Market commentary

Shining a light on ESG investing in Asia

Charles Yonts, Head of Asian ESG Research, Macquarie Group

25 March 2021

  • Growing societal demand sees ESG increasingly take centre stage within investment strategies, with Asia set to become the next frontier for sustainable investing.
  • Data and scoring are fundamental to quick and systematic analysis of ESG risks and opportunities, but the current system is the biggest hurdle to faster and more robust ESG growth.
  • Macquarie’s new ESG scoring system for Asian equities provides a forward-looking approach to help identify companies that will create sustainable value over the long-term.

There was a brief moment early in 2020 when it looked possible that Environmental, Social, and Corporate Governance (ESG) issues would be shunted aside by the focus on COVID-19. However, as the year progressed, it became increasingly clear that the pandemic had only served to reinforce and strengthen the rise of ESG investing.

By almost any metric, capital inflows into funds that class themselves as having a sustainable objective or binding ESG investment criteria continued to accelerate through 2020. According to Morningstar, they grew by 88 per cent in the fourth quarter alone, and the year ended with assets in sustainable funds hitting a record high of $US1.6 trillion.1

While Europe and the US have traditionally been leading the growth of sustainable investing, Asia is now the next frontier in this space. A record $US5 billion was invested in sustainable funds in Asia in the last four months of 2020, bringing the region’s total to $US25.4 billion – up 131 per cent on 2019.1

A key driver behind the growth both in the region and globally is asset owners’ demand for ESG integration and more transparent corporate stewardship. Just under two-thirds (60 per cent) of asset owners ‘strongly agree’ that ESG criteria are important when selecting investment managers, and close to a fifth (19 per cent) had terminated managers on ESG grounds.2

Another key reason that ESG continues to gain so much ground is that it works. A rapidly growing body of evidence – both academic and real-world – is finding that ESG integration helps to deliver better risk-weighted returns.3

Fund managers’ attention has also been focused by regulators pushing for more transparency around ESG reporting among both corporates and investors. The EU’s Sustainable Finance Disclosure Regulation (SFDR), which came into effect in March 2021, is the most comprehensive regulatory regime for sustainable financial reporting. And it is now being used as a reference for regulators across Asia, as they ramp up reporting requirements.

As sustainable finance continues to mature into a core element of the financial services industry in Asia, investors need to be ahead of the curve when using ESG data to properly assess earnings risks and opportunities.”

As sustainable finance continues to mature into a core element of the financial services industry in Asia, investors need to be ahead of the curve when using ESG data to properly assess earnings risks and opportunities. However, the quality and reliability of data and scores has been singled out repeatedly as the biggest hurdle to even faster and more robust ESG growth across the region.

Most ESG scores are backward-looking, but the investment world looks forward.”

Most of the major stock exchanges and regulators across Asia have issued ESG reporting guidelines, but while there is some coordination between different bodies in the same market – such as in Hong Kong – and even between similar entities within different markets – such as the Hong Kong Monetary Authority and Monetary Authority of Singapore – it is still a disparate patchwork of regulations and directives.

There is no single master set of sustainability questions that can be used across either the region or industries. In the absence of such generally agreed-upon sustainability metrics (such as that provided by the International Financial Reporting Standards for financial reporting), investors have had to make do with a patchwork of local regulations, competing data vendors, and a myriad of differing standards bodies.

This is the single biggest things holding back the growth of ESG investment in Asia. A view supported by a 2019 study that found data and scoring issues to be the dominant obstacles to further ESG integration.

Source: EIU (2019), Macquarie Research, March 2021

To assist investment managers in navigating these issues, and assessing the opportunities across industries in Asia, Macquarie has developed a new propriety research assessment system for the region’s stocks.

The Macquarie Governance & Risk Score (MGRS) uses the Sustainable Accounting Standards Board (SASB) parameters as a foundation, but modifies the sector-specific, materiality-driven performance indicators to an Asian context.

Deploying local language scraping tools, the system systematically identifies and uncovers external data in multiple languages from media, non-government organisations (NGOs), government reports and other sources to contribute to the sustainability assessment criteria.

By geographically tailoring a system to the region and introducing a forward-looking angle – one that includes at expectations of how ESG will evolve at equities over time – it introduces a much-needed new level of transparency for investment managers, and quicker, more systematic analysis of emerging ESG risks and opportunities.

Macquarie’s ESG scores will be rolled out on a sector-by-sector basis in the first half of 2021 – starting with the semiconductor sector, which has now been published – and made available through Macquarie Research.