Corporate Governance in China

CORPORATE GOVERNANCE IN CHINA

Scores for Chinese companies cluster around the median relative to global peers, VIEs and SOEs have distinct governance risks

September 2017  China adopted its first corporate governance code in 2001, ahead of many APAC peers, and with updates in Contents 2011 and 2016. As China’s market becomes more accessible to global investors, corporate governance practices Ownership Snapshot 2 will likely face increased comparison to global standards. This report examines the opportunities and risks to Variable Interest Entities 3 minority shareholders presented by current corporate governance practices in China. Founders Favored 5  Companies employing variable interest entity (VIE) structures are large (16 companies with constituent weights Legal Uncertainty 9 on the MSCI China Index of 12% as of 1 August 2017) and show generally strong returns. But VIE governance State Involvement 12 structures are often tilted to favor the founder and ownership risk is increased due to legal uncertainties. Misalignment 14 Misappropriation  In contrast to private enterprises, over the past five years shareholder returns at Chinese state-owned 21 enterprises (SOEs) have underperformed the MSCI China Index. The Chinese State has undertaken a multi- Appendices pronged reform program aimed at improving returns, but the possibility of misalignment between the strategic Regulatory Developments 22 interests of the state and those of minority shareholders remains a key governance risk. Corporate Overview 26  In aggregate, constituents of the MSCI China Index cluster more around the median score on corporate Board Overview 27 governance relative to constituents of the MSCI ACWI Index. Key areas of concern include pay and board issues Gender Diversity 28 (no independent chair, no independent board majority), controlling shareholder and related party transaction Key Metric Overview 29 conflicts, and limited shareholder protection rights. Regulatory oversight differences between A-share Best and Worst Scores 30 (Mainland China) and H-share (Hong Kong) listings, in some cases for the same company, contribute additional State Ownership 31 layers of risk and complexity.

Top 5 Scores Bottom 5 Scores CORPORATE GOVERNANCE SCORE DISTRIBUTION China Shenhua Energy Co Ltd 7.2/10 Alibaba Group Holdings Limited 0.0/10

China Merchants Bank Co Ltd 7.2/10 CTRIP.COM International Ltd. 1.6/10

China Telecom Corporation Ltd 7.2/10 JD.COM Inc. 2.1/10

Sun Art Retail Group Ltd 7.1/10 Netease, Inc. 2.7/10

Lenovo Group Ltd 7.1/10 Huaneng Renewables 2.8/10 Laggards Leaders

This report is based on the 149 constituents of the MSCI China Index as at 11 September 2017. Some references are made to other Chinese companies in coverage. 0 1 2 3 4 5 6 7 8 9 10 MSCI China Index MSCI Emerging Markets Index MSCI ACWI Index

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

OWNERSHIP SNAPSHOT

Governance risks vary widely depending on the nature of the company’s ownership, the separation of ownership and management, and the design of the capital structure and its impact on shareholders’ voting rights.

Largest Owner Classification Key Owner Types Complex Ownership Structures Control Enhancing Structures

Concentrated ownership dominates in China, Most Chinese firms are state-owned at 59.7%, Few MSCI China Index constituents are Companies with unequal voting rights are where 81.9% of MSCI China Index constituents often controlled by other state companies via party to cross shareholdings or generally listed on US exchanges (variable include a shareholder or shareholder group, intermediate holding companies. At 26.2%, positioned at levels 3 or below in a interest entities, see page 3). In a market where often the State itself, who controls 30% or founder firms are the next most significant stock pyramid, although the pyramidal 81.9% of companies are controlled, such control more of the voting rights, group, and many of these are VIEs (variable nature of many of the SOEs (state enhancing structures are not really needed, and interest entities, see page 3). owned entities) is noted. yet they are employed anyway.

