Top 10 Trends in Responsible Investment in China 2023
On 11 January 2023, SynTao Green Finance and China Sustainable Investment Forum (China SIF) jointly released "Top 10 Trends in Responsible Investment in China 2023", which continues to help market participants to observe trends, rationalise ideas and set strategies.
Trend 1: Fragile Markets Accentuate the Resilience of ESG Investment
In 2023, the global economic outlook will be less promising amidst various adverse factors. The International Monetary Fund (IMF) predicts that one-third of the world's economies will be hit by recession. China's economy will gradually improve after adjusting the COVID control policy. However, it will take time to rebuild confidence in financial markets. Against this backdrop, ESG investments will face challenges and questions more often. However, sustainability issues, represented by climate change, are impelling China, the US and Europe to communicate and cooperate more closely and regularly with each other. We believe that in a fragile market, ESG is all the more needed as a "stabiliser" to inject resilience into the market. According to Morningstar, in the first three quarters of 2022, the global sustainable fund market has maintained the net inflows since 2020, whereas other funds have seen two quarters of net outflows, demonstrating the resilience of ESG investments.
As a result, we expect continued interest in ESG investing in the Chinese market and growth in the number of products and institutions integrating ESG strategies. However, the short-term growth rate of ESG investment in the public equity market may slow down due to market fragility. However, as green credit from commercial banks continues its rapid growth, the size of ESG investment in the broad sense will also continue to grow.
Trend 2：ESG Becomes Part of the Chinese Path to Modernisation
The Chinese path to modernisation is characterised by a huge population, common prosperity for all people, harmony between material and spiritual civilisation, and harmony between human beings and nature. It is a peaceful development path. The synergy between ESG investment philosophy and the Chinese path to modernisation can help to realise the latter in many ways. We expect development ideas such as ecological civilisation, rural revitalisation, common prosperity and high-quality development to create a favourable external environment for ESG development in China.
The word "Chinese" has a profound meaning here. Firstly, it emphasises that China's national conditions should be considered in the process of modernisation, and the success stories of other countries should not be rigidly replicated. Secondly, it emphasises the need to develop the Chinese experience and contribute Chinese solutions to the world. This is also the case for ESG development in China, where we need to explore suitable practices in terms of standard definition, disclosure requirements, rating methods and investment strategies to provide references for the development of ESG and green finance in global markets, especially in emerging markets. The ESG Committee of the China Association for Public Companies (CAPCO), established in November 2022, mentioned that China needs to build an "ESG management system and evaluation system with Chinese characteristics and international recognition", illustrating the integration of the Chinese path to modernisation into the ESG development in China. We expect to see an increase in the number of such arguments and practices. The development of ESG in China and abroad will be "harmonious but different".
Trend 3: Transition Finance is to Embrace Rapid Growth
In November 2022, the "G20 Framework for Transition Finance", led by the People's Bank of China (PBoC) as Co-Chair of the G20 Working Group on Sustainable Finance, was launched. It is the first time major countries have reached an international consensus on the development of transition finance. The Framework covers five pillars and 22 principles on defining criteria for transition activities and transition investments, information disclosure, transition finance instruments, policy incentives and just transition, which will help the global market reach a principled consensus and facilitate the rapid growth of transition finance. Prior to this, the Chinese market has seen innovations in transition finance products such as sustainability-linked bonds and transition bonds. Some banks have introduced their own transition taxonomies or checklists. We expect Chinese regulators to introduce standards or criteria that align with the G20 Framework for Transition Finance to enhance the credibility and transparency of transition activities, which will significantly increase the confidence of market players to participate in transition finance and usher in the rapid development of innovative products related to transition finance.
At the same time, increasing attention will be paid to achieving a just transition, i.e., protecting residents, workers and MSMEs who are likely to be affected during the transition. We expect more discussions between regulators, investors and businesses on an orderly and just transition.
Trend 4: More Organisations are about to Set Net-Zero Targets
The key to a low-carbon transition is establishing a transition path and timeline. Since the introduction of China's "Dual-Carbon Goals", setting net-zero targets has been an essential part of companies' dual-carbon strategies. However, because the transition paths of various provinces, cities and sectors are still unclear, many companies are hesitant to set and announce net-zero targets. Over the past year, the "1+N" policy system has been gradually refined. The transition paths at the regional and sectoral levels have gradually become more apparent, creating the conditions for enterprises to set and announce net-zero targets. We expect more companies to establish and announce net-zero targets and how to achieve them in 2023. In this process, applying methodologies such as the Science Based Targets initiatives (SBTi) will help companies to set more scientific and reliable net-zero targets.
