09 September 2020

China’s ESG Iceberg: Sustainability in the Age of Technological Disruption

China’s ESG Iceberg: Sustainability in the Age of Technological Disruption

From the outside, it may be hard to imagine China as an emerging leader in sustainable business practices. For one, it remains one of the world’s top carbon emitters. Yet, at the same time, it is one of the world’s largest renewable energy producers and electric vehicle markets.1 On the ground, awareness of environmental, social, and governance (ESG) best practices is growing among Chinese companies, largely driven by regulatory policies. Notably, some companies are integrating ESG practices across their businesses and deploying technological advances such as artificial intelligence (AI) and big data to amplify their impact, which may affect millions of people. Yet in this vast market, it is also not surprising to see variation in companies’ ESG performance.

The challenge for investors is how to see through the layers of ESG changes in China and recognize the drivers of opportunities to come. Here, we cover three areas that will shape the development of ESG in the world’s second-largest economy.

  • Financing: Capital as a lever of ESG change 
  • Adoption: Technology as an accelerator  
  • Metrics: Data as key to identifying opportunities

In doing so, we will highlight examples of ESG business activities where government leadership, entrepreneurial drive, and technological prowess intersect, potentially forming the next alpha frontier in China. Aside from our own research and point of view, we sought perspectives from Gobi Partners, a Pan-Asian venture capital firm helping to power entrepreneurial startups. Like many other emerging developments in the Chinese economy, ESG developments may appear limited or unsystematic on the surface, but the scale and speed of transformation may indicate a much larger opportunity lying beneath.

Financing: Capital for change

Among the ESG factors, the “E” has taken on greater prominence in China as environmental protection became a government priority, part of China’s structural shift toward sustainable growth. In recent years, a string of new policies nudged companies to comply with stricter environmental standards.

Capital has emerged as a key lever to drive environmental change – including financing not only for companies in environmentally linked sectors, such as renewable energy, but also those in traditional industries that are seeking to “green” their operations, for example by adopting energy-efficient processes. Various government subsidies and incentives have been put in place, and in 2016, seven ministries and regulators issued the Guidelines for Establishing the Green Financial System, which paved the way for development of the green bond market.2

Banks, the primary source of credit in China, have also increasingly recognized the financial opportunity in green financing products, as well as the financial and reputational risks associated with lending to companies whose activities cause environmental damage.

In just four years, China has become the world’s second-largest issuer of green bonds after the US, raising US$31.34 billion in 2019.3

China Was the Second Largest Green Bond Issuer in the World in 2019

China Is the Second-Largest Green Bond Issuer in the World in 2019

Source: Climate Bonds Initiative as of February 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

The majority of Chinese green bond proceeds have been used to finance projects in low-carbon transport, renewable energy, and sustainable water.4 Internationally aligned Chinese green bonds, however, are still a small fraction of total global green bonds. That said, steps are being taken to harmonize local standards with globally accepted taxonomy, which we believe should enhance the market’s attractiveness to foreign investors.

Green financing has become an important enabler of ESG adoption – perhaps representing the tip of the “ESG iceberg” in China – and its rapid growth signals the extent of change still underway.

Adoption: Technology-enabled change

“In China, interest and developments on the ESG front have experienced a step change, with both government and social pressure fueling the need for companies and investors to systematically include ESG-related considerations across the board,” says Chibo Tang, a partner of Gobi Partners China, based in Hong Kong and overseeing the Greater Bay Area region in China (see below).

ESG performance can be defined and manifested in different ways: internally, through better operational processes, such as by improving corporate governance or hiring a more diverse workforce; or externally, through products and services that promote sustainability in the broader community.

Perhaps no other industry has exemplified the ability to do both in China better than the technology sector. With their international exposure and foreign shareholders, some Chinese technology companies are setting the tone on ESG adoption by incorporating their sustainability objectives into their business objectives. A Chinese e-commerce giant, for instance, focuses on seven sustainability priority areas: corporate governance, intellectual property rights, cyber security, data protection, human capital, environmental impact, and social impact.5 And with hundreds of millions of users, the ability to roll out new products and services quickly, and the capacity to change mass consumer behavior, these tech companies are deepening and expanding ESG’s impact on society.

Technological prowess can also be used to narrow gaps in sustainability areas, such as health care, financial inclusion, and carbon emissions reduction. And given these companies’ vast networks, the multiplier effect of their activities on the rest of the economy could be exponential.

