With the world continuing to emerge from Covid-19 lockdowns, cracks in economies, societies, and environmental ambitions are becoming clearer. Looking ahead to the sustainability outlook for 2023 and beyond, the debt legacy from that crisis limits governments’ capacity to continue supporting societies through difficult times.

We’re likely to see more interventions, and businesses will be expected to play a greater role in tackling critical issues, from climate challenges and biodiversity threats to the cost-of-living crises. In short, the future looks like it will play out very differently from the past.

In that context, a fund manager’s active management and ability to adapt investment strategies to the challenges and opportunities ahead will be more important to investment performance than ever.

Sustainability Outlook For 2023: Five Trends To Watch

1. Climate Change And Political Will

First, climate change is an inevitable question. All investors are exposed to the impact, not just of global warming and environmental damage, but of political and economic action to tackle their causes. Investors must make sure any exposures to these risks are contemplated and managed alongside opportunities in solutions to the climate challenge.

At Schroders, we committed to transitioning toward net zero over the coming decades, including setting a Science-Based Target, validated by the Science-Based Targets initiative earlier in 2022. But setting a target is the easy part. How we, and other businesses, decarbonise is critically important to the value we will create for our clients. Our Climate Transition Action Plan outlines our roadmap.

Political momentum slowed in 2022, but importantly the private sector continues to push ahead, helping close some of the gap between the ambitions global leaders have laid out and corporate readiness for transition. In November, the COP27 climate summit in Egypt did little to cement global commitments to action.

That said, agreement on a “loss and damage” fund to help developing nations should ease one key challenge to delivering the changes needed to reach the goals laid out in Paris in 2015. Attention will turn to COP28 in the UAE later in 2023.

Our focus has been on using our voice and influence to engage the most exposed companies and pushing them to lay out transition plans. In the year ahead, we will be intensifying those efforts.

2. Natural Capital

In that context, the role of natural capital and wider biodiversity threats are central. Climate threats are symptomatic of the structural and growing tensions between escalating demand from a larger, wealthier and hungrier global population and the world’s finite resources to support that population.

Today we use resources equivalent to those provided by 1.7 Earths every year, pushing us further into natural capital deficit and intensifying the threats degrading global ecosystems create. By some estimates, roughly $10 trillion of natural capital value is lost every year, underlining the hidden liabilities building in the global economy.

The reality is stark: nature risk is fast becoming an integral factor to investment risk and returns. That’s why we released our first company-wide Plan for Nature in late 2022, drawing together our action to date and setting a future direction for the action we are taking to tackle the causes and implications of nature loss.

3. Cost Of Living And Other Social Stresses

At a human level, a cost-of-living crisis has taken a grip in many countries, and while the most acute pressures may abate in 2023, poverty is a threat we will be monitoring. Few governments have the fiscal capacity to absorb shortfalls in household budgets, and social stresses could intensify.

Companies are coming under pressure to protect vulnerable workers – whether through wage increases and benefits for their employees or their responsibility to workers in supply chains.

We could see greater pressure on the political systems. This could undermine investors’ faith that political leadership will clearly define priorities, pushing responsibility back to companies and investors like ourselves. While climate change and nature have dominated headlines, particularly in the run-up to COP27 and COP15, we expect a bigger focus on social issues, including human capital management, human rights and diversity and inclusion in the new year. These are core themes for active ownership for us at Schroders.

4. Active Ownership And Impact

As the forces shaping value in financial markets multiply, stock-picking will be only a partial solution. Our ability to engage with the companies and assets in which we have invested will be a critical lever and a necessary one to create value for our clients.

Few companies are prepared for the world we are heading toward, and encouraging or pushing them to adapt will be important to protect their value. We published our Engagement Blueprint early in 2022, laying out our expectations of the companies we invest in and plan to build on that foundation in the future.

As our focus on impact investing continues to grow, active ownership will also be an important component of those strategies. Our survey of more than 700 institutional investors in 2022 found that around half (48%) are focusing on the impact of their investments, up from about a third (34%) in 2020. We expect that trend to continue.

