IFC Advisory Services in Sustainable Business 62637 The State of Sustainable Investment in Key Emerging Markets SYNTHESIS REPORT May 2011 In partnership with Canada, Ireland, Italy, Luxembourg, Norway, South Africa, the Netherlands, and the United States Copyright© 2011 International Finance Corporation 2121 Pennsylvania Avenue, N.W. Washington, D.C. 20433 All rights reserved. ABOUT IFC IFC, a member of the World Bank Group, is the largest global development institution focused on the private sector in developing countries. IFC creates opportunity for people to escape poverty and improve their lives by providing financing to help businesses employ more people and supply essential services, by mobilizing capital from others, and by delivering advisory services to ensure sustainable development. In a time of global economic uncertainty, IFC’s new investments climbed to a record $18 billion in fiscal year 2010. For more information, visit www.ifc.org . ABOUT ILLAC A signatory to the UN Principles of Responsible Investment (UN PRI), ILLAC is a research and advisory services firm with a social mission, incorporated in London in 2001. ILLAC is specialized in corporate governance and sustainability with a focus on emerging markets and Turkey specifically. ILLAC undertakes voluntary not-for-profit projects, as well as commercial assignments, with the objective of helping the advancement of governance frameworks and practices in emerging markets. Please direct questions and comments to info@illac.com. THE AUTHORS Melsa Ararat is director of the Corporate Governance Forum of Turkey, director of the Carbon Disclosure Project- Turkey, a professor of management at Sabanci University’s Faculty of Management, and the founder of ILLAC Ltd. (UK) and Logos Asset Management (Turkey). (melsaararat@sabanciuniv.edu and melsaararat@illac.com) Esra Suel is a PhD student at the Imperial College and a consultant at ILLAC. (e.suel10@imperial.ac.uk and esrasuel@illac.com) 2 The State of Sustainable Investment in Key Emerging Markets INTRODUCTION To support the growth of sustainable capital flows, IFC’s processes. The six reports primarily investigate sustainable Advisory Services team seeks to influence, support, and enable investments through the supply of financial capital to capital allocation and portfolio management processes, using publicly listed firms in the form of equity investments IFC’s own investment practices as a model. IFC is playing its through the stock markets, using strategies that incorporate part in supporting the growth of the market by funding the environmental, social, and governance (ESG) risks into the development of enhanced stock market indices and financial investment process, with a long-term perspective. These instruments and through targeted market research. investments can be purposefully ESG-inclusive and marketed as such (theme-based or labelled), or they can include ESG Compiling data on the state of development of the sustainable factors somehow in the processes without explicitly referring investment (SI) industry is important for global investors to sustainability-related factors. and investment managers seeking to understand the scale and location of opportunities in the market for sustainable The reports also consider the supply of financial capital in investment products. Although a number of organizations various classes and forms to listed and privately held firms provide this information in developed economies, such data with a consideration of the investment’s impact on economic are scarcely available in emerging markets (EM). and social development or on investors’ values. IFC thus launched a series of sustainable investment country The data are based on end of 2008 figures for Brazil and reports covering major emerging capital markets attracting India and end of 2009 figures for South Africa, Turkey, and global portfolio investors: Brazil, India, China, Sub-Saharan the Middle East and North Africa (MENA). The key markets Africa, the Middle East and North Africa (MENA), and Turkey. covered—India, China (excluding Hong Kong), Turkey, and South Africa—constituted 51 percent of the MSCI Emerging “The State of Sustainable Investment in Key Emerging Markets Index at the end of 2009. Markets” provides a snapshot of the findings of these country reports and seeks to identify common themes and trends TABLE 1: MARKETS COVERED BY IFC’S COUNTRY REPORTS ON across and highlight crucial differences among these markets. SUSTAINABLE INVESTMENTS The report is intended as a summary and the actual country reports themselves would provide a fuller picture of the state EMERGING MARKETS FRONTIER MARKETS of sustainable investing in each market. While this report Brazil Kenya(SA) seeks to capture the findings from the individual reports it does not reflect specific input from the authors themselves. India Nigeria(SA) Equally the synthesis and analysis reflects the thoughts of the China Bahrain(MENA) author of this report not of the individual country reports. Turkey Kuwait(MENA) Although the country reports have a similar content, there are South Africa Lebanon(MENA) differences among them that reflect the authors’ style, their Egypt(MENA) Oman(MENA) analytical approach, and the unique attributes