ESG Transforms with Wartime SOS

Prior to the Russian invasion into Ukraine, emerging market stock and bond offerings in the ESG space soared. Issuers and investors alike expanded offerings beyond the traditional “green,” with greater attention to the “social” and “governance” categories. With the Covid-19 pandemic, they addressed inequality in jobs and healthcare as a popular theme.  In 2021 emerging and frontier market governments sold ESG bonds totaling USD 230 billion, up from just USD 75 billion a year earlier, according to the Institute for International Finance.

Despite growing attention ESG emerging market funds were so focused on yield pick-up that they continued to hold and trade sovereign bonds from countries such as Belarus after its sham election and inhumane crackdown on citizens in 2020. A new report by Inclusive Development International found that hundreds have stakes in 33 companies that the United Nations says has provided weapons, communications, and technology to the Myanmar military which overthrew a democratically-elected government just over a year ago. These companies are in MSCI’s ESG Screened Index, according to media reports.

As gas prices soar across the globe with rising hunger on wheat prices up nearly 50% since the war started, screening is under the microscope after the euphoria phase. In the immediate aftermath debate centers on military-related companies, which in a “perfect world” would be a red line for ESG funds.  Just a year after Sweden’s SEB bank’s new sustainability policy excluded defense stocks it has reversed position, according to a report in the Financial Times. Even the EU has seemingly softened its stance. It raised the bar to companies that outright violate international rules instead of calling all arms and weapons manufacturers harmful.

With oil and gas prices spiking, climate change and transition from fossil fuel reliance promises are second-guessed. Despite the “net zero” flurry last year at the COP26 Climate Summit, deadlines for carbon reduction were decades away at the earliest. The war is distorting the availability and price of clean energy components like nickel.  Continued growth of the carbon trading market both through voluntary emissions offsets and regulated markets is not in the forefront. It is widely viewed as the newest asset class, returned 108% last year, according to the IHS Markit Global Carbon Index. The Task Force on Scaling Voluntary Carbon Markets, sponsored by IIF with support from McKinsey, estimated market size at USD 50 billion by 2030.

 “S” and “G” components are clearer in allocation choice post-war as portfolio and foreign direct investors weave them into “top down” macro-economic-political decision-making.  For example, when McDonald’s closed Russian operations after 30 years, it announced it will continue to pay employees as a labor-management best practice.  Even before the outbreak of war – and leaving aside “unorthodox” monetary policy – investors seized on governance issues in Turkey.  The present administration detains political opponents and independent journalists on bogus charges, and President Erdogan has for two years ignored a ruling from the European Court of Human Rights to release philanthropist Osman Kavala. Turkey is now threatened with suspension from the Council of Europe democratic club, of which it is a founding member, and the NATO member remains neutral in the war.

The Russian attack on its European neighbor puts the buzzword acronym to an extreme test that should strengthen commitment to all three standards. Climate goal urgency got a reminder with a UN report that time was running out to cap warming at 2 degrees Celsius. The “S” and “G” may be more difficult to measure but investors can instinctively flag poor treatment. They were surveyed on removing Russia from benchmark indices, and human rights outrage featured along with traditional liquidity and capital control reservations. In the individual company context, paying employees when they cannot work due to no fault of their own has been warmly received by shareholders at this initial stage. With a charter member of the two decades ago BRIC group undergoing a harsh reassessment, the ESG label is in the same clarification of original assumptions, and across-the board portfolio guideposts will be set that endure into a post-war era.

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