Technology is enabling progress

The explosion of fintech in China in recent years has helped extend financial services to a multitude of people faster than ever, thereby jumpstarting more economic activities, creating new jobs, and helping address rural poverty. For instance, the ubiquitous WeChat app has in many ways become an economic universe of its own, creating over 29 million job opportunities in 2019.6 Used by more than a billion people,7 it is a unique ecosystem offering messaging, e-commerce, payment, and other services.

Digital technology has also bridged location limitations to enable small entrepreneurs from across China to join the digital economy. An e-commerce company leveraged its sprawling retail platform to help entrepreneurs in rural areas start their own businesses online.8 And the use of AI, cloud computing, and big data enabled a digital bank  to approve small unsecured loans to individuals and small enterprises via WeChat in under five seconds. Facial recognition technology is used to fulfill the regulatory “know your customer” requirements. For a majority of the bank’s small and medium enterprise (SME) borrowers, it was their first time receiving a loan from a financial institution.9

With second- and third-tier cities expected to be engines of the next wave of growth in China, these digital connections are shaping up to be important facilitators of more inclusive economic development.

Bringing high-quality health care services to rural areas using AI and big data has the potential to save countless lives and complement the capability and reach of the public health care system. A large insurance group offers AI-assisted diagnostic and treatment services to rural areas via a “village doctor” version of its popular healthcare app.10  Another company’s efforts to digitize China’s health care system led to a WeChat-based digital health care card, which offers lifelong and secure medical records for patients that can be used in different hospitals across the country, while its AI-based medical image analysis technology helps increase the accuracy of early-stage cancer diagnosis and has been used to assist in Covid-19 diagnosis.11 

Technology is changing behavior

Companies are also using technology to nudge people to adopt more sustainable practices or socially responsible behavior. Users of one of China’s largest digital payment platform can collect “green energy points” for adopting a low-carbon lifestyle, for example by using e-payments instead of paper invoices and taking public transportation, biking, or walking instead of driving. They can then donate these points toward the planting of trees in China’s arid areas. Tapping into the power of social networking, users can also share their progress via social media and keep track of progress in real time. As of May 2020, over 500 million users had helped plant 200 million trees, and the initiative had also generated over 650,000 job opportunities for local communities.12

More recently, digital technology has taken on a greater social purpose during the coronavirus outbreak. Services such as an “anti-pandemic express services” – a dedicated section in the payment  app that aggregates services that provide real-time updates, online medical consultations, online grocery delivery services, and others – have helped millions of users avoid leaving their homes during the outbreak.13 Perhaps one of the biggest technology-enabled changes in people’s lives in China after Covid-19 is the use of color-coded health code apps to verify citizens’ health status and travel history. Citizens must use the codes generated by the apps as an e-access pass to enter buildings or travel within the country. Developed and rolled out just weeks after the lockdown in Wuhan, the apps are examples of how technology played a critical role in China’s virus containment effort.

Technology tracking ESG results

As with product development cycles, monitoring the effectiveness of companies’ ESG programs informs their next steps. Using AI, a large insurance group mapped over 500 indicators from different regulatory agencies, automated data collection and monitoring of its own ESG performance, and accelerated its reporting process.14 The broader use of such technology should enable faster disclosure of information that would be actionable for market participants.

The above examples demonstrate how ESG has been integrated into the business offerings of some of China’s largest companies. Driven by customer needs and developed along business lines, ESG-related products and services no longer take the form of charitable or token undertakings; rather, they are financially material to the company, helping them maintain or increase customer relevance, brand loyalty, and market share in a highly competitive market. At the same time, these examples show how China’s technological advances can take ESG to a higher level, creating new opportunities for investors.

Metrics: Key to identifying opportunities

ESG investing is still in its early stages in China compared with the EU and the US, but shifts in investor attitudes could speed up the trend – especially as more foreign investors participate in the A-share market and as a new generation of sustainability-conscious Chinese investors gains prominence.

This evolving landscape opens up opportunities for investors seeking to capitalize on this transformation at the company level. To find the companies that are genuinely making meaningful changes, data is key.

ESG by nature is hard to quantify and measure, as traditional and discrete metrics such as financial indicators do not paint a full picture,” says Tang, of Gobi Partners China. “Data that can be used to evaluate ESG performance is difficult to collect and analyze – only the application of technology can provide the tools and frameworks with which to do so. There are many startups spread across various industry sectors utilizing AI, blockchain, cloud solutions, connected devices, and more to address either very specific industry problems or broader ecosystem issues.”

Traditional ESG data come largely from companies’ voluntary or mandatory disclosures to regulators and exchanges. Disclosure among larger companies has steadily improved: over 80% of CSI 300 constituents now voluntarily report on their ESG performance.15 However, the quality of disclosures may vary. Standardized, comprehensive, and material ESG information disclosure can allow the market to better assess – and price – a company’s risk.

