The last few years have seen a huge boost in ESG investing worldwide (you can learn more about this here), bringing sustainable investment to the spotlight, especially among the younger generations. According to Cleary Gottlieb, the ESG trend is only accelerating, as capital flows into funds incorporating sustainability and ESG-driven strategies hit an all time high in 2019 and 2020. The 2020 events (including COVID-19, the Black Lives Matter movement in the USA, and increasing wildfires around the world) are further increasing scrutiny on ESG considerations from consumers, employees and regulators. Although the rising focus on ESG considerations has been a global phenomenon, it can look very different around the world. This article is going to assess the development of ESG across developed and emerging markets.
Europe is the worldwide leader in sustainable investing, holding almost half of the world’s sustainable investment assets. EU regulators are also leading the way when it comes to reforms in the field. For example, in 2018, in response to the commitments set by the 2015 Paris Agreement goals, the European Commission launched the “Sustainable Finance Action Plan”, providing much of the conceptual framework for sustainable finance regulation in Europe. This was further strengthened in 2020, when the EU announced their “Green Deal” and many investors started pushing governments to place sustainability considerations at the heart of the EU’s post-pandemic recovery plan.
Despite the rising demand for sustainable investment in Europe, there are widespread concerns that some providers have been “greenwashing” (i.e. making claims about the sustainability of their products or services that are misleading). On a positive note, there are hopes that the EU’s new requirements for ESG disclosure – the Sustainable Finance Disclosure Regulations (SFDR) – which came into effect on the 10th of March 2021 will improve the situation. The SFDR will require asset managers to define entry-level ESG policies and make ESG disclosures in pre-contractual documents. According to Investors Corner, the main purpose of the SFDR is to ensure that financial market participants can finance growth in a sustainable manner over the long term, while combating greenwashing. Wolfgang Kuhn, director of financial sector strategies at ShareAction (a responsible investment group), claims that “we’re getting somewhere with the new standard of financial disclosure regulation by making sure that if you call yourself ESG, you explain what it is. And if you call yourself a force for good, then you really have to show it”.
The recently enacted SFDR is clearly very relevant for ESG in the EU, and for countries dealing with the EU. However, with the UK having left the EU and the transitional period having come to an end, how relevant is it for the UK?
Following Brexit, the UK quickly identified ESG investment as a “regulatory battleground”, announcing its refusal to align with upcoming EU legislation (SFDR) and intention to become a global green finance leader. Many believe that the EU and the UK are in a “race to the top” on ESG reporting regulation, seeing as the UK is also a worldwide leader when it comes to sustainable investment.
The SFDR is set to strengthen ESG disclosure in the EU. However, it does not force disclosure. Instead, players can choose not to comply and explain why (this is called the “comply or explain” approach). The UK government decided not to implement SFDR into its domestic legislation and intends to bring in its own stricter legislation that will be based on TCFD and force all companies to disclose information, with no “comply or explain” option. The EU has recently postponed the release of SFDR’s technical regulations, possibly until the end of this year. While this is necessary to ensure rigors in the compliance process, the delay is causing uncertainty and might have handed the UK government a chance to grab the upper hand.
Leaving the EU does offer the UK a chance to become a green finance leader. However, it also presents challenges. For example, many UK fund managers think that diverging from EU rules could force them to negotiate clashing regulations, which can create uncertainty, making the complex field of sustainable investing even harder for consumers and companies to navigate. While the precise nature and scope of ESG regulation in the UK continues to develop, ESG is most likely to remain a critical consideration for all operational aspects of UK businesses.
Based on Thomson Reuters ASSET4’s integrated ratings for 2009, Asian markets, in general, are behind on implementing ESG. Of course, it has been over a decade since that report, and while Asian companies have been slow in adopting ESG into their business strategy, evidence signals that this is changing for the better. This is in part as a result of the rising pressure from international investors investing into Asian markets. The diversity of fund markets in Asia means that the adoption of ESG has been quite diverse throughout the region. For this reason, I will discuss ESG trends with reference to selected Asian countries: in China, Japan and Singapore.
