The 2nd Sustainable Finance Forum Successfully Completed: Discussion on ESG Academic and Practice

【ESG 30 Forum】COVID-19 has accelerated people’s awareness of social and environmental governance. With the introduction of the carbon emission peak and neutrality “3060” goal, topics like the active role sustainable finance can play to better deal with public health, lack of resources, the gap of wealth and climate change have raised growing concerns.

The 2nd Sustainable Finance Forum (SFF) recently held in Shanghai Advanced Institute of Finance (SAIF) focused on the most relevant issues in ESG academic and practical fields. These issues are related to the practical aspects, such as ESG and fixed income, information disclosure of ESG investing products, ESG macro framework, ESG and big data, ESG investing under the background of carbon neutrality, ESG and excess earnings and impact measurement. Further, academic aspects of climate finance, such as carbon risk pricing, carbon finance, climate change exposure pricing, global carbon investors and corporate response were also discussed.

The SFF is held in cooperation with the China ESG30 Forum and was co-initiated by professor Tzu-Kuan Chiu from SAIF of Shanghai Jiao Tong University, professor Zhang Bohui from the Chinese University of Hong Kong (Shenzhen) and associate professor Liang Hao from Singapore Management University. Bringing together experts and scholars from policy-making bodies, academic institutions, investment management institutions, financial services institutions, fintech companies and other fields related to sustainable finance, the forum held seminars on seeking approaches for a common development.

How can ESG investing be applied in fixed income?

When it comes to the process of investment analysis, investment decision-making and investment management, three issues need to be taken into consideration — environmental, social and corporate governance. ESG investing has long been used in equity assets, while its application in fixed income assets came much later. China’s fixed income market has developed rapidly over the past decade. As of 2020, China’s bond market reached 110 trillion yuan ($170.3 billion), corporate bond market exceeded 30 trillion yuan with more than 5000 issuers. This, however, has been accompanied by increasing credit risk events in the bond market. How can ESG investing be applied to the bond investment system? How should the impact of bond issuers on society and the environment be assessed? Is ESG evaluation also involved in the analysis of local government financing vehicles (LGFV)?

Guests who delivered speeches in this link held a discussion revolving around the above-mentioned questions. One guest pointed out that applying ESG strategy to fixed-income investment requires integrating ESG into the entire credit investment system, with three aspects to be considered — “further profits,” “impact risk” and “active ownership.” Besides, quantitative tools should be used to assess the ultimate impact of enterprises on society and the environment.

Another guest proposed that ESG investing should be integrated into the analysis framework of fixed-income investment and that the working mechanism of pre-scoring evaluation, in-process risk monitoring and post-evaluation should be established by combining investment, research and risk control, and this investment philosophy should be constantly practiced on active and passive products.

In assessing whether green bonds are truly green, a speaker pointed out that it is necessary to implement identification standards, as well as build up information disclosure platforms and databases. Meanwhile, green bond pricing and carbon pricing can form a benign complementarity and interaction in the future to promote price discovery and market pricing.=

When it comes to the ESG investing strategy for LGFV, one participant said that the evaluation of LGFV should consider the substantial impacts. The evaluation also requires attention paid to the sustainability of local social and economic development, to the sustainability of local government’s support, to the proportion of LGFV-based public welfare projects and to corporate governance.

How can information disclosure of ESG investing products be promoted?

With the rise of ESG investing in China, ESG mutual funds are springing up. By the end of 2020, there were about 104 to 153 funds, according to the statistics of different channels. However, according to the international definition of ESG investing and corresponding strategic requirements, professor Chiu estimated that there are no more than 50 “pure ESG” funds based on her examination of these products one by one. She mentioned that ESG investing is a kind of “double bottom line (DBL) investment,” and investors pursue both financial and social returns, thus it requires reports of “DBL performance.” In other words, the performance report of ESG investing products should not only include traditional financial information such as rate of return and volatility, but also provide KPI that can reflect the ESG performance of the product. However, Chinese domestic ESG funds do not clearly mark the concept of “DBL investment,” and some even only disclose financial performance, without mentioning ESG performance.

Chiu contemplates that the information disclosed by ESG investing products should be substantially related to the characteristics of ESG investing, involving the following aspects: the description of the purpose of the product in materials such as prospectuses; the specification of how to choose an appropriate strategy to achieve the goal and the indication of corresponding KPI; the introduction of how to measure the ESG performance of enterprises through data and the formation of a KPI to evaluate the performance of ESG products; the disclosure of compliance and tracking for ethical bottom lines, including relevant data sources. Chiu believes that under the goal of carbon neutrality, we can learn from the ideas of the European Green Deal to further sort out the financial reform that empowers the reform on real economy, and give disclosure guidelines to the corresponding financial products. In particular, the Sustainable Finance Disclosure Regulation (SFDR) issued by the EU in 2019 provides specific disclosure requirements for ESG investing products, which can be used as references.

One guest pointed out that there are no clear rules for the disclosure of ESG investing products, and that all parties are working hard to promote the formulation of rules. Before that, however, the priority is to figure out the logic of investment, and then focus on the product itself and the mandatory norms that corporate governance can propose. Taking the climate change disclosure framework proposed by TCFD as an example, one speaker argued that the results should be disclosed in a quantitative manner. Another speaker suggested that the disclosure information should be divided into the part of public disclosure and the part of targeted disclosure to institutional investors.

