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Environmental, Social and Governance (ESG) Investing – The Potential and the Challenges

The Fundamentals of ESG

Environmental, Social and Governance (ESG) strategy has a direct impact across the entire array of business operations for virtually all commercial enterprises – from early-stage ventures through to long-established multi-national corporations.

The functional areas of any business affected by the increasing ESG focus include company reporting, asset management, finance, banking, insurance, investor relations, governance and compliance, human resources, ethics, procurement and supply chain management as well as product and service development.

ESG standards are defined as concepts that prioritize sustainable development, investment strategy and business operations with three main components - namely environmental, social and governance.

Environmental criteria include the relationship of the entity with the physical domain(s) within which it operates and the obligations arising from regulations on – for example - carbon emissions and the use of renewable energy supplies.

Meanwhile, social criteria include the impact of the entity both on society as a whole and in particular on the stakeholder community with which it engages. Explicit issues include workforce practices, community relations, human rights, personal health and safety, and financial inclusion.

The governance criteria relate to company leadership, executive compensation, audit activity, internal controls, and shareholder rights. Areas of risk include corruption and bribery, reputational integrity, leadership team effectiveness, and company compliance with all applicable legal and regulatory mandates.

Implications for Investors

The broad-ranging definitions of the ESG landscape have tended to blur the boundaries for potential investors. Multinational companies are still struggling to reconcile competing and disparate ESG frameworks around the world.

As regulators begin to roll out mandatory ESG reporting across regions, alignment will be critical to ensuring that the clarity and efficacy of ESG reporting continues to improve globally.

Moreover, the interwoven and simultaneous environmental, geo-political and economic crises – the defining factors that characterized the global situation in 2022 – significantly slowed the upward trend in ESG investing. Rising energy prices, accelerating consumer inflation and slower economic growth deflected the attention of investors and impacted overall sentiment levels.

Nonetheless, equity investors and policymakers alike are acknowledging the importance of investing in businesses that are adopting ESG measures with the aim of protecting these entities from such unforeseen risks in the future.

And a recent report from global auditing company PwC (‘Climate Tech Investment Index’ – November 2022) indicated that climate tech markets worldwide have shown encouraging resilience, with more than a quarter of aggregate venture capital (VC) funding in 2022 being deployed within climate tech enterprises.

In addition, eight out of ten investors surveyed by PwC expressed an intention to increase their investment in ESG products over the next two years (PwC: ‘Asset and Wealth Management Revolution 2022’).

Companies with strong ESG implementation will more easily enter new markets and expand their sphere of operations. In addition, consumers also prefer product brands that uphold sound values and are environmentally friendly.

Businesses with good governance will also be able to face various pressures from regulators, environmental activists, trade unions, and other stakeholder groups.

Firstly, an ESG focus can help management to reduce capital costs and improve the valuation outlook. This is because as more investors look to inject funding into companies with superior ESG credentials, so larger pools of capital will be available to those companies.

Secondly, positive action and transparency on ESG matters can help companies protect their valuations as global regulators and national governments mandate additional ESG-related disclosures.

Role of the Indonesian Government

The ESG imperative was a prominent feature of the discussions at the 27th United Nations Climate Change Conference (COP27) of the UN Framework Convention on Climate Change (UNFCCC) held in Egypt, and at the Group of 20 Summit (G20) staged in Bali – both in November 2022.

An outcome of these events was the endorsement by the Indonesian government of two critical and challenging targets for the nation:

  • The NDC (Nationally Determined Contribution) for the reduction of greenhouse gas (GHG) emissions has been increased to 32% (‘CM1’ - Unconditional) and to 43% (‘CM2’ Conditional - with International Assistance) by end-2030 and

  • The end date for the achievement of the maximum Net-Zero Carbon Emissions Target by Indonesia has been set for 2060

The Government issued Presidential Regulation (Perpres) No. 98/2022 on the implementation of the aggregate carbon economic value required to achieve the above-mentioned NDC targets and to control greenhouse gas emissions

Moreover, this signals a new era of optimism for carbon trading in Indonesia.

From the perspective of economic analysis, the enactment of this 2022 Ministerial Regulation is a positive development as it provides a major stimulus for carbon trading both within the private sector and across State-owned enterprises in Indonesia, as well as for mandatory and voluntary carbon trading.

Let’s Connect!

In this latest Wellington Perspective, we examine the various dimensions of these rapidly-evolving dynamics – both across the global ESG landscape and in particular for the Indonesian market.

ESG is a complex, multi-layered area of focus for local and international investors alike, hence we would very much welcome the opportunity to share further insights with you.

Please feel free to contact us.

Wellington Perspective - ESG Investing
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