By Devanesan Evanson
AS more institutional investors/stakeholders embrace “responsible investing”, the acronym ESG (environmental, social and governance) has gained prominence of late to the extent that public listed companies (PLCs) which fail to adopt sustainable business practices risk finding themselves erased from the radar of ESG-abidance investors.
A good case in point is that UK pension giant Brunel Pension Partnership which oversees £30 bil of pension funds has pledged to sack fund managers who refuse to prioritise ESG-friendly investments.
In fact, ESG investing is increasingly popular, judging from the rapidly rising number of signatories of the Principles for Responsible Investment (PRI). The number of signatories increased from 100 (representing US$6.5 tril of assets under management) in April 2006 to 3,300 signatories (representing US$103.4 tril of AUM) as of March 2020.
PRI is a United Nation-support initiative to promote the incorporation of ESG issues into investment practices across different asset classes.
Most local PLCs not well-prepared
Sadly, many local PLCs are ignorant – or conveniently ignoring – this global trend.
According to the inaugural EY Climate Risk Disclosure Barometer (CRDB) 2020 Malaysia, Malaysia’s top 100 PLCs lack comprehensive climate risk disclosures.
The findings were based on the analyses of reporting disclosures by the PLCs, benchmarked against the global Taskforce on Climate-related Financial Disclosures (TCFD) recommendations in four areas, namely, governance, strategy, risk management, and metrics & targets.
The study found that the top 100 PLCs scored only 34% for overall coverage of climate change-related risks, and 12% for the overall quality of disclosures when benchmarked against the global Taskforce on Climate-related Financial Disclosures (TCFD) recommendations.
The scores were higher for coverage of metrics & targets (45%) and risk management (41%). The coverage of governance and strategy was lower at 22% and 24% respectively.
“As communities and economies struggle to cope with the COVID-19 pandemic, as well as the climate change trends increasingly apparent across regions, a “wait-and-see” approach could heighten the risk of not developing comprehensive and robust strategies to strengthen business resilience,” said Ernst & Young Advisory Services Sdn Bhd director for Climate Change and Sustainability Services Arina Kok.
Inaction can be costly
With the rampant occurrence of climate change disasters and rising global temperature, Kok believes inaction is no longer an option for businesses.
“Companies need to consider the broader value chain resilience and build preparedness in facing systemic shocks from external factors such as the pandemic and climate change,” she said.
Thus, mapping out the potential future climate scenarios and their implications is critical. After all, developing climate risks reporting can further steer strategic thinking towards the design of a “green” roadmap to build enterprise resilience.
“There is significant scope for Malaysia’s PLCs to leverage climate risk assessment to build organisational resilience and help create long-term value in today’s challenging times,” she added.
Proactive communication with stakeholders
Interestingly, PwC’s SDG Reporting Challenge 2020 found that although 73% of Malaysian companies mentioned Sustainable Development Goals (SDGs) in their reporting, only 20% had included the SDGs in their published business strategy.
As the SDGs outline the areas of impact for ESG considerations, it suggests that ESG has yet to become a core focus for companies.
More broadly, PLCs need to ensure that material ESG risks, opportunities, and strategic decisions are consistently and transparently disclosed to all stakeholders through their reporting exercises.
And beyond reporting, companies need to create a dialogue with their stakeholders on their impacts and plans, so that informal channels reinforce their formal disclosures.
Instead of accessing information made available by the companies themselves, studies have shown that investors turn to public information and third-party research when they intend to assess the ESG practices of companies. However, much of this third-party information may be unverified.
“Corporates are missing an opportunity to craft their own sustainability narrative if they are not proactive in communicating how they are doing business responsibly as a competitive advantage,” advised PwC Malaysia’s sustainability & climate change leader Andrew Chan.
ESG premium for ESG-compliant stocks
In addition, AmInvestment Bank’s equity research head Joshua Ng opined that despite potentially reduced returns (lower earnings and cash flow) for a company that observes high ESG standards, its market valuations may not fall, and may rise instead.
“As more investors embrace ESG investing, they raise the weighting of ESG-compliant stocks in their portfolios,” he said in a recent report titled Malaysia: ESG: A New Mega Trend in Investing.
“This bumps up the demand for ESG-compliant stocks which pushes up their prices based on the simple law of supply and demand. The market effectively prices in an ‘ESG premium’ as reflected in its willingness to accept a higher P/E multiple or a lower discount rate in valuing ESG-compliant companies.”
Using the S&P 500 ESG Index as a gauge, it can be observed that the index has outperformed its benchmark S&P 500 consistently. In fact, the outperformance has been more prominent on a one-year and three-year basis versus five-year and ten-year, which could be a testimony for the increasing recognition of the “ESG premium” by investors.
Closer to home, however, the FTSE4Good Bursa Malaysia – the best ESG barometer for the local bourse – has underperformed its benchmark index the FBM EMAS (which comprises the constituents of the FTSE Bursa Malaysia Top 100 Index and FTSE Bursa Malaysia Small Cap Index) persistently on all one-year, three-year and five-year basis.
Nevertheless, this could be due to the under-representation of glove stocks in the FTSE4Good Bursa Malaysia index – with only Top Glove Corporation Bhd and Hartalega Holdings Bhd in the index – at a time when the Malaysian market has been driven predominantly by glove stocks.
Having said that, the FTSE4Good Bursa Malaysia index is poised to outperform its benchmark index over a longer time horizon, as more investors embrace ESG investing, and as the index further expands its list of constituents, enabling it to better represent and capture ESG-compliant stocks.
Moving forward, minority shareholders must be aware that the ESG investing or sustainable investing is becoming a new norm in the investing fraternity.
Whatever their views on climate change, a wide swathe of related regulatory changes, penalties and taxes is set to come into effect worldwide and companies must take these measures into account seriously.
From now on, MSWG as a movement that advocate shareholder activism will play a more proactive role to raise environment-cum-governance issues at the AGMs of relevant PLCs.
Devanesan Evanson is the CEO of the Minority Shareholders Watch Group, an independent research organisation to encourage good governance among public listed companies with the objective of raising shareholder value over time. He can be reached at [email protected].
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
