Investing in ESG

Investment decisions based on ESG criteria are growing and for an increasing number of asset managers, ESG inclusion in their decision-making is ever more apparent, as they see this focus as return-enhancing and risk-mitigating.

Sustainability-focused funds continue to attract more capital. For example, CNBC (2020) referenced a statistic from Morgan Stanley that in years of market turbulence, including 2008, 2009, 2015 and 2018, sustainable funds' downside risk was substantially smaller than traditional funds.

Mitigating risk is even more pertinent when looking at commodities trading, as many commodities are exposed to environmental and social risks. Collaboration between key stakeholders, such as consumers, governments, NGOs, and investors across many commodity types is improving ESG. This includes the natural rubber industry, where there has been increasing focus on sustainable business practices across the supply chain.

Risks of ignoring ESG in commodities  

Natural rubber is a key product in the automotive industry, and increasingly important for the manufacturing of gloves and other essential protective equipment in dealing with Covid-19. As with other commodities, there are substantial risks in ignoring ESG requirements and potential negative impacts on revenue growth, operating margins and reinvestment potential.

As recently as 2015, Indonesia suffered its worst haze in two decades due to illegal fires which were started to quickly and cheaply clear land for new plantations.  Investigations by Singapore’s National Environment Agency (NEA) found four Indonesian companies guilty of this and took legal action.  Under Singapore's Transboundary Haze Pollution Act, those guilty can be fined up to $100,000 a day, capped at $2 million, for causing unhealthy haze.  

As a result, those companies who were caught now may suffer from higher exposures to grievous, or even catastrophic event risk, arising from operating with too little consideration of societal costs.  Other recent examples include events like the Union Carbide gas leak in Bhopal, Vale’s dam bursting in Brumadinho and BP’s oil spill in the Gulf of Mexico.  These highlight the risk of ESG shortcomings, which create long-term problems, at times even catastrophic, for these companies.  

In addition to these high-profile disasters, where poor ESG positioning increases vulnerabilities to negative event risks and crisis, it is increasingly true that informed customers will buy less from companies who do not comply with ESG commitments. Companies that do not focus on ESG positioning at an early stage could face reduced margins and higher borrowing costs as they try and play catch up, particularly because ESG certifications are awarded through regulatory practice.

Finally, all of this could result in lenders baulking at lending against those that are poorly positioned and demanding higher interest rates. The industry is beginning to recognize that sustainability risks are holistic and compounding.  

Can technology pave the way for a sustainable natural rubber future?

One of the key variables for all market participants to make the best decisions using ESG principles is access to relevant information and data, at the right time and in the right way. Another way is to contemplate how deals can be structured so that benefits can flow to all market participants. Technology, which can address both needs, is currently chronically underused in the rubber industry. Boston Consulting Group has indicated that there is US$70 billion to be gained in incremental value from commodities trading by deploying appropriate technologies. Additionally, the onset of the Covid-19 pandemic has created a further impetus for change, with new remote working environments and market movements.

Many people in the natural rubber industry feel that technology is going to play a key role in helping the industry meet its sustainability goals, as well as in trading and pricing in the markets for ESG criteria. With a move towards the democratisation of markets, and insiders having less power, some business models are going to come under intense scrutiny in the next 5-10 years.

The rubber market does a commendable job of delivering volume, but how do we ensure the cost of sustainability and pricing is not dominated by large conglomerates? It is going to be an issue that is going to continue to dominate moving forwards.