of the markets Morocco(MENA) Qatar(MENA) covered. In general, the authors have defined sustainable Tunisia(MENA) investments as investments that incorporate environmental (E), social(S) and governance (G) factors into the investment United Arab Emirates(MENA) The State of Sustainable Investment in Key Emerging Markets 3 OVERVIEW SI trends in emerging markets have to be understood in the wider context of the countries’ overall economic and sustainable development. We present a summary of key macroeconomic indicators for the countries covered in table 2 and stock market indicators in table 3 below. TABLE 2: MACROECONOMIC INDICATORS FOR KEY EMERGING MARKETS Country GDP GDP GDP per Growth Projected Unem- Popula- Popula- Gross Current FDI FDI Rank Capita Rate Growth ployment tion tion Account of Real Rate Balance GDP (%) (%) (%) 2009 2015 Do- Inflows (%) mestic Savings (%) Brazil 1,574.04 9 8,220.36 4.7 4.69 8.1 191.48 231.89 16.15 -1.54 25.948 1.65 China 4,984.73 2 3,734.61 10.8 9.66 4.3 1,334.74 1,453.12 54.17 5.96 78.193 1.57 India 1,236.94 4 1,031.59 8.41 7.15 10.7 1,199.06 1,396.05 29.84 -2.88 34.577 2.64 South 276.77 25 5,684.68 24.301 49.32 52.979 18.58 -3.97 5.354 1.88 Africa Turkey 614.466 16 8,711.16 6 4.47 14.03 70.54 83.57 13.68 -2.27 7.955 1.29 Notes: GDP is in current prices ($ billion), GDP per capita is in current prices (USD), the growth rate of real GDP is the average of the growth rates between 2004-2008, the projected growth rate is based on the average of the projections from 2010 to 2015, Unemployment is expressed as % of total labor force, Population is in million. Gross domestic savings are expressed as % of GDP. Imports and Exports are in from the IMF (Figures for India reflect 2008 data), Balance of Payments Statistics Yearbook and they are expressed in current $ million. FDI inflows are in $ million and FDI in % is expressed as a fraction of GDP. Source: All data are from the World Development Indicators (September 2010) and International Monetary Fund, World Economic Outlook Database (October 2010). TABLE 3: STOCK MARKET INDICATORS FOR KEY EMERGING MARKETS Stock Market Since Number Stock Market Number of Listed Stock Market of Listed Capitalization Companies-Jan. Capitalization Companies ($ Millions) 2011 ($ Millions)-Jan. 2011 Brazil BM & FBOVESPA (2009) 1890 386 1,337,248 373 1,476,951 China Shanghai SE (2009) 1891 870 2,704,778 899 2,724,037 China Shenzhen SE (2009) 1990 830 868,374 1,195 1,233,101 India Bombay SE (2009) 1875 4,955 1,306,520 5,047 1,436,567 India National Stock Exchange India 1992 1,453 1,224,806 1,558 1,403,069 (2009) South Africa Johannesburg Securities Exchange 1887 885 746,000 395 841,143 (2010) Turkey Istanbul SE (2009) 1986 325 233,997 340 282,852 Egypt Cairo Stock Exchange Market 1883 220 75,212 228 69,661 (2010) Morocco Casablanca Stock Exchange (2010) 1929 73 60,468 74 69,885 Source: Compiled from IFC’s Sustainable Investment country reports (2009-2010) 4 The State of Sustainable Investment in Key Emerging Markets The markets covered also exhibit differences with respect to The markets further differ with respect to their sustainability regulatory interventions in promoting SI, acceptance of global challenges. Using the authors’ observations of and insight into frameworks and norms, level of law enforcement, and voluntary individual markets, three risk areas stand out as cross-cutting themes disclosure (see table 4 below). across all of the countries; water sanitation, climate change adaption, and labor rights. These are followed by water scarcity, air quality, human rights, poverty, corruption, disclosure, and corporate ethics TABLE 4: VOLUNTARY DISCLOSURE as key sustainability issues. UN PRI Investor CDP GRI 2010 Signatories 2010 Table 5 summarizes eight indicators associated with sustainability, drawn from a set of globally recognized research and surveys.1 Brazil 46 47 134 China 1 17 61 India 3 42 24 South Africa 31 65 53 Turkey 6 12 10 Egypt 0 0 1 Morocco 0 0 0 Source: Websites of UN-PRI(www.unpri.org) , CDP(www.cdp.org) and GRI(www. gri.org) accessed in February 2011. TABLE 5: GLOBAL PROXIES OF ESG PERFORMANCE Category Variable Brazil China India South Africa Turkey Egypt Morocco Environmental Environmental Performance Index 2010 63.4 49 48.3 50.8 60.4 62 65.6 Social The Global Competitiveness Index – 58 27 51 54 61 81 75 Rank 2010-2011 Social The Global Competitiveness Index – 4.28 4.84 4.33 4.32 4.25 4.00 4.08 Score 2010-2011 Social Human Development Index- Rank 73 89 119 110 83 101 114 2010 Social Human Development Index- Score 0.699 0.663 0.519 0.598 0.679 0.62 0.567 2010 Governance Anti-director Rights Index 5 1 5 5 3 3 2 1998 Governance Anti-self-dealing Index 2008 0.27 0.76 0.58 0.81 0.43 0.2 0.56 Governance Ease of Doing Business - Rank 127 79 134 34 65 94 114 Governance Corruption Perceptions Index-Score 3.7 3.3 3.5 4.5 4.4 3.1 3.4 Governance Corruption Perceptions Index – Rank 69 87 78 54 56 98 85 2010 Sources: Environmental Performance Index (2010): http://epi.yale.edu , The Global Competitiveness Index (2010): http://gcr.weforum.org/gcr2010/ , Human Development Index (2010): http://hdrstats.undp.org , Ease of Doing Business Index (2010): Doing Business, 2011, the World Bank Group, Corruption Perception Index (2010): http://www.transparency. org , Anti-director rights Index: La Porta, Lopez-de-Silanes, Shleifer and Vishny (1997,1998),Anti-self-dealing index: Djankov, La Porta, Lopez-de-Silanes and Scleifer(2008) 1. Readers should consider these rankings as broad guidelines and as sources of additional knowledge, rather than absolute insights; rankings based on proxies and perceptions are context- and culture-dependent. The State of Sustainable Investment in Key Emerging Markets 5 THE STATE OF SUSTAINABLE INVESTMENTS IN BRAZIL KEY EMERGING MARKETS Brazil is the world’s 10th largest economy. Its main stock exchange, The total stock of SI in key emerging markets covered by IFC BM&F BOVESPA, is the world’s 13th largest exchange. In 2008, country reports is summarized in table 6. the net asset value of 8,300 investment funds reached around $700 billion, out of which about $500 billion was controlled by the top 40 A common feature of all the markets is the lack of data on SI. asset managers. Brazil has a well-developed fund management and Figures are best estimates based on extrapolations of available pension fund industry built on domestic savings, which has increased data and interviews with market players. The figures are more significantly in recent years. The country’s 278 pension funds have reliable for domestic SI, and firm-specific holdings of international combined assets of about $185 billion, representing 22 percent of total institutional investors are not available because they rarely reach assets under management. This amount corresponds to 18 percent the threshold level that requires disclosure. There is a consensus, of GDP. Thirty-two percent of pension fund assets are invested in however, that in markets where foreign institutional investors equities or equity funds. The majority of the leading pension funds dominate; 1 to 2 percent of the investments take sustainability manage their equity portfolios in house. Eighteen pension funds factors into consideration. representing 60 percent of the country’s total pension fund corpus, amounting to $110 billion, are signatories to the UN PRI. Retail TABLE 6: SI MARKET ESTIMATIONS BY COUNTRY AND REGION customers constitute around 22 percent of the assets. Nine percent of those investments belong to 143,000 high net worth individuals. Estimat- ESG-Inte- %ESG-in- Sustainable ed Stock grated tegrated Investments Against these domestic portfolios, the total stock of foreign portfolio of Invest- ($ Billion) / Total in PE ($ investments stood at about $232 billion in 2008, while American ment ($ AUM Billion) Depositary Receipts (ADR) issued by Brazilian companies and Billion) traded on the New York Stock Exchange had a total market cap of Brazil 585 86 15.0% Not a further $110 billion. The São Paolo stock exchange is dominated (end of 2008) estimated by the financial sector, oil and gas, mining and steel. Thirty-four China-branded 411.6 4.12 1.0% Not percent of the benchmark IBOVESPA Index is concentrated in two (1. Q 2009) estimated stocks: Petrobras and Vale do Rio Doce. India 170 1.13 0.7% Not (1.Q 2009) estimated Uniquely among the emerging economies, ESG issues have had a South Africa 556 111.2 20.0% 14.2 prominent place in the Brazilian financial and investment community (end of 2010) for a decade. BM&F BOVESPA introduced its corporate governance- Turkey 234 1.5 0.6% 1 themed Novo Mercado listing segment in 2001, and in the same year (end of 2010) Banco Real launched Brazil’s first socially responsible investment Middle East 17.1 0.7% (SRI) mutual fund. This was followed by BM&F BOVESPA’s and North corporate sustainability index, the ISE, launched in December 2005. Africa (2010) In 2009, 10 asset managers offered retail SRI funds with combined Canada (2008) 609.2 19.9% assets under management of $315 million. USA (2010) 3,070 12.2% European 3,500 45.7% The enabling environment for SI in Brazil is relatively strong, Union (2010) particularly in terms of voluntary disclosure. About 60 percent of Sources: IFC country reports for emerging markets, Eurosif and Social Investment companies in the IBOVESPA publish sustainability reports. Five Forum reports for advanced markets. Brazilian companies are included in the Dow Jones Sustainability Index (DJSI). We provide the following summary of highlights from each key market. Foreign institutional investors play a less important role in Brazil’s SI market, although they have become increasingly important to the economy. 6 The State of Sustainable Investment in Key Emerging Markets INDIA billion. Twenty-six of these QFIIs are UN PRI members; however, data are not available on the extent to which they incorporate sustainability India is the world’s 12th largest economy. India has two main stock factors into their investment strategies in China. exchanges: the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The BSE is the 14th largest market in the The pension system in China is underdeveloped. The National world by market capitalization, while the NSE is the 16th largest. Social Security Fund (NaCSSef) was established in 2000 with At the end of 2008, the total market cap of the two exchanges initial funding from the government. The fund is the largest in was $600 billion. The estimated stock of investments