ESG REPORT 20 21 - Future Investment Initiative
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www.fii-institute.org 20 ESG 21 REPORT
REDEFINING ESG:
TOWARDS ACHIEVING
INCLUSIVE GLOBAL
SUSTAINABLE
DEVELOPMENT
2
CONTENT
MESSAGE FROM THE CEO 4
SUSTAINABILITY ON THE GLOBAL AGENDA 6
THE “ALPHABET SOUP” OF ESG REPORTING 8
THE CONUNDRUM OF ESG DATA 10
ESG RATINGS: HOW USEFUL ARE THEY? 11
DIGITIZATION IN ESG: UNIQUE OPPORTUNITIES 12
EMERGING MARKETS: ESG CHALLENGES 13
INCLUSION OF EMERGING MARKETS IS KEY TO GLOBAL
15
SUSTAINABLE DEVELOPMENT
3
As we continue to battle a global pandemic, we need to rethink our approach
to sustainability. For despite the progress achieved since the 17 Sustainable
Development Goals (SDGs) were adopted, and the growing alignment of
Environmental, Social, and Governance (ESG) principles with the SDGs, achieving
just and inclusive sustainable development remains one of the major global
challenges of our time.
In 2020, companies that had strong governance structures and responsible
social policies in place demonstrated greater resilience in the face of a global
recession. This accelerated the rate of ESG integration and enhanced the quantity
and quality of ESG disclosures around the world. Nonetheless, commitment
to disclosing ESG performance remains generally low, and the absence of a
universally accepted sustainability reporting standard makes identifying
strong ESG p e r f o r m e r s challenging for investors, who continue to be faced
with unreliable, contradicting, and often incomparable data and ESG ratings.
In 2021, we need to build more sustainable markets and ensure that economic
activities align more consistency with the SDGs. Harmonizing sustainability
frameworks and standards, improving ESG rating transparency and consistency,
enhancing integrated reporting - linking financial and sustainability reporting,
and minimizing biases in scoring ESG performance can help propel the world in
the right direction.
We at the Future Investment Initiative Institute believe that the “ESG system”, as
it stands today, does not fully consider the unique environmental, social, and
economic realities, challenges, and stages of development of emerging markets,
even though holding companies in emerging markets accountable to standards
that are relevant to their specific realities is key to effective risk management and
inclusive growth. We believe that market nuances – including varying value systems
4
and political realities - need to be considered when judging the ESG performance,
risk exposure, and sustainability prospects of companies within the context of their
operating environment. At the same time, current ESG principles and definitions that
are rooted in the values, cultural, and political norms of developed countries need
to adapt and account for the diversity of beliefs, cultural norms, market structures,
and the social, economic, and political realities of different markets.
The lack of a truly inclusive and equitable ESG system is a challenge to global
sustainable development and inclusive growth, as participation in a non-inclusive
system is likely to remain low. We call on all stakeholders to engage so that the
current ESG system can evolve into an inclusive system that incorporates the
realities, priorities, and limitations of all markets and bolsters positive, just, and
inclusive sustainable development for all.
Richard Attias
CEO - FII Institute
5
SUSTAINABILITY ON
THE GLOBAL AGENDA
A report published by ISS EVA in January 2020
argued that ESG management is linked to
improved financial performance as companies
with higher ESG ratings are associated with
higher profitability and lower risk.i The growing
realization am o n g the global investment
community that a company’s long-term financial
health is closely linked to its ability to manage
ESG related risks and opportunities across the
value chain is leading many investors to price
ESG risks and favor investing in companies that
reduce ESG risk exposure. More sustainability-
focused capital allocation can be expected in
2021 as ESG awareness among investors and
communities continues to grow.
International sustainability regulatory frameworks
are also proliferating. The SDGs, Paris Agreement,
EU Taxonomy, and many other global, regional
and local frameworks have come into effect in
the past five years and have shaped the global
conversation on sustainability. As of December
2020, almost half of the stock exchanges on the
planet have provided or have committed to
providing ESG reporting guidance to their issuers
according to Sustainable Stock Exchanges.
