The recent surge in interest around environmental, social and governance (ESG) issues is undeniable. Issues like climate change, racial inequality, and business ethics are at the forefront of public conversation and, increasingly, investment portfolios. In 2020, investors in the US alone contributed US$51.1 billion into "sustainable" funds, more than twice the amount contributed in 2019.[i] In this new paradigm, asset owners with diversified, global portfolios must understand the specific ESG risks that may apply to investments in different regions and industries, as well as the variety of approaches to ESG risk mitigation across public and private markets.
Southeast Asia is a particularly attractive region for investment, in part due to its extraordinary growth potential in industries like e-commerce.[ii] At the same time, however, the region is difficult to assess and understand due to its rich diversity of economies, cultures, and natural environments. To help asset owners make better decisions about their investments in this dynamic environment, this article highlights a selection of ESG risks common to the 10 nations that comprise the Association of Southeast Asian Nations (ASEAN) and East Timor, and outlines risk mitigation considerations for investments in both public and private markets.
Southeast Asia is marked by a contrast between rapid urbanisation and industrialisation amidst an extensive, diverse natural environment. Almost half of its land area is still forested,[iii] while 50 per cent of its 650 million people are expected to live in urban areas by 2025—up from only 28 per cent in 2000.[iv] While the region occupies about three per cent of the world's surface, it accommodates almost 20 per cent of all plant, animal and marine species.[v] This great patchwork of human development and natural resources within close proximity to each other creates the potential for significant environmental risks, including with respect to greenhouse gas (GHG) emissions, biodiversity, and physical risks associated with climate change.
Scope 2 GHG Emissions
Asset owners should consider the amount of energy needed to fuel the region's rapid urbanisation and industrialisation in light of the CO2 emissions associated with energy consumption (so-called "Scope 2 GHG Emissions"). According to the International Energy Agency (IEA), Southeast Asia is one of the fastest growing regions in the world in terms of electricity demand and, at the same time, one of the few regions of the world where coal-fired power generation is expanding.[vi]
The combination of increased electricity demand and significant coal-fired generating capacity means that the CO2 emissions associated with electricity use are relatively higher in Southeast Asia than in other parts of the world where coal may represent a smaller part of the energy mix. According to the IEA, in 2021 Southeast Asia had a carbon intensity of approximately 600 grams of CO2 per kilowatt hour, the highest regional output in the world and well above the global average of approximately 450gCO2/kWh.[vii] For asset owners focused on emissions reductions and, particularly, those with net zero commitments, energy efficiency should be a key part of the investment analysis for Southeast Asian companies.
The global investment community has turned its attention to the protection of our natural environment with the formation of the Taskforce on Nature-related Financial Disclosures, which will develop a framework for businesses to assess, manage and report on their dependencies and impacts on nature. As one of the most biodiverse regions on the planet with one of the highest rates of deforestation in the world,[viii] biodiversity can be a key concern for asset owners in Southeast Asia.
Tree plantations and mining are important drivers of biodiversity loss in the region.[ix] The deforestation rate is estimated to be about 1 per cent of loss annually, driven in large part by plantations linked to the production of palm oil, rubber, and wood pulp which predominantly cover formerly forested areas.[x] In particular, the monoculture practices required to support large-scale palm oil plantations in Indonesia and Malaysia, which are responsible for 90 per cent of the global palm oil market, have been recognised as significant drivers of biodiversity loss.[xi]
Mining in the region occurs in two principal forms that threaten biodiversity. Limestone mining for the production of cement, driven by strong demand in India and China, often occurs in areas "recognised as hotspots of endemism".[xii] Separately, mining for underground minerals can involve forest clearance and pollution within or near protected areas. [xiii] This is a key concern in Laos, where 50 per cent of its exports are copper ore. [xiv] Even if asset owners do not invest in companies directly involved in tree plantations or mining, the importance of palm oil, cement and minerals as raw materials for many products means that ESG-focused investors must scrutinise supply chains to properly assess biodiversity risk in Southeast Asia.
