Have ESG management systems failed to recognise Russia’s risks?
The current war in Ukraine has opened the debate about responsible investment managers current and future exposures in Russia. Similar to the 2008 financial crisis, when Lehman Brothers’ rating was still investment grade just days before its collapse, many ESG data analytics firms downgraded Russia only after the crisis escalated – thus failing to adequately identify ESG risks. Indeed, data shows that ESG funds had USD 8.3 billion in Russian assets right before the war in Ukraine.(1) However, not all fund managers integrate ESG considerations in the same way. The key difference is in how they construct their portfolio, i.e. whether they passively track an index or actively select investments based on their own research. Therefore, the answer to the question is yes and no.
While passive ESG integration relies on third-party indexes to screen companies for compliance with various ESG criteria, active ESG integration implies conducting their own research to identify investments that meet their criteria. If we look at the current allegations related to Russia, most of them are related to passively managed ESG funds.
Active ESG management can be game-changing
BlueOrchard, for example, takes an active approach to assessing ESG risks. This has resulted in investments in Russia being off the table for years – mainly because of very high ESG risks in the country due to significant political and governance concerns. While at BlueOrchard we rely on reputable external sources to provide information on ESG risks, the analysis is ultimately conducted internally. One of the main pillars of B.Impact, our proprietary impact management and measurement framework, is an ESG assessment based primarily on ESG questionnaires completed by the companies in which we invest, inputs from our impact management team, from our investment teams during on-site due diligences, and discussions with various stakeholders.
Excluding investments in certain regions or countries is never an easy decision. As impact investors, we seek to generate and promote positive environmental and social change in emerging and frontier markets, where development gaps are larger, and exclusion is greatest. Deep knowledge and understanding of the markets, including ESG considerations, are paramount. In certain circumstances, the ESG risks may be so high that the likelihood of a positive impact is reduced.
In Russia, the lack of effective supervision and regulation and the extremely high probability of exposure to financial crime and KYC (Know Your Customer) issues have made the market untenable for BlueOrchard since 2014.
Our assessment of country risk and investment readiness of markets and companies is an ongoing process and while we do not take decisions lightly, we often see changes over time. The vast majority of our investment professionals are based locally in our emerging markets offices and we work closely together to ensure we can respond quickly to any developments at country, regulatory, and company level.
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