Demand for ESG investment products in the Asia Pacific region has been climbing significantly, according to several flow reports, driven by commitments from large institutional investors, but also increasingly by regulatory pressures

According to UBS, the assets of APAC-based ESG funds reached $62.8bn by June 2020, while assets in ESG ETFs domiciled in the region increased dramtically from $1.56bn in Q1 2018 to $7.01bn in Q1 2020.

At the same time, more and more APAC-based asset managers are recognising the values of sustainable investing, with the number of asset managers in the region signing up the Principles for Responsible Investment (PRI) almost tripling in five years from 104 to 303.

Some of the key driving forces behind this growth are large institutional asset holders, such as Japan’s Government Pension Investment Fund, which committed to ESG investing over five years ago, followed by the national pension or sovereign funds in China, Hong Kong, Malaysia and Thailand in the last couple of years.

Regulatory support

But it isn’t just the investors that are driving the change. According to Maitri Asset Management, governments in Asia are now getting behind sustainable initiatives, even despite the pressures caused by the Covid-19 crisis.

Edris Boey, ESG practice lead at Maitri, said:“Governments in Asia appear to be catching up and are favouring a longer-term view as regulators show no sign of stepping back from pushing the sustainable finance agenda.

“For example, the People’s Bank of China (PBOC) and the Monetary Authority of Singapore (MAS) have made strides in green financing in the previous quarter, in spite of the global daily number of Covid-19 cases hitting new highs.”

For example, the PBOC has just updated its list of eligible green bond projects to exclude “clean utilisation of coal”, a big win for carbon reduction goals, while the MAS has recently proposed new guidelines on environmental risk management for asset managers, banks and insurers.

“This is a key indicator of what is to come in Singapore,” said Boey. “The city-state has set itself up well by aligning with global trends and publishing the MAS proposed guidelines, which are a good starting point for investors looking to begin their responsible investment journey.”

Challenges

However, according to UBS, ESG investing in the APAC region still poses a number of challenges, often requiring a different approach to that implemented when investing in European or US equities.

For example, UBS said “excluding ‘sin’ stocks could be more challenging in APAC because their exclusions are more likely to affect the factor exposures of the portfolio and the availability of suitable replacements is more limited”.

Instead, the analysts believe screening and integration are more suitable approaches to sustainable investing in the APAC region and can be expected to grow over time.

“In practice, we expect most APAC asset managers to implement only basic levels of ESG integration, with a focus on making ESG information accessible and presented. Mandatory consideration of ESG information as well as monitoring/recording will likely be rare in the short- and medium-terms,” UBS said.

Additionally, the group noted that the percentage of APAC managers who implement engagement and voting is significantly lower than the global average, and while these are expected to rise, they will likely take different forms to what we are used to in Europe.

“Interest in investing in companies that are imperfect from an ESG angle could catalyse engagement,” UBS said. “By engaging, asset managers can seek to deliver ESG improvements while keeping the scope of their investable universes largely intact.”

New investment framework

As a result of these challenges, UBS said ESG investing in the APAC region must be a combined approach that can accommodate both the developed markets (DMs) and emerging markets (EMs) that constitute the region.

“Without substantial adaptation, well-established approaches for DMs could fail to account for the development needs, physical vulnerabilities, social nuances and institutional weaknesses that characterise many EMs in APAC,” the analysts said.

UBS proposed a new framework for ESG investing in the APAC region based on four key dimensions:  (1) social and environmental variation between and within individual markets; (2) corporate / institutional cultures; (3) investment ownership practices and structures; and (4) sectoral idiosyncrasies.

“Our framework links megatrends and country-level risks with the competitive conditions in sectors to ultimately arrive at financial implications and impacts for companies,” UBS said.

The group believes ESG investing in the region must be seen within the context of resource constraints and local conditions, but sees scope for a great deal of further growth, with the total assets in ESG funds still below 1% of total AUM of funds domiciled in the region.