China’s ESG iceberg: sustainability in the age of technological disruption

Arthur Lau and Elizabeth Soon discuss the potential for ESG in the world’s second large economy

It may be hard to imagine China as an emerging leader in sustainable business practices as it remains one of the world’s top carbon emitters. However awareness of ESG best practices is growing among Chinese companies, largely driven by changes in regulatory policies as part of China’s structural shift toward sustainable growth.

As with other developments in the Chinese economy, ESG may appear limited or unsystematic on the surface. Still, the scale and speed of transformation may indicate a much larger opportunity for investors.

The challenge for investors is how to see through the layers of ESG changes in China and recognize the drivers of future opportunities. Three critical factors to analyze are financing as a lever for ESG change, adoption of technology and the effective use of metrics to monitor progress.

Capital has emerged as a key lever driving environmental change in China. This is not limited to companies in environmentally linked sectors, but also those in traditional industries that are seeking to “green” their operations by adopting energy-efficient processes. Since 2016 various government subsidies and incentives have been put in place, with China rising to become the world’s second-largest issuer of green bonds after the US; raising $31.34bn in 2019. 

Most of China’s green bond proceeds have been used to finance projects in low-carbon transport, renewable energy, and sustainable water. Looking ahead, this market is likely to grow, as steps are being taken to harmonize local standards with globally accepted taxonomy, which should enhance the Chinese green bond market’s attractiveness to foreign investors.

Beyond financing, China’s technological prowess is coming to the fore to improve sustainability across a variety of sectors including health care, financial inclusion, and carbon emissions reduction.

For instance, the explosion of fintech in China in recent years has helped extend financial services faster than ever, jumpstarting more economic activities, creating new jobs, and helping to address rural poverty. The ubiquitous WeChat app has in many ways become an economic universe of its own, creating over 29 million job opportunities in 2019. Used by more than a billion people, it is a unique ecosystem offering messaging, e-commerce, payment, and other services.

It is notable that companies are using technology to nudge people to adopt more sustainable practices or socially responsible behaviour. Users of one of China’s largest digital payment platforms can collect “green energy points” for adopting a low-carbon lifestyle by using e-payments instead of paper invoices and using sustainable transport methods instead of driving. Users can then donate these points toward the planting of trees in China’s arid areas.

Tapping into the power of social networking, users can also share their progress via social media and keep track of progress in real-time. As of May 2020, over 500 million users had helped plant 200 million trees, and the initiative had also generated over 650,000 job opportunities for local communities. 

While ESG investing is still in its early stages in China compared with the EU and the US, shifts in investor attitudes could speed up the trend – especially as more foreign investors participate in the A-share market and as a new generation of sustainability-conscious Chinese investors gains prominence.

Chinese companies are likewise beginning to take significant steps to monitor the effectiveness of ESG programs as a guide to next steps. Using AI, a large insurance group mapped over 500 indicators from different regulatory agencies, automated data collection and monitoring of its own ESG performance, and accelerated its reporting process. The broader use of such technology should enable faster disclosure of information for market participants.

Driven by customer needs and developed along business lines, ESG-related products and services no longer take the form of charitable or token undertakings. Rather, companies are making material changes to help them maintain or increase customer relevance, brand loyalty, and market share in a highly competitive market.

This evolving landscape opens up opportunities for investors seeking to capitalize on this transformation at company level. Challenges remain, particularly in finding standardized, comprehensive and material ESG information. That said, disclosure among larger Chinese companies has steadily improved, with over 80% of CSI 300 constituents now voluntarily reporting on their ESG performance. 

Despite the challenges of effective ESG data, technology offers powerful tools for investors to complement existing disclosures. For instance, one company is deploying its own microsatellites into space to provide real-time data through imagery. The company is likewise embedding microchips in the satellites themselves so they can perform machine-learning processes faster.  Another data provider company also offers data from proxy variables of economic activities. For instance, by inspecting land surface temperature and nitrogen dioxide emissions, it was able to offer a picture of the coronavirus’ impact on economic activities. 

China has the potential to be a game-changer in global sustainability investing. While ESG investing is still in its early stages in China compared with the EU and the US, shifts in investor attitudes could speed up the trend – especially as more foreign investors participate in the A-share market and as a new generation of sustainability-conscious Chinese investors gains prominence.

Given the potential scale of ESG-driven changes at the enterprise level, investors in China will likely see ESG practices emerge as a valuable source of alpha over the long term. Yet in China’s idiosyncratic market, these opportunities may not always be easy to discern.

The building blocks are in place: a growing green credit market that is encouraging companies to invest in ESG-related projects, clearly defined government policies, and companies that are eager to leverage technological advances to deliver better outcomes. A rigorous evaluation of these opportunities, informed by local knowledge and experience, will be key to success.

Arthur Lau is Co-Head of Emerging Markets Fixed Income and Head of Asia ex Japan Fixed Income at PineBridge Investments


Elizabeth Soon is Head of Asia ex-Japan Equities at PineBridge Investments