not necessarily constructive, particularly if they are making all the right steps to make that transition to a lower-carbon role. Funds Global – As investors, when you see huge oil companies leaving powerful lobby groups, is that something that is positive for US investors? Sheehan – I think it can only be viewed in that light. Hirn – We are part of Climate Action 100+, which is a very good initiative, to ensure the world’s largest corporate greenhouse-gas emitters take necessary action on climate change. The companies include 100 ‘systemically important emitters’, accounting for two-thirds of annual global industrial emissions. We co-lead the engagement with Gazprom, which ranks very high on that list. As one of the oldest and largest investors in Russia, we have some leverage and even more so when we cooperate with other investors. This year, on a global scale, many annual general meetings (AGMs) of oil majors have seen a surge in climate activism, and I am sure there is more to come. Colton – We have been engaging on climate-related matters with companies for a very long time, whether it is providing guidance on what is effective climate-related disclosure to understanding how the board is addressing climate change in the context of long-term strategy. Recently we have also been engaging with companies beyond high-impact sectors, looking at agriculture and forestry, for example, where around 25% of the global carbon emissions are coming from. The agriculture and forestry sectors are also among the most susceptible to the negative implications of climate change, so how are they adapting and positioning their business to either capitalise on, or mitigate against, a transition to the lower-carbon economy? That is what we are doing from the stewardship side – trying to enhance disclosure and think about how the board is integrating climate change into their long-term strategy. It is also very much aligned with what the Task Force on Climate-related Financial Disclosures (TCFD) is trying to accomplish. With more forward-looking, robust disclosure, you think about the range of solutions that you can offer from an investment perspective. Generation one was exclusionary, such as getting rid of high-carbon emitters and coal. We are currently at generation two, which is about mitigation or increasing exposure to companies with more green revenue while decreasing exposure to heavy carbon emitters. Wilson-Otto – Governance ties into data quality. The idea of having senior-level responsibility for these issues is more likely to ensure that the reporting and disclosure requirements are taken seriously and are seen within a strategic context. That is critical because one of the things we saw with the first round of data coming out of Asia was that it was typically seen as a compliance exercise and not as a strategic exercise, or something that needed board oversight. That is a huge potential risk in that companies can be disclosing data but not necessarily engaged with it, and so are they really addressing the fundamental risks or opportunities? Colton – How is the scenario planning that you are conducting impacting capital allocation decisions? Having that tangible link between climate change and long-term strategies is really going to be the essence of what investors are going to look at for the next generation of climate-related solutions. Climate solutions will evolve to include adaptation alongside mitigation. Cheng – If we need one buzzword for the whole climate narrative for this year, and we highlight that to our global investor audience, it is ‘urgency’. We even quoted Frodo Baggins in Fellowship of the Ring: “I wish it need not have happened in my lifetime.” Sorry, it is happening in our lifetimes. Funds Global – There is also rising tension between Asian and Western nations over the dumping of rubbish in Asia on an industrial scale, so waste management is also a big issue. Hirn – Yes, and China was the world’s biggest importer of plastic waste. When they stopped doing it, clearly the countries that were sending the plastic waste there realised they did not have the capacity to deal with it and needed to find other places to take them to, such as Thailand and Vietnam, but these countries also are putting the same kind of bans in place. Cheng – Even Australia and Malaysia. It also impacts the companies exposed in the various industries, and only the companies that can come up with innovative recyclable packaging, for example, will survive and thrive. China declining to import waste has a big knock-on effect on the whole ecosystem. Wilson-Otto – It comes back to the way of assessing financial materiality and the ability for companies to think ahead and plan for this. One way that we think about these types of risks is to look at whether a company is currently doing something which is not being priced. For example, if a consumer goods company produces a lot of waste such as plastic or has negative health impacts such as high sugar content, these negative impacts could result in higher costs or lower demand and may not be currently factored into existing profit margins. There are a lot of examples where negative externalities which are created by a business are not necessarily reflected by the market in the current price. Funds Global – As Beijing opens its equity markets to greater foreign participation, will this have a positive knock-on effect on ESG factors in China by default? Sheehan – Absolutely, and I think it can only be a good thing. To put it into context, the onshore market is the second-biggest equity market in the world, but less than 3% of the foreign market is foreign-owned, so there is a huge opportunity for increased foreign participation. The broadening of the investor base will bring international norms to China and exposing local management to what we see in international markets already can only be positive. China has a very poor track record, particularly on the governance side. It has got track records of unnecessary suspension of companies and questions of independence of independent directors, so as long-term investors in China, we have had to tread very carefully. We also view ourselves as agents of change, so when we invest in a Chinese company, we are not just providers of capital, we consider ourselves to be partners and we do try and get management to raise their game in terms of disclosure, governance standards and capital management. As a concrete example, in