ESG and Asia Fund Managers

Q. Do you see any retreat from the ESG imperative in Asia right now?

Shubha Shanbhag: Absolutely not. If anything, the focus has grown—we’ve seen increased focus on ESG and dedicated budgets for ESG initiatives are being allocated. Where we are, in India, the commitment from the Government on where we want to be on net zero—which would be 2070 as declared by Prime Minister Narendra Modi—as well as the focus that has come from regulators such as the Securities and Exchange Board of India (SEBI), is really helping to evolve the ESG landscape. For instance, SEBI has mandated the top 1,000 listed companies (by market capitalization) to make ESG disclosures as per the Business Responsibility and Sustainability Reporting (BRSR) on a mandatory basis from FY 2022-23.

Above all, the corporate commitments and ESG ambition of tenant companies—are also increasing, so they need us to engage with the ESG agenda.

Q. How do you approach ESG given those drivers?

Shubha Shanbhag: We integrate ESG across our project lifecycle right from site selection, project development, operation and post-occupancy stages. We also adopt a value chain approach where we engage and influence our business partners (contractors, suppliers, service providers, tenants) on ESG integration.

Within IndoSpace, ESG is a separate function and there are dedicated resources available. It sits within asset management. That said, when it comes to implementation, we work in a very cross-functional nature. I have a very close working relationship with every key department of the business.

The ESG department reports to Managing Director, Fund & Asset Management, who reports directly to our Chief Executive Officer and Vice-Chairman.

We have an Environmental and Social Management System Committee, where the managing directors of all the vertical business lines sit, with direct reporting at the vice chairman level. Our ESMS Committee provides regular feedback and insights on our ESG risks, opportunities and overall sustainability performance. It holds meetings on a quarterly basis that address our strategic priorities and roadmap on ESG.

Q. How does ESG influence the decisions that Indospace makes?

Shubha Shanbhag: ESG is not a short-term trend for us; rather, it’s an approach that is going to help us create lasting positive impact and value for all our key stakeholders. We are not just trying to mitigate risk—we also see ESG as a way to identify opportunities that drive sustainable growth.

Certainly, improving our resilience is important. So, we try to focus on the material topics for our business—we did a very extensive materiality and stakeholder engagement exercise that identified key focus areas for us including resource efficiency, green buildings, climate change, local community and employee health, safety and wellbeing. We align our ESG initiatives to meet the expectations of our key stakeholder groups (tenants, investors, and local communities).

Another angle is that it is vital to stay ahead of regulatory compliance, particularly in India, where the regulatory landscape is evolving very quickly. And finally, we understand that ESG/sustainability is the foundation for the future workforce and is one of the critical requirements to attract and retain human capital.

Q. Is ESG performance a consideration in Indospace’s pay and performance policies?

Shubha Shanbhag: Yes—we have introduced this as a pillar of our performance management systems. ESG-related metrics are one of the factors considered in performance-related criteria for IndoSpace senior executives and responsible function employees. All the departments have goals and targets related to ESG and its sub-components, and these link to executive compensation at a senior management level as well as with each department. The way it cascades down might be different from one department to another, but there is a direct link between ESG and compensation.

Q. What does ESG mean to Hop Lun?

Anand Ramachandran: ESG is one of our critical cornerstone policies, not least because our founder, Erik Rydhas, has always been a visionary and has been very active in the sustainability space.

From a climate perspective, the apparel and garments industry is considered one of the largest sources of greenhouse gas emissions, so we are looking to work our way through that challenge. We are working toward net zero targets, which we will submit as part of science-based tracking.

But other issues matter too. For example, this industry employs a lot of women from different countries, so ensuring women are getting equal opportunities at work and are able to lead fulfilling lives is important to us; Women Empowerment was the theme of our most recent sustainability report.

There are other social metrics that are key too. Are we giving our employees a decent living wage? Are we providing them with access to sufficient leave entitlement, childcare, nutritious meals, and primary medical care?

Q. Beyond the management team’s personal values and commitment, what is driving Hop Lun’s increasing focus on ESG issues?

Anand Ramachandran: The primary motivation comes from our stakeholders, including our major investor, Platinum Equity. The investor community wants to hold us to account in the sustainability space. Do we have meaningful sustainability programs in place? Are we improving our sustainability metrics year on year? We see that embrace of sustainability across the whole financial sector. For example, we recently revised the terms of our existing loan where the interest rates are pegged to our sustainability metrics—if we hit our targets, we qualify for a small reduction in interest rates.

