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Environmental, Social and Corporate Governance in Emerging Markets


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I. Environmental, Social and Corporate Governance in Emerging Markets

Much ado has been made about the lack of normative Environmental, Social and Corporate Governance (ESG) methodology as applied to financial analysis. Be that as it may, demand for financial products that pay more than lip service to the ESG concept is rapidly expanding and the array of funds integrating ESG is wide. As a result, it is easy to forget that responsible investing, at least on an industrial scale, is a relatively young concept. Until the end of the twentieth century, the dominant line of thought in investing followed Milton Friedman’s free-market affirmation that the – financial – bottom line was the chief bellwether for a viable investment. Promoting corporate responsibility was seen as incompatible with financial returns. Yet, numerous studies1 have shown that, over time, diligent sustainability policies can translate into superior economic performance; in other words, doing good was good for investment. This view began its shift from margin to mainstream with the publication of an influential report by Freshfields, who argued that integrating ESG analysis was no less than a fiduciary duty to investment firms’ clients.2

Emerging Markets are no exception and the incremental effect of ESG factors could be even more prevalent in Emerging Markets in the foreseeable future, not the least because of a “low base and catch-up” phenomenon.

1. ESG factors increasing relevance

The significant outperformance of ESG indices in the Emerging Markets space – much larger than in the developed markets - has increased awareness of the applicability of ESG within EM. The MSCI Emerging Markets ESG index has significantly outperformed its standard index counterpart (see graph below). According to a study from Cambridge Associates, there is a consistent evidence that ESG-based stock selection explains a significant part of this excess return after controlling for other factors. This empiric observation could be the tip of the iceberg, as it seems that there are quite a number of structural factors at work.

1- ESG coverage of Emerging Markets has expanded and new global indices have been launched in recent years (MSCI Emerging Markets ESG index was launched in June 2013 for instance).
2- Corporates’ Corporate Social Responsibility (CSR) disclosure improvements are encouraging even though there is still room for improvement. Frequently cited issues include number of reporting companies, quality of data and in some instances language. Stock Exchanges have been implementing CSR reporting
guidelines for listed companies. Brazil and Peru require ESG disclosures as a criteria for listing.
3- Increasing awareness on the part of local asset owners and managers. Stewardship codes have been increasingly adopted by asset managers, notably in Asia. Meanwhile, China’s relentless support of cleanenvironment technologies is spurring strong growth in environment-friendly thematic investments.
4- Global companies deriving sales from Emerging Markets could be acting as a conduit for best practice dissemination. For instance, a “Duty of vigilance” law was passed in France toward reducing supply chain abuses by multinationals.



Share of EM in sustainable investments marginal

Graph 2 - Emerging markets 2017-10-03


Large Outperformance of ESG in Emerging Markets

Graph 3 Emerging markets 2017-10-03





2. Materiality of ESG factors

Many have questioned the materiality of the ESG factors, that is to say, how much influence they have over a company business prospects, either negative or positive, and what the implications are for investors. Several initiatives have tried to answer to this question. For instance, the SASB, Sustainable Accounting Standards Board, has developed a materiality map which allows investors to look at specific sustainability risks and opportunities on an industry-by-industry basis. Amundi has developed its proprietary framework where a total of 37 measurable criteria have been identified to have a material impact over corporate value drivers –either tangible or intangible- on a sector-by-sector basis.




Graph 4 Emerging markets 2017.10.03



Corporate Governance is usually the dimension that EM investors tend to focus on.
Superior corporate governance has been shown to reduce a firm cost of equity3. ESG ratings show low scores in absolute terms in Emerging Markets compared to their Developed Markets peers. If some countries like South Africa have been an exception, low governance scores can be explained by the existence of crossshareholdings and family businesses, which have been inherited from a multi-stakeholder governance culture where minority shareholders rights are often overlooked. For practitioners, key items to monitor short-term trends typically include related party transactions, aggressive accounts practices or any measure pertaining to alignment of interest.




Environmental criteria, including environment management practices –inclusive of pollution- and resource efficiency, demonstrably impact a firm’s operations and financial performance, even though statistical evidence is still lacking in Emerging Markets.Two recent examples highlighting economic performance impact from issues over environmental resources include: (i)recent boycotts of fizzy drinks from Coca Cola and Pepsi by more than a million traders in India, after claims the companies were using scarce water resources of the south Indian state of Tamil Nadu. (ii)a large mining company in Russia, which typically garners low scores due to its largescale pollutant emissions, is facing a $3.5bn investment into a sulphur clean-up project; undoubtedly good for the surrounding city, but negative for the company’s cash flow availability. A good example of the cost of poor ESG scores to investors. Having said that, depending on the level of economic development and the availability of financial resources at companies, the cost of protecting the environment may still be relatively high especially when technical expertise is not locally (affordably) available.

On the other hand, notable items whose materiality on financial performance have not been identified include corporate social behavior, such as worker-safety standards for instance. This reality needs to be analysed in the context of labour cost remaining one of the key competitive advantage of many Emerging Countries’ companies. Another notable fact is that large-scale buyers, often located in developed countries, have bargaining power vis-à-vis producers in Emerging Countries. This complex issue is being gradually given attention to, and awareness of the need for heightened oversight over global supply chains in industries such as information technology or textile for instance has been rising.

The field of ESG in an Emerging Market context is dynamic and shows great promise for both shareholders and stakeholders alike. It is an exciting time for practitioners as the paradigm shift from pure returns to sustainable returns gathers momentum.


1. Freshfields Bruckhaus Deringer, A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment: A Report Produced for the Asset Management Working Group of the UNEP FI, 2005

2. Freshfields Bruckhaus Deringer, A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment: A Report Produced for the Asset Management Working Group of the UNEP FI, 2005

3. Chen, Chen, and Wei, 2009





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GIELEN Pierre , Investment Specialist
PHILLIPS Valérie , Investment Specialist
ROUX Barthelemy , Investment Specialist
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