China worries war-blinded ESG managers in Russia

(Bloomberg) – Caught off guard by Russia’s war on Ukraine, fund managers who are paid to avoid environmental, social and governance risks have begun to look at China with a new sense of unease.

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Their exposure to China is enormous. Pure ESG funds domiciled in Europe alone have about $130 billion invested in Chinese assets, according to data compiled by Bloomberg. Another $160 billion is held by European funds that have screened for ESG-related risks.

And yet, the investment industry is beginning to contemplate what was once unthinkable, as China’s ambiguous response to Russia’s invasion of Ukraine leaves the world on edge. China, the world’s second-largest economy, has sought to straddle both sides of the geopolitical divide, condemning the loss of life in Ukraine while accusing NATO of provoking Russia. And when the International Court of Justice voted to order Russia to “immediately suspend” military operations in Ukraine, only two countries objected: Russia and China.

“It’s time to be extra careful,” said Kristin Hull, founder of Nia Impact Capital, a $400 million sustainability fund in Oakland, Calif. Given China’s much deeper ties to the rest of the world, “there are so many global ramifications of this relationship.”

Investors have already offered China a taste of what could happen if it strays too far into Russia’s corner. Its shares were hit by a sell-off on March 9, partly triggered by fears that the United States would punish Beijing for its close ties to Russia.

Simon Pilcher, managing director of Universities Superannuation Scheme Investment Management Ltd., said he is watching Beijing’s relationship with Russia closely as he and his team decide how to manage their Chinese assets.

If China moves closer to Russia, it would “very potentially” influence its investment approach, Pilcher said in an interview. About 3% of the $120 billion his group oversees is currently in China, he said.

Prior to Vladimir Putin’s invasion on February 24, there was no lack of analysis as to why he would not launch a full-scale war against Ukraine. This blind spot now has investors wondering if they are underestimating China’s ability to surprise them, potentially with an invasion of Taiwan. Type the words “China” and “invasion” into a Google search engine and the next word that pops up is “Taiwan”.

Ukraine’s attack has not only renewed scrutiny of parallels between Russia and China, it has thrust relations between the two countries into the spotlight. Just before the war began, Chinese President Xi Jinping hosted Putin at the Beijing Olympics, a public display of warm relations.

For its part, the United States has made it clear that it will not tolerate any signs that the government in Beijing is providing economic or military aid to Putin’s regime. The Biden administration is also urging China to unequivocally distance itself from Putin.

“The Chinese government is beholden to no one but itself,” said Sonia Kowal, president of Zevin Asset Management. Russia’s invasion of Ukraine and international condemnation through sanctions could be a dress rehearsal for China, she said in an interview.

“What worries us is that the risks become even higher in the future,” Kowal said. Boston-based Zevin, which managed $720 million at the end of February, has yet to decide whether it will scale back its investments in China, she said.

Numbers…

Of the ESG funds holding Chinese assets, a number are classified under Article 9, which is the highest sustainability classification within the European Sustainable Finance Disclosure Regulation. Together, these funds hold $7 billion. An additional $124 billion is in Article 8 funds, which is a more lax ESG category within SFDR.

About $162 billion is in Article 6 funds, where managers review their portfolios to decide whether to disclose ESG risks.

–Bloomberg Global Data

In a sign that China may be growing increasingly worried about what is happening in Ukraine, state-owned Sinopec has suspended talks on a major petrochemical investment and gas marketing venture in Russia, Reuters reported on Friday.

The situation with China is “complicated”, said Joe Dabrowski, deputy policy director at the Pensions and Lifetime Savings Association in the UK, in an interview. The country is such a global power that any decision to blacklist it would have “such far-reaching consequences”, he said.

Whether it’s even a debate for ESG managers, who now manage around $2.7 trillion in funds, is a sign the movement has lost sight of its purpose, according to Paul Clements-Hunt, who led the team that coined the acronym in 2004 together. with the late former United Nations Secretary General, Kofi Annan.

The “G” in ESG, which stands for governance, means investors should consider the political regime of the country whose assets they own, Clements-Hunt said in a recent interview. “If you ignore autocracy and a malicious government, you have failed your ESG assessment,” he said.

And in a note to clients earlier this month, analysts at JPMorgan Chase & Co. wrote that “the Ukraine-Russia conflict could bring the question of how ESG investors manage investments in regions with governments of undemocratic and hybrid regimes. .”

“What we are seeing now is a very stark reminder that there are times when the only option you have is to leave,” said Eric Pedersen, head of responsible investments at Nordea Asset Management.

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