Corporates are a few steps behind on ESG disclosures, but momentum is building under pressure from regulators and investors.
As an emerging global superpower, China plays a vital part in the transition to a greener economy.
In September 2020, President Xi Jinping pledged to achieve net-zero greenhouse gas (GHG) emissions by 2060, setting in motion plans for a more environmentally-conscious business ecosystem. China also launched its national carbon market earlier this year, the world’s largest.
It’s increasingly clear that the risks of climate change are driving policy in China, presenting more sustainable investment opportunities for non-domestic asset owners.
Despite progress, the transition won’t be easy and requires backing from both domestic and non-domestic investors, wrote Jie Lu, Head of China at Robeco recently. Thankfully, “the formidable challenges associated with the transition also come with many investment opportunities”, Lu said.
In the run-up to COP26, non-domestic ESG-conscious investors will increasingly find opportunities to invest in innovative Chinese corporates, says Kathlyn Collins, ESG Analyst at investment manager Matthews Asia.
“China has been moving fast to reverse some of the climate externalities brought on by its huge [population] growth over the last decade. [Net-zero] is going to accelerate the pace of change in certain technologies and innovations that we were already seeing before the  commitment,” Collins adds.
China has spent twice as much as the US on climate action to date, she observes, bolstering its solar energy capacity to almost triple that of the US last year.
Research by Fitch Ratings found that non-coal generation plants accounted for less than half of China’s total power capacity share for the first time in 2020. The power output of non-fossil fuels also made up one third (34%) of China’s total power output, 1% higher than in 2019.
However, much remains to be done if China wants to fully reform its energy mix and improve renewable energy usage by Chinese industrial companies, Collins says.
“China needs to next promote green lifestyles and ramp up its carbon capture and storage technologies,” she tells ESG Investor. “There are huge opportunities in renewables and electrification, for example. The mobility opportunities in the transition to a low-carbon economy are tremendous here.”
Slow coal phase-out plans notwithstanding, the Chinese government’s commitment to addressing social factors is less clear than its stance on environment.
From the imposition of National Security Law by the Chinese government to quash Hong Kong riots in 2019, to Turkic Muslims being detained in Xinjiang, social issues in China remain a point of contention, according to Human Rights Watch.
However, change of any kind will require ongoing government-led regulatory reform, as foreign investors encourage a greater focus on ESG factors by Chinese corporates from a distance.
Domestic versus international
Domestically, China’s regulatory bodies, financial institutions and leading corporates are backing sustainable fund launches to help spearhead investments in green projects and sustainable development.
Last year, the National Green Development Fund (NGDF) was launched by the Ministry of Finance, Ministry of Ecology and Environment and the Shanghai city government. The state-run private equity fund is currently worth USD 13.6 billion and is backed by 26 investors.
More recently, PetroChina – the listed arm of state-owned China National Petroleum Corporation – announced plans to establish an investment fund to help fuel the growth of new sources of energy.
Overall, however, the recent uptick in ESG investing in China has largely been driven by demand for more ESG integration from international investors, with domestic investors largely sitting “in the investigative stage”, according to a CFA Institute report.
Domestic asset owners remain more focused on the short term, the global association of investment professionals said, adding that “once investors learn about the opportunity to reduce risk and generate alpha through ESG investing, more will practice it”.
Pairing the fact that domestic asset owners are not yet prioritising ESG integration with how China is encouraging foreign investors to purchase A-shares (stock of China-based companies listed on the Shanghai and Shenzhen Stock Exchanges), international investors face fewer barriers to investment.
Robeco’s Lu says renewable energy, electric vehicles, upgrades in power networks and energy storage technologies, and China’s hydrogen industry are sectors of interest for investors looking to bolster and diversify their portfolios.
Non-domestic asset manager Invesco’s Asian Fund (UK) has “significant exposure” to China’s tech and Internet stocks, due to their strong financial performance and low carbon footprint.
But just as in the US, the appeal of China’s Big Tech firms tend to be tied to social issues. For example, last year Chinese regulators launched an anti-monopoly investigation into Alibaba and, in February, Reuters reported that a company executive for Tencent is being investigated by authorities over allegations of “personal corruption”.
Invesco’s fund is exploring options elsewhere within China’s A-shares, most recently backing Ming Yang Smart Energy, a manufacturer of generators for wind turbines. “[It] should be well-positioned to take advantage of long-term wind installation targets in China”, Invesco said.
