ESG investing in emerging markets – a roadmap towards net-zero

ESG investing was top of investors minds as experts in the field of emerging markets, credit, and sustainability came together to discuss EM debt and ESG within the region.

A recent event hosted by BNP Paribas in association with the Emerging Markets Investor Alliance (EMIA), brought together experts in the field of emerging markets, credit, and sustainability to discuss Emerging Market debt and the importance of ESG within the region. Speakers addressed ESG regulation and data, how investors can support the transition in emerging markets, sovereign engagement as an essential tool to drive forward ESG adaptation and the increasing need to incorporate biodiversity in investment decisions.

The difficulties of regulation & data in the market

When it comes to attracting and generating sustainable investments, emerging markets face even more complex issues than developed markets. This includes the lack of clear frameworks and the differing standards across ESG regulation and reporting. The demand for enhanced ESG disclosure is substantial and only growing as investments continue to increase accompanied by exponential growth in the amount and types of data available for ESG investors to consider. 

While the outlook for emerging markets is promising, the higher-for-longer rates regime is proving challenging for investors – rate differentials have tightened, filtering into currency weakness and worsening credit fundamentals.“The higher cost of debt is going to be a legacy for many years to come”, said Trang Nguyen, Head of EM Credit Strategy, BNP Paribas. In such a backdrop, credit managers need to look at risk on a long-term basis and ESG is a central part of that. In fact, ESG sits at the core of EM investing. The challenge that remains however is a lack of standardisation of both regulation and of data which has only been further exacerbated by differences in expectations and requests from a diverse base of investors.

According to Paola Lamedica, Head of Credit ESG, BNP Paribas, what will matter going forward is the interpretation and standardisation of regulation and data in the market, particularly, the Sustainable Finance Disclosure Regulation (SFDR). The SFDR, which requires European investment firms to disclose their positioning of ESG factors within their investment decisions sets forth multiple disclosure categories: funds that address ESG risks but have no sustainability goals (Article 6); funds that promote ESG characteristics (Article 8); and impact funds that have intentional and measurable sustainability objectives (Article 9).

In our 2017 ESG Survey, our client’s cited data irregularities as their top issue, and once again in 2023 they cited these irregularities as their top challenge. But, reading between the lines we can see that data has become more granular and accurate, while investors have become more sophisticated in their approach, meaning we see that data is continually evolving to address investor needs. So, while it may remain a top issue in 2025, the quality of data is likely to continue to improve significantly.

Trevor Allen, Head of Sustainability Research, BNP Paribas

There is currently a large demand for sustainable investments in the market, however demand is outpacing supply, meaning that building a Paris-aligned portfolio of investments has proven to be a challenge. Article 8 funds for instance, have a very small share of sustainable investments, whilst amongst sustainability-linked bonds, most KPIs relate to carbon emissions exclusively (only 5% are linked to waste or water) and often do not match the ambition required from the issuer. “This reinforces the need for more innovation in financing structures going forward, with risk-sharing and blending solutions” affirmed Nguyen.

“In our 2017 ESG Survey, our client’s cited data irregularities as their top issue, and once again in 2023 they cited these irregularities as their top challenge. But, reading between the lines we can see that data has become more granular and accurate, while investors have become more sophisticated in their approach, meaning we see that data is continually evolving to address investor needs. So, while it may remain a top issue in 2025, the quality of data is likely to continue to improve significantly,” said Trevor Allen, Head of Sustainability Research.

How can investors support the energy transition in emerging markets?

A second topic that emerged from the event was centred around how investors can support the energy transition in emerging markets. Emerging markets face unique challenges compared to their developed counterparts.  For many countries this can include a heavy economic reliance on environmentally damaging industries such as coal and mining. This not only complicates energy transition objectives but as well, creates additional constraints due to high levels of dependence on foreign investment, poor availability of ESG data and weaker corporate governance and climate frameworks in line with the Paris Agreement.