While ESG is an important value driver
in emerging market investments - the MSCI
Emerging Market ESG Leaders Index has
consistently outperformed the broader MSCI
Emerging Market Index since 2008 - participation
of emerging markets in ESG, and representation
of voices from emerging markets in major ESG
conversations and decisions, remain limited
in comparison to developed markets. The low
level of inclusion and participation of emerging
markets in the development of ESG frameworks
is counterproductive to global sustainability.
i
https://www.issgovernance.com/file/publications/ISS_EVA_ESG_Matters.pdf
6
At the same time, given the subjective nature of ESG definitions, a “one size fits all” approach
risks alienating companies in countries that do not adhere to the same definitions of “good”
and “bad” that are dominating ESG conversations today. For example, companies in emerging
markets often receive blanket negative scoring for ownership structures that are common
in those markets (e.g., family-owned businesses and State-Owned Enterprises (SOE))
because such companies are presumed to be all risky despite evidence that commitment
to sustainability in SOEs is higher than among other firms.ii
Blanket negative ESG scoring of market and company structures and norms that do not
adhere to the standards of developed markets, without rigorous investigation of the financial
materiality of a perceived risk, could create a bias against alternative market structures based
on developed markets’ values and presumptions rather than actual ESG risk exposure. In 2021,
the development of unbiased ESG definitions and principles, as well as conducting nuanced
analysis, and actively and constructively engaging with emerging markets is necessary
to improve understanding of the true resilience of companies within their own operating
environments.
When we look at accounting, it took decades for the world to agree on
common standards. I hope we don’t have to wait that long for ESG.
Loh Boon Chye
CEO, Singapore Exchange, Singapore
ii
https://www.oecd-ilibrary.org/sites/5ad33666-en/index.html?itemId=/content/ component/5ad33666-en
7
THE “ALPHABET SOUP”
OF ESG REPORTING
In recent years, more than 80 ESG general and
focused frameworks and reporting standards
addressing different aspects of sustainability
have been developed across the world using
different assessment methodologies and
approaches, creating complexity and uncertainty
for investors and companies alike.
The current lack of standardization presents
investors with uneven disclosures by companies
based on a v a r i e t y of f r a m e w o r k s and
standards. The diversity in content, methodology
and emphasis will continue to limit a true
understanding of a company’s performance.
Companies will continue to be overburdened by
multiple data requests from investors and rating
agencies using different frameworks. At the
same time, resources will continue to be wasted
on trying to navigate the opaque ESG reporting
landscape. This is particularly problematic for
smaller companies in emerging markets, who
might not have the resources required to collect
and report ESG data using various standards.iii
Standardization of sustainability reporting will
help companies around the world disclose ESG
performance in a manner that helps investors
better assess a company’s or an investment
portfolio’s exposure to legal and regulatory
risks, climate-related financial risk, systemic
disruptions, and other ESG-related risks. In 2020,
several steps towards global ESG standard-
setting and mainstreaming sustainability
accounting were undertaken. Despite attempts of
convergence and attempts to create mandated
sustainability reporting based on a common set
of global standards, consensus is still lacking.
iii
https://www.responsible-investor.com/articles/we-mustn-t-miss-this-crucial-moment-to-create-a-global-sustainability-standards-board
8
The IFRS’s foundation recent proposal to develop a global sustainably
standard is an opportunity to build on their own global governance and
their links with securities regulators.
David Schwimmer
CEO, London Stock Exchange, UK
The European approach favors the inclusion of more stakeholder-centric models of reporting
(i.e., in line with the Global Reporting Initiative (GRI) and SDGs). The Anglo-Saxon approach,
however, favors building ESG reporting upon investors’ needs (i.e., in line with the Sustainability
Accounting Standards Board (SASB)) and particularly around climate risk.iv The recent step by
the International Financial Reporting Standards Foundation (IFRS) to standardize sustainability
accounting, if successful, will be applied across most of the world’s jurisdictions. However, emerging
markets’ inputs need to be taken into account in the development of global sustainability
standards through effectively engaging the IFRS’ Emerging Economies Group and enhancing
their participation in the process.
