The climate crisis, rising income inequality, competition between the United States and China, the rise of populism and authoritarian governments, and the 24/7 news cycle hyper-driven by social media lead to growing government intervention that impacts business.
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Traditional environmental, social and governance (ESG) requires companies to maximise financial return while ensuring fair treatment for employees and customers, and minimise environmental impacts while being in full compliance with laws and regulations.
Today, however, investors must consider and predict actions by governments across multiple jurisdictions simultaneously. They must also figure out how those actions will impact their actual and social licensees to operate if they want to generate outsized returns while taking into account investing in sectors for which regulations will impact the bottomline.
To ordain the material risks and opportunities of any given business, integrating ESG into the investment process requires investors to possess an intimate understanding of how the business operates, generates revenue, impacts the environment, and effects workers, customers, and the locations in which they operate.
In the world of private capital in Asia, ESG leads must not only understand what happens in their home markets. They need to know what’s happening in Beijing, Brussels, Washington DC, and any other capital in which a company operates or sources – and predict what might come next.
As crises worsen, policymakers will act. A price on carbon, tougher rules to protect human rights globally, requirements for the environmental and social impacts of global supply chains to be the responsibility of the sourcing company, and the expansion of the definition of national security to include trade and investment are coming from governments around the world.
It’s time for a second G in ESG – geopolitics.
ESG needs another ‘G’ beyond governance
Geopolitics goes beyond governance.
Governance focuses on how well a company manages itself. Gauging the independence of its board, ensuring regulatory compliance, achieving diversity, equity, and inclusion, being transparent with its stakeholders falls under the first ‘G’.
Governance remains vital, but no longer suffices.
In addition to an emerging suite of regulations that touch on environmental and social issues, ever-evolving international relationships will transform the way businesses operate.
In the world of private capital, investors need to anticipate the legislative and geopolitical developments of the next five-10 years, which will impact the exit valuations of investments being made today.
Four areas highlight what fits within geopolitics, and why it should be on every investor’s radar screen.
First, Asia must stay a step ahead of the decisions being issued in Brussels. When it comes to following the European Union (EU), investors in Asia seem to channel Henry Kissinger’s apocryphal quote that Europe does not exist because there is no phone number to call them. Asia’s private sector must stay apprised of new developments in Europe – or else face the consequences.
A long and growing list of EU sustainability legislation will have profound financial and legal implications for many businesses in the region. This will include new disclosures and fees associated with the Corporate Sustainability Reporting Directive, which requires all large companies and listed small-to-medium sized enterprises to publish regular reports on their environmental and social impact, and the Carbon Border Adjustment Mechanism, a regulation that places a tariff on carbon intensive products imported by the EU.
Second, heads of state are increasingly raising the need for multilateral bank reform. At next month’s World Bank meeting in Morocco, President Ajay Banga will begin enacting a suite of changes which could change the viability of projects in emerging markets. President Banga will ask shareholders to broaden the Bank’s mission statement to include climate and hopes to nearly double the organisation’s lending capacity over the next decade – an increase that could soar as high as US$125 billion. Investors tracking these developments could achieve outsized returns.
Third, a global plastics treaty could have major impacts on plastics-heavy businesses once its negotiations wrap up. Even if a treaty does not transpire, customer demands will impact business regardless.
Already, heightening trade tensions between the US and China impact markets globally, such as from China’s “dual circulation” policies and the proposed US’ outbound investment regime, which could prohibit or require notification of certain types of US investments into China.
In the coming decade, nothing will impact geopolitics and investing as much as the climate crisis. Businesses should prepare for the regulatory and legal environment to heat up.
Climate action and a price on carbon
Global climate action will result in emissions disclosure requirements and carbon pricing from countries around the world.
At this year’s COP28 climate talks, delegates will discuss several proposed global taxes – on fossil fuels, shipping, and even kerosene. It’s unlikely that they’ll win broad support, but businesses should be aware of emerging requirements and fees regardless.
However, even though these discussions are taking place on an international stage, don’t expect nations to coordinate on what they ask of the private sector.
The EU’s new levies on maritime shipping provides one such example. Starting in January, shipping into the EU will fall under the bloc’s Emissions Trading System, incurring hundreds of millions of dollars in carbon taxes.
EU policies like this and its Carbon Border Adjustment Mechanism could prompt Asian countries and the US to launch their own climate-related trade restrictions.
With the 14-country Indo-Pacific Economic Framework (IPEF) negotiations heading into the home stretch, there are opportunities to discuss how IPEF can facilitate investment and opportunities as countries make the transition to clean economies, which include complicated issues like carbon credits, opening new markets for investment.
California, which may as well be a country in terms of its global influence on environmental policy, has already passed legislation that will force major companies operating in the state to report their greenhouse gas output, including Scope 3 emissions.
As the US implements the Inflation Reduction Act, which offers tax breaks to companies that deploy clean technologies inside the United States, China’s “dual circulation” policy includes government support for domestic technology companies, each impacting global investors.
Risks and opportunities
As the climate crisis worsens and as US-China competition intensifies, governments will react with even more legislation and regulation impacting investments in clean technology, transition pathways and net-zero. Southeast Asia will be impacted by what happens in China, the EU, and the US.
Going forward, investors need to be fully aware of geopolitics – or else remain oblivious to risks and opportunities.
Governments’ spotty environmental records paired with lagging international climate negotiations will put pressure on companies to make strong ESG commitments regardless – another form of geopolitics. Corporate net-zero commitments, though scrutinised, will be demanded considering the continued global deadlock.
In the coming years, corporates will be expected to become a driving force in achieving net-zero climate targets, as nations increasingly prioritise domestic concerns and political survival over commitments on paper.
Investors who understand this, and act accordingly, will outperform the market.
Managing ESG issues will not be enough. Now, ESG requires the application of materiality for geopolitical risks. Already, ESG practitioners should be assessing their supply chain with that in mind.
Geopolitics now features heavily in business considerations, whether or not investors want it to.
To stay competitive, ESG must become ESGG.
Steven Okun served in the Clinton Administration and is chief executive of APAC Advisors, an ESG consultancy in Singapore and Senior Advisor to geostrategic consultancy McLarty Associates. Gillian Meyers is a climate and ESG associate at McLarty Associates.