5. Regulation

These trends are playing out against a backdrop of an industry under more intense scrutiny and scepticism than ever. Regulation is spreading from the EU to other parts of the world, and demands for transparency and clarity in product promises are rightly likely to increase.

Greenwashing headlines have underlined the importance of transparency; the antidote is honesty, transparency and consistency. For example, ahead of COP15, we’ve signed Business for Nature’s Make it Mandatory campaign, calling on mandatory disclosure for all large businesses and financial institutions of nature-related impacts and dependencies from 2030.

We are determined to help our clients navigate our investment products and understand what they can expect from different strategies.

Conclusion

For those of us focused on sustainability in the investment industry, the last few years have felt incredibly busy.
Keeping up with the scale and pace of regulatory change has been challenging enough. Developing the analysis and the models and adapting our engagement with portfolio companies to reflect our deepening understanding of the implications of structural social and environmental trends in the expanding volume of ESG data all add to those demands.

None of this will change in 2023, and there you go with the sustainability outlook for 2023.

Andy Howard is the global head of Sustainable Investment at Schroders.

Anything to do with ESG (environmental, social and governance) has become a trending hot topic these days, and its adoption rate is faster than ever. With more than nine out of ten publicly-listed companies adopting ESG as part of their goals and business plans, its popularity is more than just a buzzword in the industry. Some of the ESG benefits are higher returns on investment, better financial performance, and reduced business risks.

Smart Investor spoke to Datuk Wira Ismitz Matthew De Alwis, executive director & Chief Executive Officer at Kenanga Investors Berhad; Dr Sumitra Nair, head & senior vice president of Strategy & Policy at Malaysia Digital
Economy Corporation (MDEC), and Azzahraa Annuar, director of Governance, Risk & Compliance at edotco Group to get a deeper understanding about ESG and ESG benefits.

This includes exploring the impact of an ESG focus to their business and industry, what makes for a successful ESG deployment, the challenges they have faced, and the trends to look out for. While we all know what ESG stands for, what it means, and what are the ESG benefits could be entirely different for each industry.

We got the ball rolling by asking, “Why is it important to your business, and how does ESG impact your industry?”

Read: The Islamic Sustainability Approach In ESG

ESG Impact

To which Datuk Wira Ismitz Matthew De Alwis answered “The impact of ESG on the financial markets has been significant. Investors and businesses alike are beginning to acknowledge that an ESG-driven perspective promises stronger and more resilient economies and businesses. As a result, this awareness has changed the way individuals and institutions invest. For example, many are now focusing on mitigating their portfolio exposures to carbon risk.”

“As a partner to the sustainability agenda, we are dedicated to the goal of developing Malaysia’s impact investing landscape. Currently, we believe that the local environment faces issues in capacity building to address sustainability issues such as lack of competencies, skills, and technical awareness on ways to adopt a sustainability-driven top-down model at each level of the organisation. Recognising this, Kenanga Investors, as an established financial institution, must actively seek out and collaborate with regulators and other corporate entities finding its footing within the local green economy,” De Alwis added.

To ensure sustainable performance for Kenanga Investors’ stakeholders, they are confident that the integration of
carbon exposures, ESG ratings, financial quality metrics and active engagements, amongst other factors, in a diversified and risk-controlled portfolio has historically resulted in better risk-adjusted returns for investors than just plainly investing in a broad market index.

Adding to that, Dr Sumitra Nair is of the opinion that “ESG is about carrying out business in a way that is respectful to people and the planet, and about generating profits ethically. This is important to ensure that businesses can carry out their operations in a sustainable manner. For example, operations of a business could
be impacted by climate-related risks, or governance related risks, hence impacting business continuity.”

A sustainable business model also improves productivity by uplifting employee motivation and loyalty, and boosting talent attraction and retention. There is also increasingly strong evidence of a connection between
good corporate practices and financial performance – an ethics premium.

According to Ethisphere’s Ethics Index, the world’s most ethical companies outperform a comparable index of companies by 24.6% from January 2017 to January 2022.

The Global e-Sustainability Initiative (GeSI)’s ‘Digital with a Purpose: Delivering a SMARTer 2030’ report estimates that digital tech can directly influence 103 out of 169 UN Sustainable Development Goals (UN SDG) targets. The same report has identified key technologies that have the highest potential influence on the world, and more specifically on the UN SDGs.

