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April 11, 2006

New Analysis of Sustainability Risks and Opportunities in Developing Asian Markets
    by Bill Baue

New report from ASrIA and IFC seeks to bring consideration of environmental, social, and governance factors into investment decisions in developing Asian markets.

SocialFunds.com -- Integrating environmental, social, and governance (ESG) issues with the investment decision process in developing Asian markets recently took a 288-page step forward toward. That is the length of a new report from the Association for Sustainable and Responsible Investment in Asia (ASrIA), sponsored by the International Finance Corporation (IFC--the private lending arm of the World Bank.) The report notes a significant gap in ESG analysis by investors in developing Asian markets, and seeks to take first steps in filling this gap.

"This analytical gap is striking in view of the fact that Asia is the fastest growing source of sustainability risks globally due to the rapid growth of economic activity in Asia and of associated ESG impacts," writes editor Melissa Brown, executive director of ASrIA, in the introduction. "Indeed, developed market companies increasingly frame their discussion of ESG risks in terms of their activity in Asia."

"Nonetheless, it must be acknowledged that the process for crystallizing risks in terms that Asian capital markets can address is relatively subdued," Ms. Brown states in the report, entitled Taking Stock: Adding Sustainability Variables to Asian Sectoral Analysis.

The report focuses on Asia excluding Japan, in part because Japan is more comparable with developed markets in addressing ESG issues, but primarily because Asia ex-Japan is how investors typically approach the region.

Ms. Brown identifies three dominant issues arising from the research.

"One of the most significant conclusions to emerge from our research is that Asian equity markets will struggle to value ESG issues until both government and corporate disclosure norms are improved," she writes. "In Asian markets . . . there is a persistent gap between legal norms and common enforcement standards which is reinforced by a lack of transparency."

The second main issue is government ownership and control, as the largest Asian companies are effectively quasi-privatized entities and hence less accountable to external stakeholders than public companies. And the third main issue identified by the report is globalization and market development, with the integration of ESG issues throughout the region being largely determined by how they are addressed in China and India, the largest and fastest growing markets.

The rest of the report is broken up into sections devoted to each of eight sectors: auto, banking, energy, metals and mining, power, pulp, paper and timber, supply chain companies, and technology. While each section reads like an independent sector report, they all have common formats, such as addressing "cross-cutting issues," looking at long-term sustainability issues, and including questions for investors to ask companies.

The energy sector report summarizes the challenges faced in the developing Asian markets succinctly.

"Although major oil, gas, and petrochemical (OG&P) firms such as PetroChina, ONGC, PTT, and CNOOC are appropriately considered to be Asian blue chips, they generally are in the early stages of dealing with issues related to sustainability, governance, and responsiveness to broad stakeholder interests," writes Stephen Fleming, the ASrIA researcher who authored this sector report. "As highly visible, highly profitable firms, Asian oils are likely to find themselves unwittingly thrust into roles as sustainability pioneers, taking some of the first arrows as sustainability issues inevitably gain greater prominence in the minds of regulators, consumers, investors, and other stakeholders positioned to influence value returned to shareholders."

This sector report identifies three challenges specific to energy: rapid demand growth, government ownership, and limited disclosure. Increasing privatization will help solve the second challenge, with benefits accruing to shareholders who otherwise lacked control--and this may drive progress on the third challenge, as shareholders demand better disclosure.

However, government regulation may have the opposite effect stifling sustainability progress. For example, the sector report cites a 2003 United Nations Development Program (UNDP) and World Bank study finding that subsidies of kerosene intended to help the very poor in fact transferred wealth to the non-poor. This exemplifies the depth of analysis the sector reports delve into.

The report introduction ends proposing three potential scenarios. First, a struggle between large companies that are best capitalized to integrate ESG factors into their operations and smaller companies whose nimbleness could help them incorporate sustainability practices more efficiently. Second, higher disclosure standards for initial public offerings (IPOs) should drive more awareness of sustainability issues, a trend that could spread market-wide. And third, ASrIA sees ESG factors becoming a new bellwether for assessing country risk in emerging markets, as sustainability issues tend to coincide with the longer-term factors comprising a country-wide assessment.

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