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EM governance: Breaking through

2 Mar 2018

Those calling for better governance in emerging markets are reporting some progress, but, as Mark Dunne reports, there is still a lot of ground to cover.

As a codename, Operation Car Wash sounds a little dull. Yet the ongoing four-year investigation into Brazil’s national oil company has generated enough drama to fill a Hollywood blockbuster.

What started as an investigation into money laundering at Petrobras has put executives and politicians behind bars and even toppled the country’s president, as details of a deeper scandal emerged.

The probe uncovered allegations that billions of dollars were diverted from company profits to executives and members of the ruling political parties, while bribes are reported to have been the deciding factor in awarding contracts by the oil giant.

Lawsuits from investors, who bought shares in New York and São Paulo, soon followed to claim back their losses.

The scandal has heightened concerns among risk-adverse developed-world investors about the quality of corporate governance and transparency standards across emerging markets.

Investing is about trust. Investors are backing the people running a business, not just what is written in an annual report. Investors want senior management to be responsible for the performance of the business, provide clear and timely information on its financial health and activities as well as treat minority shareholders fairly.

Companies adopting such practices could generate long-term sustainable growth, while those choosing not to increase the probability of a permanent loss of shareholder capital.

Companies judged to have a track record of higher governance standards are better positioned to withstand market shocks, the International Monetary Fund (IMF) claims. In its Global Financial Stability Report 2016 the organisation found that moving from the lower end to the upper end of its governance index reduces the impact of global shocks on emerging market firms by an average of 50%.

Adopting strong governance practices may also help boost performance. The MSCI EM ESG Leaders index improved by 40.9% in 2017, which was slightly better than the 37.7% recorded by the MSCI Emerging Markets index.

“A positive trend that one can take out of the emerging markets seems to be borne out by the outperformance of the MSCI EM ESG Leaders index,” says Michael Cheng, MSCI’s vice president of ESG research.

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