Opinion: China is Playing the Long Game as Torch-Bearer for Corporate Responsibility
Environmental, social and governance (ESG) is rapidly moving into the mainstream in China as a key element of the modus operandi of asset owners, be they investment managers or corporate boards.
China’s engagement with the environmental component of ESG has advanced exponentially over the past few years, thanks to a boom in green bond issuance, where the country leads the world in terms of primary bond deals brought to market.
There is increasing recognition in the country’s investment community — as indeed there is across the sector globally — that ESG factors play a definitive role in determining risk and return and that there is a fiduciary duty on the part of asset owners to their clients and beneficiaries.
Globalisation and the rise of social media have upped the stakes in terms of reputational risk emerging from areas such as climate change, environmental degradation, working conditions, corruption and aggressive tax strategies.
China has lagged in the ESG stakes over the past decade versus its peers in Europe, North America and Australia but it has been catching up rapidly in 2018.
The London-based Principles for Responsible Investment, a United Nation-supported initiative founded over a decade ago to promote ESG among asset owners globally, appointed a China head just over a year ago, to engage with China’s policy makers and asset owners in a bid to spearhead the growth of the ESG mindset in the country.
Certainly China has been on a drive in 2018 to attract green investment, and that drive is utterly warranted. According to the Peoples’ Bank of China (PBOC), the country requires $600 billion in annual investment up to 2030 in order to meet the government’s stated commitments on climate change and address widespread environmental pollution.
China’s President Xi Jinping has advocated the aspiration for the country to develop an “Ecological Civilization,” and China’s financial authorities have placed the development of green finance at the center of realizing this aspiration.
The country raised more than $10 billion via green bonds in 2018 — accounting for half of the total raised in the product in Asia Pacific in 2018 — in what was a record-breaking year for green bonds, with more than $100 billion raised globally.
As with the ESG-related project finance sector across much of the developed and developing world, the private sector needs to shoulder much of the capital investment required — in China’s case with as much as 80% needing to come from private capital.
China has also made strides in 2018 in terms of the “G” element of ESG, having revised its Code of Corporate Governance for Listed Companies to include a far greater emphasis on ESG disclosure, a stewardship code for institutional investors and the accountability of board directors.
ESG disclosure was made an optional requirement in 2018 for listed Chinese companies according to recommendations made by the Green Finance Committee (GFC). And by 2020 such disclosure will become mandatory — at that point China is likely to become the only G20 economy where ESG reporting is compulsory for listed companies.
The GFC is designing a template that will grade Chinese companies’ assets according to a variety of environmental measures including carbon dioxide and sulfur dioxide emissions and energy and water consumption.
And from the governance point of view, the sensitive issue of the relationship between corporate China and the Communist party was also addressed in the Code, with Party committees now having to be formally incorporated into company documentation rather than exerting influence while remaining formally unacknowledged, as had been the case previously.
Meanwhile, the country’s embrace of green finance contains some striking revelations and dynamics that go beyond the aspirations of the 2015 Paris climate agreement — under which China joined 125 countries in committing to policies which will limit the rise in global temperatures to below 2 degrees Celsius above pre-industrial levels.
At a September speech to the PRI’s annual conference in San Francisco, Ma Jun, Chairman of the GFC and formerly the chief economist of the PBOC revealed that data on green loans in China demonstrate that such financing makes eminent financial sense.
According to data cited by Ma, the non-performing loan ratio of green loans in China’s banking system stood at 0.4% at the end of 2017, versus 1.8% for “Brown” loans made outside the strictures of green financing.
He also noted that there is a move to reduce the risk weighting for green assets on Chinese banks’ balance sheets; in other words, green finance will reduce the cost of capital in the country’s banking system.
That dynamic has also been explicitly pushed by China’s financial authorities in a pilot scheme launched last year in Huzhou, under which the local government offers interest subsidies to banks which finance green projects.
Loans are classified according to their adherence to green principles: “Dark Green” for the most green compliant, moving through “Green” to “Light Green.”
Subsidies are offered at 12%, 9% and 6% for each category respectively and in this way, banks’ funding cost is reduced, their return on equity enhanced and the entry of private capital into the green sector is encouraged. The subsidy system is expected to move from incubatory status to be adopted nationally over the next few years.
Meanwhile, China’s financial authorities are exploring the possibility of disintermediation in the green finance sector under which the securitization of green loans via instruments such as asset-backed securities, collateralized debt obligations and covered bonds will allow the country’s institutional investors to participate in the green loan market, freeing up Chinese banks’ balance sheets in the process.
Another milestone in China’s embrace of ESG came in 2018 via the pilot scheme on climate-related and environmental risk disclosure initiated between the Chinese and U.K. governments under the auspices of the PRI.
China’s largest bank, ICBC, which is pilot coordinator of the scheme, was joined by participants Bank of Jiangsu, Industrial Bank and Bank of Huzhou in publicly disclosing key environmental performance indicators, the first time Chinese banks have made such disclosures.
British signatories to the scheme include HSBC, Aviva and Hermes Investment Management, while the Bank of England and the PBOC represent the respective countries’ central bank presence on the initiative.
China’s move to become torch bearer of the ESG cause comes in stark contrast to the stance adopted by the United States under the Presidency of Donald Trump, where the denial of the climate change thesis has become government orthodoxy, signally expressed in the U.S. government’s refusal to sign up to the Paris agreement.
As outlined above, the embrace of ESG, particularly the “E” element, promises to prove a radically transformative economic policy, bringing comparative advantage to those countries which take the ESG-compliant route.
China’s aspiration to move from a “Brown” economy to a “Green” economy is gaining critical traction and although it has faced key challenges in 2018 in the form of the Trump administration’s imposition of trade tariffs, the country is playing a long game, with ESG as a central plank of policy.
On the basis of the dynamics outlined above, it would be unwise to bet against China’s long-term strategy.
Jonathan Rogers is the CEO of Singapore-based financial communications consultancy Ostinato Associates.
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