in listed China with total assets of $82 billion. It can invest in equities, up Indian equities was around $151 billion (excluding the ADRs). to a 40 percent limit, and has a responsibility to take a long-term Sixty percent of this amount is held by international institutional investment perspective to facilitate sustainable development of the investors. Pension funds are largely absent in India’s stock markets, Chinese economy. Despite this mandate, NaCSSef has not yet representing only about 0.4 percent of investments in listed equities. developed a formal approach to SI. The key local players in the market are the 22 life insurance firms. The state-owned Life Insurance Corporation of India (LIC) has a 74 In 2006, the Shenzen Stock Exchange issued social responsibility percent market share in the sector. LIC had $36 billion invested in guidelines for listed companies. At the same time, the government listed equities in 2008. India’s first and only sustainability themed mandated that state-owned enterprises issue sustainability reports mutual fund, launched in 2007 as the Sustainable Development on an annual basis. As of 2008, 150 leading state-owned enterprises Fund, raised around $12 million but fell to around $2.6 million were issuing sustainability reports. In the same year, the Shanghai toward the end of 2008. The fund’s ESG analysis is provided by Stock Exchange mandated that financial-sector companies and S&P’s local representative, based on the methodology of the S&P companies issuing stocks abroad publish sustainability reports. Two ESG India Index. This index was launched in January 2008 but has hundred eighty-two listed firms released sustainability reports in not yet had a discernable impact on the market. 2009. The China Banking Association followed suit and published guidelines for Chinese banks for the fulfilment of their “social There is little information about ESG integration in foreign responsibilities” and requested its members to issue sustainability institutional investors’ investment processes in India. India attracts reports in 2009. The guidelines call for integration of sustainability private equity (PE) investments from all over the world, thanks to concerns into the banks’ business structures, governance, and its vibrant economy and exit opportunities. The existing examples assessment mechanisms. Sectorwide reporting programs in the of PE investments are encouraging from a sustainability perspective. manufacturing sector and in the textile and apparel industries support the sustainability reporting trend. India’s enabling environment for SI in listed equities is currently weak. Nonfinancial reporting and voluntary disclosure is low, The Shanghai Stock Exchange (SSE) launched the SEE Corporate although there are signs of improvement. Governance Index (SEE CGI) in January 2008. In May 2009, the index included 230 companies. The companies can voluntarily apply to be included in the index, provided they meet the criteria. CHINA Building on the success of CGI, SEE launched the first sustainability index in China, SEE Social Responsibility Index (SSE SRI), in China became the world’s third largest economy in 2009, up from 2009. The index selects 100 leading companies out of the members ranking 10th in 1978. In 2009, the Shanghai and Shenzhen Exchanges of SSE CGI. SSE has adopted a unique methodology that measures listed more than 1,500 firms with a combined market capitalization the social contribution per share of each listed firm. of $2.74 trillion. This figure compares to a $2.12 trillion market capitalization for the Hong Kong Stock Exchange. At the end of The first SI product, the China-Industrial Social Responsibility 2008, there were 61 fund management companies of which 33 were Fund, was established in 2008 by AEGON Industrial Management. joint ventures. The estimated stock of investments in Chinese equities The fund’s criteria are specific to China and differ from developed- was around $1 trillion at the end of 2008. Three hundred sixty-four market models. In 2009, the fund was one of the top five funds in retail funds represented 26 percent of the total market capitalization terms of growth. Although the history is too short to be conclusive, in the country, whereas individual investors accounted for 51.3 percent the fund has outperformed its benchmarks. The second SI fund of the total market. This figure compares to 24.4 percent for Brazil, was launched in 2009 by CCB Principal Asset Management (CCB) 13.1 percent for India, and 10 percent for Turkey. Domestic pension as a passive fund, following the SSE CSR Index. At the time the funds represented 10 percent of the equity investments, insurance firms China report was written, CCB was planning to launch the first SI 6 percent, and international institutional investors (Qualified Foreign Index Exchange-Traded Fund in China, while Sumitomo Trust and Institutional Investors-QFII) 3 percent—up to the limit allowed by the Banking was planning to launch an SRI Retail Fund. applicable quotas. In 2008, the combined quota of 85 QFIIs was $10.8 The State of Sustainable Investment in Key Emerging Markets 7 TURKEY and it is not used for developing investment products. The Istanbul Stock Exchange became a member of UN