Why emerging markets are defined by ESG

ESG forces are moving deeper into emerging markets from the network of central banks sharing best practice, stock exchanges mandating ESG disclosure requirements, regulators acting in the area of fiduciary duty and the launch of new EM-focused investment products.

Introduction

Emerging market countries are particularly exposed when it comes to environmental, social and governance issues such as population growth, income inequality, biodiversity loss, water stress, extreme weather events, corruption and forced labour. While many of these issues also exist across developed markets, the macro stability risks for emerging markets are more acute and the institutions available to address them weaker.

For some emerging markets, their increased vulnerability reflects the greater dependency on natural resources from an export earnings and GDP perspective. For example, rising global temperatures will threaten agricultural productivity which will hit low lying EM agricultural-based economies particularly hard.

Meanwhile technological change, government regulation and changing consumer preferences have introduced new hazards for fossil fuel exporting countries, many of whom are based in EM countries. Since emerging markets constitute 60% of world GDP¹ and 80% of the world’s population², these hazards pose significant risks to the global economy. On our estimates, EM countries are forecast to contribute just over 75% of the 3.2% gain in world GDP growth this year.

It should therefore come as no surprise that when examining the link between ESG and corporate financial performance from a regional perspective, our research shows that emerging markets display the strongest correlation of any region³. Surveys also reveal that investors in emerging market countries have the highest levels of concern when it came to ESG issues such as the burning of fossil fuels, the use of child labour, excessive CEO remuneration and companies that make use of tax loopholes4. Consequently, how a company manages such ESG issues provide important insight into how the company is run.

Yet, the adoption of sustainability initiatives across the investor, corporate, supervisory and regulatory universe in these countries remains patchy and typically concentrated in just a few emerging market countries.

To assess the penetration of sustainable finance activity across emerging markets, we track membership of the Network for Greening the Financial System (NGFS), the Principles for Responsible Investment (PRI), the Principles for Sustainable Insurance (PSI), the Sustainability Stock Exchanges (SSE) Initiative, the number of TCFD supporters, the corporate take-up of RE100, as well as the activities of insurance and pensions’ regulators.

We find EM Asia is making the most strides. This is reassuring since the region faces acute climate risks from a financial perspective. Regulators are also stirring in South America while efforts in Africa and the Middle East are concentrated in a handful of countries, namely South Africa, Kenya, Morocco, Nigeria and the UAE.

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