Investors grapple with ethics of Chinese companies

Applying environmental, social and governance screening processes to Asian companies can mitigate risks for investors, say experts

Jaideep Panwar, manager, research projects (Singapore), Sustainalytics: most Chinese companies rank the lowest in the world in ESG factors

Investors can reduce the risks of entering the Asian market by looking at the environmental, social and governance (ESG) record of potential investments and partners.

Jaideep Singh Panwar, manager of research products (Singapore) for Sustainalytics, noted at this year's Social Investment Conference in Vancouver that nearly two-thirds of companies in Asia, and more than 75% of companies in China, ranked the lowest in the world with respect to achieving ESG benchmarks. Companies in Hong Kong were nearly as bad, with more than two-thirds ranking poorly using ESG metrics.

Not surprisingly, more than half of European companies rank high in having progressive ESG policies and practices.

The relative lack of progress around ESG issues in Asian companies is partially because Asian business leaders – and institutional investors in the region – don't see it as helping the company's bottom line.

"I've consulted with companies and sought stakeholder responses from investors and, often, the domestic, institutional investor is completely uninterested," said Panwar. "Some of the [business] leaders find it increasingly frustrating that this is not translating into investor action or their efforts have not been rewarded."

And while a growing number of Asian business leaders want to improve their ESG record, those goals are hampered by the huge gap in progress between what exists in Asia and the Western business world.

"Many companies will have policies with an emphasis on corruption and following environmental laws and regulations. But some of the pollution control boards are the most corrupt institutions in many of these markets. To get your pollution-control certificates passed, often you need to put a lot of money on the table," said Panwar.

"I've known companies that have to ask themselves, 'Should I be compliant with the corruption laws or should I have that document that says I meet the emissions standards that I need to?' These are the issues you have to deal with in Asia and, in particular, China."

These issues certainly can have a material impact for overseas investors and potential business partners. Dana Sasarean, senior associate at MSCI, noted that almost 20% of companies in China will be involved in a corruption scandal or fraud; 10% will have an issue with pollution, food safety or employee health and safety.

"Such events have a real impact, for example, in stock values," she said. "Most of these [Chinese] companies are laggards, underperforming their Canadian peers and the world index."

While there are obvious risks in entering the Chinese market, progressive change is happening with new legal and regulatory changes by the national government to improve the country's ESG record. Sasarean said that recognizing the material risks from ignoring ESG factors is a crucial step toward improving the business and investment performance of Chinese companies.

But risks remain as companies pursue that goal.

"This regulatory shift is good news but, in the short term, it could mean that the liabilities for these companies will go up before things get better," said Sasarean. "But it's important to recognize where the risks are coming from and how to close the gap between risk and performance. Knowing this is going to be crucial." •

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