Physical Climate-related Risks
According to the International Panel on Climate Change (IPCC), over the past century temperatures in Southeast Asia have been increasing along with the number of hot days and warm nights.[xv] The projected impacts of our changing climate in the Asian region as a whole include water scarcity, which will be compounded by increasing demand associated with higher standards of living, and more extreme climate events such as more frequent and intense heatwaves.[xvi] In addition, approximately a million people along the coasts of South and Southeast Asia will likely be at risk from flooding, with Bangkok, Ho Chi Minh City, Haiphong and Yangon particularly exposed in terms of population and assets.[xvii] While the effects of climate change are in many ways unpredictable, asset owners should note that water scarcity has the potential to increase operational stress on businesses dependent upon water as an input, and extreme climate events like flooding can significantly impair asset values.
As in the rest of the world, human rights issues, including democracy and free speech, are hotly debated in Southeast Asia. Asset owners should be aware, however, that the region's political, cultural and economic diversity can create significant differences in approach to these issues among governments, regulators and companies. While certain jurisdictions in Southeast Asia are seen as international exemplars on various social issues, others may raise significant concerns. Importantly, political change can happen fast and unexpectedly—the region has experienced no less than 40 coup attempts since 1950, each with the potential to change the social and political landscape in a given jurisdiction.[xviii] Human rights and labour standards, in particular, can be concerns.
Protest movements, political upheaval and alleged human rights abuses in the region have recently captured headlines globally. These events can generate significant human rights-related investment risk in both a primary sense, insofar as companies may be involved in perpetrating actual abuses, and in a secondary sense as consumers increasingly expect companies to address perceived human rights issues.
For example, a Singaporean firm was recently targeted by activists for selling anti-drone products to Myanmar's police and was ultimately pressured into halting further business with the country.[xix] Protestors have also threatened to boycott popular Singaporean products in an effort to force the Singaporean government to engage Myanmar politically.[xx] In Thailand, student-led protestors have threatened to boycott business deemed "pro-government", reflecting their concern over the current political situation.[xxi] Accordingly, asset owners should understand the political and human rights landscape of the jurisdictions in which they invest and consider the action, or inaction, of investee companies and management teams to appropriately assess and address social risk.
Across the Asia-Pacific region as a whole, the International Labour Organisation (ILO) estimates that 7.4 per cent of children are labourers and approximately 17 million people are in forced labour.[xxii] In addition, labour legislation in some countries imposes considerable restraints on the rights of all workers to organise, bargain collectively or strike, and millions of people suffer from work-related discrimination due to gender, race, religion and other factors.
In particular, Myanmar, Cambodia, the Philippines and Laos rank comparatively high on vulnerability to modern slavery issues, including forced labour.[xxiii] Research has identified specific products as being particularly at risk of forced labour, including bricks, garments, fish, rice and electronics from certain Southeast Asian countries.[xxiv] Given the region's importance as a manufacturing hub, forced labour risk assessment is relevant for investments in the manufacturing industry generally but also in any company operating along the supply chain for these products.
In the late 1990s, weak corporate governance practices in Southeast Asia deepened and prolonged the impacts of the Asian Financial Crisis.[xxv] Since then, governments and regulators have strengthened corporate governance practices by introducing and enacting principles, codes and regulations relating to corporate behaviour and directors' duties. The situation has markedly improved in many Southeast Asian countries but asset owners should note that risks related to bribery and corruption, as well as board composition and capacities, may still be more pronounced here than in other parts of the world.
Bribery and Corruption
Bribery and corruption issues are particularly salient in Southeast Asia, where a majority of ASEAN nations rank in the bottom half of Transparency International's Corruption Practices Index 2020.[xxvi] Importantly, these issues may present themselves in circumstances unique to the cultural, political and economic context of each country, region and industry.
For example, the potential for bribery relating to smaller groups of political party leaders has been identified as a key risk in Malaysia, while patron-client relationships between individual government officials and businesses may be cause for concern in the Philippines, Indonesia and Thailand.[xxvii] In all cases, bribery and corruption issues may be more prevalent in regulated industries involving frequent interaction with government officials.