PRI in 2009 and is planning Turkey is the 16th largest economy in the world, and it is expected to launch its sustainability index-ISE SI toward the end of 2011. to grow at an average of 5 percent until 2015. It is the largest economy in the process of integration with the European Union There is a growing interest in sustainability issues within the (EU). Although Turkey has a vibrant functioning market economy, corporate sector in Turkey. A notable increase in voluntary disclosure the equity market is much smaller than in the BRIC countries. The reflects this trend. EU integration appears to be the strongest driver total market capitalization of listed companies in the Istanbul Stock and enabler for SI to emerge and grow in Turkey. Exchange (ISE) was $234 billion at the end of 2009. This represents 37 percent of Turkey’s GDP with a little over 300 listed firms. The free float of total equity is around 35 percent. The market is highly SOUTH AND SUB SAHARAN AFRICA concentrated with 16 companies representing 64 percent of the market capitalization and 55 percent of total trading volume. Despite South Africa is the largest economy on the African continent with the shallowness of the market, individual investors’ intensive trading estimated $354.4 billion in GDP in 2010. As invitee in 2011 to activities keep the market highly liquid. Turkey’s domestic saving the BRIC bloc of emerging markets and a member of the G-20, rates are historically low and directed toward short-term deposits and South Africa is a middle-income, emerging market with a formal fixed-income instruments, predominantly government bonds. economy covering mining, manufacturing, agriculture, financial services, and retail. The country also has well-developed financial, Turkey relies on foreign capital inflows to finance its current legal, communications, energy, and transport sectors. account deficit. Foreign institutional investors dominate the stock market, but their average holding period is under a year. Total The total market capitalization of the Johannesburg Securities investments in Turkish equities stood around $85 billion at the Exchange (JSE) at the end of 2010 was $893 billion, making the JSE end of 2009. Foreign institutional investors represented 67 percent the 19th largest exchange in the world. The JSE has comprehensive of this figure, whereas individual investors represented 20 percent. regulations and stringent listing requirements: following the Local institutional investors’ total equity exposure is estimated to be incorporation of The King Report on Governance for South Africa around 3.2 billion. Four leading fund management firms represent 2009 (King III) into the Johannesburg Stock Exchange (JSE) Listings more than 70 percent of the market. The overlap between asset Requirements, listed companies are required to issue an integrated management and asset ownership creates moral hazard problems. report for financial years starting on or after 1 March 2010, or to The state pension system is not integrated with the economy and explain why they are not doing so. South Africa has a well-developed remains a budget item with increasing liabilities; however, the pension fund system. In 2009, the net worth of South African private pension industry, although very small, is well-regulated households was estimated at $690 billion ($600 billion in financial and growing fast. Private pension firms’ equity investment, despite assets, $250 billion in tangible assets, and $160 billion in debt). Of their minuscule levels, is the main source of domestic institutional this, roughly a third was invested in pension funds. In South Africa, investments in the country. pension fund assets more than doubled between 2002 and 2009, from about $100 billion to $250 billion. Banks affiliated with business groups dominate the financial sector and control the top four asset management companies. By the end South Africa is the biggest investor in Sub-Saharan Africa. Exchange of 2009, there were 23 asset management firms in Turkey with total control reforms are expected to increase South African institutional assets under management of around $25 billion. investment into Sub-Saharan Africa beyond 2010. Regional and international exposure by South African-listed firms demonstrates the Currently, there are no sustainability themed funds in Turkey. There value of globalization: the top 10 companies by market capitalization is also no indication of incorporation of sustainability factors into earn about 43 percent of their revenues from outside Africa. The investment process in a systematic way by the mutual fund industry institutional investment segment outstrips the retail market, driven although there are examples of heuristic approaches for screening by pension fund investments amounting to $250 billion (2009). badly governed companies by the leading asset management firms. In February 2011, a RisCura analysis of South Africa’s top 25 asset One asset management firm became a signatory to the UN PRI in managers estimated institutional fund assets to be $511 billion, or 2009. The only investment category that incorporates ESG factors $381 billion excluding the Public Investment Corporation (PIC), is PE, although the size is small. which