How is ESG regulation looking in China?
While ESG-related topics have been in the forefront of concerns for many investors and companies globally, a global framework for ESG regulations, specifically addressing disclosure, has yet to be fully formed. We expect there to be steady updates in the global regulatory landscape in these next few years and China will prove to be an important market to watch.
Looking at China as a whole, we see a mismatch in demand for ESG-related information from companies, investors and government entities. The government has called for development of “green finance”, such as the mandatory release of environmental data, in order to attract more attention to the Chinese market. With the Hong Kong Stock Exchange already introducing new mandatory rules for ESG risks this year, Shanghai and Shenzhen Stock Exchanges are also set to follow suit and apply more standards.
Yet, several companies have pushed back on the increase in these new regulations. Some view it as unnecessary while others see it as a waste of resources. Especially when there is inconsistency in quality of information demanded, certain companies believe it is a hassle to navigate the standards and may prove to be a burden for companies instead. For others, they don’t believe mandatory disclosures on ESG risks motivate firms to improve.
Both local and foreign investors alike are looking for more clarity and consistency, which would allow them to make better decisions. Having better formulated ESG frameworks would help eliminate ambiguity and doubt in the Chinese market. For example, China has been climbing the ranks in the green bonds trend, but many foreign investors are wary to jump on the wagon as these Chinese green bonds may not match up to the norms provided by associated organizations like the Climate Bonds Initiative. Several asset management companies have also voiced concerns over the quality and transparency of these bonds. Yet, not all investors are convinced with the shift in regulation. While they are aware of the rise in ESG risks, different levels and types of investors still need more convincing on the value of addressing ESG issues to their portfolios in the current business landscape.
Recently, we have seen China making a big push in ESG regulations, with various entities becoming involved in issuing guidelines and regulations for both investors and companies. These newly rolled out regulations seem to support the sentiment of a market’s growing interest and need for understanding how to approach and evaluate ESG performance. While they might not be entirely comprehensive, they do provide certain measures and guidance that players interested in the market should be highly aware of.
Perspectives from the US and EU
In order to put China’s situation in a better perspective, it may be useful to first explore how other markets in the world have been moving. All in all, there currently is no global guideline or framework that has been fully adapted and utilized across different markets, but we may see some convergence in the very near future.
On the US regulation side, there is no real mandatory ESG disclosure or reporting standards. The SEC adopts a principles-based, wait-and-see approach in which it closely monitors the market situation to see what the companies voluntarily disclose. There have been some guidelines released, such as the 2010 guideline relating to climate risks, but so far, the SEC has been only gradually releasing binding measures. In 2019, we saw US Congress taking key steps towards addressing ESG disclosures and related measures. For example, the ESG Disclosure Simplification Act 2019 was taken up for debate in the House but no companion bill was introduced in the Senate. The bill has been intended to amend the Securities Exchange Act in having companies disclose how ESG metrics relate to their long-term business strategy. It would also require SEC to adopt rules for issuers to disclose ESG metrics in financial statements and incorporate appropriate international ESG standards. Yet, it is unlikely that this bill would pass to become a law. Other proposed bills include Shareholder Protection Act of 2019, Climate Risk Disclosure Act of 2019, and Corporate Human Rights Risk Assessment, Prevention and Mitigation Act of 2019.
We see strong efforts from other organizations, e.g. non-profits, instead in the US. The Sustainability Accounting Standards Board (SASB) has released financial materiality guidelines with 77 industry guides typically used in core communication to investors. The Global Reporting Initiative (GRI) advocate for disclosure against topics affecting the company’s stakeholders. The Task Force on Climate-related Financial Disclosures (TCFD) also provide on certain financial filings standards. Acknowledging the variance in understanding of materiality and disclosure formats, these various relevant organizations united under the Corporate Reporting Dialogue in 2018 order to better coordinate and compare corporate reporting standards. This unification allows for better consistency among the frameworks released, as well as clearer interpretation of recommendations by the Task Force on Climate-related Financial Disclosures (TCFD). In addition, the Environmental Protection Agency (EPA) has also been aiming to introduce better measures to address climate risk.
Overall, while the US possesses a mature market of companies and investors who have been advocating for more coherent and understandable ESG disclosure and frameworks, it seems to be cautious on a whole in releasing binding measures. The market players have then been relying among themselves in deciding what ESG information to disclose to the public, and discerning how to make themselves competitive to other ESG guidelines in global markets.
On the other hand, the EU has been actively tackling ESG these recent years. The three main supervisory bodies, or ESAs, consisting of European Securities and Markets Authority (ESMA), European Insurance and Occupational Pensions Authority (EIOPA) and European Banking Authority (EBA) have played a key role in formulating a framework for tackling ESG. Particularly for the environmental category, this year we are expecting to see the awaited Taxonomy Regulation take some effect, with continued phased implementation into 2022. For social and governance categories, the Disclosure Regulation is a main guideline to refer to.
