Sustainable Investment in China | How Private Equity is Investing Responsibly in China

In China, where there are numerous environmental, social, and governance (ESG) risks and sustainability challenges, responsible investment is both necessary and common sense, as PRI’s James Gifford explained at the forum. PRI signatories Lunar Capital and Orchid Capital, along with Tsing Capital and Hui Nong Capital, agreed with this statement and outlined how they integrate responsible investment throughout their investment processes, from analysis to audits and due diligence to engagement and management of portfolio companies.

At BSR's recent forum in Beijing—held in conjunction with the UN-backed Principles for Responsible Investment (PRI), Beijing Private Equity Association, and Magic Stone Investment and attended by 60 investment professionals—the focus was on the overall context in China for responsible investment and how private equity in China is investing responsibly.

The Context for Responsible Investment in China

Awareness of responsible investment in China is still low, making the need for a clear business case especially important. However, the need and the opportunity for responsible investment could not be greater.

The social impacts of environmental problems caused by industry are a major concern for the stability and development of China, as the government acknowledges, according to Bie Tao, policies and regulations department head, Ministry of Environmental Protections (MEP). The government has more than 230 policies and multiple initiatives underway to protect the environment. Bie Tao discussed the clear risks to business and investors when companies do not act responsibly, citing several examples of the adverse social and economic impacts of projects stalled or dragged into the limelight by environmentally-related protests.

The government also understands the economic opportunities for the country to direct capital towards projects that produce environmental benefits and away from those that negatively impact the environment, as the China Banking Regulatory Commission’s Wang Qingrong, department division chief, explained. The Shanghai Stock Exchange’s Yang Xu, from the Capital Markets Institute, elaborated on this, explaining that the Exchange plays a role in improving corporate disclosure of environmental, social and governance (ESG) issues and that it plans to expand mandatory disclosures, particularly for industries with a large environmental and social footprints. The Exchange also plans to provide detailed guidelines to address the poor quality of current disclosures—for example, only 22 of the 351 CSR reports released in 2011 by Shanghai Stock Exchange listed companies were independently assured.

China’s regulators have made efforts to identify and support responsible investment, for which the International Finance Corporation’s (IFC) Rong Zhang commended them. These efforts include the recently revised Green Credit Guidelines, which Rong said were some of the most progressive worldwide, making China a leading example in Asia. Rong also cited the IFC’s development of performance standards, detailed sector-specific guidelines, the Equator Principles, and tools and resources specifically for private equity firms. The resources are publicly available and can aid banks and investors integrate responsible investment into their investment processes.

BSR explored the implications of sustainability challenges for businesses in China and explored whether companies should regard increased transparency as an opportunity rather than a risk, in light of the MEP’s point that many protests and public criticism occur due to a lack of trust in companies’ communications about their performance—rather than companies’ actual poor performance. Furthermore, as BSR highlighted, there is a clear link between responsible, sustainable business and traditional economic success: When companies mitigate the risks related to fines for breach of environmental regulations or stopped work due to labor strikes, they avoid significant economic losses.

How Private Equity is Investing Responsibly in China

In China, where there are numerous environmental, social, and governance (ESG) risks and sustainability challenges, responsible investment is both necessary and common sense, as PRI’s James Gifford explained at the forum. PRI signatories Lunar Capital and Orchid Capital, along with Tsing Capital and Hui Nong Capital, agreed with this statement and outlined how they integrate responsible investment throughout their investment processes, from analysis to audits and due diligence to engagement and management of portfolio companies.

Both Lunar Capital and Tsing Capital focused on the importance of being an active investor (the second principle of the PRI), though this looks very different for each of them: Lunar Capital takes majority investments and Tsing Capital takes minority investments. The funds  also emphasized the importance of influencing the management of their companies to focus more broadly on sustainability as part of demonstrating good management.
 

However, there were clear differences in approaches among the different investors. Tsing Capital intentionally invests with the aim of positive, quantifiable environmental impact—and therefore only invests in specific industries such as sustainable agriculture, energy efficiency and clean energy. However, Orchid Capital takes a different approach and invests in companies in any industry, as long as these companies understand and manage well the economic and social issues within their respective sectors.

The two different approaches are not necessarily conflicting but rather represent two current modes of thinking:

1. Risk Management: The “we have to manage ESG if we want to make money” approach focuses on integrating ESG into investments and reducing ESG risks while viewing good management of ESG issues at a company as a proxy for good management overall.
2. Impact Investment: The “we want to make an impact while also making money” (or impact investment) approach places a greater focus on the external environment, and investment decisions are made specifically for measurable social or environmental impact, while also being profitable.

Both approaches are necessary to responsible investment. With such dramatic ESG risks in China, the first approach may look at ESG through more of a risk management and competitive advantage lens, whereas the second may focus more on business opportunities and social/environmental impact, because of the tremendous need to help address social and environmental challenges in China. As the field evolves, the crucial question is how to drive investors in China to take one (or both) of these approaches.

The forum concluded with perspectives from LGT Venture Philanthropy, New Quest Capital, and Harvest Fund, who discussed how to move forward successfully with fostering responsible investment in China. They agreed that the major challenge is not to demonstrate the business case for responsible investment, but rather to raise awareness of the business case and to work on the “how”: how to implement responsible investment effectively throughout investment processes and to support companies with implementation of responsible business practices.