Leverage sustainability to de-risk EM portfolios

The assessment of sustainability parameters has become a sine qua non for asset managers investing in emerging markets (EMs).

While offering secular growth, EMs command a higher risk premium because of frequent changes in macro policies, relatively narrow financial markets and feeble investor-protection regulations.

In this milieu, strong governance and disclosures, credible use of the proceeds, sustainability-linked financing, and supply-chain and social safeguards go the extra mile to reduce information asymmetry and volatility, broaden the qualified buyer base and support the stability of environmental, social and governance (ESG) ratings.

The upshot is tighter spreads and lower equity risk premium for resilient issuers, creating opportunities to capture alpha from sustainability-driven improvements while securing portfolio resilience.

• Macroeconomic and political volatility: Currency and inflation swings, policy reversals, and social unrest increase cash flow uncertainty and country-risk premia. Also, volatility is typically more acute in these, given thinner buffers and rapid policy shifts
• Less-mature market infrastructure: Lower liquidity, information asymmetry, and weaker enforcement of shareholder/creditor rights elevate fraud/recourse risk and cost of capital
• Regulatory whiplash: Sudden imposition of tariffs or rollback of incentives amplify uncertainty, trigger outflows, and widen funding spreads
• Forex and external-funding dependence: Mismatches between hard-currency liabilities and local-currency revenue expose issuers to earnings volatility
• Operational fragility across supply chains: Longer, import-dependent chains heighten disruption risk and input-price pass-through
• Social and community risks: Safety incidents, high turnover, or unresolved community grievances that can affect operations and impair credit profiles

Asset managers should apply norms-based screens including United Nations Global Compact (UNGC) / Organisation for Economic Co-operation and Development), exclusionary screens for severe controversies, and positive/best-in-class tilts for governance. They should also allocate thematic sleeves (renewables, efficiency, circularity) and impact sleeves for credible transition stories aligned with the United Nations Sustainability Development Goals (SDGs) and taxonomy criteria. 

Broadly, their activities should cover:

Due-diligence signals of credibility

• Board-level sustainability oversight and key performance indicator (KPI)-linked remuneration
• TCFD/ Taskforce on Nature-related Financial Disclosures (TNFD)-consistent risk registers and scenario analysis
• International Sustainability Standards Board (ISSB)-aligned reporting with decision-useful KPIs and external assurance
• Robust International Capital Market Association-aligned frameworks for use of proceeds / sustainability-linked bonds (SLBs) / sustainability-linked loans (SLLs), and calibrated KPIs with clear baselines and interim targets
• Activity mapping to aligned/regulatory taxonomies and disclosure of SDG contribution, enabling placement with sustainability-mandated investors

Engagement priorities for the next 12–24 months

• Upgrade reporting to ISSB quality and expand TCFD/TNFD coverage
• Calibrate SLB/SLL KPIs to science-based pathways, and obtain second-party opinions and verification
• Publish a supply-chain resilience and localisation plan with milestones
• Codify social KPIs (injury rates, turnover, training) and just-transition measures
• Explore blended-finance options with multilaterals to derisk large capex or first-of-a-kind projects

Portfolio construction and risk management

• Use sovereign/country overlays for macro risk
• Size positions by governance quality and KPI credibility
• Stage entries post-framework verification to capture spread compression
• Hedge FX where revenue-liability mismatches persist

The first step is improving governance, transparency, and risk oversight by adopting UNGC principles, implementing TCFD/ TNFD for governance, risk management, and metrics/targets, and report as per ISSB guidelines. Also, establish Board-level oversight and link executive pay to material ESG KPIs. 

Result: Lower information risk, improved stakeholder confidence, and better rating outcomes.

Also, companies should diversify financing beyond issuing a green bond. Select from a menu, comprising use-of-proceeds instruments (green/transition), SLL/SLB with science-based KPIs, local-currency issuance where feasible, and blended finance with multilateral guarantees/first-loss tranches.

Result: Broader investor demand, improved tenors, and potential spread compression.

Then, there are mapping activities to EU Taxonomy/ Sustainable Finance Disclosure Regulation, disclosing contributions to SDGs (e.g., SDG 7, 8, 9, 12, 13), and maintaining eligibility for developed-market distribution channels.

Result: Access to deeper pools of sustainability-mandated capital.

Also, the companies should ensure supply-chain resilience and localisation via dual-sourcing of critical inputs, building local supplier capabilities, and deploying supplier ESG onboarding, traceability, and audit/remediation.

Result: Shorter lead times, reduced FX as well as transport exposure, and lower disruption probability.

The companies should look at building social safeguards and a ‘just transition’ lens by setting targets for injury rates, training, turnover, and community grievance resolution, and publishing workforce reskilling and supplier-transition plans in carbon-intensive sectors.

Result: Stronger grounds to operate and reduced protest/strike risk.

Implementing sustainability principles is a win-win not only for asset managers but also companies. It helps asset managers navigate the complex terrain of EMs by ‘shutting out the noise’, ultimately catalysing value creation, while companies gain attractiveness in the eyes of investors.

We have been supporting asset managers to derisk their EM portfolios through effective sustainability integration across the investment lifecycle.  

Our clients benefit from pre- and post-investment solutions, leveraging our nuanced approach to research. Some of our solutions include extensive due diligence of EM companies, ongoing monitoring and comprehensive engagement processes with issuers in emerging market portfolios.

Click here to know more about our solutions.