As China’s equity markets gradually open up to foreign investors, Chinese companies could face greater scrutiny, according to Franklin Templeton Emerging Markets Equity’s Michael Lai. He weighs in on some emerging trends he’s seen in regard to environmental, social and governance (ESG) issues there.

Awareness of environmental, social and governance (ESG) issues has increased in China, and government initiatives and increased foreign investor participation in China’s markets are largely driving it.

Over the years, China has slowly opened up its equity markets to foreign investors. The introduction of the Shanghai-Hong Kong Stock Connect program in 2014 was a milestone, followed by the government’s decision to lift restrictions on foreign investment in China in 2019. The rapid expansion of China’s equity markets is evident—foreign holdings of Chinese equities hit a record of 1.77 trillion yuan (US$253.14 billion) in the third quarter of 2019.1

As China’s equity markets hit the international stage, it also propelled ESG issues to the forefront.

As the participation of foreign institutional investors in the China A-share market rises, Chinese companies are likely to face greater scrutiny from these investors, who often have high ESG requirements. This in turn should lead Chinese companies to improve their ESG standards. However, at this point in time, China is still in the early stages of embracing ESG. As such, disclosures remain fairly weak compared to Western markets where ESG awareness is ahead of China.

We see signs confirming the above trends, as outlined below.