Customers are pushing us hard too. Many of our customers are large multinational brands with significant sales in developed economies where consumers are carefully inspecting sustainability credentials. They are under pressure on sustainability and a lot of that gets pushed down the supply chain, including to us, because that’s where so many of the emissions and so much in the social space originates.

Q. Does the work you’ve done on so many ESG issues provide the business with a competitive advantage?

Anand Ramachandran: Definitely. Customers want to hear more and more about what we’re doing on sustainability, and we’re often asked to present on that at supplier events. But it’s not only about gaining a competitive edge because we want to improve the industry as a whole. When we make those presentations, we hope other suppliers will follow our example, and we share lessons that will be useful to them.

Q. What about your own suppliers? How closely are you working with them on ESG issues and concerns?

Anand Ramachandran: This is really important. If you’re talking about our greenhouse gas emissions, for example, Scope 1 and Scope 2 emissions account for less than 5% of our total emissions—the rest come from Scope 3, and mostly from our supply chain’s emissions.

We work with many suppliers by encouraging them to enroll on the HIGG platform, which is our industry standard for measuring and reporting sustainability metrics. Once they’ve done that, they have a clear idea on where their gaps are, and we work with them to help close their gaps and improve their scores; we do this on a continuous basis.

Q. How does your relationship with Platinum Equity affect your approach to ESG?

Anand Ramachandran: We are constantly sharing information and providing them with progress updates on what we’re doing. We have a fruitful two-way relationship—they’re supportive and ready to offer help when we need it.

“From a climate perspective, the apparel and garments industry is considered one of the largest sources of greenhouse gas emissions, so we are looking to work our way through that challenge. We are working towards net zero targets, which we will submit as part of science- based tracking.”

Anand Ramachandran, Hop Lun

Q. To what extent do investors regard ESG as a driver of value creation?

Ruari Sinclair: Value creation and superior returns on exits are widely considered globally, and now in Asia, as the critical driver for ESG initiatives with financial sponsors. We see ESG being integrated more and more into the post-acquisition value creation plans. However, we also see differences in ESG approach and maturity across the region by different financial sponsors, industries and portfolio companies. There is still a lot of work to do in Asia for ESG, but it is certainly gaining momentum.

Q. How do you demonstrate the ESG value?

Ruari Sinclair: This is a key question that we get asked regularly. The reality is the ESG valuation premium is specific to each company and exit process. It remains challenging to give even a ballpark estimate for the IRR or multiple uplift from successful ESG initiatives, let alone a precise one. However, through various factors such as measurable ESG data, financial analysis, benchmarking and good leadership, we believe a premium valuation can be achieved on exit. Finally, ESG is now a recurring cost (or investment) of operating and owning a business. You can’t ignore ESG because if you do, you may lose your competitive advantage, fall on the wrong side of the increasing regulatory requirements and greenwashing risk. ESG improvements and value creation takes time and requires significant expertise and resources to create value.

Q. Where is value most likely to come from?

Ruari Sinclair: There is a range of ESG factors now responsible for creating value on an exit, but we need to identify these on a case-by-case basis.As companies strive to have more sustainable business models, they focus on new product development, entering new markets, developing cleaner manufacturing processes, supply chain improvements, etc. Focusing on the ESG value factors, which are most material to the company and the industry, will yield the highest returns on an exit.

We are currently working on a sale process for an Asian sponsor for its European consumer portfolio company. The company is facing increased product sustainability regulation changes in the coming years. They have invested significant resources and leadership to create a more sustainable product which will create significant environmental benefits for customers and employees, along with improving profitability from the new products and a cleaner manufacturing process. We believe communicating the ESG equity story will support the investment thesis for the company being a market leader, commanding a premium valuation on exit. Finally, further value from ESG initiatives will start becoming more prominent with wider use of sustainability-linked financing where the interest rate of the credit facility will be linked to agreed targets, such as reduction in greenhouse gas emissions (GHG) and gender diversity.

Q. How does BDA approach ESG in an M&A sales process?

Ruari Sinclair: BDA has established an ESG Transaction Advisory team where we work with clients to better understand the material ESG initiatives, opportunities and risks relevant to their portfolio company.

ESG is now more integrated into both sell- and buy-side due diligence, especially for financial sponsors and how they look at acquisitions at various stages through the acquisition process with their investment committees. Consequently, this needs to be communicated early in a sales process to avoid sponsors rejecting an opportunity for not being able to address key ESG questions.

The BDA ESG Transaction Advisory team follows three steps during the M&A sales process. First, we communicate in our sell-side marketing materials the company’s successful ESG initiatives to date, the stage of the company’s ESG journey and future ESG strategy.

