Environmental, Social, and Governance (ESG) investing relates to a collection of principles employed by responsible investors to evaluate potential investments based on a company's conduct. ESG refers to the three central factors in measuring the sustainability and societal impact of an investment in a company or business. These criteria help to better determine the future financial performance of companies and are becoming increasingly important for investors who seek to ensure that the organisations they invest in adhere to ethical, sustainable, and responsible practices.
The environmental aspect assesses a company's efforts in preserving the environment, encompassing policies related to climate change mitigation, among other things. The social criteria scrutinises the company's handling of employee relations, supplier interactions, customer engagement, and community involvement in the areas of operation. Governance concerns itself with the company's leadership, executive compensation, audit practices, internal controls, and the rights of shareholders.
The year 2022 proved to be a challenging period for ESG funds as they encountered significant headwinds stemming from recent global events like the Russia-Ukraine conflict. The ongoing crisis in Ukraine since 2022 disrupted the energy market and raised questions about energy security, impacting ESG investments focused on sustainability.1 Additionally, the Israel-Gaza conflict in 2023 affected regional economic stability and heightened concerns around human rights, influencing ESG investment strategies and decisions. These events underscored the complexity and evolving nature of ESG investing in a rapidly changing geopolitical landscape.
However, investors are picking up speed in ESG investing. Permodalan Nasional Berhad (PNB), one of Malaysia's largest fund managers, has pledged to invest RM10 billion in new green and transition assets by 20304.
It can be challenging to predict trends and foresee what lies ahead for firms and their ESG journeys. Potential trends that lie ahead may include:
- Local Risk is Increased by Global Catastrophes
A number of global issues combined and had profound local repercussions. The resilience of nations, regions, and communities were impacted by rising global energy prices, political upheaval, harsh weather and climatic disasters, food shortages, inflation, supply chain disruptions, declining ecosystem services, and pandemic effects.
Throughout 2022 and into 2023, global socio-economic challenges were exacerbated, with the United Nations reporting that cost-of-living increases had pushed an additional 165 million people into poverty by using the $3.65-a-day poverty line.5 This surge in poverty was attributed to successive economic shocks, including the COVID-19 pandemic, wars, and climate change-related disasters.
As of the end of 2023, the International Monetary Fund (IMF) anticipated a continued challenging economic landscape. The global growth estimates for 2023 was 3.2%, with a similar forecast in 2024.6 This economic outlook, coupled with persisting global issues, may indeed feel like a degrowth to many, contributing to ongoing social upheaval and a heightened need for effective poverty alleviation strategies.
In Malaysia, rising food and utility prices have contributed to the uptrend in inflation. The latest update as of July 17, 2023, shows that domestic food price inflation remains high globally, with many low and middle-income countries experiencing inflation higher than 5%. In Malaysia, this surge in inflation has put additional socioeconomic stress on the population.
Moreover, the increase in government spending during the COVID-19 crisis to support the economy has raised debt levels and reduced Malaysia's fiscal space. These financial constraints impact the country's ability to address local poverty alleviation and invest in measures to improve livability and economic growth.
These economic issues have led to increased socioeconomic stress, impacting communities and nations worldwide. This stress, while primarily economic in nature, has also had social ramifications, contributing to unrest and instability in various regions.
Amidst these conditions, there has been a noticeable rise in resource nationalism, a trend where countries assert more direct control over natural resources within their borders. This can include measures like nationalisation of industries, increased taxes or royalties on foreign resource companies, or more stringent regulations on resource extraction and export.
Companies operating in 2023 faced an interconnected web of challenges that went beyond their immediate operational concerns. Understanding the bigger picture, including the impact of social upheaval and resource nationalism, is essential for fostering stronger bonds within communities and managing asset-level social risk.
Contributions made by companies towards local poverty alleviation, improving livability, and supporting economic growth can play a pivotal role in strengthening their operational context. By acknowledging and responding to the challenges faced at the local level, businesses can foster a more resilient and sustainable environment for both their operations and the communities they serve.
- Investors Anticipate Stronger Community Behaviours
A rising number of industry and commodity-specific standards, principles, and protocols are helping to formalise social management techniques. One such notable standard is the Global Industry Standard on Tailings Management (GISTM), which contains a comprehensive set of expectations around community engagement, participation, and collaboration, as well as socio-economic assessment. The International Council on Mining and Metals (ICMM) introduced the 2022 Performance Expectations that encourage the implementation of these standards.
For instance, GISTM was implemented by ICMM members, responsible operators, and miners with particularly ESG-oriented (Environmental, Social, and Governance) investors in 2023, making tailings management a key area of action. To better understand its implications, let's delve into what "Tailings" involve:
Tailings are the waste materials left after the extraction of valuable minerals from ore. They often contain remnants of chemicals and can pose environmental risks if not managed properly. The GISTM addresses these concerns, emphasising the importance of responsible tailings management.
GISTM sets a higher benchmark for operational community involvement across the mining sector in 2023. By incorporating principles of community engagement, participation, collaboration, and socio-economic assessment, GISTM aims to improve tailings management practices significantly. However, the implementation of these practices remains a challenge for many companies.
Through GISTM, the standard for operational community involvement across the mining sector has risen in 2023. Companies that do not conform to the GISTM means that they are missing out on opportunities to assess and enhance their social management processes with the support of ESG-oriented (Environmental, Social, and Governance) investors.
The implementation of GISTM can greatly benefit mining companies by not only aligning their practices with internationally recognised standards but also attracting responsible investors who value sustainable social management.
- Widespread Implementation of UNGPs
The UN's Guiding Principles on Business and Human Rights (UNGPs) is a well-known global standard for corporate human rights, especially for asset-level community feedback (or grievance) mechanisms. Even with the support from 88 investors worth US$5.3 trillion, there are still only a few frameworks used by the industry that specifically mention alignment with the UNGPs such as RGMPs, GISTM, IRMA, Equator Principles, and ICMM's Performance Expectations.
The Mining Association of Canada (MAC) has published a brand new Towards Sustainable Mining (TSM) protocols well as the Voluntary Concepts on Security and Human Rights and the IFC Performance Standards aid in making the principles practical. Starting 1 January 2023, UNGP disclosure has been included/embedded in the new GRO Reporting Standards demanding more frequent ESG audits and due diligence from companies as today's investors are more aware of the significance of human rights risk.
- Motivation to Boost DEI Performance
In recent years, there have been growing expectations for a company’s position towards diversity, equity, and inclusion (DEI). This follows numerous studies exposing pervasive instances of discrimination, harassment, racism, and sexual assault, where it is evident that not enough is being done to sufficiently establish inclusive and safe work environments that attract and retain a diverse pool of talent.
Thus, a variety of interested parties are already taking notice and acting. As asset managers, they demand disclosure on a wider range of DEI themes, particularly as major proxy advice firms change their proxy voting strategies on DEI. Additionally, CEOs anticipate increased scrutiny from investors on DEI performance as one of the most significant social issues in 2023.
- Radical Openness
IBoth voluntary and mandated disclosures build a company's credibility through radical transparency on its consequences, risks, and performance. This involves a new standard for disclosure on a wider range of subjects established in 2023 by the GISTM, GRI, EU Corporate Sustainability Reporting Directive (CSRD), and other projects.
As a result of transparency, stakeholders will gain better information including collaborative risk management and co-design. Even though some companies may initially feel vulnerable about disclosures, perhaps due to imperfect practices, companies are anticipated to adapt to these new expectations.
