Tighter rules needed to ensure sustainability

203e7361 investment business 7.3.23

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Investors and asset managers must be more discerning when deciding on which company to invest in, say analyst and activist.

203e7361 investment business 7.3.23
Investors must ensure that the companies they put their money in also meet environmental, social and governance (ESG) requirements.

PETALING JAYA: More stringent rules on disclosure are essential to ensure that investors put their money only in businesses that meet high sustainability standards, according to an activist and an analyst.

This will ensure that investment funds do not end up parking their money in companies that preach environmental sustainability without practising it — a practice known as “green-washing”, according to Climate Governance Malaysia (CGM).

Stricter rules could also attract more foreign funds into Malaysia, an analyst said.

Currently, Bank Negara Malaysia (BNM) does not require investment funds to demand information on how the companies they invest in meet environmental, social and governance (ESG) standards.

Neither are these funds expected to get the targets of their investments to provide details on how they meet ESG requirements.

Nonetheless, given the rising demand for companies to integrate ESG principles in their business practices and financial systems, steps must be taken to identify those that preach but do not practise those principles, CGM chairperson Sunita Rajakumar told FMT Business.

Higher standards

The EU has long been ahead of the game. Its sustainable finance disclosure regulation (SFDR) had earlier set the standard, but it has since raised the bar by introducing even stricter compliance standards under SFDR Level 2 that came into effect on Jan 1, 2023.

In the scramble to comply with the upgraded rules, asset managers and investors have had funds valued at more than US$125 billion (RM532.8 billion) downgraded, leaving them in a state of limbo.

But for the EU, the SFDR Level 2 is merely a step closer to full disclosure. The question now is whether or not Malaysia will follow suit.

Sunita said that while BNM’s classification that was issued in April 2021 was ideal back then to introduce the concept of sustainability in a lending and investment portfolio, it was timely now to have a more granular classification.

She said as the interest in ESG-mandated investments grows in Malaysia, it will be necessary to tighten the rules to not only ensure disclosure but to also require specifics in each disclosure.

However, an extensive revision of the rules may be necessary to reach the required standard.

As Danny Wong, executive director at Areca Capital, told FMT Business, ESG investing in Malaysia is not subject to a central standard like it is in the EU.

“As a result, all parties use their own ESG scores based on their own criteria, especially in the weightage they put on each factor,” he said.

Prevention is better than cure

Disclosure can also be a powerful tool to unearth otherwise hidden shortcomings in a company’s social and governance practices.

Wong pointed out that one can easily identify deficiencies, such as bias, from information culled from the firm’s organisation structure and disclosure documents.

He said that as the ESG-fund market grows in Malaysia, regulations will be important to guide decisions made by investors, lenders and insurers.

“Rampant green-washing only means that capital will go towards false promises and achieve no material results,” Wong said.

“Such procedures may feel like a vapid administrative burden and additional costs for businesses but their importance cannot be understated,” he added.

Sunita said stricter rules will also enable asset managers and investors to identify businesses that are on the road to becoming sustainable.

Many shades of green

Requiring businesses to disclose information on their carbon emissions can also expose the reality of their operations.

On the other hand, it may be unfair to hold all businesses to the same standard regardless of their size or the industry they are in, according to Sunita.

To make room for such differences, Wong proposed that the ESG framework be adapted to suit individual industries rather than apply the same rules across the board.

Similarly, different rules may be necessary for small and medium enterprises (SMEs), he added.

SME Association of Malaysia president Ding Hong Sing said many businesses are still not fully aware of such requirements.

“Ultimately, the government must introduce regulations that are supportive and instructive for all industry players,” he added.

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