Secondly, we are recommending to our clients to include ESG vendor due diligence (VDD) along with other VDD reports. ESG VDD can also be connected with the commercial and financial VDD reports to help evidence the financial and commercial drivers. To the extent material—and where the data allows—any ESG driven margin improvements, new product launches and capex should be separately identifiable in the financial model to evidence the value creation.

Thirdly, being aware and on the front foot regarding key risk ESG due diligence topics such as GHG and supply chain reporting (especially in Asia) will help preserve value. Supply chain is a particularly important topic for companies in Asia serving customers in the West, where modern slavery, health and safety, and labor rights are gaining increased focus. This became a key diligence topic when we advised on the recent sale of Hop Lun to Platinum Equity. Communicating the ESG value creation story and addressing any risks early in a sales process will help increase buyer interest globally, avoid sale process disruption and maximize returns on exit.

About BDA Partners

BDA Partners is the global investment banking advisor for Asia. We are a premium provider of Asia-related advice to sophisticated clients globally, with over 25 years’ experience advising on cross-border M&A, capital raising, and financial restructuring. We provide global reach with our teams in New York and London, and true regional depth through our seven Asian offices in Mumbai, Singapore, Ho Chi Minh City, Hong Kong, Shanghai, Seoul and Tokyo. BDA has deep expertise in sustainability, chemicals, consumer & retail, health, industrials, services and technology sectors. Since 2022, BDA has advised on eight sustainability-focused transactions across a variety of sectors including cleantech, ESG advisory/financing, e-waste recycling, water and energy, along with advising on ESG topics on our closed and current transactions though our ESG Transaction Advisory Team. We work relentlessly to earn our clients’ trust by delivering insightful advice and outstanding outcomes.

Q. There are some indications that Asia-based funds are pausing or even rolling back ESG policies and efforts lately. What are you seeing in terms of ESG adoption and implementation among your peers—and how is ESG being treated within your fund/organization?

Brian Gu: This certainly seems to be the case, that in light of growing economic challenges, the push for ESG among many funds has taken a back seat to more short-term impact on portfolio company performance.

For ShawKwei & Partners, on the other hand, we remain committed to the long-term value creation prospects of sustainable business and we actively deal-source target companies with technology-driven innovation. This approach gives a strong start in raising the portfolio company’s market valuation in the long run.

For instance, ShawKwei recently announced its acquisition of ZymeFlow, an innovative chemical decontamination solutions business that enables its customers to become more sustainable in their ESG journey. ZymeFlow’s diverse line of chemistry is focused on a biodegradable formulation and takes a fundamentally different physical approach to decontamination chemistry compared to the competition. When combined with other proven chemical operations ZymeFlow allows clients to meet their sustainability goals, helps reduce their carbon footprint, and drives green initiatives.

Another recent acquisition was ShawKwei’s investment into Group14 Technologies. The company developed and now manufactures an advanced silicon battery technology for lithium-ion batteries used in electric vehicles (EVs) and other electronic products and devices. Most of the lithium-ion batteries in today’s EVs use anodes made of graphite, which are sourced mainly from China. By using silicon for the battery anode material instead of the more common graphite, Group14’s technology produces a lithium-silicon battery with significantly higher energy density and a faster charging time. Group14 exemplifies our strategy to invest in cutting-edge science and capabilities to accelerate decarbonization and support the energy transition to a more sustainable future.

Q. To what extent are the customers of your portfolio companies asking questions about the carbon emissions of your portfolio companies in anticipation of disclosure requirements that will apply to those customers? And to what extent are your portfolio companies taking steps to prepare to respond?

Brian Gu: Our portfolio companies are in the traditional manufacturing and energy services industries where there is an increasing trend of customers performing supplier ESG audits to adopt ESG considerations into their supply chain management. For our portfolio companies, creating an ESG management framework based on a comparable ESG standard, verifiable data, and a goals and result review process that is woven with the portfolio company’s core-business activities is a critical step to address our customers’ ever increasing ESG requirements. Specifically, our ESG framework requires annual reporting for our portfolio companies under a uniform ShawKwei & Partners ESG framework, and then continued adjustment of ESG strategies in annual business plans to drive compliance and adoption of strategic ESG priorities.

As an example, ShawKwei focuses on a holistic approach for sustainable production in managing our precision manufacturing company Beyonics. As a result, Beyonics achieved a measurable impact on ESG priorities in areas of technology and engineering solutions to streamline and automate manufacturing processes, adopt biodegradable plastics, recycle metal raw materials, design lower weight automobile parts that decreases energy consumption, and actively manage production to reduce electricity including the implementation of a solar-photovoltaic system to achieve a sustainable reduction of the carbon footprint.

