A green wave of ESG is poised to break over China

Dec 4, 2020

A man wearing a protective mask is seen inside the Shanghai Stock Exchange building, as the country is hit by a new coronavirus outbreak, at the Pudong financial district in Shanghai, China February 28, 2020.

Demand from foreign investors is driving an increase of ESG reporting in China Image: REUTERS/Aly Song

Jessica Tan

Investor demand and stricter regulation are driving an acceleration of ESG awareness and reporting in China.
The trend is clear - but Chinese companies face several challenges that are slowing this process.
Here's where they should be focusing to release this wave of foreign investment.

2020 marks a watershed year for the global economy. The case for a heightened focus on environmental, social and governance (ESG) concerns has been clearly laid out both by business leaders and other experts.

It will likely fuel a wave of responsible investment that is already becoming a mainstream phenomenon in global capital markets – and is increasingly so in China. Driven by greater investor demand and stricter regulatory requirements, ESG awareness, monitoring and disclosure in China are bound to accelerate.

1. What are the latest ESG trends in China?

A few years ago, it was hard to make ESG-themed investments in China because there was insufficient data to assess companies’ ESG performance. However, that is rapidly changing. In 2019, 85% of CSI 300 companies released official ESG disclosures, a rapid growth from 54% in 2013. However, among the companies that disclosed, only 12% had audited reports, suggesting ample room for improving the quality of disclosures.

ESG reporting is increasing in China - but most reports are not, as yet, audited Image: Ping An Digital Economic Research Center, 2020

The trend of increasing ESG disclosures in China is driven by a few forces. In terms of regulation, Chinese regulators had set a goal for mandatory disclosures for listed companies by the end of 2020, now expected to be 2021 due to the pandemic. In addition, President Xi has announced China’s goal to be carbon-neutral by 2060, which will further fuel the transition to low-carbon economy transition. In terms of investor demand, foreign investors who invest in Chinese assets have to meet their fund domicile standards on ESG when investing in China, driving improved reporting by Chinese firms.

Such forces have led to higher disclosure rates and also a plethora of third-party rating and data providers. Over a period of five years, the number of providers increased from zero to eight in China. Also, the type of providers is more diverse in China. While the global landscape consists of established financial data providers and a recent wave of fintech companies, Chinese providers range from traditional index/data providers, fintech companies, asset managers/owners and academic/non-profit institutions to consulting companies. The diversity of providers could be a positive force in terms of enriching the market with more data sources and viewpoints.

It is only with comprehensive ESG data that we can create the necessary ingredients to develop ESG-themed financial products such as indices and funds. Indeed, there has been a spur of such products available to investors in China. Out of the 19 indices constructed based on comprehensive ESG scores, half were released in 2020. Similarly, total asset under management for ESG-themed funds in China grew by 50% this year compared to 2019.

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2. What are the existing market gaps and pain points?

Although there has been exponential growth in ESG adoption and awareness in China, gaps still exist both for companies trying to improve ESG performance and investors trying to integrate ESG into their investment processes.

Despite increasing attention from foreign and domestic investors, Chinese companies still lag behind their developed-market peers in ESG disclosures. As more Chinese companies list overseas, foreign investors are paying more attention to the extent to which Chinese companies meet international standards, including higher expectations on ESG disclosures. Domestically, investors have also become more ESG aware because of regulatory guidance. However, Chinese companies still lag behind their global peers in the scope and quality of their ESG disclosures. For example, the average Bloomberg ESG disclosure score of CSI 300 companies ranks the lowest among companies of major stock market indices.
Companies are confused about what to disclose because of various guidelines’ differing requirements. CSI 300 companies already follow a total of nine guidelines. Companies also have to respond to different rating providers, which diverge significantly in their frameworks. Without a unified set of guidelines, companies lack clarity on what is the most material information to provide for their shareholders and external rating providers.
Most companies have little to no processes for collecting high-quality ESG data. Manual collection across departments lead to low data quality and time-consuming processes. This is especially challenging in large companies with complex revenue streams and sub-divisions. There is also little monitoring and benchmarking with their industry peers, and a lack of actionable insights on how to improve.
The market for ESG ratings and data is in its early stages in China. Examples of existing gaps include low coverage of companies and slow development of fixed-income data, which has limited the development of more diversified ESG investment products such as passive funds, quantitative funds and investment products for primary markets.

ESG disclosure among CSI 300 companies by industry (2019) Image: Ping An Digital Economic Research Center, 2020

3. How can market participants work together to address these pain points?

To further propel ESG development in China, we need a concerted effort from regulators, companies, data providers and investors to strive for more unified requirements, higher-quality data, and more investment options.

To better guide companies in higher quality disclosures and data comparability, regulators should develop unified guidelines and converge on a set of most material indicators. Regulators should build on guidelines from international organizations such as the Global Reporting Initiative (GRI), “Stakeholder Capitalism Metrics” from the World Economic Forum, and integrate considerations specific to Chinese companies. Regulators should also encourage companies to audit their ESG disclosures. Better ESG disclosures and performance can help improve the credibility and value of Chinese companies for global investors.
Companies should leverage technological solutions to collect, monitor and learn from their ESG data. Instead of a resource-intensive manual process, this can and should be automated across departments.
Data providers should leverage AI-driven solutions to expand ESG data sources to reduce reliance on disclosure-based data with alternative data. Providers are already starting to do that, using proprietary solutions to collect information from news, social media and government websites to monitor ESG controversies. These alternative data sources can be important signals that complement traditional ESG ratings.
With more data available, investors should incorporate ESG signals into their investment decisions and develop more diversified financial products. Investors should analyze the impact of ESG indicators on investment decisions. Asset owners can include external managers’ ESG practices as part of their manager selection criteria. During company engagement, investors should encourage more specific and longer-timeline ESG data from companies. Only with clear expectations from both investors and regulators will companies be more motivated to improve their disclosures.

Going forward, we expect comprehensive disclosures from a broader set of companies and more alternative ESG data signals, which will enable increasing diversity in financial products that help channel capital towards sustainable development and transition into a low-carbon economy.

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