invests funds on behalf of South Africa’s public-sector entities. The Istanbul Stock Exchange launched the first sustainability-related Business and investment guidelines have merged in The King Report index, the Corporate Governance Index (CG), in 2005. It is a voluntary on Corporate Governance South Africa launched in 2009 (King scheme, and 30 companies were included in the index by the end of III) and the draft Code for Responsible Investing by Institutional 2010. The CG index in Turkey underperforms the benchmark indexes Investors in South Africa (CRISA) is due to launch in 2011. The King 8 The State of Sustainable Investment in Key Emerging Markets Code focuses on the corporate governance of companies and is widely THE MIDDLE EAST AND NORTH AFRICA supported by South African business, while the Code for Responsible Investment in South Africa (CRISA) is an institutional investor The MENA region9 includes diverse economies with different initiative. Furthermore, a Framework for Integrated Reporting, fundamentals and varying degrees of development. The region produces 2011, outlines a principles-based approach to integrated reporting. $1.5 trillion in GDP and represents 3 percent of global GDP. Asset Regulatory changes, for example Regulation 28 of the Pension Funds clustering is problematic due to significant differences and political risk Act in South Africa, that in 2011 introduced enabling regulation for correlations in the region. There is no key emerging market in MENA. the concept of integrating ESG factors, have the potential to be a Egypt and Morocco are two countries that are included in the MCSI strong driver for SI in South Africa and in the region. EM Index. The majority of the remaining markets are included in MSCI’s Frontier Markets Index. MENA’s growth has been lower than In Sub-Saharan Africa, funds profiled and/or marketed as ESG- the average for emerging markets during the past decade. branded at 31 December 2010 total about $5.5 billion in assets under management (AUM) (<1% AUM). But using a broader definition that Fourteen sovereign wealth funds (SWF) comprise an estimated 60 covers self-reported integration of ESG factors into fund investment percent of all assets under management in the region, with $1.54 policy and/or process, sustainable investment in South Africa, Kenya, trillion in net assets. MENA’s SWF assets account for 44 percent and Nigeria is estimated at $125 billion AUM (20% AUM). The of all the SWF assets in the world with the Abu Dhabi Investment relatively high proportion of ESG-integrated investment is the result Authority as the largest SWF in the world. A growing emphasis of the largest asset owner in the largest African investment market, on sustainability in national development agendas suggests SWFs South Africa’s Government Employee Pension Fund (GEPF) ($131 will play a large role in SI in MENA, but these SWF investments billion AUM) and the asset manager of 92 percent of its assets, Public are generally not transparent. Four funds in MENA have signed Investment Commission (PIC), both adopting ESG-integrated the Santiago Principles of the International Working Group sustainable, responsible and/or developmental investment policies. of Sovereign Wealth Funds (IWG), the voluntary guidelines Demand for pure-play SI mandates in general asset management is low. that assign best practices for the operations and transparency of Investment managers complain of static demand from asset owners SWFs.10 This affiliation with IWG represents a major shift and an who request education and advocacy, but seldom fund mandates. opportunity for SI in the region. Private equity (PE) is a small but growing investment discipline in During recent years, most of the MENA countries have undertaken Sub-Saharan Africa, expanding in response to improving economic reforms to improve the functioning of their stock markets and fundamentals. In South Africa in 2010, sustainability-branded PE increase diversification of their oil-based economies. Most of these funds made up $1.1 billion of ESG-integrated PE funds amounting reforms focus on fundamental corporate governance issues. Large to $6.3 billion of around $14 billion PE in SA. Development corporations and business organizations have, more recently taken Finance Institutions (DFIs) have been a major positive contributor a leadership role in creating awareness of sustainability issues. to funding PE mandates integrating ESG in Africa, while large The level of broad-based SI in the MENA region is estimated to South African institutional investors invest up to 5% in alternative be around 0.7 percent of total investment in equities, on par with investments, mostly in domestic PE funds. More capital is coming: peer countries. This figure is much lower than Shari’ah-complaint 92 percent of PE investors interviewed in the survey supporting investments, which are twice the size of SI in the region. The the ‘Sustainable Investment in Su-Saharan Africa’ report expect an countries that receive the highest level of SI in MENA are the increase in PE commitments into Sub-Saharan Africa over the next United Arab Emirates with an estimated $14 billion and Egypt five years. A counter-intuitive finding from the IFC/SinCo 2011 with an estimated $1.5 billion. study is that, while a much smaller asset class, PE funds relative to general asset management, has greater exposure and experience in A regional ESG index-S&P/Hawkamah Pan Arab ESG Index was integrating ESG factors in the region. launched in February 2011. The index included 50 companies from 11 MENA countries. S&P also launched the S&P/EGX ESG Index together with the Egyptian Stock Exchange earlier in March 2010 and included 30 stocks. PE plays a significant role, as in other emerging markets, as a catalyst for creating awareness of ESG issues. 