A new and fairer ESG framework for emerging markets

Environmental, social, and governance has been a buzz phrase in the world of finance for nearly two decades since its acronym, ESG, was coined by the UN in its campaign for a more just and sustainable world.  

Since its inception, ESG investment principles have helped provide a framework to organize a fairer, cleaner, and more equal global community. But, as head of the ACT investment division of FII Institute, I know they have to be adjusted and made more inclusive if they are to achieve the aims set out for them. 

ESG is a set of standards with research-backed metrics designed to guide capital flows toward less risky and more sustainable investments, avoiding sectors deemed more harmful to society and the environment.  

The “E” factor takes into account how much energy and resources a business consumes in its everyday activities, and the impact of that usage on the global environment. For instance, investing in a mangrove park has a significantly lower environmental footprint than establishing a new car manufacturing facility. 

The “S” category rates the relationship an organization has with its employees, its partners and the wider community. Investments in education, healthcare and cultural initiatives are obvious examples.  

As for “G,” or Governance, it necessitates that decisions within a business align with best practices for management, internal and external values, and laws. It is better to be invested in a well-run ethical company than one flouting the law with zero accountability.  

Numerous studies have proved that organizations with robust ESG scores not only perform better financially but also withstand the storms of change. They have longevity and stability so that they can keep delivering economic returns and benefiting humanity. 

In an ideal world, we would see ESG frameworks that originated in Europe and North America applied to emerging markets, where they can be the most helpful but also where the markets operate differently. However, in the world of investment, one size rarely fits all. ESG principles, based as they are on what works in Western and more developed markets, do not easily translate into very different markets and cultures across the rest of the world. 

For example, certain ESG rating methodologies assign lower scores to the energy industry compared to other sectors due to the size of the contribution to global warming and climate change.   

These industries, however, are the economic lifeblood of many countries in regions such as the Middle East, providing the essential power the planet needs to thrive. A well-run energy company based in emerging markets should be able to achieve a favorable ESG score if it demonstrates market leadership, but current methodologies penalize these companies based on their country of origin. 

On governance, ESG guidelines are well-suited to the publicly listed company model prevalent in the West, but less appropriate to corporates in other parts of the world, where the government has retained a commanding central role in business, or a family has control. 

In social factors, ESG disparities are probably at their widest. For example, many companies in the US promote a social agenda that does not match the values of more conservative societies in the Middle East and many parts of Asia. 

The result is that ESG-led investment flows from the West have not found a destination in those emerging markets where they are most needed and would be most effective.  

Studies have shown that, while emerging markets are the growth engines of the future with 86 percent of the world’s population and 58 percent of global gross domestic product, they have received less than 10 percent of global ESG investment flows. 

A main barrier, as research has found, is that the ESG ratings agencies employ criteria that are not relevant to emerging markets and weigh the raw scores in favor of developed markets creating bias and discouraging investment.   
This is why, at FII Institute, we have released the Inclusive ESG Tool and Score to empower companies in these markets to enhance sustainability efforts and results, while helping investors identify current and future performance leaders. 

The new tool has the potential to help reduce the $5.4 trillion ESG investment gap in emerging markets.  We are working with global investors, the international development community and financial regulators to even this playing field and promote a more inclusive and nuanced approach to ESG.  

At the Future Investment Initiative Institute in Riyadh in October, we announced a new resolution to increase ESG investment in emerging markets. We want to see investors and government leaders from the West, East and Global South take collective action by reporting more and better data, demanding inclusive data analytic tools, and increasing investment activity. 

We are calling upon our partners to implement the new inclusive ESG methodology with the goal of increasing assets under management in emerging markets to 30 percent of global sustainability portfolios by 2030. 

The rest of the world deserves inclusive, objective, and nuanced frameworks and scoring methodologies that respect the reality of the markets outside of London, Paris and New York.   

As FII Institute heads to Hong Kong for the PRIORITY summit on Dec. 7 and 8, we will be working closely with our partners and encouraging them to join us in unlocking investment to flow where it is needed the most.  

• Anthony Berkley is head of ACT, the investment division of the FII Institute.