These include high speed internet, cloud computing, internet-of-things, machine learning, AI, digital reality and blockchain. Such technologies can help to reduce environmental impacts, as well as narrow socio-economic disparities, which strengthen transparency and governance.

For example, from an environmental perspective, the effective use of digital technologies is projected to reduce global Green House Gas emissions by 15% by 2030, which translates to one third of the global 50% target reduction. This is mainly using digital tech solutions in the energy, manufacturing, agriculture and land use, buildings, services, transportation, and traffic management.

“Therefore, the digital tech ecosystem plays a very significant role in the agenda of ESG in Malaysia. It is also very
much aligned to the recently launched national strategic initiative, Malaysia Digital (MD), which seeks to increase
the overall ecosystem value sustainably,” shared Dr Sumitra Nair.

Meanwhile Azzahraa Annuar has said: “It is not about what ESG means to me, but it is about what ESG means to us. At edotco, ESG is central to how we do our business from planning to execution. To be a sustainable business, we believe that a strong governance is key to ensure our business is run in the most equitable manner.”

To edotco, their belief is that internet connectivity should be viewed as part of a human right in today’s world. As such, they are passionate when it comes to taking care of the communities around their towers and even more passionate when it comes to their greatest asset, that is their people.

They will continue to invest in innovation as innovation is the key to net zero emissions. Each component of ESG with the E, the S and the G are equally important and must be addressed together as one, and not separately.

Read: ESG Investing And The 3 Steps To Build An ESG Portfolio

What Are The Key Factors For Successful ESG Deployment?

It’s all fine and well to talk about ESG benefits, hopes and dreams and plans, but how do we ensure a successful implementation of these policies and intentions?

De Alwis shared: “We believe that there are a few critical factors required for a successful ESG implementation. To begin, a supportive and knowledgeable board is critical in steering the company’s ESG agenda as well as building the appropriate corporate culture, which leads to effective ESG implementation. Furthermore, the ESG goals must not only be specified, but also time-bound and practical during the implementation process. Policies, plans, and oversight mechanisms must address these issues both qualitatively and quantitatively.”

Kenanga Investors believe that the continuous delivery of consistent top performance stems from the premise of
an effective stewardship and active ownership approach throughout the investment value chain. In search of long-term value accretive investments, they aim to influence investee companies as shareholders through the
promotion of responsible and sustainable practices.

Nair has four key factors for successful deployment of ESG in Malaysia:

1. Leadership commitment is key

ESG must be driven from the top, ideally from the Board, top management and across the organisation.

2. ESG culture and mindset

ESG should be seen as a way of doing business, rather than a separate function or set of responsibilities.

3. Taking a longer-term perspective of business performance

The over-emphasis on short-term gains may impact a company’s ability to manage its ESG risks which may manifest in the longer term. For example, the focus on cutting costs in the short-term may result in non-eco-friendly or non-ethical purchasing decisions.

4. Measuring and managing ESG impact

As the saying goes, “what gets measured, gets done”. Similarly, defining and tracking ESG performance metrics is key to managing ESG impacts.

For Annuar, it is all about the culture. “At edotco, we believe in the mind, the heart, and the hands. This means, we inculcate the culture of a sustainable world for the future, for the next generation in the minds of our people. We hire passionate individuals who fit within edotco’s culture and core values to ensure our people have the heart of edotco. And finally, when we build our towers, our products, we continue to innovate for best possible output.”

Read: Reevaluating ESG And Cryptocurrency In The Context Of Modern Money

What Are The ESG Challenges?

These intentions are not without its challenges. According to De Alwis, the lack of knowledge and comprehension of ESG among our retail investors in Malaysia was one of the hurdles that they faced in implementing their ESG objectives and ESG benefits. Businesses also lacked transparency and reliability when it came to ESG data and disclosure.

Furthermore, when it comes to ESG practises, there is a lack of consistent standards, measurements, and focus as
some may focus on climate change, whilst others may focus and emphasise on human rights issues.

