China’s ESG investment trends and market challenges
ESG investment is becoming a mainstream strategy for investors around the world, who are increasingly incorporating elements of ESG into their decision-making process. In China, this shift has been especially pronounced in the public and private sectors. Several important trends are arising from the rapid development of ESG investment, providing a strong foundation for continued growth in the market.
The first of these trends is a policy environment that is conducive for both green and inclusive finance. In both areas, China’s government has implemented policies to provide impetus for green finance while supporting SMEs, which are drivers of sustainable development.
An example of these policies is the Guidelines for Establishing the Green Financial System issued by the country’s central bank the People’s Bank of China (PBOC). These guidelines introduced incentives for green finance, including re-lending operations by the PBOC through the medium-term loan facility (MLF), specialized green guarantee programs, and interest subsidies for projects supported by green loans.
Another driver is the further opening up of China’s market, which has bought many qualified foreign institutional investors who are well versed in ESG investment in China. This has created a ripple effect, leading to more local investors focusing on ESG concepts and investments. From January 2018 to March 2020, the number of institutional investors from China who are signatories to the Principles for Responsible Investment, an organization backed by the UN that works with global policymakers to encourage ESG investment, increased from 7 to 37.
Capital markets have also seen great strides being made in keeping investors informed when making green investments. The Asset Management Association of China published the Green Investment Guidelines4 under the supervision of the China Securities Regulatory Commission (CSRC). These practical guidelines cover many aspects of green investment and the monitoring and evaluation of fund managers. In addition, mainland China’s A-Share and Hong Kong’s H-Share listed companies are facing more stringent requirements on ESG information disclosure. These stricter standards are key for investors who are relying on accurate and reliable information when making decisions on green investment.
While these trends are promising for the future of China’s green market, challenges remain. First, the number of investors and the scope of China’s ESG market are increasing, but the ESG products available on the market are still relatively limited. Second, ESG information disclosure is still in a transitionary phase for many of China’s listed companies, with ESG reports generally lacking qualitative information. Finally, there remains room for improvement in terms of upgrading the quality of ESG ratings, product pricing, assessments of investment effectiveness, and investment reports.
Ambitious to get their shares in this massive addressable market, companies are launching different types of green products, including green insurance and green loans to expand the ESG product line.
Green insurance
The Ministry of Ecology and Environment took action in 2013 by implementing the Compulsory Environmental Pollution Liability Insurance Regulation. This requires enterprises engaging in industries involving high environmental risks to be insured for third-party compensation and the costs of cleaning up potential polluted sites.
Green building insurance and climate insurance are also areas in which China is making progress. In March 2019, the government announced the country’s first signing of a green building performance insurance contract. Energy-efficient buildings are a relatively new concept in China. The contract brings in a third-party assessor to ensure that each phase of the construction of the building meets the evaluation standards for a green building.
China is one of the countries most exposed to natural disasters, and it is designing insurance programs to cover those most affected. Farmers are especially vulnerable because their crops and livelihoods are susceptible natural disasters. In 2019, China launched an agriculture natural catastrophe insurance program to cover seven counties in Shangluo, Shaanxi Province5. Insurance companies in China are working with third-party certification bodies to improve the assessment and management of risk.
Green loans
The government’s expansion of green credit guidelines and the improved capabilities of the private sector to calculate environmental risks have made green loans more accessible and inclusive. According to China’s Green Finance Development Report (2018) released by the PBOC, the year-end credit balance of national banking institutions in 2018 was US$1.16 trillion.
The Chinese government has actively improved the information disclosure requirements for green loans. In 2012, the China Banking Regulatory Commission (CBRC), the regulator for banks at the time, issued the Green Credit Guidelines to establish the framework for the development of green credit for all domestic banking institutions. The guidelines called for banks to identify and monitor the environmental and social risks associated with their credit activities. The regulator followed up by launching the Green Credit Statistics System (GCSS) in 2013, which mandates banks to report and categorize green loans. The GCSS was expanded in 2019 to include green trade and personal consumption loans.
The expanding role of assurance agencies in green assessment
Assurance agencies play an important role in addressing the challenges of identifying green projects, risk management, and reporting green credit. These key functions are crucial to facilitating the capabilities of banks in risk assessment.
First is the identification and classification of green projects. Through green financial-management systems, assurance agencies are becoming more efficient at accurately identifying and classifying individual green projects. Once a green project is identified, the environmental and social risks need to be calculated.
Second, environmental and social risk is a relatively new field of risk management that is difficult to quantify. By using advanced technologies, such as big data analysis, assurance agencies can calculate the environmental benefits of a project by referencing industry environmental benchmark values.
Finally, assurance agencies are helping companies with green credit reporting and information disclosure. As information disclosure requirements become increasingly strict, listed companies will need to examine their own ESG reporting procedures.
The financial industry in China is embracing green finance and rapidly moving toward a more sustainable future. Although there are challenges to be tackled, extensive policy support from the government, expanding ESG product lines, and increased capabilities in assessment are driving the growth of green finance in China.
