China’s reputation as a laggard in sustainability is well known: its economy got big in large part by growing dirty.
As it presses ahead with government-led aims to hit peak carbon by 2030 and achieve carbon neutrality by 2060, it faces a far larger and more complex challenge that is linked to how it goes about resetting its global image.
That challenge is what to do about the woeful state of the environmental, social and governance (ESG) data its corporate and financial institutions publish (or in many cases, don’t publish) every year.
This presents many problems.
First and foremost, it makes it harder for president Xi Jinping to hit the twin 2030/2060 targets. How can, say, a multinational or big state lender set out a timeline to decarbonize, or establish rules limiting its exposure to highly polluting firms or sectors, if it doesn’t know what ESG parameters it should use?
The reporting scope of ESG in every company is usually different. Even if we try to compare companies it’s impossible
Second, due to a lack of direction from onshore regulators, many listed and unlisted mainland firms just publish whatever ESG data they believe to be relevant.
The net result is that domestic and foreign analysts and institutional investors have little or no clue how sustainable many companies in China really are.
Let’s explore why this problem exists, why it matters, and what the likes of Chinese policymakers and big data providers are doing to fix it.
First, some context and history. It’s fair to say that China’s image as a sustainability laggard is merited.
“When compared to European countries, China is lagging on ESG reporting and awareness,” says Jonathan Ha, founder and chief executive of Seneca ESG, a Shanghai and Singapore-based business intelligence firm. “It’s still early days in terms of getting a standardized approach to ESG agreed upon and embedded in the overall ecosystem.”
But it also lags many other jurisdictions. When index provider MSCI measured countries by their median ESG performance in June 2021, the UK led the way with a score of 7.7 out of 10, against 7.1 for Australia, 5.9 for Japan, and 5.5 for the US. The global average was 5.
China ranked 47 out of the 50 countries measured, with a score of 2.9.
It doesn’t even perform well in its own backyard. In a March 2021 note titled ‘A leapfrog moment for China in ESG reporting’, the World Economic Forum noted that Hong Kong has required listed companies to publish annual ESG reports since 2016.
Those rules were upgraded in July 2020 to ensure that all manner of additional information – including how ESG was embedded in business strategy, key decision-making and supply-chain management – was made visible to investors.
The WEF report adds: “Market participants expect that regulators will issue new ESG reporting requirements for companies listed in Shanghai and Shenzhen.”
The key word in that sentence is ‘expect’.
Waiting for rules
One China-based analyst says he has been waiting for regulators of the main boards in Shanghai and Shenzhen to formulate ESG standards for years: “We have expected something to emerge since 2018. First Covid delayed them – we think – and now we are looking at 2022.”
Seneca ESG’s Ha reckons both bourses will roll out sustainability disclosure requirements for all listed companies “within the next year”.
He expects them to have “similar scope and intent as policies enacted by other regional markets”.
Esther Tsang, ESG analyst at Bloomberg Intelligence in Hong Kong, reckons onshore regulators will set out ESG requirements for listed constituents “within the next two to three years.”
When companies do publish sustainability reports, they are polished products … but can often be lacking in specific quantifiable data
That would take us close to the middle of the 2020s, and within touching distance of Xi’s 2030 peak-carbon pledge.
Other sources tip the Shanghai Stock Exchange to publish its first ESG report around April 2022. They say regulators are working with the most engaged onshore firms to figure out how to frame new rules, to ensure every company understands how to collect and report standardized sustainability data.
Of course, there is always a chance Beijing could arrive at the United Nations Climate Change conference in Glasgow in November armed with a full and fresh set of ESG rules for its firms and lenders to follow.
China’s political leaders are not known for their opacity. They draw data and perspective from many sources when they deliberate. Ultimately however, it is a one-party state where rules are mulled over, sometimes at great length, before being presented as a fait accompli to the outside world.
That makes it tricky for firms to get serious about ESG reporting, as they don’t know what they are supposed to be doing or saying.
This is a particular problem for state-run lenders and corporates, who take their lead from those at the top of the party.
It might explain why it is so hard right now to get any of China’s big banks to open up about sustainability. When they avoid media requests, it is usually because the political backdrop is uncertain, or they are unsure of their footing on a subject.
No comparison
A glaring lack of top-down direction makes it all but impossible to compare the ESG metrics of two similar companies, or the overall performance of an industry in China.
Data providers face this quandary every day.
“The reporting scope of ESG in every company is usually different,” says Bloomberg’s Tsang. “Some report ESG data from their head office while others report from individual sites, so even if we try to compare companies it’s impossible.”
The state wants to serve the people by generating economic growth and making their lives better, but pollution is putting that at risk
The result, notes Seneca ESG’s Ha, is that the ESG data packaged and offered by data providers “is, alas, not at the level we would expect or hope it to be.”
He adds: “It is because when you look at the starting point of where ESG data comes from, it is essentially self-disclosed by companies in the form of annual sustainability reports, which is unstructured data, and there is no single industry standard or global standard for what is being disclosed, and how.”
Many companies do publish sustainability reports.
E-commerce firm JD.com’s 2020 sustainability report is 57 pages long. China Merchants Bank’s 2020 report runs to 135 pages and is full of data and information about internal projects. It places a slightly heavier emphasis on ‘S’ issues such as poverty alleviation than on matters relating to the environment or corporate governance.
Often the problem isn’t so much a lack of ESG data, more the inchoate way it is assembled and framed.
“It is disclosed in an inconsistent way across companies, sectors and entire markets, which don’t align with any prescribed standard or data structure that allows you to easily assess it,” says Ha.
He adds: “When companies do publish sustainability reports, they are polished products with glossy photos and stories providing a positive narrative, but can often be lacking in specific quantifiable data.
