Sustainable Investment in China ISSUE BRIEF Introduction To support the growth of sustainable capital flows, IFC’s IFC thus decided to launch a series of Sustainable Investment advisory services seek to influence, support and enable Country Reports initially covering the largest emerging capital market stakeholders to better integrate environ- capital markets attracting global portfolio investors – Brazil, mental, social and governance factors (ESG) into capital al- India and China. Further regional reports will be added to location and portfolio management processes, using IFC’s the series covering Sub-Saharan Africa and the Middle East. own investment practices as a model. IFC is playing its part to support the growth of the market by funding the This summary version of the report Sustainable Investment development of enhanced stock market indices, financial in China 2009, which may be downloaded in full from IFC’s instruments, and through targeted market research. website, provides a snapshot of the Chinese market. While there has been an increase in sustainable-related research Compiling data on the state of development of the and investable products, for example the Shanghai Stock sustainable investment (SI) industry is important for global Exchange and China Securities Index launched China’s first investors and investment managers to understand the scale sustainability index, the Social Responsibility Index (SSE-SRI) and location of opportunities in the market for sustainable in August 2009, challenges lie ahead for the growth of investment products. While a number of organizations sustainable investments in China. provide this information in developed economies such data is scarcely available in emerging markets. In our own investments and through our interactions with clients and other stakeholders, IFC will continue to play a role in promoting sustainable investment in China. EXECUTIVE SUMMARY Chart 1. Estimated Stock of Sustainable Investment in China To better acknowledge the current state and future potential of SI in China, IFC engaged Business for Social Responsibility’s Market Participant Total Estimated Estimated SI Invest- Potential Beijing office (BSR) to undertake a review of the SI industry AUM Stock of stock of SI ments % for SI and enabling market conditions in China. BSR partnered with (US$ B) Investment (US$ B) of Total market the People’s Bank of China (the Central Bank) to analyze in Chinese Invest- dev. short China’s financial markets, regulatory framework, and SI Equities ment to med market infrastructure. BSR also conducted approximately (US$ B) term 100 interviews with government agencies, institutional Domestic: 294.73 294.73 3.32 0.011% High investors, asset managers, equity research, and academics. Mutual funds Domestic: NSSF 82.29 33 0.33 1% Medium China is the world’s third largest economy. The Shanghai and Pension /High funds Shenzhen stock exchanges list more than 1,500 companies with Enterprise 27.96 8.4 0.08 1% Medium a combined market capitalization of US $2,658.2 billion as of Annuity /High November 2008, rivaling the Hong Kong Stock Exchange (US Domestic: Insurance 518 26.9 0.26 1% Medium $2,121.8bn) as Asia’s second-largest stock market. However, International: QFII 13 13 0.13 1% Medium unlike the Hong Kong Stock Exchange, both the Shanghai International: ADR n.a. n.a. 0 0% Low and Shenzhen stock exchanges are not entirely open to foreign TOTAL 971.83 411.63 4.12 1% investment due to tight capital account controls exercised by Chinese authorities – investors are restricted to investing Source – BSR estimates through a Qualified Foreign Institutional Investor (QFII) – the government-mandated quota is currently set at 85 QFIIs, A Nascent SI Market with managed assets of only US $13 billion. However it is noted that China’s fast growing capital market, backed by Though certain conditions signal a promising future for the more than US $1 trillion in gross domestic savings creates a SI market in China, the market currently remains under- huge potential for the development of sustainable investment. developed. Mainstream investors have limited awareness and capacity related to ESG issues. Most domestic market participants have not yet moved from the ‘what’ and ‘why’ to the ‘how.’ Also, confusion over terminologies obscures the differences between sustainable investment and environmental 2 Sustainable Investment in China thematic investment, and there is lingering skepticism about The SSE-SRI index launched in July 2009 is comprised of the business case for ESG integration and statistical evidence 100 SSE-listed stocks with good ESG performance based on on SI financial returns. A lack of qualified personnel—analysts SSE’s rating system. The SSE claims that social contribution and researchers trained to perform both ESG and financial value is one of the key rating criteria, and the index’s average evaluation— further limit the ability of institutional investors social contribution value per share of RMB 2.42 and average to successfully execute sustainability-oriented investment. earnings per share of RMB 0.69 in 2008 were both higher than the overall average of SSE-listed stocks. There are some encouraging cases in which a small number of market pioneers and innovators in different segments of Figure 2: Shanghai Stock Exchange Social the market have started to explore ways to integrate ESG Responsibility Index (SSE-SRI) – Sector Breakdown factors into their investments, but these efforts are generally in the very early stages and often are limited to a broad public Agriculture 0.07% commitment to social responsibility rather than a rigorous Construction 4.79% Whole sale and retail trade 2.19% process of evaluation and screening. Extractires Utilities 0.12% 12.70% In the mutual fund sector, AEGON-Industrial Fund Management Transportation 4.79% Co. Ltd, an SI pioneer in China, has offered the first socially Tourism 0.24% responsible investment retail fund since May 2008. The fund, Real estate 2.5% which had attracted US $375 million as of March 2009, has done well thus far, outperforming the market benchmark by 47% from its inception in May 2008 through June 2009. Manufacturing16.81% Financial intermediaries While most pension funds in China show only limited Information and 51.13% interest