In China, the government has set a “green finance” strategy. Its 2021-2025 plan focuses on sustainable development, and its 2016-2020 plan focused on actively implementing the 2030 agenda for sustainable development. This signals that authorities are seeking to increase their focus on green development in coming years. Arguably as a result of this, responsible investing is growing in China. In September 2018, the China Securities Regulatory Commission (CSRC) established the ESG information disclosure framework for publicly listed companies and developed a standard template for disclosure of ESG information to enhance the compatibility of such information among enterprises. The Asset Management Association of China (AMAC) also released a report in September 2019 that emphasised the importance of growing the uptake of ESG in both private and public fund markets. Furthermore, Chinese regulators had set a goal for mandatory ESG disclosures for listed companies to come in effect by the end of 2020 (now, expected to be pushed to the end of 2021 due to the COVID-19 pandemic). Although there has been an exponential growth in ESG adoption and awareness in China, Chinese companies still fall behind their global competitors when it comes to ESG disclosures, and, according to the Financial Times, China still has the worst ESG ratings of any major market.
The practice of Gapponshugi – ethical capitalism – has been long present in Japan. Hence, it is no surprise that Japan is one of the fastest growing markets for sustainable investment globally. The Financial Services Agency amended the Stewardship code (a set of regulatory guidelines to establish fiduciary duty by institutional investors on behalf of their clients) in 2019 to factor in ESG implications on risk mitigation and growth opportunities, explicitly instructing institutional investors to consider sustainability in their investment strategies. Alongside the growing number of actors who recognize the importance of ESG, sustainable assets under management in Japan quadrupled from 2016 to 2018 to a total $2.2 trillion, the third highest globally. Furthermore, in Japan, most of the corporate disclosures with environmental and social issues have to be sent to the national regulators for monitoring and compliance purposes. This prevents practices of greenwashing. According to a report done by Bloomberg, ESG investing is so popular in Japan that even Buddhist Monks are getting into it!
Singapore is one of the leading financial centers in Asia, and one which is perceived to prefer incentive-based regulation for fear that an overly-prescriptive approach might drive investment and business away. So far the Singapore approach to ESG regulation is consistent with such a perception. According to Singapore Law Review, the government is generous when funding companies to encourage them in their pursuit of sustainability, while also maintaining a flexible regulatory regime. In 2016, the Singapore Exchange (SGX) introduced rules requiring companies to publish annual reports on a “comply or explain” basis. However, there is no official body that serves the function of an independent auditor/regulator monitoring the accuracy and the extent to which these companies actually follow through with the ESG plans they set out in their sustainability reports. According to the Financial Times, while Singapore’s regulator has introduced general environmental risk management guidelines, the lack of standardised ESG regulations and reporting in Singapore leaves local investors at a greater risk of being exposed to greenwashing.
The Australian market is known for hugely supporting the idea of sustainable investing. According to Cleary Gottlieb, Australia and New Zealand make up the region with the world’s greatest proportion of responsible investment assets relative to total assets under management, with 63% of assets using a responsible investment approach. Like in the EU, asset managers, asset owners and trustees are required by regulations to consider key risks and opportunities when making investment decisions in Australia.
While initially, the focus of ESG efforts in Australia was primarily on corporate-governance related issues, recently, interest in environmental and wider social issues – the E and S in ESG – has also developed. According to Aberdeen Standard Investment, the local investor community has a strong awareness of the risks and opportunities linked to climate change. This is a critical issue given the economy’s reliance on fossil fuels and commodities exports. Australia is also susceptible to drought, extreme heat waves and flooding.
Australia has developed a number of frameworks and policies aimed at ESG integration. Domestic responsible investing groups were set up, such as the Australian Council of Superannuation Investors, the Investor Group on Climate Change and the Responsible Investment Association of Australasia. These groups are now well established, offering investment advice and policy advocacy around ESG themes. Furthermore, Australia’s Modern Slavery Act, which took effect in January 2019, requires companies to report on their exposure to the risk of modern slavery within their own businesses. These are part of a greater push by investors for more transparency in ESG reporting, seeing as, like in many other parts of the world and despite Australia’s good performance in sustainable investing, greenwashing is a concern here.