Alignment on ESG principles and definitions would also improve ESG adoption and reduce the
subjectivity of ESG definitions and the existing biases in ESG scoring. To be effective, standardization
efforts need to balance the sustainability priorities of different markets as well as investors’ focus
on enterprise value creation and societal concerns for sustainable development that extends
beyond investors focus.v
https://www.responsible-investor.com/articles/a-new-dawn-for-mandatory-esg-reporting-how-it-came-about-and-
iv
what-to-expect-next
v
https://hbr.org/2020/12/the-future-of-esg-is-accounting
9
THE CONUNDRUM OF ESG DATA
Investors are continuing to sound the alarm over the poor quality and fragmentation
of ESG data, which reduces their ability to make informed investment decisions. The
absence of a required auditing process in some markets negatively impacts data
reliability and has led some investors to develop alternative data sources. For example,
in 2020 Microsoft and BlackRock announced joint research grants to improve ESG data
quality, State Street plans to bring together a “critical mass of asset managers” to
work on climate data, Dutch investment house Robeco adopted ‘spatial’ information,
and Allianz and S&P joined forces to offer a free-to-access, open-source ESG data
and analytics platform.
Other challenges persist with data availability, reliability, and integrity. Risk of
greenwashing by companies, alongside difficulties with ESG benchmarking and with
providing accurate and consistent ESG ratings continue to hinder progress. At the same
time, while publicly listed companies in many markets are coming under pressure to
report on their sustainability performance, privately owned companies are not legally
required to report their sustainability performance in most markets. Thus, limiting the
availability and comparability of voluntarily reported ESG data.
A one-size-fits-all approach to scoring companies on environmental,
social and governance standards is inhibiting the progress of firms
wanting to adapt to more sustainable business… We are chocking
them from the capital they need to evolve.
Scott Minerd
Global Chief Investment Officer, Guggenheim Partners, USA
10ESG RATINGS: HOW USEFUL
ARE THEY?
ESG ratings and scores developed by third-party providers using ESG data are used by
investors to analyze the performance of companies in their portfolios and make investment
decisions accordingly. However, the lack of convergence in ESG ratings between providers
has led to criticism and reduced usability of ratings. In addition, ESG rating agencies generate
profit by selling their detailed ESG ratings and anonymized benchmarks to interested parties.
To enhance the availability of data on a wide scale, most of the big ESG providers made their
ratings free in 2020. Yet, while top-line ratings are now freely accessible, the transparency
of ratings is still questionable as underlying ESG data used for the analysis is not always
available and only high-level ratings are being reported.
ESG rating agencies have different approaches to calculating ESG scores – leading to limited
comparability of ratings. In addition, differences exist in coverage and scope as not all rating
agencies cover all ESG pillars. Other issues include high heterogeneity of themes and key
performance indicators, and different weighting methodologies. Because of differences in rating
methodologies, major indexes can differ in up to 1 in 5 cases and can even be contradictory.
Finally, the data aggregation process by ESG rating agencies can be opaque, leading to
difficulties for third parties to understand and interpret the ratings.
Overall, the issues surrounding the consistency and comparability of ESG ratings reduce
trust in the ratings from users and cause negative reactions to the ratings from companies.
In addition, inaccurate and confusing ratings could lead to a higher ESG risk exposure than
anticipated, creating risk blind spots for investors.
11Limited Data Reliability – Examples of contradiction between major rating agencies
COMPANY COUNTRY RANKING FROM AGENCY 1 RANKING FROM AGENCY 2
BAE Sysem PLC High ESG Risk (34.4) AA (Leader in ESG)
Huntington Ingalls Industries Severe ESG Risk (41.3) A (above average ESG performer)
Bunge LTD High ESG Risk (35.6) AAA (Strong leader in ESG)
Northrop Grumman Corporation High ESG Risk (30.4) AA (Leader in ESG)
Kansai Paint Corporation Severe ESG Risk (43.2) AA (Leader in ESG)
Sumitomo Chemicals Corporation High ESG Risk (33.7) AAA (Strong leader in ESG)
Giant Network Group Low ESG Rish (17.5) CCC (Strongly behind in ESG)
Eiffage SA High ESG Risk (35.3) AA (Leader in ESG)
Bouygues SA High ESG Risk (36.5) AA (Leader in ESG)
1) Not exhaustive
DIGITIZATION IN ESG:
UNIQUE OPPORTUNITIES
Application of technology in ESG has significant potential to help with overcoming ESG related
challenges. Technology can, for example, reduce the subjectivity arising from manual scoring,
and enable high-frequency assessments to support timely investment decisions through
improving data collection, ESG reporting efficiency and ESG rating processes. Moreover, artificial
intelligence technologies such as natural language processing, remote sensing image analysis
and machine learning allow for larger and faster data collection from all sources. Similarly, live
monitoring of environmental and geospatial data using sensors based on the Internet of things
(IoT) technology can enable real time data generation. Finally, increasing transparency of supply
chain sustainability effects through block chain transactions and enhancing investment decision
using self-learning models - to increase reporting frequency, data accessibility and allow trend
forecasting – could aid investors with a better decision -making process. Thus, accelerating the
speed of digitization of ESG data collection, analysis, and reporting will improve the quality of
the information used by investors and the accuracy of ESG ratings.
