Maximizing opportunities from regulatory breakthroughs like the QFII requires moving swiftly in jurisdictions that may not be familiar to the international fund managers. This article discusses the risks and opportunities associate with investing in China’s market with ESG consideration. Engaging in such a shifting market is no picnic, we are here to help to navigate through the change!
- Timing -
Investing in the Chinese market is in fact an inevitable trend. Diversifying your portfolios with this emerging market was a wise choice before and an even more inevitable move now that its strength being proved during COVID-19. More importantly, the power moves by claiming its commitment to achieving carbon neutrality in 2060. Fund managers around the world just cannot afford to ignore the Chinese Financial market evermore.
China’s growing economic strength and improving market accessibility has transformed the characteristics of the emerging-market asset class and its role in global portfolios. China has pivoted towards domestic-driven growth with its Dual-circulation Model and shown its strength in recovering earlier than the rest of the world. In the first half of 2020, consumption accounted for around 60% of the country's growth in gross domestic product.
- Market -
The open-up of the Chinese Financial Market is a major tune and strategic move that continually written in its economic growth path ever since the Chinese economic reform. There are more ways to invest in the market now.
Access to the country through cross-border programmes are easier than ever for foreign asset managers without the need to incorporate a local entity in the PRC. The newly reformed Qualified Foreign Institutional Investor (QFII) Scheme last year and the China-Hong Kong Stock Connect (Stock Connect) creates greater accessibility to the market. The change of the QFII since last November is a big step for the scheme to get more competitive compare to the existing methods that have been introduced to enter the Chinese financial market.
And as official records show, The China Securities Regulatory Commission (CSRC) approved five manager-of-managers funds run by China Asset Management, CCB Principal Asset Management, Penghua Fund Management, China Merchant Fund Management, and TruValue Asset Management on the last day of 2020. The move aims to boost the availability of products with asset allocation features in the market, as reported by Selena Li from Ignites Asia.
Movements on decarbonization policies and guidance are even more ambitious. Following the commitment of reaching carbon neutrality by 2060 announced at the UN General Assembly in September 2020 by President Xi Jinping. Five key Chinese government bodies (Ministry of Ecology and Environment, National Development and Reform Commission, People’s Bank of China, China Banking and Insurance Regulatory Commission, and China Securities Regulatory Commission) published new guidance to promote Climate Investment and Finance in October 2020. This sets out aims including the development of new standards and regulations, encouraging private and international capital for climate finance, and strengthening international collaboration on climate finance, as reported by PRI.
The fourteenth Five-Year Plan set strengthened mandatory energy efficiency targets for industrial plants widening coverage beyond the 30,000 businesses covered in the thirteenth Five-Year Plan. The green premium for low-carbon transition could be found in China’s market - the world’s largest emitter of CO2 emissions - as Chinese businesses transforming to rather sustainable ones for meeting the policies’ mandates and compete for survival. The need to fund for such change is growing for both foreign entities onshore to meet the ESG mandates in their home countries and local businesses to grow their competitive strength as well. ESG investment opportunities in China’s markets are on the rise.
- Returns -
Returns of the A-share market is growing to be more than just an emerging market. According to research by Alexandra DeLuca from Institution Investor LLC. while most of the world is still grappling with Covid-19, China is reporting little to no community spread and market recovery. With the MSCI China Index up about 23 per cent in 2020 and renewed investor interest in the Chinese A-share market, market observers are expressing cautious optimism. As one of the few economies to grow GDP in 2020, through strong revenue growth on the internet and selected consumption, China is desirable for more global capital.
Moreover, our recent research shows less correlation between CSI300 and the rest of the major market indices around the world, like the S&P500, etc. data shown in the figure below as of April 30th, 2020.
- Foreign Investment -
Foreign investors have been an increasingly important force in the A-share market. The ongoing inclusion of China A-shares in the MSCI indices is a part of the wider financial service reform and rebalancing of the economy away from traditional bank finance, which is critical to longer-term growth sustainability, according to UBS.
As A-shares inclusion drives structurally higher foreign ownership, the needs and wants of domestic and international clients are also merging, according to Alexandra DeLuca. With more involvement from foreign investors, especially since the MSCI inclusion, the A-shares market has rapidly become more institutionalized. To step into the game, foreign investors come to realize the role of government policy can have a far-reaching impact on the valuation and price momentum for certain sectors or stocks. These emerging trends require a close lens on the market including its regulatory shifts and analysis.
China is the largest and most influential emerging market in the world, and it is poised to become the largest economy in the world. Invest in this market requires strategical navigation that aligns with the target of your portfolio. Maximizing opportunities from regulatory breakthroughs like the QFII requires moving swiftly in jurisdictions that may not be familiar to the international fund manager. It, therefore, requires comprehensive, seamless and trustworthy support.
GC insights is a research and advisory firm focusing on the Chinese market and providing insights on investing in China with ESG consideration. Dedicated to public market manager research and selection, differentiate by deep, on-the-ground research purely on China’s quality yet hard-to-reach managers. We help our clients comply with ESG investing mandate and create an innovative and transparent business model that monetizes on managers rather than investors.