For financial institutions, achieving net-zero at the operational level is relatively easy, but achieving net-zero at the asset level is more challenging and critical. According to the "ESG Survey Report for Asset Owners (2022)", 57.1% of overseas respondents have set asset-level carbon neutrality targets and 66.7% have measured the carbon footprint of their investment portfolios, while only 26.7% and 20% of Chinese respondents have done so. We expect that as policy pressure increases and pilot experiences spread, carbon accounting for financial institutions and climate stress testing for banks will progress significantly, more Chinese financial institutions will set and publish net zero targets, and more banks will explore personal carbon accounts at the retail end.
Trend 5: ESG Investment Products Will Be Further Regulated
Globally, the anti-greenwashing movement in ESG investing is set to continue. The "Sustainable Finance Disclosure Regulation (SFDR)" that has been introduced in the EU and the United States Securities and Exchange Commission's (SEC) proposed rules on ESG disclosure as well as the "Names Rule" all reflect this trend and have prompted asset managers to become increasingly rigorous in their product naming and marketing materials. Although no such regulations have been introduced in the Chinese market, regulators are prioritising the issue of anti-greenwashing. As the number of ESG investment products increases, the regulators' efforts to combat greenwashing will also increase. We expect that the requirements for the standardisation of ESG investment products will become stricter. In particular, product naming should reflect its ESG investment strategy, marketing communications should not be exaggerated, and information disclosure should clarify ESG impacts. Over the short term, this may affect market size growth. However, in the long run, a higher level of standardisation and transparency will foster a greater potential for sustainable market development.
Compared to green finance products, transition finance products are subject to a higher risk of greenwashing due to their closer association with brown assets. As such, we expect transition finance products to become a regulatory priority to prevent the emergence of "fake transition" products in the market.
Trend 6: Engagement and Stewardship are Rising
Engagement and stewardship are common practices for ESG investments, designed to reduce risk and add value to assets by promoting improved ESG practices in portfolio companies. Mature markets have more experience in this area. Many regions have already introduced guidelines such as stewardship codes, which most leading asset managers adopt. In the Chinese domestic market, engagement and stewardship have only recently emerged, and only a few large asset managers have adopted the practices. In September 2022, the Insurance Asset Management Association of China (IAMAC) published the "ESG Stewardship Initiative for the Chinese Insurance Asset Management Industry", setting out a six-point initiative. We expect this initiative to encourage major insurance asset management institutions to adopt stewardship practices, leading to more large asset managers joining the initiative. At the same time, regulators or industry associations may also introduce relevant policies, guidelines or codes in due course to enhance the ability of institutions to implement engagement and stewardship.
The "Green Finance Guidelines for the Banking and Insurance Industry", issued in June 2022 states that banks and insurance institutions should strengthen their engagement and stewardship, and develop and implement targeted management measures for clients with potentially significant ESG risks. The guideline provides a policy basis for banks and insurance asset management institutions to implement engagement and stewardship.
Trend 7: Impact Analysis and Measurement Receive Increased Attention
In the field of responsible investment, "impact" is increasingly being referred to, for example, as one of the four key concepts in the new GRI standard. The Principles for Responsible Banking (PRB) also require banks to conduct impact analysis. More recently, the term "dual materiality" has become popular, emphasising "impact materiality" in addition to "financial materiality". "Impact materiality" refers to the significant positive or negative impact on the economy, society and humans caused by a business (or organisation). Investors are increasingly concerned about negative and positive impacts in the US and European markets. For example, the EU requires disclosure of Principal Adverse Impact (PAI) by asset managers. At the same time, ESG rating agencies are looking at new ways to identify and measure listed companies' positive impacts effectively.
These changes in the European and US markets will impact China as well. The identification and measurement of the impact of the Chinese market on companies and projects will gradually emerge and go beyond the previous context of impact investing. We expect to see two crucial developments in identifying and measuring impact in the Chinese market. One is measuring the positive impact of listed companies, for example, by quantifying their environmental and social impacts as additional information for ESG ratings or by integrating them into ESG ratings. The second is the management of indicators for sustainability-themed bonds, such as social responsibility bonds, enabling them to present a more quantitative picture of the positive environmental and social impact of the proceeds, as with green bonds, for better integration into the internal management of the bond issuer.
