China’s green shoots

China has experienced phenomenal economic growth in the past 30 years and its stock market has grown from being virtually non-existent in the 1990s to the largest constituent country in the MSCI Emerging Markets Index today, and with a market cap available to local investors well in excess of US$1 trillion.

With this rapid economic progress has come a growing awareness among some Chinese policy makers, companies and investors of the potential impacts of environmental, social and governance (ESG) issues on their investments — perhaps to the surprise of outsiders.

Mercer recently undertook a research project for the International Finance Corporation, World Bank Group that examined the extent to which investment management organisations investing in a number of emerging equity markets were considering ESG issues as part of their investment decision-making.

Over 40 money managers based in China, India, South Korea and Brazil were interviewed and then rated by Mercer’s research specialists. The highest ESG-rated strategy was one managed by a Chinese-based investment manager.

Mercer’s latest findings indicate that while China, like many other nations, has a significant way to go before responsible investment becomes a mainstream reality, it is beginning to show developments within its local funds management industry.

In tandem with such local developments, global asset owners who invest into China are also driving concepts of sustainability, particularly pensions that are signatories to voluntary initiatives such as the United Nations Principles of Responsible Investment.

Mercer’s Responsible Investment team recently met with major national funds in China and other Asian emerging markets, to research responsible investment practices.

Major institutional investors in China include mutual investment managers, insurance investment management companies and funds such as the Chinese Investment Corporation (CIC), the National Council for Social Security Fund (NCSSF) and Qualified Foreign Institutional Investors (QFIIs). To become QFIIs, foreign investors need to apply for a licence and a quota to trade in China’s domestic A-shares market. In 2008, there were 59 QFIIs and their quota to invest in the Chinese A-shares market reached US$10.67 billion.

The Chinese Government has been promoting sustainable development in recent years. Recently, China’s President Hu Jintao raised issues of climate change and sustainability in speeches to senior party members.

Government-controlled national funds have policies that encourage use of investment approaches where ESG factors are part of security evaluation processes.

High-level policy announcements also seem encouraging although there remains a lot of work to do to make this gain traction. Issues associated with ESG, such as the environment, including energy, air pollution and water pollution, social issues such as food inflation and healthcare and corporate governance issues, such as financial disclosure and reporting, will present challenges to the investment community both locally and globally.

While the research Mercer has conducted has shown firsthand that Chinese investors are starting to take these issues more seriously, environmental and social issues in particular are very complex and sensitive in China.

Achieving sustainable development and a market for responsible investors will be a long road and it will take time to factor ESG risks into investment decision-making to improve investment outcomes.

Helga Birgden is Mercer’s Asia Pacific head of responsible investment and Dr Xinting Jia is an associate at Mercer.