As providers of capital, asset owners – pension funds, insurance companies, investment trusts and other investment vehicles – set the tone for stewardship and can play an important role in influencing the behaviour of investment managers and companies, whether it’s in the way companies manage risk, the way they remunerate their employees or how they vote on key resolutions.

Stewardship codes worldwide play an important role in influencing company behaviour. The Principles for Responsible Investment (PRI) recently welcomed the launch of Australia’s first compulsory asset manager stewardship code for members of the Financial Services Council (FSC).

The Internal Governance and Asset Stewardship Standard, which will be mandatory for all of the FSC’s funds manager members, formalises a code of practice on how they should meet obligations for transparency in their internal governance and stewardship practices. This includes rules for the disclosure of voting policies and engagement with investee companies on material environmental, social and governance (ESG) issues.

The development of an Australian stewardship code was one of several recommendations put forward by the PRI in its Australia roadmap in December 2016 to enhance investment industry policy and practice on responsible investment and bring these into line with global best practice.

In making this recommendation, we envisaged a total industry approach that included both asset owners and investment managers, so we are pleased to hear the Australian Council of Superannuation Investors (ACSI) is looking at the development of a stewardship code for asset owners.

Australia can then join a long list of countries that have already developed stewardship codes in recent years, including the UK, Italy, Denmark, Switzerland, the Netherlands, the European Union, the US, Canada, Japan, Hong Kong, Philippines, South Korea, Malaysia, Taiwan, Thailand, Brazil and Singapore.

For many countries, stewardship codes can help foster sustainable, long-term growth and attract foreign investors which feel that stewardship codes can help ensure better corporate governance.

While Europe and Asia have been steaming ahead on stewardship codes, however, the US has been slow to look at this issue. But progress is being made.

Some of the largest asset owners in the US including the California State Teachers’ Retirement System (CalSTRS), the Florida State Board of Administration and Washington State Investment Board, along with leading investment managers including BlackRock, Vanguard and State Street Global Advisors, have led on the Investor Stewardship Group (ISG).

This collective of some of the largest US-based asset owners and managers has articulated a set of fundamental stewardship responsibilities for institutional investors and has released a corporate governance framework that articulates six principles it considers fundamental for US-listed companies in order to improve governance practices in US publicly traded companies.

Codes improve company ESG risk management

In late 2016, the PRI undertook some research to look at whether or not codes made a difference to long-term investing.

The research showed that companies in countries with mandatory, government-led, comprehensive ESG reporting requirements have, on average, a 33 per cent better MSCI ESG rating than those in countries without. The score indicates better ESG risk-management practices relative to risk exposure.

In addition to codes, globally we are seeing more and more regulation to support long-term responsible investment coupled with recommendations for additional disclosure from the FSB taskforce on climate-related financial disclosures and the draft recommendations from the High-level Expert Group on Sustainable Finance on financing a sustainable European economy.

Both voluntary and mandatory policy recommendations are coming together to create a perfect opportunity for us to take responsible investment into the mainstream where it belongs.

As a minimum the PRI believes that asset owners and investment managers should be effective stewards of the assets they hold for their beneficiaries.

Asset owners should appoint, select and monitor asset managers on their ability to align stewardship activities with their investment beliefs, policies and guidelines, and the PRI will continue to work with its asset owner signatories to support them in this goal.

Fiona Reynolds is the managing director of PRI.

A lot has been written about the superiority of the “Canadian model” for managing pensions, but can a value be assigned to this organisational design structure? Keith Ambacthsheer seeks to find out.

When The Economist wrote about the approach to investing by Canada’s largest public pension funds in its article, Maple Revolutionaries it started the hype around the “Canadian model” of investing that includes large allocations to direct investments, and managing a high proportion of assets inhouse.

Five years since the article has been written, and Keith Ambachtsheer seeks to find out whether this model of investing actually produces better result. Or in other words what is the Canada model worth?

To find out, Ambachtsheer draws on the data of the CEM Benchmarking database, of which he is founder and part owner. CEM collects information on gross investment returns, the internal and external costs of running the investment operation, a passive reference portfolio which captures the organisation’s investment policy, as well as organisational data such as fund size, proportion managed internally and proportion invested in private markets.

