Better disclosure rules can help China’s financial markets work for the climate

The markets are seeing enhanced climate disclosures, but there’s a need for more consistent reporting and uniform application of rules across market sectors
<p>Liquid fuel made from coal at a mine in Inner Mongolia. None of China&#8217;s &#8216;Big 5&#8217; power generation companies are listed, meaning they need not disclose their emissions. (Image: Liu Lei / Alamy)</p>

Liquid fuel made from coal at a mine in Inner Mongolia. None of China’s ‘Big 5’ power generation companies are listed, meaning they need not disclose their emissions. (Image: Liu Lei / Alamy)

Across global capital markets, regulators and investors are pushing companies to strengthen their climate disclosures. Last year saw a flurry of new mandates on climate reporting by securities regulators and legislatures, from pace-setting requirements out of the European Union to ambitious new legislation in California.

KPMG research estimates that in 2022 around 80% of the top 100 companies by revenue across the world’s 58 largest economies issued environmental, social and governance (ESG) or sustainability reports. That is an almost twofold increase since the late 2000s.

Chinese capital markets are part of this trend. Equity and debt issuers in Hong Kong have been required to issue ESG reports since 2020. Mainland stock exchange regulators are working on expanding ESG reporting mandates, which should substantially raise reporting rates in these equity markets. Only around 30% of A-share companies (which have shares in mainland China denominated in yuan) issued ESG reports in 2021 – an increase from 25% in 2020, but still less than a third of the market.

In global and Chinese markets alike, expanded reporting seeks to meet growing investor demand for data that they can use to incorporate climate and sustainability risk into their decision-making. But how can regulators ensure this surge in reporting meets investor needs? For Chinese regulators, equity-market reporting mandates are a great start. Our research on Chinese corporate climate disclosures points to two pressing tasks to build on this work.

Aligning ESG disclosure with investor needs

The first task is to raise the quality of ESG reporting. Our analysis of disclosure quality scores from the Transition Pathways Initiative, drawn from 600 Chinese and non-Chinese firms in the world’s highest-emitting sectors, indicates that Chinese firms consistently lag behind their peers in both developed and emerging markets. Other comparative assessments, on topics from net-zero targets and carbon footprints to materiality assessments, echo our findings. (A materiality assessment is a formal process of identifying the ESG issues that affect a firm and its stakeholders.)

These challenges are already attracting attention. In 2020, Hong Kong regulators introduced a requirement that by 2025 issuers must align their climate reporting with the global standards set out by the Task Force on Climate-related Financial Disclosures (TCFD). Low reporting levels on China’s mainland suggest that progress may be slower there, as regulators focus on basic capacity-building to meet expanded reporting mandates in equity markets. But rising ESG scores in recent years indicate that – among large Chinese firms at least – awareness of sustainability reporting issues is deepening.

Authorities can steer efforts to match and inform global best practices by partnering with organisations like the International Sustainability Standards Board (ISSB), which opened a Beijing office last June. The ISSB took over the activities of the TCFD after releasing its first set of disclosure standards this summer.

The second task is to expand emerging regulatory efforts among equity markets to include public corporate debt markets. China’s US$7.4 trillion corporate bond market is the second-largest in the world, with central and (especially) local state-owned enterprises dominating issuance (80% of issuance in 2017). ESG data can inform investments in public corporate debt markets in many of the same ways as it does for public equity markets. Public debt and equity markets are just two of the many ways that companies can raise capital. Regardless of how they do it, their operations can face the same types of ESG risks and opportunities, on issues from extreme weather and the energy transition, to social licence and corporate governance. Better ESG disclosure would help investors to understand how these considerations affect the companies whose debt instruments they hold, and to manage their portfolios accordingly.

a person standing in a factory with rolls of aluminum
Rolled aluminium in Chongqing, southwestern China. The authors’ study focussed on Chinese companies in seven high-emitting industries – thermal power, iron and steel, cement, aviation, petrochemicals, chemicals, and aluminium. (Image: Cynthia Lee / Alamy)

Providing this information to debt investors requires reporting regulations that apply not just to public equity markets, but to public corporate debt markets too. This is because the Chinese state-owned entities (SOEs) that are listed on the stock market represent only a fraction of the total revenue and assets of all Chinese SOEs (35% and 25% in 2020). Many unlisted firms – especially SOEs – are active on public debt markets. Our research, for instance, covered 30 of the largest companies in China’s highest-emitting sectors. Twenty of these firms are unlisted, so do not issue stock on public equity markets. Almost all of them issue debt on public markets. (Many do participate in public equity markets via listed subsidiaries, but these subsidiaries often include only a portion of their assets.) Chinese regulators’ latest five-year plan goals for boosting environmental information disclosure cover both public equity and debt markets. However, both the existing and proposed ESG reporting mandates for mainland companies still only apply to those listed on the stock market.

Our findings on emissions reporting underscore the need for reporting mandates to cover unlisted firms as well. Among the 30 companies we studied in China’s highest-emitting sectors, eight are listed in Hong Kong, where a fairly stringent emissions-reporting mandate applies – all eight report their emissions. By contrast, 20 are unlisted and only one of those reports its total emissions. The power sector underscores the magnitude of unreported emissions here. In 2019, the major listed subsidiaries of China’s “Big 5” power generation companies reported around 0.9 gigatons of greenhouse gas emissions. Researcher Anthony Ku has estimated that their parent companies’ emissions that year were 3.2 gigatons, around three-and-a-half times greater.

China’s mainland authorities can close these gaps by expanding planned reporting mandates to all public markets. Doing so would align the mainland with other major capital markets, such as Hong Kong and the EU, where sustainability reporting requirements cover both equity and debt issuers.

Added benefits

The expansion of reporting mandates could also bolster China’s cautious progress in opening up its bond markets to international capital, which tends to be more ESG-conscious. International investors have generally preferred the low-risk profile of government bonds; stronger sustainability reporting can help them better manage their risk exposure in the corporate debt market.

Most importantly, more reporting would aid risk-management efforts among China’s mainland commercial banks, insurers, and investment funds, which now dominate the market. ESG awareness among this community is growing rapidly. Better reporting will let them make use of it.