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Week 35: The problem with China – from an ESG perspective
In this issue: ▸ China ranks very low on ESG disclosure ▸ China seen through the prism of ESG ▸ It is these companies we do business with ▸ What can we do?
It came as a confirmation. Heavy and numb. The UN report on human rights violations in China in the Xinjiang region in relation to the Uyghur minority. Nothing new. We know it and we have known it for a long time. And? What has this got to do with ESG? Why is it so quiet in an industry that has been shouting out its commitments. Net-zero. We are all in this together. We can do it. And all other sorts of superlatives to make it clear to the world. We get this. No we don’t. We don’t get it at all.
To put it bluntly. We know that China is a dictatorship and we know that the government in China heavily suppress free press, personal freedom of billions and uses means and methods of control and intimidation that none of us living in democracies, for what ever we think about them now, would ever accept. We know this. We have seen it and there has been a zillion pages written about this.
We also know that our personal consumer freedoms are very much connected to the Chinese capacity to produce cheap volumes of stuff we apparently deem important for our very survival. Yes, we are part of a communist version of capitalism controlled by a group of people in a country far in the East. We contribute and benefit from it every day. So far all is clear.
Without China no growth in the rest of the world. It’s that simple. You take China out of the globalised economic disorder and big problems will start punching holes around the world. Intertwined, connected, an unholy alliance, for the benefit of all of us. It sounds almost poetic. Well, then again what has this to do with ESG?
Given the size of the Chinese economy and the growing number of profitable (the numbers are never really clear) companies in China, as well as its industrial complex supplying brands outside China with everything from socks to parts of spaceships, it is more than oblivious why this has to do with ESG. We invest directly or indirectly in Chinese companies or in companies with heavy supply chain-exposure in China. We invest in companies that have huge markets in China. We are all in the same boat and we have bought the ticket.
I have done some research on this rather thrilling topic, and here are some takeaways.
China ranks very low on ESG disclosure
In 2019, Bloomberg published a compilation of ESG disclosure data for more than 11,500 public companies trading on major exchanges across 25 countries. Using data points collected from published disclosures, news items, and third-party research, Bloomberg found that China ranked among the lowest in terms of ESG disclosure.
A low rate of information disclosure creates difficulties for investors and asset managers to integrate ESG considerations into their investment process for Chinese firms. Nondisclosure and a lack of standardisation on the metrics reported by Chinese companies could lead to an inaccurate assessment of how a firm compares against its domestic and global peers on key ESG issues.
MSCI ESG Research data show that China ranks 47 out of the 50 countries in the MSCI All Country World Index (ACWI), with a median Industry-Adjusted Score of 2.9, out of a scale of 0 to 10. Only Peru, Qatar, and Egypt score lower than China on this metric.
China’s low median score arises from the fact that a significant portion of the companies in the MSCI China Index are considered “ESG laggards” relative to their global peers, with a MSCI ESG rating of B or CCC. As of June 2021, just ten companies representing 1.9% of the rated companies in the MSCI China Index are considered “ESG leaders,” with a rating of AAA or AA. In contrast, close to half of the companies are rated B or CCC.
The majority of China’s larger companies, such as Alibaba, Tencent, and Meituan, are currently rated as “ESG average” by MSCI.
Chinese companies also score lower on the corporate behaviour front, indicating higher risks surrounding items such as fraud, executive misconduct, antitrust violations, or tax-related controversies.
China seen through the prism of ESG
Now, let’s look at China more specifically in relation to the three pillars of ESG – Environment, Social and Governance.
Environmental Pillar: Chinese companies rank lower than their global peers across a broad range of issues, such as carbon emissions and toxic emissions & waste.
Social Pillar: Chinese companies have some of the lowest social-pillar ratings relative to global peers. One area in which Chinese companies received a heavier penalty is privacy & data, indicating lower privacy and internal data security management systems and higher occurrence of data breaches and/or privacy-related controversies. In addition, lower health & safety scores reflect a higher risk of health and safety accidents that can lead to production disruptions, litigation, and liabilities.
Governance Pillar: In terms of corporate governance, Chinese companies generally scored lower when it comes to board and pay. One of the concerns relating to board performance is independence, as many companies lack an independent majority of board members or in some case have politically appointed communist at the board.
It is these companies we do business with
Chinese companies in the materials and energy sectors have among the lowest ESG scores relative to their global peers, with around 80% of the companies in these two sectors having B and CCC ratings. Many of the materials companies are involved in the mining industry and have issues relating to pollution, water stress, and toxic emissions & waste, while energy companies in China (which are predominantly coal or oil & gas related companies) are flagged for similar issues. Corporate governance is also a concern for many of the energy companies due to board and executive pay issues.
It is these companies we do business with and indirectly invest in, to supply our self with solar and wind power, batteries for our EV’s and semi-conductors filled with rare-earths. It is from Chinese refineries and smelter cobalt extracted in DRC (under heavy working conditions and huge environmental impact) is transformed into components we use for our so called sustainable transition.
China’s new standard for corporate ESG disclosure has made international headlines, but its impact is expected to be minimal as it has not yet been endorsed by any regulator and remains voluntary. And it does not mention, with one word, Human Rights. There are millions if not trillions of dollars committed to UN Global Compact, UN PRI etc etc. Words on the paper.
What can we do?
Now the big questions is, after reading all of this, what can we do?
We cannot stop talking about the issues and we cannot stop addressing them when we invest in or do business in China. We can not ignore them or make them disappear.
Is it possible to invest in China and do with stringent ESG approach in the back? Yes. But it’s hard and hardly done from the offices in Stockholm, London, Paris or New York. ESG is a contact-sport and understanding what is really going on, on the ground in China, demands a lot of ground work in China (as long as you download WeChat and give the Chinese government full discretion of everything you do).
The pre-notion, gladly sold to all of us, has been that economic exchange, trade and business with dictatorships, eventually to democratise them, opens them up and softens the grip. Really? What examples can we show and learn from?
Here you have some links that can be useful when looking at China and ESG.
Have a great week!