9. For countries covered please see Table 1 10. The principles were proposed in 2008 through a joint effort between the International Monetary Fund (IMF) and the “International Working Group of Sovereign Wealth Funds” (IWG-SWF). The State of Sustainable Investment in Key Emerging Markets 9 ANALYSIS The authors of these reports agree that there is space in the financial market for emerging-markets specialization in ESG/ There are significant differences across these markets with respect sustainability research—with an emphasis on governance. None to the savings rate, size, and depth of stock markets, the size of of these markets have yet managed to support the establishment the pension funds, and the development of the asset management of an indigenous sustainability research and rating industry; industry. Domestic institutional investors dominate the Brazilian while international research houses have not managed to scale up and South African markets, whereas individual investors dominate their coverage to include emerging-market firms. Their current the Chinese market. In India and Turkey, where domestic savings are coverage is limited to a handful of firms from each country, and low, foreign institutional investors are the dominant owners of traded assessments are arguably lacking depth, reliability, and relevance. stocks. Pension funds are the leading players in shaping investment The availability of comparable, reliable, and relevant data with trends in South Africa and Brazil, whereas the government, regulators, sufficient coverage on ESG can provide a basis for the development and industry associations are more effective in China. In Turkey, of collective investment instruments. corporations and business organizations set the trends. Although sustainability is a more important concern for emerging Emerging markets further differ from each other with respect economies for investors and also for issuers and their stakeholders, to their economic fundamentals and institutional frameworks. the percentage of investments that factor in firm-level sustainability The interplay between firm-level sustainability factors and factors is much lower in emerging markets than in developed ones, these institutional factors is also different in each market. These with the exception of South Africa. At the micro level, capital differences manifest themselves in a diverse set of sustainability market institutions and collective investment frameworks are issues, priorities, and key players. significant drivers for social and environmental performance. In countries with high domestic savings and a competitive domestic Government quality, state ownership, domestic savings, and financial- asset management industry, SI can be driven by retail investors. sector development shape the investment landscape, which can be On the other hand, in other emerging markets that rely on foreign less or more enabling for SI. There are prerequisites for sustainable capital inflows to finance the growth of their economies, foreign investments to emerge and take root in an emerging economy: the institutional investors can play a role in promoting sustainable size and depth of the stock market, the size and competitiveness of investments and sustainable business practices. the local investment industry, and a country’s sovereign credit rating. These highly correlated conditions separate emerging economies such There does appear to be a difference in emphasis between as Brazil, China, and South Africa from others. These markets serve domestic and international investors. Domestic investors in as a hub, as a financial center from which investments are managed, emerging markets tend to focus on opportunities related to and norms are developed and transmitted to the neighboring markets. climate change and on the investment’s positive social impacts. Cluster effects are not apparent in all regions. These considerations sometimes overshadow the potential negative impacts of investment projects. Global investors, on Academic research suggests that political institutions (e.g., the the other hand, focus on risk management and as such appear absence of corruption) and the prominence of an egalitarian concerned about mitigating an investment projects’ negative ideology are the most important determinants of firms’ social and impact. Differences in values and ethical norms between domestic environmental performance in a given market. Therefore, we see a investors and global investors suggest that engagement strategies greater role for regulatory interventions (both public and private) may be useful to develop a mutual understanding between global accross emerging markets in promoting