Asset managers say responsible investment is gaining ground in China after a slow start. Cybil Huichen Chou reports.
As in the rest of Asia, the concept of environmental, social and governance (ESG) investing remains relatively novel in China without being widely embraced by companies and investors. Some investors still have the perception that sustainable investing is a luxury that may mean sacrificing returns; alternatively, they think it is something entirely separate from fundamental investment analysis.
Yet with a slew of Chinese policies geared towards green finance developments, asset managers in China and abroad believe that ESG integration will proliferate in years to come.
Still a minority
“China is moving fast to embrace ESG as a critical input in government policy and in boardrooms,” says Nan Luo, head of China at the United Nations-supported Principles for Responsible Investment. However, “in comparison with many developed Western economies, which have stringent regulatory frameworks in place, China lacks formal regulatory mechanisms that require investors, and in particular asset owners, to take ESG factors into account in their investment processes. There’s also a lack of guidance to help investors integrate ESG factors into their investment decision-making.”
A report published in 2017 by Syntao Green Finance, a China-based provider of ESG data, found companies listed on the Shanghai and Shenzhen stock exchanges have released more than 5,300 corporate social responsibility (CSR) reports. Another 5,600 have been released by non-listed companies.
In 2016, 763 A-share listed companies issued a CSR report, of which 54% were non-central state-owned enterprises (SOEs), 34% were private businesses, 8% were listed companies controlled by central SOEs and 4% were joint ventures. Given China’s more than 3,300 A-share listed companies, those that have issued CSR reports remain a minority.
In the past, limited green investment products were on offer in China due to lukewarm institutional investor appetites. Yet domestic issues of green bonds, stocks, stock indexes, exchange-traded funds (ETFs), asset-backed securities and real estate investment trusts with a green focus have risen in the past few years.
In 2016 in particular, China became the world leader in sustainable bond issuance, accounting for 26% of global issuance – up from practically zero in 2015. (Chinese issuance expanded about 1% the following year to $23.1 billion in 2017, trailing the US.) China also represents about 30% and 27% of global investment in renewable energy and energy efficiency respectively, according to figures from BNP Paribas Asset Management.
Green bonds aside, as of August 31, 2017, China had 62 responsible investment-related funds in the market, composed of 16 funds that account for the ESG and sustainability performance of listed companies, and 46 funds connected to green industries, according to a Syntao Green Finance report. In the same period, the country had 30 responsible investment-related stock indices in the securities market, composed of 12 indices that track the CSR performance of listed companies and 18 related to green industries.
As the Chinese capital market isn’t fully liberalised, accurately comparing the level of returns with the mature markets in the ESG investing space is difficult. Yet the much broader green investment options and lucrative returns offered abroad are enticing deep-pocketed Chinese institutional investors.
Last May, BNP Paribas Asset Management said its wholly foreign-owned enterprise, BNP Paribas Overseas Investment Fund Management (Shanghai), had been granted a qualified domestic limited partner (QDLP) qualification. Under the regime, the firm will be the first to introduce an ESG-related product to onshore clients.
“The fund is a global equity, multi-sector fund that invests in companies that have at least 20% of their revenue exposure in water. These could be companies in the industrials, utilities, healthcare, materials, technology or consumer sectors,” says Mandy Lui, head of wholesale distribution for China, Hong Kong and Singapore, BNP Paribas Asset Management. “On average, companies that the strategy invests in have water-related revenue exposure of 50%.”
Lui says there is strong interest from private banks and family offices in China – and the returns are handsome, too. “This is a strong reason as to why we see a clear growth in this theme as a long-term investment. On an annualised basis, the fund has returned 14% after fees since the fund was incepted in 2008.”
Meanwhile, for foreign investors looking to invest in either clean technology or green bonds, China is an interesting target, either through a dedicated China-only strategy or as part of a broader Asian or global portfolio.
That said, asset managers still need to tackle hurdles when adopting ESG integration strategies.
“From an investment perspective, one challenge to developing ESG investing in China is the availability and quality of ESG data for Chinese companies,” says Lui. “With the MSCI inclusion of 233 A-shares [in the Emerging Markets index], ESG data providers have been expanding their coverage of Chinese companies, which, together with increased engagements by investors, should lead to both better disclosure and integration of sustainability challenges in Chinese companies’ strategies.”
Because of the lack of information, some entities are working with local partners to help them understand the market.
“Foreign investors are more likely to cautiously approach ESG investing in China in the initial phase by forging partnerships with Chinese counterparts to test the water rather than rushing into the market and splashing money on their own,” says Guo Peiyuan, chairman of SynTao Green Finance.
Such a partnership is exemplified by APG, the Dutch pension fund, which tied up with Guangzhou-based E Fund Management, China’s third-largest asset manager, to launch the first concentrated equities strategy that invests in China A-shares and adheres to sustainable and responsible investing frameworks and criteria.
Although the partnership holds promise, E Fund Management is aware that responsible investing presents difficulties. “The challenging part for us is the complexity, because the integration between ESG and investment strategies involves detailed scoring and weighting systems,” says a spokesperson for E Fund who prefers not to be named.
Another issue is the challenge of finding quality Chinese investment options. On average, the 233 Chinese companies included in the MSCI benchmark indexes rank poorly on ESG criteria when compared with other stocks in the MSCI Emerging Markets index, according to MSCI. Some 37% of the 233 domestic Chinese companies scored the lowest ESG rating of CCC, compared with 8% of companies already in the index.
At the other end of the scoring spectrum, only 3% of the Chinese companies were placed in the top three out of seven ESG categories, compared with 22% of the stocks that already comprise the index.
The index provider says that despite the Chinese government’s efforts to issue numerous green policies, at a company level the ESG consideration has not yet been embraced. Hence MSCI is planning to launch China ESG indices some time this year to help investors screen out riskier firms.
China is rapidly becoming one of the brightest stories in clean energy transformation. The Chinese government has introduced stricter regulations to protect the environment and direct significant investment into clean technology in a bid to reverse the damage caused by decades of energy-intensive growth. More importantly, it is regulating and enforcing environmental regulations and implementing a comprehensive policy designed to achieve a sustainable, quality-focused economic growth model.
The China Securities Regulatory Commission has introduced new requirements that by 2020 will mandate all listed companies and bond issuers to disclose ESG risks associated with their operations in their annual or semi-annual reports. Meanwhile, the Shanghai and the Shenzhen stock exchanges have joined the UN Sustainable Stock Exchanges initiative and are committed to supporting the development of green and transparent markets in China.
The latest move is the decision by the Chinese this June that it will moderately expand the scope of securities including green loans, corporate bonds issued by small and micro firms and green finance bonds rated at least AA as collateral for a lending tool during the medium-term lending facility operations.
There is much work to do and progress may not be fast. But in time, China could become a giant of socially responsible investing.
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