The emerging new reality through the recovery phase is to deliver sustainable finance everywhere. Given governments’ climate change commitments, sustainable finance was already on regulatory agendas. The pursuit of sustainable finance is now driving regulatory priorities. The regulatory initiative that started in the EU is spreading, and corporate reporting requirements and financial services regulation are aligning. In this changing time, invest with insights from the front line is crucial.
- Transparency -
Transparency is one of the major concerns when it decides against investing in China. Unclear ESG disclosures and worries about the quality of ESG reports could be a deal-breaker for entering this market. It could be difficult and costly to translate these documentations without insights from experienced research teams. Especially when Sustainable Finance Disclosure Regulation (SFDR) phase-in implementation starts from 10 March 2021. International fund managers are in demand for greater transparency when conducting financial activities in China. This challenge cannot go unaddressed.
- Regulation risk -
According to SFDR and latest insights from BNP Paribas, financial products that do not claim to achieve any degree of sustainability may face marketing difficulties as they will have to clearly disclose in their pre-contractual documents that they do not consider sustainability risks, Principal Adverse Impacts (PAI) on sustainability factors or EU taxonomy criteria that define environmentally sustainable economic activities. Moreover, under MiFID II amendments adopted at the end of 2020, those products would no longer be advised to clients that have expressed ESG preferences.
The difficulty of implementation for financial products that consider sustainability issues and for their manufacturers will depend on the availability of the ESG data that will be required by the Technical Regulatory Standards (RTS) supplementing the Regulation and the obligation for investee companies to make these ESG data publicly available.
The European Commission (EC) has agreed to postpone the entry into application of the RTS to be finalized by the end of January 2021 until a date still to be confirmed. Nevertheless, expertise in the ESG area and costly access to ESG data will be needed from 10 March 2021 to meet the principle-based requirements of the Regulation while not publishing misleading information.
According to KPMG’s latest, in addition to changes to national corporate reporting standards to implement global and regional recommendations and requirements, jurisdictions around the globe are enhancing their national listing rules and stewardship codes with explicit references to ESG-related disclosures and considerations, China among others are developing its regulation as well.
Growing awareness of ESG and the open-up of China’s financial markets are demanding higher ESG risk management from internal and external pressures. As mandatory reporting requirements and increasing management awareness of ESG, such as to align with The Guidelines for Establishing the Green Financial System published in 2016 by the People’s Bank of China (PBoC) and the introduction of ESG scoring system for listed A-share companies. And as the growing international standards are emerging, global companies will drive changes to improve their supply chain and push Chinese companies to improve the management of their material ESG risks to meet their ESG mandate onshore and offshore, such as the EU Taxonomy.
And since these regulations are still developing at a rather initial phase, asset managers shall bear the risk of coping with the relevant regulations and prepare for the upcoming potential ESG policies that are emerging onshore and offshore. Since an increasing number of investors favour companies with lower ESG risk, Sustainalytics predicts that ESG leaders would trade at a more obvious premium, which provides a potential opportunity to boost portfolio return.
- Bubble -
According to a report from Principles for Responsible Investment (PRI), there are 31 Chinese investors signed PRI. Asset managers in China are increasingly developing ESG strategies. Evidence has found ESG incorporation outperforms traditional benchmarks in China. Active engagement to leverage qualitative research and expert analysis in their analytical framework to meet the challenge in data quality is a common approach. As a growing market, China’s sustainable finance market is developing with the risk of mispricing. To realize the intrinsic value of the assets in an emerging market is difficult with possible misleading information and bubbles. Translation of useful information during due diligence from a reliable source is above essential. Additionally, experience in conducting peer evaluation and stress test is important for asset managers to interpret the value of the investment.
Looking forward, the State Administration of Foreign Exchange (SAFE) commits to continue to deepen the reform of foreign exchange administration, take effective measures to expand opening-up, support foreign investors to invest in domestic financial markets, and enhance the facilitation of cross-border investment and financing. At the same time, the SAFE will adapt to the opening up, effectively prevent the risk of cross-border capital flows and safeguard the national economic and financial security. Recent news also suggests more open records in alerting ESG risk among A-share listings. To seek and generate ESG alphas, fund managers need to interpret and act ahead with the accelerating news.
Regulations and benchmarks are merging into today’s financial markets which brings challenges for fund managers to keep up with the sustainable finance trends. To seize the opportunities in China’s financial market - an important economic - and managing ESG risks associated with the market. Strategic allocation in this market is useful to hedge the exposure of global portfolios. Fund managers need more comprehensive, seamless and trustworthy assurance from ongoing research that supports the sustainable growth of value. Maximizing opportunities from regulatory breakthroughs like the QFII requires moving swiftly in jurisdictions that may not be familiar to the international fund managers. Engaging in such a shifting market is no picnic,
GC-Insights provides insightful and up-to-date research in ESG and rich experience in navigating through the Chinese everchanging market.
(written by Yitong Yuan)
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