The ESG issues constraining interest in Chinese bonds

The mounting appeal of China's local bond market is being counterbalanced by its lack of quality research and paucity of good information about companies' ESG track records.
The ESG issues constraining interest in Chinese bonds
While international investors are increasingly excited by green bond issuance from China, uncertainties still abound. Key among them? A lack of clarity over ESG deployment.
Some large pension funds remain wary over how rigorous and standardised China’s borrowers and regulators are when it comes to environmental, social and governance criteria in their green bond products.
Gregory Suen, head of China fixed income at APG, told AsianInvestor that the Dutch pension fund manager, which had €583 billion in assets under management as of April, will not invest in green bonds from issuers that do not meet its ESG requirements.  
“The new guidelines and the large amount of green bonds being issued recently [by China] are certainly good news and steps in the right direction.  However, APG looks beyond such ‘green bond’ label and makes sure that the issuer itself meets our high ESG standards before investing,” Suen added. 
One example would be if a corporate borrower used its green bonds proceeds to invest in green projects while simultaneously expanding its high-emission production capacity elsewhere, resulting in overall higher carbon emissions.  
Suen declined to reveal APG’s exact exposure to China fixed income, beyond noting that it is currently quite small.  
While offshore investors remain wary for the time being, Bos said what was once a sizeable gap in terms of green quality between green bonds from China and those of western countries is closing. 
“We want to see how green bonds fit into companies’ strategy. You need to have a clear guidance on how the company adopt transparency on green bonds financing. This is the most crucial part when you want to spot greenwashing,” he said. 
One obstacle to this is access. Bram Bos, lead portfolio manager of green bonds at NN Investment Partners, noted that it has been a challenge for NN Investment Partners to set up meetings with Chinese companies to get more non-public ESG disclosures, although this is slowly changing. 
“We encountered a resistance of sharing information which is not publicly available yet, but as transparency is becoming increasingly important, we see that also in China companies are increasingly willing to disclose,” he added.
China’s fancy-looking credit ratings coverage is also currently proving an impediment for offshore investors. Local ratings agencies tend to cluster almost all borrower ratings at the uppermost levels, which causes confusion and not a little concern among offshore investors about the quality of their risk analysis. 
“There is an education process for investors to understand the rating structure of China bonds. Their rating structure is still concentrated in high-level ratings such as AAA,” said Martin Dropkin, head of Asian fixed income at Fidelity International. 
The lack of certainty over the quality of local credit analysis has led most offshore fund managers to target policy bank bonds and government bonds in the country, which makes a reliable rating on companies and green bonds products essential and urgently needed. 
Dropkin said his firm is considering expanding its 180-strong Chinese corporate research team in due course. 
While concerns over local research leave international investors cautious, Sean Chang, head of fixed income from Ping An Asset Management (Hong Kong), argues that investors looking for opportunities in Chinese green debt should act quickly since such investments cannot wait, from both social responsibilities and longer-return cycle aspects. 
He added that the returns from green investments should not be mixed up with traditional return. 
“Green investments are something you have to take action as soon as possible since all projects or assets are supposed to reflect their value in a longer period. When it comes to return, it is not a hardcore number. You have to make projections with many criteria,’” he said. 
Typical fixed income investing requires identifying and chasing potential returns. But green investments make this more complicated, as investors need to combine investment returns with the longer-period environmental impact from investing into green bonds or other ESG related assets. 
That does not necessarily translate to lower returns, however, Chang added. 
“There is a general thinking that you have to take some sacrifices on lower return, but investors gained a 40 basis by investing in a green bond portfolio compared to a regular fixed income portfolio over the last seven years in euro-issued bonds products.” Bos explained. 
“In the long run, green bonds, ideally, should have a higher return compared with traditional fixed income products.”
Ever eager for a new asset class to cover, the world’s index providers have looked to offer products that help investors track green assets, particularly in China.
Wang Xiaoshu, head of environmental, social and governance (ESG) research team for Asia Pacific at MSCI, said investors have had varying needs when it comes to ESG indices, with the firm giving bespoke ratings/research to investors who are particularly interested in niche areas such as compliance screening and track records of green investments. 
At the same time, there is also fast-rising interest of the ESG scores of Chinese firms. 
“Our coverage in China firms used to be only above 100 but largely expanded after the China’s A inclusion in MSCI ACWI Index in 2018. Our ESG Ratings product currently cover all the Chinese constituents of MSCI ACWI index which are around 700 firms as of May 2021,” Wang said. 
In terms of methodology, MSCI adopts a total of 37 key issues to provide ESG rating for companies. It provides more than 1,700 ESG indexes altogether, 12 of which are designed for China specifically. 
Increasingly, pension funds are using indices to make in-house ESG/green investment more efficient. For example, the S&P/JPX carbon efficient series was selected by Japan’s Government Pension Investment Fund (GPIF) to serve as the benchmark for its ESG investment strategy. As of 2020, GPIF had invested over $30 billion into these strategies.
Reid Steadman, global head of ESG indices at S&P Dow Jones Indices, told AsianInvestor that asset owners in Asia and around the world have become more interested in ESG indices. 
“The environmental factor is the first and foremost, but there is a growing awareness that environmental issues do not stand alone, they are very linked to other aspects, for example, social inequality or governance issues, so there is no ‘one size fits all’ index solution,” he said. 
He noted that extra effort is needed to collect diversified ESG disclosures in China. 
“For governance data in China, same as the other two aspects of ESG, we try to primarily collect data through direct engagement with companies in addition to gathering public information. In our Corporate Sustainability Assessment, we directly ask companies questions – this type of engagement allows us to ask sensitive questions and gather information beyond what is in the public domain, such as gender ratio, cybersecurity etc.”

This article was first published in the summer 2021 edition of the AsianInvestor print magazine.

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