For pension schemes with emerging markets exposure, environmental, social and governance factors pose a challenge that is forcing them to confront issues of governance and data transparency, along with considering how best they can exert their influence on emerging market portfolio companies.
Emerging markets broadly tend to trail their developed market peers when it comes to ESG considerations. This is not to say there are not companies with good policies in these markets, says Aviva Investors portfolio manager Jonathan Toub.
He notes that emerging economies are “courting” European investors’ capital by getting up to speed with ESG and developing an understanding of what is “now expected of them” from large pension schemes.
Human rights and stability issues are other areas we pay attention to, not just from an ethical perspective, but also because of the potential ripple effects for a country’s debt dynamics
Lisa Chua, Man GLG
While some markets and sectors have been quick to adopt ESG themes, others have been more reluctant to match the pace set by ESG-conscious schemes, resulting in a “huge range in the level of understanding” of ESG by emerging market corporates, says Toub.
Compounding this is the broad range of ESG readiness demonstrated by emerging market corporates.
Some companies have a long track record in “meeting requirements for the provision of transparency and detailed information” to perform necessary reporting exercises. Others have had “very little contact with western investors”, Toub adds, meaning that no two emerging market companies can be viewed in the same light by investors.
Assessing the challenges
From the perspective of western institutional investors, driving ESG in emerging markets starts with understanding the factors associated with that particular market and evaluating whether they may undermine the ESG process, thus resulting in heightened investment risk for equity and fixed income investors alike.
Man GLG portfolio manager Lisa Chua says that assessing ESG factors is part of identifying “latent risks for a country’s credit trajectory”. In practice, this means governance factors are “particularly important” as data transparency procedures are rarely as “robust” as developed markets.
“Human rights and stability issues are other areas we pay attention to, not just from an ethical perspective, but also because of the potential ripple effects for a country’s debt dynamics,” she says.
“Implementing meaningful fiscal reforms to stabilise debt ratios becomes significantly more challenging in countries vulnerable to social unrest.”
But these two areas stand in contrast to the environmental aspects of ESG, which is still a “work in progress for many emerging markets”, she adds.
As such, Chua’s approach is to avoid focusing on “static measures” and data points, and instead look at the “underlying trends” for the country to better understand the future role of environmentalism within a nation’s economy.
Exerting influence
Once a picture has been painted of a company’s overall ESG potential, attention turns to the practical steps investors can take to steer portfolio companies.
However, a lack of board independence, often stemming from the predominance of founding shareholders or state-controlled public companies, results in headwinds for well-intentioned investors, Toub explains.
“This can present challenges for minority shareholders to exert influence on decisions and drive good governance. However, by making these companies aware of investor concerns during AGM voting, and through ongoing engagement with company management, the message is starting to land,” he says.
The increasing weight that international investors place on a strong governance culture is further cementing this change, but with important milestones such as the 2030 deadline for the UN’s Sustainable Development Goals approaching, the need for investors to make an impact is heightening, Toub adds.
Crown Agents Bank head of ESG Charlie Bronks says investors must be acutely aware of the “inequitable burden of transitioning to an SDG-orientated economic structure”.
“It is key for the challenge of achieving the SDG goals to be a fair and global effort, with wealthier economies taking on the appropriate developmental lead, as has been frequently highlighted at recent COP meetings and from the start of the formulation of the SDG goals,” she adds.
But the capability of governments and corporations within emerging economies to embed the SDGs into policy and business practices is often limited by the “absence of strong institutions, local understanding and, most importantly, resources”, says Toub.
For international companies, governments and investors, this makes it all the more important to push for the adoption of SDGs at both corporate and government levels, he continues.
“We do this by engaging at both a sovereign level, through our macro stewardship team and our EM debt teams, and also at the corporate level through our equity and credit teams.”
Three-quarters of asset managers yet to set climate transition targets
Seventy-three per cent of asset managers surveyed by consultancy Mercer have yet to set climate transition targets — such as goals on achieving net zero — across their strategies.
Active voting during AGMs, including voting against the reappointment of directors if asset managers believe the board to be backing improvements in ESG areas, is a prominent tool available to investors.
The UN’s Principles for Responsible Investment reported 576 resolutions being filed during the 2022 annual meeting season, and while they are predominantly targeting western companies, the volume of evidence showing that active voting can successfully steer companies is mounting.
While the headwinds surrounding ESG in emerging markets are plentiful, the number of tools available to actively engaged schemes is increasing alongside greater levels of regulatory scrutiny, governance demand and appetite for global ESG strategies.
