Rethinking ESG Metrics in Emerging Markets: The Path to More Flexible Comparability
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Rethinking ESG Metrics in Emerging Markets: The Path to More Flexible Comparability
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By Izabela Silva, Botho Researcher
June 1, 2023
The growing popularity of sustainable finance and sustainability accounting practices has led to a significant increase of their adoption in emerging markets. As a result, these markets are gaining greater visibility in the global investment landscape, attracting increased funding for various projects and ventures. The adoption of these measures improves the reliability of projects in emerging markets, prompting the need for increased engagement and incentives from investment firms, regulatory agencies, and other key stakeholders. However, it is important to define what sustainable finance looks like in the context of emerging markets and assess whether it needs to be redefined to better address the unique challenges faced by these countries.
The implementation of sustainability finance and accounting practices can significantly influence emerging markets by increasing disclosure and visibility of information, thereby promoting growth and higher investment. However, since emerging markets are at varying stages of economic development and face different challenges, it is important not to compare them to advanced economies based on the same ESG metrics. Instead, a more nuanced and country-specific approach should be adopted, while also ensuring that the metrics themselves are adaptable and flexible to meet the specific needs of different markets.
In their current format, ESG assessments disproportionately attribute 50% of a company’s value to factors like country, size, and activities. This implies that even before a company is considered for its sustainable policies and ESG compliance, its location can majorly define what kind of funding and score it receives. This is evident from the Sustainable Development Report’s rankings, which consistently place European countries in the top 10 and African countries in the bottom 10 based on their progress to meet the UN’s 17 Sustainable Development Goals. Likewise, Global Risk Index, which assesses ESG risk exposure, categorizes all low-risk countries to be in Europe or Oceania, while high-risk countries are predominantly developing economies.
The current labeling and scoring system hinders emerging markets from accessing necessary ESG funding, which is crucial to improve metrics and outcomes. Companies in developed countries receive around 90% of financial flows from ESG, while the rest of the world only receives 10%. Thus, funding is not directed to places where it is most needed, mainly due to metrics that fail to consider the complexities of sustainable development in emerging markets. So, while developed countries have had the opportunity to achieve rapid growth using carbon-intensive methods in the past, emerging markets are required to achieve growth while prioritizing ESG compliance. Hence, if these markets were approached more flexibly by ESG standards boards, they would be able to focus on growth while also keeping environmental, social, and governance questions in mind.
To better represent emerging markets, ESG metrics need to incorporate and reflect growth-centric goals in their assessment. For example, most metrics nowadays focus on quantifying impact in monetary terms, such as the amount of CO2 emissions per dollar of revenue. Instead, these metrics should be more nuanced in quantifying growth and development in emerging markets. For example, a new growth metric could be developed where CO2 emissions per dollar of revenue could be directly compared to or offset by positive impact generated by a company within the community, city, or country.
Efforts to standardize and increase the comparability of ESG metrics should, however, not be disregarded. Adopting consistent analytical and assessment processes across all countries facilitates the ease of comparability and standardization of training, expectations, and understanding ESG practices. Standard boards and initiatives aiming for a unified ESG framework have increased accessibility and promoted higher compliance. But there is a tradeoff between comparability and flexibility - especially for the accurate assessment of emerging markets’ performance. Thus, established standards boards and agencies need to adjust their approach to better fit the needs of developing countries. Taking action would involve implementing new cross-cutting metrics that would help with comparability, coupled with designing new metrics that would be more nuanced and context-specific in nature. These would provide alternative methods to assess impact and help secure more ESG funding for developing countries, all whilst achieving higher levels of compliance.
Izabela Silva is a Researcher at Botho Emerging Markets Group