ESG is here to stay


Companies can no longer pay lip service to these guide lines that many investors are embracing

WHILE the concept of ESG, which stands for environmental, social and governance, is relatively well established, its significance here came to the fore recently.

Two particular developments led to this. One was the Top Glove Corp Bhd saga. After it was revealed that the glove making giant had paltry workers’ housing conditions that led to high Covid-19 infections, some analysts lowered their target prices thereby impacting the stocks’ value.

And then BlackRock, the world’s largest asset manager that held a 1.61% equity stake in Top Glove, voted against the re-election of six independent directors at the rubber glove maker’s annual general meeting.



The move was ESG-driven as BlackRock held the view that the board had failed in its oversight responsibility relating to TopGlove’s migrant workers’ health and safety. Top Glove has since pledged to rectify those concerns.

Another more significant development is the recent declaration by the Employees Provident Fund (EPF) that it aims to make all its investments based on ESG practices by 2030.

So arguably, the EPF may no longer invest in oil and gas counters in 10 years time, because drilling for fossil fuels can be deemed a non-ESG compliant activity.

This brings the ESG discussion into two hotly debated aspects. One, what exactly is the correct interpretation or standard of ESG and secondly, what is the correlation between ESG and returns on investment.

There are other questions too. What is the state of ESG compliance of Malaysian listed companies? Are many even aware of this growing concept? And where do these companies start in attempting to get certified?

A lack of standardisation

At this point, there is no global standard for ESG. There are multiple bodies that have come up with their own standards. This does make it difficult for investors and issuers to figure out their ESG strategies.

“Different assets managers employ very different methodologies for ESG scoring, ” points out Vincent Khoo the head of research at UOB Kay Hian Malaysia.

That though should not stop Malaysian companies from beginning their ESG compliance journey, says Amarjit Kaur, an experienced environmental consultant.

“The journey and thought process needs to begin with an almost existential type question. Why does the company need to exist? What contribution and impact are you having on the economy and society? If you answer these questions honestly, you will then realise if you are doing the right or wrong things. Of course there are many standards out there that we can help companies with in their assessment but ultimately, the intention and spirit of those owning and running the companies needs to be in the right frame, ” she opines.

The good news though is that more companies are beginning to embark on their ESG journey. Amarjit says that her consulting firm, Shemsi Sdn Bhd, is seeing increasing client engagements.

As for concerns about the lack of global standards, Eugene Wong of Sustainable Finance Institute Asia makes an interesting point -- that there is unlikely to ever be a single standard or definition of ESG.

“That’s because ESG characteristics are qualitative and it’s hard to translate them into a single number. If you look at ESG ratings, you’ll find that the correlation of ratings on the same company by different ratings providers is less than 0.5, whereas credit ratings from different credit rating providers have correlations higher than 0.9. This is because there is a difference in what is considered as part of the ESG definition, the indicators used to evaluate those aspects and the way weightings are assigned to get to the final number.”

Wong adds: “Because markets are different, the slant on ESG in each market can also vary. Take for example the Nordic countries where social responsibility and equality are built into the culture. There’s a focus of the ‘right’ profit over profit maximisation. But in places like Asia, profit maximisation is important. So ESG products need to consider that too.”

Sustainable Finance Institute Asia is a newly set up independent institute advocating sustainable finance in Asean.

For Andrew Chan, who leads PwC Malaysia’s sustainability and climate consulting arm, the definition of ESG that works can be summarised as ‘sustainable value creation’.

“In this context, the key paradigm shift for companies is moving from a profit maximisation lens to a value optimisation lens. And moving from a shorter term profit focus to a longer term consideration of profits as well as impact to customers, communities and the environment. Is the organisation out to maximise profit, or is it there to optimise value? Are shorter term gains more important than longer term? How are shareholder interests balanced with stakeholders?” he poses.

On the issue of the ambiguity over ESG standards, Chan says this: “Financial reporting standards have been evolving over 100 years, and they are still changing.”

Correlation between ESG and returns

For investors though, can limiting one’s bets on ESG compliant companies still lead to higher returns? Some think so.

Alizakri Alias, Chief EPF Officer, explains. “The market volatility during the first-half of 2020 was challenging. For the EPF, at the height of the first wave of the Covid-19 pandemic, our top 10 ESG-ranked stocks outperformed the bottom-10 in the first quarter of the year. If we were to rank the companies by their ‘social’ scores from our proprietary ESG rating tool, companies in the top 10 list outperformed the FBMKLCI by 6% in the first quarter of 2020.”

He adds: “We view ESG to be the vaccine for any crisis. At worst, ESG-compliant assets’ performance did not deteriorate as badly as other assets. This is key in delivering sustainable growth.”

Funds like the EPF and The Retirement Fund Inc (KWAP) are also pushing stock brokerage firms brokerage in Malaysia to ESG considerations into their research process alongside traditional financial metrics. As far back as 2018, KWAP had begun putting some of its money into ESG-rated assets.

Affin Hwang Asset Management (Affin Hwang AM) director of equity strategies and advisory Gan Eng Peng says the anecdotal evidence is clear that the ESG theme is having a correlation to stocks’ valuation.

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Gan points to listed planters on Bursa Malaysia.

“Although crude palm oil (CPO) prices in US dollar terms at a nine-year high, listed palm oil company shares in Malaysia and Asia have not moved anywhere near the CPO price movement. They have all underperformed the CPO price movement. We think there is a general avoidance of non-ESG friendly sectors and there is no differentiation consideration for those within the sectors that have better ESG practices or rating, ” he says.

He adds that companies linked to renewable energy and electric cars have surged to premium valuations.

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ESG drivers

Still, there is yet to be clear and definitive research showing that ESG investing leads to higher returns. And looking at returns as a driver to becoming ESG certified may be missing the point.

Rikke Netterstrom, executive director of Helikonia, a sustainability and ESG advisory in Malaysia explains: “There is very limited evidence of a direct link between share price and ESG performance. I would expect this to change over time, but this isn’t the most critical driver. In discussions with CFOs in Malaysia and beyond, what appears to be more important is access to capital. Malaysian companies seeking international finance are finding that ESG performance is a critical requirement in obtaining loans, insurance and other financial products. Southeast Asian banks have yet to set up very strict requirements, but financial professionals and boards are expecting this to be a basic requirement for obtaining finance over the coming years.”

Yet another driver for ESG is coming from global supply chains. Explains Amarjit of Shemsi: “If you are part of a supply chain linked to the EU or US where ESG requirements are stringent, you will have no choice but to adhere to stricter requirements.”

How ESG compliant are Malaysian listed companies?

So what is the state of ESG compliance among listed companies in Malaysia?

One indication is when companies get into the FTSE4Good Bursa Malaysia Index, which has become the local stock exchange’s measure for ESG compliance. However a mere 75 out of 933 listed companies are on that index. Getting on the index is also limiting as it is only drawn from the top 200

Malaysian stocks in the FTSE Bursa Malaysia EMAS Index.

Another problem is that while listing guidelines require companies to report on their ESG issues, there is no third party audit done to verify these disclosures.

To date there has been no assessment done yet by the regulators of the local capital market on the state of ESG adherence by listed companies. It is likely to be poor in general, with some impressive exceptions.

“Many listed companies are paying lip service to ESG, hiring specialist writers to produce these reports because there is a requirement to do so. And many more still think that ESG is like Corporate Social Responsibility or CSR. It is clearly not, ” points out a consultant with a corporate advisory firm, who declined to be named.

The good news though is that Malaysia has a decent base from which to build on the ESG model.

Says Wong of Sustainable Finance Institute Asia: “Awareness of ESG is growing and with the Covid-19 outbreak, people are seeing the importance of it. They’ve also seen the impact on the business of a company where ESG adoption is wanting. There’s a huge intersect between ESG and Shariah investing and in that respect, Malaysia has a good base”.

For listed companies trying to get into the ESG spirit, some advise is given by Helikonia’s Netterstrom: “As to the standards, our best advice for listed companies is to look first at frameworks set out by regulators. Bursa Malaysia’s listing requirements and the linked FTSE4Good indices is where listed companies should start.”

“Secondly, to ensure that efforts and strategies are somewhat future proof, adherence to multi stakeholder reporting standards in the form of the Global Reporting Initiative is critical, as this standard is often a step ahead.

Finally, companies should look to global sector-specific standards, such as the RSPO or FSC as these provide robust guidance at a practical level.

It is worth mentioning that no company can excel in ESG indices simply by reporting and disclosure. A robust sustainability strategy which tackles all material issues for that specific company is at the heart of superior performance.”

PWC’s Chan adds: “It’s confusing to companies because investors, finance providers, regulators and stakeholders have different expectations on which approaches they prefer.

“We found that if you respond to these frameworks from a reporting basis and are just compliance based, you would fail to capture the value from the sustainability agenda. Most likely you would see sustainability as a cost to the business.

“If you use the sustainability agenda as a performance improvement concept, you are much more likely to drive innovation, cost reduction and risk reduction, as well as elevate your brand. You can use ESG data to provide intelligence and recommendations to the management team, who can then act on it positively.”

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