Challenges and prospects for ESG investment in China
Limited corporate information disclosure is an obstacle, though guidelines have been released to facilitate more disclosure
In conventional investment valuation models, financial information is a major factor for investors when making valuations of investment targets. The ESG (environmental, social and governance) investment strategy means investors also take into account the ESG factors of the enterprises they are investing in.
Currently, the application of the ESG investment strategy in China’s capital market is still in its infancy. Though some investment institutions have demonstrated the feasibility of this strategy, ESG investment is still limited in China. The main factors restricting ESG investment are limited information disclosure from companies and the difficulty of obtaining relevant information.
Joining the United Nations Principles for Responsible Investment (UNPRI) is one of the most important ways in which institutions can publicly signify their ESG commitment.
By the end of 2018, a total of 18 Chinese institutions had joined UNPRI, including 13 investment managers and five other institutions, far fewer than financially developed markets like the US (414 institutions) and the UK (339 institutions).
By company category, Chinese mutual funds have been the most active in joining the UNPRI, accounting for seven of the 18 Chinese signatories. These seven funds are China Asset Management, E Fund, Harvest Fund, Penghua Fund, Fortune SGAM Fund, Southern Asset Management and Bosera Funds. However, none of the Chinese UNPRI signatories are financial trusts, securities firms or banks.
Chinese funds and other asset management products that feature ESG as an investment theme are not numerous.
As of the end of December 2018, among 7,851 mutual funds, only the CSI CAITONG China Sustainable 100 (ECPI ESG) Index Enhanced Securities Investment Fund, with a net asset value of only 84.58 million yuan (US$12.31 million), expressly stated that it would focus on investment in ESG stocks.
Even if the investment theme is expanded to include “sustainable development” and “green”, only 10 funds fit the criteria, with a net asset value of only 8.36 billion yuan.
ESG information disclosure
The ESG-related information disclosed by enterprises is insufficient and investment institutions are often not able to obtain enough information. As a result, regulators and industry organizations have released some guidelines for enterprises to disclose related information.
In August 2012, the Hong Kong Exchanges and Clearing Limited (HKEX) released its Environmental, Social and Governance (ESG) Reporting Guide, encouraging listed companies to actively disclose their ESG performance on an annual basis.
In July 2015, HKEX issued a consultation paper, raising the requirement of “suggested disclosure” to “comply or explain”. Thereafter, most companies listed on HKEX started releasing their first ESG reports and disclosing related social responsibility information on their official websites.
In June 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 on November 10 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 (Trial), building a core indicator system to measure the ESG performance of listed companies and opening a new chapter in China’s ESG investment practice.
ESG Investment Strategy Outlook
Though ESG investments are growing quickly in Western financial markets, Chinese theoretical research and practices are still in the initial phase and relatively undeveloped and limited.
However, according to the Special Research Report on ESG Responsible Investment published by the AMAC, most Chinese investment institutions have started to explore ESG investment strategies. It is foreseeable that China’s ESG investment will see the following trends:
1) Public demand becomes stronger
As the Chinese economy continues to develop, the national disposable income and material standard of living will improve significantly, and public awareness of ESG will increase gradually. Regarding the environment, the development experience of developed countries shows that the environmental pollution of a country and its income have a U-shaped curve relationship, i.e. Environmental Kuznets Curve (EKC). At present, China is approaching the vertex of the EKC curve. Hence, public demand for a cleaner environment is increasing.
2) Regulatory mandatory disclosure
The AMAC survey report reveals that 70% of investors consider the “lack of standardized ESG information disclosure rules” as the main impediment to the implementation of an ESG investment strategy.
We think that this problem will be gradually mitigated. According to the overall arrangement of the Guidelines on Building of Green Finance System, China will force listed companies to disclose environmental information starting in 2020.
In September 2018, in the newly revised Corporate Governance for Listed Companies, the CSRC established the ESG information disclosure framework for listed companies, and developed a standard template for listed companies’ disclosure of ESG information to enhance the comparability of such information among enterprises.
3) More institutions will join the UNPRI
Currently, no Chinese commercial banks, securities companies and trust companies have joined the UNPRI.
However, some Chinese financial institutions, typically commercial banks, practice an ESG investment strategy such asproviding green credits with a threshold, limit, price and other supports; creating poverty alleviation groups for targeted poverty reduction; and releasing social responsibility reports on an annual basis to disclose companies’ ESG information. Therefore, we believe that commercial banks, wealth management subsidiaries of banks, and other investment management institutions will eventually join the UNPRI.
Since enterprises with low ESG scores are removed from ESG investment products, these products play a certain role in defusing risks, and their investment returns and volatility and risk-adjusted returns are generally better than those of non-ESG products.
In the case of the emerging country index prepared by the MSCI, the Sharpe ratios of ESG investment and ordinary investment in the 10 years from the end of 2008 to the end of 2018 are 0.65 and 0.47 respectively. Therefore, we believe that ESG asset management products will have a broader space to develop.
The article has been translated from Chinese and edited for style and clarity. This is an excerpt of the original article that first appeared in Financial Market Research, a magazine sponsored by China’s National Association of Financial Market Institutional Investors (NAFMII). The author is a postdoctoral researcher at Tsinghua University School of Economics and Management.
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