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Opinion

ESG investment starts to gain a foothold in China

Companies focused on environmental, social and governance factors perform better

| China

The rise of environmental, social and governance, or ESG, factors as crucial markers on the investment landscape of the world's capital markets has been nothing short of spectacular over the past five years.

From the low- to mid-single digits at the beginning of the decade, in late 2018 39% of all professionally managed assets were invested according to ESG inputs, valued at $31 trillion, according to the Global Sustainable Investment Alliance.

During that time China has also experienced rising ESG awareness but in muted form. Rather than the powerful fast-moving wave that has engulfed the markets of developed economies, ESG has manifested in that country as more of a ripple. But that is changing rapidly as China turns its attention to ESG.

There are numerous factors that have been a drag on the rise of ESG in China: a reluctance among asset owners to divulge information; a fundamental belief that investing according to ESG factors will crimp returns; and a patchy regulatory backdrop.

That is about to change as new regulations come into force this year in China making disclosure of environmental factors mandatory for 3,000 of the country's listed corporations and primary bond market issuers.

The rapid internationalization of China's equity markets, now that global stock market indexes include its domestic or A shares, has led to the importation of the ESG mindset to the companies admitted.

Much the same is true for issuers in China's booming green bond market, where companies must comply with international standards of sustainability and where the big agencies such as Moody's and S&P have begun to produce separate ESG ratings alongside standard credit ratings.

We at the Principles for Responsible Investment are profoundly aware of the sea-change toward ESG in China: we have seen a rise in the number of signatories since establishing a significant presence in the country in late 2017. The number of signatories -- who agree to invest according to the six ESG-based principles -- has grown from seven to 33 in that time.

That is still a relatively small number given the PRI's current 2,700 signatories, representing $90 trillion of assets; China's status as the world's second largest economy; and the size and depth of the country's A share market, with 3,500 companies.

Yet I have little doubt that this number is set to grow exponentially over the coming years as ESG takes hold in China, and the opportunity is clearly huge.

A milestone on China's road toward the full of embrace of ESG was giant insurer Ping An, which has a market capitalization of $219 billion, signing up to PRI, the first asset owner -- rather than asset manager -- in the country to do so.

A milestone on China's road toward the full of embrace of ESG was giant insurer Ping An signing up to PRI.   © Reuters

This development is significant because it indicates the emergence in China of a new dynamic which resembles that seen in North America and Europe, where asset owners have been the prime movers in ESG integration. There is, however, still a long way to go.

A major challenge for now is the lack of comparable historical data, making extensive analysis by investors problematic. That is set to change after disclosure becomes mandatory this year and, after a few years, investor adoption of ESG factors should improve markedly.

Still, there remain concerns among China's financial authorities about market readiness and the ability of listed companies to disclose information pertinent to ESG or that they do so too soon. At the same time they are also mindful of the cost to Chinese companies associated with mandatory ESG reporting.

For example, the adoption of mandatory human rights due diligence, should it form part of China's ESG reporting, carries potentially high costs in relation to supply chains and labor usage.

In a report the PRI recently published together with the CFA Institute of investment professionals on the growth of ESG in China, we observed that mutual funds in the country are integrating ESG factors into their fundamental analysis both for equities and fixed income, while private equity firms are setting up proprietary ESG frameworks and exploring stewardship.

What is required is a fundamental shift in China's investment mindset, underpinned by the established empirical proof that assets invested according to ESG factors outperform bench marks in the long run. This will ensure that China's corporate culture does not become a barrier.

Where there has been ESG awareness in China, it has been focused on the environment, partly as the result of tougher regulations. The social aspect, such as gender equality, has typically been seen as of little importance.

Another area for development is an agreed set of ESG criteria which allows for comparisons across asset classes, regions and countries. We hope that China will match the EU's sustainability criteria with its own, to enable onshore and foreign asset managers investing in China to compare like with like.

That move would serve definitively to confirm that ESG is moving to the front and center of China's investment arena.

Fiona Reynolds is CEO of Principles for Responsible Investment, a UN-supported organization which aims to foster the incorporation of environmental, social and governance factors into investment practice globally.

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