Environmental, social, and governance (ESG) investing standards – also called ‘sustainable investing’ – have taken on greater importance in the investment community in recent years. China is no exception.
The ESG movement has gained momentum as investors increasingly seek to align themselves with concern for the environment, the impact of their investments on society, and a desire to invest in companies run with transparency, paying heed to the interests of minority shareholders and following best accounting practices.
How has ESG developed in China?
In 2012, the Hong Kong Stock Exchange (HKEX) and Clearing Limited (HKEX) released its ‘ESG Reporting Guide,’ encouraging listed companies to disclose their ESG performance on an annual basis.
In 2015, HKEX issued a consultation paper, raising the requirement of ‘suggested disclosure’ to ‘comply or explain.’ Soon after, most companies listed on HKEX started releasing their first ESG reports and disclosing related social responsibility information on their official websites.
Later in 2017, the Ministry of Ecology and Environment of the People’s Republic of China and China Securities Regulatory Commission (CSRC) jointly signed the ‘Cooperative Agreement on Jointly Conducting Environmental Information Disclosure of Listed Companies,’ aimed at formulating rules on the mandatory environmental information disclosure of listed companies and implementing environmental protection.
At the annual meeting of China M&A funds held in 2018, the Asset Management Association of China (AMAC) formally released the ‘Research Report on ESG Evaluation System of China’s Listed Companies and the Green Investment Guide.’ With this, AMAC is building a core indicator system to measure the ESG performance of listed companies and opening a new chapter in China’s ESG investment practice.
In 2019, HKEX published its ESG guidance to mandate improved ESG disclosures among companies listed on the bourse.
Hong Kong’s new requirements govern fiscal years starting in July 2020. From that point on, companies must produce a statement documenting the board’s discussion of ESG risks as they relate to the company, how the board considers the importance of ESG factors, and how they impact the company’s business. Later this year, stock exchanges in Shanghai and Shenzhen are expected to follow suit.
Although it is not a new concept, Chinese companies have recently begun to take these standards seriously. Therefore, currently, China’s ESG disclosure score – calculated by Bloomberg – is lower than that of most countries.
The main reason behind was that most Chinese investors considered compliance with ESG guidelines to be an unacceptable compromise on returns – allowing cash-rich companies to rubber-stamp their ESG credentials and skate by, while the increased burden cripples smaller companies.
An individual investor responded to the HKEX 2019 open consultation period regarding its ESG mandate as: “ESG reporting after all is just to produce a report… it only wastes investors’ money to those consultation firms. Please be reminded that wasting a listed company’s money is the same as wasting investors’ money,” and that the ESG disclosure is “not more than a paper target for fulfilling the listing rules.”
However, the Chinese government is increasingly encouraging companies to apply ESG standards. Industry experts see this effort as a bid to attract more foreign investments.
But what factors does ESG investing usually consider?
Unfortunately, at the current stage, there isn’t a uniform standard of ESG. But in general, these standards look at a company’s environmental impact and policies such as waste management, emissions impact, and environmental protection; social policies such as labor standards, employee relations, equal employment, and impact on local communities; and governance factors such as ownership and structural transparency, investor voting rights, independence of the board/oversight, business ethics, and executive compensation fairness.
Supporters of ESG standards claim that these standards will finally force companies to become better corporate citizens and will allow investors to use their cash to drive change at companies.
Challenges for Chinese companies
Almost every pillar of ESG investing is a challenge for Chinese companies. However, the ‘environmental’ side of the concept seems to be the most achievable – since the Chinese government has made it such a priority – but progress simply isn’t fast enough.
According to Corinne Bendersky, London-based associate director with S&P Global Ratings sustainable finance team, environmental performance information, in particular, remains insufficient and will require greater environmental risk information statistics and data disclosures to meet the demands of green bond investors.
In terms of the social pillar of ESG, the companies need to make some fundamental changes. Chinese technology companies, such as Alibaba, ByteDance, Baidu, Tencent and Huawei, are known for their ‘996 working hour’ culture, meaning workers work from 9 a.m. to 9 p.m., six days a week. That’s a total of 72 hours per working week! Technology workers are sick of this and have increasingly taken to the Internet to complain.
However, the long hours at China’s technology giants must seem like a blessing to China’s horde of factory workers. China Labor Watch in 2016 documented workers in southern China’s toy factories working in toxic and dangerous environments while earning minimum wages.
Therefore, the social issues of ESG represent one of the biggest challenges for Chinese companies to overcome in order to attract more investors.
Lastly, the governance pillar will be a tough aspect to handle. Many Chinese listed companies have an opaque and confusing ownership structure where investor voting rights have no actual weight. Moreover, transparency is another issue. ESG rating agencies are regularly working with outdated information, while senior management often never receive emails as contact information is outdated. Therefore, getting accurate data for Chinese companies will require in-depth research beyond superficial scorecards.
Not all is bad
But on the positive side the Chinese government seems to be determined to improve ESG standards for all the Chinese companies. Thus the top-down drive might show its effects faster than expected and increase foreign investment to Chinese companies.
Industry experts are optimistic about the ESG future in China. Andrew Steel, London-based global group head of sustainable finance with Fitch Ratings, says, “China is likely to move faster than anybody else on this given their centrally controlled model. They’ve already introduced some legislation on compulsory ESG disclosure requirements which kick in next year for listed entities and public bond issuers.”
Moreover, Pierre-Francois Thaler, Paris-based co-founder and co-CEO of EcoVadis says, “While other, more developed countries have slowed down on their investments in sustainability, China is still growing and growing fast.”
Therefore, although current practices are below the usual ESG standards, the situation might change with the government push. Soon, attracting international investors will require Chinese companies to substantially improve their treatment and disclosure of the broader set of ESG risks and opportunities and to remain accountable to the environmental and social commitments.