Saturday, May 18, 2024

Malaysia’s ESG Challenge

Over the past five years, three letters have been at the forefront of the business landscape – ESG or Environmental, Social and Governance in full. This is driven by a growing demand for corporations to demonstrate their adherence to environmental stewardship, social responsibility and good governance. Having an ESG framework or policy in place enables organisations to show and ensure that their work processes, as well as supply and value chains are in line with best practices of sustainability.

– Datuk Seri Mohamad Azmin Ali,
Senior Minister of International Trade and Industry (MITI) speaking at MITI’s Annual Dialogue Session on 25 August 2022.

According to Simon-Kucher & Partners’ Global Sustainability Study 2021, more than one-third of respondents surveyed globally said that they are willing to pay a premium for sustainable products and services. Closer to home, 61 percent of Malaysian respondents to PwC’s Global Consumer Insights Pulse Survey 2021 said that a company’s commitment to protecting the environment is a factor in their purchasing decisions.

It is not just consumer sentiment that is driving companies to be more ESG conscious. Investors are increasingly focused on companies that are. This is illustrated in a study by Bain & Company which revealed that sustainability investments in Southeast Asia rose to US$3.2 billion in the first half of 2019 – a 60 percent increase year-on-year.

A National Commitment

In Malaysia, the government has committed to a target of having net zero greenhouse gas emissions by 2050, in line with the 12th Malaysia Plan 2021 – 2025 (RMK-12) as well as commitments made during the United Nations (UN) Climate Change Conference 2021 (COP26). This has resulted in the Ministry of International Trade and Industry (MITI) working to formulate a National Environmental, Social

and Governance (ESG) Framework for the Manufacturing Sector (National ESG Framework), which is expected to be completed and released by the end of 2023.

In order to set the Framework, MITI is holding consultation sessions with various stakeholders including representatives from the industrial, regulatory and financial sectors as well as trade organisations and chambers of commerce.

Carbon Tax on the Horizon

The IBR Asia Group CEO and International Business Review Editor-in-Chief, Datuk Beatrice Nirmala attended one such session held on 6 September, which was chaired by Datuk Seri Norazman Ayob – the Deputy Secretary-General of MITI (Industry).

Datuk Seri Norazman highlighted the possibility of the Malaysian government introducing a carbon tax in the near future. A carbon tax is a charge on carbon emissions, usually on each tonne of carbon dioxide equivalent (tCOe). This is meant to dissuade companies from carrying out activities that add to greenhouse gas (GHG) emissions, and in doing incentivise the adoption of clean energy and energy efficiency.

While a carbon tax has yet to be officially announced in Malaysia, it has been included as a possibility in RMK-12, which makes it a case of when and not if it is imposed. Therefore, it is better for companies in Malaysia to start preparing for it and explore ways to mitigate the cost.

One method highlighted during the session is a carbon credit system, where companies can purchase permits that enable them to emit a certain level of GHG. In other words, the more carbon credits you have, the more GHG you can emit. Companies with excess carbon credits can also sell them to others that need them more.

Germany’s New Law

Aside from domestic regulatory and taxation reasons, there are also external factors driving the need for the Malaysian manufacturing sector to adopt ESG into their ecosystems. Datuk Seri Norazman revealed that these include ensuring that Malaysian companies continue to have access to international markets.

For instance, Germany – Malaysia’s 14th largest export destination with US$6.9 billion worth of exports in 2021 – has introduced a law known as the German Supply Chain Act (GCSA) or, to use its official German name, Lieferkettensorgfaltspflichtengesetz. This Act, which will come into force on 1 January 2023 compels German companies to ensure that their supply chains do not have any risk of human rights, labour rights or environmental violations, otherwise they would be fined 2 percent of the company’s annual revenue.

In the first year, this law would only be applicable to companies that have 3,000 or more employees. And this will be extended to companies with 1,000 ore more employees by 2024.

And so, if Malaysian companies want to continue doing business with Germany, they will need to integrate ESG into their organisational and operational structures.

While this law is only applicable to companies in Germany, there is the likelihood that other EU countries may also adopt it into their national legislations. If and when this happens, it will create another barrier of entry for Malaysian companies and goods into the EU.

