Asset managers and asset owners across the world face a rapidly evolving global landscape in which environmental, social and governance (ESG) issues have come to the fore — and China is no exception. ESG integration and sustainable investment have become increasingly important for Chinese investors and asset managers.
Assets under management reached US$16 trillion in China’s asset management industry by the end of 2019, representing a tenfold increase over the past 10 years and making it one of the largest and fastest-growing asset management markets in the world. Actions taken by China’s government, regulators, asset managers and asset owners can have a lasting impact on global sustainability efforts. These actions could mean the difference between achieving the goals of the Paris Agreement and the 17 Sustainable Development Goals (SDGs) by 2030 or failing on both fronts.
Mercer has long believed in the benefits of integrating ESG factors into investment strategies. Sustainability forms one of our core investment beliefs, and we evaluate ESG integration when we research and rate investment strategies.
With one of the largest and fastest-growing asset management markets in the world, China has the opportunity to make a significant impact on global sustainability efforts.
In this paper, we provide an overview of current policy and trends driving ESG practices among Chinese institutional investors and asset managers, highlighting key considerations for international investors in China’s capital markets.
China is making significant progress in addressing its sustainability challenges and scaling up green finance efforts. Government regulation and social pressure regarding environmental protection, labor rights and food safety have driven this progress, and the increasing exposure of international investors to China A-shares is shining more light on these issues. The COVID-19 pandemic has shifted focus to the “S” (social) in ESG. Companies are facing scrutiny for their treatment of a wide range of stakeholders — not least, their employees — during this time.
Chinese government policies and regulations have driven much of the sustainability development across the investment industry in recent years. Key to this was President Xi Jinping prioritizing the development of a national green finance system as part of China’s 13th five-year plan (2016–2020). Part of this drive has been an emphasis on “Beautiful China” — representing a shift in focus from seeking growth in absolute terms to a higher quality of sustainable growth and the environmental and social implications of economic growth. Pressure to address the economic impact of COVID-19, however, could undermine these commitments in the shorter term. Separately, some view the recent introduction of a national security law in Hong Kong as a reminder that China’s approach to the “S” in ESG differs from that adopted across Western liberal democracies.
There have been many developments in China in response to the call for “scaling up” green finance, particularly after the People’s Bank of China, along with six other government agencies, issued the Guidelines for Establishing the Green Financial System in 2016. The Guidelines stress that the primary purpose of establishing the green financial system is to mobilize and incentivize more social (or private) capital to invest in green sectors (such as renewable energy) while restricting investment in polluting sectors (such as high–carbon-emission industries).
Chinese government policies and regulations have driven much of the sustainability developments across the investment industry in recent years.
Pressure to address the economic impact of COVID-19 could undermine these commitments in the shorter term.
The People’s Bank of China, regulators and related bodies have led recent efforts to promote green finance and ESG investing through domestic and international initiatives. China is also the world’s largest investor in renewable energy and energy-efficiency solutions, accounting for 30% and 27% of the total global investment, respectively. Against the recent challenging economic backdrop, however, it is worth noting a spike in approvals for coal-fired energy capacity. This may signal a move by government officials to boost the country’s domestic economy after the slowdown from COVID-19.
The desire of the government and regulators to reach international standards has been instrumental in driving change. China’s focus on aligning green bond guidance with international best practice is one example. As a centrally planned economy, China may soon be able to overtake more mature markets on this front.
The government and regulators have issued a number of regulations and guidance on ESG data disclosure in the past few years. Perhaps most importantly, the Environmental Ministry and the Securities Regulator (China Securities Regulatory Commission, or CSRC) agreed to join forces to establish a mandatory environmental disclosure system for listed companies and bond-issuing enterprises. The CSRC is pushing for these disclosures to become mandatory for 3,000 of China’s listed companies and bond issuers this year. This is a welcome development given that the current lack of high-quality ESG data and standardized disclosures makes it hard for investors to assess ESG risk. As it stands, leading investors often have to develop their own proprietary ESG databases and scoring systems.
In addition to environmental disclosures, the CSRC issued a revised Code of Corporate Governance for Listed Companies in September 2018. This code established further ESG requirements and a reporting framework, stating that a listed company “shall be concerned with the welfare, environmental protection and public interest of the community in which it resides, and shall pay attention to the company’s social responsibilities.”