Voluntary ESG Reporting in China Is on the Rise

Voluntary ESG Reporting in China Is on the Rise

Source: SynTao Green Finance, Ping An as of June 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

In this area, technology also offers powerful tools for investors to complement voluntary or mandatory disclosures. One company is deploying its own microsatellites into space to provide real-time data through imagery. It is embedding microchips in the satellites themselves so they can perform machine-learning processes faster.16 Another data provider company also offers data from proxy variables of economic activities. By inspecting land surface temperature and nitrogen dioxide emissions, it was able to offer a picture of the coronavirus’ impact on economic activities.17

Tip of the iceberg

With its sheer size, China has the potential to be a game-changer in global sustainability investing. The building blocks are in place: a growing green credit market that is encouraging companies to invest in ESG-related projects; strategic government policies; and companies that are eager to leverage technological advances to amplify the impact.

Given the potential scale of ESG-driven changes at the enterprise level, investors in China will likely see ESG practices emerge as a valuable source of alpha potential over the long term. Yet in China’s idiosyncratic market, these opportunities may not always be easy to discern. Therefore, a rigorous evaluation of these opportunities, informed by local knowledge and experience, will be key. In our view, sustainability should not be a point-in-time measure, but a long-term value creator – and may offer tangible benefits to investors.

Footnotes

1 International Energy Agency, October 2019; McKinsey, July 2020; Climate Watch data, accessed on 20 July 2020.
2 People’s Bank of China, September 2016. http://www.pbc.gov.cn/english/130721/3131759/index.html; Tsinghua University National Institute of Financial Research, March 2020. http://www.pbcsf.tsinghua.edu.cn/upload/default/20200321/154d214ec2b61acb33518e01819e1b5b.pdf
3 Climate Bonds Initiative as of February 2020. https://www.climatebonds.net/resources/reports/2019-green-bond-market-summary
4 China Green Bond Market Report 2018. https://www.climatebonds.net/files/reports/china-sotm_cbi_ccdc_final_en260219.pdf
5 Alibaba 2018 ESG Report
6 South China Morning Post, 15 May 2020. https://www.scmp.com/tech/enterprises/article/3084585/tencents-wechat-app-creates-millions-new-jobs-chinas-digital
7 WeChat, 18 May 2020. https://www.prnewswire.com/news-releases/wechat-releases-new-report-on-the-qr-code-economys-fight-against-covid-19-301060807.html
8 Alibaba 2018 ESG Report
9 WeBank, Forrester Research, 31 October 2019. https://www.prnewswire.com/in/news-releases/webank-the-world-s-leading-digital-bank-decoded-811666527.html
10 Ping An 2018 Sustainability Report. http://www.pingan.cn/app_upload/file/official/2018ESGReport_EN.pdf
11 Tencent, as of 21 February 2020, https://www.tencent.com/en-us/articles/2200960.html; Tencent Corporate Social Responsibility Report, 2019.
12 Alipay Sustainability Report 2019-2020, https://gw.alipayobjects.com/os/bmw-prod/e39c99c2-0193-40fc-8265-cf4f72a8367e.pdf
13 Alipay Sustainability Report 2019-2020, https://gw.alipayobjects.com/os/bmw-prod/e39c99c2-0193-40fc-8265-cf4f72a8367e.pdf
14   Ping An Sustainability Report 2018. http://www.pingan.cn/app_upload/file/official/2018ESGReport_EN.pdf
15 Syntao Green Finance, 14 January 2020. http://www.syntaogf.com/Menu_Page_EN.asp?ID=21&Page_ID=327
16 DigiFin, 20 January 2020. https://www.digfingroup.com/webank-esg/
17 MioTech, 13 March 2020. https://www.miotech.com/en-US/insights/article/5e69fee54dfdef0040211f58
18 Gobi Partners, as of 30 June 2020.
19 South China Morning Post,27 April 2020. https://www.scmp.com/tech/apps-social/article/3081625/autox-alibabas-autonavi-roll-out-robotaxis-shanghais-ride-hailing


Disclosure

Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of an individual market topic at a specific time and is not a guarantee of future performance results or market movement nor is it an endorsement of any particular focus, mandate or strategy. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any views, opinions, projections, forecasts or forward-looking statements expressed herein are solely those of the author, may differ from those expressed by other individuals or areas of PineBridge Investments, are inherently speculative, are only for general informational purposes, and are valid only as of the date indicated. Content may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.

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