China ESG

As China emerges onto the stage as a global superpower, they are making more and more efforts to apply sustainability principles to their business practices. Sustainability and ESG are key to being perceived as not only a manufacturing powerhouse, but also a responsible member of the global community.

What is ESG?

ESG, or Environmental and Social Governance, is a broad set of principles that represent a company’s, or country’s efforts to evaluate their overall sustainability and make their actions more socially responsible. The purpose of this is to ensure their actions improve the world for everyone, and not only their board members and shareholders. This means that companies and organizations should focus on the following aspects:

Environmental:

• Through taking steps to reduce emissions
• Conducting zero-waste initiatives
• Improving waste management and reducing the carbon footprint

Social:

• Through evaluating the ways in which a company interacts with its employees, customers, partners, other institutions and society.
• Conducting more initiatives to better understand and promote human rights, social justice campaigns, inclusion and diversity.

Governance:

• In evaluating and assessing an organization’s structure and management practices.
• Promoting equity within the company and the way it is run.

ESG also incorporates principles for the internal running of the company. This includes protection for whistleblowers, impartial audits to avoid corruption and bribery, and responsible executive compensation that ensures employees are paid fairly, first.

Companies receive an ESG score between CCC (low) and AAA (high) that places them on a social responsibility scale. This scoring information is based on ESG data provided to MSCI, a global financial data analysis firm.

More and more companies worldwide are including sections on ESG compliance and success in their annual reports. Shareholders, consumers, and citizens want to see that companies are not only financially successful, but financially and socially responsible as well.

China is no exception to this – as a global economic superpower, Chinese companies realize that ESG is an important part of becoming a globally recognized brand.

Challenges of ESG in China

As the world’s largest emitter of greenhouse gases and significant other ESG challenges, as a result of rapid industrialization, there are a number of key considerations of with regards to ESG in China

• Environmental challenges – China has a number of environmental challenges which it would need to combat. This includes pollution, soil contamination, problems related to climate change and more. Due to the level of these environmental factors, going forward companies should place more importance on environmentally friendly and sustainable practices.
• Social – With such a large population and a significant disparity between economic groups, it is expected that certain social challenges will arise. Additionally, with the rapid industrialization, many labor practices were not in line with the standards imposed in the west. Great emphasis needs to be placed on prioritizing social responsibility and enforcing proper labor standards.
• Governance – Companies operating in China should place greater importance on internal practices and adhering to local regulations and standards. In past years there has been concerns around practices, especially related to transparency, accountability and corruption.

In order for China to keep up with global standards regarding ESG, companies will need to ensure they operate transparently and disclose all ESG risks and performance through their annual reports or other various reports to stakeholders.

There is a need for investors into China to carefully assess the risks and opportunities which are associated with Chinese companies, taking into account the economic, social and political context of the country.

Does China have an ESG Score?

Since the ESG scoring system is aimed at individual companies, rather than countries as a whole, China itself does not have an ESG score. However, many Chinese companies do. As of 2021,

• 74 Chinese companies have committed to the UN’s Principles for Responsible Investment (PRI).
• More than 250 of the country’s 300 largest companies on the Shanghai stock exchange publish ESG data as part of their annual report.
• Over 1,000 companies in total on the Shanghai exchange publish yearly ESG reports.

Their individual ratings vary, and there are no Chinese government standards for what constitutes ESG reporting. According to MSCI, most of the Chinese companies reporting ESG data fall on the low end of their 7-step AAA-CCC rating scale. However, as Chinese companies transition more and more into the global economy, these ratings are expected to rise over the next few years.

How have China’s ESG regulations evolved with the development of its sustainability market?

While the UN’s PRI initiative began in 2006, Chinese sustainability efforts officially began in 2016, when the People’s Bank of China (PBOC), the China Security Regulatory Commission (CSRC), and other Chinese government bodies introduced their own green finance system.

In 2017, guidelines were laid for how publicly traded (listed) companies should report their environmental data. In 2018, the CRSC stated that listed companies have the responsibility (but not a requirement as yet) to report their sustainability data.

In 2020, Chinese President Xi Jinping laid out the country’s goal of carbon emissions peak by 2030 and carbon neutrality by 2060. In 2021, these goals were formalized by being placed into the official Government Work Report.

Finally, in February 2022, the Chinese Ministry of Ecology and Environment finalized a requirement for five different types of companies to issue mandatory yearly environmental reports. These are: key pollutant-discharging enterprises; enterprises that are subjected to mandatory review for clear production; publicly traded companies and their subsidiaries; enterprises that issue debt financing instruments for non-financial enterprises; and a fifth catch-all group that includes all enterprises that “should” report environmental data due to existing laws and regulations.