81.9% MSCI China Index MSCI China Index MSCI China Index MSCI China Index MSCI Emerging Markets Index MSCI Emerging Markets Index 16.0% MSCI Emerging Markets Index MSCI Emerging Markets Index 68.3% MSCI ACWI Index MSCI ACWI Index 59.7% MSCI ACWI Index MSCI ACWI Index 53.7%

9.7% 9.2%

37.3% 34.5% 6.0% 26.2% 28.2% 4.2% 24.2% 16.1% 18.6% 15.1% 2.3% 1.8% 12.1% 0.0% 1.2% 14.8% 11.8% 7.2% 10.5% 10.4% 0.0% 0.0% 0.0% 7.5% 8.9% 6.3% 3.5% 5.4% 2.0% 2.7% 1.7% 3.4% Multiple Share Voting Rights Extra Voting Golden Shares Classes w/ Limits Rights - Controlling Principal Widely Held Founder Family State Corporate Cross Shareholdings Pyramid Structure Unequal Voting Ownership Parent Rights Duration

Controlling – Largest shareholder or shareholder Founder – Founder serves as Chairman or CEO. Cross Shareholdings – Two or more Multiple Share Classes with Unequal Voting Rights (or group holds 30% or more of the voting rights. Family – Family holds 10% or more of the voting entities hold at least 0.5% of shares in each no voting rights for one class) or classes which carry Principal – Largest shareholder or shareholder rights and maintains at least one board seat. other, or via a circular or more complex different rights to vote on director appointments. cross-shareholding arrangement. group holds between 10% and 30% of the voting State – State directly or indirectly controls 10% of Voting Rights Mechanisms include ceilings on rights. the voting rights. Pyramids – Control is exercised through a ownership or voting rights, voting rights limits based chain of non-controlled companies, which on nationality, or additional voting rights accruing Widely Held – No shareholder or shareholder group Corporate Parent – Issuer is a subsidiary (30% or ultimately results in a shareholder gaining depending on ownership duration. holds more than 10% of the voting rights. more) of a corporate, which itself may be listed. voting power that is misaligned with their Golden Shares – Government veto rights for *Owner types may overlap or separate owners may be of economic interests. transactions or changes to governing documents. different types at a company

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

CHINA IN CONTEXT Recognition of the importance of corporate governance principles has a long The expectations of global investors regarding the governance of publicly history in China. China’s first corporate governance code was introduced by traded companies have been guided by the adoption of corporate governance the China Securities Regulatory Commission (CSRC) in 2001, ahead of many codes and standards across virtually all global markets, beginning with APAC peers, and updated further in 2011. In August 2016 a review of this publication in the UK in 1992 of “Financial Aspects of Corporate Governance”, code was announced by the Chairman of the CSRC, and other legislative more widely known as the “Cadbury Report”. According to Cadbury, “The reforms are also under review. As more and more global investors consider shareholders’ role in governance is to appoint the directors and the auditors investing in Chinese equities, the importance of these efforts to adopt and and to satisfy themselves that an appropriate governance structure is in adhere to global standards of good corporate governance can only continue place” and “The responsibilities of the board include setting the company’s to grow. Our report examines the many opportunities – and risks – presented strategic aims, providing the leadership to put them into effect, supervising by current corporate governance practices in China, based on the the management of the business and reporting to shareholders on their expectations of these potential investors. stewardship. The board’s actions are subject to laws, regulations and the shareholders in general meeting.” These core principles have been used to

inform the definition of good corporate governance ever since.

MARKET CHARACTERISTIC |VARIABLE INTEREST ENTITIES Despite being some of the largest, most discussed companies in China, four of offered attractive returns and hence the VIE structure was devised to offer the bottom five governance assessments for constituents of the MSCI China foreign investors access to these companies through a listed SPV. Figure 8 (on Index utilize a variable interest entity (‘VIE’) structure. Tencent Holdings and page 9, below) sets out the legal structure of the VIEs. Alibaba, both of which use VIE structures, are actually the largest by market Many VIEs retain the involvement of their founders, and their governance cap as of August 2017. structures have been designed in such a way as to preserve the founders’ Under current Chinese legislation, foreign investors are not permitted to tight control over the direction of the company. Furthermore, investors in invest directly in Chinese companies that operate in key industries, e.g., VIEs are exposed to certain legal risks relating to the VIE structure. internet, education and telecommunications. However these sectors have

