Investors who may be used to only looking at financial reports will have another document to parse through next year. The Singapore Exchange (SGX) has mandated climate reporting for all listed companies in the current financial year.
All companies must provide these disclosures on a comply-or-explain basis in their sustainability reports for financial years starting on or after Jan 1.
The disclosures will then become mandatory from FY2023 for companies in the financial, agriculture, food and forest products and energy industries.
The materials and buildings, and transportation industries must do the same from FY2024.
As sustainability reporting gathers steam, bourses, governments and boards are attempting to measure the immeasurable — to put a number on carbon emissions, corporate governance and even employee satisfaction.
How, then, can seasoned and rookie investors make sense of this new set of data?
See also: Is your financing really green?
Research houses put a price on ESG
Perhaps to help investors understand the material impact of ESG factors, some analysts have attempted to put a price on ESG.
Research houses like RHB Group Research and OCBC Investment Research apply premiums and discounts on their 12-month target prices for stocks, based on whether the companies fare well or poorly on ESG matters respectively.
See also: A US$12 bil climate fund is readying a rare bond issuance
Others, like CGS-CIMB Research, allocate a page in their research notes to the company’s ESG performance, along with its material implications.
The practice is still in its infancy; RHB, for one, only launched its ESG scoring in mid-2021.
RHB’s regional research and editorial teams developed its internal scoring methodology over nearly six months, says Vijay Natarajan, analyst at RHB.
“The idea started in 2021; a lot more funds started questioning ESG and we definitely did see that becoming a lot more prominent among fund managers and investors in late 2020,” says Natarajan to The Edge Singapore.
If your assets are not green, if your assets are going to be outdated, it will definitely be a lot more difficult to rent out.
RHB grades companies across nine pillars — three for each component of ESG. Companies can score between one and four points for their progress in mitigating carbon emissions, preserving natural resources, limiting pollution and waste, ensuring health and safety, engaging the community, managing employee relations, ensuring board independence, maintaining transparency and addressing shareholders’ concerns.
Taken together, RHB then compares the company’s average score against Singapore’s national median of 3.0 to calculate either a premium or discount.
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For every notch above the country median, the company receives a 2% premium to its target price and vice versa.
For example, Natarajan scored Ascendas REIT an average of 3.3 in a July 8 note — the highest ESG score among the industrial REITs here. Ascendas REIT thus received a 6% premium on its target price from RHB totalling $3.60, representing a 25% upside.
In his coverage of the Singapore REIT market, Natarajan notes how ESG performance “definitely impacts” the balance sheet.
“If your assets are not green, if your assets are going to be outdated, it will definitely be a lot more difficult to rent out… Your operational costs are going to be much higher and revenues are also going to be impacted because tenants might not be willing to pay the same rent, or even a comparable rate, as a green asset. So, it’s about future-proofing the portfolio,” says Natarajan.
That said, he acknowledges that the methodology can still be further improved. “One factor that we can fine-tune is that my score is based on my judgement. Some analysts may be lenient, others may [expect] more. So, that is something that we can refine.”
‘Overly simplistic’
Not everyone is a fan of the new practice, even among proponents of ESG investing. Flora Wang, director of sustainable investing at Fidelity International, thinks applying premiums or discounts is “overly simplistic”.
“Valuation is not a science, which means you can’t take a mechanical approach to the 20,000 companies listed across different exchanges. It really has to be company-specific,” Wang tells The Edge Singapore.
According to Wang, analysts must do better in their ESG assessment or risk being ignored by portfolio managers. “If you apply a mechanical 20% discount to your lowest-rated company, for example, I can tell you what will happen. What will happen is that portfolio managers will just work backwards to get the original stock price because a seasoned investment professional will know what’s actually being factored in by the market and what is not.”
Valuation is not a science, which means you can’t take a mechanical approach to the 20,000 companies listed across different exchanges. It really has to be company-specific.
