ESG Ranking of Russian regions

For the second year, the European rating agency RAEX-Europe has prepared the unique ESG ranking of Russian regions, which allows a direct comparison of the environmental and social risks, as well as the quality of public administration among regions in Russia. This year, the agency also assessed how regions are prepared to face the economic crisis caused by the COVID-19 pandemic and the drop in oil prices.

Crisis comparison and 2020 forecast for regions

The current economic crisis has no analogues neither in Russian nor in world history, as for the first time it was not caused by economic or political factors but by the epidemiological elements. Nevertheless, we would like to compare its course in the regions with the previous crises of 2008-2009 and 2015-2016.

With our best case scenario showing a contraction of only 3% and the worst case scenario a recession of up to 6%  in the Russian economy, it is certain that the number of regions with negative growth will exceed the figures of 2015 (45), and will be closer to the values of 2009 (67). Gross regional product is a lagging indicator, so we looked at more up-to-date data on industrial production, construction, investments, agricultural output, household incomes and retail trade. Most of the indicators showed a slowdown by the end of 2019 after overcoming the 2015-2016 recession. Industrial production in 2019 grew only by 2,3% against 3,5% a year earlier, with a decline in 17 regions (13 in 2018); construction showed an increase of 0,6% (after 6,3% in 2018), with a decline in 45 regions; investments grew only by 1,7% with a decline in 31 regions (5,4% growth in 2018 with a decline in 34 regions). The exception is the agricultural sector, which grew by 4% after a 0,6% decline in 2018, but this sector usually moves out of the general trend due to the weather factors and global market dynamics.

The main difference between the current crisis and the recession of 2008-2009 is that its preceded by an almost six-year stagnation of the real income of the population, which still has not reached the level of 2013 in real terms (by the end of 2019 it amounted to 93% of this level). The share of the population with incomes below the subsistence minimum, after reaching the local minimum of 11% in 2012, has actually been at the plateau of 12-13% for five years, and the gap between the “worst” and “best” regions fluctuates around 28 and30 percentage points. Against this background, given the high debt load of the population, we can expect a sharp increase of social risks at the exit from the acute phase of the crisis in both depressed and relatively developed regions.

Due to the expected negative dynamics of average personal income in 2020 and the extension of quarantine measures in regions, retail trade will be the most affected industry, which is on of the most important sectors for the regions. As in other sectors, the dynamics of retail trade turnover slowed down already in 2019, showing growth of only 1,9% (after 2,8% in 2018), and by the end of the year we can expect a decline of significantly more than 10%, as it was in 2015. The number of regions with negative dynamics will exceed the previous peak at 76.

Similar to the case of the last two crises, as soon as we exit the current one, the largest cities and agricultural regions will be the fastest to recover. Regions with a narrow industrial specialization and the presence of “single-industry” towns will demonstrate a stronger and longer-lasting decline, and the way out of the crisis will follow the dynamics of world commodity markets. The performance of “oil and gas regions” will almost entirely depend on when and to what extent the oil market will recover and what will happen to the RUB exchange rate; after all, oil and gas companies bear costs in national currency while their revenues are in USD. Underdeveloped regions in Central Russia, especially those specializing in machinery engineering, are likely to continue in stagnation even after the acute phase of the crisis. The southern republics of Russia will emerge from the crises non-uniformly, since the dynamics of their economy will strongly depend on the decisions of the federal government for financial support and the implementation of large infrastructural projects.

Social risks and preparedness of the healthcare system

The expected increase in social risks will be largely levelled in the regions that have the leading positions in our social sub-ranking. These include relatively sparsely populated “oil and gas” regions, such as Nenets Autonomous Okrug- 1st place; Yamalo-Nenets Autonomous Okrug - 2nd place; Sakhalin region - 3rd place, as well as the capital cities and their surroundings including Moscow City- 5th place and; St. Petersburg - 6th place. In both cases oil and gas rent is transformed into good indicators of the healthcare system, safety, welfare and basic education.

Certain indicators in the social section of the ranking show quite interesting results, especially due to the large burden on the healthcare system. It is worth mentioning that before the crisis there was a change of the main source of financing medicine from the regional budgets themselves to the territorial funds of compulsory health insurance. While in 2013, 97 kopecks (cents) spent from the fund accounted for 1 RUB of budget expenditures. Then, by 2018, more than 2 RUB from the compulsory medical insurance system accounted for ruble of budget money. Accordingly, the share of health care spending in regional budgets decreased from an average of 14-16% in 2012-2014 to 7-8% in 2017-2018.

A sufficiently high gap remains between the regions in terms of provision of basic medical infrastructure and staff, although this gap was gradually narrowing against the background of the health care system reform. While in 2013, there were on average 0,41 hospital facilities per 10,000 people in Russia, by 2018 this figure declined to 0,36, and the gap between regions with maximum and minimum provision decreased from 12 to 11 times.

Environmental protection and waste management reform

Despite a clear decreasing trend in total amount of pollution from the industrial enterprises, the indicators of environmental risks generally show stagnation. At the same time, the pollution volume of road transport emissions in the atmosphere (15,108 thousand tons) is already almost equal to the one from industrial enterprises (17,100 thousand tons), while the key environmental indicators of the Russian automotive transport (volumes of emissions per one car) have remained unchanged over the last six years. There are some positive trends in terms of the preservation of water resources - in 2018 the total reuse and recycling of water for the first time exceeded the total volume of contaminated wastewater discharge.

