While some degree of deglobalisation may be desirable today, this process also carries grave risks, from skyrocketing production costs to geopolitical conflict. The only way to mitigate those risks is through enhanced multilateral cooperation.

WASHINGTON, DC – With the COVID-19 catastrophe having laid bare the vulnerabilities inherent in a hyper-connected, just-in-time global economy, a retreat from globalization increasingly seems inevitable. To some extent, this may be desirable. But achieving positive outcomes will depend on deep, inclusive, and effective multilateralism.

Read Less globalisation, more multilateralism, published in Project Syndicate on June 10, 2020

China’s decision to demolish the “one country, two systems” arrangement in Hong Kong appears to be a fait accompli, and in fact seems to have been preordained. Viewed in a broader context, the move represents a major salvo in a new cold war that is already playing out across three critical dimensions.

SEOUL – In retrospect, the decision by the Communist Party of China (CPC) to impose a new security law on Hong Kong seems to have been preordained. Historically, rising powers always try to expand their spheres of geopolitical influence once they pass a certain stage of economic development. It was only a matter of time before China would do away with the “one country, two systems” arrangement and impose its laws and norms on Hong Kong – a territory that it considers integral to the motherland.

Read The shape of Asia’s new cold war, published in Project Syndicate on June 10, 2020.

Nick Wade from Northfield and the Curious Quant discuss the impact of COVID on risk modeling frameworks, assumptions, and how the recent movements in asset markets may or may not impact the short and long-term assumptions of asset owners. 

There is a lack of understanding in investment decision-making about how big the climate crisis is which could lead to investments and risks being mis-directed, according to Professor Cameron Hepburn, Professor of Environmental Economics at Oxford University.

“In the decision-making process there is still a lack of understanding of how big this is. It’s a rewiring of the whole economic and financial system, if you are unaware of how that rewiring is likely to happen then you’re probably putting money into the wrong categories, or taking risks you’re unaware you’re taking. Are boards and investment committees having the right level of sophisticated awareness of these topics?”

He says boards and investment committees can access executive education programs at Oxford and other universities that will upskill their capabilities in regard to the climate emergency.

“There is a lot to think about. We have just seen what can happen when the science is ignored. All the science said it was coming and you didn’t listen,” he said in regard to COVID-19. “Personally I sold out of equities in January, because I looked at the science and thought it didn’t look good. It will just be gutting if that happens again with climate, all the science is telling us that it is coming at us, so listen to it.”

Investors should do more forward-looking risk modelling, and abandon old paradigms, Hepburn said, and argues the investment industry can learn a lot from science in the management of complex adaptive systems.

Looking at sensitive intervention points and the idea that small changes in one area can trigger knock on effects to the whole system, known as complex systems science, is an area of science gradually being brought into economics.

“This is the idea that if you have a complex adaptive system like the climate or the economic system then small deviations or changes in one part of the landscape can trigger knock on effects to the system as a whole, especially if it is at a state of criticality,” he said in a podcast interview.

“Applying it to climate we have been observing small and apparently unrelated changes have had big impacts on energy, transport, and food systems.”

Hepburn, who is director of the Smith School of Enterprise and the Environment and leads a number of programmes on sustainability at the Oxford Martin School, said investors need to get out of the old paradigms and look at a better way of understanding complex systems.

“Even the concept of the black swan doesn’t’ really help us to capture the fact these distributions are not bell shaped, or fat-tailed or non-normal distributions. The interactions between parts of the economy are shifting the distribution all together. So these things that are supposed to be a 1 in 10,000 event become the mean because you’ve shifted the distribution,” he said.

“Put another way, if you’re walking towards the cliff edge, except you’re walking towards it backwards looking where you’ve been previously walking and saying there’s no evidence of a cliff edge, then you walk off the edge,  you’re looking in the wrong direction. It’s pretty obvious that only using backward or historical looing data does not tell you what you need to do, especially where there are non linear dynamics in the system. It’s uncomfortable because in order to turn around and look forward you end up having to be a bit more speculative, to understand the underlying connectivity and network of the system. If you don’t do that you’re pretending they don’t exist. It’s important we start doing more forward looking work in this area of finance risk modelling.”

Hepburn, who advises governments in the UK, China, India and Australia as well as the OECD and United Nations, is an advocate for a price on carbon. Compared with other policies he said a carbon price tackles the demand and supply side at the same time and so there is less leakage. But the challenge is getting the right level.

“Views will differ among economists, the mean range I would say is about $50-100 a tonne. Some will say that’s way too low and want $300 a tonne to get us to zero, others say the innovation down the line means we don’t need it that high and would be damaging to the economy. There are a number of countries that have prices in that range. Many have implicit prices much higher than that range. We economists may know what we need to do – the action is in the policy, psychology and acceptance of these policies.”

For investors looking to integrate climate change into their policies, Hepburn advises starting at a high, top down level, which is what the Oxford endowment did.

He said a set of Oxford Martin principles helped guide questions around climate in the investment portfolio, which includes:

  • Are you investing in funds/companies/investments where the people managing them get it and the imperative to get to net zero?
  • Do they have a plan to be profitable in that scenario?
  • What’s the plan, how to get there and when?
  • Can you track progress?

