ESG is poised for take-off in Asia

08 November 2023

Environmental, social, and governance (“ESG”) investing has already matured in Europe, while in Asia, with far lower penetration across the market, the boom years are still ahead. Asian regulators are supporting the trend with a wide range of initiatives and the rewards will be worthwhile for those asset managers that can navigate them successfully.

ESG has been one of the strongest investment trends in Europe over the past decade and it is starting to gain real momentum in leading Asian financial centres. But while the European Union (“EU”) ensures national regulators follow a unified approach across the bloc, Asian countries are taking increasingly divergent approaches.

There is a huge amount of room for ESG to grow in Asia, even for it just to catch up. In Europe, sustainable funds’ assets under management (“AUM”) exceeded $2trn in the final quarter of last year while the figure for Japan was just $25bn and for the rest of Asia combined was $51bn (Statistica, 2023). But in Europe, market penetration has already reached 30% while in Asia it only accounts for 3%, so there is still clearly a long way to go (Invesco, 2023).

The giddy growth phase of ESG may be plateauing in Europe; a tempering of new flows was inevitable after years of breath-taking growth. However, while tightening regulation and bumper returns from the non-ESG oil sector have created substantial turbulence in asset flows, its long-term outlook seems secure.

ESG flows have been tempered since the EU imposed the Sustainable Finance Disclosure Regulation (“SFDR”) in 2021, differentiating Article 8 funds, with weak sustainability credentials, from more impactful Article 9 funds. However, weaker overall flows obscure the strengthening of commitment to making ESG impacts. In the second quarter, 60% of redemptions from all funds were from Article 8 funds while Article 9 funds continued to receive inflows (Reuters, 2023). Only the froth has been removed from the market, while serious investors remain.

Meanwhile, there are clear signs that ESG activity is growing in Asia. In Q2 2023, China-domiciled sustainable funds experienced $1.66 billion in inflows, while Asia ex-Japan and ex-China recorded net inflows of roughly $322 million over the third quarter, led by Singapore and South Korea (Morningstar, 2023).

ESG is also increasingly important in private markets. In a recent Bain & Company survey for their Asia-Pacific Private Equity Report, 50% of the general partners planned to significantly increase their focus on ESG over the next three to five years, up from 30% three years ago (Bain & Company, 2023). The survey also found that ESG was important in decision making, with 60% of investment in the energy and natural resources sector being made in utilities and renewables.

Regulatory support

Tighter regulation, including a clampdown on greenwashing, is leading to a mature ESG sector, providing investors with far greater confidence that the capital they deploy will have the impacts they expect. There’s much to learn from Europe’s earlier regulatory challenges and create a robust regulatory system ahead of vast amounts of money being invested.

EU initiatives such as SFDR, the Corporate Sustainability Reporting Directive, and its taxonomy have, however, paved the way, providing benchmarks to guide Asian regulators as they develop and adapt rules to suit their specific needs.

Several countries are embracing a combination of mandatory and voluntary regulations. Singapore, Japan, and China are at the forefront of this movement and are achieving substantial regulatory momentum.

China is taking steps which align with the EU through its Common Ground Taxonomy. Japan is undergoing a shift towards mandatory disclosure which encompasses climate risks, and ESG funds. Singapore stands out with a robust and comprehensive ESG regulatory environment, positioning itself as a progressive green financial hub. Beyond these leaders, nations such as Korea and Thailand have also introduced their own regulations, including sustainable taxonomies.

Eugenie Shen, MD, and head of ASIFMA’s asset management group, pointed out recently that while the EU is motivated by promoting sustainable investment, Asian regulators are more concerned about risk management (Reuters, 2023). For example, the Monetary Authority of Singapore launched guidelines for environmental risk management and greenwashing while Hong Kong has restricted its regulations narrowly to climate-related risks.

While the development of sustainable investing regulations is welcomed in Asia, its pathway is also throwing up challenges. The growth of AUM in Europe was facilitated by consistent rules, however imperfect, across the block. Asset managers operating in Asia with cross-border strategies could find themselves subject to multiple regulatory classification regimes, with data reported in multiple ways that are not readily compatible.

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