COP27 is on the near horizon. The lead-up to it has come with more fervent discussions about how governments, businesses, and communities from the world over must work more diligently to capitalize on their commitments to create a more environmentally sustainable future.

Yet, environmental action is just one part of the sustainability dimension. Socio-economic inequalities continue to rise year every year, especially in the world’s emerging regions, while organizations must also raise their governance levels to be more accountable to their stakeholders.

At the nexus of these three pivotal aims is the push for Environmental, Social, and Governance – or more colloquially known as ESG – which is now gaining strong traction and adoption by businesses and investors globally. While fulfilling these responsibilities has largely been top-down and piecemeal (led by governments and civil society groups), more businesses are being encouraged to further the ESG cause, especially as they and their investors are well-positioned to make a more significant, bottom-up impact in the markets they operate.

Enabling real, lasting change hence requires a whole-of-ecosystem approach. The venture capital (VC) industry is primed to catalyze it to the benefit of not only its stakeholders but also the world they operate in.

VCs can lead the ESG charge

Essentially, ESG is being called on to encourage organizations, especially businesses, to strongly consider factors beyond just their bottom line – particularly environmental impact, employee culture, and the ethics of how the company is being run.

The reason why VCs can make a difference is that they have shown their ability to do so, having played a crucial role in shaping innovation as allocators of capital to startups. Historically, VC funding has been instrumental in the growth of iconic companies from Google, PayPal, and Twitter to more recently, Grab and Airbnb. The scale of disruption caused by these companies cannot be understated, as they have transformed how not only their industries, but also societies, operate. This places VC fund managers – especially those who are early investors – in an opportune role to steer a burgeoning company’s growth direction and establish a strong set of ESG culture and values as part of their growth trajectory.

On the demand side, many consumers today are increasingly aware of and consider ethical business practice, alongside their impact on the environment and society when selecting a brand. This results in a new rising trend in the consumer markets where we are seeing the rise of sustainable fashion, food, and circular economy.

On the risk management side, ESG can be advantageous for LPs and investors. For instance, a start-up criticized for a lack of diversity, environmental concerns, and poor employee treatment may reflect poorly on not only the company but also on investors. Such scandals may even affect the sales of a start-up hurting the investors in the process. In contrast, managing ESG risks may result in better financial outcomes – with the added benefit of improving the brand while strengthening customer relationships.

Over the past few years, ESG adoption within the fast-emerging VC landscape in Southeast Asia is growing momentum, and with this maturity also comes the need for its players and their investees to act more responsibly. To support this, governments across the region – such as Malaysia, Singapore, Indonesia, and Thailand – are providing a supportive base for ESG investments to spur broader action, as part of their national mandate. Yet, it will be up to private sector actors such as VCs and their portfolio companies to take the momentum forward.

This call is being responded to. Across the region, institutional investors as well as the Davids and Goliaths of the tech sector are seeking to raise the effectiveness of ESG financing. In Singapore alone, there were over 64 deals amounting to about $385 million invested into early-stage sustainability startups in Singapore within 2021 which were to be utilized by these start-ups to further their research and development to produce innovative solutions for the market.

Overcoming ecosystem teething issues

Despite the general boom in ESG investments, this trend in Southeast Asia – especially between VCs – is still in its nascency. While there are many factors to consider, the major hurdles include the following:

Conflict of interests

On one hand, the primary goal of VCs is to generate a return for their investors, especially by identifying an alpha deal. Meanwhile, ESG-focused start-ups aiming to provide innovative sustainable solutions to an industry often do not have a proven business model yet.

Verifiability of ESG compliance

While there have been common and uncommon forms of ESG compliance – i.e., pollution control, energy saving, gender equality, as well as employee good health and wellbeing – there currently is no established and enforceable set of rules, as there is no single regulatory or standard-setting body to investigate social development goal (SDG) SDG compliance practices by private companies. Instead, testing how these startups manage such issues are done based on their ability to manage the related risks – yet, startups may refrain from disclosing the actual truth, or are reporting their SDG practices in an unconventional format which creates uncertainty for investors when choosing to back such start-ups.

Given that ESG investing in Southeast Asia has only gained significant momentum over the past few years, there is still much room in terms of the action needed to address these challenges. To scale and sustain the impact of ESG investments, VC ecosystem players must work with regulatory bodies to create an enshrined set of standards for startups to disclose their SDG practices and then enforce them. With this, the region’s ESG investing landscape can have a solid base to generate more activity between local, regional, and foreign VC stakeholders.

Charting the way forward

Already, we are seeing how young fledgling startups are responding to sustainability call-to-action. For instance, both Glife and Fefifo are working to improve sustainability in Southeast Asia’s food supply chain; Naluri and Healthmetrics are seeking to digitally improve health and wellness access for communities; Pandai is working to improve quality education delivery to future changemakers and; Alami is leveraging FinTech to help address financial inclusion.

It is startups like these that will require support to make a real market and societal impact. However, as is the case for tackling the world’s most pressing issues, addressing sustainability challenges requires a concerted ecosystem effort from both the public and private sectors. In the case of VCs that are building the businesses of tomorrow, ESG financing can provide a meaningful and long-lasting effect on ecosystems beyond their own.

Rachel Lau is the Managing Partner of RHL Ventures.

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