Insight: How Russia's war blindsided the world of ESG investing
01/07/2022 06:00
By Ross Kerber and Tommy Wilkes
BOSTON/LONDON, July 1 (Reuters) - Russia's invasion of
Ukraine has exposed a gap in socially-minded investing – a
hands-off approach to geopolitics and human rights.
Before Moscow sent troops into Ukraine on Feb. 24, Sberbank
SBER.MM , a Kremlin-backed bank already the target of
international sanctions, enjoyed higher ratings for
environmental, social and governance (ESG) risks than some
western lenders.
MSCI Inc MSCI.N and Sustainalytics improved their ESG
scores for Russia's largest lender last year as recently as
December, citing factors such as improved data privacy. S&P
Global Inc SPGI.N also gave Sberbank a positive review late
last year.
The ratings firms quickly changed course after the
offensive, downgrading or suspending their scores on Sberbank
and other Russian government-linked companies citing pressures
such as their exposure to new western sanctions.
The U-turns have sparked calls from some investors for an
overhaul of how geopolitics, sovereign governance and human
rights are factored into ESG ratings.
A first step would be to include warning signs of war,
allowing the selling of stocks while they could still be sold,
said Dana D’Auria, co-chief investment officer for the asset
management division of Envestnet Inc.
“Wouldn't it have been great to divest from Russian stocks
before they became frozen?” D’Auria said. She and Envestnet
declined to discuss specific holdings.
Simon MacMahon, head of ESG research for Sustainalytics,
said the invasion of Ukraine was "a black swan event" because of
its low probability and high impact, and said that investors
were aware of the risks of investing in the region.
"To suggest that investors were relying solely on ESG
ratings to tell them that investments in Russia, (Belarus) and
Ukraine were increasingly high risk is nonsensical," he said.
Still, Morningstar Inc MORN.O -owned Sustainalytics is
revamping its methodology to capture companies' exposure to
unpredictable, unmanageable events.
Its new “Systemic Event Indicators” aims to capture any
development it defines as “a sea change event that is somehow
unpredictable in nature and that affects larger groups of
companies at the same time and across a multitude of ESG
issues."
Sustainalytics gave Sberbank a 21.47 score pre-invasion,
better than scores given to JPMorgan and Deutsche Bank at the
time. The Russian bank’s risk rating was then raised to its
current "high risk" rating of 33.4, incorporating the new
systemic indicators.
MSCI, which in December upgraded Sberbank to an "A" rating
from "BB," said that it regularly reviewed its ratings
methodology and that it had put a ceiling on Russian company
ratings and removed them from its indexes.
MSCI spokesperson Melanie Blanco said that across all
markets covered by MSCI, state-owned enterprises on average have
lower ESG ratings, typically due to weaker corporate governance
and higher corruption risk.
A spokesperson for S&P said it continued to review its
coverage and methodology for affected companies in Russia but
declined to discuss ratings in detail.
AUTOCRACY RISK
Funds that exclude or are underweight companies from
countries with weak human rights records are a tiny fraction of
the tens of trillions of dollars held in ESG investments.
MSCI Managing Director Meggin Thwing Eastman told Reuters
that while Russia's invasion was forcing "a revisiting of a lot
of people's thinking" in how they assess geopolitics many
emerging markets (EM) investors still want exposure to countries
despite their sometimes poor human rights records.
"If what you want to do is buy EM, that's part of what
you're buying into," she said.
But demand for strategies with a human rights screen is
growing.
Julie Cane, CEO of Democracy Investments, investment adviser
to the $5 million Democracy International Fund DMCY.P , said it
had a rush of new interest and inflows since Russia’s invasion.
It attracted $3 million in net new deposits this year, including
$1 million in each of February, March and April, according to
Lipper data.
The fund reduces the weighting of some of its holdings if a
company's home country receives a low score in The Economist
magazine's Democracy Index.
That still leaves it with exposure to state-connected
businesses, including in China, which has come under increasing
international pressure over human rights in the Xinjiang region.
Cane said it was better to keep such stakes, however
diminished, "to put pressure on authoritarians to become better
citizens of the world."
China's foreign ministry and the State Council Information
Office did not respond to requests for comment.
The United States says China is committing genocide against
Uyghur Muslims in the Xinjiang region. Beijing has denied all
accusations of abuse.
Another fund, the $220 million Freedom 100 Emerging Markets
ETF FRDM.K , takes a harder line. It excludes companies from
countries that score low on a measure of "human freedom" kept by
the Cato Institute and the Fraser Institute.
That makes it a rarity among EM funds because it omits
Russian and Chinese holdings. Fund manager Perth Tolle said
Russia’s invasion helped attract new money. Lipper data shows it
has taken in $117 million so far this year.
“The invasion seems to have made investors more aware of
autocracy risk than ever before, and they see that freedom works
as a leading indicator,” Tolle said.
Moscow calls its invasion a "special military operation" to
protect Russian speakers from Ukrainians intent on taking Kyiv
into NATO, a move Russia says it cannot accept. The West and
Ukraine say Russia is waging an unjustified war of aggression.
RUSSIAN EXPOSURE
To be sure, most ESG-focused funds had little or no exposure
to Russia. Close to $320 million in securities linked to
Russia’s government, including via sovereign debt and shares in
Sberbank and other state-backed companies, was held across 75
ESG labelled U.S. and European funds as of March according to
corporate accountability NGO Inclusive Development
International.
Some $100 billion is held in passively managed funds linked
to sustainable indexes compiled by MSCI and others according to
Sustainable Research and Analysis.
Some ESG raters had flagged the sanctioning of
government-connected Russian firms pre-invasion, but those
assessments had a limited impact. In a Nov. 29 note a unit of
S&P credited Sberbank for conducting risk assessments and
strategic planning.
The note cautioned against corruption and centralized power
in Russia, but said "the inclusion of the bank on international
sanctions lists currently does not affect the effectiveness of
its corporate management and does not create any immediate
financial or operational risks."
Despite being put on 2014 U.S. and European Union sanctions
lists after Russia's annexation of Crimea, Sberbank grew in the
following seven years, maintaining a sizeable presence in some
European markets and reporting a 74% jump in net profits to a
record 1.24 trillion roubles for 2021.
Sberbank said in a statement that its "impressive progress"
on ESG ratings in 2021 reflected "internal ESG transformation
efforts as well as its sustainability leadership in Russia." It
did not respond to specific questions about the ratings.
(Reporting by Ross Kerber in Boston and by Tommy Wilkes in
London. Additional reporting by Simon Jessop in London and Ryan
Woo in Beijing. Editing by Greg Roumeliotis and Carmel
Crimmins.)
((thomas.wilkes@tr.com; +44 (0) 7769 955711;))