In November 2018, the Asset Management Association of China (AMAC) released Green Investment Guidelines (for Trial Implementation), which seeks to standardize green investment activities within investment funds. Further, both the Shanghai and Shenzhen Stock Exchanges have joined the Sustainable Stock Exchange Initiative and have provided guidance on how companies should report on ESG issues.
Although the AMAC has also outlined its ESG guidelines for private fund managers, there is little ESG data relating to the public market. ESG is still a very new concept for Chinese private equity firms, with only a few PRI signatories. However, there is evidence of change. Increased awareness began with the larger Pan-Asian private equity funds leveraging their global ESG frameworks. We are now gradually observing it in the larger China funds that focus on control buyout transactions where they can influence management and strategy. These funds primarily raise capital from global institutional investors that typically cover ESG as part of the due diligence process.
Despite the increased disclosure requirements, the quality of ESG practices remains an issue. Many companies consider ESG data disclosure a box-checking exercise and a drain on their resources. A similar concern applies to ESG ratings and research providers that often lack the resources to dig deep on the issues. Based on disclosures alone, it may be difficult to get an accurate picture of ESG practices. Investors need to engage with companies to gain a complete understanding of these practices.
The Chinese government and regulators have issued a number of regulations and guidance on ESG data disclosure in the past few years. However, the quality of ESG disclosures remains an issue, mainly due to poor data and lack of resources.
Chinese investors demonstrate low levels of engagement with companies when compared to more mature markets.
In an Institutional Shareholder Services study, international investors cited governance concerns as the main reason for not investing in China. Transparency and abusive related-party transactions were the top corporate governance concerns for overseas institutional investors.
The idea of stewardship is also relatively new to Chinese institutional investors, especially large asset owners (asset managers are typically more active). Voter turnout statistics bear this out. Turnout at mainland-listed companies is lower than in developed markets (around 50%–60% compared to 80%–90% in the US). Although shareholder proposals are not uncommon in China, nearly all are presented by controlling shareholders and typically receive more than 95% support. Retail investors, which make up a large proportion of the overall investor base, tend not to vote at shareholder meetings.
Because of the controlling stakes held by the state in many Chinese companies, particularly the large-cap companies, Chinese institutional investors may feel that their vote will not affect the outcome. Many non-state-owned enterprises also have a concentrated shareholder structure (for example, the founder has an overwhelming proportion of voting shares), which makes active engagement difficult.
Engagement and stewardship face a number of challenges in China, including the large retail investor base, the state-controlled nature of many large-cap companies and concentrated shareholder structures.
The evolution of ESG investing in China has arguably been led by the development of ESG products, such as green thematic funds, rather than by local investors developing their ESG policies first. China has grown its green bond issuance from having zero before 2015 to being second globally in 2017, and at the end of Q1 2018, it boasted nearly 500 green private equity funds. China also saw the launch of its first ESG equity index, the SSE 180 ESG Index, in November 2018. The rapid development of green lending in the banking system has also enabled the development of green asset securitization.
China’s ambitious Belt and Road Initiative (BRI) offers significant green infrastructure investment opportunities. Applying internationally recognized environmental standards to the BRI infrastructure projects that span Asia, Africa and Europe — with one to four trillion dollars of planned investment — will be crucial for aligning with global climate goals, managing risks and attracting international capital.
Environmental issues (such as renewable energy and carbon emissions) among heavy manufacturing and equipment industries are often easy to understand and address. But it may be more difficult in sectors with less obvious ESG implications, such as customer-facing software, e-commerce and social media. As China transitions from an export- and investment-driven economy to one built on domestic consumption, the government is increasingly considering social risks with internet companies. Future regulations, such as the introduction of curfews on video games, may adversely affect such companies.
The inclusion of China A-shares in major emerging market and global indices has brought new international investors to a market historically dominated by domestic investors. Some of these international investors with strong ESG disciplines have applied their ESG policies and practices to their analysis of Chinese companies. This has led to greater demand for ESG information from companies and fostered an increase in ESG integration by local investors. Compared to developed markets, however, there is still a long way to go.
To attract more assets from international investors, local asset managers have led the way in improving their ESG practices compared to local asset owners. Overall, however, the approaches of Chinese asset managers and owners to ESG integration are still in the development phase and lag the rapid growth in green investment products. This may reflect a strong focus on short-term performance, with lower priority assigned to longer-term issues, such as ESG factors that may have no perceived short-term performance benefits.