Wang is also wary of simplifying complex ESG issues into just one figure. “In reality, most of them are producing targets for the next 12 months, whereas these ESG factors take a much longer time to actually impact the company’s operations and financials. Some of that be reflected in stock price, some will not. When they actually do, it’s very difficult to attribute a part of that stock price movement to a specific ESG factor.”
Instead, ESG data is far more nuanced, says James Gifford, head of sustainable and impact advisory at Credit Suisse.
“I think the mistake that many people make is to think ESG data is precise in the way financial data or physics is,” says Gifford to The Edge Singapore. “It’s far more nuanced; many indicators are really open to some level of interpretation.”
ESG factors are almost unlimited in their scope and interpretation, he adds. “Now, it’s not to say that it’s not useful; it is very useful. It’s just more of a social science, in terms of how we interpret questions around human capital, [it is] very difficult to put a number on the impact of having diverse boards, [for example]. It’s very difficult to understand that, from the raw data.”
That said, UOB chief sustainability officer Eric Lim thinks the move is encouraging. “I think it’s interesting that our financial analysts are incorporating ESG into a valuation composition. Not because I think it’s wrong, but the causality of it is very hard to see at this point … It’s too simplistic.”
When you look at companies that have good ESG ratings, they tend to outperform the market. But it’s not causality; it’s a correlation.
Companies that outperform on ESG factors do so because they are well-governed, says Lim, and not the other way around.
“When you look at companies that have good ESG ratings, they tend to outperform the market. But it’s not causality; it’s a correlation. Because companies that have good ESG scores tend to be well-governed. They are more progressive, have strong strategic boards and have strong management teams.”
Analysts must now move ahead of investors as ESG issues become mainstream, says Wang. “Previously, we were just looking at financial statements and operational performance; we were just looking at a black and white picture of a company. Now, we’re starting to look at ESG.”
She adds: “Talk to any investor and they will say confidence is the key, but because they are environmental and social issues, they’re not being effectively priced in by the market, that’s why I think it has been ignored for a large part of the investment history.”
But now, investors are starting to care about those externalities, says Wang. “Even though they’re not being priced in, they still want to know. Some are saying: ‘Even if it may hurt my alpha, I don’t care. I just don’t want to give my money to companies that are doing bad things.’”
Reading the reports
When companies issue their sustainability reports next year, investors should look out for three things, says UOB’s Lim, who is also head of group finance at UOB.
“The first is: Is there a clear articulation of what sustainability means for the business and is it central to the business’ strategy?” he asks.
It’s not about throwing a couple of solar panels or doing your best corporate social responsibility event.
Companies who are genuine about sustainability efforts should have “high-quality roadmaps” that are central to what the business does for a living, he adds. “It’s not about throwing a couple of solar panels or doing your best corporate social responsibility event. If I’m a manufacturing company, how do I integrate sustainability into my manufacturing processes? My raw materials sourcing, my supply chain, that kind of stuff. So, number one: Is it authentic and core to your business model?”
The second thing investors should look out for is whether companies can report on each of the ESG metrics of their business, says Lim. “[For example,] if you are a construction company, you want to be talking about your waste and water management, fatalities, worker health and safety.”
Data centre companies, meanwhile, should report on energy efficiency, retrofitting efforts or new data centre initiatives that will reduce energy consumption, says Lim. “If you’re a bank, you want to understand how you’re addressing net-zero commitments, how you’re managing your finance emissions through your lending activities, and how you are disclosing [according] to the key frameworks, guidelines and policies that are required by your regulator or your investors.”
Finally, the third thing Lim would look for is the company’s grasp of disclosure frameworks. “By demonstrating compliance or referencing the right frameworks, it is the first step for a report to go through internal and external assurance. If you’ve got a report that demonstrates how sustainability is integrated into the core of your business model, you’ll have the evidence to show for it.”
Photos: Albert Chua/The Edge Singapore
