China was a latecomer in ESG investing. Its first ESG index and ESG-themed public mutual fund were launched in 2005 and 2008, respectively. The assets under management of socially responsible or green investments in China reached an estimated RMB 50 billion (US$ 7.3 billion) as of August 2017, compared with US$12 trillion in the U.S. at the start of 2018. As of November 2018, more than 30 ESG-related indexes got listed on Chinese stock markets. Shanghai Stock Exchanged joined the United Nations Sustainable Stock Exchange initiative in 2017. Some 29 Chinese investment funds had joined the United Nations Principles for Responsible Investment (UNPRI) as of June 2019.
China is seeing a growing interest in ESG or SRI investing. Chinese fund management firms are launching increasingly more ESG-themed mutual funds, insurance funds and are taking the lead in ESG investing, and PE and VC funds have started looking at ESG integration, according to the 2019 trends for ESG investing in China published by SynTao Green Finance, a Chinese consulting service provider focused on green finance.
While appearing to be followers of a global trend, it is believed that the Chinese fund manager community is more motivated by potential higher returns driven by economic policies than investors’ ethical preferences or other widely cited motivations, and the possibility to monitor and mitigate firm-specific risks with newly available data.
Investor expectations for higher returns in ESG or SRI investing in China is to a greater extent drawn from ongoing economic changes. State policies have played an important role in China’s equity markets and the financial sector in general. Investors expect the stock price performance of Chinese public companies to be considerably correlated to the recent government-led economic restructuring, which supports sustainable or tech-driven businesses while suppressing those that caused industrial pollution and overcapacity. The Asset Management Association of China said they’d promote ESG evaluation frameworks that can help align enterprises with the target of the state-led economic restructuring and mitigate compliance risks, according to a research report on ESG evaluation issued by it in November 2018.
Some investors are also encouraged by the conclusion of some international research findings, that ESG factors has a proven track record of generating higher returns in equities from emerging markets than those of developed markets over the past years.
At the same time, ESG data and monitoring services, especially those from the newly emerged alternative data services developers, are expected to help investors manage firm-specific risks, which have a greater influence on stock prices in China than systematic risks and on average are greater than that in the U.S., according to such research works as this 2015 NBER paper on China’s stock market.
Stock frauds, noncompliant or unethical practices are still rampant in China. Low transparency and asymmetry of information have long been problems with China’s equity markets. Self-reported information, including financial information, has always been under serious scrutiny. It is hoped that the capabilities of collecting and analyzing unstructured online data are able to help fund managers better understand company risks and get timely risk alerts.
Apart from the motivations behind ESG research and investing, investors in Chinese stocks have also a different understanding on the relevance or importance of some ESG metrics. For instance, while Chinese regulators punish heavy polluting entities, many of which are state-owned and use oil and gas, investors in China don’t equate oil and gas companies to having the same ESG risks. The local fund management community believe that ESG data offerings and evaluation frameworks should be tailored to China to be effective.
The demand for ESG information about Chinese listed companies is expected to grow along with China’s further opening of its equity markets to international investors and the increasing number of international listings.
But China lacks both ESG evaluation services and useful data
A few ESG rating or evaluation frameworks for public companies were developed by businesses, government-backed organizations or universities over the last decade. But none are widely accepted due to problematic or unconvincing methodology, the insufficiency of methodological models borrowed from abroad, or lack of consistent data, according to the aforementioned research report by the Asset Management Association of China.
Useful ESG information is especially lacking. There are no established ESG information disclosure standards. The two stock markets in China have only issued guidelines for voluntary disclosures. A small portion of public companies have begun issuing CSR reports, but the self-reported information is generally considered self-serving and unquantifiable. Even though the national mandatory disclosure guideline is believed to be under development, neither the quantity nor quality of self-reported ESG information is expected to dramatically improve in the near future.
Most of the company risks can’t be well managed with self-reported information. For instance, the top five ESG-related downside risks of Chinese stocks are, in decreasing order of importance, 1) workplace health and safety, 2) corruption and fraud, 3) environmental and industrial pollution, 4) business ethics, and 5) product quality and safety, according to a survey of Chinese fund managers cited in the aforementioned report by the Asset Management Association of China. None of them has been addressed enough by traditional risk management measures.
The existing third-party data providers and newly emerged data technology startups are exploring using the most advanced digital data collection and analysis technologies to generate structured or quantified data from non-traditional information sources and analysis services.
Some startups have customized their offerings for the Chinese equity investment market. MioTech, a Hong Kong-based financial data and service provider, applies artificial intelligence techniques, such as natural language processing and image recognition, to extract and structurize data from the Chinese web.
AMI’s ESG Risk Metrics help investors benchmark companies, assess risk exposure and monitor risk trends.
The vast majority of ESG data MioTech provides is mainly from publicly-available sources, such as government websites, environmental protection sites, and even social media, with only about 10% from companies’ voluntary disclosures.
The alternative data-driven services like what MioTech offers are able to monitor and detect risks. For instance, in early 2019 MioTech successfully detected a major outbreak of food poisoning at a ski resort in Northeastern China two weeks before it was publicly known.
MioTech clients are now able to access a wide range of ESG factors. The company is looking at such new sources of data as satellite images illustrating environmental impact.
“In the past, ESG data has had an ex-post focus, such as incorporating companies’ existing environmental impacts. However, there is more ex-ante data coming through”, said Jason Tu, CEO of MioTech.