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

Figure 1 | MSCI China Index VIEs 3-year Total Return BIGGEST CONCERNS| JD.COM, INC 3-year Return % JD.COM's articles and by-laws provide that 400 the company's board will not be able to 341.5 350 muster a quorum in the absence of Richard Liu, founder, CEO and Chairman. As such, 300 he can veto anything by simply staying home. Combined with his controlling 250 224.6 shareholding due to a multiple share class 200 176.0 structure with unequal voting rights, Mr. Liu can defeat any resolution from which 150 137.4 he is not legally required to abstain. 100 68.2 31.7 37.6 50 -39.6 -27.4 -18.4 -10.6 -4.3 27.0 BEST IN “VIES”|TENCENT HOLDINGS 0 Among the VIEs in the MSCI China Index, -50 Tencent Holdings has the highest governance score. Although it is also a -100 YY Inc. Alibaba 58.Com Inc. Vipshop Baidu, Inc. SINA Autohome Inc JD.Com, Inc. CTRIP.Com Tencent New Oriental Weibo Corp Netease, Inc. Cayman Islands exempt company, it is Pictures Group Holdings Corporation International, Holdings Education & Limited Limited Ltd. Limited Technology listed in Hong Kong where arguably the Group Inc. shareholder protection rights are stronger. Tencent also does not have a dual class *Alibaba Group, Momo and TAL Education listings are within three years structure with different voting rights. Source: Ownership Structure/TSR Data - MSCI ESG Research and/or Thomson Reuters Data as at 27 July 2017 (5-year TSR data not included given only 8 VIEs have 5-year trading history).

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

RISK – GOVERNANCE STRUCTURE FAVORS FOUNDERS  Many VIEs retain founder involvement. Due to the nature of the FOUNDER FIRMS contractual relationships and the associated risks, the reputation and equity commitment held by the founder is often key to an IPO’s success. More than 70% of VIEs are founder firms, with the founder remaining as Chairman or CEO of the company (Figure 2).  Founders typically use three primary tools to maintain a tight grip on the control of the listed SPV – a dual share class structure granting them Figure 2 | Controlled Versus Founder Firms at VIEs

superior voting power; incorporation in a management-friendly Controlling Shareholder No Controlling Shareholder jurisdiction; and dominating the board, often via the key role of Founder Baidu, Inc. 58.Com Inc. Chairman while retaining executive powers. Firm VIEs JD.Com, Inc. Alibaba Group Holding Limited MOMO Inc. CTRIP.Com International, Ltd. With VIEs being a relatively recent development, it is no surprise that at the Netease, Inc. New Oriental Education & Technology Group Inc. majority of these firms, the founder remains involved. Indeed, in many cases TAL Education Group Tencent Holdings Limited the founder exercises tight control over the direction of the company. Often Vipshop Holdings Limited the founder seeks to control the company with a lower level of economic YY Inc. interest than a normal capital structure would typically require. In some cases Other VIEs, Alibaba Pictures Group Limited Sina Corporation this may be combined with other governance arrangements that are typically including Autohome Inc viewed as detrimental to minority shareholders. Listed Weibo Corp Subsidiary

Why the Tight Control? Source: MSCI ESG Research. Data as at 27 July 2017. In many cases the registered owners of the operating companies (OPCOs) are executives, sometimes even the founder. As discussed in the next section, one of the risks of these structures is that of transfer of the OPCOs beyond the reach of the investors in the SPV. However, in the reverse situation the founders may seek to reduce the likelihood of change in the control of the SPV through:

 the use of dual share classes;

 incorporation in jurisdictions which are management-friendly; and  ensuring that the board and board leadership remain closely aligned with the founder.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