With MDEC’s ESG focus this year starting with a highlight on climate change (which has been globally acknowledged as one of the most critical issues of our time), MDEC has also recently launched the Malaysia Digital
Climate Action Pledge (MDCAP), which aims to galvanise digital tech companies to commit to specific actions addressing climate change, and to support the decarbonisation of SMEs.

“At the same time, MDEC with our partners such as the UN Global Compact Malaysia and Brunei (UNGCMYB) will provide guidance and know-how to the digital economy ecosystem via a Digital Economy Climate Playbook, and training programmes,” shared Nair.

These initial efforts are tailored to address some of the key success factors MDEC has identified in their journey to
encourage digital companies in Malaysia to adopt ESG practices and reap the ESG benefits.

These include:

1. Raising the level of awareness and understanding about ESG amongst digital businesses;

2. Access to resources to address ESG risks and compliance – for example funding, talent, etc;

3. Encouraging digital tech companies to create shared value through opportunities arising from ESG trends – for example, via digital innovations/solutions that help governments, businesses, or society to achieve ESG-related targets and the many ESG benefits.

For edotco, Annuar discloses their two key challenges: “Firstly, macroeconomic challenges mean cost pressure continues to be central. We need to ensure we deliver a strong return for our shareholders amidst such a challenging environment. Our supply chain is struggling, the communities around our towers are struggling. This impacts our operations tremendously. Nevertheless, our engineers continue to innovate, and we manage to come up with LCS i.e., a low-cost structure in a country like Bangladesh.”

“Secondly, whilst we are certain with our Scope 1 and Scope 2, we are still struggling with Scope 3. This will be an
area of focus for edotco in 2023 to ensure our carbon emission calculations are based on international standards
and continue to be validated independently. We will also be reviewing our supply chain as part of this initiative,” she added.

Read: Driving The Development Of ESG With Sukuk

Key ESG Trends To Look Out For

We have to look forward. So, saving the best for last, we ask our experts: “What are the key trends you see gaining traction for ESG? What are the areas of growth amongst the pillars to look at in 2023?”

De Alwis responded with, “During the COVID-19 pandemic, there was a significant increase in ESG awareness. During this period, many firms suffered financially, whilst others with ESG policies were more protected from the
pandemic’s consequences and were able to outperform their peers and competitors.”

As ESG awareness continues to grow, trends within the ESG economy increases in tandem as well, most notably is impact investing. Finally, we will be able to reap the ESG benefits.

ESG Benefits

“This was apparent in the deployment of financial firepower to investments and causes that could provide quantifiable ESG benefits, allowing investors to see and measure the beneficial effects of their investment,” he added.

There is currently a significant trend in assuring the interconnectedness of human and developmental needs. Assuring that these needs are fulfilled in a way that ESG benefits society while being environmentally and ecologically sustainable is a delicate balance. The blue economy and nature-based infrastructure are two examples of this.

For Dr. Nair, climate change is an immensely important topic – one that has been gaining traction for the past ten
years.

“It is evident from the World Economic Forum’s Global Risk Report that climate action failure and extreme weather conditions dictate global risk factors,” she said.

MDEC took a proactive approach to launch the MDCAP initiative to advocate climate action amongst the digital economy ecosystems. Besides, social factors such as forced labour and the livelihood crises of the B40 group have also gained a strong pull for ESG in Malaysia.

In 2023, we can expect other areas of the environmental pillar to grow, such as the carbon market, carbon tax and carbon offsetting, which involves carbon capture, storage, and sequestration activities. Regarding the social pillar, the topic of diversity and inclusion in the workplace is growing in prominence, be it gender, age, ethnicity, or other forms of diversity.

Finally, Annuar points out that ESG is not a one size fits all around the globe. It varies for different economies and
markets.

“It depends on which side of the world you are in. In developed markets, the focus is more on the governance aspect. In developing markets, the focus is more on the environmental aspects, while in the underdeveloped markets, the focus is more on the social aspects.”

For edotco, they have done independent reviews to see what are the areas that they need to focus on including
materiality assessment. They will continue to focus on strengthening every pillar because they believe that all three are equally important.