one of our portfolio holdings we have been agitating for improved capital management, because it is sitting on a huge cash pile and we have been talking to them for five years about raising their dividend payout. International ownership of the company has gone from 2% to 10% over the five-year period and other international investors have rallied around us. Accordingly, they have upped their dividend payout ratio from 20% to over 50%. I think we are going to see a lot more of these improved standards as local management look to satisfy international investment standards. Hirn – I would disagree. I am not saying that corporate governance is great in China, but in our own experience, the offshore Chinese companies are sometimes worse than onshore ones because bad corporate governance practices in China can have very serious legal consequences, including criminal penalties. Funds Global – In April 2019, the Hong Kong Securities and Futures Commission told asset managers who claim to take ESG factors into account to make it clear how exactly it is that they do this. What is your view and what does Asia need to do as a region to achieve tighter standards? Colton – Being transparent in how your ESG scores are being calculated is very helpful when we talk to portfolio companies. We can go into a company and say: ‘Here’s your score, here’s how it’s calculated, here’s how to improve’. That level of transparency allows company to be in control of their score and is what will drive change. We all know that what is measured is managed or improved, and so through disclosure and transparent frameworks, you will see this positive feedback loop that is going to create improved ESG standards. Hirn – What is really going to change the momentum here in Hong Kong is when we see more initiatives from asset owners and the large institutional investors in Hong Kong. The Hong Kong government’s planned HK$100 billion ($12.7 billion) green bond programme is a big deal, it makes people change and think differently. Hong Kong was really lagging behind in terms of green finance, and now it is the third-largest green bonds market in Asia after mainland China and Japan in just a very short time. Wilson-Otto – The rapid growth within ESG and a lack of clarity around what ESG is, or what an ESG product looks like, can lead to a lot of confusion. One of the critical issues in the industry is concerns about greenwashing, both from a corporate and asset manager’s perspective. Within our global sustainability strategy, we make it clear around the KPIs that we are going to deliver, and it is transparent to be able to say: ‘This is what you get from that fund, it is measurable and reported.’ Similarly, if we look at a lot of companies as ESG disclosure becomes mandatory, the problem becomes that they are releasing a lot of policies because they have to, but the question remains, has disclosure changed engagement with the underlying risks? Funds Global – How are you using artificial intelligence (AI) to identify risks and integrate ESG factors into the investment decision-making process? Cheng – Globally, the voluntary disclosure data by companies only featured about one-third of the data points we use in our ESG analysis. In this era of a cocktail of transparency, it is about regulatory transparency, disclosure transparency, looking at data from the government and NGOs, industry standards and the media and so on. Dealing with this plethora of ESG information and distilling them into what is financially material signals that you can achieve your investment objectives. We look at a lot of what we call alternative data sources. On governance, for example, if you look at US proxy filings, we use natural language techniques to analyse governance data and look at NGO and media resources for controversies surrounding issuers. We also have access to satellite data. If you look at the tailings dam collapse in Brazil, we combine mining data with, for example, flood risks and have this level of granularity to provide financially material information to clients. We have now a requirement on having graphics and charts that are able to reflect this kind of satellite granular data on mines. We also use Freedom of Information Act data, because sometimes companies conveniently do not disclose certain fines they face with various authorities globally. Hirn – Think about the day we get the social credit scores of the board members and the management of the companies we are investing into! Funds Global – Are you optimistic or pessimistic about sustainable investing in Asia for the next year? Sheehan – Sustainable investing is not a short-term or cyclical investment approach, it is going to be paramount in all the decisions that we make, so it is something that will remain positive for the longer-term. If you are not looking at ESG issues as part of your investment approach, you are really missing out on what is effectively one of the key megatrends that will drive capital flows over the coming years. Colton – We are really excited about ‘R-Factor’, which is what we are calling this proprietary scoring system. I am very optimistic of the trends in general in ESG and with more transparency and better data quality, integrating that into the stewardship efforts is something that is going to really continue to push the ball forward. Hirn – East Capital announced that I will take responsibility for sustainability efforts, but people are asking me if that means I am moving back to the headquarters as my role is global. Absolutely not, because this is one of the most exciting places in terms of developments, client demand and the best practices. There is a momentum and so I personally feel very optimistic. Wilson-Otto – There is a growing recognition within Asia that ESG investing is just part of good investing, and that is one of the reasons that I am optimistic about the growth. Increasingly, it is not seen as something niche, but as fulfilling fiduciary duty, dealing with risks and opportunities facing companies. If we look at risk from climate change or any other ESG risk, Asia has huge potential exposure. The more engaged companies are with it, the better placed they are to outperform their peers – and there is a growing recognition of that. Cheng – Hopefully in a few years’ time, 2019 will be regarded as the bumper year where there is a paradigm shift on sustainable investing in Asia. ©2019 funds global asia
Jan-Feb 2023
December 2022
