ESG investing is a new initiative with fast-growing awareness among Chinese companies. It impacts the entire investment value chain including asset owners, asset managers, as well as listed companies and their stakeholders. This initiative is yet to become a mainstream phenomenon in the Chinese market. The majority of shareholders across the value chain still integrate ESG considerations passively, driven by external factors such as stricter ESG reporting requirements and regulatory policies.
Stakeholders across ESG investment value chain
The global ESG disclosure status shows more listed companies will report ESG performance if clearly-stated regulatory is an external mandate. With a comprehensive coverage of ESG related regulations, EU outperforms in all ESG disclosures. It gains highest disclosure rates of 76%, 70%, and 74% in environmental (E), social (S), and governance (G) pillars, respectively, followed by North America with an average rate of 66%. For example, within the S pillar, Gender Pay has been an outstanding material indicator but seldom been disclosed. The fact that UK market with relatively high disclosure rate is because of the existence of relevant local regulation. Same as the lobbying and political involvement policy indicators in the G pillar, US Lobbying Disclosure Act forces the US companies to report. The growing adoption of TCFD standards and EU Taxonomy of sustainable activities also improves reporting at the broader environmental level. On the contrary, the APAC market lags across all pillars, around half of issuers disclosing their ESG performances. Unlike the European market, ESG reporting is mandatory only in Hong Kong, Singapore, and Malaysia, while it remains to be put into place in the Chinese Mainland. Although policies and regulations push companies’ ESG integration, compliance is the minimum criteria for corporates. Companies should actively use ESG frameworks as a self-assessment tool to improve performances in risky areas and to explore new opportunities.
Asset owners sit at the top of the value chain and design the rules and can largely affect asset managers and listed firms’ behaviors. According to the UN PRI, the asset owner signatory number increases by 21% over 2020 from 432 to 521. More importantly, on average 73% of asset owners are adopting sustainability concerns in asset manager selection in 2020, as well as in other investment processes across all asset classes. That means asset managers that want to raise capital from such major institutional investors have to be serious about ESG issues and fulfil all ESG requirements with caution. Asset owners in emerging markets are also picking up, such as a newly issued ESG mandate from Kosovo Pension. Chinese sovereign wealth fund, NCSSF, also initiated ESG manager hiring at the end of 2020.
On the asset manager side, the size of total ESG related assets has been growing steadily globally. In terms of geographic breakdown, EU accounts for the biggest chunk both in sustainable funds’ inflows and total assets globally, occupying 79.2% and 81.9% respectively. In the Chinese Mainland, sustainable funds have been gaining momentum as well, reaching to around RMB120bn of assets under management (AUM) in 2020. Nonetheless, it still only accounts for a tiny portion of total industry assets. Moreover, these ESG assets are mutual funds, while ESG mandates that are issued out, like NCSSF and Kosovo Pension, are structured as separate accounts and not counted within ESG funds as total AUM. Therefore, total ESG assets will be much larger.
Performances of ESG funds available on the market
There are generally four different types of ESG funds worldwide, each integrating ESG indicators differently in its investment process. Exclusionary funds exclude controversial sectors or names such as fossil fuel, weapon, or gambling from their investment universe, while strong ESG practice funds will screen for sectors or names with higher overall ESG ratings. Impact funds will focus on and only invest into names that help solve environmental or social issues. The last group of thematic funds tend to eye one specific ESG indicator or issue. In conclusion, the investment universe for these types shrinks across the spectrum and help all shareholders better engage in sustainable investment.
However, it is still debatable on whether ESG funds can outperform in the financial market. By looking into four top ESG-rated US funds and MIROVA Euro Sustainable Equity Fund, the observation results indicated no unanimous assessment of their performances in the past ten years. Some ESG funds outperformed the index, while others underperformed or overlapped with the index. One possible explanation is that one decade may not be a long enough period and ESG funds might be able to avoid the majority of the downside within a long real bear market. Another reason, by examining holdings in the example, is that funds are not actively managed as 95% of the holdings are index constituents. Finally, compounded management fees over the ten-year period could be a sizeable contributor comparing with the unmanaged index performance.
In China, by analyzing the oldest “ESG” fund, Xingquan Social Responsible, it clearly demonstrated that there was clear cross-cycle absolute outperformance for this particular fund. However, analysis also elaborated on whether so-called ESG funds in China lived up to their ESG propositions, pointing out that China’s top ten ESG funds lacked a clearly defined investment process regarding ESG or the allocation to other non-ESG products.
New ESG Regulation: Sustainable Finance Disclosure Regulation (SFDR)
EU issued SFDR, effective from March 2021. This regulation asks financial market participants to disclose ESG related details in their investment approaches and the consideration of adverse sustainable impact, both on entity and product levels. Despite it being a European regulation, it also affects players in the Chinese market, including China’s asset managers that either hold UCITS products or provide consultancy over financial products in the EU. With regards to assets, in China, SFDR will have influence on private funds more than on mutual funds, and thus increase the willingness to commit to ESG integration. However, private funds account for smaller size in China, which indicates that the impact of ESG related regulations like SFDR on pushing the sustainable investing development has a long way to go in the country.
About Seneca ESG
Seneca ESG is a business intelligence company delivering solutions for corporate sustainability assessment, reporting, and integration with financial services. The company’s flagship ZENO (for investment firms) & EPIC (for corporates) platforms facilitate ESG data management, sustainability-driven analyses, and workflow automation, for both corporate and investment manager clients. ZENO & EPIC allow for complete customization of the ESG data collection, ingestion, analyses, scoring, and assessment process, while taking into consideration the entire range of data sources, reporting standards, and assessment frameworks that currently exist today. These standards include SASB, GRI, TCFD, CDP, CDSB, IIRC, PRI, GRESB, UN SDGs, UN GC, WEF Guidelines, and more.
About European Union Chamber of Commerce
The European Union Chamber of Commerce in China was founded in 2000 by 51 member companies that shared a goal of establishing a common voice for the various business sectors of the European Union and European businesses operating in China. It is an independent, non-profit, advocacy organisation governed by and for members. Being the independent voice of European businesses in China, the EU Chamber presents on behalf of its members to relevant Chinese government and agencies their key concerns and recommendation regarding regulatory environment in China.
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