ESG Global and Asia Outlook 2023

The year to come on ESG will look back on 2022 as one of focus on definitions and education on ESG amongst the wider community, that for better or worse were thrown into having an opinion on this highly complex topic. Heightened media attention and focus on preventing greenwashing are themes that will continue for years to come as more individual investors are being asked to have a view and opinion of aligning investing with their values.

1) Navigating the complexity of ESG Investing

Global: Widespread confusion - supporting our clients through complexity and varying ESG landscapes

The ESG landscape has evolved rapidly, globally and in a very public way. Coupled with a lack of clear definition, varied interpretation of new rules and a spectrum of personal values, it is no wonder that there is widespread confusion around the ESG world. The big items that we are supporting our clients with centre around:

• Innovation in products and solutions: In 2022 Invesco launched several strategies focusing on themes relating to climate, net zero and agriculture/ food. While we continue to expect this sustainability thematic to remain a relatively smaller component of the overall ESG landscape, we expect 2023 to see increased interest from our clients in these solutions that have clear and measurable sustainability outcomes.
• Structuring the data landscape: Invesco leverages over 50 different ESG data sources in our various product and strategies and this is growing¹. This comes with an enormous data governance and technology to enable this data to be leveraged effectively. Our clients face similar challenges of data aggregation, manipulation and structuring to enable a clear signal that can be used for reporting and product solutions. In 2022 we launched ESGCentral to help our internal and external clients in this regard. In 2023 we expect this to be a key enabler for helping our clients with their portfolio disclosure.
• The language of ESG: Invesco consulting have surveyed 1500 financial advisors in the US and have provided clear advice on how to initiate the ESG conversation with individual investors. Market discussions indicate that MIFID II Suitability rules introduced in August 2022, which require advisors in Europe to ask clients about sustainability preferences, show that around 20-40% of customers tick “yes” for a clear sustainability preference. In 2023 we expect many more opportunities to help our clients create greater clarity to the ESG landscape.

Asia: Increasing breadth of opportunities and capabilities for ESG investing

ESG AUM penetration in Asia is still in early stages of growth (3% of broader market AUM) as compared to Europe (30%)² but similar to global developments, implementation of ESG will likely be more nuanced and sophisticated alongside increasing complexity.

• Deepening ESG integration: Whereas exclusions tend to be a common implementation of ESG investments, we expect the region to continue to increase on broad-based and systematic integration where outcome-based engagements will play an increasing role in conversations.
• Opportunities in wider asset classes: The diversity in approaches also applies to asset classes. For instance, Morningstar data shows ESG ETFs penetration in Asia has grown from 10% to more than 20%³. The region will see increasing breadth of ESG implementation tools and approaches. 
• Data landscape: ESG data coverage has improved greatly in recent years; China’s latest ESG data coverage is at 30%⁴. Corporate disclosures, transparency of data providers alongside alternative data capabilities will be interesting spaces to watch. Invesco also has a partnership with Tsinghua, where research has also included proprietary alternative approaches to estimating carbon emissions data in China. 

2) Growth of the “S” in ESG

Global: Social aspect takes greater share of the conversation amidst rising costs of living

Invesco’s ESG dialogue last year saw social issues being part of company dialogue around 30% of the time compared to closer to 60-70% for environmental and governance issues⁵. There are good grounds to expect the social issues taking a greater share of the conversation in 2023:

• Reporting on social: Today, reporting on social issues and management of them globally varies a great deal. This is illustrated by the social transformation baseline assessment by the World Benchmarking Alliance. In January 2022 they looked at 1000 companies globally against 18 social indicators under the broad umbrellas of decent work, ethical behaviours and respecting human rights. The average score was only 5.2 out of 20 clearly finding many gaps in approaches by companies⁶.
• Human Rights: The EU published its action plan in August 2022 and the US introduced the human rights sourcing legislation also implemented in the summer of 2022. These developments are putting additional pressure on investors to implement due diligence, which is limited by data availability. In 2022 Invesco made a start with the latest addition to our data set has been a childrens rights score which is a proxy for human rights in operations and products and services. This score is generated from the Global Child Forum, an organisation set up by the Swedish Royal family to generate better data and awareness on human rights. It scores over 3000 companies globally and includes materiality assessments, grievance mechanisms, working age metrics, amongst others.
• Remuneration one-offs: and a high number of shareholder resolutions are likely to be a theme that we are going to see in the 2023 voting season. The significant market turmoil could lead companies to issue shares to enable their workforces to receive some compensation for expected reduced cash awards. Invesco’s policy on voting is that one-offs should be considered in the overall context of the remuneration scheme as well as the track record seen.

Asia: Understanding the supply chain implications of social

Many of the upcoming due diligence requirements and national climate plans will have direct impact on supply chains particularly in Asia and China.

• Supply chain impact on issuer selection:  As new supply chain legislations are enacted, the inclusion or exclusion of issuers in ESG-focused funds have to transcend reliance on singular data providers to having robust underlying ESG processes and data to evaluate issuers on.
• Building local supply chains: Due diligence requirements, potential sanctions and recent national climate plans would also shift supply chains from global interdependencies to more regional and localized supply chains. Asia and China for example still dominates EV raw materials and renewable components’ global supply and it will be interesting to see how supply chain dynamics shifts ahead.

3) Opportunities from climate adaptation and transition

Global: Climate adaptation and transition plans – will the people move and the plants evolve?

