Drawing on the Russia-Ukraine war, we observe that ESG framework is not set in stone and will be evolving based on changing global landscape.
The ESG (Environmental, Social, and Governance) community was flabbergasted and alarmed at talks on labelling weapons as sustainable ESG assets with the backdrop of the Russia-Ukraine war.
Supporters justified this by claiming weapons maintain peace and “are of key importance to uphold and defend democracy, freedom, stability and human rights”. And this may not be the first time ESG investing is dealing with such controversial debate, with industries and companies moving from outcast to hero status in times of crisis.
There is absolutely nothing wrong with this, as ESG investing achieves the best results when it evolves according to the dynamic world we live in, considering the changing risks and opportunities at different points in time. Even as ESG investing may look different as it develops across time, it is here to stay.
According to Bloomberg, global ESG assets are on track to exceed US$53 trillion by 2025, representing more than a third of the US$140.5 trillion in projected total assets under management.
In Asia, more than two-thirds of institutional investors indicated increased interest in ESG investments in the post-COVID world, and total ESG assets in Asia have grown from a mere US$801 million in 2019 to US$7.9 billion in 2020.
The shift to Social (S) in ESG
In the venture capital (VC) space, there are observations on rising numbers of thematic funds specific to the environmental (E) aspect (e.g., climate change, decarbonisation, and nature-based assets) and a focus on governance (G) aspect (e.g., internal audit, management commitment to ESG, stakeholder engagement).
This exemplified that ESG investing is gaining steam, but it may seem that the “S” in ESG has taken the role of the forgotten middle child.
But not for any longer, as investors realise that people/ social impact forms the basis of ESG investing. Everything does not matter if it de-risk or benefits the people, as sustainability arising from environmental and governance factors would ultimately translate into the social value created for the people.
Just like how weapons are used to be excluded in ESG investing before the Russia-Ukraine war, its social value is now taking the centre stage together with the environmental impact.
The human-centricity of ESG investing will become more apparent, and the social impact investment will take a more proactive form.
Dynamic ESG based on changing landscape to future-proof the firm and portfolio
Drawing back to the Russia-Ukraine war, we observe that the ESG framework is not set in stone and will be evolving based on the changing global or regional landscape. Just like how ESG investors avoided weapons before this war, now there is an ongoing talk about labelling it as a social-positive asset because it has the potential to prevent death and destruction.
From this, the ESG community demonstrates that ESG investing will not be rigid to target outperformance above-market returns. Many investors, including VCs, have acknowledged that ESG does not hamper financial performance but creates long-term value and outsized returns.
More and more started to price in material risks, along with material benefits, effectively de-risking the portfolio while adopting a pro-impact approach. This optimises the future-proofing of the firm and portfolio.
For example, for Quest Ventures‘ portfolio companies like Fefifo, food security and sustainable agriculture could materially influence topline sales. For Flex and GajiGesa, financial inclusion can materially convert non-consumers into a new market that is untapped in emerging Asia.
Building back better towards a resilient and sustainable future for the people
Investors, including VCs, invest in sustainable market-creating innovations that shape all nations and regions’ resilient and sustainable futures.
According to Global Sustainable Investment Review 2020 (GSIR), Sustainable investment assets under management make up 35.9 per cent of total assets under management, up from 33.4 per cent in 2018.
The most common sustainable investment strategy is ESG integration (US$25.2 trillion AUM), followed by negative screening (US$15.9 trillion AUM), corporate engagement, and shareholder action (US$10.5 trillion AUM).
Integrating ESG into the investment process will build more sustainable companies early through incorporating ESG during portfolio engagement/ investment stewardship.
However, as Harvard Professor Clayton M. Christensen mentioned in Prosperity Paradox, “all good theories must be used in context. They are only useful in certain circumstances. Every country in the world is different in size, population, culture, leadership, and capabilities. Those circumstances play a role in their destiny.”
We must note the nuances across regions and markets when doing ESG investing and building a resilient and sustainable future. With the Russia-Ukraine war in the backdrop, it compels us to keep ESG supporting flexible while allowing for comparison when measuring its impacts.
Taking a pragmatist approach to ESG investing (investing in companies with moderate unmanageable ESG risk and high ESG unmanaged manageable risk) would be optimal in Southeast Asia, as the emerging market presents vast opportunities to improve ESG financial performance at higher-risk companies vastly.
According to the profiling by Pitchbook, a pragmatist VC may:
- Conduct pre-investment due diligence on the ESG risks derived from broad industry sustainability.
- Conduct slightly less-intensive pre- or post-acquisition identification of manageable risk mitigation gaps and opportunities.
- Evaluate how scale will influence sustainability and ESG.
- Have proactive implementation of ESG-related policies and procedures and quarterly monitoring.
Concluding, the Russia-Ukraine war, amidst its wide-ranging and devastating impacts on people from both nations, had triggered the ESG community and could be changing the conversation on ESG investing through:
- There is a shift to social (S) in ESG, with a social impact no longer isolated from environmental and governance aspects.
- The development of a dynamic ESG based on changing regional and global landscape to future-proof the investment firms and portfolio.
- Building back better towards a resilient and sustainable future by adopting a pragmatist ESG approach.
If you are curious about my position regarding the war: Echoing Singapore’s statement on the Russia-Ukraine war, I too believe that a country’s “sovereignty, independence, and territorial integrity must be respected”.
This post first appeared on e27.