DNSH makes emerging markets ‘effectively ineligible’ for ESG investment, says MSCI

The firm also warned against the rise of 'orphaned emissions' which are excluded from company tallies.

European sustainability-focused investors may struggle to allocate capital to emerging market companies as many do not meet minimum social requirements under the EU Sustainable Finance Disclosure Regulation (SFDR), MSCI has said.

An MSCI paper published on Tuesday noted that emerging market issuers “fell short far more often than their developed-market peers” on social indicators included in Do No Significant Harm (DNSH) requirements, which EU investment funds are required to meet in order to self-classify as sustainable.

This was particularly the case for DNSH criteria relating to compliance with international human rights and social norms and board diversity.

While investors can set out their own tolerances on other indicators, the two social indicators are pass-or-fail. The former requires companies to demonstrate compliance mechanisms with the UN Global Compact and OECD guidelines, while the latter mandates at least one female director.

This means that “markets that desperately need transition capital… effectively become ineligible for many investors’ portfolios”, said researchers.

Orphaned emissions

Separately, MSCI warned investors to be wary of companies omitting certain types of direct emissions, which it named “orphaned emissions”.

The data giant said it had seen an increase in the practice among companies. It found that four unnamed listed utilities had excluded between 17 and 97 percent of their overall emissions footprint.

MSCI said this was partly due to companies wanting to avoid “walking back their climate promises”. “It may be these sorts of criticisms that have given rise to footnotes and exceptions in climate reporting that allow companies to stay connected to certain fossil-fuel assets without counting their emissions in top-line tallies.”

The report cited common methods used by companies, including not counting emissions of assets that are not wholly operated by the company, transferring polluting assets to a JV “while continuing to incorporate their share of net income”, excluding emissions from units which are planned for sale, and choosing not to report the average emissions intensity of grids on which energy consumption occurs.

Finally, MSCI found that boards of global large-cap companies were prioritising new skills when appointing directors. It cited survey data which showed an overall decrease in the number of board seats held by directors with traditional competencies in financial, risk management and industry expertise.

An analysis of director biographies showed that technology and cybersecurity were the second most commonly identified areas of expertise after general management experience. Other top 10 skillsets included ESG and sustainability, engineering, and manufacturing and logistics.