ESG challenges in emerging markets

In 2004, the UN Global Compact published "Who Cares Wins," highlighting the importance of Environmental, Social, and Governance (ESG) aspects in investment decisions. This led to the 2006 Principles for Responsible Investment (PRI) launch, solidifying ESG's role in global investment strategies.

While ESG aims to promote sustainability and responsible business practices, its implementation in emerging markets often comes with significant social and economic costs.

Historical Context and Initial Challenges

In the early 2000s, Cambodia emerged as a reliable production hub for multinational garment companies like Nike and Gap. However, reports of underage workers and sweatshop conditions prompted these companies to sever ties, leading to the closure of more than 20 factories within five years. This episode underscores the complexities of enforcing labor standards in emerging markets without adequate support mechanisms, resulting in economic instability and social challenges. It is a stark reminder of the need for a balanced approach to implementing ethical standards in emerging markets / developing countries.

Financial and Economic Constraints

Emerging markets inherently possess limited resources and capital for investment, making ESG initiatives appear unwarranted. The costs associated with sustainable practices, compliance, and reporting obligations can be prohibitive and add to the administrative hustles. Additionally, the volatility of emerging markets makes sustaining long-term ESG investments difficult, deterring investors who prioritize stability. Also, most financial institutions funding projects in developed and emerging markets insist on ESG factors when considering financing projects. Obviously, this leads to lesser and restricted capital deployment in emerging markets due to the widespread incompliance or low enforcement of ESG in local projects. 

Data and Standardization Issues

Emerging markets often lack comprehensive and reliable data on ESG practices. Small and medium-sized enterprises (SMEs) may not have the resources or expertise to collect and report accurate ESG data. Additionally, infrastructure for data collection, such as monitoring systems and technology, may be underdeveloped or inconsistent. The absence of a universal standardized ESG metric system further complicates efforts, rendering efforts to adhere to ESG standards futile and leading to labels of non-compliance, making them unattractive to ESG-sensitive investors.

Resource Dependency and Environmental Impact

Many emerging markets heavily depend on extracting and exporting natural resources like oil, minerals, and agricultural products. This reliance often leads to unsustainable practices such as over-extraction and deforestation, which are at odds with ESG initiatives. The economic instability caused by fluctuating global commodity prices further complicates the investment in sustainable practices, making these markets appear less favorable for ESG standards and difficult to reform.

Governance Challenges

Emerging markets face governance challenges, including flexible regulatory frameworks, varying standards, and corruption. Regulatory frameworks are often underdeveloped or inconsistently enforced, creating environments where businesses can operate without strict adherence to ESG standards. Different regions within countries may have varying standards, complicating the implementation of cohesive ESG strategies for multinational companies. Moreover, the lack of resources to enforce these standards or fear of deterring investments may prevent strict enforcement.

Strategic Implementation of ESG

While ESG initiatives aim to create sustainable business practices, their blind implementation across all markets can have adverse effects. Applying the same standards to both developed and emerging markets without contextual adjustments can be counterproductive. Some economists argue that ESG standards divert investment from high-risk emerging markets to perceived safer developed markets, potentially starving emerging markets of essential capital. Therefore, a gradual, tailored incorporation of ESG standards, fine-tuned to fit the specific contexts of emerging markets, is crucial for equitable and effective implementation.

Conclusion

Emerging markets' unique challenges in adopting ESG standards highlight the need for a nuanced approach. Balancing the ethical imperatives of ESG with the economic realities of these markets is essential. Stakeholders can ensure that ESG initiatives promote sustainable development without imposing undue burdens on emerging economies by realizing the unique position the emerging markets occupy, providing targeted support by extending grants and sensitization to gradually develop ESG compliance, standardizing metrics, and fostering a stable regulatory environment.