1. Climate change is becoming an important issue for the financial industry
Climate change attracted increasing attention from the international community and the global finance industry in 2019. As pointed out by the UN Environment Programme (UNEP), the global temperature is likely to rise by 3.2-degree centigrade, even in an optimistic scenario, which would bring more widespread and destructive climate impacts. The transitional risks and physical risks brought by climate change will influence the financial industry in multiple ways. The financial industry may face decreases in the value of collateral and property or uncertainties around the transition to a low-carbon economy, for instance. China has started taking active measures to address climate change: the pilot China-UK working group on climate and environmental information disclosure has further expanded, and completed the first step towards environmental and climate information disclosure. In January 2020, Ping An Insurance became the first Chinese asset owner to sign up to the global investor group Climate Action 100+.
We expect regulators and financial institutions in China to accelerate their actions on climate change: The central bank may incorporate climate and environmental risks for the financial industry into the macro policy framework, and issue guidance for financial institutions to strengthen the analysis and disclosure of climate-related risks. We recommend banks, insurance companies and asset management institutions pay more attention to climate risks, conduct related scenario analysis and stress testing, and keep improving the capability of climate-related risk management.
2. ESG disclosures are becoming more material
ESG is an important part of listed companies’ information disclosure. Standardised, comprehensive and material ESG disclosure could help the market to better assess a company’s risk management ability for sustainable development. Promoted by regulators, the number of Chinese listed companies with ESG information disclosure has increased significantly in recent years: In 2019, 945 listed A-share companies, accounting for 26% of all A-share companies, issued Corporate Social Responsibility reports, and the rate of ESG reporting among the CSI 300 companies exceeded 80% for the first time.
Driven by regulation and the market, we expect that the materiality of listed A-share companies’ ESG information will be gradually enhanced, and the rate of quantitative information disclosure will increase again in 2020. Regulators have repeatedly indicated that ESG disclosure standards, especially for environmental information, will be raised in 2020. In the new version of the ESG Reporting Guide issued by the Hong Kong Stock Exchange, many amendments are related to quantitative disclosure, including mandatory disclosure of emissions, energy use, water efficiency and waste reduction. A growing number of investors are demanding that investee enterprises enhance their ESG disclosure, which may in turn effectively drive increasing materiality of such information. We suggest listed companies actively collect and disclose quantitative ESG information to align with the regulatory requirement and investors’ expectations. We also recommend investment institutions promote companies’ ESG disclosure through active ownership and engagement, etc.
3. ESG investment products are becoming more diversified and getting better recognition from investors
Driven by both policies and the market, various investment institutions launched ESG investment products in 2019. According to statistics from 2019 China Sustainable Investment Review by China’s Sustainable Investment Forum, as of November 2019, 42 fund management companies had launched 95 pan-ESG mutual fund products, 15 of which were launched last year. ESG products from, for example, E Fund, China Southern Asset Management and Hwabao Fund, have been well received by the market. Meanwhile, some bank investing departments also issued popular ESG wealth management products. Huaxia Bank raised more than RMB10bn for its product, in five rounds. Both Bank of China and China Industrial Bank launched or announced plans to launch ESG products last year.
We expect that more diverse ESG investment products will rapidly develop in 2020. Firstly, we expect there to be more types of institutions launching such products. Apart from the mutual fund companies and wealth management arm of banks, insurance asset management companies and private funds will follow the trend. Also, the type of products will become more diversified. Apart from active funds and ETF funds, there will be an increase of ESG quantitative funds and bond funds. This growth will improve investor awareness of ESG, so we suggest asset management institutions build capabilities in ESG investment research and product development as soon as possible, to seize the opportunity in a rapid developing market.
4. ESG Factors are being incorporated into fixed-income investments
In the past, the application of ESG in the fixed-income area focused mainly on thematic products such as green bonds. With increasing ESG risk exposure, bond issuers’ creditworthiness is becoming more directly affected by ESG factors, driving investors to consider ESG more broadly in fixed-income investment. According to research from SynTao Green Finance and other institutions, there is a correlation between the ESG ratings of Chinese companies and their bond default rates. In December, E Fund and APG jointly launched an ESG-heavy China Fixed-Income Strategy, while in January, MSCI launched 15 ESG fixed-income indices.
As the concept of ESG becomes more widely accepted and understood by the market, we expect more leading institutions to integrate ESG consideration into their analysis of fixed-income. Both Moody’s and S&P have recently acquired ESG research houses, indicating that mainstream fixed-income players are actively following the trend of ESG integration. We recommend investment institutions enhance ESG fixed-income investment research capacity, develop related ESG databases and pay closer attention to the issuance of green, social and sustainability bonds.
5. There will be further development of ESG investment in the primary market
Last year, local private equity and venture capital institutions started to pay attention to ESG, and begin integrating some of the ideas into their investment processes. Nearly 10 private equity houses, including CGP Investment and Legend Capital, signed up to the Principles for Responsible Investment, while Starquest Capital proposed an ESG investment strategy for Fund of Funds, which won an award from the PRI. As the Asset Management Association of China pointed out, responsible investment among Chinese private equity funds has progressed from ad-hoc to a strategic development.
Chinese private equity has gradually entered the stage of high-quality development. Private equity and venture capital institutions are attaching more importance to long-term value investment, which is consistent with the value of ESG. We expect that ESG will rapidly develop in these markets in China. The opening-up of Chinas capital market means such institutions could attract more overseas capital by including ESG in products and strategies. With increasing requirements for listed companies to disclosure environmental and social information, incorporating ESG into investment decision making could help mitigate risks and screen high-quality projects with diversified exit channels. We recommend that private equity and venture capital institutions establish a comprehensive ESG management system as soon as possible, and consider ESG factors in every stage of private investment, in order to promote the high-quality development of the fund as well as the wider industry.
