Environmental, social and governance (ESG) strategies have become increasingly important for companies globally, including in emerging markets, where sustainable practices are increasingly linked to long-term growth and stability. For risk managers operating in these regions, implementing ESG strategies presents unique challenges, including financial constraints, inconsistent regulatory frameworks, and a lack of reliable data.

While ESG frameworks aim to support responsible development, risk managers must deal with complex issues such as resource dependency, governance challenges, and high compliance costs, all of which complicate efforts to comply with global ESG standards.

In 2004, the UN Global Compact published a report, Who Cares Wins, which highlighted the importance of ESG factors in investment decisions. This report laid the foundation for the Principles for Responsible Investment, launched in 2006, which established ESG as a core element of global investment strategies.

Although ESG frameworks are designed to promote sustainability and responsible business practices, their implementation in emerging markets poses a series of social and economic challenges.

According to Amalia Lowe, partner at Clyde & Co, these difficulties arise primarily from financial constraints, regulatory challenges, and resource dependency in these areas.

Historically, emerging markets have faced complex challenges in complying with global ESG standards. In the early 2000s, for example, Cambodia became a major production hub for multinational companies such as Nike and Gap.

However, reports of underage workers and poor working conditions in garment factories prompted these companies to withdraw, resulting in the closure of more than 20 factories within five years.

This example highlights the difficulties of enforcing labor standards in areas that lack adequate support systems, which often leads to economic instability and social unrest, Lowe said. It illustrates the need for a balanced approach when implementing ethical standards in emerging markets.

Financial barrier

Financial and economic constraints further complicate the adoption of ESG standards in these regions. Emerging markets often lack the capital and resources to meet ESG reporting obligations, which can make sustainable practices seem less relevant.

Compliance costs, coupled with administrative burdens, create significant obstacles. Lowe explains that emerging market volatility also makes it difficult to sustain long-term ESG investments, especially for investors seeking stability. Moreover, many financial institutions require ESG compliance when considering project financing. This has limited capital deployment in regions with low levels of ESG enforcement, which is common in emerging markets.

Data collection and standardization issues also pose barriers to the adoption of ESG standards in these regions. Small and medium-sized companies in emerging markets often lack the resources to collect and report accurate ESG data.

According to Lowe, underdeveloped infrastructure, such as monitoring systems and technology, exacerbates the problem. The lack of a global ESG measurement system adds to the complexity, leaving many companies in these regions classified as non-compliant. This could deter investors focused on ESG from engaging with companies in emerging markets, further restricting capital flows.

Another important issue is the heavy reliance on natural resources in many emerging economies. Countries that rely on the extraction and export of resources such as oil, minerals and agricultural products often face challenges in complying with environmental, social and corporate governance (ESG) initiatives. Over-extraction, deforestation and other unsustainable practices are common, driven by the need for economic stability in the face of volatile global commodity prices.

This creates an inherent tension between the need for immediate economic gains and long-term sustainability goals, Lowe points out. For investors seeking to comply with ESG standards, this reliance on resources poses significant challenges.

Governance issues in the context of environmental, social and institutional governance

Governance issues also play a critical role in the complexity of implementing ESG standards in emerging markets. Regulatory frameworks in these regions are often inconsistent or underdeveloped, creating environments where companies may not adhere strictly to ESG standards.

In some cases, varying standards within regions of a single country add complexity, especially for multinational companies trying to implement coherent ESG strategies. Corruption and limited enforcement capacity are hampering progress in many of these markets, Lowe says.

Despite these challenges, there are opportunities to adopt a strategic approach to applying ESG standards in emerging markets. Applying the same ESG standards to developed and emerging markets without taking into account local contexts could lead to negative consequences.

According to Lowe, some experts argue that ESG requirements may inadvertently divert investment from riskier emerging markets to safer, more developed ones, depriving these regions of crucial capital. Gradual and tailored integration of ESG criteria, tailored to the specific needs and capabilities of emerging markets, is essential to achieving fair and effective outcomes.

Emerging markets need targeted support to help them achieve their ESG goals, Lowe said. This could include grants, training and developing ESG compliance awareness programs.

Moreover, harmonizing ESG standards and fostering stable regulatory environments would help build the infrastructure needed to support sustainable development. These steps would ensure that ESG initiatives promote responsible business practices without imposing undue burdens on emerging economies.

The unique position of emerging markets in the global economy calls for a nuanced approach to implementing ESG standards. Stakeholders, including governments, businesses, and financial institutions, must work together to balance the ethical imperatives of ESG standards with the economic realities of these regions.

The key, Lowe said, is to recognize the specific challenges these markets face and provide the necessary support to develop sustainable and responsible practices over time. This approach can lead to the successful integration of ESG principles without compromising the growth and stability of emerging markets.

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