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Unlocking the Potential of ESG in China

Updated: Nov 2, 2023

As the world pays more attention to environmental, social, and governance (ESG) factors, China is no exception. In 4 parts, we'll give an investor perspective of the ESG landscape in China where we'll cover the undeniable rise of ESG in China and conclude with practical reminders for private investors to consider when navigating this space.

Part 1

The dramatic rise of ESG in China

China has seen a surge in ESG investments in recent years, this is largely in part to regulatory support and international demand. In this part, we'll share 4 key drivers that catapulted China to the forefront of ESG progress.

1. Regulatory support and international demand

President Xi's announcement of "dual carbon" goals in 2020 has spurred Chinese financial institutions and companies to address climate change. But it is not just regulations that are driving the growth of ESG in China. International investors, who prioritize ESG and are more active in company engagement and stewardship, are also putting pressure on Chinese companies to improve their ESG policies and disclosure standards. This is especially the case since MSCI began including China A-shares in the MSCI Emerging Markets Index and the MSCI ACWI Index in 2018.

2. Observation from PRI signatories in China

As observed from PRI (Principles for Responsible Investment) signatory statistics, there are proportionately more signatories who are asset managers than asset owners in China, compared to the global average. Asset managers’ proportion is higher because they are more market-oriented and there are clearer market forces driving them to take a position on ESG and PRI.

Though the number of PRI signatories in China is growing, there's still room for more signatories to engage with towards ESG investment. These include Chinese insurance companies, and government-related fund managers with significant AUM (e.g. state pension funds, social security funds).

3. Insufficient local ESG data providers

One challenge for Chinese PRI signatories is the lack of local ESG data providers compared to the global market. However, the gap between China and global market is narrowing as a new wave of providers have been entering the market since 2020. (See below graph comparing both markets). This is understandable as ESG data providers have a considerably longer history in the global market, (emerging since 1990s) than in China where the concept of responsible investing and hence ESG data requirement has only become prevalent since 2015.

Some domestic asset managers have set up their own ESG databases and rating systems, which creates another noteworthy difference between international providers, who are typically pure data providers, and domestic providers, who are set up by asset managers. Expectedly, different data providers would have their own rating methodology which are not necessarily aligned. If there is no dominating, well-recognised and credible data provider that the majority of fund managers choose to reference then the collective monitoring influence exerted by data providers towards the listed companies may not be as strong as that of the global market.

Note: Size of ball = number of new data providers

Source: Ping An Digital Economic Research Center

4. Thematic funds are more prevalent while Pure-ESG funds are the minority

In terms of ESG investment products, thematic funds are more prevalent in China than pure-ESG funds (funds that consider 2 or more of the ESG factors, account for only 11% of China's ESG fund assets - see below chart for details). Environmental-themed funds dominate at 37%, followed by pan-ESG concept funds (i.e. funds that consider the concept of ESG but cannot be classified into specific categories due to insufficient information) at 40% and governance-themed funds at 12%.

Our view on the prevalence of thematic funds in China are mainly investor demand-driven as many of these themes are government policy-friendly (e.g., carbon-neutrality) and hence present a strong investing angle.

Source: Ping An Digital Economic Research Centre, figures recreated as % by SFi

While we are delighted to witness the growth of in China, we must allow room for market participants and the related support to improve.


Part 2

Unlocking the Potential of China's ESG Market: Challenges

Sustainable investment products in China have increased significantly in recent years, reflecting the growing interest in environmental, social, and governance (ESG) factors. Yet, challenges do exist which the industry needs to address. Let's take a closer look.

1. Lack of quality ESG data

One of the major challenges facing ESG investors in China is the lack of quality ESG data. Not all listed companies in China are required to disclose their ESG data, resulting in only 30% of A-share companies reporting their ESG data. However, even for those that do disclose, only 5.3% disclose GHG emissions data, and less than 1% disclose scope 3 emissions data. This makes it overall difficult for investors to assess the ESG performance of Chinese companies.

Source: miotech

2. Lack of centralised ESG disclosure standards

Another challenge is the lack of a centralized ESG disclosure standard. A Chinese company might have to disclose several sets of ESG data to comply with regulatory requirements from different authorities. For instance, if a company is dual-listed in SSE/SZSE and HKEx, and is a heavily polluting company, it might have to follow 2 sets of mandatory requirements (i.e. HKEx, MEE), and 3 sets of voluntary requirements (i.e. SSE/SZSE, CSRC, CERDS) already. This can result in confusion and inconsistency in ESG data.

3. Insufficient awareness and education

Insufficient awareness and education on ESG is another key challenge. According to a survey conducted by Asset Management Association of China on Chinese fund managers’ ESG investment appetite, 71% of Chinese fund managers surveyed have yet to implement ESG in their investing processes despite their awareness of ESG concepts, preferring to remain confined to their existing investing methods. This also fuels the misalignment between local practices and international standards in ESG investing. For example, the cultural disparity surrounding the inclusion or exclusion of the alcohol industry in fund portfolios, and China’s understanding of ESG is ultimately skewed more towards green investing.

4. Engagement issues

China's current proxy voting procedures and disclosure requirements are not friendly enough to allow sufficient preparatory time and necessary information for institutional investors to meaningfully consider and engage with companies at annual general meetings.

