The importance of ESG for companies, investors

Stakeholders are calling for the establishment of independent watchdog to monitor greenwashing and misreporting

by JUNE MOH / graphic MZUKRI

MALAYSIAN investors are slowly recognising the importance of sustainability as more investors are starting to care about whether their funds are environmental, social and governance (ESG)-compliant, according to Deloitte Malaysia risk advisory leader Justin Ong Kean Hu.

Ong said non-ESG-compliant investments were hard for the economy to grow due to the ESG issues the economy was experiencing.

“There are direct and indirect impacts to return generation for ESG investment. For example, when glove manufacturer Top Glove Corp Bhd was involved in (forced labour practices), investors holding Top Glove (stocks) at that point in time suffered huge losses.

“In the broader market and ecosystem, if companies do not follow these basic human rights, it is very hard for the economy to grow because you are facing manpower issues. The international market knows about companies’ human rights issues and they will not do business with them. How does a market attract manpower if they practise forced labour? How do they maintain their level of business operation?” Ong told The Malaysian Reserve (TMR).

Companies do not align with sustainable narrative, generally, “derive significant revenue” from alcohol, gambling, tobacco, pornography, guns, for-profit prisons, oil and gas (O&G), and coal, Ong said, it should be analysed in two ways.

“First, a company’s performance around ESG themes. Second, from a sustainable development perspective, does the company contribute to a more sustainable development future?

“In terms of O&G, you still need power no matter what. Certain regions of the world, for example, Africa, need O&G-based power to go about day-to-day. If you stop investing in O&G abruptly by now, they will not be able to get relatively affordable energy and how would that affect their livelihood?

“I do not agree with making a blank statement such as ‘I don’t want to invest in O&G anymore’. It depends on where the investment is and the socio-economic dynamics of the location in that these O&G companies operate. It does not mean that because you invest in O&G then you are bad,” he said.

Sunway University Business School economics professor Dr Yeah Kim Leng said the list of industries were applicable to Malaysia.

“It covers O&G companies, gaming and alcohol industries, and the relatively small arms industry. There is a strong international investor demand for ESG investments in Malaysia but the opportunities are limited due to the scarcity of investable assets packaged as ESG-compliant.

“Nevertheless, due to the availability of large pools of global ESG funds, more and more firms are likely to take the ESG route,” Yeah told TMR.

Studies linking ESG to corporate performance have shown that the improved financial performance due to ESG is more evident over longer time horizons.

“Companies that adopt sustainability initiatives and manage for a low carbon future also show improved financial performance. Socially conscious funds, therefore, should incorporate the ESG matrix in portfolio asset selection and allocation.

“Investors should care about ESG-compliant funds because a large number of studies have shown that they generate higher returns compared to conventional funds and contribute to sustainable development,” he said.

Institute of Corporate Directors Malaysia (ICDM) president and CEO Michele Kythe Lim said not just investors but businesses have to understand and internalise the value of integrating ESG as part of their business strategy.

“ESG affects everything for a business across public and private sectors, the global supply chain with regulators, purchasers, investors, banks and financial institutions also applying ESG screens in their evaluations before contracting with any business.

“Thus, organisations will need to prioritise incorporating ESG as a core part of their business strategy as otherwise they risk becoming obsolete,” Lim told TMR.

Lim said ESG is not a new conversation as Malaysia has been transitioning and driving a sustainability-focused culture within organisations and the landscape, starting from the corporate governance reforms with the first publication of the Malaysian Code on Corporate Governance and the subsequent five updates — corporate responsibilities, corporate social responsibilities, ethical and Islamic, to what we know today, as ESG.

“The transition, or rather evolution, is a clear indication of the increased level of awareness of leading organisations, including those within corporate Malaysia, in the importance of taking a more holistic approach in managing their business strategy and risks.

“Conventionally, the sustainability conversation was very much focused on the regulatory aspect such as reporting. Today, sustainability is less about compliance but about forward-looking leadership.

“It should set the right tone for a culture that facilitates the development of competencies needed to respond to market changes to ensure long-term resilience and value creation,” she said.

Corporate Malaysia, Lim said, had adapted to this mindset shift, with some small wins that showcased the progress in terms of ESG integration with the launch of the FTSE4Good Bursa Malaysia Index (2014) and FTSE4Good Bursa Malaysia Shariah Index (2021), Sustainability Reporting Guideline (2014), enhanced ground rules for inclusion into the FTSE4Good Index, sustainability Reporting Framework with new climate change reporting (2022) and Mandatory Leading for Impact Programme.

Establish Independent Watchdog

On a separate note, according to Greenpeace South-East Asia regional research and investigation coordinator Margo Prebend, there currently does not appear to be any watchdog in place that is effectively regulating, monitoring and auditing corporate ESG claims, and as a result, this area is full of greenwashing.

Greenwashing is defined as the situation where companies use misleading claims to make their investment funds or strategies appear to be ESG-compliant.

Prebend said while non-governmental organisations (NGOs) are playing a big role in highlighting greenwashing and calling out inadequacies of corporate ESG claims, it should not only be NGOs that monitor companies.

“It should be ensured through government regulations and an independent watchdog along with comprehensive reporting requirements. For most companies, ESG reporting is entirely voluntary.

“On the other hand, there are some stock exchanges that are starting to require certain ESG reporting for companies to be listed on their exchanges, for example, Bursa Malaysia is a partner of the United Nations Sustainable Stock Exchange Initiative and has required ESG reporting as a listing rule.

“However, this does not prevent false reporting, and does not require companies to reduce their carbon footprint — it only seeks to make it more visible to investors. This is a good start, but polluting companies continue to be listed without any consequences,” she told TMR while explaining that it is happening because governments are relying more on investors to pressure corporations to become more sustainable, while governments themselves still do not have effective regulations or watchdogs in place.

ESG funds were rife with greenwashing, as many of them include O&G in their portfolios, she said.

“This is because O&G companies can claim to be working on renewable energy while they continue to pollute the planet. If a fund is marketing itself as green or sustainable, there is no reason it shouldn’t be 100% sustainable, otherwise, it is misleading the public.

“In 2019, it was reported by an international business daily that ‘Eight of the 10 biggest US sustainable funds are invested in O&G companies’ and as recently as July, there were reports that ESG funds were quietly buying up more oil stocks as O&G prices rose.

“The argument from banks on ESG funds is that O&G majors are vital to energy transition. However, buying O&G stocks and calling it an ESG fund not only misleads the public, but it also does nothing to guarantee that O&G companies are investing any more in energy transition — it simply supports polluting companies, sends the message that their inadequate net zero targets are acceptable, and signals that they will not suffer any financial consequences from continuing to pollute as long as they can.

“In conclusion, governments need to do more to ensure there is not only mandatory reporting, but also means of verification for ESG claims, accountability for big polluters and strict limitations around what terms companies are allowed to use if they are continuing to engage and invest in polluting activities,” said Prebend.

Meanwhile, Lim said the focus on ESG issues by investors saw rapid growth over recent years.

“Organisations are facing increased scrutiny and engagement from investors, in the form of investor activism, for companies to do more across all three ESG pillars.

“For any strategy or policy to succeed, it must be driven by the organisation’s purpose, supported by a strong, positive culture, robust governance framework and performance management structures that shape and motivate right behaviours.

“And to drive this, internalisation of the purpose, company policies and values are instrumental to effective implementation of any strategy — including ESG integration. And this is where ICDM’s role comes in,” she said.

  • This article first appeared in The Malaysian Reserve weekly print edition