Latin America and the Caribbean are increasingly relying on environmental, social and governance, or ESG, investments to help address their financial needs. The region faces an infrastructure gap and has recently seen financial institutions withdraw, in part due to the region’s vulnerability to natural disasters and climate change. While some financial institutions have withdrawn from the region, according to the Climate Bond Initiative, Latin America and the Caribbean saw an increase in the green bond markets in 2019, contributing to 2 percent of green bonds issued globally. With oil and gas markets hitting record lows, the region and global investors may use this opportunity to shift their focus to sustainable and green investments.
With the arrival of the Covid-19 pandemic, ESG in Latin America and the Caribbean is needed now more than ever, offering a potential growing market for investors looking at the space. Specifically, Covid-19 revealed gaps in infrastructure globally, including in Latin America and the Caribbean. Pandemic-response bonds are already emerging and are designed to deal with the social and economic repercussions of Covid-19. It would seem that at this point in time, Latin America and the Caribbean present a unique market for ESG investment. Indeed, the region, once heavily associated with corruption, has increased anti-corruption efforts, in part to increase global investment and make the region more inviting to investment dollars on projects other than the exploitation of natural resources. Companies are eager to boast ethically conscious and socially responsible investments in an effort to differentiate themselves and receive attention from international investors.
Latin America, like anywhere else, has companies that care about ESG issues and others that do not. It is important to understand what lens you are looking at ESG through: are you an investor or asset manager, or are you the company’s board and c-suite overseeing and implementing an ESG strategy? Any way you look at it, ESG has arrived globally—especially in the investor community—and cannot be ignored locally or regionally by any company. ESG is here to stay and even more so because of the global disruption Covid-19 has wreaked.
There are two key factors in whether a company is ESG responsive: 1.) how enlightened and responsible leadership and the board are on these issues, or how superficial, greenwashing-oriented or downright irresponsible they are; and 2.) how committed, proactive or outright activist key stakeholders are—especially investors but also communities, customers, NGOs, suppliers, regulators and employees. Additionally, the seriousness with which ESG is taken also depends on the sector and how immediately exposed that sector is to ESG.
Thus, a company in the mining and extractive industry will or should be much more attuned to environmental and social issues than most (though these also interconnect directly with good, mediocre or poor governance, as we have seen in several notorious scandals in Latin America—Petrobras, Odebrecht, Vale). While other sectors may think they do not have a strong ESG remit or profile, they should think again—for example, the rise of ESG awareness is especially strong in the investor and asset management community globally. Add to the mix we already had pre-Covid-19 (for example, climate change), additional pandemic-induced systemic changes such as supply chain disruption, social and racial inequality, popular unrest, health care and economic failures potentially on a massive scale.
Now more than ever is the time for both investors and issuers in Latin America to adopt and fully integrate an ESG agenda as part of their daily business, long-term strategy for value creation, resilience and sustainability. It is a matter of survival, not just competitive advantage, to do so.
ESG has been a growing theme for private capital investors in Latin America over the last decade, with fund managers dedicating new resources to monitor and measure the social and environmental impact of their investments.
Since 2014, LAVCA has been tracking deal cases with important environmental, social, governance and gender outcomes. These examples are wide-reaching and range from traditional impact sectors such as financial inclusion and renewable energy to businesses in consumer/retail, IT, agribusiness, financial services, health care, education, real estate and infrastructure. In addition, there have been a number of traditional fund managers co-investing alongside those with an impact-only mandate in Latin America, indicating that there is an appetite and opportunity to invest in companies and projects that yield tangible social and environmental objectives across sectors and countries. Correlated to an increasing limited partner/general partner focus on climate change, investment in clean tech, alternative and renewable energies in Latin America has gone from $470 million invested across 35 deals in 2014-2016 to $2 billion across 63 deals in 2017-2019, according to LAVCA Industry Data.
Climate change and environmental considerations have never been more prominent in investment conversations across emerging markets. More than three-quarters of commercial limited partners (LPs) participating in the latest EMPEA LP survey on emerging markets private capital cited taking such factors into account when making investment decisions. While most LPs do not yet face specific restrictions on their allocation choices, a multitude of factors—including pressure from boards and beneficiaries and increasing evidence of ESG’s role in positive investment outcomes—has generated significant momentum behind sustainable investing. One family office said, “In recent years, we have been actively divesting our public stock portfolio in developed markets to increasingly focus on private capital in emerging markets for social/charitable purposes.’ With a shift in priorities becoming even more obvious in the current world scenario, we are seeing investors better understand their role in maintaining the long-term sustainability of global markets by way of responsible investing.”
Good governance is a major concern in the Caribbean. Indeed, the issue of corruption is an ongoing point of discussion in some countries and a topic that tends to arise during elections. This was amply evident during 2020 voting in the Dominican Republic, Guyana, Suriname, and Trinidad and Tobago. In each case, campaign narratives included citizens’ concerns over governance, which impact their day-to-day lives in the form of quality of public services, accountability of government finances, and law and order.
While the need for better governance is an issue in the Caribbean, the region is hardly unique in dealing with such challenges. Caribbean governments are finding themselves increasingly brought into a broader international system of governance accountability. While at times this may be perceived as external interference, the creation of such a global accountability regime generally functions as a force for positive change, especially if it contributes to the creation of more robust civil societies.
The Caribbean is hardly unique in facing governance issues. According to the World Economic Forum, the global cost of corruption in 2018 was estimated to be $2.6 trillion. In recent years, international news has been rife with headlines of corruption in high places. In Malaysia, the 1MDB scandal helped bring down the government and put its former prime minister on trial for corruption.