Trend 8: ESG Application is Expanded to More Business Areas
ESG applications have gradually expanded from listed equities to fixed-income and private equity investments in recent years. We expect this trend to continue, mainly in three areas.
First, it reaches the banking and insurance sectors. The "Guidelines on Green Finance for the Banking and Insurance Industry" set out clear requirements for banking and insurance institutions to incorporate ESG factors, encompassing credit and non-credit business in the banking industry and underwriting and asset management business in the insurance industry, in a rather comprehensive manner. Second, it reaches the supply chain management, where ESG expands from influencing the success of investment to affecting securing orders. We expect some leading companies to start incorporating ESG into supplier codes of conduct and introducing ESG assessment systems in supplier management. Third, it extends to industrial policies. In November 2022, the National Development and Reform Commission (NRDC) issued the "Opinions on Further Improving the Policy Environment and Increasing Efforts to Support the Development of Private Investment", which proposed to explore the development of ESG evaluation of investment projects. The "Shanghai Pudong New Area Green Finance Development Regulations" and the "Guangdong Province Implementation Plan for the Development of Green Finance to Support Carbon Peaking" also proposed ESG assessments for companies and projects. There are even requirements for local governments to include ESG factors in investment promotion to create pi0neering cities for ESG investment development.
Trend 9: New ISSB Standards will Strengthen Carbon Disclosure
The International Sustainability Standards Board (ISSB) has received much attention since its establishment in 2021. in March 2022, the ISSB issued exposure drafts of disclosure standards, namely "Exposure Draft IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (General Requirements Exposure Draft)" and "Exposure Draft IFRS S2 Climate-related Disclosures (Climate Exposure Draft)". We expect the ISSB to publish these two Requirements in early 2023, which will significantly impact the global landscape of sustainability disclosure standards. It will also be interesting to see how the ISSB interfaces with the EU's "Corporate Sustainability Reporting Guidelines (CSRD)" and Global Reporting Initiative (GRI) standards.
There is no doubt that climate-related information disclosure is a common focus across sustainability disclosure standards. As such, the ISSB has not only integrated the Climate Disclosure Standards Board (CDSB) but has also largely referenced the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations in the "Climate Exposure Draft". The TCFD recommendations are becoming increasingly popular. According to statistics, the number of companies making disclosures according to the TCFD recommendations in FY 2021 is nearly five times higher than in FY 2017. We expect the voluntary adoption of TCFD by Chinese institutions, especially financial institutions, to increase and the level of climate-related information disclosure to rise gradually.
Trend 10: SOEs and Financial Institutions will Lead the Reporting Movement
Guided by both active and prudent policies to enhance ESG disclosure, the number of ESG reports issued by listed companies in China has increased year on year. According to SynTao Green Finance, about 31.5% of A-share listed companies issued ESG reports in 2022, an increase of 6.2% year-on-year. We expect this figure to increase continuously. Comparatively speaking, the proportion of listed companies with large market capitalisation issuing ESG reports is already high. In contrast, there is more room for small and medium-sized companies to increase their proportion.
We expect two types of institutions to lead the wave of ESG reporting due to policy implications. The first group is state-owned enterprises. In May 2022, the State-owned Assets Supervision and Administration Commission (SASAC) issued the Work Plan for Improving the Quality of Listed Companies Held by Central State-owned Enterprises, setting the target of full coverage of ESG report by 2023. Hence, the number of ESG reports of listed companies held by SOEs will grow significantly in 2023. The second group is local financial institutions. This is because cities such as Shenzhen and Shanghai have passed legislation to compel or encourage financial institutions within their jurisdictions to disclose environmental-related information. In Shenzhen, banks, mutual funds, private equity funds and other institutional investors that have reached a certain size of AUM should disclose environmental-related information from 2023. The regulator has also issued complementary "Guidelines on Environmental-Related Information Disclosure for Financial Institutions in Shenzhen" to regulate disclosure practices. By doing so, it will facilitate the disclosure of environmental information reports by a large number of local financial institutions and the Shenzhen branches of legal entities. The practice in Shenzhen will also have an impact on other regions.