“The challenge then becomes extracting data from the report – data that may well not be there at all.”
No standards
Data providers are always looking for new ways to scrutinise firms’ sustainability credentials.
“We have a very thorough way of looking at controversies that companies are involved in,” says Wilco van Heteren, executive director of ESG risk research at Sustainalytics, an Amsterdam-based expert in ESG ratings and research. “We screen around 50,000 media sources, and when a company name starts to pop up more often, we look into it.”
This is a problem for global investors, who struggle to gauge the performance of one mainland corporate against another.
How can you have standardized outcomes if no one stipulates standardized inputs?
It isn’t a demand issue.
“Buy-side firms are clamouring for standardized ESG data,” notes one Shanghai-based analyst. “They tell data providers: ‘Find me some common ground these companies are disclosing and package it into a data set that investors will want to buy’. So, they do.”
But the outcome is completely scattergun.
“How can you have standardized outcomes if no one stipulates standardized inputs?” the analyst asks. “Plus, you have issues relating to translation. The net result is that every data provider has a different approach to Chinese ESG data [from] the next.”
Learning process
To be sure, there are mitigating factors at play. China is far from the only country still to develop its own coherent set of sustainability disclosure rules. It can be argued when it comes to ESG reporting, even financially advanced markets are still crossing the river by feeling for stones.
Seneca ESG’s Ha notes: “We don’t yet have a standardized approach to ESG data disclosure scope, measurement and structure. Companies issuing securities often divulge only as much information as they see fit, or the minimum that the exchanges require. This is true for most, if not all market jurisdictions, so the onus is on regulators being stricter about sustainability disclosure.”
It is a learning process. One source remembers working with the Hong Kong Stock Exchange when the city published its first disclosure demands.
“Most firms didn’t know what to do,” they note. “They didn’t have the resources, capacity or knowhow to publish an annual report, much less what information to put it in it. It was a muddle, but things improved. China will get there.”
Heading – slowly – in the right direction
Disclosure in China has improved over the last decade. The share of firms in the Shanghai-Shenzhen CSI300 Index that voluntarily and annually disclose internal environmental, social and governance data nearly doubled between 2009 and 2018, from 43% to 82%, the United Nations Environment Programme Finance Initiative reckons.
In February 2021, the investment firm Abrdn published a report called ‘China’s ESG trailblazers’ in which it highlighted onshore firms that go the extra yard.
On that list are: Nari Technology, a Shanghai-listed maker of secondary power equipment; the much-reformed state-run China Tourism Group; and Contemporary Amperex Technology, a Shenzhen-listed maker of lithium batteries.
Progress is also filtering into financial services.
“There are several progressive fund management companies in China that are starting to integrate ESG into their investment processes,” says Jonathan Ha, founder and chief executive of Seneca ESG. “It’s not a 'just dot-the-‘i'’ approach but a more data-driven approach, where they can generate higher than expected risk-adjusted returns for discerning investors.”
Examples of ESG leaders in this corner of finance, experts say, are Shanghai-based Ping An Asset Management, as well as China Asset Management and Harvest Fund Management, both headquartered in Beijing.
But China needs to get moving. In a September 2021 report titled ‘ESG challenges and opportunities in Chinese equities’, Cambridge Associates notes that half of the companies in the MSCI China index were considered ‘ESG laggards’ – defined as any firm with an ESG rating of ‘B’ or below.
The only mainland-based corporate with a triple-A rating was Yadea, maker of electric two-wheeled scooters. Even China’s big technology firms, including Tencent and Alibaba, are only rated ‘ESG average’ by the index provider, the report notes.
That is almost certain to happen, and for two reasons.
First, China has belatedly realized the triple threat a deteriorating environment poses to the economy and to national security.
It needs to shed its image as a ‘dirty superpower’ and transform itself into a world leader in everything from, say, ‘green’ concrete and hydrogen, to advanced medical, logistical and technical equipment.
That, it hopes, will create more higher-paying jobs, and close the widening income gap that threatens to undermine social cohesion.
Biodiversity, overlooked in a rush to generate jobs and growth at all costs, is a big threat. On October 15, Beijing revealed its first group of national parks, covering 230,000 square kilometres, from Tibet to the southern island of Hainan.
It is part of sweeping plans to patch together fast-fragmenting habits and tackle the insidious pollution that kills land and lives.
“The state wants to serve the people by generating economic growth and making their lives better, but pollution is putting that at risk,” says Sustainalytics’ van Heteren.
Second, China cannot self-generate the capital required to build a ‘clean’ economy fit for the 2020s and beyond. It needs to tap into external sources more actively, and to do that, it needs to get better at ESG reporting.
“Post-Covid, they have a reputation deficit, so it’s important to step up and show the outside world they are doing a better job,” adds van Heteren.
Third, most Chinese firms are aware of the direction of travel on ESG. If a mainland company doesn’t publish an annual report charting its ambitions and achievements in the realm of sustainability, “it is a huge warning sign that it doesn’t care about ESG or isn’t being transparent”, notes Bloomberg’s Tsang.
Adds van Heteren: “We penalise companies for not disclosing on ESG related topics, as we believe lack of disclosure implies a higher risk for investors.”
Over time, global investors will give errant onshore companies an ever-wider berth when stocking or restocking funds and portfolios.
It will be impossible to hit Xi’s twin 2030/2060 pledges on peak carbon and carbon neutrality if the companies that generate goods and services don’t know what ESG is, much less how to measure and report their impact on the environment and society.
The scale of the challenge is laid bare by the situation van Heteren faces each time his firm assembles an ESG report.
Prior to publication, his team asks companies across the world for feedback: to check if anything has been missed, or if they feel their rating is unfairly low.
He says: “The feedback rate among Chinese companies is the lowest among any country in our research universe.”