Moreover, in 2020 the U.S. investment bank, Goldman Sachs, reached a settlement of $3.9 billion with the Malaysian government for its part in the scandal. In Brazil, the 2010s were rocked by Operation Car Wash (Lava Jato), which revealed extensive money laundering and bribery involving the state-owned oil company, Petrobras. The ripples from that scandal ultimately sent one former president to prison, helped impeach another, ruined the reputation of one of the country’s largest and best-known companies, Odebrecht, and snared high-ranking political figures in other parts of Latin America.
The United States also saw its share of public corruption. It is often forgotten but it was only in 1883 that the U.S. officially did away with the spoils system with the Pendleton Act. Even since then there have been many financial scandals—not necessarily involving the government—but nonetheless causing damage to the public faith, including the Savings and Loans scandal, Enron, and Bernie Madoff.
Another governance rating database is the World Bank’s Worldwide Governance Indicators (WGI). This covers a wide range of indicators related to governance and corruption. The World Bank’s program includes items such as “control of corruption” and “voice and accountability”. Under the first are considerations like corruption among public officers, public trust of politicians and transparency, accountability, and corruption in the public sector. Under “voice and accountability” are items such as press freedom, human rights, the role of the military in politics, and openness of the budget process. Another part of the global accountability regime is ESG standards.
Private investors use ESG to gauge how a company or project meets these standards, either through green bonds or direct investment. ESG now accounts for billions of investment dollars and, in the post-COVID-19 environment, is projected to expand further. Moreover, many of the world’s leading companies—a number of them active in the Caribbean—are adopting ESG standards.
According to a KPMG survey, 75 percent of the largest 100 companies across 49 countries indicated that they are employing ESG business models or incorporating aspects of sustainability approaches. This 2017 number indicates substantial growth from just 12 percent in 1993. For Caribbean governments, ESG’s importance is abundantly clear. Investors may shy away from investing in companies operating in countries that have poor track records with environmental compliance, governance, and transparency. This is particularly critical for companies operating in the extractive industry sectors, which have encouraged the adoption of Blue Economic policies that tap the potential of the local ecosystems to add to a widening ESG investment menu.
Considering the competition for international capital, this trend could provide Caribbean countries a wider platform to attract foreign and domestic investment.There are other ways that Caribbean countries and territories are rated. These include organizations like the Organization for Economic Cooperation and Development (OECD), the Financial Action Task Force, and other multinational groups. These create “blacklists” and “greylists” for jurisdictions that are regarded as facilitating financial crimes or tax evasion. The European Union’s Economic and Financial Affairs Council maintains a list of “non-cooperative” jurisdictions for tax evasion.
The last revision, in February 2020 included the following Caribbean countries: the Cayman Islands, Panama, Trinidad and Tobago, and the U.S. Virgin Islands. Jurisdictions that were previously on the EU blacklist were Aruba, Barbados, Belize, Bermuda, and Dominica, but they were removed as they worked with the EU to improve their tax compliance standards.The stakes for the Caribbean are high in terms of governance, especially because the COVID-19 pandemic highly affected the region. The Caribbean already has a number of reasonably well-developed organizations, including CARICOM, the Caribbean Court of Justice, the Caribbean Development Bank, and Caribbean Financial Task Force.
Although there are often complaints over their value, the region would be much poorer without these organizations. They provide important forums for discussion, technical expertise, and the creation of regional standards. Moreover, they reinforce ideas about the need for robust civil societies and their projects help promote civic organizations throughout the region.Looking ahead, good governance and tackling corruption are important to the Caribbean. This comes in many shapes and forms, but for governments in the region to deliver the package of goods their citizens expect—law and order, functioning public utilities, and working healthcare and educational systems—there has to be a commitment to maintaining systems that promote the public good.
This means not just having laws on the books, but enforcing them. At the same time, Caribbean governments have to be aware that as citizens hold them to a higher standard, they are also being held to international standards. Accountability to both domestic and international constituencies may add to an already long list of pressures, but the results are more inclusive and equitable societies—a goal to which all citizens can aspire.
Caribbean economies, which have struggled to recover from the 2008 – 2010 financial crisis, have been particularly hard hit by Covid-19 and the resulting economic fallout.Increasing focus on the region by the U.S. due to its economic, social and security significance is heightened by major oil discoveries and Chinese interest in the region.
Massive flows of ESG capital could aid in remaking the region, financing a new economic model built on technology and improved infrastructure.An old-fashioned oil boom will also contribute significantly to growth, particularly in Guyana, Suriname and Trinidad & Tobago.With all of these powerful economic drivers converging in the Caribbean, it is time for investors to take note of the region.
While there remain challenges, the nations of the Caribbean understand that embracing technology, such as blockchain, along with upgraded communication infrastructure are essential keys to catching up with the rest of the world. This presents both opportunity for international investors and will itself be a significant driver of future economic growth in the Caribbean.
ESG & SDG Investment
Investing in accord with “environmental, social and governance” (“ESG”) principals and “sustainable development goals” (“SDG”) of the United Nations is here to stay. According to an article by the Chief Economist of the Inter-American Development Bank ESG dedicated investment funds account for more than $20 trillion, or one-quarter, of professionally managed assets world-wide.This includes the Caribbean as part of a larger discussion of Latin America and is convincing in its argument that the focus of major international development institutions in facilitating ESG and SDG investment in both the Caribbean and Latin America represents an entrenched, long-term trend.