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ESG moves to centre stage as China’s economy eyes Covid-19 recovery
Nation seeks to become de facto champion of sustainability movement as 68% of Chinese asset managers view ESG integration as a method of alpha generation
25 Mar 2020 | Jonathan Rogers

China appears poised to recover economically ahead of other countries, judging by the relative resilience of its equity and bond markets and the renminbi against the carnage inflicted elsewhere - particularly in developed countries - where bear markets are in full swing.

And the damping down of the pandemic in China while much of Europe and Southeast Asia enter lockdown underlies this resilience; yesterday there were no new cases of the coronavirus reported from Hubei, the epicentre of the outbreak, while cases in Western countries surge.

While environmental, social and governance (ESG) issues might seem like off-radar topics when put up against the ongoing carnage, they will become front-and-centre in China as the country’s factories reopen and its companies and financial institutions seek to access capital in the green financial markets. 

China’s ongoing attempts to align the country with ESG issues via mandatory ESG reporting for companies, particularly with regard to the “E” element of ESG, the continuing pricing of green bonds and loans in the primary market, and the fast-moving development of the ESG discipline amongst onshore asset managers, all point to ESG factors becoming a central plank of the Chinese government’s economic growth policy.

And with the opening up of the country’s capital markets to overseas investment, along with the growing perception that China’s equity and bond markets offer something of a “haven” for overseas investors staring down collapsing US and European equity and corporate bond markets, the growing requirement among those investors for ESG compliance pushes the integration dial in China further.

This is all the more the case as China looks to build its “soft power” following the initial outbreak of Covid-19 in the country, by positioning itself as having bought time for Western countries now battling the disease and its offering of assistance in the form of medical personnel and shared expertise.

In the same way, China is seeking to become the de facto champion of the sustainability movement, anchoring this position in the green finance market - the country has been one of the world’s biggest sources of green bonds, with US$31.2 billion issued in 2018 - as it seeks to build a green financial system rooted in a circular economy.

A new report published by the UN-supported Principles for Responsible Investment (PRI) in conjunction with MSCI highlights the growth of ESG integration in China and a shift in mindset among China’s onshore asset management community.

While ESG had traditionally been regarded by China’s investment managers as essentially about philanthropy, that thinking has changed; a recent survey by the Asset Management Association of China (AMAC) found that 68% of managers view ESG integration as a method of alpha generation.

A striking key finding of the new report is that the efficacy of ESG factors in delivering stronger risk-adjusted returns is more pronounced in the MSCI China universe than in wider emerging markets.

The report presents concrete examples from investors in China - China Asset Management, E Fund Management, Harvest Fund Management, Hwabao Fund Management and BNP Paribas - illustrating how ESG issues and data are analyzed and integrated into investment research when investing in Chinese companies.

In recent years, China has sought to become the global cheerleader for sustainability and is seeking to align its economic and environmental performance as well as building a green financial system.

This transformation started in 2016, with a government-backed surge in green bonds, green credit and lending, while a year later the People’s Bank of China added green credit into the macro-prudence assessment framework and the National Development and Reform Commission clarified standards for green industry and green projects in the national industrial catalogue.

Greening investments followed suit, with the first guidelines on green investment published by AMAC in 2018 as ESG integration kicked off in the country.

“In China, two key drivers have recently prompted interest in responsible investment: a government effort to promote green finance, and the increasing globalization of China’s investment market. New research by the PRI shows there is a third driver for responsible investment in China: that ESG integration is a source of investment value,” says Margarita Pirovska, head of fiduciary duty at the PRI.

“Preliminary analysis led with MSCI ESG data in China and emerging markets, and case studies by local and international investors suggests that ESG is a source of alpha in China.”

The PRI’s new report is based on data collected between June 2013 and June 2019 and uses the MSCI China ESG Leaders, MSCI China ESG Universal, MSCI Emerging Markets ESG Leaders, and MSCI Emerging Markets ESG Universal indexes to derive its conclusions.

“Analysis indicates that both best-in-class and tilting strategies using ESG scores deliver alpha and relatively lower maximum drawdowns over their respective benchmarks. In addition, the efficacy of ESG factors in delivering stronger risk-adjusted returns is more pronounced in the MSCI China universe than in wider emerging markets,” says Pirovska.

As is the case across industries globally, the quality of China’s ESG data remains an issue for comparative purposes, the country’s investment managers have been able to use ESG-oriented insights and information to enhance their understanding of industries and companies.

For example, China AMC used ESG considerations to validate fundamental insights and as potential flags for risk management while E-Fund and Hwabao used environmental risk and corporate management capability to analyze industry dynamics, which enabled portfolio managers to make investment choices.

Meanwhile, Harvest used a proprietary ESG framework and methodology to conduct quantitative ESG analysis across the A-share market, and BNP Paribas Asset Management identified three sources of alpha from sustainable investment practices: the pricing of avoided risk, ESG momentum and the stewardship dynamic and identifying opportunities through key ESG issues.

“From a policy perspective, the main message is that with better data, investment managers can make better investment decisions and generate better returns for their clients. A standardized, mandatory ESG disclosure framework is key to mainstreaming responsible investment in China,” says Pirovska.

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