Responsible Investment

Asian Corporate Governance Association (ACGA)

Public pressure and the ability to attract foreign capital are driving progress in...
December 2018

Juan Salazar

Vice President, Analyst, Responsible Investment

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Risk Disclaimer
Past performance should not be seen as an indication of future performance. Stock market and currency movements mean the value of, and income from, investments in the strategy are not guaranteed. They can go down as well as up and you may not get back the amount you invest.
 
Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.
 
The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

Public pressure and the ability to attract foreign capital are driving progress in environmental, social and governance (ESG) practices across Asia. This became evident as governance experts gathered in Beijing for ACGA’s 2018 annual conference. Expert navigation of these changes will contribute to our ability to conduct ESG research and engagement activities effectively.

Background

We attended the ACGA’s 18th annual conference in Beijing, the largest one to date with more than 300 delegates present. A significant majority of delegates came from Asia, particularly Greater China, which speaks volumes about the rising attention investors and companies in the region are paying to environmental, social and governance (ESG) issues. This is hardly surprising – both the public and private sectors are under increasing pressure to respond to the consequences of extreme weather events, pollution problems and demographic change. Despite some setbacks, like the introduction of dual class share structures in Hong Kong and Singapore, the recognition that better governance standards will help attract foreign investment flows and open capital markets has started to take hold.

China catches up

The conference had a clear focus on China, with sessions structured around topics such as accounting and auditing developments, the state of tech innovation, state sector reform and governance reforms.

Compared to other markets in Asia, China had been moving rather slowly in implementing ESG-related reforms. The revision of its Code of Corporate Governance for Listed Companies earlier in 2018 is an indication that the pace of change is picking up. The revamped code includes greater emphasis on ESG disclosure, investor stewardship and director accountability. Furthermore, the China Securities Regulatory Commission introduced new requirements that, by 2020, will mandate all listed companies and bond issuers to disclose ESG risks associated with their operations.

Investors will need to develop a robust understanding of how to navigate these changes, considering that governance in China is a unique hybrid of local and global standards. The incorporation of Party Committees, required for all companies under the new Code, provides a striking example. The presence of Communist Party units has long been a fact of doing business in China, where they exist in nearly 70 percent of privately-owned companies. Executives had regarded these units as more symbolic than anything to worry about. Formalising their existence as committees has raised concerns that the Party might play a role in companies’ operational decision-making – potentially leading to decisions made for political rather than business reasons. Investors should, therefore, seek greater clarity around the composition, mandate and role of Party Committees.

State-Owned-Enterprises

Trade frictions with the United States are likely to have led the Chinese government to step on the gas in its long-gestating attempts to improve the competitiveness of the country’s sluggish state sector. State owned enterprise (SOE) reform has unequivocally moved up the policy agenda, with the government trying to capitalise on the progress achieved so far. SOEs across a range of industries have improved their performance by shedding excess capacity, optimising balance sheets through debt reduction, and introducing executive share incentive schemes. We believe the ultimate success of the reform process will be in part determined by the adoption of robust governance practices, particularly in the areas of board effectiveness, transparency and shareholder protection.

 
ESG – finally sweeping into Asia?

It will take time for policymakers to take decisive action to uncouple economic growth from resource consumption across Asian economies, or implement measures to enhance protection of minority shareholders. In the meantime, financial industry participants can and should play a part in accelerating this transition by helping move capital markets onto a more sustainable basis.

We left the conference encouraged that our ability to play this part, through our ESG research and engagement activities with Asian companies, will improve going forward. Two reasons support this view.

Firstly, regulators and stock exchanges across the region continue to develop and implement stronger ESG reporting standards and ESG practice guidelines. Secondly, there is growing appetite from local investors, including through minority investors associations, to lend their voices to foreign investors’ calls for better ESG practices.

The two forces above, together with the drive to remain relevant as millennials and younger generations rise, are helping mark a turning point in the way Asian companies look at ESG. However, some challenges remain for this turning point to happen more quickly.

Board effectiveness:

There is insufficient recognition that a board with a strong set of skills is critical for the long-term success of companies. Most non-executive directors are lawyers, accountants or academics that lack relevant expertise, fail to constructively challenge management, or are not tuned into governance or sustainability issues. Moreover, investors often lack access to directors.

 
Compliance-focused approach:

Companies continue to see governance and sustainability management as a compliance requirement rather than a strategic imperative. This effectively means that board effectiveness is rarely a concern, materiality does not really inform their sustainability practices, and they have difficulty addressing questions about how their businesses are going to evolve in the face of long-term, ESG trends.

Next steps

A solid grasp of the different local contexts has significantly contributed to improving the depth and breadth of our active ownership activities with companies in Asia. Going forward, we will closely follow how ESG management and reporting practices evolve across the region to assess potential implications for our approach to engagement.

Our ability to drive positive change is largely shaped by the trust we can build with the people running the companies in our clients’ portfolios. We will have a higher chance of building that trust by engaging in discussions informed by the history, culture and conditions within which companies across the region have evolved.

Risk Disclaimer
Past performance should not be seen as an indication of future performance. Stock market and currency movements mean the value of, and income from, investments in the strategy are not guaranteed. They can go down as well as up and you may not get back the amount you invest.
 
Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.
 
The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

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