On September 4, Shenzhen Stock Exchange (SZSE) revised measures for reviewing information disclosure of companies listed on the bourse, in an attempt to further boost company quality. Under the new measures, Shenzhen authorities for the first time added environmental, social, and governance (ESG) performance disclosure into company assessments. Specifically, SZSE will rate listed companies based on their information disclosure quality, which now includes aspects such as if firms conduct active ESG disclosure and participate in national initiatives such as poverty alleviation and pandemic control.
ESG reporting in China is transitioning from voluntary disclosure to mandatory disclosure
ESG refers to three non-financial factors of companies, which could be used to measure their sustainability. To push ESG disclosure development, Chinese financial watchdogs are stepping up efforts to set up a standardized disclosure framework, so that investors can have access to comparable data.
In 2006 and 2008, SZSE and Shanghai Stock Exchange (SSE) issued respective guidelines, encouraging public companies to voluntarily release their corporate social responsibility (CSR) reports. Later, in 2016, Chinese regulators started introducing mandatory requirements for environmental information disclosure. Specifically, PBoC, CSRC, and other Chinese financial watchdogs issued guidance on building a green finance system, a mandatory mechanism for listed companies to report performance in the environmental area. Meanwhile, CSRC also modified templates and formats for information disclosure, asking companies that are heavy polluters to report environmental data regarding pollutant emissions. Other companies followed the “comply or explain” principle, under which firms either comply with national rules or explain their non-compliance. CSRC also urged all A-share listed companies to disclose their environmental data by year-end 2020.
Authorities are also expanding the scope of mandatory disclosure from environmental protection to more areas. For instance, in September 2018, CSRC revised governance guidelines for listed companies, asking them to report not only environmental-related data but also practices on poverty alleviation and fulfillments of other social responsibilities. The regulatory watchdog is also set to release additional mandatory ESG reporting requirements end of 2020 or early 2021.
Standardized ESG disclosure is inconsistent, but index performances indicate ESG-focused companies can generate better long-term returns
The lack of standardized and comparable ESG data is one of the main challenges for those who aim to make responsible investments in China’s markets. For investors, ESG investment, which goes beyond traditional investment based on financial data and enables investors to identify underperforming companies as well as potential financial risks, is likely to generate higher long-term returns. Specifically, China Securities Index Company (CSI) reported that the SSE Social Responsibility index recorded a 4.97% annualized return in a five-year period ending on October 19, 2020. SSE Social Responsibility index tracks the stocks of SSE listed companies that have favorable CSR performance, including Ping An Insurance Group [601318:CH] and China Merchants Bank [600036:CH]. Additionally, the following graph shows the index movement from December 17, 2014, to October 20, 2020, citing data from Investing.com. With the index’s closing price growing from RMB1,152.21 on December 17, 2014 to RMB1,542.66 on October 20, 2020, the index presents an overall upward trend over the period, signaling public companies with better ESG performance have more stable stock price growth.
Comparatively, China Securities Index disclosed that the SSE Composite Index, which tracks all stocks traded on SSE, recorded a five-year annualized return of 0.91% as of October 19, 2020, and a closing price of 2,991.5 on October 20, 2020. Additionally, though the index’s closing price on December 17, 2014 stood at 2,812.66, the following chart graphs a slight downward movement overall from December 17, 2014, to October 20, 2020.
Other Existing ESG Disclosure Policies in China
SSE is piloting stricter and more detailed ESG disclosure guidelines
At the end of 2008, SSE released guidelines for drafting CSR reports, which required listed companies to disclose practices on promoting environmentally and ecologically sustainable development such as efforts in pollution prevention, water resource conservation, maintenance of local biodiversity, etc. Additionally, since 2018, the Shanghai bourse has been piloting the implementation of drafted guidelines for ESG disclosure. According to Sohu, as compared to ESG disclosure requirements from other stock exchanges, the SSE rules not only provide guidance for reporting on ESG policies, effects, and measurements but also lists stricter regulations for companies to report their implementation of national rules as well as negative news such as violation penalties. Under SSE’s requirements, ESG disclosure this is too general and CSR reports that only cover positive development will be regarded as non-compliant.
SSE STAR Market a voluntary ESG disclosure with very few companies reporting ESG data
In March 2019, SSE launched ten sets of rules and guidelines for listings on the STAR Market. The rules include requiring companies listed on the Chinese Nasdaq-style board to disclose social responsibility performance on their annual reports and prepare additional CSR reports. SSE also asks companies to disclose major ESG violations, explain reasons, find solutions, and assess potential impacts.
On September 25, 2020, in efforts to further encourage STAR Market listed companies to conduct ESG disclosure, SSE published voluntary disclosure requirements, which came into effect immediately. The stock exchange specifies the scope of voluntary disclosure, covering not only corporate strategies, financial forecasts, R&D, business performance but also ESG practices.
According to the STAR Market Report 2019-2020 released by SMDC, a data center specializing in the board, as of June 22, only 8.77% of companies listed on the STAR Market have released separated CSR reports, while 68.42% of companies included their environmental data disclosure on annual reports and 59.76% included social related information on annual reports. The data indicates that listed companies still have a low willingness to conduct extra ESG releases.
HKEX ESG reporting requirements are becoming more specific
In December 2019, HKEX [0388:HK] officially released its third edition of its ESG reporting guidance, effective from July 1, 2020. Compared with previous editions, the Hong Kong bourse added mandatory requirements to the new guidance in terms of corporate governance structure, reporting rules, and scopes, canceling previous “comply or explain” requirement on the S Front. Specifically, HKEX asks companies’ Board of Directors to form complete procedures to oversee ESG performance. Also, HKEX encourages companies to conduct third-party audits of their ESG reports, which was not mentioned in old editions, to prevent firms from modifying ESG data to influence investors’ investment decision-making.
The overall requirements from stock exchanges in the Mainland and Hong Kong regarding ESG reporting are becoming increasingly mandatory. Meanwhile, regulators are also pledging to expand the scope of disclosure, encouraging firms to report on not only the E front but also more S and G related information.
Currently, China’s bourses are actively including ESG into company quality assessment and adding stricter requirements, since voluntary disclosure gives Chinese listed companies little incentive, and impetus to release a separate CSR or ESG report so far. Completeness and effectiveness of company ESG reporting would significantly air investors to make better investment choices and it is expected that China will launch more policies supporting such a thematic investment style.
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