Developing ESG, infrastructure considerations for investors in Asia

“If only a small fraction of the trillions of dollars currently under management by institutional investors were allocated to infrastructure projects, there would be a catalyzing impact on emerging Asia’s growth potential,” said Dong-Ik Lee, director general of investments at the AIIB, in the release. “By setting up this portfolio, we hope to develop a proof of concept that over time will mobilize other like-minded investors to join us in cultivating an ESG market in Asia.”

In addition to helping develop debt capital markets relating to infrastructure, the bank also wants to include environmental, social and governance considerations when building the fixed income portfolio.

The bank, which represents the interests of some 93 countries, including non-regional members that aren’t actually in Asia, started with 57 founding members three years ago. The bank’s move to encourage sustainable infrastructure projects in the region is within its goals, but it also aligns with China’s aspirations, according to Patrick Drum, senior investment analyst and portfolio manager at Saturna Capital Corp.

“It’s been part of China’s broad agenda to do a heavy adoption of green bond issuance and the inclusion of ESG,” says Drum. However, the AIIB could have a bit of trouble coaxing private capital from foreign investors hoping to ramp up allocations to ESG-friendly assets because China is one of its prominent members, he adds.

“Chinese bonds, specifically Chinese-issued green bonds, are distinctly different from most standard, typified green bonds.”

The issue with green bonds associated with China is that its definition allows for them to be linked to projects most investors wouldn’t agree are environmentally conscious, such as coal power plants, says Drum. Investors should also be cautious since those definitions are subject to change at the whim of the Chinese government.

Notably, the bank has its own lengthy environmental and social issues framework, which doesn’t explicitly suggest any given investment would be disqualified for being problematic. It does, however, outline the bank’s willingness to provide extensive disclosure on issues like carbon emissions and impacts on Indigenous Peoples to clients and partners.

“The [AIIB] has a triple-A credit rating, so the bank itself has a higher credit rating than China, which is negative A at this point,” says Drum. “Through that bank, it acts as a sort of conduit in which the Chinese can issue projects that are broad and global . . . touching communities as far as Malaysia, Indonesia, Africa and parts of Europe. So it attracts a high credit rating, and the green bond issue increases diversification of the investor base and provides a different kind of appeal, coupled with the strong credit rating, to other institutional investors that might not consider Chinese-issued bonds or a bond generated by that community.”

The AIIB noted ESG investing is still in its infancy within Asian emerging markets. It also said it anticipates its proprietary ESG framework will help build knowledge on how this type of investing can be implemented in the region.

However, sustainability with regard to environmental factors and localized community welfare in emerging markets is integral to the bank’s mandate, says Manu George, senior investment director for Asian fixed income at Schroders. “When you focus on development along these lines, you tend to have a more holistic and sustainable policy than just arbitrarily throwing money at building toll roads or rail tracks. The way they’re going about this is worth highlighting as a good thing.”

George suspects the AIIB is trying to lead by example with the large amount of capital it has at its disposal. As a result, investment managers in the region will have to engage with ESG if they want to be involved with the bank’s projects, he says.

“They are hoping it will be a self-fulfilling cycle, such that it forces other asset owners, whether sovereign wealth funds, pension plans or corporate treasuries to notice that investment managers are highlighting the sustainable ESG credentials a lot more when they are pitching for other types of business. And they are hoping it will lead to discussions at the asset owner’s level about whether they will start inculcating these as part of the process around how they go in.”

Overall, both infrastructure and fixed income are asset classes with massive and often under-explored potential in the region, says George, noting investors have a tendency to focus on equities, especially when looking at regional allocations in emerging markets. “Rarely do they allocate on a fixed income basis to this part of the world. Primarily because emerging market debt is perhaps less well-known compared to emerging market equities.

“What client owners are beginning to understand is the importance of the region and how it’s beginning to dominate their own emerging market debt benchmarks. And China is a big driver of that,” says George. “Today, if you look at the corporate landscape in emerging markets, around 25 per cent or more is China alone and that’s huge. And Asia represents close to 50 per cent of the investible market in emerging market corporates and that number continues to grow at quite a rapid pace.”

This situation will accelerate as India and Indonesia begin to advance to a similar degree as China, he adds. And in 15 years, he notes, Asia will be to emerging market investing what North America is to developed market investing. “I think that realization is only beginning to dawn on the more sophisticated institutional managers, particularly in Europe.”