But these investment opportunities come with a caveat if the required information on ESG risks is not forthcoming. Compared to other global corporates, Chinese companies are behind in their understanding of ESG issues and in the incorporation of ESG factors into their business practices. They are therefore not easily comparable to international counterparts, said Willis Towers Watson (WTW).
Chinese corporates currently display a more limited understanding of ESG issues, a lack of company culture around ESG investing and more restricted access to comparable domestic and historic ESG-related data, WTW noted.
“The market for ESG ratings and data is in its early stages in China. Examples of existing gaps include low coverage of companies and slow development of fixed-income data, which has limited the development of more diversified ESG investment products such as passive funds, quantitative funds and investment products for primary markets,” wrote Jessica Tan, Co-CEO and Executive Director at Ping An.
Speaking on a recent panel for the Principles for Responsible Investment’s (PRI) China Carbon Neutrality Week, Crystal Geng, Head of ESG at Ping An Group, acknowledged investors “aren’t getting a very clear answer” from Chinese corporates on their exposure to ESG-related risks and opportunities.
When non-domestic investors assess Chinese corporates on their ESG performance, these limitations should be taken into account, says Yoshihiko Kawashima, Head of ESG Asia ex-Japan at Invesco.
“ESG risks [to investors] may include the availability and quality of ESG data and lack of standardisation of disclosures. We believe that many corporate governance issues and lack of various environmental and social policies are due to the lack of a proper ESG governance structure within a company to formulate proper ESG philosophy and strategies,” Kawashima explains.
Encouraging ESG-related disclosures
Sustainability reporting is an important part of China’s 2030 Sustainable Development Agenda, yet Chinese corporate disclosures on ESG-related issues are inconsistent at present.
While corporates listed on the Hong Kong Exchange are now required to produce a statement which outlines its board’s consideration of ESG risks, companies listed in mainland China are not yet subject to such mandatory requirements, says Collins.
The China Securities Regulatory Commission (CSRC) collaborated with China’s Ministry of Environmental Protection last year to set the ball rolling and introduce mandated ESG-related disclosures for all listed companies (around 3,000), meaning they must report all ESG risks associated with their operations. Further details on this are expected soon and could have a very dramatic effect on the quality of ESG disclosures.
In the meantime, a recent upturn among Chinese corporates in their awareness of ESG factors is seen as a positive sign. Evidence of growing pressure from regulators and investors is reflected in the growing quantity of ESG-focused disclosures provided by Chinese corporates.
In 2019, 85% of CSI 300 companies provided ESG disclosures, an improvement from 54% in 2013, according to Ping An research.
However, while quantity is improving, the quality of that information remains inconsistent, with just 12% of submitted ESG disclosures in 2019 being audited, Ping An noted.
“This so-called ESG momentum can be a financially significant indicator in its own right, despite weak absolute ESG performance,” WTW said in part one of its whitepaper.
In the absence of a standardised mandatory framework for Chinese corporates to report against, there has been a reluctance to adopt voluntary approaches.
Unlike many other countries, China still has “low adherence to international reporting norms” on sustainability performance, such as the Global Reporting Initiative (GRI) standards or the TCFD guidelines, says Collins.
If Chinese corporates are going to incorporate ESG-related reporting and practices into their business models on a wide scale, then action needs to be taken by the policymakers, experts say.
The tide is beginning to turn as China’s regulators look ahead to COP26 and achieving the country’s net-zero target.
Last year, the Chinese government published a new policy document which aims to develop a common sustainable finance taxonomy with the EU.
Furthermore, China’s carbon market is forcing carbon-intensive corporates to reduce their reliance on fossil fuels and find renewable alternatives. In February, China’s State Council issued new guidance to help accelerate the development of green finance and a low carbon economy.
As well as this, Yi Gang, the Governor of the People’s Bank of China (PBOC) spoke at the China Development Forum in Beijing in March, calling for more private green investment into green projects and initiatives, noting that this will be an essential requirement if China is to reach net-zero emissions by 2060.
The PBOC has also said efforts are under way to standardise mandatory environmental information disclosure requirements.
Change is in the works, and China may soon become an attractive option for ESG-conscious investors.
“Chinese companies are aware of the importance that asset owners place on ESG performance,” Invesco’s Kawashima says. “With tighter disclosure requirements and government policies (such as carbon neutrality), companies will continue to increase their ESG efforts [and] improve the way companies’ operations are managed.”
Read more articles like this on Regulation Asia’s sister publication, ESG Investor.