In latter 2017, financial sector and overseas investment in China appeals to be restricted regarding ESG (Environment, Social and Governance). Guidelines and initiatives emphasizes environmental and social risk management have been issued frequently, including "Environmental Risk Management Initiative for China’s Overseas Investment" led by the Green Finance Committee of China Finance Association, "Application of Environmental Risk Analysis in Financial Industry" initiated by G20 green finance study group in the G20 Hamburg summit in July, "Measures for the Administration of Overseas Investment in Enterprises" issues by National Development and Reform Commission and so on. Even though the publish of these documents, to certain extends, reveals the government’s willingness in supervising and monitoring overseas investments’ environmental and social risk management, these incentives still require underpinning laws and regulations for enforcement.
In the end of 2017, financial institutions of China and development banks partially founded by China have conducted investments, policy decisions and actions recognizing the significance of environmental and social risk management in financing overseas. In October, BRICS New Development Bank held two-days engagement meeting with representatives from NGOs and CSOs regarding environmental and social framework, information disclosure and accountability. In the end of November, representatives from China Development Bank, Export-Import Bank of China, Bank of China, Industrial and Commercial Bank of China, China Construction Bank and Agricultural Bank of China attended "2017 Training on Compliance Mechanism for Financial Institutions in Overseas Environmental and Social Risk Management”. During 1st to 5th December, China Construction Bank, Industrial and Commercial Bank of China and Bank of China rule out funding the controversial Adani coal mine.
From a perspective of environmental and social risk management in overseas investment, we followed and analyzed new policies and major events of the latter of 2017.
Stronger Financial Regulation with focus on Environmental and Social Governance
Report from National Audit Office showed that some enterprises have weak risk management on overseas investments and acquisition projects. 20 Central SOEs carried out 155 overseas deals in 2015, among them, 61 deals, nearly 40%, have risks that may result in loss amounting to nearly 38.5 billion Yuan. Prior to this, according to the "2015 Report on the Sustainable Development of Chinese Enterprises Overseas" jointly issued by SASAC Research Center and the Ministry of Commerce, only 13% of the companies are profitable in their overseas M&A deals while 48% companies have yet to achieve profitability or operate at a loss for the time being.
Such risks are resulted from unsound investment decision-making and management, inadequate research and demonstration as well as insufficient risk response. Furthermore, in addition to direct financial risks, unawareness that environmental risks may become financial risks also result in economic and reputation losses; at the same time, lacking environmental awareness on investor side is causing difficulty for enterprises to realize responsible overseas investment. From the stance of financial institution and investors, recognizing non-traditional risks such as environment and human rights, disclosing related information, could enable the market’s risk management and improve its profitability, and enable related monitoring body to make comprehensive decisions when facing the risks.
As the G20 Green Finance Study Group puts forward in the G20 Green Finance Synthesis Report in 2017, one of the challenges for green finance development is the lack of ability to identify and quantify the impacts of environmental risks in financial industry. Although there is certain degree of consensus on the role and impact of quantitative environmental risk analysis, mass application still faces challenges.
To solve these problems, besides enhanced awareness of environmental risks and risk management capability on part of financial institutions and investors, the roles of governments and regulators are also crucial. In 2017, China has introduced new regulations and guidance documents for overseas investment consecutively. The National Development and Reform Commission, the State Administration for Foreign Exchange and the Ministry of Commerce have been vocal on regulating overseas investment and cross-border mergers and acquisitions. Thus, overseas investment risks have attracted much attention:
• From August 1, 2017, "Finance Management Measures for Overseas Investment of State-owned Enterprises" issued by the Ministry of Finance takes into effect , which clearly stipulated that the state-owned group company shall perform finance management duties on overseas investments of the whole group, including claiming responsibility on officials who caused loss in overseas investment.
• On August 4, 2017, the General Office of the State Council forwarded the “Opinions on Further Guiding and Regulating Overseas Investment Orientation” formulated by the National Development and Reform Commission, the Ministry of Commerce, the People's Bank of China and the Ministry of Foreign Affairs , the Opinion made clear guiding principles for overseas investment. Notably, circumstances for restricted investments are listed in the "Opinion" which includes “failure to meet standards on environmental protection, energy efficiency and safety of investment destination countries ", which is a clear sign that ESG perspective is incorporated in major regulatory document, thus, the Opinion and the ESG perspective it adopted bear significance for ESG risk management in overseas investment in the future.
• December the 26th, National Development and Reform Commission issued “Measures for the Administration of Overseas Investment in Enterprises”. Measures discriminated sensitive industry from overseas investments, different approval approach will be applied to nominated sensitive industry from which applies to the others. Designated sensitive industries include “development and production of weapon, development and utilization of cross-boarder water resource, news and media, and other industries restricted by host country development strategies”.
ESG risk is already one of the key risk categories in various policy documents on overseas investment risk management, which is also a clear policy consensus and has been translated into regulatory signals. Under these control measures, foreign investment had a 45.8% decline in the first half of this year , and in real estate, culture, sports and entertainment industries, foreign investment even dropped by 82.5%.
