In mainland China, the situation is similar.
“ESG awareness [in China] is quite low and disclosure is not that good compared to developed markets, that’s the reality,” said Jie Lu, head of research at Robeco in China and portfolio manager. “We make the best of what we have.”
Mainland company management often doesn’t understand what ESG is about and “a lot of companies don’t read English and don’t know how to respond in English. And when there is no reporting, then the company gets a negative ESG rating in response”, he said.
However, Lu noted a rising awareness due to increasing foreign capital inflows after A-share inclusion in major indices.
“More companies realise that they have foreign institutional investors, some holding more than 15% of the company, which is a very big chunk compared to last year.
“Over last two years, I’ve seen more companies willing to commit to ESG principles and ask what they can do to improve their scores.”
Lu said senior management is usually open to ESG discussions, particularly suggestions on how to improve the ESG profile. “We don’t come in as a potential activist,” he added.
For example, China’s technology companies used to be vague about R&D spending, but they recently started disclosing R&D spending details, which helps Robeco determine fair valuation.
“ESG disclosure builds trust, but we still need to validate. We do a channel check as well,” Lu said.
Building a profile
The team of three in Shanghai look at 400-500 A-share companies annually in order to build a profile, he said.
ESG analysis is done by the investment team and it supplements – ideally with deeper and broader information – the decision on whether to include a company in the portfolio.
Focus is only on those ESG factors that have a direct impact on the bottom line, which leads to a suggested valuation.
“ESG analysis allows us to see where the risk comes from and we can then adjust the valuation,” Lu said.
“We ask what is important for the near-term investment case. Certain areas like board diversity are too early to address in China. But a mining company with a safety risk is different. If a company had the potential for a lot of accidents, it would impact an investment.”
In China, there are no centralised databases containing ESG-related data. To build a company ESG profile, Lu and his team use proprietary and third-party data as well as financial databases, annual reports, news reports and social media.
With social media, Weibo is widely used in China – and monitored by the authorities. Lu said any controversial social media comments by a company’s management would be included in an ESG profile as potential risk.
The team also visits selected businesses to talk to management, building a profile that will be used for input into an investment decision.
“Are they doing better or poorer than peers? How much premium or discount should we give? The judgment is always difficult,” Lu said. “We want to work to a high standard, but don’t want to miss opportunity.”
Less than 10% of A-share companies per year are declined on the basis of ESG criteria, Lu estimated.
One trigger to reject an investment is if a company has a record of consistent disregard for minority shareholder interests. “We probably wouldn’t even look at it, even with a discount [on valuation],” he said.
Another warning sign is the widespread practice of share pledging in China –when owners pledge their company shares as collateral for a business loan because financing is hard to come by. Robeco has turned down companies with high share pledge ratios.
“At the end of 2018 when the market corrected, the share pledge ratio became a real issue,” Lu added.