As the fallout from the 1MDB continues, and Mahathir Mohamad returning to power on an overly ambitious reform agenda, it is easy to be sceptical about Malaysia’s ESG credentials. But as Stanley Kwong explains, the reality is far more nuanced.
4 minute read
Corporate scandals stir public anger and, sometimes, bring about broader remedies to redress unfair or illegal business practices. Witness the 2002 Sarbanes-Oxley Act in the aftermath on the Enron scandal in the US, and the 2014-2015 landmark introductions of Japan’s stewardship and governance codes following the Olympus accounting fraud case.
Malaysia may be heading in a similar direction. Between 2009 and 2015, as much as US$4.5 billion (£3.5 billion) was allegedly diverted from 1 Malaysia Development Berhad (1MDB), a government investment vehicle, according to the US Department of Justice (DOJ). Riding on the backlash of the money laundering controversy surrounding 1MBD that implicated former prime minister Najib Razak, Mahathir Mohamad won a shock election victory as prime minister in 2018 with a mandate to enact reforms. That the 93-year-old Mahathir, who served as prime minister from 1981 to 2003, returned to power promising corporate governance initiatives may be surprising to some observers. During his previous term, Mahathir frequently faced accusations of facilitating crony capitalism.
As such, international investors may be tempted to dismiss Malaysia’s overhaul attempts, but they could be missing out on long-term opportunities. True, it is too early to gauge what impact Mahathir’s reforms will have on improving environmental, social and governance (ESG) practices. But even if his pledges flounder, Malaysian companies now have more market incentives to improve their ESG credentials, and those who do may be in a more resilient position to weather volatile conditions. Judging by recent capital flows into Malaysia, market sentiment appears cautiously optimistic (see chart below).
In the second part of a Q&A series on how ESG is evolving in emerging market equities, Stanley Kwong, analyst in Aviva Investors’ Global Responsible Investment team, discusses how governance is becoming more of a differentiator when investing in Malaysia.
What are some of the key changes that Mahathir is proposing?
To prevent a repeat of the 1MDB scandal, Mahathir’s new government is planning to introduce transparency rules in public procurement procedures, anti-graft provisions within public services and stricter requirements to make institutions more independent and accountable. Separately, strategic reviews of large infrastructure projects, including the high-speed rail link between Kuala Lumpur and Singapore, point to Mahathir’s willingness to act quickly to curb money politics and reduce the government’s financial deficit.
Outside of the government initiatives, what incentives do companies have to upgrade their ESG credentials?
They are starting from a low base, but there’s some momentum. A lot of Malaysian companies are beginning to understand how ESG links to their business values. That’s where engagement can really help them to see that if they were to improve in ESG, they might get more attention from foreign investors and command a higher premium. As they venture internationally, companies are seeing that ESG can give them competitive advantages.
Can you describe the existing ESG investing environment?
There is currently a disconnect between the roles of the government, local industry and individual companies. On the one hand, we were already seeing robust frameworks and improvements that put Malaysia ahead of many other emerging markets in corporate governance1 (see chart below). The 2018 Corporate Governance Watch ranked Malaysia fourth of 12 Asia-Pacific economies, the biggest mover for the year in terms of market accountability and transparency. This has been driven centrally by the Bursa Malaysia and Securities Commission, resulting in a new Malaysian Code on corporate governance and ESG reporting requirements for all listed issuers.
Despite this, Malaysian companies are generally weaker around implementation, with poorer ESG disclosures and a widespread lack of independence on boards. However, patient investors may still benefit by supporting companies that add more relative value potential by establishing stronger ESG foundations.
Do you have an example of how investors can benefit?
We engaged with a semiconductor company that put in place governance and sustainability processes, but it wasn’t disclosing any of this publicly. Therefore, we initiated a discussion with the company to firstly disclose the information, then to set clear targets. The company agreed to disclose detailed progress on its ESG targets in their recent annual sustainability statement, which not only gives us more visibility about its sustainability commitment but also its operational efficiency improvements. This gives us a clearer picture to assess the company’s valuation. Long-term engagement with a company can affect the most change, and we want to be there early in companies’ ESG improvement journey. That’s the positive side of the growth story.
What might be some of the barriers when engaging with EM companies, including Malaysia’s?
Firstly, it really depends on who you engage with at the company. If you talk to the founders, they can be more receptive. They also can act swiftly as the key decision makers in the business. Secondly, it’s how you approach them. It can’t just be a one-way critique of their company. Some engagement approaches that work for more established companies in developed markets may not work in emerging markets.
Lastly, it’s important to build a strong understanding about the company’s business operations. Many companies in emerging markets may have different ESG priorities compared to similar companies in developed markets. The ability to tailor the engagement approach according to the differing circumstances of individual companies is crucial.
What should investors be looking for when analysing the ESG credentials of Malaysian companies?
ESG data in emerging markets is inconsistent, so we need to look beyond the data and engage directly with companies, sharing knowledge on best practices as well as building long-term relationships with management. However, we’re also wary of ‘greenwashing’; we’ve seen sustainability reports that are nicely presented but don’t include any of the important, tangible elements such as metrics and actual targets. In some instances, there’s no one accountable for the information in the sustainability report. The availability of information, especially among small- or mid-cap companies, is particularly low, so this is where we can see the potential for more value in engagement.
As businesses grow, companies need to think about ESG in a broader context than their core areas. For a fast fashion retailer, we would ask questions such as whether they have a system to measure what is happening across their supply chain and do they have control over it? They may have excellent labour standards in their core business, but it also needs to trickle down through their supply chain. If they can demonstrate that they have really embraced ESG, there’s an opportunity from an investor’s perspective. It is at this early stage that you can truly shape and affect the organisation’s ESG culture.
1 ‘Corporate Governance Watch 2018’ is a biennial market survey of corporate governance in Asia-Pacific, 5 December 2018, Asian Corporate Governance Association, CLSA Limited.