In his analysis Ambachtsheer chooses eight Canadian funds which have provided CEM with data for 2006-2015 and have had three Canadian model features for the 10 year period – which he defines as a clear mission, a strong independent governance function, and the ability to attract and retain talent. And they have had sufficient scale to insource the investment function if they chose to.

CEM has continuous data for another 132 funds which provide a comparison point for the performance of the Canadian funds over the period.

The analysis looks at net value added (NVA) which is gross return minus the cost of running the investment operation minus the return on the passively managed reference portfolio

Ambachtsheer compares the eight Canadian funds to the wider database and finds the eight “Canadian model” funds insource more than the wider group (75 per cent versus 17 per cent) and they also have a tendency to invest more in private markets (average of 23 per cent versus 11 per cent). But despite the bias to allocate more to private markets, the investment cost structures of the Canadian funds generally fall in the middle of the broader fund universe (48 basis points versus 50 basis points average for the broader universe).

The Canadian model funds were more successful at generating positive net value added over the 10-year period than most of the 132 other funds, with a success ratio of 88 per cent versus 61 per cent.

And the net value added of the Canadian model funds was higher at 0.6 per cent a year versus 0.1 per cent for the broader universe.

In a bid to place a value on the Canadian model, Ambactsheer takes the aggregate average value of the eight funds over a 10-year period, which is $832 billion, and applies the excess return relative to the broader CEM universe, which is 0.5 per cent.

He thus calculates the “value” of the Canada model, according to his analysis, to be $4.2 billion a year. Which Ambachtsheer points out “pays a lot of pensions!”

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After 25 years as CIO of Idaho PERS, Robert Maynard, has seen it all. He’s convinced a simple, transparent and focused investment strategy prevails in all terrain. The philosophy is reflected in the fund’s asset allocation focused on cheap, passive strategies in public markets.

Robert Maynard became chief investment officer of the Public Employee Retirement System of Idaho (PERSI) in 1992. His 25 years at the helm of the $16 billion pension fund for Idaho’s public sector employees has thrown every kind of financial weather his way from the collapse in emerging markets to the tech wreck of the early 2000s and the global financial crisis of 2008-9.

It’s all conspired to convince him of the merits of what he calls “conventional investment strategy” that relies on simple, transparent and focused investment vehicles.

It lies behind PERSI’s asset allocation, divided between a 70 per cent allocation to equity and a 30 per cent allocation to fixed income, and explains Maynard’s other key preferences. Namely for public markets over private, cheaper passive strategies that depend on market movements for success rather than active management, and capping diversity at between 7-10 asset types. He likes long-term postures rather than short-term efforts to fight market volatility, and his internal team comprises just two investment professionals. Strong returns, he says, are proof that it works. PERSI’s five-year return is 8.8 per cent and the 20-year return is 7 per cent.

But Maynard is also quick to articulate the key reason PERSI can afford this no frills approach. The fund’s robust financial health means it only targets a real return – above inflation – of between 3.75 per cent and 5.0 per cent.

“The way that we are set up means that we don’t have to get above market returns and this makes all the difference in the world. We can accept normal, or sub normal returns. Looking at our liabilities, we are fine as long as we get returns somewhere between 3.5 and 4 per cent above inflation. And if inflation is lower we don’t’ have to make as much.”

It is a backdrop to his investment strategy that contrasts with the many endowments forced to reach for returns of 7 per cent above inflation, or other US public funds struggling, and failing, to introduce new contribution levels, he says.

His preference for simplicity is born from a belief that picking winners, or trying to beat the market, is inherently risky.

“It involves entering a game where the odds are stacked against you. I can pick the good from the bad and the pro from the amateur, but I can’t pick the great from the good.”

He believes the demand for high returns for many funds is pushing them towards riskier strategies that extend beyond straight forward risks.

“It’s about more than simply finding a large cap growth manager who can beat the S&P 500 growth Index. The out-performance may be there, but it is not going to be at the level that is going to save your fund.”

