3 ways sustainable finance is reshaping Asias capital markets
27 May 2019 | Mitigation
This year, Asia will account for half of the world’s GDP growth. And while this has undoubtedly improved living standards and reduced poverty in recent years, such gains have come at a cost.
Degraded natural resources and ecosystems, worsened water stresses, and increased levels of hazardous waste, comprise just some of the many unintended byproducts of Asia’s resource-intensive growth model–exposing the entire region to a domino effect of risks. Take water, for example, one recent study by MIT suggests that more than 100 million people in the region could endure severe shortages over the next decade, with devastating impacts on food security, economic growth and political stability. Without meaningful action to address climate risks, GDP in the Asia-Pacific region could decrease by more than 3% by 2050–a significant erosion of the region’s economic gains in recent decades. Furthermore, Asia-Pacific economies still feature among the highest rates of income inequality in the world. In this region, one percentage point increase in the Gini coefficient, a generally accepted measure of inequality, reduces GDP per capita by $154.
Financial returns cannot outrun the costs of these social and environmental risks, especially at this scale. New sources of investment capital and greater investment, overall, are desperately needed to address society’s greatest challenges. It is imperative to bank on new financial instruments that can both tap the estimated $200 trillion currently invested in global capital markets and incentivize investment. Indeed “sustainable finance” is increasingly proving it can generate strong returns and address risks posed by issues like climate change as well as offer valuable portfolio diversification opportunities.
Asia could be the epicenter for a seismic shift in the way capital markets create value, profitably and sustainably, as detailed in FSG’s latest report, Financing the Future of Asia: Innovations in Sustainable Finance, supported by The Rockefeller Foundation. Here are three reasons why we’re excited about it:
First, governments in Asia’s strongest economies are leading concerted efforts to grow sustainable finance. Major institutions and governments are driving market-building efforts around more established instruments, such as green bonds and environmental, social and governance (ESG) investing. The latter is well-established, attracting $1 out of every $4 invested in the US today. In China, the Shanghai and Shenzhen stock exchanges will require ESG reporting for all listed companies by 2020. It’s not just ticking boxes, it’s profitable: the Social Value 99 index, which tracks China’s top companies ranked by ESG factors, is outperforming traditional indexes. The government has also established a regulatory framework for green finance investment, and is fostering innovation through the creation of five pilot zones to develop new green finance products, enhancing foreign capital flows into domestic green bonds through its support of the launch of the Hong Kong Bond Connect Scheme.
Meanwhile, the world’s largest asset owner, Japan’s Government Pension Investment Fund (GPIF) is going beyond simply incorporating ESG into its own investments, and is encouraging external asset managers to do the same, working with external evaluators to create greater convergence in assessment methodologies and impact measurement. Given the size of its portfolio–$1.4 trillion in assets under management as of July 2018, representing 6% of Japan’s stock market capitalization for its domestic equities alone–the impact is significant.
Second, novel mechanisms are being pioneered in Asia, while innovative approaches from other markets are being applied here at scale. Across the region, asset managers are leading the charge in integrating sustainability into the core of their investment models, often in novel ways. For example, Althelia Climate Fund has invested in the rehabilitation of 22,000 hectares of peatland rainforest in Indonesia, generating returns by combining capital gains from appreciation in asset value, selling commodities from asset utilization, and monetizing carbon credits. Innovation around more established instruments enhances their usage. The first green sukuk in Malaysia, a green bond compliant with Islamic finance principles, now enables a whole new segment of investors seeking such compliance to invest in green growth.
In other cases, new financial mechanisms are being adapted from innovations launched elsewhere. The Southeast Asia Disaster Risk Insurance Facility (SEADRIF), a pooled parametric insurance facility covering Cambodia, Laos and Myanmar, was inspired by a risk insurance facility that covers Caribbean and Central American governments. Both provide rapid payouts to member countries in the event of disasters, thus reducing their dependence on their own fiscal resources for disaster response.
Third, innovation in the region is being met with unparalleled opportunity to solve issues close to home. The current wave of innovation across a diverse array of issues in Asia demonstrates unmatched potential to lead the space’s transformation, and that of broader society. Online market places have bridged access between urban and rural markets in China and now across the region, as demonstrated by platforms, buttressed by fintech solutions that also expand the reach of formal financial services. S New crowdfunding platforms are enabling impact investments traditionally outside the reach of non-traditional players and individuals, the way Ethiscrowd channels micro-funding toward the social housing sector in Indonesia, which suffers as shortfall of 11.8 million houses for low-income families.
While these early developments are fueling sustainable finance’s burgeoning momentum, greater levels of innovation and market-building efforts are necessary to truly exploit its full potential. Importantly, new mechanisms and vehicles must not only be created, but also made investment-ready for mainstream investors so sustainable finance can attract the amount of capital necessary to transform the entire market. The pieces are in place to catalyze a financial revolution in Asia, we just need to seize the opportunity to shape this emerging sector, and move toward a future in which the entire industry is invested, both literally and figuratively, in building a more prosperous world.