Emerging standards of IR: from environmental disclosure to human rights KPIs
What can you tell us about East Capital and your role there?
East Capital is an emerging and frontier markets specialist, investing originally in Eastern Europe and Russia, which was expanded to Asia and most recently to the Middle East and Africa. We run a number of UCITS public equity funds and some specialist funds.
Louise Hedberg, head of corporate governance at East Capital
Governance has historically been a huge issue in our investment region, so we’ve always been looking at who owns the business, who comprises the management team, what interest those people have, where they are going with these interests and what it means for us as a minority investor. The partners at East Capital also understand that other governance-related issues such as the greater sustainability challenge are important in investment decisions so they decided to have a full-time specialist working on that. I’ve been head of corporate governance since 2010.
What kind of filters do you use for screening companies, and which sectors have you been focusing on this past year?
When we formalized our ESG screening in 2010, we tried to figure out how to take an existing asset management business and make it as responsible as possible. We’re of Nordic origin and therefore have this built-in sense of responsibility but it was also important to do that in a way that was credible, understandable and transparent. In Sweden historically we’ve seen asset managers have two products: an SRI fund and a regular fund. We agreed internally that we should apply ESG screening to all our products.
We exclude tobacco, pornography and all types of weapons as we don’t see the investment case in any of those industries over the long term, even though returns have been attractive. Given that regulations and standards vary greatly from country to country, with very limited environmental, human or labor rights regulation in some of them, we rely on international conventions and norms: the UN Global Compact, the International Labor Organization principles and the OECD principles that create some guidance and a basic common ground for expectations related to sustainability issues. We have a screening process that alerts us to any breaches and allows us to start a conversation with the company about it. It also shows us that if it happens to a company, say, in France, then potentially it can happen to a company in the same sector from another country.
Where I think this creates real value is when you try to understand how these ESG factors would affect a company, and whether we should discount the company or apply a premium. It’s an organic process: we’re trying to understand what costs money and what doesn’t. In our region, the demands on the companies are not that high – yet. We try to understand where the risks are and where to ask more questions. For instance, health and safety in the mining industry: regardless of regulation, that is something that can become extremely costly, even catastrophic if you don’t manage it correctly. That’s why we say there’s no such thing as a non-financial issue, because at some point in time it will affect your income statement.
Given that we invest in the development of these markets and societies, we like consumer stories: food retail, food production, financial services, real estate. We have some oil and gas holdings but much less than other emerging market investors.
Are you seeing ESG factors having a direct impact on the valuations of companies you invest in?
Not yet, but they will in the long run. In the short term, it doesn’t have much of an impact unless there’s an accident that blows up in your face. But it does help set apart the good companies from the bad ones: firms that understand ESG issues and are clearly communicating on them are setting themselves apart as being well versed on these risks. Investors will see them as more attractive investment targets, which will subsequently make their valuation go up.
Which emerging/frontier countries do you believe have most improved their ESG standards in the past five years?
I would point to markets that are joining the sustainable stock market initiative: Nigeria and Kenya, for instance. Hong Kong is not part of it but it is now issuing ESG disclosure rules. It’s all these markets where you see stock exchanges taking their responsibility seriously, as companies listed and willing to list there obviously will need to comply with their rules.
Their guidelines are not just about ticking the box but also about encouraging company boards to assume responsibility for these strategic issues. This will push peer competition and help raise local reporting and transparency standards.
And while we see emerging and frontier markets often lagging behind on these initiatives and regulations, we also see very interesting examples coming out of China, for instance, with ambitious climate targets that will force it to become the biggest investor in solar energy in the next few years. That’s why we’re a bit more hopeful about countries that are directly affected by water scarcity or pollution because they simply understand that they need to take action. A country like Russia, for example, is so much bigger, and it has a lot more land, fantastic forests and lots of water, so it doesn’t feel the pressure to get there as quickly.
Some companies have an understanding of these strategic issues but maybe not the true incentives to get the work started. If you’re exporting a lot to the EU, for example, consumer pressures will require that you fulfill certain standards in your purchasing process. But if you’re a local player you may not have many incentives and development will be slower.
Which tips would you give IROs to better engage investors on ESG issues?
It all goes back to the long-term impact of ESG factors. In general I find it hard to get IROs to explain how these issues affect general operations and the bottom line. The IRO’s role is always about providing guidance that is as clear as possible on the value of a company, so if certain ESG issues are relevant and material enough, the IRO must make sure they are communicated.
With all the ESG data available, we can compare companies from the same sector and start a conversation around that. Some firms are better prepared than others for this: some put out their sustainability report a half year after the annual report, which doesn’t make sense as you don’t see how it ties into the annual accounts. The Global Reporting Initiative can help companies sort out which things they should disclose and report based on their sector. Also, consistency is important: some firms change their key performance indicators (KPIs) every year, which makes tracking progress difficult.
There is a Russian company we haven’t invested in because of environmental risks, but I still meet with it often to assess its progress. The IRO was told by the CEO to regain one of the firm’s largest investors, which had sold its stake, and asked me for advice on how to do that.
Finally, I believe environmental issues are well understood now, even in smaller markets, but I think human rights topics will be the next big issue for companies to start communicating on. With the UN Guiding Principles on Business and Human Rights and other standards pushing for more disclosure on the subject, related KPIs are bound to become more common and developed.