Instead these pension funds need to “find places” where if they “hit it big” it actually makes a difference. Private equity, hedge funds and internal management are the most common strategies. All involve manager fees and competing against the market, but also against other investors trying to work with the best managers too.

Sticking with a conventional strategy is most difficult when market conditions turn challenging. “The worse time to make a decision is in the middle of a crisis. You’ve just got to stick with it and keep the discipline when the automatic view is that you think you need to do something,” he said. “Switching in and out of select asset types in a time of crisis means getting three investment decisions right. When to get out, how to get back in and where to put the money in the meantime.”

 

Robust manager relationships

Maynard has a deliberately low turnover of managers with relationships typically stretching for 10-15 year periods, and only ending if a manager merges or their investment style changes.

“We did a manager search in the early 2000s, and finished another one last year,” he says, illustrating the point of how rarely the portfolio opens up. When PERSI leaves a manager relationship the money usually goes into an index fund, or is reallocated to existing managers, he says.

“We don’t fire for performance,” he adds.

Indeed, he is quick to defend managers that do underperform. He asks for separate accounts so securities that can be independently priced on a daily baisis. It means at the end of each day he knows “within 10 basis points” what that manager should have done.

“We know exactly what type of stocks they have, what their style is, and what their turnover is and it’s clear if they are doing anything different. Given this, if they are underperforming a benchmark like large cap growth or international value it says more about what the market is doing than it says about the manager. They are still doing the same thing we hired them for.”

He favours managers with a clear style and concentrated portfolios and avoids “black box” managers that aren’t easily explainable. This excludes hedge funds, quantitative strategies and other short-term strategies like tail risk insurance or covered call option writing – strategies he likens to “cutting up the same pie and putting on new labels.”

Half of the fund is in passive strategies; active strategies are split between public markets (35 per cent of assets under management) and private markets (15 per cent). PERSI has 18 relationships with public market managers and 22 relationships with private managers, mostly private equity GPs. It has two mandates with real estate managers.

PERSI investments comprise US equities, international developed market equities, international emerging market equities, REITs, private equity, private real estate, government and sovereign debt, TIPS, credit debt instruments, private debt (the Idaho Commercial Mortgage program), and cash. He favours a home bias because PERSI liabilities are in dollars; he also likes assets that are sensitive to US inflation.

The fund doesn’t hedge its currency exposure, avoids emerging market debt and high yield bonds, although the fund allows active bond managers to venture there if they want to. A typical scenario could see a bond manager invest in dollar emerging market debt to try and outperform the general fixed income benchmark, he says. The fund’s two biggest overweight positions are emerging market equity (accounting for between 8-10 per cent of the total fund) and an allocation to TIPS.

PERSI’s board comprises five members, none of whom are required to have a deep investment experience. Something that Maynard is convinced is an attribute since the board tests his ability to explain strategy in commonly understood terms.

“One of the most valuable resources we have is board time. If we can explain it to our board we can explain it easily to the legislature and our constituents.

 

A large photograph stands apart on the corridor wall of the private capital division on the 8th floor of Ontario Teachers’ Pension Plan’s (OTPP) Toronto offices. It shows a crowd of 70-odd employees gathered in front of a sign celebrating the pension fund’s quarter century of investing in private equity and the 20 per cent returns, net of all costs, the asset class has brought in. Taken in February 2016, it captures what Jane Rowe, senior vice-president of private capital at OTPP calls an “awesome, awesome” achievement.

Since its inception in 1990, the C$175.6 billion ($138 billion) fund for more than 300,000 of Ontario’s teachers has achieved an average, annualised return of 10.1 per cent; fully funded four years on the trot, it now boasts an $9 billion surplus. It’s a track record achieved by a revolutionary investment approach that prioritises active, internal management and buying chunky direct stakes in companies, infrastructure and property, and has made OTPP the benchmark for endowments and pension funds the world over.

Much of that investment alchemy takes place on the 8th floor where Rowe nurtures a culture balanced between honouring all her department has achieved in the past, with encouraging innovation.

