China A-shares inclusion set to light ESG fuse

The opening of the China A-shares market to foreign investors provides a window for China-focused funds to push ESG criteria into greater prominence in the world’s second largest economy.

The environmental crisis facing China is off the scale – literally. Air pollution in Beijing is so impenetrable that the US embassy’s air quality measuring station describes it as “beyond index”. More than half of China’s surface water is so polluted it cannot be treated to make it drinkable. Rivers run black with sludge. Factory farming has led to desertification. Deforestation threatens hundreds of species.

But after avoiding the issue for years, Chinese economic policy is now tackling the country’s environmental problems head on.

AllianceBerstein China equities portfolio manager John Lin says: “When President Xi Jinping made a speech last year in November it was the first time in Chinese history that the number of words about the environment surpassed the number of words on the economy, which is a real indication that policy makers are prioritising pollution issues.”

On 1 June, the MSCI added 234 Chinese mainland-listed stocks (A-shares) to represent 0.8% of the MSCI Emerging Markets Index. While this initial inclusion is low it is expected that over time A-shares will have a significant representation in the future.

Daniel Poon, managing director of Zeal Asset Management in Hong Kong, says the MSCI A-shares inclusion will help the country’s new environment push.

“There is a general misconception that Chinese governance is like the Wild West with really bad reporting and management structure.”

“The inclusion into the MSCI global indices is a good starting point for the amalgamation of investor expectations and this will help the governance quality of the A-share market to move up to another level,” Poon says.

ESG labels

Lin says it is hard to differentiate companies within the A-share market that had ESG inclusion due to a lack of A-shares coverage by international rating agencies.

“Up until this month the majority of these A-shares were not really rated at all on their ESG integration. While international investors realise that ESG is important, there is not a lot of systematic information,” Lin says.

Lin adds that MSCI says there would likely be a change in ratings over the coming months and quarters as more information becomes available.

When PA‘s sister title Expert Investor looked at European domiciled A-shares funds that had a Morningstar Sustainability Rating, only one had achieved the highest rating – five globes.

The fund, East Capital China A-Shares Investors A Distribution, has its highest sector weightings towards financial services (28.6%), followed by consumer cyclicals (17.8%), consumer defensive (13%), technology (12.2%), and industrials (11.1%).

The only fund that achieved four globes was AllianceBernstein’s China Investments – China A Shares Value Equity Portfolio SP1 USD Accumulation. Its top weighted sector was also in financial services (25%), followed by basic materials (18%), and industrials (14.7%).

Both funds have the highest stock weighting in Ping An Insurance Company of China.

Overall, only five funds had a Morningstar Sustainability Rating, emphasising the lack of information on A-shares stocks.

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