Are ESG data demands hurting emerging markets?

Disclosure is improving in emerging markets, but data challenges continue to deter some investors.

Investor concern over global environmental and social problems has massively expanded in recent years. This does not, however, mean that more investment has flowed into the parts of the world where these problems are most acute.

On the contrary, the real and perceived difficulty in obtaining ESG data from companies in emerging markets appears to be a factor in deterring many ESG conscious investors from allocating to EM-focused strategies.

A study produced last year for Mobilising Institutional Capital Through Listed Product Structures (MOBILIST), a UK government programme, found that many funds with an ESG mandate apply screening criteria that exclude or down-weight emerging market countries.

The report added that the perceived lack of high-quality ESG data is “amplifying” the tendency for investors to avoid emerging markets. Companies based in emerging markets typically have less experience reporting ESG data compared with companies in Europe, where regulations on disclosure have been evolving for many years already. But assumptions about the lack of ESG data can be exaggerated or outdated.

Simon Whistler, senior specialist in investment practices at the UN Principles for Responsible Investment, warns that part of the problem comes from investors conflating country-level and corporate-level ESG risks. Corporates in emerging markets “get given defacto sovereign ratings”, he says, meaning even companies that perform well on ESG are “effectively being tarred with the same brush as everybody else”.

Perception and reality

“It is a misconception that ESG standards are subpar across emerging market companies,” says Catriona Macnair, investment director for global emerging markets equities at abrdn. “Often, emerging market companies already monitor and communicate the necessary ESG data internally. However, some fail to disclose relevant ESG data points externally since they don’t perceive there to be sufficient market interest or indeed value in such information.

“For companies that do disclose ESG-related soundbites, they can be erratic and non-standardised, which makes it relatively more difficult for investors to unearth a company’s stance on ESG practices.”

Of course, there are huge variations in the availability of ESG data within emerging and frontier market countries. “The practice in South African companies is, in many instances, way ahead of a lot of the developed markets,” argues Shameela Soobramoney, former chief sustainability officer at the Johannesburg Stock Exchange.

She notes that sustainability considerations have been integrated into South African corporate governance standards for over 20 years and points out that the JSE was the first stock exchange in the world to introduce a sustainability index.

Simon Cooke, portfolio manager at Insight Investment, adds that availability of ESG data continues to improve. “There’s been a massive acceleration in data availability across the emerging markets over the past five years,” he says. “Perception is out of touch with reality – the data is far better than people think.”

While Cooke is enthusiastic about the improvements in data availability, he concedes that researching the ESG practices of companies in emerging markets is often more demanding than in developed markets. “There’s sometimes more leg work involved,” he says. “Part of the expertise you need is to understand the local context of where an issuer is coming from.”

For funds with an ESG mandate, passive strategies therefore generally appear to be less well-suited to emerging markets, not least because of lower coverage from ESG ratings providers. “What we realised is that in terms of doing an assessment of whether something qualifies as a sustainable investment, we need to do the bottom-up work,” says Nazmeera Moola, chief sustainability officer at Ninety One.

“One of the realisations is your ability to assess the risks for passive strategies is lower because you don’t have the same analyst coverage of each stock that you would have in active strategies. This becomes particularly acute in emerging markets.”

Macnair takes a similar view. “It’s essential for investors to do their homework,” she says. “Forming a high-conviction view on ESG practices for emerging market businesses, especially small mid-cap or newly-listed emerging market companies, requires local market experience, significant research resource, and frequent, consistent dialogue with the key corporate decision-makers. This is required in order to delve into the nuances and, if required, to liaise around key areas for engagement with a view to steadily improving disclosures over time.”

Boots on the ground?

Conventional wisdom suggests that assessing companies in emerging markets requires on-the-ground engagement with companies to access data, as well as local expertise on ESG risks in the relevant markets.

“If you really want the data, you can get it,” says Whistler. “A lot of that is about having boots on the ground – having people in emerging markets who properly understand those countries, those companies, those markets.”

However, technology may offer – at least to some extent – a more efficient and cost-effective way of accessing ESG data on emerging market companies.

Devin Nial, portfolio manager at Acadian Asset Management, says that a large amount of ESG data is available from listed companies in emerging markets. But, Nial adds, this data often tends to be buried within corporate disclosures and annual reports in an unstructured form.

In an effort to address this, Acadian uses natural language processing (NLP) techniques to collect and collate ESG data from company documents, among other public sources. NLP, Nial argues, can be equivalent to boots on the ground.

“Natural language processing allows you to incorporate a variety of perspectives,” he says. “It’s about cross-referencing, looking for consistency relating to certain ESG themes across multiple stakeholders.

“When you have NLP, you have much greater scale to draw insights from. You’re synthesising information at a very large scale.”

The extent to which tech solutions can supplement – or even supplant – traditional methods of ESG data gathering in emerging markets remains to be seen. In the meantime, many EM companies are struggling to cope with relentless demands for ESG data coming from investors in Europe and North America.

The proposed development of a ‘global baseline’ of disclosure requirements, which offers the hope that data requests can be streamlined, is therefore being keenly watched in emerging markets.

“The concept is really, really a good one,” says Soobramoney. “If we can get there, it will help a lot.” A global baseline will be particularly useful, she adds, in jurisdictions where regulators are starting from scratch in developing rules for ESG disclosures.

The million-dollar question is whether the International Sustainability Standards Board’s draft disclosure standards can truly function as that baseline and facilitate interoperability between standards. “The interoperability might be more difficult, because – as it stands – we’re seeing fragmentation in different jurisdictions,” Soobramoney warns.

Critics of the ISSB’s draft standards have drawn attention to their complexity, warning that the requirements around topics such as Scope 3 emissions data and scenario planning exceed the capabilities of many emerging markets companies. In a submission to the ISSB last summer, the China Securities Regulatory Commission said the drafts “fail to adequately incorporate differences between developed and emerging markets, large companies and SMEs”.

Others are more positive that the ISSB has adopted a pragmatic stance. “What we like about the way the ISSB is approaching things, at least from our initial discussions with them, is they’re seeking to [require] data that companies can actually report on,” says Cooke. This is a welcome contrast, he adds, from some regulatory bodies that tend to make “unrealistic” demands for data that a large proportion of companies are unable to collect.

Attracting capital

There is more work to be done in improving the curation of data, as well as in finding common ground between investors and emerging market corporates on the reporting of that data. But there are reasons to believe that it will become easier for investors to collect ESG data in emerging markets.

Moola believes that emerging-market companies will continue to catch-up, particularly when it comes to disclosing climate data. “I would expect to see the data in that area increasingly converges over the next few years,” she says.

But Moola caveats that it will be harder to bridge the gap with data on certain social issues, which may be divisive in both developed and emerging markets. “In many of these jurisdictions, companies haven’t been expected to report on these issues historically. And the governments are not going to suddenly change their process,” she says. “Will the gap get narrower? Yes. But by a significant amount in some cases? No.”

Emerging markets badly need investment – the world is at the half-way point on the road to the Sustainable Development Goals, yet the UN warned last year that almost all the goals are set to be missed. There is no doubt that closing the ESG data gap is therefore an urgent priority as emerging markets seek investment.

“In the broadest sense, it’s moving in the right direction,” says Whistler, noting that many countries, including Malaysia, Brazil and Colombia, are developing sustainable finance architecture. “There’s an understanding in a number of places that better disclosures and better performance on ESG is a way of attracting capital.”