Strategy Note /
Global

Corruption in emerging and developed markets – an ESG investing blindspot

  • We revisit the issue of corruption after this week's update to the Financial Secrecy Index from the Tax Justice Network

  • In a composite of third-party corruption indices, the two largest markets in EM and FM, China and Vietnam, score poorly

  • But do developed markets deserve generally better corruption scores than EM, given their complicity in EM corruption?

Corruption in emerging and developed markets – an ESG investing blindspot
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
22 May 2022
Published by

We revisit the issue of corruption in light of this week's update by the Tax Justice Network of its Financial Secrecy Index.

Similar to restrictions on press freedom, the two largest markets in the emerging and frontier equity indices, China and Vietnam, respectively, rank among the worst on corruption scores.

In general, developed markets score better on third-party measures of corruption than emerging markets. But does that make sense when the illicit wealth that flows out from EM often ends up in DM?

Corruption composite index

We construct a composite index by standardising and calculating a simple average of three index scores:

  1. Transparency International's Corruption Perception Index;

  2. Tax Justice Network's Financial Secrecy Index; and

  3. Basel Institute of Governance Anti-Money Laundering Index.

Corruption composite index in emerging markets

If DM is complicit in EM corruption, does it deserve cleaner corruption scores?

Developed markets are arguably at least as complicit in financial secrecy and illicit financial flows as emerging markets.

  • In the Tax Justice Network's latest Financial Secrecy Index, the version of their index that estimates the share of financial secrecy (crudely, a mix of the legal secrecy of a jurisdiction and the amount of offshore wealth it manages), the US accounts for 5.74% of global financial secrecy on its own. In aggregate, developed markets account for at least 40% of global financial secrecy.

  • In its October 2021 Pandora Papers, the International Consortium of Investigative Journalists (ICIJ) describes how financial trusts created in the US "have become a go-to vehicle for financial secrecy", holding assets for people from 40 countries outside the US, with over US$1bn in real estate in and bank accounts in Luxembourg and Switzerland, as well the Bahamas, Panama and Puerto Rico.

  • The original documents in the September 2020 FinCEN Files emanated from a number of large global banks, which, according to the ICIJ, "continue to play a central role in moving money tied to corruption, fraud, organised crime and terrorism, and again according to ICIJ, the five banks that appear most often in the FinCEN Files – Deutsche Bank, Bank of New York Mellon, Standard Chartered, JPMorgan, HSBC – "repeatedly violated their official promises of good behavior".

Our EM Country Index in this context

Corruption – via the World Bank's governance indicators, which form one part of the ESG component – is incorporated into our EM Country Index.

Our index weights c30 factors on growth (short and long term), policy credibility, politics, sanctions, ESG, equity valuation and liquidity.

The weights in the index can be changed in order to model different global themes and portfolio styles.

Related reading

ESG needs to focus on countries, not just companies, Oct 2021

Pandora Papers: A reminder of ESG corruption risk in EM and DM, Oct 2021

Scandal at the World Bank and IMF is not good for EM, Sep 2021

Corruption: FinCEN Files a reminder of challenges for EM and ESG investors, Sep 2020

Corruption: The ugly truth for EM and ESG investors, Jul 2020