in SI, the National Social Security Fund of China communication (NSSF), the country’s largest pension fund with total assets technology 4.64% of US $82 billion, lists “responsible investment” as one of its four core investment principles. Source: China Securities Index, Ltd. In the private equity arena, Tsing Capital, a leading Chinese private equity firm focused on clean technology, spent 8 years developing its own core competence through integrating ESG SI with Chinese Characteristics factors into the entire investment process, from due diligence to monitoring and engagement. Three-digit financial returns SI activity in China has so far been focused almost exclusively on and significant reported social and environmental impacts ESG screening criteria. demonstrate the potential viability of the SI model in China. The limited number of existing SI products, with few details available on specific screening methodologies, makes it difficult to draw Figure 1. Investment in Clean Tech Enterprises by conclusions on what a uniquely Chinese approach to ESG investing Sector may look like. The AEGON Industrial Fund’s ESG screening Water/waste Others 3.20% methodology provides some clues: AEGON employs a positive water treatment screening process which rates listed Chinese companies from four 12.20% perspectives—economic responsibility, sustainability responsibility, compliance responsibility and business ethics—and then selects the Air/environmental 6.70% companies with the highest comprehensive score to be part of their core stock pool. The Fund’s Investment Committee selects stocks New material 4.70% from this pool to build its portfolio. Solid waste treatment 1.60% New energy Energy efficiency 69.80% 1.10% Further Growth in ESG The central question is whether these developments are merely a New agriculture 0.10% flash in the pan or rather the early signs of a growing market in ESG Green building 0.00% investment. The increase in strategic management of CSR by Chinese companies reinforces the latter view. Taken together, the two trends Source: Source Zero 2IPO, China Clean Tech Report, 2009 Sustainable Investment in China 3 are a strong sign that we will see significant growth in both CSR and Figure 3. Number of Sustainability Reports by ESG investment activities in China in the coming years. A number of Enterprises in China additional developments suggest fertile ground for continued growth in ESG investment in China: 140 - Evolving ESG Regulatory Landscape: The government recognizes 120 that China’s environmental challenges threaten to constrain future economic growth and therefore social development. Environmental 100 legislation is increasingly stringent and comprehensive, with new 80 regulations continually being developed even as authorities struggle to enforce existing laws and standards. The government is leading the way 60 in linking environmental and financial policies with two examples in 40 particular: the Green Credit Policy requires Chinese banks to integrate environmental information into their lending processes and criteria, 20 and the Green Securities Policy requires companies in certain sectors 0 to pass an environmental audit from the Ministry of Environmental 2005 2006 2007 2008 Protection (MEP) before being allowed to apply for a public listing. Source: SynTao, A Journey to Discover Values, 2008 In 2008 the MEP inspected 73 companies going public, and of 38 completed inspections, only 18 enterprises passed. - Increasing attention from international SI initiatives: Though - Growing Awareness of the Need for Risk Management: Increasing international investors play a relatively limited role in the market due numbers of high-profile business ethics cases have caused investors to QFII quota mentioned previously, China does attract a handful of to consider ESG factors more seriously when evaluating potential international SI investors. Robeco and Sumitomo Trust & Banking investments. As a result, a growing number of domestic institutional (STB) are the first two companies to launch Chinese SI products. investors are actively screening for governance and compliance issues, while asset managers increasingly hold the belief that ESG risk Challenges and Opportunities management improves a company’s market value in the long term. - Very limited but increasing third party information: Chinese media Despite these encouraging trends, China has to overcome a number is beginning to become more critical of business, and environmental of challenges to effectively channel the growing interest in SI into a NGOs in particular are becoming more vocal, with two organizations mainstream ESG investment market. Some of them can be overcome in already providing regular information to financial institutions through the relatively short term, but others, like changing investors’ corporate newsletters. In terms of professional research providers, there are only a attitudes to ESG and market infrastructure, will take several years. couple of independent ESG research organizations active in China, and even those face a limited demand for their services at the current time. The challenges and solutions identified, as well as recommended strategies are discussed in more detail in the report. Sustainable Investment in China 2009, full report: http://www.ifc.org/sustainableinvesting Written by Adam Lane, BSR Editorial team: Berit Lindholdt Lauridsen, Maria Delores Hermosillo, Brunno Maradei Photo credit: Curt Carnemark (World Bank) The findings, interpretations, views, and conclusions expressed herein are those of the authors and do not necessarily reflect the views of the Executive Directors of the International Finance Corporation or of the International Bank for Reconstruction and Development (the World Bank) or the governments they represent. The material in this publication is copyrighted. IFC encourages dissemination of the content for educational purposes. Content from this publication may be used freely without prior permission, provided that clear attribution is given to IFC and that content is not used for commercial purposes. International Finance Corporation • 2121 Pennsyvlania Avenue NW • Washington, DC 20433 USA Tel. 1-202-473-3800 • Email: asksustainability@ifc.org • www.ifc.org/sustainability 4 Sustainable Investment in China