The dual class share is commonly utilized by technology and media companies CAPITAL AND OWNERSHIP STRUCTURE in the US for similar reasons – to allow a founder or family to maintain control. In the case of VIEs however, shareholders are exposed to greater Dual Share Classes with Unequal Voting Rights governance risks than at these US media and tech companies due to the Among the 12 VIEs that are founder firms, eight utilize dual class share combination of the VIE structure, the exempt company status in its structures with the share class held by the founders carrying superior voting jurisdiction of incorporation, and the foreign private enterprise regime in the rights. This arrangement has allowed the founders to reduce their capital venue of listing of many of the VIEs. investment while maintaining control of the company. With this dual class share structure not permitted in Hong Kong,1 these eight companies are listed JD.COM's ownership structure deviates from the one-share, one-vote voting on U.S. stock exchanges as a foreign private issuer. principle and effectively gives 80% of the voting rights to its founder, Richard Qiangdong Liu, despite his owning less than a majority of the company’s Figure 3 | Disparity between Founder Ownership and Voting Rights at VIEs outstanding shares. These risks are exacerbated by his combined roles of CEO and Chairman. 100% Partnership Structure 75% Alibaba Group is effectively a controlled company due to its partnership structure and a voting agreement. Through the partnership agreement, the 50% Alibaba Partnership has the right to nominate the majority of the Board. The partnership membership comprises some members of management of the 25% company and its affiliates. The Alibaba Partnership’s nomination rights and related provisions of the articles of association may only be changed upon the 0% vote of shareholders representing 95% of the votes present in person or by 58.COM Alibaba VIPSHOP JD.COM Baidu,Inc. YY Inc. MOMO TAL Inc Holdings INC Education proxy at a general meeting of shareholders.

% of Shares Held % of Total Voting Rights Held This is supplemented with a Voting Agreement, the signatories to which control almost 55% of the total votes, thereby limiting the likelihood of a Source: MSCI ESG Research. Data as at 27 July 2017 hostile takeover.

1 This approach is not viable on Hong Kong Exchanges & Clearing (HKEX) as a result of the opposition to dual class shares by the Securities and Futures Commission in October 2015, which aborted an earlier consultation to allow dual class shares to be listed on HKEX. In June 2017, HKEX started a consultation with a view to allowing dual class shares on a new board http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/170616news.htm.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

For Cayman Islands ‘Exempt Companies’ there are no requirements to hold DEPRIVATION OF SHAREHOLDER PROTECTION RIGHTS annual general meetings. The requirements to hold AGMs are typically The VIEs are typically incorporated in the Cayman Islands (see Figure 4), with enshrined in company law in most markets. The Cayman Islands ‘Exempt some utilizing the Cayman Islands ‘Exempt Companies’ provisions. Two Companies’ provisions are thus a real outlier. With no requirement in the laws provisions are of particular concern – the absence of legal requirement to of incorporation, and the fact that the Foreign Private Issuer regulations in the hold AGMs and setting the requisition threshold for an EGM at an excessively U.S. (location of listing) do not impose a requirement for AGMs, shareholders high level. Hong Kong Listing rules specifically require the holding of AGMs. are left without a regular forum in which to hold the board to account.

Figure 4| Listing, Incorporation & Control Enhancing Mechanisms  Last AGM …

Listing Company Incorporation Dual Class Other Mechanisms Two VIEs have taken advantage of the flexibility under the ‘Exempt Shares? Companies’ regime to avoid the holding of AGMs. Hong Kong Alibaba Pictures Group Limited BM Baidu JD.com Tencent Holdings Limited KY Last AGM >> NASDAQ Baidu, Inc. KY Yes 2008 None since 2014 IPO CTRIP.Com International, Ltd. KY Poison Pill In their respective Articles of Association, Alibaba, Baidu and JD.com have JD.Com, Inc. KY Yes taken advantage of the Cayman Islands ‘Exempt Company’ provisions to MOMO Inc. KY Yes impose unusually high thresholds to request an EGM. In other global markets Netease, Inc. KY voting right thresholds to request general meetings are generally set at 5% to Sina Corporation KY Poison Pill 10%. Weibo Corp KY Yes  EGM Threshold versus Aggregate Voting Rights of Minority Shareholders YY Inc. KY Yes NYSE 58.Com Inc. KY Yes Baidu JD.com Alibaba Alibaba Group Holding Limited KY Yes Partnership Agreement EGM Threshold >> 50% 33.3% 33.3%

