It is a well-known fact that companies with better ESG metrics tend to have lower cost of capital and higher valuation – a fact that doesn’t go unnoticed by company managements in China and emerging markets in general. I do take the point that companies have improved. In many cases, these companies are run by very smart entrepreneurs who will do whatever it takes, including better ESG standards, to get better market multiples and the cheapest cost of capital. They may make these changes not because they necessarily believe in ESG, but because that is seen as a good thing to do for their bottom line and I think we should be fine with that.
Where I slightly disagree with Donald is when you are looking at governance. I understand it’s a journey, and companies are making improvements, but I see a real risk of things going backward under a very assertive and at times interfering governmental tendencies. Yes, it’s good to have a stable political regime but the entire corporate ecosystem may get increasingly subservient to the Party ethos and vision. One has to accept that reality and framework when investing in China and I do not expect the framework to change. As we have seen in multiple cases, supremacy of the Party and its vision is a red line that no one would be allowed to transgress, even a company as large and systemically important as Alibaba.
Why is this a problem? If you look at why China has done so well, the Communist Party takes a long-term vision and there’s plenty of continuity there. However, if decision-making gets too over-centralised and idiosyncratic, there is a problem. There’s now an expectation that any company of any significant footprint may need to have a Party member on its board to ensure alignment of vision and purpose. I don’t know what direction such things would take and that’s the kind of political risk I’m worried about. The very idea of a Party member sitting on boards and modulating the company’s activities is a potential risk with unexpected outcomes. To me, that’s the biggest ESG risk, it’s so unconventional and therefore so difficult to quantify and potentially mitigate. It is understanding and managing this unique political construct and its interplay with various investment themes and metrics which would be the difference between good, average and bad investment outcomes in China.
Kellaway – We strongly believe that China and ESG are the two biggest investment trends in a generation, not just in 2021. Eight-five percent of the CSI 300 constituents released ESG reports in 2019 – up from 54% in 2013. That’s a positive trend, but only 12% of those reports were actually audited. So, back to Donald’s point: whilst the will is certainly there, there’s a lack of true understanding as to how companies could and should adopt ESG policies effectively and efficiently, and also at a level that will be subject and acceptable to international scrutiny.
If you look more deeply, there are obviously standout Chinese companies and those companies that are doing not so well, but broadly there’s a lack of full understanding of ESG issues, a lack of standardised investment practices, and a lack of standardised tools to measure and report, particularly on the green impact in Asia. As such, I feel that the continued inflow of capital from foreign institutional investors, coupled with the active deployment of that capital, rather than a passive allocation approach, will continue to drive up standards. This in itself will have a significant impact in terms of the ability of companies themselves to respond to the demands of international investors.
We are actively looking at ways we can support investor clients with their ESG monitoring and associated disclosures, predominantly through post-trade investment compliance reporting. In this respect, the challenge with China is no different from anywhere else: what is required is a standardisation of asset tracking and ESG categorisation and agreeing these with underlying investors and the target companies themselves.
Patel – I want to pick up on Padmesh’s point earlier around the commercial imperative for Chinese asset managers and for Chinese company managers to better hit these requirements. There is a timing mismatch which is relevant here. If you take the UK institutional market in terms of the Task Force on Climate-related Financial Disclosures (TCFD) and the pace of regulatory change around investors’ behaviour (particularly pension funds), and you combine that with the EU’s policies, the taxonomy and Sustainable Finance Disclosure Regulation (SFDR), and combine that with US asset owners, who despite a lack of government policy, are moving at a very fast pace, what you actually have is a massive push towards stronger ESG metrics more than anything else, with reducing carbon emissions being the most obvious common goal.
For many of those investors, making an active allocation to increase Chinese onshore exposure is counterproductive to what they are doing on the ESG front, and so there’s almost an issue of one has to happen first. If the behaviour of Western institutions continues at this pace, then China will always be excluded until at some point in the future when China suddenly satisfies their requirements, because what these investors are not going to do is get to a very good position in their ESG metrics and then put in something which worsens their scores. If you take the chief officers of asset owners, they have to report to a board, they don’t want to report a negative change. So, what you then have to do is almost say: “Well, China has a deadline to improve all of these metrics so that it makes it easy for institutions in the rest of the world to invest in China,” and that’s almost the race that we’ve got. If that doesn’t happen, despite the good investment opportunity, you delay any mainstream adoption of the onshore China market into the 2030s before you get meaningful Western institutional exposure to onshore China.
Wang – From China’s on-the-ground perspective, this is a chicken-and-egg scenario. We need to have more global investors to bring in the perspectives and trying to engage with the local listed companies to help them understand what ESG is all about. The other way I see it is in China, you really have to have a top-down push, and China’s government is talking about ESG, but what they are talking about is a different ESG as compared to what you see from outside of China. That’s where, if you can reconcile what Beijing’s talking about in terms of ESG with what is being talked about outside of China, this top-down push will help, otherwise I think it’s a chicken-and-egg situation.
Amstad – On politics in China, our chairman goes and has been going to China very regularly for a number of years and he meets people at the highest level in the party and in government. Obviously, China works very differently to a Westminster democracy system like the UK, and what is said in private in China is very different to what is said in public. So, my first question to him was: “You’ve met all these senior leaders, what is it like?” He said: “Once the doors close and you go into a meeting with a very senior person, you can have a very frank and honest conversation and you can talk about absolutely anything, but it just won’t be reported in the press afterwards, and it certainly won’t be recorded and played live out on TV and radio and online.”
About the rising standards of ESG and the situation that many institutional investors in the UK and Europe and the US find themselves, I worry though that if you wait until 2030 or 2035 or whatever the year is when China Inc. has finally reached these global standards, then the opportunity will be gone. It is precisely because standards in China are low now relative to the rest of the world that there is opportunity. If you take a passive approach to investing in China, then absolutely you’re investing in some very poor-quality companies and some better ones, the trick is to try and find that middle path.
Shukla – My sense is the government seriously believes that through this partnership and opening up of the markets to foreigners, the foreign managers and investors can definitely bring something unique to the table, and that something is clearly better disclosures, better expectations around E, S and G, and it should be a win-win for both the parties. China has a long way to catch-up, which in some ways is no different to the situation in any other emerging market where disclosures are generally not as good and ESG metrics can be a lot better. This can be seen either as an opportunity or as a threat. I would be in the former camp because if engagement brings better ESG outcomes, then that is a source of additional alpha in active portfolios.
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