This article first appeared in Forum, The Edge Malaysia Weekly on August 21, 2023 - August 27, 2023

The recently launched “Ekonomi Madani” places a strong emphasis on achieving inclusive and sustainable growth, making it a fundamental pillar for structural reforms of the Malaysian economy. In conjunction, the National Energy Transition Roadmap (NETR) provided a framework for Malaysia’s transition to the net zero target while also emphasising the significant economic opportunities that accompany the transition. Capital markets play a critical role in supporting both of these national policies by advancing the integration of environmental, social and governance (ESG) principles into investment and business processes.

However, while the adoption of ESG principles is progressing gradually in Malaysia, there remain significant challenges. Some stakeholders have already taken steps to integrate ESG into their investment and business processes, while others are still concerned about short-term financial returns and are just beginning to track governance indicators. As such, the Institute for Capital Market Research Malaysia (ICMR) conducted research to assess the current state of ESG integration, identify challenges and opportunities for integrating ESG principles and provide policy recommendations to accelerate ESG practices in businesses.

One of the major obstacles to implementing sustainable practices is the fragmented nature of ESG reporting. This has resulted in disproportionate levels of ESG readiness among stakeholders as well as a poor quality of information available. To address these challenges, a consultation process involving regulators, businesses, investors and civil society is necessary. The Bursa Malaysia’s enhanced guidelines on the sustainability reporting framework now require public-listed companies (PLCs) to align sustainable reporting to the Task Force on Climate-related Financial Disclosures (TCFD) framework starting in 2025 and identify common sustainability indicators for the PLCs to report.

Another significant challenge is overcoming the perception of high transition costs to integrate ESG principles. Since managing environmental externalities is factored into the cost of production, adhering to ESG principles often leads to higher production costs. But traditional cost-benefit analysis, which conveniently ignores these negative externalities, understates the cost of exploiting the environment and contributing to climate change risks. Until the cost of these externalities is factored in, for example, through regulations like carbon taxes, this perception is likely to persist.

Despite the growing global demand for sustainable investment opportunities, Malaysia is also experiencing slow growth in the supply of sustainable assets. Investors and asset managers have voiced concerns regarding insufficient assets to create a Malaysian-focused sustainability portfolio. The majority of Sustainable and Responsible Investment (SRI) equity funds are globally focused. Similarly, despite being one of the pioneers in issuing sustainability bonds in Asean, Malaysia’s efforts to promote sustainability bonds are lagging behind regional peers like Indonesia and Singapore.

Beyond practical issues in adhering to ESG, the lack of expertise and specialist talent in ESG remains a significant challenge to the transition towards greater sustainability. Strengthening the linkages between industries, universities and government institutions is critical to addressing this issue.

The transition to sustainability and ESG disclosure is no longer just something good to have but an absolute necessity for businesses to remain relevant and competitive. Stakeholders from all sectors must work together to promote sustainability, using policies, incentives, financing and education to ensure a smooth transition towards a sustainable future. On this note, ICMR proposes three key strategies to resolve existing challenges: promoting policy coherence, facilitating ecosystem motivation and fostering network cohesion.

First, policy coherence is necessary to minimise uncertainty and drive investment in sustainable initiatives. Regulators and policymakers can adopt global ESG standards while developing a unified national standard tailored to Malaysia’s specific needs. In this regard, the sustainable finance taxonomy by Bank Negara Malaysia and the Securities Commission Malaysia, as well as the role of the Joint Committee on Climate Change (JC3) in pursuing collaborative actions for building climate resilience within the financial sector, can help provide clarity to bankers and investors to identify economic activities that are aligned with environmental, social and sustainability objectives.

Likewise, Bursa Malaysia’s enhanced disclosure is expected to improve the quality of disclosures. However, making the information available on a digital platform is necessary to provide investors with access to ESG data in a consistent, structured and efficient manner. Effective information sharing through an open-source portal will increase market efficiency and enhance price discovery capabilities, particularly for ESG assets.

Incentives for motivating stakeholders to embrace ESG could be implemented through taxation policies and awareness programmes. The introduction of a carbon tax and a regulated domestic emissions trading scheme (DETS) can create a more level playing field by pricing emissions for carbon-intensive industries. While the government has committed to establishing compliance with rule-based carbon markets with an unspecified timeline, Bursa Malaysia launched the world’s first Islamic Voluntary Carbon Market and successfully carried out the inaugural carbon credit auction in March this year.

Meanwhile, to narrow the gap between global demand and local supply of sustainable assets, both regulators and industry players should encourage innovation and expand the range of product offerings, such as ESG exchange-traded funds (ETFs), green real estate investment trusts (REITs), ESG-linked bonds and more. Malaysia can leverage its position as a global leader in Islamic finance to promote “shariah-ESG” instruments by focusing on halal and tayyib principles. Apart from financing instruments, there is also an opportunity to build the halal industry with ESG considerations. Both share significant commonalities and their combination has the potential to broaden market access for halal products while benefiting from the price premium enjoyed by ethical brands.

Finally, fostering network cohesion within sustainable ecosystems is critical to supporting transition efforts. To address the talent gap, multiple stakeholders can join forces through capacity-building programmes that focus on training and upskilling. Financial training institutions can facilitate upskilling by designing ESG- or sustainability-focused training modules. Local universities can leverage the strong network of capital market institutions, such as the Securities Industry Development Corporation (SIDC), Capital Markets Malaysia (CMM) and ICMR, to connect with industry experts and develop multidisciplinary curricula. ICMR facilitates networking and knowledge flows through its Research Collaboration Network (RCN) programme.

As highlighted by the NETR, the business opportunities that arise from the transition to sustainable business models are massive. However, there could be potential transition risks that arise from abrupt changes, especially if they are not adapted for Malaysia’s context. Thus, to further complement the NETR and ensure a smooth transition, a clear policy direction with specific timelines and awareness programmes is necessary. Nonetheless, Malaysian companies must also recognise that the pressure to transition will come from both domestic regulations and international regulations via supply chain pressure, foreign investments and trade requirements. Now is the best time to act on sustainability.

Dr Gopi Krishnan is an associate director at the Institute for Capital Market Research Malaysia (ICMR). Julianna Roslan is a research and data analyst at ICMR. For more information on ICMR’s research and recommendations on ESG, please visit www.icmr.my. Please address your comments to Gopi Krishnan at [email protected].

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