A 75-strong team oversees a $20 billion global portfolio that spans funeral parlours, crisp manufacturers and childcare providers, and complex relationships with some 40 core private equity funds.

Rowe joined OTPP in 2010 from a distinguished career at Scotiabank Group. Back then Ontario Teachers’ had $9.5 billion in private equity representing 11 per cent of the assets under management. Today this has grown to around 15 per cent — although it shifts in line with realisations of which 2016 saw a lot — and will grow, she says, to at least 19 per cent of assets under management in the future.

OTPP invests in private equity funds where managers serve as general partners, but it also invests directly into portfolio companies. Here OTPP co-underwrites deals with GP fund partners in a relationship Rowe likens to having “a smart friend at the table”; it also allows more control over issues like capital deployment and risk, and cuts costs.

In 2010 about 60 per cent of the private equity portfolio was in funds versus 40 per cent directly into portfolio companies. Now this has shifted in favour of direct investing with around 30 per cent of the allocation in funds and the remainder directly into portfolio companies, the vast majority in developed markets. Until now.

Looking for opportunities

Last April OTPP co-sponsored its first deal with India’s Kedaara Capital, co-founded in 2011 by Manish Kejriwal, the former India head of Singapore’s state investment fund Temasek, to back micro-finance provider Spandana. The small deal has given OTPP a taste of the opportunity to be found in India; it also provides a window into how Rowe moulds new fund relationships as it pushes into emerging Asian markets, adding to its relationships with names like South Korea’s MKB Partners and Hong Kong-based Boyu Capital.

“Whenever you work with a fund partner in a first co-investment opportunity, you are both learning how the other thinks,” Rowe say. “You have to make sure you are thinking about the risks in a similar way; how you want to incentivise the managers that work in that business and the key metrics to measure that. These are the growing pains of an evolving partnership. It is about ensuring how everyone gets everything they need and strengthening the relationship with our GPs so that when the next opportunity comes along in that market, it is even smoother.”

Fast forward a couple of years and OTPP is in a position to swoop on the highest quality deals. None more so than when managers, with their typical three to four year investment horizon, need to realise their investor’s returns.

In 2012 OTPP was a minority investor alongside Wind Point Partners in snack industry group Shearer’s Snacks, best known for manufacturing Kettle potato chips, a brand she admits, with the humour that peppers her speech, is a summer weekend favourite. A couple of years later, when Wind Point sought to share its realisations with investors, OTPP bought out Wind Point.

“We already knew the company, we knew the management team, the sector and key customers,” she says. “We like this company and like where it’s going.”

She used a similar strategy to snap up a stake in OGF, France’s funeral services group, buying out some of private equity group Pamplona’s position. Proven market share and the demographics of the business, she says in another flash of humour, made it stable and lower risk.

“We are not an investor in their fund but we were intrigued by the ownership they had in OGF. We went in there as a minority shareholder under their stewardship and have since bought out a lot of their ownership position and become the controlling owner in OGF in France.”

Long-term advantage

It’s this ability to invest longer-term that distinguishes OTPP from conventional private equity, and is something Rowe is making much more of in another innovation.

A relatively new allocation to long-term equities now sits within private capital and accounts for at least 25 per cent of the direct portfolio. It is distinct because here OTPP typically invests alone.

“It’s one of the things we’ve done since I joined; I would love to say that I was the mastermind but I wasn’t,” she says with disarming self-deprecation.

It’s a strategy other pension funds are desperately trying to copy. The $323 billion California Public Employees’ Retirement System, CalPERS, is the latest to shift its strategy and consider direct investments in private companies.

“We identify companies where the management teams, and maybe the founder, don’t want to be in a typical private equity structure where someone will be looking to sell them after three or four years,” she says. “We go in with the desire to hold onto the company for a long time and this differentiates us from private equity. It is an ability for us to work on some unique opportunities outside the typical private equity structure. OGF is an example.”

Her team targets lower risk companies able to generate cash dividends that sit between the two spots on the risk spectrum of infrastructure and the typical private equity LBO-like exposure. Seniors housing, storage, and the lottery space are typical examples.

