How should the responsible investor approach the Chinese market?
China’s viability for sustainable investment can be balanced between its dominance in the renewables sector and a questionable ESG record.
China is leading the way in the renewables industry, with 80% of the world’s solar panels manufactured in the nation, and is also showing great strides in introducing renewable energy into its own power mix. For instance, the country is set to add at least 570 gigawatts (GW) of wind and solar power between 2021 and 2025, more than doubling its installed capacity in just five years.
However, from both a fiduciary and an ESG perspective, investments in the nation may need to be considered with caution.
Key events when considering investment into China came in late 2022 from the policy side. In mid-November, outsiders were surprised when the governing party announced plans to ease up on an intense “zero-Covid” approach that was leading to rare mass protests in the nation and damaging economic output.
Following from this, in a December 2022 Politburo statement, policymakers stressed “two unwaverings” of support for the public and private sectors. The statement further made clear that regulation going into 2023 would be focused on “significantly boosting market confidence” and “expanding domestic demand.”
Sahil Mahtani, a strategist at asset manager Ninety One, assesses the impact of this legislative realignment: “There had been a prevailing consensus after the Party Congress in October that China was becoming uninvestable, driven in part by geopolitical risks, ESG issues and an underwhelming performance on the equity side.
“Now there's a massive shift in China, which very few people anticipated. There was a view that the governing party had turned decisively against the private sector, yet a lot of our private sector contacts were telling us that was a sort of caricature of what was going on. It’s important to learn that China has this policy of tightening and loosening cycles.”
With the wider economy in the earliest stages of rebounding, it is a boon for net-zero investors, with the green economy a major driver of growth in China.
China is the largest electric vehicle market in the world and there are multiple investment opportunities ranging from manufacturers of electric vehicles or components to renewable energy providers. Within its own energy mix, the nation is the world’s largest producer of wind and solar energy.
In July 2022, the International Renewable Energy Agency (IRENA) released a report that outlines a plan that could enable China to achieve carbon neutrality by leveraging renewables.
With all these Chinese renewable investment opportunities available, Faisal Rafi, head of research at investment advisory firm RisCura, says: “Whether something is a good investment, as opposed to a good company, depends on additional factors, not least the price paid for that investment. What is clear though is that China offers possibly the widest range of companies in the sector for investors to consider and, as new technologies develop, it is likely that many will emerge within the Chinese renewables ecosystem.”
Rafi also anticipates that Chinese domination of a sector such as solar is likely to continue, as the nation also dominates the mineral extraction and raw materials sector necessary for the development of such technologies, holding back US and European companies that are looking to compete.
From a wider perspective, Rafi also anticipates the lifting of Covid lockdown laws to be beneficial in the long term for the renewables sector and the Chinese economy overall, though in the short term there is likely to be a further impact as a wave of infections keeps workers and customers at home.
Of renewables investing, Mahtani refers to Ninety One’s Global Environment Fund, which styles itself as a highly concentrated portfolio of equity enablers for the carbon transition. A significant portion of stocks within the fund are Chinese stocks (between a quarter to a third), according to Mahtani, due to China being a key player in facilitating the carbon transition.
“Some of those companies are really helping not just in energy production, where we already know China is a big driver of wind and solar components, but also on the energy efficiency side”, says Mahtani.
The ESG considerations to be made when investing in China are varied and complex. From an environmental perspective, while the nation has a set a net zero for 2060 goal, new coal plants are currently being built in China. Social considerations are also huge, from the totalitarian nature of the Covid lockdowns to the repression of democracy in Hong Kong in recent years.
On the governance side, such data has been typically more difficult to extract from Chinese companies, and there have been previous concerns raised that even private companies in China are still more beholden to the state than the shareholder.
Of governance concerns, Rafi says: “ESG data quality and breadth from Chinese companies lags that of Western counterparts. However, the quality is improving, rapidly in some cases. Step changes occur when the state demands that certain information be provided, after which compliance by Chinese companies is generally good with decent data quality.”
Progress is also being made on the climate reporting side, with Hong Kong’s Securities and Futures Commission currently working on a set of climate risk disclosures, based on the recommendations of the Task Force on Climate-Related Financial Disclosures, which would apply to Hong Kong-listed companies.
On wider ESG concerns, Rafi says: “It is clear that ESG is incredibly important when working in China. A ‘bad ESG outcome’, such as a company being shut down due to unsustainable practices, can have an outsized impact on a Chinese equity portfolio.
“Some companies are beholden to the interests of the state. One needs to be very careful when investing in sectors of social or political importance, such as education, some areas of finance, or utilities. On the other hand, there are many privately-owned companies operating in multiple industries that solely seek to deliver growth for equity shareholders with no political interference.”
There are also the aforementioned wider concerns about humanitarian crises affecting the Chinese state, and how they may impact a responsible investor, or a climate-conscious investor in an intersectional manner.
James Peel is a portfolio manager at Titan Asset Management and is responsible for the firm’s approach to sustainable investing, having previously worked as a researcher at the British Chamber of Commerce in Taiwan. Of considering wider issues in China when making ESG investments, Peel refers to concerns such as solar panel manufacturing in western China that is linked to forced labour camps containing detained Uyghur Muslims.
“For Titan’s ESG labelled proposition, while we do not screen out any individual countries at this point, the screening does limit our exposure to governments that you would consider to be controversial from a sustainability point of view. We’re also underweight from an equity point of view in places like China, as a consequence of this policy”, Peel says.