ESG Leadership Series in association with BNP Paribas Asset Management
Walking the walk
How Asia's regulators, sovereign wealth funds, and government pension funds are leading in ESG investment
31 Aug 2020 | Asset Benchmark Research

WHETHER by carrot or stick, leading by example or enforcing by decree, government entities in many Asian countries are encouraging listed and private companies to improve their environmental, social and governance (ESG) practices. By taking a leadership role, sovereign wealth funds (SWFs), state pensions, stock exchanges and regulators are setting their sights on sustainable economic growth. But there is no one model, and some countries are more advanced than others. A review conducted by Asset Benchmark Research (ABR) highlighted several different approaches.

Japan’s Government Pension Investment Fund (GPIF), the world’s largest retirement scheme, has a track record of ESG investing. It is not alone. Across the region, government-linked investment funds are using their financial clout to effect change. “Over the last few years, we’ve seen an accelerating momentum for sustainable investment in Asia. For instance, from only 30 Asian signatories of the United Nation’s Principles for Responsible Investment (UN-PRI) in 2012, we’re now looking at over 200 today, with more and more asset owners joining and adopting increasingly advanced ESG standards,” observed Paul Milon, sustainability and ESG integration specialist, APAC, BNP Paribas Asset Management.

For GPIF, the process began in 2015 when the fund became a UN-PRI signatory. Since then its ESG focus has accelerated. “It is our belief that considering ESG issues properly will lead to an increase in corporate value, foster sustainable growth of the investee companies, and enhance the medium- to long-term investment return for the pension recipients,” GPIF stated. To put its commitment into action, the pension fund has suspended stock lending recently to avoid fuelling short-termism investment.

GIC, Singapore’s sovereign wealth fund, is likewise clear in its commitment to being a responsible investor. “ESG is an area where markets are aiding the allocation of capital,” explained Dr Jeffrey Jaensubhakij, GIC’s group chief investment officer, in October 2019. In Jaensubhakij’s analysis, GIC’s focus is to protect and enhance the long-term value of its total portfolio, as well as safeguard its reputation. “Sustainability opportunities and risks are assessed alongside conventional financial and market considerations for better-informed decisions,” he added.

Such commitment is also evident in emerging markets like Thailand. The nation’s 956.5 billion baht (US$31.7 billion) Government Pension Fund (GPF) has introduced its own ESG scoring tool for local stocks and bonds, and begun screening all fund investments using that “ESG lens”. In 2018, GPF set up an investment portfolio worth 1 billion baht, investing in 33 listed companies found in the Thailand Sustainability Investment list (THSI). “It is the first ESG fund in Thailand,” said Vitai Ratanakorn, during his tenure as secretary-general of the GPF. “The GPF wants to be a leader in investment in companies that have responsibility towards the environment, society and corporate governance.” By October 2019, the fund was reported to have delivered a return of 4.6%, outperforming its main equity fund by 50 basis points (bp). During the Covid-19 induced sell-offs in March 2020, GPF’s ESG-Focused Portfolio outperformed a corresponding benchmark (SETTHSI index) by 73bp.

As if there were a virtual competition in impact investment, Temasek has taken an active role in financing innovative solutions to some of the most pressing climate change issues. Together with Singapore Power, Temasek co-funded a waste treatment system at Gardens by the Bay to repurpose unsorted waste into hot water for food and beverage outlets and biochar for soil remediation. In addressing the global food supply and sustainable agricultural development, Temasek also invested in new technology companies like Pivot Bio, Ceva Santé Animale', and Impossible Foods, which re-engineer sustainable agriculture by advancing technologies in microbiome, precision agriculture, gene editing, and alternative proteins.

Taking a lower-profile approach, the Hong Kong Monetary (HKMA), an active investor in green bonds since 2015, invested in the Managed Co-Lending Portfolio Programme in 2017, which is run by the International Finance Corporation and focuses on sustainable projects in emerging markets. In May of 2019, HKMA’s year of action towards sustainability, it unveiled a three-phased initiative to promote green and sustainable banking. In the same month, it issued its inaugural US$1 billion green bond successfully. Going forward, it will join with other SWFs to construct ESG-themed mandates in equity investment by adopting an ESG equities index as a benchmark for passive portfolio and engaging active equities managers to apply ESG factors.

Apart from constructing impact investing and ESG-focused portfolios, pension funds and SWFs are turning to index providers for further progress. Since the rise of ESG investment, index providers have become important key stakeholders in guiding ESG investment in the market. Yet, the underlying conflicts of interest between index providers and companies, lobbying to be included in ESG indices, are often overlooked. Being one of the forerunners of ESG investing, Japan’s GPIF strictly examines the relationships between stakeholders (shareholders, major customers) and rating agencies/index providers, their decision-making processes (such as whether they have independent committees or what topics they are discussing), and whether they engage in any business (such as performing consulting services) that is likely to fall under conflicts of interest rules.

In addition, Japan’s pension fund has raised the bar for its external asset managers who compete for its mandates. Since 2018, the pension fund has required its external asset managers to nominate corporates that lead in ESG practices. It also requests that they disclose the details of proxy voting records and submit an ESG report on a regular basis.

To further align interests between GPIF and its asset managers aimed at achieving sustainable and stable returns, the fund introduced a new performance-based fee structure and multi-year contracts for its active managers in the 2018 fiscal year. In the immediate future, other SWFs and pension funds are set to follow GPIF’s example and explore compensation structures, a useful measure to enhance and align the long-term interests of funds and their asset managers.

Three key points can be concluded from this non-exhaustive review. First, SWFs and government pension funds are constructing their own ESG portfolios by integrating ESG into their analysis, selecting best-in-class securities, screening out laggards, and investing thematically to achieve ESG impact.

Second, SWFs and government pension funds will increasingly become active owners engaging with companies on ESG-related risks. This is evident in GPIF’s request for its external managers to be ESG proof and transparent in exercising voting rights.

Third, SWFs and government pension funds will selectively choose to ally with trustworthy external stakeholders, such as index providers or rating agencies, to maximize their influence on the ESG practices of corporates.