Fiduciary Duty in the 21st Century: Responsible Investing in China

The second in a series from the PRI, UNEP FI and The Generation Foundation exploring interpretation of fiduciary duties in Brazil, China, EU, UK and US.

China is the world’s fastest growing and second largest capital market. The Chinese government has set an ambitious goal to position green finance as a key driver of global growth and long-term sustainability. At the nexus of these developments, the Fiduciary Duty in the 21st Century project is seeking to support establishing duties that align investors with the government sustainability agenda.

The Guidelines for Establishing a Green Financial System, issued by seven regulators and ministries in 2016, together with the long-term government goal of creating the Ecological Civilisation, provide the first national policy framework to support China’s sustainability strategy.

The legal, regulatory and normative frameworks defining investor duties in China do not explicitly connect investors with national sustainability goals.

Domestic and international capital markets are expected to play a significant role in financing this transformation. China needs a minimum of RMB3-4 trillion each year in green investments from 2015 to 2020, at least 85% of which is expected to come from the private sector. A small but growing part of the market, asset owners, and specifically state pension funds, are of critical importance to this process. Through their investment practices and the signals they send to the wider investment community, they have the ability to cascade and drive green and sustainable capital through the investment value chain.
Chinese pension funds are subject to general duties of loyalty, prudence and care, and are expected to act in a way that supports the government’s objective of ensuring social welfare. The legal, regulatory and normative frameworks defining investor duties in China do not explicitly connect investors with national sustainability goals. They do not require investors and pension funds to integrate material ESG issues or long-term goals into their investment practices and processes, nor do they clarify their duties towards the Ecological Civilisation. However, there is a strong investment case for doing so, which is in line both with the interests of clients and beneficiaries and with the government sustainability agenda.The central recommendation of the report Investor Duties and ESG Integration in China, published in partnership with the International Institute of Green Finance, is that investors should integrate ESG issues into their investment decision-making processes as part of fulfilling their duties towards their beneficiaries and to support the development of China’s Ecological Civilisation. The regulatory framework defining investor duties should reflect and align with the Chinese government’s Guidelines for Establishing a Green Financial System.
There is already notable progress on this matter on behalf of regulators and increasing interest from institutional investors. The China Securities Regulatory Commission (CSRC) has announced that, by 2020, it will require listed companies to disclose key environmental information in their annual or semi-annual reports. The Shanghai and the Shenzhen Stock exchanges have joined the UN Sustainable Stock Exchanges initiative and are committed to supporting the development of green and transparent markets in China. China is increasingly recognised by the international community for its leading role in green finance development worldwide, for taking green finance to the G20, and for enhancing inter-governmental dialogues on issues related to private sector climate disclosure.
To support and strengthen this trend, the Investor Duties and ESG integration in China report outlines five recommendations:

1. Issuing sustainable investment guidelines for all investors, clarifying their duties towards beneficiaries and clients, and proposing practical solutions for ESG integration in traditional financial analysis. Such guidelines would serve a double purpose: informing investors how ESG integration helps aligning their investment practice with the government sustainability goals; and setting a level playing field for a very diverse universe of investment companies in China. A stewardship code could complement such guidelines, even if engagement is not yet a well-developed practice in China. The CSRC, the Asset Management Association of China (AMAC) and stock exchanges could support the adoption of the sustainable investment guidance and the stewardship code through publishing and disseminating examples of implementation best practices.

2. Revising pension fund regulations to require them, in order to represent the long-term interest of Chinese citizens, to integrate in their investment policies and processes ESG issues in line with the Ecological Civilisation concept. Chinese pension funds are opening up to capital markets and start investing in equity. They also need to provide for a rapidly ageing population, with an old-age ratio expected to be nearly double the world average by 2040. Setting the example in investing sustainably for the long term is an opportunity for China’s leading pension funds, such as the National Social Security Fund (NSSF), and their asset managers.

3. Improving the quality and quantity of ESG data through a mandatory disclosure framework, in alignment with international reporting standards. China is setting an ambitious goal of creating a mandatory environmental reporting framework. To ensure its effectiveness and completeness, the CSRC and the Ministry of Ecology and Environment (MEE) need to consider the disclosure of all material ESG factors in conventional accounting reports, an assurance process similar to financial data and the use of common performance metrics to allow for comparability by industry, portfolio and across time series. This reporting framework could also include forward looking and scenario-based frameworks such as the TCFD.

4. Promoting the creation and harmonisation of green banking products, labels and tools for investors, focusing on long-term sustainability goals, and building on the development of the green bond market. While the Green Financial System Guidelines have spurred a boom of green products and indexes, it is important to standardise the emerging taxonomies for green finance. Adding definitions for ESG integration will further contribute to expanding products to include relevant social and governance aspects. The role of stock exchanges and service providers in mainstreaming the offering of green and sustainable products, labels and tools will be key.5. Supporting investor education, responsible investment networks and promoting the integration of ESG analysis in investment research. Despite the recent growth in green bonds, credit and lending in China, most investors are not fully aware of the added value of ESG integration in investment decision making. Incorporating ESG issues in investment research and ratings, and promoting education and professional training to investment teams will help address one of the main barriers to sustainable investment in China.

It is important to standardise the emerging taxonomies for green finance.

The AMAC, with support from investment managers and service providers, should promote investor education on ESG integration and encourage China-specific academic research into the relationship between ESG factors and investment performance.
These recommendations are issued from conversations with experts from the Chinese capital market, and aim to contribute to the work of regulators, industry associations and investors in promoting sustainable investment in China. The integration of ESG factors in this market is at an early stage. The global importance of China means the pace of change matters to investors the world over.

Margarita Pirovska is a Senior Consultant for Fiduciary Duty in the 21st Century, UNEP FI / Principles for Responsible Investment.
Nan Luo is Head of China at the Principles for Responsible Investment.
Dr. Guo Peiyuan is Chairman of SynTao Green Finance, and a UNEP FI Advisor in China.

1. In January 2016, the Principles for Responsible Investment (PRI), the United Nations Environment Programme Finance Initiative (UNEP FI) and The Generation Foundation launched a three-year project – Fiduciary Duty in the 21st Century – to clarify investors’ obligations and duties in relation to the integration of environmental, social and governance (ESG) issues in investment practice and decision-making. The project involves working with investors, governments and intergovernmental organisations to develop and publish an international statement on investors’ obligations and duties, and to publish and implement roadmaps on the policy changes required to achieve full ESG integration across some fifteen countries and jurisdictions, including Australia, Brazil, China, Germany, Japan, South Korea, the UK and the US.