Why is the Taxonomy Regulation especially relevant now and where does it fit into the whole picture? In December of 2019, the European Green Deal was put forward, with the European Green Deal Investment Plan being a crucial mechanism. The Deal targets both financial and economic reforms designed to propel the EU into a more sustainable economy, covering areas like climate change and clean energy. The Taxonomy Regulation is vital because it aims to provide an EU-wide classification system for addressing environmentally sustainable economic activities, thereby supporting the Deal. This classification system lays out four criteria for determining whether an economic activity is considered environmentally sustainable. As this affects a range of asset managers and companies operating in the EU, this is a vital guideline to keep an eye on.
In addition, large companies face the Non-financial Reporting Directive (NFRD) or disclosure of non-financial information. Firms that fall into this category have to disclose and review on environmental matters, social and employee aspects as well as respect for human rights, anti-corruption and anti-bribery issues. The Sustainable Finance Disclosure Regulation (SFDR) being finalized this year will also allow Regulatory Technical Standards (RTS) on content, methodology and presentation of ESG disclosures at entity and product levels to be developed for better disclosures in financial services.
With escalating global pressure and regulatory activity, China has therefore responded with its own interpretation of ESG disclosures and regulatory framework.
The regulations and guidelines being introduced in China have been steadily evolving. There are multiple efforts on various levels involved in pushing forward guidelines and regulations regarding ESG. While these regulations may allow for a wide coverage of industry areas, it has still to be determined how effective this is for approach ESG. MSCI has been tracking ESG regulations introduced and regulators responsible in China. Regulators have been generally divided into financial regulators, industry bodies and government, while the entities that are impacted by regulations include issuers and investors. Among the three regulator categories, the bulk of regulations have come from financial regulator but mainly regarding information disclosure. Both government entities and industry bodies have stepped in to address ESG in a wider scope of industry types and disclosure formats.
Breaking it down further, we can see more of the actual entities that have issued some sort of guideline or regulation addressing ESG. Depending on the industry or scope of interest, there may be even more entities involved.
By the number of entities involved, it is natural that variations of definition or requirements can occur. While this may allow for flexibility, this also lends to vagueness. Taking “green finance” as an example, we found six relevant regulations, with three coming from a government body, two from financial regulators and one from an industry body (Asset Management Association of China). A 2020 ADBI working paper has indicated that although within the realm of green finance regulations there has been very specific and useful technical regulations, some major differences in local and international standards have occurred as well as discrepancies across disclosure requirements. This may hinder the growth of the attractiveness of green finance in the Chinese market.
We scoured public resources to identify 123 relevant ESG guidelines or regulations that have been introduced these past years. Some specifically tackle environmental and climate issues, including environmental information disclosure. Others give a general guideline on how to incorporate ESG into business operations or appropriate disclosures. Several point to one sector, e.g. green finance. A few suggest a more concrete action plan that companies can take. We also see a wide range of industry areas covered by the regulations, from information disclosures to green packaging.
Out of the 123, there are 15 major guidelines or standards that play a bigger role in the current regulatory landscape.
Disclosures on climate-related matters appears as a top priority. One overarching guideline addresses information disclosure in general, covering certain ESG disclosures. There are then four guidelines specifically targeting environmental disclosures. In addition, there are two further regulations touching upon environmental protection. This isn’t a huge surprise as China has received a lot of pressure regarding the negative impact it has had on the environment and climate.
On the topic of social responsibility, we identified three significant measures introduced. There is a large focus placed on listed companies and banking institutions. The rest tackle specific systems of green finance, corporate governance, supply chain, credit system and circular economy.
These major measures are largely intended to provide a foundation of basic definitions and standards, that align with existing laws. For example, the Code of Corporate Governance for Listed Companies outlines the basic principles of good governance, which serves as a major measuring standard for comparison of governance structure across different companies. Another example we see is in the financial system. The Guideline on Corporate Social Responsibility for Banking Institutions in China unites the various existing laws dealing with the banking system and provides guidelines for creating a harmonious banking environment.
China’s banking system has come under certain international scrutiny due to issues like shadow banking which impacts foreign investment interest in the market. We may continue to see major regulations aimed at tackling these areas that are targeted by external pressures.
What to watch out for this year
1. Convergence of regulations and standards: this will continue to be a trend as local markets attempt to elevate their competitiveness on a global standard. But as there is no current global standard, we expect to see more convergence on the local level (unification of different regulatory entities and agencies), as well as coordination on the international level.
2. More action: we see a lot of guidelines and basic frameworks already introduced. As the EU moves into more of an implementation phase, we can expect to see other markets looking to introduce more actionable ESG-related measures. Presently, we already see new changes coming from the Shanghai and Shenzhen stock exchanges.
As the ESG regulatory landscape is both varied and complex, these changes would require some time to take effect and produce results. China has undoubtedly been putting more effort into ESG as it recognizes the need to address this issue in order to elevate its global competitiveness. But due to the existing systems and structures, it is not yet clear how these guidelines or regulations will play out in the actual business landscape.
At GC Insights, we believe in preparing ourselves and our clients for future fluctuations in the market. As ESG regulation will become increasingly important, we aim to provide the best services in this field.