Another challenge in promoting engagement in China is public concerns over collaborative engagement. Since engagement is still a nascent approach in China, not to mention collaborative engagement, some fund managers may confuse this concept with engaging with confidential information perceived for market making.

Therefore, more public education on how this communication or collaboration should be conducted and managed, as well as legal uncertainties involved are needed to address concerns and uncertainties.


Part 3

Unlocking the Potential of China's ESG Market: Opportunities

Despite challenges that exist, we see opportunities that show the market is moving in the right direction.

1. Regulatory tailwind accelerating development of ESG ecosystem

Despite aforementioned challenges, large, instrumental government bodies are banding together for ESG progress in China. For instance, the National Green Development Fund, jointly established by the Ministry of Finance, the Ministry of Ecology and Environment (MEE), the Shanghai Municipal People’s Government, and a few Chinese banks, leverages its power to stimulate more capital deployment from both private and public to onshore ESG-related sectors and projects.

In terms of regulatory efforts in facilitating the provision of higher quality ESG data, the update of environmental disclosure regulations by the MEE in 2021 requires heavily polluting companies to disclose environmental data in a standardised format, and upload the data to a centralised portal for public access. This makes the data comparable and easier for cross-verification with other environmental information platforms, providing convenience to investors in considering ESG performance in their stock selection. Due to this changing investors’ appetite, for Chinese companies, they must invest in ESG in their Research & Development process to mitigate regulatory risk for companies.

2. Opportunity to tap a bigger international capital pool

As international investors who uphold higher ESG standards continue to invest in China, we also expect the ESG reporting standards of domestic companies to gradually converge with international standards.

That being said, it is unlikely the 2 standards will perfectly align in the near term, as China is adamant about constructing its own locally adapted ESG framework which might not directly address some metrics (e.g. Social factors) of interest to global investors. Unfortunately, this will remain to be a nuance that global investors must acknowledge in order to participate in Chinese economic growth.

3. Stewardship plays a significant role in China with a localised approach

Chinese companies need guidance or hand-holding from asset managers as they get started in ESG investing. Effective ways to speed up the process during stewardship and engagement include:

  • Using the same language to communicate with investee companies,

  • Understanding which engagement and voting techniques are appropriate to China, and

  • Keeping in mind local cultural sensitivities when customizing stewardship strategies.

In conclusion, while there are challenges to ESG investing in China, there are also opportunities to tap into the growing ESG market. Investors should stay informed and consider the unique characteristics of the market when making investment decisions.


Part 4

And last but not least, Key Reminders for Private Investors

China’s ESG capability is rapidly catching up with international standards, with ample opportunities opening up for investors to participate. As a private ESG investor, what should investors know in order to navigate this landscape.

1. Operational gaps exist in China towards ESG integration

One area where improvement is needed is the incorporation of ESG elements into investment strategies. A recent survey found that few funds in China have fully integrated ESG elements into their investment models, meaning they rarely adjust their valuation models based on ESG data. Instead, Chinese fund managers typically put ESG elements as a secondary consideration factor, such as negative screening or sector allocation. However, survey respondents expressed that they are working towards building a comprehensive ESG system that is adopted by all internal teams. This is a space to watch along with any new strategies that adopt a more holistic ESG integration methodology.

2. Quality of ESG integration room for improvement

Chinese firms offering thematic funds may not have a robust ESG investing framework disclosed (at least not publicly available). This is because many firms see ESG investing as having exposure in sectors or themes that have an ESG angle, without recognizing that responsible investing requires a more in-depth understanding of the fundamental ESG factors of the underlying companies. While the underlying motivation for some of these managers might not be purely ESG-driven, it is still a good sign to see increased capital being allocated to companies that could help build a more sustainable future for China. As private investors, it would be prudent to have comprehensive due diligence and ask questions specifically around attribution and contribution methodologies.

3. Quality of Chinese signatories’ PRI reporting varies

Many boutique Chinese signatories publish fairly simple, basic reports that meet only the minimum requirement, with no elaboration on their ESG strategy nor publicly available ESG investment policy. Specifically, the firm’s ESG policy as provided in the PRI Public Signatory Report is a brief word document that includes basic descriptions of the firm’s ESG approach without insights or details provided. No detailed ESG investment policy is also made publicly available. Therefore, more diligence work is required from investors to ascertain the quality of ESG investing.

4. ESG investing capabilities of onshore and offshore investment team of the same asset manager could differ

Onshore teams typically face domestic Chinese investors who may not be adequately educated on ESG, while offshore teams often deal with more sophisticated international asset owners who care more about ESG and would consider the ESG investing framework of managers when they allocate capital. This difference in clientele could be a reason for such a gap in ESG investing capabilities.

Given the above, although many JV asset managers are backed by well-known international firms, it is recommended that private investors evaluate their ESG investing framework and practice independently and do not rely solely on branding or institutional frameworks by the international JV partner. Ensuring true integration of ESG best practices will be important as well.

To conclude, as a private investor, look beyond the "ESG fund" label and ask specific questions about investment frameworks and operations.

Throughout the years, SFi has been supporting our members in understanding the evolving ESG/impact landscape. The content of this China ESG series is extracted from one of our member-engaged projects. Reach out to us if you would like to learn more about this report or SFI's bespoke consulting services for landscape research on particular thematics or geographies.

Cover Photo Credit: Loeng Lig on Unsplash

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