Chinese firms are moving in the right direction, but they lag behind Western firms that must follow ESG goals in order to compete.
Environmental, social, and governance (ESG) goals have become major focuses around the world, and China is no exception. However, even as global investors become increasingly interested in putting their money into companies with serious ESG goals, at the country level, there are major ESG issues. Due to insufficient institutionalization of ESG measures and unique cultural practices, Chinese companies frequently lag behind their peers in these areas.
When it comes to environmental goals, China continues to use coal to generate electricity since it has intensive resources in this commodity. Chinese banks also funded many coal-powered projects in the five years between 2016 and 2020 in Belt and Road countries. As a result of intensive coal use and a high population count, the nation remains the largest emitter of greenhouse gases.
However, China is attempting to become carbon neutral by 2060. It is increasing use of renewable energy, and China is a leader in the production of relevant equipment. China also launched a national emission trading scheme in 2021, which reveals the country’s desire to improve its environmental outlook. Regulation has gradually bolstered use of renewable energy and cracked down on pollution. Most recently, several types of environmentally-impactful Chinese companies were required to disclose environmental information, which will help to improve transparency in a traditionally opaque area.
Social concerns are a mixed bag. As has been well publicized by now, China has a poor human rights record, with numerous allegations of abuse against Uyghur Muslims in Xinjiang. Inequality is high; China’s Gini coefficient is 0.47, which is above what is considered adequate equality of 0.3-0.4. On the other hand, the government has been improving workers’ rights standards and eradicating extreme poverty. To these ends, China’s Supreme Court recently banned the 9-9-6 work week, which became notorious in the tech sector for forcing employees to work extremely long hours (from 9 a.m. to 9 p.m., six days a week). The poverty alleviation program reduced poverty among 800 million people, which has been touted around the world as one of the most successful poverty reduction programs in history.
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Governance presents challenges particularly for fixed income investors whose investments reflect state ESG actions. China’s government is communist and authoritarian, and represses freedom of speech. If one is investing in the state essentially through government-supporting bonds, the governance aspect is not overly positive. Corporate governance may differ from state governance evaluation, but it remains lower in China due to the ongoing presence of state-owned enterprises. However, there are some bright spots in this area. Corporate governance is improving in some industries, such as the technology sector. There has also been an increase in companies producing ESG reports.
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Firms reflect China’s lagging institutional ESG structure. Although environmental policies have reined in some of the worst polluting firms, many firms fail to disclose emissions, and those that do may be susceptible to fraudulently representing their emissions. Chinese firms have also been found to have lower safety measures, which contributes poor working conditions. Some businesses have also been linked to the forced labor that takes place in Xinjiang.
The new Uyghur Forced Labor Prevention Act introduced in the United States attempts to enforce ESG social requirements that such Chinese firms have been unable or unwilling to address. The act prevents goods made in or tied to Xinjiang’s work programs from being imported into the U.S.
Corporate governance is improving, but remains an issue when it comes to board independence. Many companies do not have an independent majority of board members and may even have a controlling shareholder. In addition, fraud and misconduct continue to plague some firms.
Overall, we can say that Chinese firms are moving in the right direction, but they lag behind Western firms that must follow ESG goals in order to compete. Regulation is the thing to pay attention to in China, as firm activity is highly driven by new rules. Rules that push greater transparency are on the rise and will force some ESG issues into the open that were previously hidden.
In some areas, particularly in state governance and human rights, China is likely to continue to stagnate, but firms may be able to overcome such challenges if they have the will. This will depend on the demands of domestic and overseas investors and consumers, as well as the leadership of the company. The next few years will reveal how well Chinese companies can implement ESG goals.