Board Composition and Capacities
Asset owners should be aware that corporate boards, particularly at the SME level, may lack the composition and some governance capacities that are expected in other regions. Corporate boards in Southeast Asia are often marked by the concentrated ownership of the company by a single family or a government entity as well as a general lack of diversity.[xxviii] These structures create the potential for conflicts of interest and opaque decision-making processes which can complicate ESG reporting practices.
Additionally, boards may generally lack governance maturity, role clarity, international experience, sustainability knowledge and the understanding and application of Key Performance Indicators (KPIs).[xxix] In these cases, asset owners should carefully scrutinise corporate boards and consider options to leverage an investment to improve processes where appropriate.
At a high level, ESG risk mitigation techniques are similar to more traditional financial risk mitigation tools. In public markets, investors may rely on their own internal analysis of public company disclosures while investors in private markets may undertake comprehensive due diligence investigations of potential investments and address or allocate risk accordingly in related investment documents. Key differences arise, however, when examining the tools available to obtain information relevant to the investment and the detailed approaches investors may take with respect to individual ESG issues.
In public markets, investors often address ESG issues through the use and analysis of ESG-related information disclosed by securities issuers, either voluntarily or in compliance with mandatory reporting regimes. The leading voluntary disclosure frameworks are issued by the Global Reporting Initiative, Sustainability Accounting Standards Board, Climate Disclosure Standards Board, International Integrated Reporting Council, Carbon Disclosure Project and Task Force on Climate-related Financial Disclosures. Companies may apply any one or more of these frameworks to their ESG reporting processes. Importantly, these frameworks each approach ESG disclosure differently, and they may not cover all of the risks identified in this article or that may otherwise be relevant to a given investor. When relying on voluntary ESG disclosures to assess an investment in Southeast Asia, investors should be careful to understand the different frameworks that might apply to relevant disclosures and obtain and assess a range of disclosed information. It is important to focus on information that is comparable across relevant companies and industries wherever possible.
The public disclosure process is more streamlined in some jurisdictions, including Hong Kong and Singapore, where securities exchanges require issuers to disclose ESG information through their listing rules. For example, companies listed on the Hong Kong Stock Exchange are required to disclose a range of specific ESG data on a "comply or explain" basis, including tonnes and intensity of Scope 2 GHG emissions and policies related to compliance with labour standards.[xxx] Generally, companies listed on the Singapore Exchange (SGX) have more leeway to determine what information to disclose on a "comply or explain" basis but SGX directs issuers to many of the voluntary frameworks listed above and the Roundtable on Sustainable Palm Oil for reference.[xxxi]
Once obtained and analysed, investors may most easily integrate ESG factors into public market investment processes through negative screening procedures. For example, an asset owner might determine a cap on the Scope 2 GHG emissions it is willing to accept for any of its portfolio companies based on the average CO2 intensity across Southeast Asia discussed above. That investor could, wherever data is made available on either a voluntary or mandatory basis, relatively quickly determine if a public company meets that threshold. If that company exceeds the applicable threshold, the investor would "screen" the company and would not invest in it.
The range of approaches to ESG issues is predictably more variable in private markets where buyers and sellers have more leeway to structure the investment process and negotiate the terms of a deal. In particular, private investors may integrate ESG factors into due diligence processes through questionnaires and in-depth diligence investigations (for example, regarding human rights and labour issues) to better assess ESG risks at an early stage. Best-in-class companies go well beyond a "check-the-box" approach to the diligence process and actively engage with investee companies.
In Southeast Asia, however, the variety of economies, cultures and natural environments means it can be critical to rely on local expertise to fully understand and engage private companies on certain ESG issues. For example, in some industries, bribery and corruption issues may be endemic in ways that are not readily apparent to an outsider but are well understood by those fluent in local customs. In many cases, investors benefit from engaging local experts on these issues to undertake on-the-ground investigations and help tailor questionnaires and reports to reflect local considerations.
