MSCI China Index constituents improve ESG ratings in 2019
11% of issuers receive an ESG rating upgrade in last 12 months
The ESG ratings of the MSCI China Index constituents showed improvement in 2019 compared with the year before, as Chinese domestic investors and issuers move fast to incorporate environmental, social and governance (ESG) factors into their decision-making, encouraged by strong regulatory initiatives to promote ESG practices and disclosure, according to research by MSCI Inc.
Overall, 11% of issuers in the MSCI China Index gained an ESG rating update since their ratings were last reviewed by MSCI over the last 12 months, compared with 7% who experienced a downgrade. However, taking the weight of the constituents into consideration, 20% of the constituents by weight in the MSCI China Index received a rating upgrade over the last 12 months, compared with only 2% by weight being downgraded. This suggests that heavily weighted constituents contributed more to the upward ESG ratings momentum of the index overall than is apparent by the number of those ratings upgrades.
Incremental improvement was seen across the China market, with fewer Chinese companies receiving the lowest ESG rating of “CCC” (20%) in 2019 compared with 2018 (22%). Companies that received a “B” ESG rating slightly fell from 37% in 2018 to 36% in 2019.
The percentage of issuers receiving a “BB” ESG rating rose from 21% last year to 26% this year and the number of AA-rated companies remained 1% in 2019 but had increased in terms of number of companies. AA-rated ESG leaders mainly included consumer discretionary and information technology companies, such as Hangzhou Robam Appliances, Geely Auto and Legend Holdings.
MSCI ESG Research has a robust issuer communication process to allow and encourage companies to review our data sets and provide comments and additional information, if all sources are in the public domain. Over the past three years, MSCI also observed a sharp uptick in issuer contact with MSCI ESG Research, both responses to its outreach and proactive contact by companies.
The corporate response rate among constituents of the MSCI China Index doubled, from 13% in 2017 to 26% in 2018. For the majority of Chinese companies, 2018 was their first exposure to the ESG Ratings Issuer Communication process, given that more than 200 China A companies were newly added to the MSCI China Index and covered by MSCI ESG Ratings for the first time as of May 2018. In H1 2019, 401 out of 491 Chinese companies were contacted with a response rate of 19% in that half.
From a climate change perspective, MSCI’s research has also revealed a clear downward trend in the MSCI China Index’s carbon intensity since 2013. Defined as the ratio of portfolio carbon emissions normalized by the investor’s claims on sales, the carbon intensity of the index has dropped from 563.3 in 2013 to 431.7 in 2016, falling below the 453.9 seen in the MSCI Emerging Markets (EM) Index.
However, this remains far above the MSCI All Country World Index (ACWI)’s score of 252.2 in 2016. Analyzing a hypothetical portfolio mirroring the MSCI China Index as of August 1 and comparing it with emerging market and global benchmarks, the MSCI China portfolio emissions were 16.8% lower than for an MSCI EM portfolio, but 95.6% higher than for an MSCI AWCI portfolio.
Xiaoshu Wang, vice president of ESG Research at MSCI, says, “Improving ESG performance and decreasing carbon intensity among constituent companies shows that the new laws and policies introduced by the Chinese government in recent years to promote better ESG practices and disclosure are beginning to have an effect. Given the strong influence of the government in the country’s market, these regulatory initiatives are likely to further drive rapid ESG engagement by both investors and issuers.”
The government’s regulatory push is not the only driving factor. In the talent-intensive technology, financials and health sectors, these increases are in part due to an increasing focus on upskilling talent, as these sectors’ rising prominence in the economy increases their exposure to the challenges of attracting and nurturing talent.
For 18% of the China-based constituents of the MSCI ACWI Index in these sectors with an ESG Rating upgrade since 2018, that improvement was driven by better talent management and engagement programs, as of August 7. However, it was also noted the “996” work schedule (nine-to-nine, six days a week) has become the new normal in the technology sector in China, which raises concerns over employees’ health due to overwork.
Despite more stringent government regulations on product safety and demand from China’s rising middle class for premium and safe-to-use products, China-based MSCI ACWI constituents still fall behind their international market peers in in the adoption of product-safety measures.
Xiaoshu Wang adds, “China’s maturing economy is an important factor driving improved ESG performance among Chinese companies. As the country moves away from traditional manufacturing, China is striving to develop new high-skill talent to foster the transformation to a more service- and technology-focused economy, while the shift in consumer demand is presenting business opportunities for companies willing to invest in stronger safety controls, improved quality and a broader range of product offerings tailored to consumers’ new expectations.”
“China is becoming more attractive to global investors, given its growing consumer base and improved accessibility of China’s capital market. Yet the market still shows relatively high stock price volatility, low transparency of issuer disclosure and high exposure to political influence, underscoring the importance of corporate governance practices. Our research highlighted the key person risk and stock pledge risk of founder firms in China,” adds Wang.
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