ESG in Asia trips on Korean scandal

Proponents of better corporate governance in South Korea haven't lost hope that two steps forward may yet follow a big step backward involving a 2015 vote by the country's largest pension fund on a Samsung group restructuring.

Last month, South Korean authorities indicted Moon Hyung-pyo, chairman of the National Pension Service, the country's 544.9 trillion won ($469 billion) pension system, for allegedly pressuring the fund to approve the merger of construction company Samsung C&T Corp. and Cheil Industries Inc. — effectively a group holding company.

At the time, Mr. Moon was the head of the ministry overseeing NPS.

With an 11% stake in Samsung C&T, the pension fund's backing proved decisive in a July 2015 vote that just barely garnered the two-thirds margin needed to consummate the deal.

Critics, led by New York-based activist hedge fund Elliott Management Corp., said the merger helped consolidate scion Lee Jae-yong's control of the Samsung Group at the expense of minority shareholders.

The belated blowback from the NPS vote erupted just as Morgan Stanley & Co. and State Street Global Advisors issued reports in October predicting South Korea's growing focus on governance could boost valuations there, narrowing the local stock market's hefty price-to-book discount to regional and developed market peers.

Both reports tied that discount of 30% or more, in large part, to the economic dominance in Korea of family-controlled conglomerates, or chaebol.

Proponents of greater corporate accountability on environmental, social and governance-related matters insist Korea's ESG glass can still be seen as half full — even if, in a region where national pension funds have often led the way forward, the country's local champion had arguably dropped the ball in this instance.

It's good to focus not on the event itself but on what kind of reaction it produces in terms of corporate behavior, the ripple effects on policy and other changes, said Helga Birgden, a Melbourne-based partner and global business leader, responsible investment, with Mercer Investments. “That's what's important,” she said.

Market veterans pointed to growing interest in ESG among Asia-Pacific-based pension fund heavyweights — such as Japan's $1.3 trillion Government Pension Investment Fund, Tokyo, and Taiwan's $104 billion Bureau of Labor Funds — as crucial to driving improvements in corporate governance and sustainable investment.

At a conference in Hong Kong last month, GPIF President Norihiro Takahashi said the world's largest pension fund would begin making allocations to ESG-focused Japanese equity index funds by March or April. Another GPIF executive said the capacity constraints of the index the GPIF team is working now to select will help determine the volume of its allocations.

In December, meanwhile, the Taipei-based Bureau of Labor Funds issued its first request for proposals for ESG allocations, seeking four managers to passively run a combined $2.4 billion in equities.

That looks set to accelerate the growth of Asia's ESG assets under management, although admittedly from a low base. In a Jan. 30 presentation in Melbourne, Ronald P. O'Hanley, the president and CEO of SSGA, cited data showing Asia with a combined $53 billion in ESG AUM as of March 31, 2016 — a tiny fraction of Europe's $13.6 trillion and the U.S.' $6.6 trillion. Among other large countries, Canada had $945 billion in ESG AUM and Australia, $564 billion. (Mr. O'Hanley's presentation was provided to Pensions & Investments.)

Even if a focus on ESG among asset owners in Europe, and to a lesser extent in North America, has already caught the attention of companies and money managers based in the Asia-Pacific region, observers predict the addition of local asset owners will have a powerful effect in helping an ESG culture take root there.

“The influence of big asset owners such as GPIF in Japan who publicly embrace governance is very important in promoting governance reform,” said William Killeen, a Dublin-based portfolio manager, fundamental equities, with SSGA, and an author of that firm's October report on chaebols.

Having local funds focused on ESG “is a game changer,” agreed Bruno Bertocci, a Chicago-based managing director with UBS Asset Management, and lead portfolio manager of the firm's global sustainable equity strategy. “It makes all the difference in the world,” he added.

NPS had led the way in embracing ESG in South Korea, becoming a signatory to the U.N. Principals of Responsible Investment in 2009, seven years before the GPIF.

Morgan Stanley's report in October on Korea, meanwhile, depicted the country's public pension funds — and NPS in particular — as the tip of the spear driving progress in integrating ESG-related factors into Korea's corporate culture.

Some governance professionals say at this point, with the government's investigation continuing, it's hard to predict what the ripple effects of the controversy surrounding the circumstances leading up to NPS' Samsung vote could be.

“It is too early to say whether this scandal will lead to better ESG practices,” said Bang Moonok, senior analyst with the Seoul-based Korea Corporate Governance Service, which provides governance ratings for Korean companies. “We are watching where it goes,” and whether it will result in changes to regulations, including the way NPS votes its shares, he said.

Asked whether a review of its voting procedures was underway, an NPS spokeswoman declined to comment.

Even so, market veterans seemed more inclined to hope than to despair over the prospects for corporate governance in South Korea.

Nothing ever proceeds in a straight line, noted Michael Cheng, vice president, ESG research, with MSCI Hong Kong. The fact that the NPS vote is receiving such intense scrutiny ensures that governance, and broader ESG-related issues, remain very much on the country's agenda, he added.

“Sometimes bad governance leads to better governance,” said Eric Cockshutt, a Geneva-based director, head of RFP and responsible investment coordinator at Unigestion SA. NPS is “in the spotlight now, and they're not going to have too many more opportunities to react slowly or not at all to situations like that,” he said.

UBS' Mr. Bertocci agreed, cautiously. The recent NPS scandal “will energize people,” but only time will tell whether it moves the governance ball forward in South Korea, he said. Meanwhile, the chaebols' financial strength leaves them under less pressure than their counterparts in Japan, he said, “which only broke up when economic forces forced them to.”

Some observers, however, already see signs of progress.

Samsung Electronics had been talking about tapping 30% to 50% of its free cash flow for shareholder-friendly dividend payouts and share buybacks, but it recently opted for the full 50%, a response in part to those recent scandals, said C.K. Lee, CEO of ESG Moneta Co., a Seoul-based consultant to asset owners on ESG-related issues.

It's too early to predict what the investigation into NPS' ESG-related controversy will lead to, but if it does result in any changes in the fund's voting process, they will likely favor the interest of the fund's beneficiaries, he predicted.