However, per capita figures are still much lower than richer nations. The Chinese government needed to act after poor air quality in major cities came to global attention during the 2008 Olympics. Polluting industries, such as coal power stations and steel were - and continue to be - reformed.

The Communist Party included the environment as one of its seven objectives in its 13^th Five-Year Plan for economic and social development, with key performance indicators ranging from CO₂ emissions to forest growth. It remains committed to the Paris Agreement even though the USA has pulled out.

Action has followed policy. Fossil fuel remains the main source of energy, but renewables are rising. In 2017, renewables generated 26.4% of total electric power. The goal is to reduce fossil sources to below 50% by 2030. Meanwhile China has become the largest producer of photovoltaic panels and wind turbines and has the largest installed capacity of both (about 30% of the global total in 2018).

The manufacturing industry is reforming across the board. Tougher emission standards for electricity generation meant the steel sector replaced coal power as the biggest polluting industrial sector in 2017. New ultra-low steel emission standards were introduced in 2019; the goal is for 60% of plant compliance within a year and 80% by 2025. Whilst there may be challenges with enforcement, the direction of intent is clear.

Since establishing a Green Finance Committee and Environmental Protection Law in 2015, we have seen rapid expansion and improvement in Chinese green finance. Data from the Climate Bonds Initiative shows China’s global ranking of green bonds issuance rose from 8^th in 2015 (less than USD1 billion) to 2^nd in 2019 (USD31.3 billion).

Overall, it is still early days and there will be environmental setbacks. For example, coal power curbs were reduced to stimulate economic growth after Covid-19. Regardless, the intention is clear, and measures could materially impact companies bringing both challenges and opportunities. 

Rapid changes in democracies are rare. Change requires approvals by elected parliaments and congresses, with checks and balances, but also lobbying, manipulation and the desire to be re-elected. A company can continue to enjoy higher share prices as long as it can deliver earnings regardless of its impact on climate unless asset owners explicitly take climate change into consideration.

This is not the case in China. A fund manager explained that ‘getting caught in China doesn’t just mean a hefty fine but could lead to prison for a long, long time’. China is a command economy that can introduce overnight changes leading to radical shifts in the fortunes of companies and entire industries. Skilful Chinese fund managers are compelled to consider the environmental impact of a company as a main course of their due diligence because it could directly impact its financial future.

Cement was a cyclical growth story up to the 2008 Olympics followed by a spectacular crash that slowly recovered by 2011. Throughout two business cycles there was not much differentiation between share prices in the sector. Things changed after the government took concrete steps to clamp down on the most polluting sites and then reducing excess capacity in 2013. For example, between late 2013 and early 2014, Yi’an, a district built on cement production, shut down 30 plants, losing thousands of jobs.

Despite the shutdowns, aggregate demand for cement plateaued in 2014 and never crashed. This created the opportunity for better, cleaner manufacturers to increase market share. Anhui Conch, a portfolio holding across many of our managers, is one such company. The chart shows how its fortunes parted ways from its peers from 2015.

While there are differences in each company’s fundamentals, one contributing factor to Anhui Conch’s outperformance has been its continuous investment into technology and equipment upgrades to stay efficient and compliant with more stringent environmental regulations.

Understanding the environmental impact of a company and how it compares to its peers is a fundamental question for Chinese managers seeking sustainable long-term investments. Environmental impact can have a material impact on financial performance so there is no compromise between financial return and ESG. 

ESG is integral to what most investment managers do without necessarily having explicit ESG policies and processes. That is also changing. Increasingly we are seeing – and encouraging or assisting – managers to develop documented ESG policies, explicitly accounting for them in their investment process and communicating the impact on their decision making. This may not change how they research companies in practice (since environmental concerns are already incorporated) but rather makes ESG a formal part of their investment process.

Faisal Rafi FIA

Head of Research, RisCura Solutions (UK)