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How ESG strategies hurt emerging markets

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Criticisms of the environmental, social and governance investment agenda have been flowing thick and fast in recent weeks, whether from Republican politicians or from HSBC’s Stuart Kirk. Today, we consider a question that should be particularly uncomfortable for the sustainable investing world: is the ESG framework steering capital away from developing nations that need it most desperately?

The report that we dig into below argues that there are some worrying flaws with today’s ESG paradigm, with an emphasis on risk aversion that threatens to undermine financial support for sustainable development in poorer countries.

Are these concerns justified, and if so how can they be addressed? We’d love to hear the thoughts of our readers — particularly those based in developing nations. You know where to find us: (Simon Mundy)

ESG and emerging markets: Doing more harm than good?

Undermining development in poor countries is not something any investor would want to achieve with an ESG strategy. But that is precisely what seems to be happening, according to a troubling report out this week.

The study, carried out for the UK government by the consultancy Intellidex, aimed to identify the big impediments to capital flows into developing countries, through interviews with 52 market professionals. One of the biggest obstacles, it found, is the rise of ESG strategies.

“It was a surprise to me, to what extent ESG — as it’s practised — is not aligned with the SDGs,” Intellidex co-founder Stuart Theobald told Moral Money, referring to the UN’s 17 Sustainable Development Goals, which target issues ranging from hunger to education.

The key problem, according to the report, is the emphasis that many ESG strategies put on avoiding risk — especially of the reputational sort — rather than achieving positive impact. That very often leads investors to “downweight” developing markets, or avoid them altogether — either because of concerns about social and governance flaws, or a simple lack of data.

That ESG headwind is the last thing these countries need amid a broader souring of investor sentiment as global interest rates rise. Emerging market bonds have been suffering their steepest falls for almost three decades. There have been sharp outflows, too, from equities in developing countries, which have been underperforming in recent years.

So what’s the answer? An obvious one is tackling that lack of data. Intellidex is urging development institutions to help create user-friendly platforms that EM businesses can use to share the ESG data sought by investors. Fuller and more frequent reporting of economic data by national governments could also have a big impact.

But the effect of such measures can only go so far without a fundamental rethink of the ESG paradigm, Theobald argues. “Do we merely want to have capital swerving certain issuers, or do we want capital to be flowing towards opportunities to deliver on our social and environmental objectives?” While much ESG reporting is preoccupied with dodging risks, Intellidex argues for a far greater emphasis on “additionality”, centred on how far investments further the SDGs.

“A lot of investor behaviour is about reputational risk fundamentally. It’s about being nervous about anything that might bite you,” Theobald said. “If you want to make a big difference, you have to trade in harder, more difficult markets, and you’ve got to have a risk appetite for that.”

ESG investors’ nervous approach to frontier markets might be understandable. But if their strategies are impeding urgently needed capital flows, that looks like a pretty dire risk in itself — reputational and otherwise. (Simon Mundy)

Mutual funds target scope 3 in SEC proposal

The SEC’s headquarters in Washington
Lobbying associations have sent thousands of letters to the Securities and Exchange Commission about its climate proposal © Bloomberg

The comment period ends today for the Securities and Exchange Commission’s big climate proposal, and lobbying associations — companies’ attack dogs in Washington — have submitted thousands of letters to the agency.

Among the notable responses, the fund industry, represented by the Investment Company Institute, said the SEC’s requirement to make companies publish their scope 3 emissions would not work.

“Currently, data gaps and an absence of agreed-upon methodologies would leave deficiencies in any such disclosure,” ICI said. “It is difficult to see how an overwhelming amount of additional disclosure, difficult to produce and validate, would add value for investors.”

The ICI’s scope 3 stance is expected. The lobbying group last year warned the SEC not to include scope 3 among its climate demands.

Other investors also threw cold water on such disclosures. Harvard University’s endowment manager said that it was reasonable for companies to disclose their own scope 3 emissions as part of reduction targets. But it might not be useful information for investors.

Despite their scope 3 concerns, investors broadly applauded the SEC’s climate rules. Companies, however, are digging in to fight. The US Chamber of Commerce said the SEC did not have the authority to impose climate and environmental regulations. Petroleum lobbyists said they wanted the proposal rescinded.

The investors’ concerns about scope 3 disclosures imperil the SEC’s desire to require that information. Given its size in the financial industry, investment funds hold sway at the SEC. If the SEC preserves scope 3 disclosures in its final rule, it will be skating on thin ice.

All this posturing does not change the high likelihood that the SEC’s final rules will be challenged in court. Washington’s big law firms are licking their chops at the hefty fees they can bill to bring the case to a courtroom.

But the action on this proposal will take a pause until the autumn when the SEC begins drafting the final rule. (Patrick Temple-West)

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