China’s reopening will boost Asia-Pacific ESG funds market, analysts say

China reopening its borders and easing its strict zero-Covid policies will drive the growth of environment, social and governance (ESG)-themed investment funds, analysts said. Beijing must also urgently issue policies to regulate greenwashing and disclosure standards.

Last year, ESG funds in Asia-Pacific reduced their exposure to equities by US$5.9 billion, primarily driven by weak investor sentiment towards China due to its strict Covid-19 policies and three years of quarantine requirements, according to a report issued by the Bank of America (BofA) this month. However, after China relaxed its Covid-19 restrictions in December 2022, ESG funds in Asia-Pacific have rotated back towards equities by US$1.5 billion, mainly via mainland China, Hong Kong and India.

“Improving sentiment towards China, driven by consumer demand, fewer earnings downgrades and positive news trends, could help Asia-Pacific ESG funds in 2023,” the report said.

This is significant because ESG funds in the region already have considerable exposure to China. According to Girish Nair, co-head of BofA’s Asia-Pacific ESG research, ESG funds with exposure to China managed US$400 billion in assets as of the end of November 2022, quadrupling 2015 levels. BofA anticipated that these assets would grow by around 16 per cent by the end of the first quarter in 2023.

“We believe sustainable investing still has plenty of potential for continued growth in China, given that sustainable funds represent only a small fraction of the overall China fund universe,” said Dean Wang, associate manager and research analyst at Morningstar China’s Shenzhen office. “From a regulatory standpoint, it is in line with China’s road map towards green finance and capital market stability.”

The size of the green finance market in China, the world’s largest emitter of carbon dioxide, has already reached 16 trillion yuan (US$2.35 trillion), accounting for about 8 per cent of the country’s entire financial system, according to UBS. The market has been boosted by Chinese President Xi Jinping’s pledge to have the country peak its carbon emissions by 2030 and reach net-zero emissions by 2060.

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Meanwhile, a set of new rules, expected to be introduced by the Asset Management Association of China, the country’s funds regulator, in the first half of 2023 to rein in greenwashing, could lead to a decline in the number of ESG funds in China, but will also improve China’s ESG funds market, according to analysts.

The proposed rules will reportedly require ESG funds to invest at least 60 per cent of their assets into a defined green investment category, which could lead to a decrease in the number of ESG labelled funds in China, said BofA’s Nair.

Last year, entities in China raised more than US$113 billion in sustainable finance, a 33.5 per cent increase year on year, according to BofA. While in the European Union and the United States regulators have proposed standardised reporting schemes for ESG information, Chinese regulators have not yet introduced similar guidelines, Nair said.

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“So far, there hasn’t been clear rules on what constitutes an eligible ESG fund in China, or disclosure of any relevant investment strategies, which heightens greenwashing risks for such ESG-labelled funds,” said Jia Jingwei, associate director of Sustainable Fitch.

A key challenge is the divergence of Chinese and international standards for assessing Chinese companies’ ESG profiles.

“The absence of ESG disclosure standards in China has made it challenging for domestic and international investors to identify the ESG performance of Chinese companies. Using different practices or technical standards has created confusion for investors, and some existing standards from developed markets do not always apply to local Chinese contexts,” Jia said.

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A green taxonomy will be able to create a more unified language around sustainable investing, and promote greater availability and reliability of ESG metrics and disclosures to investors, analysts said.

In March last year, the China Enterprise Reform and Development Society, a think tank linked with the government, published the first set of disclosure standards tailored to the Chinese market.

“In 2023, we would like to see Chinese regulators work towards standardising the reporting guidelines for companies. Adopting comprehensive and mandatory disclosure guidelines for mainland-listed companies would bring China in line with other major economies,” said BofA’s Nair.