We also have analysed the waste-management industry through our ranking. It is a fact that the available data are only the figures published by Rosstat, which are defined based on the waybills or documents completed by usage of special equipment. All the “shadow” market of municipal solid waste, naturally, remains outside the scope of our research.

On a positive note, there is a clear trend towards a decrease in the number of regions where, according to official statistics, solid municipal waste (SMW) is practically not taken out for recycling: in 2010 the number of regions where officially registered SMW was not taken out for recycling was 56, by the end of 2019 only 21 Russian region has zero percent of the recycled or well treated SMW. In our view, the large-scale non-payment crisis and the critical financial stance of many market participants were observed before the start of a new crisis, so it is highly likely that the transition to an economically viable and civilized waste management industry in Russia will drag on for several years.

Quality of public administration

In terms of public administration quality, the leading regions are those where the high level of investment attractiveness is combined with good transparency of local authorities and budget discipline. Moscow City and Tatarstan have been among the top three leaders for the last two years; however, the second position in 2020 has been taken by the Khanty-Mansi Autonomous Okrug, while last year this spot belonged to the Tyumen region.

By the end of 2019, the regional budgets had an increase in the deficit due to a delay of gain on corporate income tax and personal income tax, although the debt had remained low with an improved structure. Apparently, in 2020 the vast majority of regional budgets will be executed with a deficit. More financially stable regions having such opportunities will increase banks’ loans and bonds issues, while the regions having restrictions from the Russian Ministry of Finance will increase demand for transfers from the federal budget and probably will face a sequester of some low-priority budget items.

Ranking process principles

The core of the majority of ESG ratings/rankings is the principle of combining the level of the risk exposure with the effectiveness of its mitigation.

Example: Assuming a company belongs to the chemical industry, where air and water pollution in general is very high as compared to other industries. However the company has shown through official policies and established programs that it takes the necessary precautions and is working on a new technology that will make it possible to decrease or to stop using hazardous substances in the future and therefore reduce the water and air pollution per production unit as compared to its industry peers, then, the total score for these parameters may be relatively high

Available statistical information from various institutions in Russia allows us to build a system of indicators to assess the exposure of regions to potential risks and the degree of their mitigation. For each factor, in order to assess risk exposure and risk mitigation at the same time two indicators were selected. For example, in the Environmental section, we use the indicator “Emission of pollutants from stationary sources per capita into the atmosphere”. It is supplemented by the “Share of captured and neutralized air pollutants in the total amount of waste from stationary sources”. In the best case scenario, if the first indicator is very high, the second indicator should be as high. However, if the second indicator is lower, this indicates the presence of imbalances, which suggests that risks are not given appropriate attention

An exception is the section G (governance), where the assessment is based on verifying the existence of key tools to improve the quality of public administration and transparency in the regions: the presence of anti-corruption commissions, disclosure of information about the income of government employees, etc. In addition, the assessment is supplemented with integral indices, such as the RAEX rating of investment attractiveness of Russian regions¹ and Monitoring of the financial position and quality of financial management of the Ministry of Finance of the Russian Federation.

List of ESG Rating indicators of Russian Regions

What is an ESG assessment and why is it important

An ESG (environmental, social and governance) assessment is based on an analysis of three key factors affecting the sustainability and ethicality of investments: environmental, social risks and the quality of corporate governance

The idea of responsible investments and assessment of ESG factors appeared in the early 2000s, when a number of companies and non-profit organizations in developed countries for the first time took initiatives to integrate social and environmental standards and rules in the financial sector. In 2006, the UN organization established the principles of responsible investments (PRI) for financial market participants and launched their implementation on the New York Stock Exchange. As a result, investors who want to understand precisely whether the project in which they are investing carries risks for the environment and societ, receive a tool to capture such exposures for investment decision. Shortly afterwards, major financial markets joined these principles. At the end of 2018, the number of companies, which had already signed the principles, exceeded 2000, and the total amount of assets under their management was USD 80 tn

Until recently, there was no systematic approach to develop this idea in Russia. However, in mid-2017, theadvisory council on the market for long-term investment under the Central Bank of the Russian Federation emerged, which was the trigger for the introduction of sustainable practices in the country. In 2018, a working group on responsible financing, including the so-called “green financing,” was created at the council and, from 2019 onwards, it is expected that a new sector exclusively specialized on green bonds will be created in the Moscow Stock Exchange, launching the circulation of the environmentally oriented securities

For Russian regions, the topic of responsible investments is important from the perspective of attracting foreign funds. Large western companies are gradually requiring ESG standards audited by specialized providers prior to establishing a partnership or choosing a supplier. For the most part, this relates to the corporate sector. In Russia, however, regional administrations play a key roleindeciding theproductionfacilities’ localization. Therefore, the assessment of exposures to environmental, social, and governance risks may be relevant during the decision-making process. In addition, while investing in Russian projects, the financial partner of a foreign company (a bank or a fund) may take into account the macro environment, which, among other things, includes the assessment of ESG parameters

¹www.raexpert.eu