Canada and the United States have taken different approaches regarding ESG integration. According to Business Wire, responsible investments that incorporate environmental, social and governance factors now represent 61.8% of professionally managed assets in Canada. Canada has followed a similar path to the UK and Australia: asset managers, asset owners and trustees are required by regulations to consider key risks and opportunities when making investment decisions. Under Canadian law, disclosure requirements around governance are well known, but there are no specific requirements for the disclosure of environmental and social considerations. Instead, issuers must disclose in a “meaningful way” material information in their continuous disclosure documents, including information that, if omitted or misstated, would “likely influence a reasonable investor’s decision to buy or sell”. In recent years, the Canadian Securities Administrators (CSA) has published guidance to assist issuers in determining what environmental information is material and should be disclosed in their continuous disclosure documents. Overall, the ESG investment landscape is evolving quickly across Canada. Many parties are not only interested in advancing the ESG awareness, but also in pushing companies to publish more, as well as more reliable, ESG-related data.
Between 2018 and 2020, total US sustainably invested assets grew 42%, according to the Forum for Sustainable and Responsible Investment’s 2020 trends report. ESG is clearly growing considerably in the US. However, despite the US being the world’s largest market for investors, it still lags behind Europe. This is not because of a lack of interest in ESG – a survey by asset manager Schroders shows over 60% of Americans agree investment funds should consider sustainability factors. However, only 15% actually put their money into sustainable investments. This is arguably because, despite the growing interest in ESG, there are many political and regulatory challenges. US regulation on ESG has gone back and forth a few times in the last couple of decades, fluctuating between a neutral stance to actively discouraging it. The US government has been reluctant to adopt ESG specific guidelines and instead only requires that disclosure of ESG risks is made if they are “material”, declining to publish specific guidelines in the area of ESG in 2020. This means disclosures can vary significantly, even between companies in similar industries. Furthermore, under the Trump administration, the federal government was actively discouraging sustainable investing and environmental protections. On a positive note, a change of direction in the US can be expected under the new Biden administration, which has shown openness towards sustainable practices. This could open up the doors to sustainable investment across the US.
In Mexico, The Mexican Stock Exchanges (BMV and BIVA) have an ESG disclosure project which intends to help listed companies consolidate all their sustainability disclosures by creating a system (which is still being designed) where companies can upload all of their ESG data, which can be accessed by different users. However, the use of this system would not be mandatory. This can create irregularities when it comes to ESG disclosure. Perhaps for this reason, the national stock exchange has recently created a green finance advisory council to support the development of green bonds and to prepare for more and better ESG financial sector disclosure practices. Despite these advancements, Financial Services Partner Guillero Uribe believes that “Mexico lacks specific regulations for the issuance of ESG bonds…The absence of widely recognized criteria for issuing ESG bonds has made it very difficult to distinguish between true sustainable investments and ‘greenwashing’”.
Like in many other areas of the world, and perhaps even more so in South America, there is a focus on the E of ESG. This is arguably because there are indications that 2021 could see an increase in Amazon deforestation, and there is a lot of global coverage around that particular issue. ESG development has been slow in South America when compared to other regions such as Europe or Australia but some advancement can be seen. For example, home to 60% of the remaining Amazon rainforest, Brazil is at the centre of discussions around climate change. Brazil has a market that is very intensive in natural resources and agriculture, two industries which can leave a strong carbon footprint. Although Brazil doesn’t have commitments as strong as those we see in Europe or Australia, companies are increasingly discussing climate change and addressing it in their strategic plans. Furthermore, the Inter-American Development Bank (IDB), the Brazilian Association for Development and the Brazilian Securities and Exchange Commission have recently launched the “Finance Innovation Lab”, a national forum on sustainable finance that aims to develop financial instruments to foster sustainable investment and to propose regulatory changes to prepare the market for sustainable finance opportunities. Despite these advancements, Brazil has a deep history of corruption, inequality, and deforestation. The latter has accelerated under President Bolsonaro, and many investors have threatened to unload Brazilian assets if this is not contained. Because of these challenges, getting across the message that ESG matters can be difficult, and perhaps as a result of the same challenges, Brazilian companies have trouble attracting and retaining investors who focus on ESG.
