Can ‘Made in China’ be responsible?

Theme of the month: Why investors must help clean up South East Asia’s companies.

Institutions have never had more assets primed for investment in China and South East Asia. Edwina Neal, chief investment officer for equities at ABP, the giant Dutch pension scheme, recently announced it would invest more of its €211bn ($288bn) in assets in China and other Asian markets, favouring sectors like energy, materials and capital goods. The reasons are clear. China – the world’s factory – continues to grow faster than any other country. It makes more than 50% of all cameras, 30% of air conditioners and televisions, 25% of washing machines and 20% of refrigerators. Its rise has been breathtaking. Millions have been lifted from poverty as a result. According to figures from the International Labour Organisation (ILO), current real GDP growth in the Asia-Pacific region is 6.3% compared to worldwide GDP growth of 3.1%, partly due to strong foreign direct investment. At least 52 foreign asset managers now have QFII approval from the China Securities Regulatory Commission to invest foreign exchange quotas worth almost $10bn in company A-shares (see link).In addition, more than three hundred private equity companies are estimated to be active in the region. Investors are expected to commit $25bn (€18.3bn) in the second half of this year to private equity funds in Asia, according to the Center for Asia Private Equity Research, on top of $15.4 billion committed to regional funds in the first half of 2007. The figure is a rise of 57% on 2006 levels.
Yet China should be on the emergency watch-list of any responsible investor, as recent events have demonstrated. China also makes more than 70% of the world’s toys. The suicide last month of Zhang Shuhong, the Chinese toy factory owner hit by the scandal of lead-tainted toys produced for US group Mattel, was a reminder that in China, supply-chain failures can have tragic consequences.
The execution, a month earlier, of the former head of the food and drug watchdog, recalled that the authorities stamp down on corruption when they want to set an example. Cyberspace continues to be repressed. Yahoo!, the internet provider, is the latest – after Google and
Microsoft – to be criticised for coercing with the Chinese government. It faces legal action by the World Organisation for Human Rights over its decision to disclose the identity of Chinese citizens writing about democratic reform, which lead to their arrest. According to Amnesty International’s 2007 report, hundreds of international websites remained blocked in China and thousands of websites have been shut down. Environmental pollution has reached critical levels. Local catastrophes such as poisoned lakes and rivers occur regularly. China has become the world’s biggest emitter of acid-rain causing sulphur dioxide and climatologists estimate it will shortly overtake the United States as the worst global greenhouse gas polluter. The pollution issue has, however, taken on some urgency as Beijing tries to clean up its notoriously filthy air before hosting the 2008 Olympics next August.
In Malaysia and Indonesia, rapid expansion of the palm oil industry – much of it, ironically, to meet European and US environmental targets for biofuel production – has been damned by non-governmental organisations such as Friends of the Earth, which has called it the most significant cause of rainforest loss today. Both topics are on the agenda as Asia-Pacific leaders sit down in Sydney this week to discuss climate change.
This short list is the thin end of a wedge of environmental, social and governance abuses that can be levelled at South East Asian companies if investors look through the prism of democratic Western standards.
Should all this matters to institutional investors? Isn’t it the prerogative of governments to sort out macroeconomic policy and corporate legislation?
The answer is no, for a variety of reasons. Firstly, such issues in China and South East Asia are already on investor radars due to the role of Western companies in China. If corporations are drawing much of their profit from cheaper production in China and South East Asia, and in turn these countries are coveting
institutional investment, then there is an onus on investors to encourage local standards to improve at a reasonable pace. Any other stance is morally dubious. Investors should also clearly be concerned about their prospects. Poor governance, labour standards and human rights are not good for business in the 21st century.
AP3, the €20bn third Swedish national pension fund, recently said it could divest shares from Yahoo! if it does not receive satisfactory answers to a letter sent to the company regarding the alleged human rights abuses.
A further lobby group of 32 investors with roughly €19bn in assets committed to online freedom of expression has been set up including the Calvert Group in the US and France’s Meeschaert Asset Management.
In addition, scrutiny of Chinese state investments abroad, particularly in Africa, has to led to funds such as the UK Universities Superannuation Scheme (USS) facing pressure from campaigners to sell Petrochina shares because of its operations in Sudan, where government sponsored militia have been accused of genocide. Sovereign fund investments, such as the Chinese government’s recent $3bn stake building in Blackstone, the US private equity company, could draw similar fire in the future. The second reason is 