Long-term investment and expert advice may sound like corporate nirvana, but Rowe is quick to clarify it isn’t.

“When we do all our due diligence and figure out the price we need to pay, often as not, people walk away from that discussion disappointed. We have to be very careful, particularly that our risk colleagues are aligned with us. They have to agree that it is a lower risk and potentially higher cash yielding type of business.”

Engaged ownership

Selection is the beginning of a rigorous corporate journey. All direct and long-term equity investments come with hands-on management in the investee company and proportionate governance rights including a voice on the board.

“As good fiduciaries for the teachers of Ontario we have to make sure they are growing their business well, and not just taking our capital for granted. The easy part in our business is buying a company. The really hard work is growing a company and we make it clear that the hard work begins after we become the owner.”

In recognition of this she has beefed up her portfolio management team, the in-house experts behind the value creation that in turn becomes the blueprint when OTPP becomes an owner in the business. Called “engaged ownership” it lays out how the business will grow over the next five to 10 years and includes key performance indicators “to make sure that folks have scorecards”, she says, to track progress.

She says that jointly owning businesses with “the best private equity funds around the world” has allowed OTPP to learn to craft these blueprints in an ongoing learning process. It does little to deflect from the fact that OTPP’s own expertise and reach must now be equal to all of them.

All direct deals are reviewed by an internal committee twice a year in check-ins with deal teams. And all investments are viewed through an ESG lens. She makes sure funds are aligned on ESG; with co- and direct investment, she says “creating change and raising consciousness” depends on how much of the company OTPP owns. But the questions she asks are penetrating.

“Are our companies honouring diversity in management teams? How is a company sourcing from Asia honouring strong labour practices in its suppliers? We own a wine company in Canada; how is it honouring responsible drinking and anti-drink drive campaigns.”

Pushing fee barriers

At OTPP private equity is one the asset classes most likely to use external managers and the direct and co-investment program has helped reduce fees. In 2016 management fees for all asset classes were $358 million, down from $421 million in 2015 due to a reduction in external assets under management and related management and performance fees.

Investing in funds, where a 2 per cent management fee is the norm, Rowe takes advantage of opportunities for lower fees where possible. She likes the benefits of being an early investor “as long as we’ve had the opportunity to do all of the work.” She also welcomes the benefits from committing more than the next LP.

“We know what those discounts are and we’re able to decide if we want to take advantage of them or not,” she says. And she likes the fee advantage that comes with backing newer funds.

“We take comfort from the fact that other pension funds have endorsed young GPs and my guess is that the industry takes comfort if we’ve endorsed a young team too.”

She insists on hurdle rates before GPs can take carry, which is usually charged at 20 per cent.

“We like to see a typical 8 per cent hurdle rate and see recovery of this before the really big profit share takes place through the carry,” she says. She doesn’t see any need to grind down on the carry. “Twenty per cent is fine as long as the hurdle rate has been reached. Let’s just make sure we’ve had some good returns before they earn their 20 per cent carry on the profit.”

Her unwavering commitment to this comes as a handful of high-performing GPs have taken advantage of stellar market conditions to raise large funds without hurdle rates. But rather than target the GPs which have seen more than $500 billion pour into their private equity funds every year since 2013, her criticism is aimed at the LPs who sign up without hurdles rates in place.

“I think anybody who is a fiduciary for a pension plan ought to be putting a discipline in place that says mega profits to you shouldn’t happen until after we’ve had at least modest returns for our illiquid capital that we’re putting at risk to back you.”

CVC Capital Partners reportedly plans a hurdle rate of 6 per cent for its Fund VII, compared with the industry standard of 8 per cent. Advent International removed the hurdle rate outright from its latest fund, which closed at $13 billion.

Greater fee transparency, backed by industry body the Institutional Limited Partners Association, ILPA, would help.

“We don’t think you should have to have people in a back office spending days trying to figure out how much is going into the pockets of GPs versus recovery by the LP.”

Private equity engrained at OTPP

Private equity at OTPP had an inauspicious start all those years ago when its first ever investment turned sour. Yet despite losing money, the board and chief investment officer at the time, Robert Bertram, remained steadfast, setting a precedent that Rowe believes is fundamental to today’s success.