“We framed it that way. Working out your carbon footprint of the portfolio is not really very informative, for example you might need to increase emissions now to reduce them later. Investors need to be a bit more sophisticated than just a carbon footprint,” he said.

For more episodes in the Fiduciary Investors Series podcast click here.

The integration of ESG issues into investment practice and decision making is an increasingly standard part of the regulatory and legal requirements for institutional investors around the world.  In China, two key drivers have recently prompted interest in responsible investment: a government effort to promote green finance, and the increasing globalisation of China’s investment market.  New research by the PRI shows there is a third driver for responsible investment in China: that ESG integration is a source of investment value.

Two years ago, the PRI published the first report on ESG and alpha for the US market. Based on a time series of 15 years of ESG data from developed markets, the report showed that ESG information offers an alpha advantage in the construction of equities portfolios. While ESG data in China does not offer the same depth and history as the one used in the US study, preliminary analysis led with MSCI ESG data in China and emerging markets, and case studies by local and international investors, similarly suggest that ESG is a source of alpha in China.

Why this matters in China

China is seeking to align economic and environmental performance and build a green financial system. This transformation started in 2016, with a government-backed surge in green bonds, green credit and lending. Greening investments has followed suit, with the first guidelines published by the Asset Management Association of China (AMAC) in 2018. ESG integration has become a known investment concept to many market participants, while only recently market participants were linking that topic with philanthropy.

Over the past two years, the number of PRI signatories in China has increased from seven to 37, with most of these new signatories being asset managers and services providers. One key motivation for asset owners to step up their responsible investment strategies is the efficacy of ESG investment.

Two main drivers for responsible investment: regulation and globalisation

Since the release of the Guidelines for Establishing a Green Financial System in 2016, Chinese regulators and policymakers have made great efforts to promote green finance and sustainable development. China is a world-leading green bond issuer, with $31.2 billion green bond issuance in 2018. The central bank added green credit into the macro-prudence assessment framework in 2017. The National Development and Reform Commission updated the national industrial catalogue to clarify standards for green industry and green projects. In 2020, securities regulators and stock exchanges are expected to establish a mandatory ESG disclosure framework for listed companies.

At the same time, the Chinese investment market is opening up to global investors. In 2019, the State Council of China released a series of policy measures aiming to lower the barriers for global investors to invest in China and for Chinese investors to invest abroad. This policy reform implies that domestic investors need to be familiar with concepts of ESG integration, climate change, the Sustainable Development Goals (SDGs), which are now key topics, and evaluation criteria for global institutional investors and asset owners.

To embrace the opportunities and challenges from ESG regulations and the influence of global asset owners, financial institutions in China need to be prepared. AMAC has conducted an investor survey for Chinese asset managers in 2018, which found although more than half (58.2 per cent) of the surveyed asset managers are considering ESG issues in investment processes, only 1.2% have already established a responsible investment strategy at a firm level. However, 94 per cent of the managers surveyed agree that ESG considerations are important to improving investment returns, and 68 per cent view ESG integration as an alpha-generation method.

ESG and alpha

The quantitative analyses in our new report, ESG and alpha in China, are based on MSCI China ESG Leaders, MSCI China ESG Universal, MSCI Emerging Markets ESG Leaders, and MSCI Emerging Markets ESG Universal indexes, and use available data from June 2013 to June 2019. Analysis indicates that both best-in-class and tilting strategies using ESG scores deliver alpha and relatively lower maximum drawdowns over their respective benchmarks. In addition, the efficacy of ESG factors in delivering stronger risk-adjusted returns is more pronounced in the MSCI China universe than in wider emerging markets.

The limitations of current A-share ESG data does not stop investors’ exploration on ESG incorporation strategies in China. Some asset managers already incorporate ESG factors into their investment processes, and some are using active engagement as a tool to better understand companies they invested in. The report presents concrete examples from investors in China (China Asset Management, E Fund Management, Harvest Fund Management, Hwabao Fund Management and BNP Paribas), illustrating how ESG issues and data are analysed and integrated into investment research when investing in Chinese companies.

The key message from this research is that it makes sense financially for Chinese investors to incorporate ESG issues in investment decisions. It also makes sense for asset owners to mandate ESG incorporation with their managers as markets are opening up and ESG risks and opportunities affect corporate performance in China and abroad. It is, after all, their fiduciary duty to take account of all value drivers, including ESG issues, in investment decision making.

From a policy perspective, the main message is that with better data, investment managers can make better investment decisions and generate better returns for their clients. A standardised, mandatory ESG disclosure framework is key to mainstreaming responsible investment in China.

Margarita Pirovska is head of Fiduciary Duty in the 21st Century, PRI

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The quest to transform this country cannot be limited to challenging its brutal police.

The national uprising in response to the brutal murder of George Floyd, a forty-six-year-old black man, by four Minneapolis police officers, has been met with shock, elation, concern, fear, and gestures of solidarity. Its sheer scale has been surprising.

Across the United States, in cities large and small, streets have filled with young, multiracial crowds who have had enough. In the largest uprisings since the Los Angeles rebellion of 1992, anger and bitterness at racist and unrestrained police violence, abuse, and even murder have finally spilled over in every corner of the United States.

Read How do we change America?, published in The New Yorker on June 8, 2020