Governments and corporates alike have been active looking at adaptation and transition plans:

• Climate adaptation: refers to the ability for people and nature to adapt to climate change risks. The most immediate issue is that of physical risks. While there is not a commonly agreed framework or definition for adaptation, there is a recognition that the climate is changing and that it is affecting everyone. While there may be calls for complete migration of populations to areas less affected by extreme weather, there is likely to be increased emphasis on protecting habitats from these changes. As such, focusing on habitat protection, flood and drought management, water and energy conservation, as well as retrofitting properties for changing weather conditions, amongst other actions, are needed in a changing world. In 2022 adaptation finance only represented around 10% of the issued green bond universe but we are expecting this to grow significantly in 2023 with particular emphasis on use of proceeds for emerging markets⁷.
• Biodiversity: While we are far away from very accurate modelling of biodiversity impacts to a changing climate, investors are being asked to consider these issues with new data sources and more people applying themselves to these problems. This is particularly the case with the sustainable finance disclosure regulation principal adverse impact indicator (PAI) number 7.  The future will need to focus on meaningful and quantifiable actions companies are taking to mitigate the impacts of their operations on local biodiversity. The interplay between climate, biodiversity and food security is significant. As popularity for biodiversity financing has grown, the connection between potential climate offsets and natural capital is becoming more apparent, with many carbon offset projects also boasting biodiversity benefits. Nature-based solutions (NbS) in the form of carbon offsets can help to reduce emissions and increase nature-based resilience. WEF reported that NbS could provide 37% of the CO2 mitigation needed by 2030 to maintain global warming within 2C and at a lower cost than other popular options⁸. However, many warn to be cautious when considering this option as quick fixes such as planting non-native trees can run the risk of eradicating local biodiversity and ecosystem services, which could have damaging (and expensive) repercussions. This is a hotly contested topic we are expecting to see more debate on during 2023. All these trends lead to heightened interest and an understanding of the importance in the topic today.
• Transition: For companies, we are closely watching the transition plan taskforce which was launched during COP27 in November 2022. The transition plan taskforce is in consultation until February 2023 but we have already seen companies issuing their versions of transition plans and expect more reports coming out in 2023. The TPT was launched by the HM Treasury in April 2022 and there are 4 key areas that have been set out for companies to consider including: an entity high level ambitions on climate change and resilience; short, medium and long term actions; governance and accountability mechanisms as well as measures to address risks to the environment and stakeholders. The taskforce is essentially being described as the Taskforce for Climate Financial Related Disclosures (TCFD) but with a greater focus on the just transition. This is important because in November 2021 the World Benchmarking Alliance surveyed 180 companies in oil and gas, electric vehicles and automotive manufacturers. It found that the vast majority of high-emitting companies are failing to demonstrate efforts towards a just transition.⁹

Asia: Opportunities to invest in transition while considering just transition and physical risk

Most regions in Asia now have net zero commitments in-place with policies to support energy transition whether in scaling renewables, EVs or hydrogen development. Potential investment considerations ahead include:

• Transition Leadership: The shift towards delivery on corporate net zero commitments in Asia will signify stepping up of green revenue and green capex investments. China’s 3060 goals alongside 1+N framework will create opportunities in transition leaders and clean and renewables technologies.
• Just transition: Given coal assets at earlier stages of lifecycle, existing economic and employment dependencies alongside energy security considerations, facilitating a just transition is critical in Asia. Innovative financing mechanisms are required and Indonesia’s recent Just Energy Transition Plan could be an interesting pilot model to watch. Such transition mechanisms could also catalyse greater private capital to invest in transition, helping to address investment transition risks.
• Physical Risks: Whether it is acute risks (events-driven changes like floods in Pakistan or droughts in China) or longer-term chronic risks (such as heat waves or high temperatures), the impact of physical risks would increasingly be felt in Asia. There is an increasing importance to assess sector-specific climate physical risks impact on stranded assets, supply chain disruptions, inflationary prices. Further importance to having broad-based ESG and climate risk integration in investment process.  

4) Defining ESG – Regulatory and disclosure developments

Global: Regulatory ESG initiatives globally continue to ramp up with emphasis on standards and transparency

• EU SFDR: In 2022 firms spent a significant amount of time implementing the EU SFDR with a divergence of approaches emerging across the market. In 2023 we are expecting to see greater consolidation of standards including on items such as sustainable investments. This will also be the first round of full reporting on principal adverse impact indicators which is likely to be seen as a first release with further refinement during the course of the year.
• Other regions: UK FCA issued its own guidelines for ESG labels and disclosures in Q4 2022 and will be consulting on these into January 2023. The proposed rules are very different to the EU SFDR proposals and are more closely aligned to the US SEC proposals which are also expected to be launched during the first half of 2023. Similarly the Canadian securities administrator is setting out its stall with regards to ESG regulation.

Asia: Addressing greenwashing and standardization for transparency

As covered in our previous piece, Asia has seen over 200 ESG regulations to-date¹⁰, many mirroring developments in Europe and the US. In particular:

• ESG Fund Disclosure: Within Asia, Hong Kong SFC and Singapore MAS both released ESG Fund Disclosures circulars in the past 2 years so we are likely to see further implementation and expect growth in Asian ESG funds following this greater regulatory guidance on standards.
• Taxonomies: China’s launch of the Green Bond Principles which also recognized EU Taxonomy or Common Ground Taxonomy was a huge step towards interoperability. More regions in Asia will adopt taxonomies, clarity in standards will facilitate more sustainable investments though cross-border flows would be contingent on interoperability.

The way for global firms to navigate these somewhat different frameworks is to have a proprietary internal standard that sits across the global geographies. At Invesco we have been transparent about our mapping of definitions and expect to spend even more time on educating around this spectrum of ESG approaches during the course of 2023.

Towards 2023

2023 will definitely be a rich year for further ESG developments, and will no doubt also bring further surprises in this continually evolving landscape.