Emerging markets are often overlooked in discussions on responsible investment because current standards and frameworks are based on the situation in developed markets and then applied globally, according to Prudential.
The life insurer called for more awareness and understanding of emerging markets which struggle with carbon-intensive production while developed markets consume the lion's share of the products manufactured by this carbon.
“When you're making policy, governments have to be aware of the fact that the Paris Agreement accounts for differences in economic development between countries,” said Liza Jansen, head of responsible investment at Prudential.
“But I'm not sure when we think of new standards and new ways or how to decarbonise portfolio, whether we actually take this enough into account,” Jansen said during a panel discussion at AsianInvestor’s Asian Investment Summit recently.
Prudential managed $193.1 billion of assets by the end of 2021.
Last year, it pledged its portfolio of assets would reach net zero by 2050. Actions include a 25% reduction in the carbon emissions of all shareholder and policyholder assets by 2025 and an accelerated transition to a low-carbon economy by engaging with companies responsible for 65% of the emissions in the portfolio.
THE EM GAP
As a life insurer operating in Asia and Africa, Prudential has a large exposure to emerging markets.
“Prudential, as an operator in many of these emerging markets, is a local asset owner and our liabilities are often also denominated in local currency ... if we want to reach global net zero, we have to make sure emerging markets’ transition needs are catered for as well,” Jansen said.
She said that current ESG framework and standards sometimes lead to a disincentive to investing in emerging markets, which could result in funding gaps. For example, ESG ratings are very often highly correlated with GDP both at a company and country level.
“So if you have a global strategy and you apply ESG overlay based on ESG ratings, you'll probably end up shifting assets from emerging markets to developed markets, because larger companies and companies in richer countries have higher ratings than companies operating in emerging markets,” Jansen said.
This is also the case for carbon intensity, she noted.
“Often companies in emerging markets are more carbon-intensive, that’s because they might be lagging on technology or energy efficiency. But it's also the case that a lot of developed markets have outsourced more of their carbon-intensive production to emerging markets and import back the goods.”
While many developed markets have relatively low production emissions, they have higher consumption emissions, Jansen noted, stressing that there should be more awareness about such differences.
“We're really looking for specific barriers to solve to get more financing to these markets,” she said.
DIVESTMENT A TOOL
Prudential has a target of divesting all direct investments in businesses that derive more than 30% of their income from coal, with equities to be fully divested by the end of 2021 and fixed-income assets by the end of 2022.
Even for companies that Prudential engages with for transition, Jansen said divestment is also an option of the last resort, based on the engagement and transition progress it gleans from annual reviews.
Any divestment decisions would be made after comprehensive consideration of the ESG impact, she said, adding that climate change is now a financially material risk.
“We have a fiduciary duty. We have a responsibility to act in the best interests of policyholders. Sometimes that means stepping away from a company if it's not transitioning, other times it might mean we have to make a careful consideration whether we actually want to divest,” Jansen said.
While changes in the portfolio can lead to fluctuations in the short term, she said Prudential monitors its portfolios once it has actually divested from any asset to make sure it's not adversely impacting the performance too much, and see how it can compensate for such an impact.
“It's always a balancing act," Jansen said.