SI and addressing conflicts investors and issuers. The studies however, report an absence of of interests associated with the concentration of economic power. engagement efforts in emerging markets. This reluctance may be related to concentrated ownership that marginalizes minority ESG information about emerging market assets is, in general, shareholders’ voices. substandard, incomparable, limited in scope and coverage, and frequently missing out on what matters. The underlying reasons are PE investments in all of the key emerging markets are on the the difficulty of codifying sustainability information in emerging rise. In most markets, they represent the very first attempts to markets due to the complexity of issues, unreliability of disclosures, integrate sustainability concerns into the investment processes and high costs associated with collecting and verifying data. These whereby the ESG risks are monitored by direct control and aspects pose challenges for analysts unfamiliar with this context. private contracts. We also note that PE investments, backed by Further sustainability information based on corporate disclosure international financial institutions with social and environmental without independent verification may create noise, cause adverse conditionality, act as a catalyst in the emergence of this segment in selection and inflate the demand for larger companies which already all the countries surveyed. However, PE investments appear to have have preferential access to finance in emerging markets. had little systematic impact on the development of the institutional 10 The State of Sustainable Investment in Key Emerging Markets investment industry and public stock markets. Similarly, project finance and intermediated loans provided to local banks by IFIs with ESG conditionality help mitigate the negative impact of large- scale projects and create awareness of sustainability issues. CONCLUSION All the reports note that Sustainable Investment has found a foothold in all markets but has done so in a number of different ways. With the exception of one or two markets SI is still very much a niche play. While the reports suggest that there are significant opportunities for the growth of these markets the drivers will be specific to each country and region. There is yet no sign of proven approaches that are universally applicable to promoting SI in emerging markets. In general, asset managers prefer to use their own methodology and/or heuristics in integrating sustainability factors into investment decisions. There is a consensus among the authors of country reports that the global asset management industry is in apparent need of innovation to overcome the barriers to sustainable investments in emerging markets. Without collective action, investments will continue to gravitate around a handful of companies with an increasing exposure to ESG risks and miss opportunities for sustainable, and probably higher, returns. Opportunities for making a positive impact on equitable development will also be missed out. Unless the growing interest in sustainability in emerging markets can be effectively matched with investor capacity and action, sustainable investments in emerging markets may ultimately stay on the margins or even fade away. The State of Sustainable Investment in Key Emerging Markets 11 The Reports The series of market reports can be found in full at www.ifc.org/sustainableinvesting. The individual reports were prepared by: IFC and TERI-Europe. (2009). Sustainable Investment in India, 2009, IFC, Washington D.C. IFC and TERI-Europe. (2009). Sustainable Investment in Brazil, 2009, IFC, Washington D.C. IFC and BSR. (2009). Sustainable Investment in China, 2009, IFC, Washington D.C. IFC. (2011). Sustainable Investment in the Middle East and North Africa Region Report, IFC, Washington D.C. IFC and ILLAC. (2011), Sustainable Investment in Turkey, 2010, IFC, Washington D.C. IFC and SinCo. (2011). Sustainable Investment in Sub-Saharan Africa, IFC, Washington D.C. Prepared for: International Finance Corporation (IFC), A Member of the World Bank Group, www.ifc.org Prepared by: ILLAC Ltd. (UK) Written by: Melsa Ararat with Esra Suel Edited By: Euan Marshall Photocredit (Left-Right): (Row 1) © Bunyad Dinc / World Bank, © Curt Carnemark / World Bank, © Cherie Vale, SinCo 2011 (Row 2) © Curt Carnemark, World Bank, © Curt Carnemark, World Bank (Row 3) © Curt Carnemark, World Bank The findings, interpretations, and conclusions expressed in this publication should not be attributed in any manner to IFC, to its affiliate organizations, or to members of its Board of - Directors or the countries they represent. Neither IFC nor ILLAC guarantees the data included in this publication, and neither party accepts responsibility for any consequence of its use. IFC encourages dissemination of the content for educational purposes. Content from this publication may be used freely without prior permission, provided that clear attribution is given to IFC and that content is not used for commercial purposes. International Finance Corporations0ENNSYLVANIA!VENUE.7s7ASHINGTON $#53! 4EL   s%MAILASKSUSTAINABILITY IFCORGsWWWIFCORGSUSTAINABLEINVESTING 12 The State of Sustainable Investment in Key Emerging Markets