Incorporating ESG into China equities investing is no easy feat
Low disclosure levels of ESG data; the absence of standardisation in ESG data and practices; and the lack of on-the-ground specialist teams have been common obstacles for investors who are eager to hop on the high-growth equities train in China.
But experts believe leveraging internal and external environmental, social and corporate governance (ESG) data and building a “China specialities” team could make ESG deployment in China equities investing less challenging.
Last year, China alone contributed almost $80 trillion to the global equity market cap. However, the country’s ESG developments haven’t seen much improvement compared to other regions. Among 4,000-plus A-share companies, only 25% have published ESG data, according to a Willis Towers Watson report in April.
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“When you analyse Chinese equities through ESG, the ratings are extremely low. Some of this has to do with Chinese companies being engaged in sectors or practices that score low from an ESG perspective, but part of it is also that Chinese companies simply do not disclose very much ESG data,” Aaron Costello, regional head for Asia at Cambridge Associates, told AsianInvestor.
China’s low median score arises from the fact that a significant portion of the companies in the MSCI China Index are considered “ESG laggards” relative to their global peers, with an MSCI ESG rating of B or CCC, according to a report by the US consulting firm in September.
“When third-party ESG rating companies try to conduct an ESG rating on Chinese companies, there is not enough data, and the companies are penalised for it. Disclosure is also poor, but we expect this to improve both by the Chinese government mandate to improve ESG disclosure, and market-driven incentives for Chinese companies to improve their ESG practices,” he added.
LACK OF TRANSPARENCY
Managers and experts are mainly building their own in-house ESG filtering criteria, metrics, and scoring systems in conjunction with third party data, which is sometimes not accurate and comprehensive.
“Lack of data – mostly due to low disclosure – or data quality issues still sit as the biggest challenge when investors are looking into China equities’ ESG development,” Jessica Tea, investment specialist for Asia Pacific and Greater China equities at BNP Paribas Asset Management, told AsianInvestor. “One should not fully rely only on third-party ESG data providers, as some data may be missing or sometimes inaccurate – partly due to a lack of local insights or language skills.”
Tea’s views were backed by Costello. “For instance, international ratings providers can score very differently,” he said. “Some investors take an average of different providers ratings, but we don’t think investors should be overly relying on third-party ratings to make investment decisions. When investing in China, the managers need to really do their own bottom-up approach. The managers need to develop their own system and not rely entirely on third-party data providers.”
Asia Pacific (Apac) investors identified the lack of robust ESG data as one of the main barriers to ESG adoption (45%), attributing a similar level of importance to the issue as the global respondents. Almost half of Apac investors (46%) also agree that a lack of product innovation is holding back greater adoption of ESG, as compared to 35% of global respondents, according to the latest Capital Group report.
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WHEN IN CHINA
Given that many large institutional investors are now investing in China via emerging market exposure to certain indexes, Tea also mentioned the importance of understanding the difference and gap between China onshore equities (A-shares) and offshore equities (Hong Kong-listed, ADRs).
“China onshore equities are typically less mature on ESG topics compared with China offshore equities markets. We’ve seen a mix of mandatory and voluntary ESG disclosure [and] reporting regimes in China onshore. That’s why we need to do a deeper dive into the market,” she noted. She believes that China is a late starter in terms of ESG practices, albeit one on a fast track. “We believe the gap will be filled by more standardisation push from the local regulators,” she said.
Experts also noted that it is crucial to adopt a China-specific mindset in ESG deployment and research.
“[One needs to] understand the local Chinese context and not try to overlay the exact same framework from a global context, because it simply may not work in China,” Aaron Costello told AsianInvestor.
“You could almost call the regulatory crackdown in China a version of ESG from the government’s perspective. The pressure on technology, online gaming, online education, and property developers will remain, given Beijing’s long-term strategic priority [of] common prosperity,” he added.
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