Q. Have you ever invested in companies with negative or neutral ESG credentials with a view to increasing their valuation by improving those credentials?

Brian Gu: Yes, our overall strategy has been to invest in traditional companies in the energy services and products, precision manufacturing, beauty product packaging & manufacturing, and marine provision industries. Our ESG strategic approach is to promote businesses with technology-driven innovation, empower traditional businesses to transform and optimize operations, or purchase companies with already advanced ESG strategies as bolt-ons to existing portfolio companies to increase shareholder value.

Q. Has this approach been successful?

Brian Gu: ShawKwei has been very active and successful in sourcing deals where we have found “green gems” while also simultaneously managing existing portfolio companies’ go-to-market strategies to pivot on enhanced ESG requirements to increase value through sustainability initiatives. The new acquisitions of ZymeFlow and Group14 Technologies in Q2 2023 demonstrates our commitment to this strategy.

We empower traditional industry portfolio companies to transform and optimize operations and create sustainable business. For instance our marine and energy company AMOS has focused on developing recyclable, energy-saving technologies and products to support the sustainable development of the shipping industry. One of these AMOS initiatives has been the development of the proprietary Alcona product line of advanced hydration systems to enable ships to eliminate over 10 million plastic bottles just in 2023.

Q. How has Silk Road Fund’s work on ESG progressed?

Hannah Cao: We are at an early stage, still setting up our framework for sustainable investment, but we’re moving very fast. In the past couple of years, we have set up a Sustainable Investment Committee under the board of directors, published our sustainable investment policy on our website, and formulated a negative list of sustainable investment “red flags”. These initiatives testify to our significant commitment to sustainable investment and help to increase awareness among our peer financial institutions in China and the Asia-Pacific region.

One major reason that we have responded firmly and rapidly is that from the top down, we have a culture that embraces sustainability. Our chairwoman of the board who joined us last year also chairs our Sustainable Investment Committee. The most senior person in the organization is herself highly committed to sustainable investment.

Q. Tell us about how you work with portfolio businesses on ESG issues?

Hannah Cao: It’s important to note first that we typically do not take control of the portfolio companies, so that will have an impact on how much influence we have. Having said that, this topic is so prominent, especially for companies located in Europe, in the US and in the more advanced developing markets, so the conversation is easier; we get very detailed answers to the questions we raise.

By contrast, in other parts of the world where the current priority is more on economic growth—in some Central Asian countries, for example—when we send out requests for greenhouse gas data, the response may be a big question mark. It’s fair to say that ESG has become an important part of the overall conversation with portfolio companies, but it’s not consistently of the same quality.

Q. How can you support these businesses to increase their knowledge and take positive steps forward?

Hannah Cao: We do have a role to play in helping the portfolio companies to make the transition or even just to get a better understanding. In the more developed markets, that education part isn’t usually necessary, but in other markets, the conversation starts with us explaining the concept.

It’s also important to explain why companies should make progress. We understand that not all management teams place ESG at the top of their agendas, so we need to convince them. We talk about how, for example, if you want to raise finance in the global capital markets, e.g., in Europe, this is something you increasingly need to deal with.

Q. Do they also face a regulatory imperative?

Hannah Cao: Absolutely. In regions such as Southeast Asia, regulators are working fast and collaborating with each other and with their counterparties in China and Europe to reach more aligned standards. In other markets, the regulators are playing catch up. There’s a parallel with the need to learn how to prepare financial statements to comply with the sustainability reporting standards in a way that meets international accounting standards. Some countries are only just mandating that.

Q. How can you move the dial?

Hannah Cao: One thing we’re doing is working with other financial institutions to set up an alliance designed to build professional capacity; it’s an initiative we hope to announce later this year. The aim is really to help in countries or in sectors that are late to this game. Working with other stakeholders, we can help them foster more bankable sustainability, launch more sustainable finance projects, and build up their own skills and knowledge base.

Q. What does the term “responsible technology” mean to you in practice, in the context of the ESG agenda?

Stephen Lam: Responsible technology is one of the key focus areas in our due diligence work. There is a list of technologies that we specifically monitor for. We would expect the company to have specific procedures in place to prevent incidents—including, where appropriate, a named individual who oversees those technologies, such as a head of AI ethics or a head of risk management. We would also expect to see data storage and processing technologies that reduce the risk of an incident.

