Active consultation drives ESG returns in China

Investors should aim to build rapport with management teams in China as a key way to effect positive ESG change and reap the rewards, says Aberdeen Standard Investments (ASI).

David Smith, Aberdeen Standard Investments

Investors who want exposure to Chinese companies with strong ESG practices need to take a proactive approach to engagement that includes forging a trusted relationship with senior management.

“Being an active shareholder is key to driving investment returns in China, in our experience. Passive investors aren’t able to make the same positive impact on the companies they own,” said David Smith, senior investment director, Asian equities, at ASI.

Achieving this is increasingly viable in China, with companies becoming more open to disclosing more information, adapting their business models and adopting a more market-oriented mind-set.

“This evolution in understanding is happening at a company management level, and this is creating opportunities for investors to generate alpha,” Smith explained.

Active interest

In his view, it is far better to be proactive in making suggestions around ESG issues than having to take remedial action to get a company back on track in response to a negative event.

“Being close to the decision-makers will facilitate more effective engagement,” he said.

This requires ongoing dialogue, including investors questioning managements with a view to encouraging improvement and learning how the business operates as well as assesses risks.

For investors, regular interactions in this way helps them understand the competence, character and commitment of boards and management teams.

Mainland China companies also increasingly appreciate this type of relationship. The belief that senior management in the mainland has rudimentary understanding of ESG issues is now a common misperception. Instead, Chinese firms realise the value that engagement on ESG factors can bring.

Raising disclosure standards

For the time being, however, Chinese companies need to improve the depth of their disclosure around ESG topics.

For example, lack of disclosure led MSCI to give one of China’s top retail and private banks a poor ESG rating. MSCI also gave a low ESG rating to a Chinese solar panel producer due to it lacking a water conservation strategy or targets; the company has never disclosed data on water consumption, intensity or reduction.

Yet Smith said the asset manager’s engagements of these firms revealed sound ESG processes in both cases. The common problem was a lack of disclosure and granularity in outlining various initiatives.

Efforts to change this are underway. A growing number of Chinese listed firms now outline their thinking on sustainability, their aspirations to reduce their carbon footprint and the frameworks they have in place to negate ESG-related risks.

Further, China’s securities regulator is devising new guidelines to improve the quality of disclosure among listed companies and to protect investor interests.

In contrast, more engagement is needed on social factors, Smith said, with state guidance less well developed on issues such as how companies interact with employees, vendors and society more broadly.

“Supporting employee well-being and adhering to fair labour principles can lead to a more engaged, stable and productive workforce, which will create value in the long run,” he explained.

“Being viewed as an attractive employer has become key in China. There’s a race for talent, particularly IT expertise, as companies move into advanced technological industries and digitalisation. Investors need to engage firms on how they are working to attract and retain talent.”