When investing in companies, ensuring good enterprise value, strong financial ratios, and robust cash flows is crucial for identifying growth opportunities. For decades, these financial metrics have been used to indicate a company worth investing in, potentially promising solid returns for shareholders.

Today, however, integrating environmental, social, and governance (ESG) factors into investment strategies is increasingly critical to capturing the full picture of a firm’s potential and resilience.

Here are three key reasons why understanding ESG factors is critical for investors, especially in the Asia-Pacific region.

Enhancing risk management

ESG considerations are at the heart of effective risk management. Traditional financial metrics are essential, but they often fail to capture a company’s full risk profile. ESG metrics provide critical insights into risks that can significantly impact a company’s performance.

For example, over 57 million people across the Asia Pacific were affected by climate disasters in 2021. Imagine the financial impact if your investee firms or its employees were located in those regions. Or, outdated technology might mean a facility consumes excessive energy, impacting not only environmental resources but also increasing operational costs. For a “Social” factor, consider an investee company in the technology sector that only hires one gender—can it truly create products representative of our diverse society?

Tracking these risks is the only way to understand the strategies needed to manage them. Often, the data exists but companies fail to operationalise its consolidation because it’s scattered across different parts of the organisation. It is also sometimes an exercise that is done once at the start of the investor relationship instead of leveraging it over the course of the investment period.

Also Read: Small steps, big impact: How SMEs can champion ESG initiatives

Driving operational efficiency

Integrating ESG metrics into traditional financial analysis provides a more holistic view of investee company performance and opportunities to create operational efficiency. For instance, tracking information about sustainable packaging for retailers can lead to cost savings through reduced material use and waste. Similarly, tracking the number of workplace injuries and days lost due to injuries are additional metrics that can contribute to better financial performance and lower risk when managed.

In Asia Pacific, companies face unique challenges, such as the lack of consistent common language that makes the understanding of global standards tricky. For example, the nuances of diversity, equity, and inclusion (DEI) policies and demographic data tracking can vary significantly between countries, leading to inconsistent data collection processes.

Additionally, human error, lack of information, and overly complex data collection methods can result in poor data quality. An effective ESG strategy involves a clear and consistent approach to yield high-quality data, which is crucial for achieving the efficiency needed for desired investment outcomes, as well as a technology platform that integrates with your current tech stack.

Meeting investor expectations and regulatory requirements

Private equity firms are increasingly requesting metrics that account for emerging risks. Issues such as cybersecurity are particularly relevant to the Asia-Pacific region as technology becomes more sophisticated. Organisations in the Asia-Pacific region experienced an alarming average of 1,835 cyberattacks per week in the first quarter of 2023, compared to the global average of 1,248 attacks per week, according to IMDA Singapore.

Last year, Asia Pacific witnessed the highest level of cybercrime activity for the second consecutive year, accounting for 31 per cent of global attacks. As digitalisation continues to expand across the region, cybercriminals are increasingly targeting Asia, making cybersecurity an essential component of risk management for businesses.

On the ESG regulatory front, there has been an uptick in jurisdictions requiring mandatory reporting from non-listed companies. While many regulations in the region are targeted to public companies, Japan, Hong Kong, Indonesia, and Singapore encourage non-listed companies to adopt sustainability disclosures on a voluntary basis. Singapore and New Zealand have also established regulatory requirements.

Starting in 2027, Singapore will require large non-listed companies to disclose climate-related information. New Zealand has already introduced mandatory climate-related disclosures for financial institutions and large entities beginning in 2023.

Also Read: ESG frameworks and standards: Cutting through the complexity for private markets

With regulatory requirements also on the rise globally, private equity firms may limit their pool of potential investors during fundraising if they lack robust ESG data. Investors based in regions such as EMEA often have stringent regulations and requirements for ESG disclosures, making comprehensive ESG reporting crucial for attracting and retaining these investors.

Practical steps for investors

To operationalise your ESG processes, consider these basic steps:

Adopt global standards and frameworks: Leverage existing ESG frameworks such as EDCI, GRI, and SASB to inform sustainability reporting. Having a policy simply means an overview on values and principals but having a framework is a more practical and prescriptive step.
Integrate ESG into due diligence: Make ESG metrics a core part of your investment evaluation and portfolio management process to demonstrate your commitment to sustainable investing and long-term value creation.
Engage with stakeholders: Regularly engage with your stakeholders and those of your investee companies.
Utilise technology: Implement technology solutions to streamline ESG data collection and reporting. If data collection is too onerous, you jeopardise the quality and completion of the process.
Address regional challenges: Language and Cultural Differences: Provide training and resources to help local teams understand and implement global standards.
Simplify data collection processes: Develop straightforward, efficient data collection methods to reduce the burden on local teams and improve data quality. This could be assisted with evolving technology today.

As the investment landscape evolves, integrating ESG considerations into your strategy not only enhances operational efficiency and risk management but also aligns with global investor and regulatory expectations, ensuring robust and sustainable growth for the future. Make sure you have the full picture.

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