China’s Regulatory Announcements Part III

From your perspective, how are you viewing China’s recent regulatory announcements?

Many of these changes can be seen through an ESG (environment, governance, social) lens. In fact, these regulations can be viewed as almost playing catch up to global best practices. What China’s government really wants is not only for companies to comply with the law, but that they also maintain and assert mainstream values. In addition, they want these companies to undertake corporate social responsibility activities.

Take, for example, the avoidance of monopolies in key sectors, and supporting small and medium-sized businesses. Another goal is ensuring social cohesion, which is considered vital. What is often underappreciated, but has been key for the long-term development of China, is the concept of common prosperity. And it's not just about the economy. China’s government has tried to ensure equality mainly through eliminating poverty, and they've been very successful at this. But at the same time, there has been a rise in inequality, which the government really wants to focus on and is a key driver of its recent regulatory push. As China has evolved (last year China hit a significant milestone of GDP per capita of US$10,000), we can see that while the country has moved to another stage of economic development, ensuring common prosperity and social cohesion remains a fundamental goal. 

When we think about common prosperity and social cohesion, which sectors are important for that stability?

Sectors considered as especially key to stability include education, housing and health care. The cost of education has caused a lot of anxiety among parents, and has been a barrier to parents having more children, for example. And this is important because the most recent census showed that in 2020, Chinese birth rates were the lowest they've been in history. Due to China’s aging population, the declining birth rate is considered a very important demographic challenge that the government seeks to address.

Within the housing sector, the government has discouraged housing purchases as investments rather than for personal use, stating outright that "Housing should not be used for speculation because housing is for living." In terms of health care, the main concern is really about just ensuring affordable health care and making sure it's accessible to the masses. But I think what's very important is this focus on corporate responsibility—especially, for example, very large technology companies—because they're so important in terms of everyday life in China.

It seems the Chinese government wants companies to strike a balance between profit and social responsibility.

Yes. The government has said that companies should really focus on the treatment of all stakeholders, including the protection of workers. And so aspects of corporate culture such as “996”—a reference to making employees work from 9:00 AM to 9:00 PM, six days a week—is something they’re looking to strongly discourage. The government has come down hard on corporate misconduct as well. And so this is crucial not only for social cohesion, but also for a company's long-term success. What's made some of these companies so successful has really been their people and overall corporate culture. So I think it's only normal that the government has looked at specific ways to reign in the power that certain companies have on everyday life in China.

How should investors think about the quality of corporate governance and Chinese regulator’s commitment to protecting minority investors?

China has taken many steps to give investors more confidence to invest in the country's capital markets by focusing policy on corporate governance reforms. We’ve seen a lot of progress in terms of commitment to protecting minority shareholders’ interests over the past few years. During this time there’s been steady positive momentum on a variety of ESG factors, not just corporate governance, but also issues such as state ownership, shareholder friendliness, ownership and control structures, disclosure, board composition, environmental stewardship, corporate conduct and even dividend policies, such as the amount of dividends being paid to shareholders as well as the number of companies paying dividends.

What have regulators done to improve transparency, disclosure and legal protection of foreign investors’ interests?

As Chinese capital markets have continued to open to foreign investors, regulators have introduced numerous policies and laws to promote better practices and disclosure among corporates. In 2018, China Securities Regulatory Commission (CSRC) revised its Corporate Governance Code to promote diversity, underscore the role of minority shareholders, promote cash dividend distribution and generally strengthen ESG principles. In 2020, a revised Securities Law went to the heart of enhancing disclosure requirements and investor protection rules by raising the cost of financial fraud with higher maximum penalties.

China A-shares regulators, in particular, have worked very hard to improve the quality of corporate governance. For example, key rules and guidelines have been either amended or issued over the past few years that relate to financial reporting, disclosure of substantial ownership stakes and Director trading. In some respects, A-share listed companies are out-doing their counterparts that are listed in Hong Kong and the New York Stock Exchange, as those exchanges don't have such strict and comprehensive disclosure requirements. 

For a number of years, investors have heard that China's remarkable economic development has come at the expense of severe industrial pollution. Do you believe that the Chinese government is serious about taking necessary steps to address climate change?

Yes. When China has targets and goals, they are generally successful in meeting them, and I think that the same will be true for climate action such as reducing emissions. Last September, China pledged to be carbon neutral by 2060, and also has a goal to peak CO2 emissions in 2030. China has been moving at a fast pace to reverse some of the damage that has been done in terms of the environment over the last few years. The country has also moved in the right direction to reverse some of those climate externalities. In 2019, for example, China added five times more renewables capacity than the U.S.

And I think it’s important to note that China’s commitment to addressing climate change has really been through innovation and through sustainable industrial development and policies.

Can you expand on that by sharing an example or two?

If you look at the electric vehicle (EV) industry, it was born out of the government's industrial policies and incentives put in place to move this industry up the value chain in terms of value add and technological innovation. The emissions from an EV versus an internal combustion engine car are obviously much less, and China has an admirable target when it comes to new energy vehicles—20% of all new car sales by 2025 to be electric. Today, China is already the largest and fastest growing market for EVs. When you think about the entire supply chain for EVs, you have to think about the battery, and China is also dominating this space, and seeking to innovate in terms of certain materials that can be used more sustainably in the battery.

I also think that this could potentially happen to the hydrogen economy—an envisioned future in which hydrogen is being used to decarbonize hard-to-abate industries such as cement and steel production. China is currently developing policy support and incentives to really bring the hydrogen economy up to scale. If the hydrogen plan follows the same path as the EV industrial movement, this could be very important. 

What are your thoughts on China’s national emissions trading scheme?

 For many years, China had an emissions trading scheme pilot program in various cities. But a few weeks ago, they launched it on a national scale, which for now is only covering the power sector. But over the next few years, more and more industries will be included which has the potential to cover about 40% of all of China's CO2 emissions, and about 10% of the global emissions.

There has been a lot of progress, even early on, when it comes to the pricing of carbon. As expected, the price is quite low but this was also the case when the EU introduced their emissions trading scheme years ago. The price was low for a long time, until they started limiting the quotas and capping the emissions. China has the EU's progress to look to as an example, so I expect they will much quicker in terms of reducing those restrictions. This could mean that we will see a higher carbon price in China in shorter time than we saw, for example, in the EU.

When it comes to climate change,  this is an important area where we're actually seeing a lot of cooperation between the U.S. and China—even in April, there was a joint statement from the climate envoys both countries. There's great work being done at a company level, at university research level, and at the government level in terms of addressing climate change, and this'll be crucial going forward.

From your perspective, why should investors remain invested in China or continue to seriously consider making dedicated investments into China?

China's past economic development has led to some serious environmental issues, as well as lingering institutional deficiencies and some social issues. The country’s leaders have understood that transforming the world's second-largest economy from one dependent on highly polluting heavy industry to one focused on clean energy, services and innovation is essential, not only to the future of the planet, but to China's own prosperity. Policymakers' focus on green policies has led to China's pivotal role in environmental protection, which can been seen through a slew of new regulation, commitments and investments in innovation. 

Additionally, China has taken many steps to give investors more confidence to invest in the country's capital markets, including improved corporate governance and better disclosures, the ability of companies to create value for investors. In my view, China’s ESG progress will be aligned with the country’s longer-term policy objectives and there is significant investment opportunity in China.

Investing in Chinese securities involve risks. Heightened risks related to the regulatory environment and the potential actions by the Chinese government could negatively impact performance.

All investments involve risk. Past performance is no guarantee of future results. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation.