Author: Lynk – lynk.global

Seow highlights that failure to meet climate commitments will not cause direct negative economic impact to most countries. Case in point, the US withdrawal from the Paris Agreement announced in 2017 put the risk of individualistic behaviours of different nations under the spotlight. “There’s a need for responsible capitalism to shape the trajectory of our recovery. Government efforts alone are not enough”.

Seow’s goal as an ESG investor is to make capital work for communities in need through market creation for vulnerable groups, access to education and healthcare, financial inclusion and fair treatment of workers. “The Prosperity Paradox by Clayton Christensen is a great book on this,” says Seow, “it is especially relevant in Southeast Asia where 10 per cent of the world’s population resides, with many countries having low population-to-physician ratios and significant rural populations”. She also talks to Lynk about challenges such as greenwashing and trends to watch in the year ahead.

L: Lynk | J: Jaclyn Seow

L: How has everything that happened in 2020 influenced the development of ESG in private markets?

J: 2020 was not all good for ESG. The triple forces of pandemic, geopolitics, and protests have amplified the voices of ESG proponents and surfaced the need for values-based businesses, supply chain awareness and the need to build resilient companies. But falling oil prices and economic imperatives were strong opposing forces as well.

There’s a need for responsible capitalism to shape the trajectory of our recovery. Government efforts alone are not enough, and the capital crunch has given asset owners and managers even more leverage to drive businesses towards better ESG practices. The pressure is now on owners of capital to participate in social contracts.

I think that investors are ready to allocate capital towards ESG, but that flow is hindered by the lack of ability to compare alternatives in the way that GAAP and IFRS allow us to make decisions by comparing EBITDAs. There is however an accelerating movement towards increasing transparency and accountability in response to pressure from governments, investors, and consumers. Stock exchanges around the world are making progress in terms of providing guidance on ESG disclosures: SGX mandates annual sustainability reporting by all listed companies, and Australia and Japan have similar guidances. But even then, reporting frameworks can vary. So it is not surprising that private markets, characterised by the lack of publicly comparable data and consistent regulations, are further behind in terms of ESG reporting. While most reporting is aligned to similar frameworks such as that of the International Finance Corporation, Sustainability Accounting Standards Board, Global Reporting Initiative, and Task Force on Climate-related Financial Disclosures (TCFD), they are almost impossible to compare in any straightforward manner.

L: US President Joe Biden’s climate plan has been described as the most ambitious of any mainstream US presidential candidate yet. Meanwhile, Japanese Prime Minister Yoshihide Suga has also pledged to cut greenhouse gas emissions in Japan to net zero by 2050 – making him the first Japanese prime minister to set a deadline for such climate commitment. With major world leaders doubling down on climate commitments, what does this mean for ESG investors and how will government commitments influence future ESG capital flows?

J: I see this as a global modern industrial policy of sorts, where governments such as China, Japan, the UK and more are channeling money into green industries. But governments are not the only ones doing so. Asset owners such as BlackRock, Fidelity, and UBS have also been ramping up their sustainable investment efforts.

But an important difference between this and regular industrial policy is that direct and immediate negative economic consequences do not follow from the failure to meet commitments – the perennial tragedy of the commons.

The Paris agreement includes commitments from all major carbon dioxide emitters. But the US withdrawal from the Paris agreement dealt a substantial blow given that the US represents 15 per cent of global greenhouse gas emissions – showing the risk that nations can easily engage in individualistic behaviour even if Biden did end up reinstating the commitment earlier this year.

Nonetheless, these government commitments will certainly boost ESG investing in climate-related sectors through various channels – targeted fiscal stimulus, multiplier effect of ecosystems that prompt the development of ESG tech platforms and skilled manpower, and education among businesses and individual consumers. For investors, this means more deal flow, more liquidity in the market, and more pressure for accountability from capital allocators.

L: How can investors best integrate ESG considerations in an investment portfolio?

J: Be honest and practical in your approach. Avoid getting caught up in trying to address every possible ESG risk. Where you focus your attention will depend on the kinds of companies that you invest in and, therefore, the risks that are material to you or the potential positive impact that you can reasonably make can also vary.

For instance, at Openspace Ventures, the levers available to us range from inclusion of reporting requirements in term sheets, board involvement, to our informal relationships with management and more. But we engage these levers carefully depending on whether we feel the issue is important for management to address and whether it is something they can be expected to influence. For example, if we are looking at a telehealth platform, we consider prioritising patient safety and data security over emissions reporting.

When constructing an ESG policy and instruments, my biggest piece of advice would be not to reinvent the wheel. There are plenty of publicly available resources and I have found that practitioners in this space are very keen to share their experiences. You just have to align these broad frameworks you obtain with your needs and priorities. FMO and CDC have also released guidance and toolkits for venture capital investors looking to integrate ESG considerations which I find very helpful.

As ESG investors, we have to recognise that a large part of the job is educational in nature. Many conflate ESG risks with ESG opportunities (or what people more commonly understand as impact). The fastest way to fail is to assume that people know what ESG risks and impacts are and how they can be applied to their business. Investors should be upfront about ESG measurement and reporting expectations, so that investees are aligned from the start.

L: ESG investing requires thorough research and due diligence processes that look into a company’s ethical conduct and sustainability of its operation. For institutional investors who are looking to include ESG in their portfolios, how can they minimise risks?

J: ESG risk management is hard work. Investors should prioritise and focus on the most material issues, then ensure that they conduct systematic, regular reviews with portfolio companies to address these. ESG management requires good policies, but it fundamentally comes down to culture to ensure these processes are actually operationalised. So it’s imperative that investors maintain ongoing relationships not just with management but also with folks at the working level.

L: A report mentioned institutional investors see greenwashing as the biggest impediment to sustainable investing. Do you see greenwashing as a challenge as well?

J: I see this more of an opportunity. The increased scrutiny will ensure that ESG investors and companies are held accountable for their claims and in fact, help separate the wheat from the chaff.

Case in point – an impact investor I spoke to recently said they couldn’t invest in a business in Indonesia which they were certain about its inherent impact because the business wasn’t able to provide proof beyond anecdotal evidence that they were achieving the impact that they claimed to have. As more investors begin to take stances on environmental and social issues, it will move us towards consistent metrics that will add credibility to the ESG sector.

The challenge will be to come up with metrics that are objective and quantifiable enough, yet account for the complex and dynamic nature of the impact that we are trying to measure. It is also important for capital allocators to educate themselves to be able to assess actual impact beyond the window dressing.

L: What will ESG investing look like in 2021? What’s on your radar?

J: With the world moving towards a more carbon neutral economy, climate is a big theme for many investors. Southeast Asia will need to wean itself off coal-fired power plants and switch to clean energy for countries to fulfil their pledges to curb emissions. An estimated US$200 billion per year is needed to achieve carbon neutrality in ASEAN until 2030.

Singapore leads the pack as the region’s centre of excellence for sustainable finance. While much of the move towards cleaner energy will be driven by capital intensive infrastructure projects such as solar grids and e-mobility, we think that cleantech is an up and coming sub-sector to watch in this respect. Technology has great potential to drive energy efficiency as well as development of waste and water management sectors and the alternative proteins space. For example, Openspace invested in Sensorflow last year because of its ability to address urgent energy efficiency needs in hotel properties.

Our focus on Southeast Asia and early- to mid-stage tech opportunities remains unchanged. Important areas to address include logistics and distribution, payments and financing, B2B SaaS, as well as solutions for agriculture, manufacturing, infrastructure and utilities. While not all opportunities will have business models that will directly advance the fight against climate change, we see ESG as a fundamental way of doing business and will continue to encourage responsibility and accountability for any of our portfolio companies across all parameters: climate, society, employees, governance and more.

This article was originally published on Lynk Insights.