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Five signs of hope for ESG

Paul Lukaszewski  |  25 Jan 2021Text size  Decrease  Increase  |  
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*This is a contributed piece by Paul Lukaszewski, Aberdeen Standard Investments’ head of corporate debt for Asia and Australia

A year can feel like a very long time, especially when that year happens to be 2020. Just over a year ago, towards the tail end of 2019, we were celebrating the start of our working relationship with the Asian Infrastructure Investment Bank (AIIB).

Together we had launched the Sustainable Capital Markets Initiative. This project seeks to entrench environmental, social and governance (ESG) principles into Asia’s corporate bond market, which is seen as critical to helping fund the region’s infrastructure development needs in a sustainable manner. We also started to manage Asia’s first ESG-driven corporate bond investment mandate, on behalf of the AIIB,  putting theory into practice. 

Last year proved to be a truly remarkable and historic one. It will be long remembered for the effects of the Covid-19 pandemic. Out of this extraordinary first year of adversity, we would like to share five observations from our responsible investing journey:

1. Bond issuers want to talk to us

When we started out, we were cautious about the reactions we would get from companies. Compared to borrowers in more established bond markets, Asia’s corporates were less familiar with even basic ESG concepts. Our team understood this and we expected an uphill struggle.

However, we were pleasantly surprised by the number of bond issuers who were receptive to our ESG message. In fact, most of the companies we approached were willing to talk to us and to engage in meaningful discussions. These companies were eager to speak and to listen. While it may be easy to generalise about Asia lagging on ESG matters, our engagements show that things are changing quickly. 

Inevitably, there were a few companies that did not want to talk to us. Two examples that we encountered were a Middle Eastern airline and an Indian telecom company. Both have repeatedly declined our requests to speak with them. Transparency and disclosure are critical so we view their refusal to speak to us as negative, although it is worth highlighting that both companies make public disclosures about their sustainability practices. 

2. ESG ratings companies are expanding their coverage

Bond investors increasingly use ESG ratings firms to support their ESG analysis and to supplement traditional analysis by credit ratings agencies.

We have noticed a modest expansion in the coverage of the bond issuers whose securities make up our portfolio. We see this as a positive sign that Asia’s corporates are acknowledging the need to develop and disclose their ESG policies. 

What’s more, we also saw a slight improvement in the ESG scores of our holdings. The extent and quality of the information collected depend a lot on the cooperation of the companies under review. Again, what we are seeing suggests more bond issuers are ‘getting’ the ESG message.

3. Talking to companies can lead to real change

One question we get asked all the time is: ‘will these companies do anything after you talk to them?’ The honest answer is that not all of them do, but many will. Corporate engagement can work.

For example, we engaged with a Russian steel producer that, by the nature of its business, is exposed to a number of environmental as well as health and safety issues.

To be fair, the management team was already aware of what’s at stake for them even before our first meeting. In subsequent discussions, the team made a commitment not to develop any coal production capacity and it took steps to improve board oversight of ESG matters.

Furthermore, we recommended that the company adopt the Mining & Tailings Safety Initiative which will lead to enhanced disclosure of its own tailings dams. A tailings dam is used to store the by-products from mining operations.  We are proud to say that the company later informed us it was planning to adopt the initiative. 

4. Progress can be uneven

During the second half of last year, six property developers from China issued ‘green’ bonds, five of them for the first time. Green bonds are unique instruments in that companies which borrow money this way must deploy the proceeds to eligible climate and environmental projects.

The rise in green bond issuance by China’s property developers is a really big deal for the region because it signals that one of the region’s larger and more diverse sectors is adopting better ESG practices. We were quite surprised to see company management teams competing with one another over who was further ahead with regards to ESG practices. Importantly, from a market perspective, where this sector goes others are sure to follow.

Our engagements with the various property developers revealed to us a wide range of progress to date, as well as in commitments to achieving future ESG targets. For example, we discovered big differences in emissions targets, as well as in their alignment with the recommendations of the Task Force on Climate-related Financial Disclosures (a Financial Stability Board initiative).

Management and board oversight structures are also very different. At its best, one company’s chairman took direct oversight of the ESG committee. However, governance structures largely remain a concern as these developers are usually under the control of an individual or a family, although things are slowly improving. 

5. Companies can (and do) backtrack

There was the case of a Korean state-owned electricity generator that had issued a green bond which was recognised under the International Capital Markets Association framework, with a second-party opinion from Sustainalytics, an ESG ratings provider.

The company faces a major challenge because it is trying to transition away from reliance on coal-fired power generation. It has to follow Korea’s national environmental policy, which is part of the country’s commitment under the Paris Agreement. We were disappointed when, after the bond sale, the board approved investments in several coal-related projects in other Asian countries.

Alarmed by this backsliding, we prioritised the company in our ESG Escalation process and voiced our concerns directly to the company’s chairman. We were pleased to see our concerns taken seriously. It subsequently updated its corporate policies and made a commitment not to develop additional coal-fired projects overseas. 

While we will continue to monitor this company for any more deviations from its environmental commitments, we do applaud the speed with which it made amends. Progress is not always a straight line.

Looking ahead

The ESG transformation we expected to come to Asia is now very much underway. Governments across the region have been promoting initiatives to support adoption of better ESG practices. 

Climate change, in particular, has become a key focus. China’s September 2020 announcement at the UN General Assembly that it would target carbon neutrality by 2060 will likely be a game-changer for ESG in Asia’s debt markets. Meanwhile, the Covid-19 pandemic has raised awareness of the importance of social factors.

ESG investing and engagement are not just the concern of the equity investor. For many companies, their only interactions with institutional investors are in the bond markets. For many publicly-listed companies, their debt funding may be a more meaningful part of their capital structure than their equity.

As we showed in 2020, bond investors have a role to play driving positive change and improving the behaviour and sustainability of the companies we help finance. 

The landscape of Asia’s credit market is shifting rapidly. We believe the future of ESG investment in this region is bright and we are very excited to be on this journey.

Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

See also Morningstar Guide to International Investing.

is head of corporate debt, Asia and Australia, at Aberdeen Standard Investments.

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