“Private equity was seen as an asset class that would be important for the pension plan,” she says. “This was honoured from the very beginning.”

Success, she believes, is also rooted in the engrained belief in delegated authority, passed from the board to the CIO, and then down to the people running the asset classes. It is something she practices today, spending little time working on the nitty gritty of the deals she loves.

“I typically have to restrict myself to enjoying it to our weekly underwriting and portfolio meetings. With a focus on our broader strategy, I rarely get involved in negotiating the specific details of a transaction. If something comes up that is an outlier from the norm, the team judges when they have to get me involved.”

And perhaps the most important pillar of success is found in the expert team she leads, divided between a funds team, portfolio management and value creation, and direct investment teams, organised by the sector where the great majority now work.

Most of the team have been encouraged and nurtured to rise up through the ranks so that her department fills most positions from within. The fact that Jim Leech, OTPP president and chief executive who retired in 2013, was head of private capital before he became chief executive isn’t lost on Rowe’s many admirers.

When Xi Jinping was settling in as China’s new president in 2013, an animated cartoon went viral that presented his path to power as much more challenging than that of newly re-elected US President Barack Obama.

The message for Chinese viewers was clear: Xi had worked his way through 16 grinding jobs over a 40-year political career, while Obama had somehow emerged as a shooting star from a pugilistic system built on glib speeches and money politics.

Later this year, Xi is set to join an elite group of Chinese Communist leaders who have had the chance to exercise paramount power for at least a decade, while the US is embroiled in speculation about the possible impeachment of President Donald Trump. How Xi’s rise is presented will say much about how he sees his place in the world.

China’s five-yearly transfer of power within the Communist Party – which flows down through the central and provincial government ranks – is due to begin by the middle of October, although it could happen earlier if the opaque power brokers can reach a consensus.

With Xi certain to retain his jobs as party general secretary, state president and head of the military, the main interest will be in which new people in the seven-member Politburo Standing Committee look best qualified – in terms of age, experience and factional ties – to take over as leader in 2022. The transition in the leadership has already been reverberating around the country over the last year, with a major turnover in senior financial regulators and shuffling of political jobs to pave the way for renewal of the roughly 200-member Communist Party Central Committee.

A truly global China

Once Xi has been formally elevated to the status of two-term party leader, he will be able to start comparing his achievements to those of Mao Zedong and Deng Xiaoping. There will be intense interest in how he faces up to mounting economic, demographic and environmental challenges that have at least partly been sidelined as he has been working on strengthening his political base.

“This is the first party congress of a truly globalised China,” says British academic Kerry Brown, who is Professor of Chinese Politics at King’s College London and director of the Lau China Institute. He argues that, for the first time, Xi and the other power brokers have to take account of how an uncertain world will view the regime’s new look.

A year ago, Brown says, Xi might have been inclined to throw his weight around and ignore convention on matters such as retirement age or the need for a succession plan. But now, amid rising global economic and political uncertainty, he will see a need and value in projecting a more calm and conventional approach.

Linda Jakobson, chief executive of the Sydney-based public policy initiative China Matters, predicts this 19th Congress will be relatively smooth, compared with the delayed 2012 Congress, from which Xi emerged as leader after an unusually bitter public brawl with a populist regional rival, Chongqing party chief Bo Xilai.

“There’s nothing that big on the horizon,” she says, but warns that, below the veneer of calm, even seemingly all-powerful modern Chinese leaders like Xi are consumed by a sense of existential anxiety. Despite their success over the past 35 years, she says, China’s top leaders are “incredibly insecure” about how best to ensure the Communist Party stays in power. This insecurity may well become even more all-consuming during Xi’s next five-year term, as the Communist Party contemplates its 100th anniversary in 2021.

Regardless of the new top leadership’s makeup, it will inherit a wide-ranging and sophisticated economic and public-sector reform program that was set out in 2013 but has been only modestly implemented, as Xi has concentrated on reinforcing his power, cracking down on corruption and pursuing a more assertive foreign policy.

