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Summary: China may still be the largest polluter of the world but there has been encouraging progress made on its tackling of industrial pollution. China’s emissions more than doubled between 2000 and 2008 but it has now reduced drastically, growing at just 2.6% every year on average between 2008 and 2018. The future targets are even more ambitious. China’s aim is to have CO2 emissions peak before 2030 and achieve carbon neutrality before 2060. Now, does this improvement in ‘E’ come under consideration when Global Institutional Investors discuss China and its track record on Sustainability or ESG (Environmental, Social and Governance)? When Global Fund Managers talk about China and its track record on E, S and G, the focus invariably is more on S and G and not so much on ‘E’. There are only a few investors proactively taking a stance that since China’s track record on ‘Environmental’ parameters has been improving, this should be incorporated into investment decision making when Chinese stocks are evaluated based on their ESG performance.

The EM investing landscape is very dynamic and China is no exception. In the context of China and how the local changes are to be incorporated into investment decisions by several large global institutions, we think that the push for Sustainability has not been analysed enough. For example, the progress China has made in controlling environmental pollution by introducing new regulations, which are far more stringent, is something that should be considered while making investment decisions. Clearly, the alleged thought process of Chinese policymakers, which was popular in the 1980s and even till late 1990s, that the environmental issues are not that important to a developing economy like China, has completely and fundamentally changed.

China may still be the largest polluter but nonetheless, there has been encouraging progress made. For example, China’s emissions more than doubled between 2000 and 2008, growing from 3.4 metric gigatons to 7.4 metric gigatons, according to BP PLC’s Statistical Review of World Energy. But the emissions have been increasing at a much slower rate in recent years and BP estimates that China’s emissions growth averaged 2.6% between 2008 and 2018. There have been specific steps undertaken that are responsible for this change. For instance, China has aggressively cut down its dependence on coal based power plants and has instead shifted focus on renewables in a disciplined manner. It also has been very aggressive in adopting new technologies such as EVs (Electric Vehicles).

China’s future targets are even more ambitious. While US, under Trump, exited from the Paris climate deal, China became even more aggressive in what it could deliver on this front over the next few decades. In September 2020, China made a surprise announcement when President Xi Jinping made public the intent to decarbonize the nation’s economy by 2060. In layman’s terms, China will stop releasing CO2 within the next 40 years. Xi’s announcement at the U.N. General Assembly was welcomed by several global leaders, especially the ones from Europe who see China as the template for pollution control in developing countries. Officially, China’s aim is to have CO2 emissions peak before 2030 and achieve carbon neutrality before 2060. Obviously, more stringent policies are likely to follow.

The efforts are bearing fruit. For example, let us look at how quickly the situation has improved in Beijing. It was one of the most polluted cities in the world but when the Government became supportive and the administration proactive, the pollution control measures led to significant improvements and to such an extent that there are virtually no parallels to what the city has been able to achieve in just a decade. Political will is the key and it worked as a catalyst as President Xi Jinping himself was keen on shedding Beijing’s image as the ‘World’s most polluted capital’.

Chart 1: Changes in annual average concentrations of air pollutants in Beijing, 1998-2017

 
Source: UN Environment 2019. A Review of 20 Years’ Air Pollution Control in Beijing. United Nations Environment Programme, Nairobi, Kenya
 

But Beijing is not an isolated case for drawing inferences on how China has decisively moved against alarming pollution levels. There are several other success stories as well and while the extent of improvement varies, the level of global pollution China is responsible for considering how the size of its economy and manufacturing industry has grown in the 21st century, is to be taken note of. Sure enough, there is still a long way to go and while there are discussions on why China has become concerned with protecting the environment in and around its big cities, there is convincing argument against the fact that China has completely stopped ignoring the harmful effects on environment from the pollution caused by its manufacturing industry, which virtually is ‘The factory to the world’.

There are other important data points which EMAlpha Machines have picked up and they indicate that China is taking the entire ‘pollution’ and ‘environmental protection’ issue very seriously. For example, the EMAlpha machines have picked up news stories on how manufacturing industry is shifting to places like Vietnam with the reasoning being, ‘less stringent pollution regulation’. There are also stories doing the rounds about analysts and fund managers talking about the bright future of speciality chemicals industry in India. The reason being the tighter pollution control norms in China, because of which the manufacturing shift is tilting towards India. This is undoubtedly great for the Indian speciality chemicals companies and their stocks.