Country ESG scores are positively correlated to the level of digitalization and robotization. This
is particularly important for enhancing ESG reporting and integration in emerging market as
digitization levels remain low relative to developed markets, thus negatively affecting ESG data
availability and quality. More importantly, the high cost of manual ESG data collection and
reporting for companies in emerging markets is often stated as a key obstacle to sustainability
disclosures especially for smaller companies. Technology transfer can offer solutions and help
track and measure ESG data for companies in emerging markets efficiently and cost-effectively.
At the same time, investing in ESG reporting enablers for emerging markets is crucial to accelerate
progress towards increased sustainability reporting and improved ESG performance in those
markets.
12EMERGING MARKETS: ESG CHALLENGES While ESG adoption is increasing in emerging countries, and regulators in key emerging markets are requiring sustainability reports for listed companies in Brazil, China, Hong Kong, India, and Malaysia, many stock exchanges in emerging markets fall short of mandating sustainability disclosures and only encourage voluntary ESG reporting or offer no guidance at all. Many emerging markets also face a shortage of expertise and human resources to lead sustainability initiatives and lack roadmaps and capability building plans or programs to develop sustainability capabilities in the long-term. As a result, overall adoption of ESG reporting in emerging countries continues to be low. This is despite the fact that emerging economies tend to have a higher ESG risk relative to advanced countries, including higher vulnerability to environmental disasters, political instability and limited social inclusion, as well as limited access to foreign capital required to transition to sustainable practices. Some emerging markets also have underdeveloped regulatory frameworks, limited expertise in ESG reporting and integration, and higher likelihood of ESG issues impacting market performance. At the same time, country ESG score biases in ESG ratings negatively impact the scores of firms in emerging markets to a larger extent – limiting the integrity and fairness of the ratings. A recent study by FTSE Russell, shows that nearly 50% of the ESG score is explained by three factors: country, size, and activity.vi Since a company’s ESG performance is generally affected by its size, sector, and country, the country bias increases the variance in ESG scores between companies in different countries, often because of matters outside of the direct control of the firms being rated. The existing country ESG score bias negatively affects emerging market firms at a higher rate also because of the nature of their economies. Presently, industrial sectors that have the lowest ESG scores are mostly in developing countries, while advanced countries have the “cleaner” parts of the value chain. This places them at a higher risk of marginalization and reduced attractiveness to foreign capital, which is needed for their continued development. Removing the country bias from ESG ratings would help to alleviate the correlation between country ESG scores and company ESG scores and would thus enable a fairer representation of companies in emerging markets. It would also encourage better ESG performance and compliance. vi https://content.ftserussell.com/sites/default/files/esg_scores_and_beyond_part_1_final_v02.pdf? ga=2.75185426.1815646875.1610380939- 1756408866.1610380939 13
ESG challenges for emerging countries – Methodological biases
AGENCY 1 AGENCY 2 AGENCY 3
"The analysis found that, on
average, almost half (%46)
of a company’s ESG score
can be explained by its size,
sector and country.
"To take the country bias
as an example, much of
the variance in ESG scores
between companies
in different countries
disappears once the bias is
Wide spread of company scores Wide spread of company scores
removed"
Based on a pool of +800 companies, the Based on a pool of +800 companies, the
methodology used by the rating agency limits methodology used by the rating agency limits
the correlation between country ESG scores the correlation between country ESG scores
and company ESG scores – allowing for a fairer and company ESG scores – allowing for a fairer
representation representation
It is likely impossible to create a global ESG framework that entirely avoids some of the inherent
biases in the ESG system because ESG ratings of companies operating in high-risk markets
will generally suffer regardless of their specific sustainability performance. Nevertheless,
it is crucial to point out the existing biases and address them in the analysis of corporate
sustainability performance because of their potential for creating reputational damage and
confusion on whether emerging market companies have low ESG scores because of non-
sustainable activities or due to their underprivileged environments. The distinction is important
to prevent capital flight and increase attractiveness of such markets to foreign investments
needed to finance their sustainable development journey.