What is the significance of big data in ESG investing?

Professor Zhang stated that data play a very important role in the development of ESG investing. How should we obtain this big data, including mobile phone data, media data, image data, supply chain data, satellite data? And what role will these data play? How can we find the correlation between data and investment by means of artificial intelligence in addition to traditional financial analysis?

A guest proposed that China needs to redefine ESG-related big data in order to get ESG investing with Chinese characteristics. Another proposed that in addition to low-frequency data such as annual reports, there should also be high-frequency data based on public opinion, which could monitor risks in real-time. While one guest suggested that the combination of satellite data and human judgment can better complete farmer-assisting loans.

How can we realize real ESG investing under the carbon neutrality goals?

Carbon neutrality will promote the transformation of the fossil energy-oriented energy supply system to a new one dominated by clean energy. This will in particular cause existing production capacity with fossil fuel in the energy, industrial and transportation industries to become stranded assets, or result in short-term fluctuations in asset values, but it will also boost a lot of new investment. According to the research of the Price Monitoring Center of the National Development and Reform Commission (NDRC), by 2060, the new investment in China’s climate field will reach 139 trillion yuan, which will be evenly shared to 3.5 trillion yuan a year. Various industries are bound to launch an extensive and profound green revolution.

Another guest speaker pointed out that the iron & steel industry, chemical industry and other cyclical industries have capital needs for transformation and upgrading, new energy green industries have heavy new demand for financing. Not only different industries but also the whole industry chain within an industry are increasingly restricted by ESG; this is a situation that can provide a lot of investment and financing opportunities. However, at present, many issuers haven’t designed products strictly in accordance with industry standards or scientific paths, resulting in greater ESG publicity benefits than practical significance. The guest speaker further added that he expects that the improvement of the regulatory policies of the green financial market will help decrease “greenwashing” behaviors. In addition, he also pointed out existing problems in carbon emission trading, including whether enterprises can really achieve the emission reduction in the end for the carbon quota they buy, whether the measurement, reporting and verification (MRV) of carbon emission can be done in real-time and effectively, and whether the allocation of carbon quotas can be fair.

Another guest said that in terms of green credit, green bonds, sustainable development bonds, social bonds, sustainability-linked bonds and transition bonds, more and more Chinese financial institutions are learning to understand sustainable development financial instruments. At this stage, banks are suggested to attach importance to the theme investment of green bonds. ESG-themed wealth management products by banks will become an important category of ESG investing in China.

Can ESG generate excess returns?

Can ESG deliver alpha, the excess return and is it valuable in terms of investment?

In response to this, one guest pointed out that whether ESG is relevant to fundamentals or performance is still in debate. As for questions like how the value of ESG information can be accurately reflected still needs to be explored, and whether there is an alpha in ESG, or whether alpha has been discovered by the market, all need to be further investigated. Since ESG investing aims at the risks and returns after 20 or even 50 years, we need clearer ESG goals to accurately measure and reflect the investment process. To answer questions such as whether clients accept the concept of ESG investing, whether investment managers can combine the understanding of ESG with investment to better optimize the income over risk and meet the higher requirement on ESG, we need a set of supporting ecosystems.

One guest pointed out that ESG is reflected in Alpha through valuation. Companies with clear future cash flow will be given a premium, and there will be profit and risk mechanisms to weed out high-risk companies.

Another guest said that the ESG has generated alphas in the past two years, but as the proportion of institutionalization reaches a certain level, alphas will become increasingly limited, which is decided by retail investors’ mentality of “following the herd” and the short-term performance evaluation of fund managers.

Furthermore, the macro framework and impact of ESG were also discussed at the forum.

The ESG macro framework is related to ESG ratings at all levels, including the enterprise level, the city level and the national level. The rating has a conceptual basis and varying requirements at different levels on the definition of rating objectives, formulation of a rating framework and identification of specific performance indicators. Then, what is the correlation between ratings at all levels? How can the enterprise ESG rating at the micro level affect the city ESG rating and the national ESG rating at the macro level? All these are important issues that have been intensely discussed at the forum.

Impact investing is one of the seven strategies in ESG investing. Since its rise in 2007, it has been favored by investors. Impact measurement and management is an important part of impact investing, and the impact-weighted accounts (IWA) established in recent years are the most representative. IWA is a set of financial accounting standards, which measures the impact of business operations and products in a systematic way, monetizes it, and then brings it into the profit and loss statement of the enterprise. This set of forward-looking accounting standards, incubated by Harvard University in the United States, has entered the pilot stage. The Impact Institute in the Netherlands is one of the organizations to carry out pilot projects of the commercialization of IWA, and the SFF invited the founder of the organization to give a speech to introduce the concept and application of IWA. The speech was well-received by the participants who showed great interest in IWA and raised a lot of questions. One guest said that the ultimate goal of ESG evaluation is the impact of ESG, and it should aim to improve the transparency of the enterprise and faithfully reflect the value that the enterprise creates for all stakeholders, such as employees, consumers and suppliers. Through the financial statement framework established by IWA, the ultimate goal of all ESG measurement and management is to deal with the impact of ESG in a systematic way and incorporate it into financial statements in order to understand the value created by a certain enterprise to the whole society.