Currently, there are 46 Chinese UN PRI signatories, with all but two being asset managers. More than half of the top 10 Chinese mutual fund managers have become PRI signatories, and they have been the driving force in implementing the PRI. Asset owners and managers say they believe they need to keep pace with global ESG market developments and international investors, provided there is no significant trade-off with returns. We also see an increasing demand for low-carbon assets as Chinese investors grapple with the potential consequences of climate change.
Chinese asset managers have led the way in improving ESG integration, driven by demand from international investors. However, the focus on short-term performance means many managers and asset owners are still assessing the impact of ESG integration on returns before taking further steps to improve their ESG practices.
Despite starting from a low base, with ongoing government support and continued internationalization of Chinese markets, Chinese investors have the potential for rapid development of their approaches to ESG and stewardship. China has shown leadership in pursuing sustainable growth policies by investing in renewable energy and issuing green bonds, while regulators seek greater ESG disclosure. The country has made rapid strides across multiple fronts in a short time.
With the nature of its economic model, China may be able to adopt and implement ESG practices in a much shorter time than it has taken other markets. However, our discussions with local asset owners and asset managers suggest that the focus on short-term returns is a key obstacle, and a greater push from the government and regulators may be required for ESG integration to take off in earnest.
Global investors considering an allocation to China should make sure their approaches to responsible investment and ESG sufficiently align with those of their managers.
 World Economic Forum. Insight Report: China Asset Management at an Inflection Point, July 2020.
. The People’s Bank of China and six other government agencies jointly issued “Guidelines for Establishing the Green Financial System”, The People’s Bank of China website, 1 September 2016.
 These have included “local piloting programs, education and capacity building, research and policy leadership, and regulatory guidance to set the framework and support the implementation of the policy.” CFA Institute. ESG Integration in China: Guidance and Case Studies, 2019, https://www.cfainstitute.org/-/media/documents/survey/esg-integration-china.ashx.
 Wagner D, McAdam M, Rogers J. “China Plays Fast Catchup with the Global ESG Wave,” International Policy Digest, August 29, 2019,
 Between March 1 and 18, 2020, more coal-fired capacity was permitted for construction in China (7,960 MW) than in all of 2019 (6,310 MW). Global Energy Monitor. “Impact of COVID-19 Pandemic on Major Fossil Fuel Projects,” https://www.gem.wiki/Impact_of_COVID-19_Pandemic_on_Major_Fossil_Fuel_Projects#.
 The percentage of offshore green bonds denominated in currencies other than RMB has increased over the past four years. Those bonds have had to reach global standards, such as the Green Bond Principles, in order to attract global investors. According to the Climate Bonds Initiative, in 2019, China raised $US31.3 billion by issuing bonds that met international standards, second to the US’s US$51.3 billion.
 Huang Runqiu and Jiang Yang attended the signing ceremony of the cooperation agreement on environmental information disclosure of listed companies to jointly deepen the green securities policy mechanism [translation for Chinese], China Securities Regulatory Commission website, 12 June 2017.
 CFA Institute. ESG Integration in China: Guidance and Case Studies, 2019, https://www.cfainstitute.org/-/media/documents/survey/esg-integration-china.ashx.
 The Sustainable Stock Exchange Initiative is a UN Partnership program. Its mission is to provide a global platform for exploring how stock exchanges, in collaboration with investors, companies (issuers), regulators, policymakers and relevant international organizations, can enhance performance on ESG issues and encourage sustainable investment, including the financing of the UN Sustainable Development Goals.
 In evaluating asset managers, Mercer reviews the approach to ESG, taking into consideration the use of proprietary and third-party ESG analysis as well as the quality of ESG disclosures and reporting in the market.
 Institutional Shareholder Services. China: Investor Stewardship — An Examination of Voting and Engagement Activities in China, 2014, https://www.issgovernance.com/file/publications/china-investor-stewardship.pdf.
 Climate Bonds Initiative.
 China Securities Investment Fund Association.
 The BRI also has developed green investment principles. However, much of the BRI relies on carbon-intensive infrastructure.
 CFA Institute. ESG Integration in China: Guidance and Case Studies, 2019, https://www.cfainstitute.org/-/media/documents/survey/esg-integration-china.ashx.