‘RESPONSIBLE investment’ defines an approach to investing that aims to incorporate environmental, social and governance factors in investment decisions. ESG factors are becoming increasingly popular criteria for investors to evaluate companies in which they want to invest. For companies to remain attractive to investors, they not only need to integrate ESG policies but also disclose ESG metrics.
ESG is made up of three key factors: 1) environmental criteria may include a company’s policies towards climate change, industrial emissions, waste management, recycling, energy efficiency, etc; 2) social criteria may include health and safety, diversity and inclusion, working conditions, human rights, etc; 3) governance criteria may include ethical standards, board diversity, pay for performance, etc.
ESG is one of the most talked about considerations in the investment sector, at least in developed countries. The trickle-down effect into developing countries is slow but they will need to catch up to remain globally investable.
Initially, there was a myth that ESG is a cost which will dampen the return on investment. But latest studies have provided sufficient evidence to confirm that good ESG practices have resulted in lowering the cost of capital and increasing the performance of companies. More factual evidence is that the MSCI ESG Emerging Markets Index has outperformed MSCI Emerging Markets Index (USD) by around four per cent per annum over the last six years.
It is vital that global standards are followed.
Climate change has become the flagbearer of the environmental factor. At COP26, Pakistan didn’t announce a net-zero year unlike some other countries but declared ambitious plans to cut 50pc of projected emissions and achieve 60pc renewable energy by 2030. This reduction is set to be achieved through a combination of the Ten Billion Tree Tsunami Programme, green transportation, a move away from coal to hydropower, wind, solar and nuclear energy and more. However, in order to achieve this green energy transition, the targets are set conditional to getting $100bn of climate finance. Pakistan has shown some commitment towards factor E via climate change initiatives on a state level but it must ensure that the private sector also makes an effort in the integration and disclosure of environmental metrics.
Pakistan’s regulatory authorities recognise the governance factor and have taken some good initiatives in this regard. The SECP’s updated Code of Corporate Governance for Listed Companies requires listed companies to adopt a ‘comply or explain’ approach to the development of policy and implementation of ESG in the organisation.
Although much still needs to be done in the E and G space, Pakistan seems to have moved in the right direction. But it is the social factor where much more investment is needed both in terms of integration and disclosure of metrics. Pakistan is a growing economy with most of the population in the available workforce age range. However, workforce gender metrics reveal that the female population is significantly under-represented. An increase in female workforce could help the economy go a long way considering some 49pc of the population is female. Similarly, there are other factors like labour standards, supplier policies, human rights, etc in the social factor which could be improved and better managed.
Pakistan’s aim in responsible investment space should be twofold: the integration of the ESG framework and the disclosure of ESG metrics in line with global standards. Authorities such as the PSX, State Bank, SECP, Chamber of Commerce & Industries could play an important role in educating and helping companies integrate ESG policies and disclose ESG metrics.
PSX is already making an effort in this space by recognising the importance of disclosure on non-financial issues in its annual reporting awards. For instance, it awards points to companies for disclosures on sustainable development goals and gender representation. A minority of publicly listed companies in Pakistan are already disclosing ESG metrics using global standards such as the Global Reporting Initiative and International Integrated Reporting Framework. However, ESG integration is needed on a much larger scale for both publicly listed and privately run companies.
Simply put, if the ESG integration is weak, global investors will screen out those companies from their investable portfolios. For ESG integration to be recognised, it is vital that global standards are followed otherwise a half-baked effort could be termed ‘greenwashing’ and discarded by the global investors. ESG factors might not sound important to some due to their non-financial nature but with the evolving global investment landscape they are becoming a more important investment criterion than ever. Pakistan’s economy is rapidly developing and timely ESG integration could prove to be a game-changer.
The writer is a pensions investment consultant based in the UK.
Published in Dawn, January 3rd, 2022