Q. Do you have a clear view of what “good” looks like in this regard?

Stephen Lam: There is no one answer. For example, in the area of discrimination, our screening identifies companies that have not put in the right protocols and guardrails to guard against that. But elsewhere in this debate, something else might be key; there isn’t a standardized application. It is really about understanding the intention, and how companies are approaching certain issues.

Q. What are the risks that worry you most in the technology space?

Stephen Lam: We would be very concerned about a company that has not appointed a specific individual to oversee how the use of technology avoids any potential exploitation of vulnerabilities. And then we would expect to see that person put some very clear policies in place.

It’s also worth mentioning that we have a separate cybersecurity due diligence process, with cybersecurity experts who also provide a layer of diligence. It is a separate team that conducts the analysis in areas such as the safety of data processing, security breaches and cloud storage.

Q. Do you expect to see more regulation in this area?

Stephen Lam: Governments have made it clear that more regulation is coming in AI, so it is incumbent on all market participants to plan ahead and ensure that they are well positioned to respond to that change when it comes.

While the specific contours of AI regulation may be unsettled, there are related areas of regulation you can look to to see how agencies have dealt with similar concerns regarding privacy, fairness and transparency. In the medtech area, for example, you can look at the AI risks that surround a particular product, but we also do diligence in respect of GDPR, HIPAA and other related concerns. You are going to be covering off many of those concerns while keeping alive to the evolving nature of legislation around AI and technology specifically.

Q. What about your own use of technology during the investment process?

Stephen Lam: We have seen innovative service providers come up with new technology solutions which have proven to be really valuable. For example, in addition to ESG information that we receive directly from the portfolio company, our compliance team also conducts background checks and press media searches using advanced data platforms. These can identify anything that may be in the public domain that the company might not want to disclose to us.

Q. How much demand is there for detailed ESG data and reporting?

Sarah Pang: The demand for ESG data and reporting is definitely growing. For example, in the first half of 2023, we saw double the number of ESG questionnaires sent from our LPs. The questions are also getting more complex—for example, in the European Union the SFDR rules have come into place with a requirement to report on Scope One, Two and, from this year, Scope Three emissions.

Q. Is this work requiring more resources—and is the data available?

Sarah Pang: The data reporting is certainly challenging. It’s one reason why we have joined the ESG Data Convergence Initiative, a program where several of our Pan-Asian peers are also members. There are six metrics that the EDCI collects data across: greenhouse gas emissions, renewable energy, board diversity, work-related issues, new hires, and employee engagement.

While collecting all this data is time consuming, it’s helpful and we use a lot of the insights to drive engagement with Affinity’s portfolio companies. For example, the ESG metrics support the conversation on improving our portfolio company carbon strategy, or about improving diversity and decision-making through hiring more women on boards.

Q. Are portfolio companies feeling the pressure to engage—and where do they stand on carbon emissions, for example?

Sarah Pang: Many companies in Asia are regionalizing or globalizing, so they’re getting questions about their emissions from new customers and partners. And I think as ISSB (International Sustainability Standards Board) starts to roll out, its standards on sustainability reporting will translate into more local legislation. The call to measure emissions is getting stronger and stronger from various fronts.

Business owners such as Affinity and our PE peers can help. All our portfolio companies measure their Scope One and Two emissions. We go through that process with them as part of the EDCI and we’ve also completed our TCFD integration so we work with our companies to calculate their emissions. We believe measuring emissions can be a tool to help companies understand their carbon footprint and develop value creation opportunities.

Q. How challenging do the portfolio companies find this work?

Sarah Pang: We drive a lot of capability building, and it is certainly challenging for portfolio companies that do not have someone dedicated to sustainability and ESG; that sort of ESG leader can make it easier to make changes more quickly. We also work hard to engage our CEOs—Affinity’s CEO round table this year, for example, is focused on ESG materiality and value creation.

Our portfolio companies and their leaders also see the opportunity here for creating value. For example, one of our portfolio companies, Plaza Premium Group, operates airport lounges and has partnerships with credit card companies; when we did the Scope One and Two emissions work with them, it helped them to win the bid for launching a net zero lounge in Helsinki airport. Thereafter, their credit card partners started asking about how they could work together on similar initiatives in Plaza Premium Group’s other lounges. It’s a perfect example of the value creation driver for ESG.

Q. And does that sort of success build the case for resolving the challenges around data collection and sustainability?

Sarah Pang: The key thing for sustainability is that we really want to embed it into the business and operations of the company; when you do that, you bring it into the heart of the company and transform it into a revenue generating opportunity, rather than just a compliance cost. Then ESG becomes an encouraging and powerful reinforcement. That is the positive loop that we try to create with our portfolio companies and set them on a profitable, productive path for the future.