Environmental regulations are not the only facet of ESG where Chinese companies are making progress. The Supreme People’s Court and the National Development and Reform Commission are both actively promoting labor rights and healthy working environments for Chinese workers, especially in the tech sector.

Has China undertaken any ESG initiatives or commitments?

China has undertaken an official ESG commitment. In 2020, President Xi Jinping committed the country to carbon peak by 2030, and carbon neutrality by 2060.

In addition to this, the government also has mandatory ESG reporting for certain sectors of the economy. These sectors are generally “dirty” manufacturing and companies that have had previous environmental or labor regulation violations.

The most ambitious Chinese companies also are voluntarily committed to ESG principles. With a more global context, they recognize that this is the way to long-term, sustainable growth worldwide.

Why is Chinese ESG important for foreign investors in China?

ESG reporting is important for investors to understand how they operate and where their money is going. With increased investment opportunities in the Chinese economy and ESG performance itself, this goes beyond the balance sheet and income statement in providing an accurate picture of how the company conducts their business and where their true long-term priorities are.

Companies with low ESG scores may provide good financial returns for investors, but they may be perceived as carrying an array of risks and challenges. On the other hand, investing in a company with a high ESG score means making a financial return on your money, as well as contributing positively.

Companies with strong ESG commitments are likely to have a strong trust with stakeholders involved, attract high quality talent and avoid reputational risks. These entities are also more likely to be sustainable and profitable in the long term.

What standards are in place for Chinese ESG disclosure?

There is no official requirement in place that companies must follow when creating ESG reports. The current reporting standard comes from the China Enterprise Reform and Development Society (CERDS), but their standards are voluntary. These standards focus less on global environmental responsibility, and more on domestic social standards. The priority is the common welfare. Companies can choose to follow their guidelines for what they report, but many companies do not.

What regulations are in place for environmental compliance?

The People’s Bank of China (PBOC) has issued environmental reporting compliance standards; however, these are voluntary guidelines. Some companies follow these guidelines when creating their ESG reports, while others do not see the importance.

In general, the Chinese government emphasizes their commitments to improving ESG. Focus is placed on domestic welfare and strong economic growth, and they do not want to over-regulate an economy already struggling after the Covid lockdowns.

Recent developments and trends in Chinese ESG compliance and reporting

According to the Green Finance and Development Center, China will continue on its trend of emphasizing social responsibility with less urgent emphasis on environmental responsibility. The government has an official commitment to carbon neutrality by 2060, but their economy is still too dependent on fossil fuels to make any sudden changes in the next few years.

The People’s Bank of China has committed to watching companies’ ESG reports and general advertising for greenwashing or pretending that they are more environmentally responsible than they truly are.

What barriers do Chinese companies face for ESG disclosure?

Two primary barriers that exist for foreign companies operating in China is language and transparency.

In terms of language, whether they are mandatory reporters or voluntarily compiled, they are only required to report their ESG information domestically. Since Chinese is not yet a global language on the level of English, it can be difficult for foreign investors who are not fluent in the language to determine ESG information about their chosen investment.

With regards to transparency, while many foreign firms and institutions operate in China, there is often a discrepancy between the firm’s headquarter and locally based entity. Due to differing procedures and regulations, as well as the gap in communication, what may be requested by the headquarters, may not be implemented locally. For this reason many foreign firms have executives based locally, or a local partner, to manage the relationship and ensure policies are correctly being carried out.

Looking forward: What is the future of ESG in China?

As of February 2023, the Chinese government is contemplating making ESG reporting mandatory for all domestic publicly traded firms. Hong Kong has already made this a requirement for companies on their stock exchange, and this move by the Chinese government would open the door for more Chinese companies to join the Hong Kong exchange as well as the Chinese exchanges. As of yet, this requirement has not been enacted into law.

As China takes its place in the global economy, many local companies and the government will assuredly continue their trajectory into better ESG reporting. Sustainability and social responsibility is the future of our world, and Chinese companies with a long term outlook are seeing this more and more.

At Moore – MS Advisory, sustainability remains core to our values as a business and service provider. With over a decade of experience assisting companies in China with regards to accounting, financial advisory and corporate set-up needs, our aim is to provide our clients with full control and transparency to faciliate sustainable growth in China. For more information on how to get started with doing business in China, get in touch with us today!

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