6. SDG-themed financial products are beginning to appear
The Sustainable Development Goals (SDGs) have become the focus of global development since they were issued in 2015. In September 2019, China officially released “China’s Progress Report on Implementation of the 2030 Agenda for Sustainable Development” at the 74th session of the UN General Assembly, which systematically outlined China’s progress on implementing the goals. The UN Development Programme has launched projects to promote SDG financing and impact assessments globally, including in China. In the past five years, great achievements have been made to meet goals, but challenges remain – including insufficient financing.
We expect more Chinese financial institutions to pay attention to the SDGs this year. Financial products aimed at facilitating their achievement are also expected to be developed, such as dedicated bonds and funds. We recommend financial institutions look into the link between their investment fields and the SDGs, and enhance their investment in the goals.
7. ESG is key in promoting the opening-up of China’s capital market
According to the report delivered at the 19th National Congress of the Communist Party of China, China will open its doors to the world: In the “Guidelines for Establishing the Green Financial System”, issued by the seven ministries and commissions in 2016, it is proposed to actively and steadily promote the two-way opening-up of the green securities market, and to enhance the “greenness” of outward investment. At present, China has greatly relaxed market access restrictions on foreign securities, futures and funds, and further opened up via Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect. Meanwhile, A-shares have been included in the MSCI indices with an increasing inclusion ratio, and FTSE Russell has also officially included A shares in its index series. Heightened transparency and non-financial disclosures, as advocated in the ESG space, are becoming important cornerstones to enhance the confidence of international investors. With ESG investment going mainstream worldwide and developing in China’s capital market, we expect that more foreign institutions and capital will enter China in 2020, helping to improve the investor structure of China’s securities market and expand the overall opening-up of China.
At the same time, China’s institutional investors shall take full account of ESG factors during the overseas investment. In 2019, 27 institutions signed the Green Investment Principles for the Belt and Road Initiative. We expect that Chinese institutions will further strengthen environment and social risk management when making overseas investment, support environmental improvements in investments and address climate change while still satisfying the huge demand for infrastructure development, by greening Belt and Road investments.
8. Local green finance is moving from the pilot phase to become the new normal
In December, the State Council officially approved the establishment of a pilot zone for green finance in Lanzhou New District, to explore new models of green finance. The pilot zone will serve to accumulate experiences and foster innovative development of green finance in less developed regions in the western part of China. Lanzhou New District is the ninth pilot zone that’s been created since 2017. According to the China Green Financial Policy Database of SynTao Green Finance, China has issued 116 green finance or green finance-related policies so far, including 17 national, four multi-province, 49 provincial and 46 policies at city-level or below.
We expect that the number of pilot zones for green finance will continue to increase in 2020. More regional green finance policies will be introduced, and related experience sharing will be strengthened. We recommend financial institutions enhance the research on local green finance policies, keep track of the policy trends and make full use of the advantages of green finance policies.
9. There will be further improvements on environmental and social risk management in banks’ overseas operations
With the launch of the Belt and Road Initiative, China’s banking sector has been increasingly involved in overseas investment, and is facing concerns over related environmental and social impacts. Following the issuance of the “Guiding Opinions on Regulating Banking Services for Enterprises Going Abroad and Strengthening Risk Prevention and Control”, the China Banking and Insurance Regulatory Commission (CBIRC) re-emphasised the importance of banks “going green” while going abroad, and called on them to establish and improve environmental and social risk management systems in its “Guiding Opinions on Promoting the High-quality Development of the Banking and Insurance Industry” in December. According to these two opinion documents, banks and insurance institutions are encouraged to adopt international standards, and enterprises are encouraged to take green and low-carbon business abroad.
To promote high-quality overseas investment by the banking sector, in the past two years, the CBIRC and the Asian Development Bank have jointly held several international seminars on environmental and social risk management and accountability mechanisms for cross-border investment and financing projects of financial institutions. We expect that in 2020, Chinese banks will further improve the effectiveness of environmental and social risk management in overseas businesses, strengthen information disclosure and communication with stakeholders, and gradually establish accountability and grievance mechanisms to ensure the development of green finance overseas.
10. There will more focus on the dual promotion of fintech and green finance
In recent years, the collaboration between green finance and fintech has become a hot topic in the financial sector, and many successful practices have emerged. In 2016, Ant Financial launched the “ant forest” and more than 100 million trees have been planted through the participation of nearly 500 million public users. In 2019, major financial institutions promoted the development of green financial services through fintech: China Industrial Bank established a professional green finance supporting system, known as Green to Gold, to improve the accuracy of green project identification and enhance the ability of environmental and social risk management. Bank of Huzhou established an internal information system and incorporated the Equator Principles’ requirements on environmental and social risk management into the process of credit management. The CFA Institute has also followed the trend and incorporated fintech and ESG into the scope of its examination.
We expect that in 2020, there will be more collaboration between fintech and green finance, which will drive the development of both. Fintech can help financial institutions effectively identify green projects and assess project environmental benefits through technologies such as big data and artificial intelligence. In the medium and long term, blockchain technology can be used to record and share environmental data. Meanwhile, green finance will provide broad application scenarios for fintech and facilitate its application. We recommend that financial institutions continue to explore the application of data-related fintech in green finance and pay attention to the issues of digital security and data privacy in its application.
Dr. Guo Peiyuan is Chairman of SynTao Green Finance