Later in the investment process, investors may reflect ESG considerations in the investment documentation through representations and warranties, covenants, and conditions. At a minimum, investee companies may be required to warrant compliance with applicable laws including those regarding labour and environmental standards, anti-bribery, and anti-corruption. Covenants might oblige the investee company to adopt specific human rights or environmental policies and implement post-completion ESG auditing and reporting processes. Where governance-related risks are present in a closely held corporation, investors might require the appointment of an independent director with oversight over related-party transactions as a condition to completion. These private market investment processes are often costly but ultimately provide the investor with a greater ability to identify, assess and mitigate ESG risks.
All regions of the world present significant ESG-related risks that are material for investment decisions. In Southeast Asia, the risks relevant to any asset owner could range from biodiversity to bribery and anything in between. Thankfully, there are a range of options to mitigate these risks and take advantage of the significant ESG-related opportunities that this exciting and dynamic region presents.
[i] G. Iacurci, CNBC, "Money invested in ESG funds more than doubles in a year" (11 February 2021), available at: https://www.cnbc.com/2021/02/11/sustainable-investment-funds-more-than-doubled-in-2020-.html.
[ii] OECD (2021), "Economic Outlook for Southeast Asia, China and India 2021: Reallocating Resources for Digitalisation", OECD Publishing, Paris, p. 24, available at: https://doi.org/10.1787/711629f8-en.
[iv] United Nations University Institute of Advanced Studies, et. al., "Climate and Human-Related Drivers of Biodiversity Decline in Southeast Asia" (2010) (UNU-IAS Report), p. 30, available at: https://i.unu.edu/media/ourworld.unu.edu-en/article/3876/UNU-IAS-Climate-e-ver.pdf.
[v] UNU-IAS Report, p. 14.
[vi] IEA, "Electricity Market Report – December 2020" (December 2020), p. 70, available at: https://www.iea.org/reports/electricity-market-report-december-2020.
[vii] IEA, "Composition of CO2 emissions and emission intensity in 2020" (11 December 2020), available at: https://www.iea.org/data-and-statistics/charts/composition-of-co2-emissions-and-emission-intensity-in-2020.
[viii] UNU-IAS Report, pp. 14, 17.
[ix] A. Hughes, "Understanding the drivers of Southeast Asian biodiversity loss" (6 January 2017), Ecosphere 8(1), available at: https://esajournals.onlinelibrary.wiley.com/doi/abs/10.1002/ecs2.1624.
[x] Hughes, p. 2.
[xi] UNU-IAS Report, p. 21.
[xii] Hughes, p. 10.
[xiii] Hughes, pp. 10-11.
[xiv] Hughes, p. 11.
[xv] IPCC, 2014: Climate Change 2014: Impacts, Adaptation, and Vulnerability. Part B: Regional Aspects. Contribution of Working Group II to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change [Barros, V.R., C.B. Field, D.J. Dokken, M.D. Mastrandrea, K.J. Mach, T.E. Bilir, M. Chatterjee, K.L. Ebi, Y.O. Estrada, R.C. Genova, B. Girma, E.S. Kissel, A.N. Levy, S. MacCracken, P.R. Mastrandrea, and L.L.White (eds.)] (IPCC AR5). Cambridge University Press, Cambridge, United Kingdom and New York, NY, USA, p. 1333, available at: https://www.ipcc.ch/report/ar5/wg2/.
[xvi] IPCC AR5, pp. 1330-1331.
[xvii] IPCC AR5, p. 1346.
[xviii] J. Powell, "Coups in the World, 1950-Present" (accessed 23 March 2021), available at: https://www.jonathanmpowell.com/coup-detat-dataset.html.
[xix] Reuters, "Singapore anti-drone firm cuts Myanmar ties after coup" (19 February 2021), available at: https://www.reuters.com/article/us-myanmar-politics-singapore-idUSKBN2AJ0XF.
