Chinese investors jump on the global ESG bandwagon to rebuild economies with lessons learnt during COVID-19 pandemic
Clouds are said to have a silver lining, but could "ESG" prove to be the golden edge to the dark COVID-19 cloud, transmuting the pre-pandemic profit craze of investors into a heart-felt desire for socially responsible, environmentally conscious investing?
Yang Yuebin, associate director of Sino-French joint venture AXA SPDB Asset Managers, believes so. He manages a 1.9 billion yuan ($271.2 million) fund that prefers financial assets offering sustainable returns with focus on ESG.
For the uninitiated, ESG refers to environment, social and governance－three fields that are receiving intense attention of COVID-19-chastened investors and fund managers who have to make quick, sensible decisions in liquidity-flush, stimulus-happy economies worldwide.
"The COVID-19 pandemic shows ESG matters more than ever," said Eric Usher, head of the UNEP Finance Initiative.
Agreed Yang. "Value investing" is the philosophy that informs his fund management now. In this regard, Yang is not alone. Value investing is a trend gathering momentum in China and the rest of the world.
Yang and his ilk believe investors have the power to influence equity issuers to value sustainable development.
Yang deeply believes that investors should "choose investment products that benefit ESG". That approach, he said, helps mitigate market uncertainty and limits volatility in a world made turbulent by the economic fallout of the pandemic.
"Like a commander in an army, the fund manager should take responsibility for the valuation of returns and risks, and the ESG label is like an insurance to mitigate risks when we discount cash flows of the equities," said Yang.
These days, he is busy preparing for new offers of funds that focus on ESG-labeled assets.
There is a good reason behind his preference. When global markets were disrupted by COVID-19, listed companies with higher ESG ratings outperformed their peers over the same period. For instance, stock indices such as the S&P 500 ESG index and the MSCI's emerging markets ESG leaders index rose more than other well-known indices.
A BlackRock report said that in the first quarter of this year, investment flows into global sustainable open-ended funds were 41 percent higher from a year earlier.
Market data provider Morningstar reported that almost $10 billion flowed into sustainable open-end mutual funds and exchange-traded funds in the United States in the first three months, more than half the 2019 total.
Usher said investors and fund managers are underlining the significance of policies that can mitigate climate change impacts, reduce economic inequality in the post-pandemic era and improve the resilience of corporations through advanced governance.
In China, investments under the theme of "sustainability" gained momentum during the COVID-19 pandemic. Issuance of bonds with the "green" label had tripled in April compared with March, according to a report from the Climate Bonds Initiative (CBI), an international non-profit institute.
Chinese green bond issuers already topped the global green bond market in 2019, recording a total of $55.8 billion in offerings in both onshore and offshore bond markets, up by 33 percent from 2018, the report said.
A key issue for investors, however, is to figure out if the bonds or shares are really "green" or "ESG-related", and whether their investment can support sustainable development of the companies and society, said analysts.
In order to receive the ESG label or other relevant high marks, companies usually need to persuade auditors and rating agencies that they have sustainable development strategies that are environmentally friendly, assure better corporate governance and pro-employee practices. They also have to prepare detailed ESG reports to comply with frameworks issued by financial regulators.
To improve the ESG information disclosure framework and bring the ESG investment rules closer to the global standards, China's central bank, the People's Bank of China, teamed up with the National Development and Reform Commission and the China Securities Regulatory Commission to issue a new version of a catalog of projects that were supported by green bond issuance. The catalog was published on July 7 to elicit public opinions. The previous edition dates back to 2015.
To ensure the catalog is advanced and in line with the global standards, the new edition excluded projects of "the clean utilization of fossil energy". It also expanded the investment scope to include relative trade and consumption financing activities, according to a PBOC statement.
Shao Huan, China Programme Manager of the CBI, called the new catalog a "big step" for China's green bond market development. As more global investors are interested in China's green bond market, the changes to green standards have boosted investor confidence.
The country has shown determination to limit the usage of fossil energy and paid much attention to climate change, she said.
Ma Jun, a member of the central bank's monetary policy committee and chairman of the China Green Finance Committee, said Chinese financial regulators will likely release new policies in the coming months. Listed companies and debt issuers may be required to commit to compulsory execution of projects that are part of their environment information disclosures.
That means, data integrity and quality will be further improved, which can benefit domestic as well as overseas investors, said Ma.
"Expected introduction of ESG disclosure requirements to the exchanges on the mainland is a positive signal," said a research note from JLL, a real estate services group.
Such disclosures are beneficial to transparency in general and will also serve to attract foreign investment, leading firms increasingly to strive to meet sustainability and social responsibility benchmarks, it said.
Brian Cahill, a managing director of Moody's Investors Service, said that financial factors like margins, leverage and liquidity are no longer the only matrix to define how vulnerable debt issuers' financial profiles are as they entered the pandemic crisis. Management of ESG risks will also influence how they will navigate through and out of such crises.
The trend is likely to encourage governments and corporates to undertake additional planning for the ESG-related risks and ponder increasing spending to mitigate potential adverse influences, so it may result in tighter governmental regulations, changing consumer preferences and bringing about stricter investor scrutiny of current business models, Cahill said.
"Since institutions are in varying stages of implementing ESG integration, we view the potential addressable market for ESG products as more than half of the asset management industry," he said.
"An increase in these products could eventually affect the cost of capital and market access for companies not adequately conveying their sustainability strategies or demonstrating appropriate engagement with stakeholders."
The COVID-19 pandemic has exposed some limitations of public health systems and exacerbated existing social inequalities, spurring the adoption of government policies to support the most vulnerable sectors.
The recent experiences of many COVID-19-ravaged countries have heightened awareness of social issues among governments, companies and investors.
Some issues receiving heightened attention include healthcare system reform and greater government spending as protracted period of social distancing could result in deterioration of social cohesion and reduced trust in institutions and companies.
Any such eventuality would necessitate measures to protect the health and well-being of employees. Otherwise, employers may display a propensity to furlough workers or make them redundant, according to analysts.
A recent study by Moody's Investors Service indicated that three major ESG trends may receive increased attention of investors and may have material credit implications over time.
These are: institutional preparedness for greater types of global risks; social considerations related to healthcare access and economic inequality; and a shift from shareholder primacy in corporate decision-making toward a consideration of the needs of other stakeholders.
"As with other likely outcomes of the post-coronavirus era, the emphasis on ESG factors will largely mark an acceleration of trends that preceded the pandemic," the study indicated.
With the pandemic, "we know we need to rebuild the economy, and we've committed the stimulus", said Usher of the UNEP Finance Initiative.
In emerging markets such as China, infrastructure needs are mammoth. "Will the infrastructure be green, building forward, or brown and lock our economies into the past, a past of environmental decline that doesn't need to be the future?" Usher wondered.
The pandemic's economic fallout is serving as a large-scale stress test to find out the resilience level of corporations across the globe. Companies with the best governance have fared better so far. Defensive capital allocation strategies have been rewarded as the level of cash on the balance sheet has suddenly become a more interesting metric for investors than the dividend yield, he said.