While the Scope 1 and Scope 2 emissions increased in 2020, the Scope 3 emissions decreased over the year. The decrease is understandable as there were covid restrictions related to traveling. The reduction in emissions from 106 thousand tonnes CO₂e to 14 thousand tonnes CO₂e related to “Employees’ business trips” validates that.

Samsung Electronics also stated that the company’s operations in China, Europe, and the US were now fully powered by renewable energy sources, thus fulfilling its 2018 pledge. While that is laudable, Greenpeace (a non-governmental environmental organization) urged Samsung to go all renewable in South Korea and Vietnam, two of its biggest manufacturing hubs. South Korea and Vietnam constitute roughly 80% of the electronics maker’s energy use and as of now the energy systems in these two countries are powered by fossil fuels. 

Granted, there are hurdles in the form of lobbies and government ministries resisting the transition to cleaner energy in South Korea, but Samsung could leverage its position in Vietnam where it is the biggest corporate employer and contributor to gross domestic product. Clearly, if Samsung keeps promoting itself as a renewable tech company while continuing to use fossil fuels in the majority of its production line, it will only be adding to its already troubled ESG scores.

Why South Korean chaebols are complex in their ESG track record

In Emerging Markets, evaluating a company on its ESG performance is a huge challenge for a variety of reasons such as lack of reliable data and complicated disclosures. Apart from that, there are also peculiarities like the complex ownership structure that has certain implications, which is a big issue in many EMs. The chaebol or conglomerate business structure of South Korea is an interesting case here. 

The term Chaebol refers to a complex, conglomerate-type ownership structure that originated in South Korea in the 1960s, comprising of either a single large company or several groups of companies. Samsung, Hyundai, SK Group, and LG Group are among the biggest and most prominent chaebols. While they are doing well on the business front, there are several issues that can’t be ignored.

There are peculiarities associated with such an arrangement, such as their oversized influence and non-transparent relationship with politicians and government officials. Although South Korean firms are making good progress on Environmental and Social Issues, the record is not as elegant when it comes to Governance. The ‘chaebol way of doing business’, could be the culprit here. 

With this in context, there are some important lessons for institutional investors that have surfaced from the latest developments in the ESG space in South Korea including, a) No two ESG scores are the same despite having the same headline figure. This shows that it is the composition that makes the difference and hence all three parameters need to be evaluated separately. 

The complex ownership structure and political linkage of senior Government officials with the controlling group families and senior management in many of these enterprises make the situation more complicated. This way of functioning acts as a hurdle for analysts and institutional investors in figuring out the ultimate beneficiaries of this complicated ownership structure and the cross-linkages between companies, families, and individuals.

There are also concerns regarding unscrupulous actors such as how senior politicians help these companies and how in turn, the families pay them back. The likelihood of it happening is much higher when the government has more power to take policy decisions that could lead to a big change in the fortunes of business entities. This is what makes the companies from Emerging Markets much more prone to challenges emanating from poor corporate governance.

Chaebols and the infamous Samsung case of 2017

It is related to an influence-peddling scandal that cost the country’s president and Samsung’s top executive their jobs. In 2017, Samsung’s top executive was jailed as part of the scandal that toppled the chair of Park Geun-hye, South Korea’s president. This scandal reverberated across the global business media and these developments also led to a revaluation of the investment decisions process for many institutional investors.

As a result of this scandal, Jay Y. Lee, the head of the Samsung Group, was sentenced to five years in prison, after a court convicted him of bribing his way to greater control of the Samsung Empire that his family had founded. But Lee appealed the conviction and in early 2018, the Seoul High Court let him free after reducing and suspending the sentence, thus sparking public anger. But this wasn’t the first time that such an incident had occurred. In the past, business leaders, including Lee’s father, were convicted for corrupt behavior, only to be let off later.

Lee was accused of playing a role in the payment of tens of millions of dollars that Samsung made to benefit a close friend of deposed president Park. The Lotte retail group’s chairman was convicted in 2018 in another trial relating to Park and was handed a 30-month jail term. Eight months later, an appeals court suspended the term and released him. This also led to public outrage as protesters calling for the president’s ouster vented their anger at the conglomerates. Park was found guilty in 2018 of crimes ranging from bribery to coercion, abuse of power, leaking of state secrets and was sentenced to 24 years in prison.

The Achilles’ heel: Governance

EMAlpha’s AI-ML aided analysis tells us that while South Korean firms are making good progress on Environmental and Social Issues, the record is not that good on Governance. This is strange because many of their global competitors do exceedingly well in Governance evaluation, thus helping their overall ESG scores. This good performance in Governance, despite a relatively poor E and S performance, gets the investors to be more interested in them. 

Across several sectors, the South Korean companies usually perform better than their global competitors on the E (Environmental) and S (Social) evaluation, but they lag on G (Governance). A simple explanation is that in recent times, there have been many South Korean companies that have focused on reducing carbon emission and that is what is helping the E scores. But that also pushes G lower in the priority order. 

The scathing remarks from some critics point out structural issues such as the South Korean companies’ management style. For example, with most South Korean companies, the CEO holds absolute power in decision making and hence changes in their corporate governance system are difficult to bring about. Is legacy the reason behind this? The discussion on Chaebols earlier in this insight is clearly an indication that this may very well be the case.

How can EMAlpha help?

There is, undoubtedly, a profound ESG movement going all over the globe right now. From countries to asset managers, from millennial investors to the old school stalwarts, everybody’s counting on the ESG chip for a better future and a better return on investment. There is almost an undisputed global consensus that businesses must incorporate sustainability into their operations.

While the ESG deliberation is appreciable, one can’t deny the challenges facing the ESG movement. Be it greenwashing, lack of proper metrics, frameworks, or quality of ESG information, ESG still has plenty of hurdles to overcome for it to be a sustainable investment instrument. It is here that EMAlpha with its proprietary AI-ML techniques becomes a much-needed tool for investors.

• Go beyond the official reported version – The data source matters and there is a need to look beyond what the companies are reporting and what the official version is. It is essential to rely on the company-reported data because other sources might not be collating as much information. Although often, there are other sources as well for environment-related information. They include the information disclosure as mandated by regulators and the EMAlpha algorithms scan through unstructured data to pick the unofficial information too.
• No two ESG scores are the same despite the same headline figure – It is the composition that makes a big difference and all the three parameters that constitute ESG need to be evaluated separately. The EMAlpha algorithms provide separate scores for E, S, and G so that an investor can review the sectoral performance more transparently. Over and above, a key feature of EMAlpha’s NLP algorithms is that the attribution analysis is fairly simple.
• An ESG score without context and background is meaningless – The ESG is as much about intent as it is about execution. For this balanced evaluation, having an understanding of the local factors is very crucial. A very good ESG track record (probably more driven by excellent performance in E and/or S) may hide serious Governance related risks and the investors can only ignore them at their peril. EMAlpha analysis meticulously incorporates this critical part of the ESG evaluation jigsaw puzzle.