Now, do we see this improvement in ‘E’ under focus when Global Institutional Investors discuss China and its track record on Sustainability or ESG (Environmental, Social and Governance)? The EMAlpha research indicates that often when Global Fund Managers talk about China and its track record on E, S and G, the focus invariably is more on S and G. And there are plenty of negatives to talk about here. But the ‘E’ gets ignored in the process. There are only a few investors proactively taking a stance that since China’s track record on ‘Environmental’ parameters has been improving, why not look at that as well while evaluating Chinese stocks based on ESG performance.

In the markets, the best investment philosophy is never based on absolute level of how good or bad things are. It is always based on an attempt to figure out ‘the direction of incremental change and whether that is positive or negative’. The markets or stocks which will do better and outperform others may be good or bad in absolute terms but they would do so because they would be improving on a relative basis. Isn’t it strange that this aspect where the Chinese Government is doing a relatively better job than many other EMs or even Developed Markets, is not getting enough attention from the investors?

While 2020 will be remembered as the watershed year for the direct relevance and impact of ESG issues, different countries are being treated differently on evaluation parameters. The value of global assets applying ESG data to drive investment decisions has doubled over four years, and more than tripled over eight years, surpassing $40 trillion in 2020. Big institutional investment managers such as Blackrock are aggressively pushing ‘Sustainability Agenda’ and this trend is gaining momentum.

Some regional variations are natural. But, Is China getting adequately rewarded by Sustainability-focused Global Investors for the country’s progress and future commitments on Environmental Issues? The answer is clearly not an emphatic “YES” and there is this dichotomy which may be important enough for an investment call on China and far too significant to miss. Ideally, the factor based ESG evaluation (the individual performance on all three parameters) should be independent and one score (for example, E) should not be influenced by other scores (S or G). That is how it will be able to capture the ESG performance correctly.

At EMAlpha, the ESG team is doing more research on why some issues like Social get more prominence as compared to others like Environmental or Governance issues. To look at specific cases in the context of ESG is a very intense yet interesting exercise and this has been an incredible learning experience for the EMAlpha Research team. The data, information and ratings are a humongous challenge for ESG and it takes time to reach to the depth of the issues as the field is evolving very quickly.

EMAlpha is making a solid contribution in tackling these challenges. EMAlpha has solutions for ESG which are practical, user friendly and although not too simplistic yet easy to use. EMAlpha has developed a Flexible ESG Framework Management System which is a proprietary technology that makes ESG scores framework agnostic, thus allowing for quick adaptation. In addition, the users decide what matters to them and the EMAlpha system does a classification into E, S, G and more granular categories.

We strongly believe that the entire ESG ecosystem requires multiple stakeholders to pull in the right direction in order to make it operational and that will be the most critically determining factor for ESG’s success in making the corporate responsibility actually work. Very importantly, the investors should see ‘E’, ‘S’ and ‘G’ separately and should not really mix issues when it comes to the comprehensive ESG evaluation. It is important to understand the right reasons behind ESG investing because this bias could hurt their investment decision making and portfolio performance.

Research Team

EM Alpha LLC

For more EMAlpha Insights on Emerging Markets, please visit https://emalpha.com/insights/. To know how you can use EMAlpha’s unstructured data and ESG (Environmental, Social and Governance) solutions for better investment decisions, please send us an email at research@emalpha.com.

About EMAlpha:

EMAlpha, a data analytics and investment management firm focused on making Emerging Markets (EMs) more accessible to global investors and unlocking EM investing using machines. EMAlpha’s focus is on Unstructured Data as the EMs are particularly susceptible to swings in news flow driven investor sentiment. EMAlpha works on information discovery and ESG solutions for Investors in Emerging Markets, using AI and NLP tech. Our mission is: “To help increase capital flow, in terms of FDI and FPI, to Emerging Markets by lowering information barriers using AI/NLP”. EMAlpha Products help achieve both alpha and ESG solutions and the idea is to help asset allocators, asset managers, banks and hedge funds along with companies with cost and time efficient access to relevant information. We use thoroughly researched machine learning tools to track evolving sentiment specifically towards EMs and EMAlpha pays special attention to the timely measurement of news sentiment for investors as these markets can be finicky and sentiment can be capricious. Our team members have deep expertise in research and trading in multiple Emerging Markets and EMAlpha’s collaborative approach to combining machine learning tools with a fundamental approach help us understand these markets better.

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