As ESG investments continue to grow rapidly across sectors in advanced economies, it is important to consider what the implications of this might be for low-income countries. In order to achieve the sustainable development goals on a global scale, development finance must play a role in ensuring these countries also benefit from this newfound focus on ESG.
The notion of equity
Many people are aware that, by signing the Paris Agreement in 2015, countries committed to nationally determining their contribution toward limiting global warming to 1.5 oC. However, less are familiar with the notion of climate equity which was also enshrined in the agreement. This clause states countries should ‘address climate change in accordance with their…social and economic conditions’, meaning richer countries should contribute more based on their historic relative contributions to climate change and on their financial capacity to do so. To meet the global agenda for the Paris Agreement contributions, the Finance Initiative of UN Environment estimates that 5-7 trillion USD of capital will be required. Considering that developing countries are set to be the worst affected by climate change, rich countries are therefore obligated, based on their economic capacity, to drive investment into the sustainable development of countries with less resources to tackle climate change. This will enable every country to successfully transition to a sustainable economy.
What does this mean for ESG?
Currently, Europe and North America account for 90% of the sustainable investment market, showing private finance is still not being funnelled into emerging markets with the speed and scale required for the sustainable development goals. There are several potential reasons for this, namely lack of standards, information and investor confidence. For example, whilst 80% of the world’s 250 largest companies follow global reporting initiatives for their ESG practices, this reporting is not mandatory, leading to unstandardized data and inconsistencies in disclosures between countries. Emerging economies also tend to be less stable, less transparent with ESG information and weaker in ESG performance, causing the markets to be more fragile. This means private companies are more reluctant to invest in developing countries due to perceptions of heightened risks and because high-capital projects may not meet their stringent investment criteria.
These challenges can be overcome if global governments and markets regulate the financial sector and encourage private investors to finance projects in developing communities. The UN Sustainable Stock Exchanges Initiative has made a start on improving ESG disclosure in emerging markets in this way, but there is more to be done. Investors should also play their part by accepting disclosures that meet these local best practices instead of imposing their own standards, and by taking the differential needs of emerging
markets into account. For instance, in a developing country, access to electricity may be one key driver of economic development, whereas this is not an ESG factor for developed markets. Equally, developed markets might be assessed by the strength of their financial institutions, whereas emerging markets should instead be evaluated based on their resilience to environmental and social risks.
Another important way to channel investment into these countries is by changing the discourse around international development. Investing in low-income countries has previously been associated with neo-colonial sentiment, such as providing aid under the guise of impact investment. The narrative must instead be changed toward considering these markets as big players on the global scale and by allocating capital to assets like real estate and infrastructure in developing countries. As the effects of the pandemic have highlighted, a country’s health infrastructure will also be indicative of its economic resilience.
This is why it is also important not to neglect the ‘G’ element in ESG; whilst the environmental and social benefits of a hydropower plant project in Pakistan are highly visible, given it is a clean source of energy and provides electricity for local facilities, the governance impacts are less tangible. Due to mismanagement, this same project has been found to fall short of its expected financial return. Decision-making should therefore be multilateral, including local communities and in-country project participants from the start, so interests can be articulated and there are no legal power imbalances between countries. Now that the Covid crisis has pushed people in developing countries further into extreme poverty, it is even more essential to ensure these places are put at the forefront of ESG investing, rather than excluded.