Increased Pressure from Europe

We say “another barrier of entry” as the EU recently introduced the carbon border adjustment mechanism (CBAM) in which a carbon tax is imposed on goods imported from outside the EU. Before the CBAM, only goods produced in the EU were subject to carbon tax, while those from the outside were not.

While the CBAM is ostensibly meant to plug a gap which allows EU companies to bypass the bloc’s ESG regulations, its effects could have larger implications on developing nations. For instance, companies from countries outside the EU, such as Malaysia, will now need to ensure that their value and supply chains are in line with that of the EU.

At the same time, Spanish international trade lawyer Miriam González Durántez has highlighted that one reason for the EU imposing the CBAM is a form of protectionism, wherein it is attempting to persuade EU companies that have moved outside the bloc to reshore operations back to the EU.

Changes in the Financing Game

Whether the EU is introducing such legislation for altruistic reasons to protect the planet or for more self-serving ones to protect their economy, the fact is that they are introducing them. And the upshot of this is that it will have a domino effect on Malaysia and Malaysian businesses.

Already, 284 banks worldwide have signed the Principles for Responsible Banking initiative by the UN Environment Programme Finance Initiative (UNEPFI), in which signatories pledge to ensure that their operations, including their financing, are in line with ESG principles. To date, two Malaysian banks – CIMB and Bank Pembangunan Malaysia – have agreed to the Principles.

And if export markets are going to be closed to companies that do not practise ESG, then business centres, such as industrial parks, will need to ensure that they set requirements for tenant companies to be ESG complaint. This is the way to ensure that companies, both from inside and outside Malaysia, will continue to set up in their parks.

The Attendees’ Feedback

One point of contention was raised by a representative from the Malaysian Associated Indian Chambers of Commerce and Industry (MAICCI). And that is the perception that Malaysian companies are being forced to adopt costly ESG measures in order to meet requirements set by Western governments and organisations, whereas other export markets – such as China, India, Southeast Asia etc – do not have such stringent demands.

And so, on the face of it, it seems rather unfair that such disproportionate influence exists, and also even if companies that do not adopt ESG lose the European and North American markets, there are still other markets available. However, as Datuk Seri Norazman highlighted, with financing institutions increasingly looking at ESG as a criterion for releasing credit, it is better for Malaysian companies to do so now rather than later.

However, taking on ESG is easier said than done, with finance being highlighted as one of the major obstacles. For instance, a representative from the Associated Chinese Chambers of Commerce and Industry Malaysia (ACCIM) revealed that the cost for ESG training, conducted by the United Nations Global Compact (UNGC), is around RM10,000.

The representative noted that the government only subsidises RM7,000 leaving RM3,000 to be picked up by the companies themselves. This might be a drop in the ocean for MNCs, large-tier companies and mid-tier companies, but for SMEs, particularly micro-SMEs, the margins could be a lot tighter.

Another issue raised was the standard of measurement for ESG compliance. According to a representative from MAICCI, one of the challenges is on how to measure ESG across in a consistent manner across the board across diverse industries and tiers. This is a particular concern to many SMEs, considering that Datuk Seri Norazman himself revealed that all companies, whatever their tiers (small, medium or large) will be treated the same under ESG rulings.

All in all, the discussion session was useful and necessary in allowing industry representatives to give their honest and open feedback on the government’s ESG initiative. And it also resulted in a number of important takeaways.

For instance, Datuk Seri Norazman revealed that the MITI will be working with the Human Resources Development Corporation (HRDC) to increase funding for ESG training. In addition, he noted that the government will be setting up a Centre of Excellence for ESG, which will be later put in the care of the private sector. And as for the private sector, he suggested that industry associations form a committee to oversee ESG among themselves.

Ultimately, the key takeaway is that ESG is inevitable, and rather than fight against it, companies in Malaysia should find ways to make it work for them. One such way, which Datuk Seri Norazman highlighted, was on how Malaysia can sell carbon offset credits to companies in Singapore, as the island-state is too small to produce sufficient carbon credits itself. That is just one of the avenues available among many. But it all boils down to one thing, Malaysian organisations need to embrace ESG and, just as important, need to demonstrate that they are doing so.  

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