[xxi] C. Setboonsarng and P. Thepgumpanat, Reuters, "Thai protest boycotts force businesses to pick sides" (26 August 2020), available at: https://www.reuters.com/article/us-thailand-protests-business-analysis-idINKBN25M0X6.
[xxii] ILO, "Bali Declaration Policy Brief No. 9" (2018), available at: https://www.ilo.org/asia/publications/issue-briefs/WCMS_613509/lang--en/index.htm.
[xxiii] Walk Free Foundation, "Global Slavery Index 2018" (2018), p. 89, available at: https://www.globalslaveryindex.org/resources/downloads/.
[xxiv] Id., p. 103.
[xxv] N. Wijayati, N. Hermes and R.. Holzhacker, "Corporate Governance and Corruption: A Comparative Study of Southeast Asia" (January 2016), p. 264, available at: https://www.researchgate.net/publication/294470236_Corporate_Governance_and_Corruption_A_Comparative_Study_of_Southeast_Asia.
[xxvi] Transparency International, "Corruption Perceptions Index" (accessed 23 March 2021), available at: https://www.transparency.org/en/cpi/2020/index/nzl.
[xxvii] O. Hellmann, " The historical origins of corruption in the developing world: a comparative analysis of East Asia" (13 January 2017), Crime, Law and Social Change, available at: https://link.springer.com/article/10.1007/s10611-016-9679-6.
[xxviii] Center for Creative Leadership, "BOLD 3.0: Future-Fluent Board Leadership in Asia" (2010), pp. 16, 19-20, available at: https://www.sid.org.sg/images/PDFs/Resources/bold-3-future-fluent-board-leadership-in-asia-report-ccl.pdf.
[xxix] Id. pp. 19-20.
[xxx] HKEX Main Board Listing Rules, Appendix 17: Environmental, Social and Governance Reporting Guide, available at: https://en-rules.hkex.com.hk/rulebook/environmental-social-and-governance-reporting-guide-0.
[xxxi] SGX, Sustainability Reporting, available at: https://www.sgx.com/regulation/sustainability-reporting.
Alexander W. Burdulia is a Registered Foreign Lawyer in the Corporate & Securities practice in Mayer Brown's Hong Kong office. He advises asset managers and other investors, corporations and financial institutions in a variety of corporate and commercial matters including private equity and venture capital investments and financings, investment fund matters and cross-border mergers, acquisitions and joint ventures. Alex is a key contact point for the ESG Initiative within the Mayer Brown network and a founding member of the Firm’s ESG Steering Committee. He has advised impact investors in investment transactions and is experienced in ESG reporting, policies and governance structures. He was responsible for sustainable finance regulatory and advocacy matters while serving as the Head of APAC Public Policy on secondment at a leading international bank and is both a GRI Certified Sustainability Professional and SASB FSA Credential Holder. Alex is a frequent author on ESG-related topics.
Mark Uhrynuk is a partner of Mayer Brown resident in the Hong Kong office. Mark represents assets managers, family offices and other investor groups, corporations, and financial institutions in a variety of transactional matters. His wide-ranging experience includes private equity and venture capital investment and related financings; cross-border mergers, acquisitions, divestitures, joint ventures and strategic alliances; investment fund matters, including the formation of private equity, infrastructure and real estate funds; and international equity and debt capital markets transactions. Mark is a key contact point for the ESG Initiative within the Mayer Brown network and is a founding member of the Firm’s ESG Steering Committee. Mark also co-leads the Firm’s Family Office Initiative in the region. An active thought leader in these fields, Mark has been widely quoted by the leading media and has authored a number of articles and legal updates on these and related topics. Mark is qualified as a lawyer and has practiced law in Hong Kong, New York and England. According to IFLR1000 (2021), clients say “Mark has deep experience in the field. He knows how to get deals done and has years of global practice experience to draw on to ensure we are able to see issues from all sides and pick the best path forward." Mark has been nominated as highly regarded Hong Kong lawyer by IFLR1000 for and Private Equity (2018-2021) and Mergers and Acquisitions (2018-2021).