Emerging markets are also on average further away from meeting the UN’s Sustainable Development Goals than developed nations. One of the most significant challenges is access to sufficient public and private sector financing that will enable companies to play a role in implementing a just transition.

Labelled bond issuance is growing as a share of total investments and is a key area to address, representing c. 10% globally, and more than 20% in EMEA with one out of five bonds being issued being an ESG labelled bond. Still allocations towards EMs remain relatively small and emerging markets are left short of investment needed to bring the infrastructure necessary to improve livings standards and align with environmental and socially sustainable standards.

Sovereign engagement – the key to spreading sustainable thinking

Sovereign engagement was brought to the table as a powerful tool to attract capital. In fact, sovereign debt accounts for 68% of total global bond markets according to ICMA, making it a pivotal instrument in the market, yet according to Delphine Queniart, Head of Sustainable Finance Climate Engagement, BNP Paribas, “engagement between issuers and investors is far less in credit than in equity markets – and in terms of standardisation of data, sovereigns are even more behind than their corporate counterparts.”

Engagement with sovereigns in ESG is paramount to responsible investing. Sustainability is a long-term determinant of an economy’s development, however it is often difficult to track how countries fare on their sustainability pledges, and once again, one of the biggest challenges that appears is data and metrics, especially in countries where little data exists. Even where there is data, it is often lagged and backwards looking, said one speaker.

Nonetheless, investors are more and more considering ESG factors at the EM sovereign level. In 2020, the government of Hungary issued its inaugural green bond framework – the first of its kind, and the only sovereign with green bonds issued in four different currencies. In line with the framework, Hungary’s green bond issuance will be used to finance or refinance central government expenditures in the green categories of clean transportation and energy efficiency among other sustainable commitments.

Biodiversity – an emerging trend

Biodiversity is becoming more central to investors ESG strategies and screening processes. And whilst it is clearly a complex and multifaceted subject, the market is increasingly finding ways to simplify it. According to Lamedica “We will see more SLBs integrating biodiversity in 2024.”

The mainstreaming of nature must be integrated into investment decision-making. Climate change poses a major threat to long-term growth and prosperity. At BNP Paribas we want to support our clients and help increase the flow of capital into the emerging markets, via both public and private channels to address climate change needs. Of course, transition is complex and needs to ensure we find de-risking solutions in EM that will be developed at scale in the future.

Delphine Queniart, Head of Sustainable Finance Climate Engagement, BNP Paribas

Use of proceeds remains a topic of debate and is currently skewed towards clean energy, energy efficiency and clean transportation while the blue economy – SDF 14 – is currently the most under-funded area and represents a massive opportunity. In fact, the World Health Organization has released clear metrics demonstrating that 75% of all nations are materially underinvesting in water and sanitation.

For EM, adaptation finance, water and biodiversity will be key areas for resilience. New and disparate regulatory and metrics frameworks continue to evolve but alignment is beginning to converge. The Taskforce on Nature-related Financial Disclosures for instance, is a framework for organisations to report and act on evolving nature related risks which aims to support a shift in global financial flows away from nature-negative outcomes and towards nature-positive outcomes.

Queniart affirms, “the mainstreaming of nature must be integrated into investment decision-making. Climate change poses a major threat to long-term growth and prosperity. At BNP Paribas we want to support our clients and help increase the flow of capital into the emerging markets, via both public and private channels to address climate change needs. Of course, transition is complex and needs to ensure we find de-risking solutions in EM that will be developed at scale in the future.”

The integration of ESG represents an untapped opportunity in the credit market and will undoubtedly help investors mitigate future risks. The question will be on, if and how the industry can be reshaped to enable greater funding flows to be directed into the markets that need it most, whether emerging markets should be held to the same standards as developed markets, and on how to increase sovereign engagement. These are questions that the panellists sought to answer and will continue to shape the future of the industry.

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