Does Investing in China align with ESG?

The Age of Transformation centres on the world’s transition into a new economic environment and the accompanying trends contributing to a more sustainable and inclusive world. But what happens when these trends appear to collide with the end goals?

As the world’s geopolitical forces shift, China is increasingly taking a more dominant role in the world order. From an investment perspective, the opportunities presented by this high growth, evolving economy are significant. Yet, its reputation has been dented by reports of poor human rights practices and its pledge to become carbon neutral by 2060 was deemed unambitious and out of sync with the Paris goal of net zero by 2050.

So it begs the question of whether you should invest in China if you want to take responsible and Environment Social and Governance (ESG) investing seriously? As ever such questions are not black and white and demand further investigation…

As the world’s biggest source of carbon emissions, at 28%¹, China’s contribution to the Glasgow COP seemed underwhelming. President Xi’s non-attendance was construed as a snub and China was one of the principal drivers behind weakening of the language around coal from phasing out to merely phasing down.

With the ripples around COP starting to fade, however, it is worth taking a closer look at what China’s doing in terms of climate action.

While its broader carbon neutral target is far off, China’s aim to have 25% non-fossil fuel by 2030 is likely to be met early. In fact, its total accumulated wind and solar capacity amounted to 635 giga watts in 2021, representing 26.7% of the national total and it aims to raise this capacity to at least 1,200 giga watts by 2030².

And while it remains committed to coal, and is continuing to build new capacity, it has pledged to control coal consumption until 2025 and will start to reduce it from 2026. Finally, it agreed to work alongside the US to reduce methane emissions in this decade as part of the two countries’ joint declaration on climate released during COP 26.

It’s also important to acknowledge that China’s size means any actions have scale.

An interesting difference between China’s approach to climate control versus that of many other nations is centred around its politics.

Many democratic governments have issued bold climate declarations and ambitious targets, but if you look beneath the surface there is little detail underlying these plans. And as we saw during the Trump presidency, such commitments can be quickly and easily overturned upon a change of leadership.

As an autocratic regime, China has a longer-term trajectory for industrial planning. It has already put a development pathway in place, environmental and ecological commitments have been written into the Chinese constitution and new laws on pollution control have been passed. Green pilot schemes are being rolled out in smaller regions that have the potential to establish new norms not only for China as a whole, but also for the rest of the world.

The Chinese government possibly has a preference for underpromising but overdelivering on its climate pledges.

Despite appearances, China aims to match the rest of the world in terms of its climate ambitions. It wants to be the world’s biggest producer of electric vehicles, with sales jumping 154% last year to reach a total of 3.3 million units sold³ .

It is kickstarting its hydrogen aspirations by subsidising fuel-cell vehicles and their infrastructure, focusing on three trial cities . And is not letting up on its already considerable leadership in renewable energy.

In realising this ambition, it is maximising its strength in both innovation and manufacturing. As such it is upping the ante in the race to deliver new and effective climate solutions. How this plays out will be interesting to watch – will this increase tensions with the US or encourage a spirit of friendly competitiveness? Either way, it should lead to further opportunities for environmental investors.

Another area where China exhibits dominance is the production of polysilicon, where it accounted for 77% of global production in 2020⁵. Polysilicon, a high purity form of silicon, is a key raw material in the solar PV supply chain and, at present, supply is struggling to meet rising demand, creating an attractive investment scenario.

However, several manufacturers are located in China’s Xinjiang province and supply has been caught up in the scrutiny around alleged forced labour practices in that area. In June 2021, the US Commerce Department blacklisted several Chinese entities connected to polysilicon supply even though the companies involved issuing fierce denials of wrongdoing .

There are recent indications that the US will soften its stance, but this situation serves as a useful reminder that chasing the best investment returns can sometimes conflict with ESG goals and requires further investigation.

While China may not try to win the war on climate change rhetoric, it is clearly demonstrating that it is taking its climate commitments seriously and is making major advances in many areas. That said, there are definitely areas of concern that must not be disregarded just because they meet the E in ESG.

At BNP Paribas Asset Management, our clear, focused, unbiased insight helps us deliver to our clients what they rightfully expect. In the context of China, this means using our experience, knowledge and technical skills to find those companies with strong governance and a proper regard for both human rights and the environment, that place delivering on ESG goals as a priority.

We have seen how engagement can have a positive impact and believe this will be the case in China as well. But to have a positive engagement impact, we have to be invested, we have to have a stake and a voice. Only then can we use our influence to try and encourage the change that we, and our clients, want to see.