09 Mar 2021
David Smith, Senior Investment Director, Asian Equities
There’s growing appreciation among Chinese companies of the value that ESG policies can bring. Here we outline five firms setting the standards for domestic peers to follow.
As a global investor, we carry out environment, social and governance (ESG) analysis when we research companies for two reasons: (1) not to lose money; (2) to make money.
We believe selecting firms with strong ESG standards improves our chance of avoiding loss-making corporate failures and scandals. We also see it as a way to generate alpha – or above-market returns – by investing in positive change at companies. Ultimately, we’re confident that progressive ESG policies will drive company returns and share prices over the long run.
To break the acronym down, the ‘E’ of ESG relates to how companies interact with the environment – what they consume, discharge, dig up or leave behind. The ‘S’ deals with the way they interact with employees, government, society and vendors; and the ‘G’ refers to the governance of a company, or how well it is managed.
We know energy use is changing the world over. Understanding who the winners and losers will be in the global transition to renewable energy is terrifically important for us as investors.
At the same time, supporting employee well-being and adhering to fair labour principles can lead to a more productive workforce, creating value in the long run. Further, instituting a code of conduct for suppliers is also key to guard against exposure to human rights abuses.
A common perception about China is that its companies retain a rudimentary understanding of ESG, with low levels of transparency and disclosure. That may have been true in the past.
Today we’re seeing a growing appreciation of the value that attention to ESG factors can bring in China.
But today we’re seeing a growing appreciation of the value that attention to ESG factors can bring in China. The nation’s securities regulator is drawing up new guidelines this year to improve the quality of disclosures among listed companies and to protect investor interests.
Many Chinese 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.
We continue to see improvements in corporate governance, in areas ranging from greater transparency and enhanced management composition to diversified share ownership. Here we outline five trailblazing Chinese firms setting new standards for ESG in the country.
Contemporary Amperex Technology Co. (CATL) is core to China’s push to achieve net zero carbon emissions by 2060. It’s a global frontrunner in the manufacture of rechargeable lithium-ion batteries, which will power the shift to the electrification of road transport. Aligned to United Nations’ goals on sustainable energy and climate change, CATL strives to emulate the quality of global peers such as LG Chemical and Samsung SDI. It leads the way in packaging technology to make batteries more energy dense without making them larger or heavier. The company has strong governance and manages its supply chain well. Lithium-ion batteries require cobalt, which can be sourced from the Democratic Republic of Congo. CATL publically discloses its policies on maintaining a responsible mineral supply chain, notably with respect to human rights and child labour. Led by veteran founder Zeng Yuqun, the firm has a healthy ownership structure and its board of directors boasts a balance of industry experts and independent professionals. It practices responsible product development with an emphasis on safety and has sound policies regarding restriction of hazardous substances. It also manages its own waste and toxic emissions below levels required by regulators.
Centre Testing International Group is pivotal to building trust in Chinese goods, services and supply chains; its strategic importance should not be underestimated. It’s the leader in inspecting, testing and certifying industrial and consumer products. It ensures Chinese companies adhere to the highest environmental, health and safety standards – in line with United Nations’ Sustainable Development Goals. Contrary to MSCI’s low CCC rating for this company, we have found its management team to be highly engaged on environment, social and governance issues – reinforcing the value of proprietary research. Centre Testing relies on specialists to develop and deliver test procedures and results, and it runs an in-house training system, a mentorship scheme and a graduate program to retain talent. Its appraisal system also rewards staff based on performance. It engages companies on research and development before product launch, so data security is a risk. But it meets the world’s most widely used information security management standards. It has two layers of checks to prevent data forgery and a system to respond to network hacker attacks and intercept security incidents. It employs firewalls and anti-virus software, has real-time back-up of key data and ensures operations are completed online to prevent data falsification. Centre Testing is in the trust business, and being trusted is integral to its own credibility, too.
China Tourism Group serves as a model for what successful reform of a state-owned enterprise looks like. Market consolidation has transformed the company into a virtual monopoly in the sale of duty-free goods in China. It is the only enterprise authorised to run a duty-free business without zone restrictions nationally. CTG is the realisation of government efforts to repatriate consumption and create a domestic duty-free champion to compete with leading global peers. As a listed entity, it can offer flexible and competitive remuneration to senior managers, which has cultivated an executive team of experienced industry figures with good strategic execution and lobbying power. They navigated Covid-19 disruptions well, upgrading their e-commerce platform and rolling out online shopping services. They also manage environment, social and governance risks well, having published a corporate social responsibility report since 2010 that is benchmarked to domestic and international standards. The company offers a full staff breakdown and runs training programs to retain staff in an industry that is reliant on a core workforce. It also circulates guidelines on energy-saving practices, periodically evaluates risk in the protection of customer data and offers an anonymous whistleblowing hotline for employees and stakeholders to promote best practice.
Nari Technology is a pioneer at the heart of China’s energy reform. The nation’s leading provider of secondary power equipment, its hardware and especially software will facilitate the transition of China’s fossil fuel-powered grid to renewable energy. Really it is more of a solutions provider than an equipment manufacturer, ensuring that China’s energy supply is fit for the future. Owing to the nature of its business, it is aligned to United Nations’ Sustainable Development Goals on energy efficiency and affordable energy. China needs to focus on making its grid smart, meaning installing sensors to monitor supply and demand and increase efficiency. The drive to embrace digital interconnectivity including 5G will be mainstream over the next decade. Nari has a leading position, in part because of its existing working relationship with the state grid. But importantly, it also has an incentive scheme in place for its technology staff – aware that retaining top talent is core to the company maintaining its edge. Explaining Nari Tech to uninitiated investors usually serves as a lightbulb moment in their realisation of its strategic importance in China.
Shenzhou International Group is a textiles manufacturer that produces athleisure wear, among other things. It is one of the highest rated companies in the garments industry. It can be difficult to verify sources for cotton, with inherent risks that companies resort to black-listed suppliers. But Shenzhou International is very transparent about its supply chain management, and predominantly deals with major suppliers in Hong Kong and Shanghai. It has experienced no labour irregularities, nor concerns over working conditions. The company requires its major suppliers to sign a declaration adhering to standards on human rights and child labour, and to complete assessment forms committing to product quality. Its biggest clients – Nike, Adidas, Puma and Uniqlo – also retain offices in Shenzhou’s manufacturing plants enabling them to perform random checks on processes and supply chains. Shenzhou is confident it does not procure yarn from black-listed sources, not least because the list is very public. Its close working relations with some of the world’s biggest brands underlines the value of reinforcing global standards to industry peers in China and beyond.
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