Monday 03 September 2018

As fiduciary duty grows, investors see ESG as too big to ignore. Has the moment arrived for sustainable investing in China?


There is an increasing awakening within China's asset management community when it comes to Environmental, Social and Governance (ESG) investing: one day, it could be even more important than value investing strategies.

Robert Li, investment strategist with China Asset Management Co, belongs to this camp of investors.

"When Buffett first promoted the idea 40 years ago, few recognised its significance, but today it is a widely followed philosophy. Likewise, ESG investing is going to be eventually accepted by all investors," Mr Li said.

Although China has yet to fully embrace the concept of fiduciary duty in its legal system, more Chinese investors like Mr Li are realising the profound implications of their duties. A complex interaction of regulation, soft law and market innovation has made fiduciary duty an increasingly important factor in investment.

Against this backdrop, the United Nations Principles for Responsible Investment has issued its latest report titled "Investor Duties and ESG Integration in China", supported by BNP Paribas. The report details recommendations for investors. The central message of the report is that investors should integrate environment ESG issues into their investment decision-making processes as part of fulfilling their duties towards their beneficiaries and to support the development of China's Ecological Civilisation. Investor duties should reflect and align with the Chinese government's Guidelines for Establishing a Green Financial System (GEGFS).

Domestic and international capital markets are expected to play a significant role in financing China's green transformation and growth. Sitting at the top of the investment chain, asset owners are critically important to this process. Through their investment practices and through the signals they send to the wider investment market, they have the ability to cascade and drive green and sustainable capital through the investment chain.

Ma Jun, Chairman of the Green Finance Committee of China Society for Finance and Banking, an organization under China's Central Bank, said at the report launch that although China is making progress on greening its financial sector, more work needs to be done to raise the awareness of investors' duties.

"China has already been taking the lead on quite a few fronts in terms of greening its financial sector. For instance, the Guidelines for Establishing the Green Financial System have won global recognition; the growth rate and prospected scale of the country's green bond market has been very impressive, so has the growth of green funds," said Mr Ma. "However, we have to admit that we're still behind developed countries in terms of fiduciary duty."

Mr Ma said asset owners' awareness of their responsibilities to green their investments is still relatively low, and that will require both better investor education from industry associations and more clear directives and guidance from supervisory bodies.

Meanwhile, although China already has a quite aggressive timetable and road map for all publicly listed companies to disclose their environmental information by 2020, more detailed research, as well as pilot work and capacity building are still needed to make sure corporate disclosure is adequate, reliable and meaningful to the green transformation, according to Ma.

He also said that compared to their Western counterparts, Chinese investors still do not have tools and methodologies for data collecting and index designing to effectively measure a company's green performances. In addition, there is a limited variety of green assets available within China's capital markets and green bonds remain in their infancy.

Hong Kong is developing its own special role in this regard, to act as a gateway for international investors to access Chinese green bonds, widening the investor pool and deepening channels for mainland issuers.

Paul Yang, Head of Greater China for BNP Paribas, said international banks must play a role facilitating the flow of capital into China.

"We see it as our responsibility, as an international bank, to help direct financial capital to projects that support sustainable economic development and eventually contribute to a better future. Our approach is to enable sustainable development by fostering the right financing and investment decisions. Our clients expect their banks to be able to advise and lead them in this regard"
Paul Yang, Head of Greater China, BNP Paribas

The report, jointly released by United Nations Environment Finance Initiative (UNEP FI), the Principles for Responsible Investment (PRI), The Generation Foundation, and the International Institute of Green Finance (IIGF), also identified barriers to integrate ESG factors in investment decision-making:

  • The lack of formal regulatory mechanisms that require investors, and in particular asset owners, to take account of ESG factors in their investment processes;
  • The lack of guidance to support investors in integrating ESG factors into their investment processes;
  • Difficulties in engaging companies on ESG issues due to the lack of consistent, comparable and reliable reporting by companies;
  • The lack of unified definitions aligned with international practice for green and sustainable investment products;
  • The lack of knowledge of the investment case for integrating ESG factors to drive value creation, and how company performance on ESG factors might be used in investment research and decision-making processes; and the perception that ESG factors and green finance are ethical issues that compromise returns, and are separate to fundamental investment analysis.
 
To close these gaps, the report also made detailed recommendations, including:

  • Publishing guidance on green and sustainable investment that articulates how institutional investors and their investment managers should implement the Guidelines for Establishing the Green Financial System;
  • Introducing regulation for pension funds to integrate ESG issues, encourage high standards in investee companies and disclose on ESG practices and performance;
  • Ensuring and monitoring the effectiveness of the mandatory environmental disclosure framework for companies, and aligning with international disclosure standards for ESG issues;
  • Expanding a standardised offering of green and sustainable investment products and comprehensive tools to support their market uptake. The demand from financial institutions for green investment is growing and can be further strengthened; and
  • Supporting investor education and ESG investment research, and building operational capacity for sustainable investment.
 
Kong Wei, a lawyer from Zhong Zhun Law Firm, said despite lacking direct definition of fiduciary duties in China's legal system, there are more than 200 pieces of law and regulations that lay out legal frameworks for ESG investing. Particularly, the concept of Ecological Civilisation that was enshrined in the constitution has provided a solid foundation for factoring in ESG issues in investment practices.

Wang Yao, director general of the International Institute of Green Finance (IIGF), said China's asset managers are starting to see how integrating ESG factors into their investment decisions also makes financial senses.

Ms Wang said empirical studies by her organisation into the top 300 stocks traded on the Shanghai and Shenzhen stock exchanges have proved a positive correlation in return on investment (ROI) and the companies' ESG performance, that is, the better a company's ESG performance, the higher its ROI. And the correlation is more visible in manufacturing than in financing and service industries.

"All investors care about returns, so to encourage more such integration, it is necessary to make investors realise that environmental risks do exist and will bring risks to their portfolio; while on the other hand, ESG investing does bring better investment returns," Ms Wang said.



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