How the new leadership takes up the 2013 Third Plenum recommendations on issues such as state enterprise privatisation and the role of markets has become more critical for the funds management industry with the recent decision to include Chinese shares in the Morgan Stanley Capital Index benchmark for emerging markets.

Most managers have, until now, tended to focus more on assets with exposure to China or the impact of Chinese actions on global markets, rather than on direct investment in Chinese assets. However, in June, MSCI decided to add the shares of 222 Chinese companies to its emerging markets index gradually, after rejecting them three times before because of limitations on capital movement and opaque regulation.

Australia’s largest industry fund, AustralianSuper, has played a pioneering role in focusing on the rise of China. The fund opened a small Beijing office and appointed Stephen Joske as a China-based senior manager in 2012. That job is more about analysing China’s role in global markets than direct investment. But the long-mooted MSCI change will force funds to take a more formal position on whether and how much to seek direct exposure to Chinese assets.

Potential debt bomb

In May, ratings agency Moody’s Investors Service bluntly defined the long-term economic challenge facing the incoming new leadership by cutting China’s sovereign debt rating to A1, due to concerns about the country’s rising debt burden.

“While ongoing progress on reform is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt,” Moody’s said at the time, warning about the economy’s dependence on stimulus measures.

Many Western economists based in China say that while Xi came to office amid expectations he would be an economic reformer, he has now locked himself into unrealistically high growth rates and maintenance of a large state-owned enterprise sector, which means debt levels will continue to rise. This is one of the biggest challenges facing the regime. In June 2017, China’s debt surpassed 300 per cent of GDP, certain analysts say.

Some economists interviewed for this article believe the current rate of credit creation can be sustained for only about three to five years, which means a severe credit crunch will probably be one of the biggest challenges for the new leadership.

Business advisory firm IMA-Asia noted in a recent outlook: “Since China’s massive debt-fuelled investment binge in 2008-09, it has become clear that the gains from its old growth model, which favoured investment and exports over household consumption, are diminishing. The rising credit intensity of growth and rapid build-up of debt are significant threats to the economy, should Beijing continue to resist slower growth.”

Those expecting some form of credit crunch within a few years tend to think that after enforcing a more authoritarian political environment in his first term, Xi is unlikely to be able to shift back to more liberal economic policies in his second term.

Other, more optimistic, observers say Xi’s flagship anti-corruption campaign, which has both rooted out enemies and restored some moral authority for the Communist Party, may now become less intense, allowing more focus on economic reform. UBS economist Tao Wang expects “improved policy implementation and co-ordination but not drastic changes in policy priority or direction”.

National School of Development economist Yiping Huang wrote after the Moody’s decision that it highlighted past problems, rather than future risks, because the government was taking decisive steps to deal with debt.

China Matters’ Jakobson says: “If Xi gets his own people appointed, he could well start genuinely reforming because he understands that is what is needed to keep the economy going. He wants to go down in history as a transformative leader.”

Experienced hands

Close observers of Chinese politics say up to 10 members of the current 25-member Politburo could win one of the four to five spots likely to be vacant on the Standing Committee and be seen as future leaders.

Jakobson says Xi may not show his hand on a succession strategy but if he does, there will probably be two competing candidates.

“A lot can happen in five years,” she says, recalling the way former President Jiang Zemin emerged suddenly, from relative obscurity, after the 1989 Tiananmen crisis, to become China’s senior leader.

Professor of International Relations and Political Science at the Boston University Pardee School, Joseph Fewsmith, says a key thing to watch at this Congress will be how Xi somehow paves a pathway to continuing to exercise power after his two five-year presidential terms end in 2022. Fewsmith predicts that Xi will try to write himself and his philosophy into the party constitution, to give himself a status similar to Mao’s and Deng’s.

“He could continue to be the central force for 10-15 years without any problem,” Fewsmith says.

But Brown says the most interesting thing to watch at this Congress will be how the Communist Party demonstrates it is responsive to public concerns despite the increasing centralisation of power around Xi.