In Africa, social issues usually dominate ESG initiatives – as opposed to the focus on the environment we often see in other regions of the world. This appears to be in response to immediate social needs such as poverty, unemployment, and security. African countries and companies are amongst the fastest-growing in the world with a big infrastructure development potential but, for many international investors, Africa still poses a risk due to wide practices of greenwashing and lack of transparency.
For example, Nigeria is leading the way in impact investing in West Africa, where twenty-eight impact investors are active in the country. Attempts to improve opportunities of impact investing in Nigeria include the growing government focus on projects centered around solving social and environmental issues. For example, in 2019 the Nigeria Rural Electrification Agency (NREA) subsidised 7 suppliers of solar energy for 5 years, who will have to connect at least 1 million rural households in that period of time. Furthermore, in 2019, The Financial Reporting Council (FRC) of Nigeria released the Nigerian Code of Corporate Governance, which highlights key principles that seeks to institutionalise the best corporate governance practices in Nigerian companies. However, Nigeria still has a long way to go when it comes to sustainable investing. There is no law with a sole purpose of regulating sustainable investment. Instead, there are many laws with implications for sustainable investment, including The Companies and Allied Matters Act, The Nigerian Investment Promotion Act, and The Investments and Securities Act. The diverging laws investors have to consider before investing is likely to cause some confusion. The difficulties in navigating through these regulations is coupled with a limited capacity of social enterprises in Nigeria. Moreover, a limited number of impact investors can demonstrate a sufficient track record or capacity for development in the country, which discourages other impact investors. All of this hampers the growth of sustainable investing across Nigeria.
- The EU is the worldwide leader in sustainable investing, holding almost half of the world’s sustainable investment assets. The SFDR recently came into force in the EU.. The main purpose of the SFDR is to ensure that financial market participants are able to finance growth in a sustainable manner over the long term, while combating greenwashing.
- Following Brexit, the UK identified ESG investment as a “regulatory battleground”, announcing its refusal to align with upcoming EU legislation (SFDR). Many believe that the EU and the UK are in a “race to the top” on ESG reporting regulation, seeing as both are worldwide leaders when it comes to sustainable investment. While the precise nature and scope of ESG regulation in the UK continues to develop, ESG is, and will remain, a critical consideration for all aspects of UK businesses’ operations.
- Although there has been exponential growth in ESG adoption and awareness in China, Chinese companies still fall behind their global competitors when it comes to ESG disclosures, and, according to the Financial Times, China still has the worst ESG ratings of any major market.
- Sustainable assets under management in Japan quadrupled from 2016 to 2018 to total $2.2 trillion, the third highest globally.
- While there are general environmental risk management guidelines in Singapore, the lack of standardised ESG regulations and reporting leaves local investors at greater risk of being exposed to greenwashing.
- The Australian market is known for hugely supporting the idea of sustainable investing. Australia and New Zealand make up the region with the world’s greatest proportion of responsible investment assets relative to total assets under management. Like in many other parts of the world and despite Australia’s good performance in sustainable investing, greenwashing is a concern here.
- Responsible investments that incorporate environmental, social and governance factors now represent 61.8% of professionally managed assets in Canada. Under Canadian law, disclosure requirements around governance are well known, but there are no specific requirements for environmental and social (E and S) related disclosures.
- The US government has been reluctant to adopt ESG specific guidelines and instead only require that disclosure of ESG risks is made if they are “material”, declining to publish specific guidelines in the area of ESG in 2020. Under the Trump administration, the federal government was actively discouraging sustainable investing and environmental protections. A major change of direction in the US can be expected under the new Biden administration
- In Mexico, the absence of recognized criteria for issuing ESG bonds has made it very difficult to distinguish between true sustainable investments and greenwashing.
- In Brazil, companies are increasingly discussing climate change and addressing it in their strategic plans. However, Brazil has a deep history of corruption, inequality, and deforestation. Because of these challenges, getting across the message that ESG matters can be difficult.
- In Nigeria, there is no law whose sole purpose is to regulate sustainable investment. The lack of clear rules around sustainable investing is coupled with a limited capacity of social enterprises in Nigeria. Moreover, a limited number of impact investors are able to demonstrate a sufficient track record or capacity for development in the country, which hampers ESG growth.