Asset owners and fund managers face a growing tension at the heart of their Asia businesses: ESG, political risk and China. They cannot side-step it forever.

Almost all international asset managers display their commitment to investing in a manner that considers environmental, social and governance principles. Several have embedded such considerations into the heart of their investment decision-making, arguing it is essential as the world grapples with climate change.

At the same time, global fund houses want to expand in China, and asset owners want more investments there. The country possesses an enormous investor base, which will need to save more for their retirements. Plus, it has vast capital markets and is home to many fast-growing companies. Fund managers want access to them.

But China throws up several problems for proponents of ESG and fair treatment. Beijing brooks no rivalry over its control of the country’s economy and has little patience with public criticism. Alibaba’s founder and billionaire Jack Ma and Ant Financial found this out last year, when the e-commerce company’s IPO was cancelled days before listing –a seeming punishment for Ma having made critical statements about the banking sector weeks earlier.

Foreign companies operating in China face a similar choice: do not criticise the government or the rules it sets if you want to keep making money here.

In March, the UK and European Union announced sanctions against certain Chinese and Hong Kong individuals after Beijing revamped Hong Kong’s electoral process to only allow pre-vetted candidates, and reports continued to emerge of human rights abuses in the far-western province of Xinjiang.

Beijing responded with tit-for-tat sanctions of EU and UK officials. At the same time Western fashion brands such as Swedish brand H&M found all information about their products and stores mysteriously deleted from e-commerce platforms such as Alibaba, Tencent and JD.com. It seems like no coincidence that the company had previously said it would not source cotton from Xinjiang in September 2020.

BALANCING ACT

China’s mixture of financial opportunity and intolerance for criticism has been well noted by the world’s investment industry.

Almost all fund managers, life insurers, industry associations and advisers that have business in the country refuse to comment on the record about the government’s actions (including for this story). They know that public criticism could lead to them failing to secure sought-after licences or lose investment mandates. It is even possible their brands could end up being disparaged on Chinese social media.  

If the price of access to China is their public silence, it is one most are willing to pay.

Such discretion is understandable. As foreign fund houses and insurers argue (on background), they have a responsibility to their customers and shareholders to maximise returns and grow their businesses. Access to China’s vast and growing economy is essential to achieving those goals. And international investors have had to publicly bite their tongues in other countries with practices that run counter to Western preferences – see Saudi Arabia, as just one example.  

However, institutional investors’ unerring focus on their bottom lines could prove increasingly hard to reconcile with the growing drumbeat about the importance of ESG.

Today, most fund managers are focusing their ESG efforts in China on environmentalism and combatting climate change. It makes sense; it is a key target of China’s latest five-year plan, which means it enjoys official sanction.

Trickier parts of ESG, such as worker rights, diversity, and good governance, are taking more of a backseat. And areas such as regulatory uncertainty, equal treatment of local versus international companies, and political suppression of criticism, is not touched on at all – despite often being intrinsically related to ESG priorities.  

COMBINED APPROACH

Ultimately, ESG standards are designed to foster better behaviour. That may be more difficult in countries like China, but it should not be abandoned as a target.

One means of doing so would be for major asset owners and fund managers to collaborate and use coordinated behind-the-scenes pressure on mainland companies whose operating habits are seen as unsavoury, be it through too much pollution or taking advantage of forced labour. And, if these companies prove unreceptive to such efforts over a year or two, the investors should be willing to potentially exclude investing into them – and accept the potentially lower returns that might necessitate.

This may seem an optimistic goal, yet it is possible. Norges Bank Investment Management and AkademikerPension are two examples of asset owners that have been willing to blacklist individual Chinese investments for ethical reasons.

Other asset owners could follow if their stakeholders are willing to risk sacrificing a measure of returns. It is also entirely possible that fund managers can find alternative company investments for such intractable companies, in China or elsewhere, minimising any drop in performance.  

It is also worth investors remembering that political – and regulatory – pressure can come from more than one direction. The Biden administration in the US has so far been less combative than its predecessor, but more confrontations and chastisements are likely to occur. If trade tensions and allegations of human rights abuses continue to mount, institutional investors could come under pressure to pull back from Chinese companies they consider to be most vulnerable.

Beijing has gambled – so far successfully – that Western companies’ and investors’ greed will outweigh their ballyhooed principles. But its inflexibility does not brook much affection or loyalty.

It might not take much – a shift in political pressure on Western investors, or greater uniformity over appropriate ESG actions and statements, or a marked fall in investment returns in China – for international investors to find that the negatives of investing in an intolerant environment are catching up with the pluses.


The views expressed here are those of Richard Morrow, editor of AsianInvestor.