Stockholm (NordSIP) – On June 1 2018, MSCI added over 230 China large-cap A-shares to the MSCI Emerging Markets Index. MSCI said the initial inclusion is expected to channel around $17 billion in passive funds, and Citigroup expects $48 billion of annual inflow to A-shares. Apart from discussions about opportunities and risk in financial returns, ESG factors in the Chinese market are always another concern for outside investors. Can the evolving ESG profile of A-shares companies provide insight to investors?
The Chinese stock market is deeply misunderstood, and therefore often under-researched, by offshore investors. Take an interesting fact, for example, red is the colour used for appreciation/positive returns, while green is used for depreciation/loss, which are inversed in western stock screening. However, with the increasing transparency and liquidity of Chinese equities, China’s domestic market deserves further exploration. For many responsible investors, an inevitable challenge is how to identify the potential ESG risks if they decide to include Chinese A shares in their portfolios.
Prior to this “MSCI inclusion”, BNP Paribas Asset Management had attempted to invest in Chinese ESG offerings. On May 9, 2018, BNP released the news that they had been attributed quotas of $50m of Qualified Domestic Limited Partnership (QDLP) from Chinese regulators. Under the regime, the firm is the first to introduce an ESG-related product to onshore Chinese clients.
A large barrier to scanning companies’ ESG factors is the lack of ESG disclosure in China. Decennial Report on Responsible Investment in China, a report issued by Aegon-industrial fund and SynTao Green Finance, shows an increase in the number of companies to issue CSR reports. However, given that there are more than 3,300 A-share listed companies in China, those that issue CSR reports are still in the minority.
Other research, such as “Materiality analysis of CSR reports by Chinese capitalization-weighted stock market index (CSI) 100 components” found that by the end of 2016, although nearly 90% of CSI 100 component companies had published CSR reports, over 70% of these CSR reports failed to be qualified in terms of information’s materiality, i.e. its importance and relevance to the issuer’s business and operations.
Three specialities of ESG investment in China can generally be summarized:
• The market is not as market-driven as the western stock market, and ESG is more driven by government and the UN Paris agreement;
• Companies’ ESG disclosure lacks agreed requirement and a third-party restriction, making it hard to make adequate and standard comparisons;
• An important issue for foreign investors is the language barrier -only 100 A-share companies have an English version of their ESG reports.
Simultaneously, opportunities are also brought about by the trend in green finance: both Chinese regulators and companies are building and improving the ‘green’ financial system. The People’s Bank of China (PBOC), along with six other government agencies, jointly issued “Guidelines for Establishing the Green Financial System 2016”, which provides an essential first step for implementing the overall strategy of promoting an ecological civilisation. Hong Kong Stock Exchange has shifted from ‘voluntary’ ESG reporting to a ‘comply or explain’ and Chinese Securities Regulatory Commission has announced the new framework for mandatory ESG reporting. Other companies, such as MSCI, have conducted ESG rating on all listed companies included in the index. Of the 423 newly rated constituents of the MSCI China A International Index, MSCI has found that 86% fall below BBB, the mid-point for MSCI ESG Ratings by far.
James Gifford, head of impact investing at UBS Wealth Management, highlights some fast-growing ESG areas in China, “The Chinese market has many fast-growing ESG areas such as education, healthcare and clean energy. Education is the most exciting area in impact investing. Healthcare is always keeping double-digit growth rate in China, and nowadays these healthcare-themed projects provide not only high-quality services for the upper class but also primary healthcare services for the lower class. Clean energy and energy storage technologies, including lithium battery technology and electric vehicles, are also influential investment areas.”
Markus Mueller, global head of chief investment office at Deutsche Bank Wealth Management, also noted that it was easier for ESG compliant investments in China and emerging markets to produce positive financial performances than those in developed markets. “There are fewer ESG standards imposed in the emerging market systems, hence companies are able to make more of a difference compared to their peers,” he said.
A large gap between developed and developing countries in ESG level will exist for a long time, but investors can help to accelerate the ESG trend in developing countries by their impact investing, or in other words, turn red into green through sustainable investing.
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