With climate change warnings reaching a crescendo, environmental, social and governance integration is becoming a core element of investment strategy – and China is leading the way. Romil Patel reports from Hong Kong.
“When an asset manager wants to be credible when it comes to ESG integration, it is a question of the ability to have full commitment from the top of the structure and cascade that down,” says François Perrin, a portfolio manager at asset manager East Capital. That means looking deeply into each ESG issue that could have financial implications on businesses and people, and managing them appropriately.
According to the International Monetary Fund (IMF), Asia now accounts for 60% of global growth. In China, the impact on the environment is quite literally never out of sight, and accountability for this lies with the top office – the general secretary of the nation’s Communist Party.
No wonder this issue is growing in importance – it is quite literally a matter of life and death. Air pollution is calculated to cause about 1.6 million or 17% of all deaths in China annually, according to research group Berkeley Earth. Having been a sleeping giant in the environmental domain during the decades of its economic growth, Beijing is now very much alert to the realities and threats that inaction poses to the survival of the current order.
“China under President Xi is firmly committed to becoming a leader in renewable energy,” says Philip Saunders, co-head of multi-asset growth at Investec Asset Management in his investment views for 2019.
In its Emissions Gap Report 2018, the UN reported that “around half of the G20 members’ greenhouse gas emissions trajectories fall short of achieving their unconditional nationally determined contributions (NDCs)”. These include Argentina, Australia, Canada, the Republic of Korea, Saudi Arabia, South Africa and the US. As if to compound woes further, the Americans have withdrawn from the Paris Agreement.
Just three G20 members are on track when it comes to meeting their NDC targets under current policies: Japan, Brazil and China. “The Chinese are leading now that the US government is no longer at the table to discuss these things, and their main climate-related issues are very much related to pollution today,” says Karine Hirn, a partner at East Capital.
In March 2018, China’s National People’s Congress pledged to increase spending to 40.5 billion yuan ($6.4 billion) – up 19% from the previous year - to tackle pollution; it aims to reduce sulphur dioxide and nitrogen oxide emissions by 3%. It has also clamped down on environmental crime, prosecuting more than 3,500 people in the first ten months of 2018.
“What used to be the anti-corruption drive has very much become the anti-pollution drive,” says Hirn. “Investments are also gigantic. On a yearly basis, they invest as much as Denmark’s GDP. The supply-side reforms around regulations are not only there, they are being more heavily implemented.”
But these high levels of spending are not necessarily being matched by allocations from global investors to ESG funds. Today, China is believed to be the largest cleantech market in the world and yet many environmental funds do not give the country a large weighting.
“On a global basis, for every dollar invested into the environment, half of it is in China. Imagine having a global tech fund, but being heavily underweighted in the US – that would be wrong,” says Hirn.
Beijing has successfully used environmental regulation as a way to enforce necessary reforms and, by spending a growing amount of its GDP to direct investment in the environmental protection space, its gaze is fixed on a global leadership position by 2025.
That said, China’s green commitment is not an act of charity. Far from having a climate-related epiphany, the Chinese government has acknowledged basic facts – that easier public access to information and a greater understanding of pollution has the potential to undermine the overall stability of the country. Once that was acknowledged, the authorities identified environmental protection as one of the systemic risks for the Communist Party of China.
“The government realised that it is easier to send a positive message to the population by committing to invest and showing that they never tried to block any of the data related to environmental pollution,” says Perrin.
“We all know the ability of the Chinese government to close down information. But when it comes to the air quality index [AQI] and so on, that information is live, and can be reached from wherever you are in China.”
Beijing is asking companies to be more ESG-conscious and appears to be leading by example. But are companies stepping up for investors?
Getting access to good ESG data is a problem for investors worldwide. Those problems are amplified in emerging markets, which have poorer data coverage, disclosure, governance and sparse annual reports in comparison to their developed-market counterparts.
At a global level, carbon dioxide emissions are the most disclosed indicator, with about 50% of companies doing so. But there are doubts about how meaningful it is to compare absolute values of carbon dioxide emissions between companies that have very different businesses.
Another problem is that E,S and G are three distinct dimensions and yet the metrics, perimeters of reporting and consolidation are not well defined. In Asia, it is rare for even the most advanced ESG reporting to exceed a ten-year period and when all these factors are combined.
While China appears to be excelling on the environmental front, driven by the elite, investors looking at greater China exposure will also be asking if companies are doing enough on the social and governance fronts.
Despite the undeniable progress on the environment, China, and indeed Asia, still have a long way to go on the social and governance aspects. Corporate governance standards and gender diversity in the region still lag far behind companies in developed economies.
“When it comes to China itself, I do not see much progress on the ‘S’ and the ‘G’, but for ‘E’ there has been a lot, it is a direct response from the central government,” says Peng Fei, chief investment officer at Wanwei Asset Management (see roundtable article). “We have seen some mutual funds launching products and labelling them ESG, but it is mainly on the ‘E’ side.”
But there are reasons to be optimistic. Beijing has spearheaded the change in attitude towards the environment, providing ample opportunities in renewable technology for investors.
As China opens up to foreign investors, the future could be bright for greater social and governance integration into investments. For example, there is greater scope to combine solutions such as private equity and private debt with relatable themes like education, technology and healthcare.
For now, the world is increasingly looking to China to fill the environmental leadership gap – and should it do so, a “cascade” of investment opportunities and social benefits may well follow.
©2019 funds global asia