How should risk managers approach ESG in high-risk emerging markets?

How should risk managers approach ESG in high-risk emerging markets? | Insurance Business America

Risk Management News

How should risk managers approach ESG in high-risk emerging markets?

Aligning with global frameworks will present a challenge for resource-dependent countries

Risk Management News

By
Kenneth Araullo

Environmental, social, and governance (ESG) strategies have become crucial for businesses globally, including in emerging markets, where sustainable practices are increasingly linked to long-term growth and stability. For risk managers operating in these regions, implementing ESG strategies presents unique challenges, including financial constraints, inconsistent regulatory frameworks, and a lack of reliable data.

While ESG frameworks aim to support responsible development, risk managers must navigate complex issues such as resource dependency, governance challenges, and the high costs of compliance, all of which complicate efforts to align with global ESG standards.

In 2004, the UN Global Compact published “Who Cares Wins,” highlighting the importance of ESG factors in investment decisions. This report laid the groundwork for the Principles for Responsible Investment (PRI), launched in 2006, cementing ESG as a key component of global investment strategies.

While ESG frameworks are designed to promote sustainability and responsible business practices, their implementation in emerging markets presents a series of social and economic challenges.

According to Amalia Lui, a partner at Clyde & Co, these difficulties arise primarily from financial constraints, regulatory challenges, and resource dependency in these regions.

Historically, emerging markets have faced complex challenges in aligning with global ESG standards. In the early 2000s, for instance, Cambodia became a major production hub for multinational companies like Nike and Gap.

However, reports of underage workers and poor working conditions in garment factories prompted these companies to withdraw, leading to the closure of over 20 factories within five years.

Lui said that this example underscores the difficulties of enforcing labour standards in regions where support systems are inadequate, often resulting in economic instability and social disruption. It illustrates the need for a balanced approach when implementing ethical standards in emerging markets.

The barrier of financial constraints

Financial and economic constraints further complicate the adoption of ESG in these regions. Emerging markets often lack the capital and resources needed to meet ESG reporting obligations, which can make sustainable practices seem less of a priority.

The cost of compliance, coupled with administrative burdens, creates significant hurdles. Lui explains that the volatility of emerging markets also makes it difficult to maintain long-term ESG investments, particularly for investors who seek stability. Moreover, many financial institutions require ESG compliance when considering funding for projects. This has led to restricted capital deployment in regions with lower levels of ESG enforcement, which is common in emerging markets.

Data collection and standardisation issues also create barriers to ESG adoption in these regions. Small and medium-sized enterprises (SMEs) in emerging markets often lack the resources to collect and report accurate ESG data.

According to Lui, underdeveloped infrastructure, such as monitoring systems and technology, further exacerbates the problem. The absence of a universal ESG metric system adds to the complexity, leaving many companies in these regions labelled as non-compliant. This can deter ESG-focused investors from engaging with businesses in emerging markets, further restricting capital inflow.

Another significant issue is the heavy reliance on natural resources in many emerging economies. Countries dependent on the extraction and export of resources such as oil, minerals, and agricultural products often face challenges in aligning with ESG initiatives. Over-extraction, deforestation, and other unsustainable practices are common, driven by the need for economic stability in the face of fluctuating global commodity prices.

Lui points out that this creates an inherent tension between the need for immediate economic gains and long-term sustainability goals. For investors seeking adherence to ESG standards, this resource dependency presents significant challenges.

Governance issues in the ESG framework

Governance issues also play a critical role in complicating ESG implementation in emerging markets. Regulatory frameworks in these regions are often inconsistent or underdeveloped, creating environments where businesses may not strictly adhere to ESG standards.

In some cases, varying standards within regions of a single country add to the complexity, particularly for multinational companies trying to implement cohesive ESG strategies. Lui highlights that corruption and limited enforcement capabilities further hinder progress in many of these markets.

Despite these challenges, there are opportunities for a strategic approach to ESG implementation in emerging markets. Applying the same ESG standards to both developed and emerging markets without considering local contexts can have negative consequences.

According to Lui, some experts argue that ESG requirements may unintentionally divert investment from higher-risk emerging markets to safer, developed ones, depriving these regions of critical capital. A gradual and tailored incorporation of ESG standards, adapted to the specific needs and capacities of emerging markets, is essential for achieving equitable and effective outcomes.

Lui said that emerging markets need targeted support to help them meet ESG goals. This could include providing grants, offering training, and developing ESG compliance sensitisation programmes.

Additionally, standardising ESG metrics and fostering stable regulatory environments would help build the necessary infrastructure to support sustainable development. These steps would ensure that ESG initiatives promote responsible business practices without placing undue burdens on emerging economies.

The unique position of emerging markets in the global economy calls for a nuanced approach to ESG implementation. Stakeholders, including governments, corporations, and financial institutions, must work together to balance the ethical imperatives of ESG with the economic realities in these regions.

Lui said that the key lies in recognising the specific challenges these markets face and offering the support needed to develop sustainable, responsible practices over time. This approach can lead to the successful integration of ESG principles without compromising the growth and stability of emerging markets.

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