Opportunities and Challenges in China

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by Heidi Berg, independent impact investment and ESG consultant based in Shanghai

China is among the least affected economies by the ongoing pandemic, and the country is also undergoing a tremendous green transition. The opportunities to invest in green technologies and projects are increasing, with great potential for impact and returns. International investors can participate, although there are still some challenges.

- Promotion -

Stockholm (NordSIP) – The Chinese economy is the world’s second-largest, and a resolute management of the COVID-19 outbreak has put the economy back on track for growth in 2020. International interest in investing in China is on the rise, as it is currently one of the few markets offering yield on fixed income securities. However, international investors represent a minor share of China’s financial market. Only about 4% of assets on the stock market and private equity is held by foreigners, for example.

Historically, regulatory restrictions on foreign access to Chinese markets have been one of the main reasons for the limited inflow of international capital, and companies listed in Hong Kong have been the main way to gain exposure to mainland China. ESG is another concern, particularly for many European institutional investors. Although the Shanghai Stock Exchange is the fourth largest in the world (and Shenzhen the 8th), China is still very much an emerging market. ESG standards and reporting are little known concepts, and government interference in the market makes international investors uneasy.

Nordic investors should be aware of ongoing changes. Capital markets are opening up, and international standards are being implemented. Earlier this year 29 amendments were made to the law regulating foreign investment in listed companies, among other things reducing the list of restricted industries. In 2016 foreign-owned companies could set up asset management offices, and there are now at least 18 private fund managers including BlackRock and UBS Asset Management operating locally. Mandatory ESG reporting for listed companies was supposed to be implemented this year but has been delayed due to COVID-19. The definition of green bonds will also be aligned with international standards, as they have been accused of green-washing. These are all strong indications that China is very interested in attracting more capital, particularly to the green sectors.

In September 2020 China’s president Xi Jinping announced very ambitious goals for reducing carbon emissions: China aims to reach peak CO2 emissions by 2030, and become carbon neutral in 2060. A study by Tsinghua University in Beijing estimates that to reach these goals China needs to invest US$20 trillion, with 85% of the capital is expected to come from the private sector.

There will be great opportunities. Beijing sets the long term goals, and now the different provinces will work out detailed plans. In some parts of the country, this means more wind energy production, other more solar. Many Chinese companies are also well-positioned for the global green transition. China already has more than 400 electric vehicle producers. BYD, Polestar and Xpeng are examples of producers doing very well in international markets. Starting to understand how to position and pick winners can be very lucrative. If you know how to read the signals by the local governments, you can identify areas which will get significant push.

For western sustainability investors, there are of course challenges related to China. One of the fundamental differences in the Chinese approach to impact investments is that Chinese companies involved in the green economy might not have any ESG reporting. Only 26% of listed companies are reporting on ESG issues, as it is still not mandatory, and there is no market demand for such reporting. In Europe, there is a continuum from exclusion, to ESG, to thematic and then impact (as described well in Hedge Nordic Nov 2020). There is no such continuum in China.

Companies are quite passive if there is no carrot or stick. ESG reporting will only be implemented when it is either made mandatory by the government or partners demand it. The manufacturing sector offers a good example. Shoes and apparel companies are doing very well on reporting because they have to if they want to deliver to brands such as H&M and Nike.”There are many responsible companies in China with missing ESG reporting. For example, environmental laws are strict and enforced. There are even publicly open databases offering full transparency on environmental conduct by companies. Local pollution has been an extreme problem, and the government has invested heavily to improve business conduct. This is now a benefit for the investor community when it comes to environmental assessments.

Another challenge for foreigners less used to China is time horizons. Regulatory changes can happen fast. There are examples from the solar energy sector where feed-in tariffs have been changed within the contract duration. VP for North Asia at the Danish IFU, Steffen Schiottz-Christensen experienced this for one of their projects. “Our Chinese partners are less worried about this, they are used to working under such conditions, while the head office in Copenhagen get very nervous when the case for investments can change so rapidly,” Schiottz-Christensen says. In China it is important to keep an eye on the long-term goals, as Deng Xiaoping famously said about how the economy would grow: “Crossing the river by feeling the stones”. We can be quite certain that the 2030 and 2060 goals will be reached, but there will be these kinds of challenges on the way.

A survey by SyntaoGreen Finance shows that 62% of Chinese investors sometimes consider ESG when investing, and those who do mainly see it as a way to reduce risk. This risk perspective on ESG should be a good way to frame the issue and engage in dialogue with players in the Chinese market. Because the risks are very real in China, both through government intervention and for effects of climate change. Shanghai is only three metres above sea-level, and the air in Beijing used to be toxic. Sustainability is less of an ethical issue for most Chinese. It is a real risk and an opportunity.

Image courtesy of Heidi Berg

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The coronavirus epidemic has further accelerated the rise of ESG into the investment mainstream. As deficits skyrocket, bond investors have an opportunity to engage with governments on climate change, argues Thomas Dillon, Senior Macro ESG Analyst at Aviva Investors.

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