“The Communist Party wants people to participate at all levels of government, just not through voting,” says Brown. “The leadership is … responding to the people without multi-party democracy. That’s the story of the Congress that probably won’t be recognised outside China.”

That 2013 animated ode to Xi made a big deal about how his long training in city and provincial posts contrasted with Obama’s lack of previous executive administration experience. This is one of the little-appreciated strengths of the Chinese political system; while leaders go through an opaque selection process, they can be better prepared for government administration than many new Western leaders.

Case in point, one of the youngest, most widely touted potential appointees to the Politburo’s Standing Committee, and a potential future leader, is Hu Chunhua. At the age of 54, he has worked as an administrator in Tibet, was China’s youngest ever governor in Hebei province 10 years ago, was then party secretary in Inner Mongolia and is now party secretary in Guangdong province, one of the country’s richest areas. This is the sort of administrative track record that will now be examined intensely around the world when the first Communist Party Congress of global China ends.

It’s been a busy year for the reporting and assessment team at the Principles for Responsible Investment, as we’ve looked to build on the services we provide to signatories.

Last year, at our annual conference, PRI in Person, the PRI made a public commitment to strengthening accountability measures.

Through our reporting and assessment process, we are able to see the progress – or lack thereof – that signatories are making towards implementing the PRI’s Six Principles.

Next, we will seek feedback on a basic set of criteria that have been developed with input from the reporting and assessment advisory committee, the signatory stakeholder engagement committee and the board. The finalised criteria will be made public at the end of 2017 and signatories that fail to meet this basic standard, based on 2018 reporting data, will be placed on a private watchlist. Our intention is not to punish signatories but to help them meet the criteria through collaboration. For those placed on the watchlist, our engagement and support will be key. However, those that fail to demonstrate progress over two years will be delisted.

At the other end of the spectrum, the PRI will also recognise responsible investment leaders by developing a leadership board. This will highlight and share good practices being carried out across our diverse signatory base.

New data portal

As part of our accountability measures and commitment to empower asset owners, we have also recently introduced a web-based platform, the Data Portal. For the first time, asset owners and investment managers will have access to a wealth of data on responsible investment across regions, types of asset owners, size of signatories and many other characteristics – all in one place. The portal will enable asset owners to collect and easily review information on investment managers. Our hope is that by giving signatories easy access to one another’s data, we will support the sharing of best practices and also encourage signatories to work together more closely.

Climate prominent on the agenda

In the last year, PRI’s data from 1200 reporting investors has shown that climate is firmly on the radar of our members. Asset owners identified climate change as the most important long-term risk, with 74 per cent of those reporting citing this issue as a long-term trend that could affect their investments. A majority of investment managers also identified the risks around climate change as a material concern.

Looking across the globe, investors in Australia and New Zealand were most likely to see climate change as a material risk, followed by those in Europe. Investors in emerging markets were less forthcoming on this issue, clearly demonstrating how not only climate change but also ESG issues in general need to gain more traction with these investors. 

Beginning next year, the PRI will be aligning its reporting framework to the Financial Stability Board Task Force on Climate-Related Financial Disclosures’ (TCFD) recommendations, providing an easy way for signatories to comply voluntarily. We think the TCFD recommendations form a valuable framework for investors to disclose information on how they plan to transition to a 2-degree world.

For PRI signatories, the TCFD brings a sharp focus to the financial impacts of climate-related risks and opportunities, providing asset owners and managers with a lens for assessing the material financial impacts of climate change in their investment processes. In addition to providing guidelines for companies, the recommendations also offer guidance for asset owners and managers on their own disclosures. This supports further evolution in good practice investor disclosure to beneficiaries, clients and other stakeholders on climate change and builds on existing good practice investor reporting, such as through the PRI Reporting Framework and the PRI’s Montreal Carbon Pledge. 

Voting and stewardship activity will continue to be essential for the stability of the financial services sector. By continuing to enhance and improve our reporting framework, the PRI believes it can play a valuable role in improving the dialogue between companies and investors about the real drivers of long-term performance, risk and return.

Mandy Kirby is director, reporting and assessment, at the Principles for Responsible Investment (PRI).