This initiative was officially released on the International Symposium on Green Finance in September 5. Chinese financial institutions and enterprises may voluntarily adopt the Initiative when carrying out overseas investment. The Initiative encourages enterprises to fully understand, prevent and manage environmental and social risks associated with overseas investment projects, strengthens environmental information disclosure, and encourages active application of green financing tools and environmental liability insurance, promotes green trade finance and green supply chain financing, and enhances environmental risk management capacity building. G:HUB contributed the first and seventh articles of the initiative.
China announced the establishment of Financial Stability Development Committee at state council level during the National Financial Work Conference held on 14-15 July, 2017. The Committee will strengthen macro-prudential regulation, alert the systematic risks, coordinate financial regulatory responsibilities under current framework, and supervise other regulatory bodies.
On July 24, 2017, the Asian Financial Cooperation Association (AFCA) was established. The AFCA is a regional international non-governmental and non-profit organization, and it will be committed to building an exchange and cooperation platform for Asian financial institutions. Ma Kai, member of the Political Bureau of the CPC Central Committee and Vice Premier of the State Council, said at the inauguration ceremony that the Asian Financial Cooperation Association, following the Asian Infrastructure Investment Bank, is another regional financial organization initiated by China, which marks China’s active exploration on providing public goods for financial sector in Asia and the world.
On November 21, 2017, “2017 Training on Compliance Mechanism for Financial Institutions in Overseas Environmental and Social Risk Management” was successfully concluded in Beijing. The one-day long training was co-organized by G:HUB, the China Banking Regulatory Commission, and supported by the Green Finance Committee of China Finance Society. The training attracted a total of 56 guests from a number of Chinese financial institutions including China Development Bank, Export-Import Bank of China, Bank of China, Industrial and Commercial Bank of China, China Construction Bank and Agricultural Bank of China.
Carmichael Coalmine Project planned to be development in Galilee Basin, Queensland, Australian by coal giant Adani Group. This project has evoked protests across Australia for the last few year because of its environmental and climate sensitiveness. Adani Group turn to China seeking for loans after the former was rejected by 21 banks. However, the China Construction Bank, Industrial and Commercial Bank of China and Bank of China has rejected lending to this project which makes this coalmine’s destiny hanging by a thread.
From 25 to 26 October 2017, representatives from 19 civil organizations in different countries and a number of senior officials of the BRICS New Development Bank (hereinafter referred to as “the NDB”) held a two-days engagement meeting. The 24 representatives came from civil organizations in China, India, Brazil, South Africa and Argentina and they closely follow issues on environment, climate change, energy, rights and interests of women and indigenous people , and sustainable development.
In 2016, China's non-financial outbound direct investment volume reached USD 170 billion, an increase of 44.1% year on year. It is noteworthy that outbound non-financial direct investment by China's domestic investors stood at USD 34.59 billion US dollars in the first 5 months of this year, down by 53% YOY. For a single month in May, outbound direct investment volume was USD8.22 billion, down by 38.8%.
On June 7, 2017, United Nations Conference on Trade and Development issued "World Investment Report in 2017" which said that China becomes the second largest home country for FDI for the first time as Chinese outward FDI surged, rising 44 percent to $183 billion. Mukhisa Kituyi, Secretary-General of UNCTAD, expressed that we are cautiously optimistic on foreign direct investment recovery despite bumpy road ahead . Although the report predicts a slight recovery in 2017, yet factors including geopolitical risks and policy uncertainty may also have impact on how strong the recovery will be.
Ma Jun, Director of Green Finance Committee of China Finance Association (Ch): in face of challenges that financial institutions lack capability to identify and quantify environmental risks, and also the challenges in promoting application of environmental risk analysis,joint efforts and cooperation from governments, regulators, financial institutions, and international organizations are essential. Governments and regulators should give financial institutions clear signal to encourage and support them to carry out environmental risk analysis. Financial institutions need to raise awareness, invest resources (financial and institutional), and enhance their capacity. NGOs and other social organizations should also support financial institutions in capacity building and actively participate in promoting such efforts.
Zhang Jingjing, Environmental Lawyer: China’s overseas investments have led to many cases of environmental damage and infringed rights. Meanwhile, Chinese firms are very bad at handling community relations overseas. The government has indicated it is willing to exercise some degree of oversight in environmental and social risk management, however, China needs legal requirements for overseas investment, not guidelines.
World Resources Institute: The Chinese government should include the impacts of overseas investments in its domestic environmental management system to protect the national reputation. Possible approaches include upgrading current environmental policies for overseas investments to enforceable laws or regulations, applying current laws or regulations for domestic investments to overseas investments, and strengthening regulation for corporate social responsibility reporting. In particular, some industries with potentially large environmental social impacts, such as large-scale infrastructure and mining, would benefit from further guidance and instruction from the government.
Report: "China Going Global Investment Index"
Report: "2017 Report on the Sustainable Development of Chinese Enterprises Overseas"
Report: "Investing in a Green Belt and Road? Accessing the Implementation of China's Green Credit Guidelines Abroad"
Training Package: "2017 Training on Compliance Mechanism for Financial Institutions in Overseas Environmental and Social Risk Management"
Observer: "Grievance Mechanism and Governance of Environmental and Social Impacts by Development Financial Institutions"
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