Richard Sheng is Secretary of the board of directors of financial services conglomerate Ping An Group.
Environmental, social and governance principles are on their way to becoming global investors' dominant framework for deploying capital, but ESG can only rise so far if China, home of the world's second-largest equity and fixed income markets, does not embrace it.
There are promising signs that this is beginning to happen, as regulators focus more on it and local ESG asset managers emerge. For now, though, China lags other major capital markets and needs to catch up in order to capture the benefits of this historic shift in capital allocation, especially as its capital markets open up to foreign investors.
What this means is that it is time to change domestic companies' approach to ESG disclosure, especially by harnessing technology, and to refine a tangle of standards for this market so that investors can make decisions based on meaningful information. China has to take ownership of how ESG standards are implemented in its capital markets.
For listed companies in mainland China, this is the moment to grasp the strategic value of sustainability and radically re-examine the way they go about ESG information-gathering and disclosure by capitalizing on new technology.
As well as meeting regulatory expectations, the incentives for doing so are real: companies that excel in ESG risk management and disclosure should, over time, enjoy an advantage in attracting capital, customers and talent. They should be better able to monitor risk and performance against competitors. They can also play their part in China's transition to higher-quality, lower-carbon and more inclusive growth.
China's listed companies are beginning to adopt ESG disclosure, but the quantity and quality are inferior to those found in more developed markets. A study released earlier in June by the Ping An Digital Economic Research Center, Ping An Insurance Group's research arm, found that the percentage of companies on the CSI 300 stock index publishing ESG reports has risen from 54% in 2013 to 85% in 2019 -- but that only 12% of those reports were audited, offering verification for their claims.
The standard of ESG disclosure by Chinese companies also trails that found in other markets. Between 2013 and 2018, the average score for how well CSI 300 companies from the Chinese mainland disclosed their ESG performance was lower than the average score for constituents of benchmark indexes from the U.S., Japan, U.K., Australia, South Korea and Hong Kong.
Internationally, ESG concepts can be traced back to the 1990s, when they were mainly driven by nonprofit organizations. In China, it is a more recent phenomenon and one that has been more government-led. But this only partly explains why China lags behind. The other main factors behind this are the large number of disclosure guidelines that listed companies are expected to follow -- and the lack of alignment between them.
According to our study, CSI 300 companies have to take into account no fewer than nine sets of guidelines from different regulators and exchanges. ESG ratings providers also have their own frameworks and assessment processes, which can diverge sharply from each other.
Inside the Shanghai Stock Exchange building, pictured on Feb. 28: CSI 300 companies have to take into account no fewer than nine sets of guidelines.
© Reuters
This array of different, sometimes conflicting, requirements means that companies lack clarity on what ESG information is most material. It can lead to companies reporting the indicators that are easiest to disclose rather than those that are the most important. Many listed companies also lack the expertise to calculate things like their carbon emissions and find collecting data a complex, labor-intensive process.
These pain points are holding back the development of more sustainable capital markets in China: it is time for listed companies to take a different approach to ESG disclosure.
Critically, the market regulator is supportive. By the end of the year, the China Securities Regulatory Commission is expected to mandate that listed companies disclose sustainability information. This should have a pronounced impact, as similar action by the Hong Kong Stock Exchange did when it raised the bar for ESG disclosure back in 2015. An updated version of the HKEx ESG Guide and listing rules amendments will take effect this Wednesday, further strengthening mandatory disclosure requirements.
We believe Chinese mainland regulators can help companies make better quality disclosure by developing unified guidelines to identify the most material indicators that all companies must disclose.
These can build on the frameworks provided by the Global Reporting Initiative and the U.N.'s Principles for Responsible Investment, but they should take into account where Chinese companies really are in this process. They should also encourage companies to have their ESG disclosures audited.
Companies themselves can make better use of technology to collect, monitor and learn from their ESG data, especially as disclosures become more standardized. Artificial intelligence can be used for ESG information collection and analysis, transforming an annual and manual process into a continuous and automated one. This will enable better monitoring of ESG risk factors as well as more effective benchmarking against competitors.
Finally, ESG ratings providers should also improve the transparency of their methodologies.
Put together, these actions will allow China to accelerate the development of ESG standards in its capital markets. This will help drive China's economic transition, as well as attract more international capital. It is vital that China itself takes responsibility for shaping this process, learning from the rest of the world but using its strengths in technology to define standards that are relevant to the local market and enable real improvement in disclosure.