When engaging with companies on their ESG performance, stakeholders need to be cognizant
of the constraints and challenges companies face when trying to improve their ESG score
while a significant part of their rating is in fact out of their control. Focusing engagement on
what a company can do rather than strictly focusing on the ESG rating of a company will
lead to more constructive engagement on ESG.
The standardization of ESG is going to be welcome by the
corporate and investor community as long as those standards
are created by both these communities so that they take into
consideration some of the differences between industries and
geographies, and make sure they are practical.
Adena Friedman
President and CEO, NASDAQ, USA
14INCLUSION OF EMERGING MARKETS IS
KEY TO GLOBAL SUSTAINABLE
DEVELOPMENT
Onboarding emerging markets in the
development of a global and inclusive ESG
system is key to achieving global sustainability.
This involves greater inclusion of emerging
countries’ institutions in the ESG frameworks
and standards setting discussions taking place
around the world. Emerging markets not only
face higher ESG risks than developed markets,
but they also have different market structures,
company structures, value systems, cultural
norms, historical experiences, and stages of
development. Designing a “one size fits all” global
ESG framework and reporting standard, without
taking into account the diversity of markets,
risks alienating key players and discouraging
cooperation and compliance to the detriment
of global sustainable development.
To improve ESG performance in emerging
markets, the development of initiatives and
programs, including ESG enablers, by international
institutions (e.g., developing capabilities,
providing funding, advancing technologies, etc.)
and the creation of partnerships with developed
countries to share expertise and knowledge will
further advance progress towards sustainability.
In 2021, we need to foster effective platforms for
global collaboration, sharing of best practices
and ESG knowledge transfer.
Global sustainable development cannot be
achieved using a system that does not incorporate
the needs and realities of all markets. Because
companies in emerging markets sometimes
receive blanket negative scoring for their unique
market attributes, some emerging markets
started developing local rating systems and
local ESG principles and guidelines that address
their specific requirements. In June 2020, Ping
An Group announced the creation of a CN-ESG
15Smart Rating System for the Chinese market, providing a suite of smart ESG investment tools
with comprehensive, intelligent and practical features that are China-specific.vii Frustration
with the current rate and quality of disclosures, as well as the lack of alignment between the
standards of disclosure from different regulatory bodies and assessments by rating agencies
which fail to rate ESG performance of companies in emerging markets in the context of their
operating environment, can be expected to lead to more local efforts in emerging markets
and further lack of standardization in the global ESG system.
A new and improved ESG system needs to emerge and find ways to reward companies that
generate positive impact where it is most needed. Some rating agencies, like Trucost, have
added a country-based SDG boost to their scoring for companies that generate positive
impact related to the SDGs in countries where that contribution is most needed. This provides
an incentive to domestic companies and enables investors to maximize the real contribution
of their investments to local economies.
It is in the interest of global sustainability to advance widespread adoption of ESG reporting
and integration and improve standardization. Stakeholders in all markets need to cooperate
to encourage widespread adoption of global ESG standards that are fair and inclusive. The
pace of ESG adoption needs to be considered too as it would be unrealistic to think that all
companies in emerging markets can apply developed world standards today, especially
given the varying stages of development.viii
It is time to have a global conversation on how the global ESG system needs to evolve in order
to advance global sustainability and enhance inclusion and equitable participation by all
for the benefit of all markets. The recovery effort that the world is embarking on is a unique
opportunity for improving global sustainability. The world needs to ensure a just transition
towards a sustainable recovery that is efficient and effective at creating jobs, upgrading
infrastructure, and delivering financial returns. Without a balanced and equitable application
of ESG, reaching our common sustainability objectives will remain elusive.
https://www.prnewswire.com/news-releases/ping-an-builds-china-specific-esg-smart-rating-system-to-promote-
vii
responsible-investment-in-china-301081066.html
https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/portfolio-insights/jpm52432-investing-
vii
16 sustainably-2019.pdfwww.fii-institute.org 20 ESG 21 REPORT
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