that institutional investors can bring badly needed investment into critical sectors of the Chinese economy, particularly those that can combat environment pollution.
Weija Ye, new ventures China director at the World Resources Institute, the US-based environmental think tank, says the country’s entrepreneurs have become attuned to clean energy projects. China is already at the forefront of solar energy production. Four Chinese solar companies listed on US stock exchanges in 2007, garnering $1.11bn. Three others went public in the last two months of 2006, raising $508.8m.
China’s draft law on what it calls a ‘circular economy’ – sustainability in other words – says government and business should control energy use and emissions, strengthen management of resource-intensive companies and divert capital into environmentally friendly industries. The Chinese National Development and Reform Commission launched a 7 billion yuan ($925m) energy fund to encourage this. Energy-saving projects to be financed include the production of 50 million efficient light bulbs, alterations to boilers, oil substitute development and the establishment of biogas units in the countryside to reduce deforestation. Ye says green energy is the third biggest growth market in China according to venture capitalists and he believes it could overtake the IT sector in a few years. “The Chinese government is making the right green noises. It has vowed to cut energy waste by 20% and pollution by 10%. These two goals are key to promoting sustainable energy, especially as most power producers in China are using 20 year-old technology and 80% of China’s energy comes from coal.”Ye says energy conversion and storage, sustainable building materials, wind power, clean water – particularly for papermills and sanitation, are other prospective growth areas.

“The Chinese government is making the right green noises.”

The third reason for more investor engagement in China is that it can give impetus to better reporting of financial and extra financial issues by Chinese companies. To date, about 50 companies, have issued reports on their ESG activities in China, according to SynTao, the respected Chinese CSR company. Good South East Asian companies, of which there are many, need support.
Guo Peiyuan, co-founder and general manager of SynTao, says: “Investors can explain to Chinese companies why ESG issues are important and meaningful to investors. They can also work closely with companies to tell them how to report ESG information that is material to investors.”
At the end of 2005 China had the 12th largest stock market in the world, and has probably grown since. However, a report issued in June this year by two professors from Colombia University, Benjamin Liebman, director of the centre for Chinese legal studies and Curtis Milhaupt, director of the centre for Japanese legal studies, said that between 1999 and 2003, there had been: “widespread false accounting and misleading disclosure among listed firms including some of the largest listed companies in China.”
The report, titled: “Reputational sanctions in China’s securities markets,” suggests that corporate governance
shaming, following the censure model first introduced by the London Stock Exchange under the UK Financial Services and Markets Act, might be the optimum way of ensuring healthy and responsible growth of the Shanghai and Shenzhen stock markets. Support from investors used to pushing for ESG reporting could become a valuable tool for transparency. Finally,
investor involvement and experience in South East Asia might help the region avoid falling off what the ILO called, in its August report, a “demographic cliff”, which it could face within a decade. The report said the large proportions of the region’s population in the working-age bracket (25-55), had created strong economic growth. However, as birth rate and fertility decreases with population dynamics, it predicts this will lead to a decline in the working age population.China, it said, was already facing a contracting workforce because of one-child family planning policies that mean it is “ageing faster than any other nation in history”.
The report said the informal economy in the Asia-Pacific region, which accounts for 61.9% of all employment, was of rising concern. With little social protection, the poverty rate is correspondingly high: 51.9% of people in Asia still earn less than two dollars a day. The ILO said economic growth has created rising inequality, which has the potential for social and political instability. It concluded: “Breaking out of the informality in the economic mainstream is perhaps the biggest challenge for developing countries in Asia”. Institutional investors that formalise their own investment strategies in South East Asia can be part of the solution.
Next week: Alexandra Tracy examines the RI strategies of SE Asia’s domestic investors.