Autohome Inc KY No Class B Aggregate Voting Rights of outstanding 30.8% 20.0% 45.2%* Minority Shareholders > New Oriental Education & KY Blank Check Technology Group Inc. Preferred Stock *Those shares not held by the executive officers (10.6%), Softbank (29.2%) or Yahoo (15.0%). TAL Education Group KY Yes Given the size of the respective controlling interests at Baidu and JD.com, the Vipshop Holdings Limited KY Yes minorities are left unable to take remedial action through convening an EGM. Source: MSCI ESG Research. Data as at 27 July 2017. At Alibaba, some 75% of minority shareholders would need to collaborate to Key: KY = Cayman Islands. BM = Bermuda. request an EGM, a near impossible task.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

Figure 6| Chairman Status at MSCI China Index - VIEs BOARD COMPOSITION The board and board leadership represent the third area of focus for 19% Founders seeking to reduce the likelihood of a change in the control of the SPV. A common feature of founder firm VIEs is the founding entrepreneurs Combined with CEO monopolizing the board by appointing executive directors with the result that 56% Executive independent directors often do not represent a majority of the board. 25% While this is typical of other MSCI China companies, it represents a stark contrast to the U.S. (where many of the VIEs are in fact listed) where 96.7% of boards are majority independent and across the MSCI ACWI where 66.2% are Source: MSCI ESG Research. Data as at 27 July 2017 majority independent. OTHER CONCERNS - CEO PAY Figure 5| Board Independence at MSCI China Index - VIEs With the issue of executive pay sometimes thought of by corporate governance experts as a window to the soul of the board and therefore a 6.3% measure of board effectiveness, the absence of disclosure on executive pay

Majority restricts the insights available to investors on board effectiveness. 50.0% Minority With many of the Founders continuing to retain a significant equity stake (and 43.8% None in some cases benefiting from dividends), the traditional justification for incentive pay (and particularly equity incentives) – the separation of interests between shareholders and executives – is absent. Yet we identify concerns as to high levels of incentive pay at some VIEs Source: MSCI ESG Research. Data as at 27 July 2017 compounded by poor disclosure. In such cases, high CEO pay may be a symbol None of the VIEs in the MSCI China Index feature an independent chairman of status and a source of value leakage away from minority shareholders. (although this is typical of the index more broadly). The board chairman of a Figure 7 | Executive Pay Disclosure – MSCI China VIEs VIE is typically an executive, sometimes separate from the CEO. (Weibo/Alibaba/New Oriental). Good Disclosure Poor Disclosure This practice raises parallel leadership concerns. At others, the combination of CEO and chair roles (JD.COM/Tencent/Baidu/TAL Education/YY Inc) in tandem with other governance arrangements profiled in this section suggests 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% risks relating to overly powerful management interests and increases the Source: MSCI ESG Research. Data as at 27 July 2017. “Good disclosure” includes likelihood of board level conflicts of interest. individualized pay disclosures for each executive director with the amount paid in respect of each component of the pay package disclosed separately.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

RISK – LEGAL UNCERTAINTY AND IMPACT OF VIE STRUCTURE

 VIE is a device designed to avoid foreign investment restriction laws in China. The legal validity of the VIE structure has not been confirmed by the Chinese authorities. While the Chinese State has not yet taken any action against any of these companies, investors are exposed to a risk of the structure being struck down by the authorities.  The ownership of the OPCOs is often in the hands of the Founders or their executives, rather than directly in the control of the Group. As such, minority shareholders are exposed to a risk that the OPCOs are transferred beyond their reach.  VIEs were (as at July 27, 2017) three times more likely to be flagged in our AGR Model as having ‘Very Aggressive’ accounting than other ACWI constituents and almost four times more likely than other Chinese companies, although this outcome seems to be unrelated to the VIE structure.

The VIE structure involves a PRC operating company Figure 8 | Typical Structure of a Variable Interest Entity (VIE) Showing Contracts between WFOE, (OPCO), wholly-foreign owned enterprise (WFOE) and OPCO and SPV offshore holding company (SPV) (see Figure 8).

 The China based OPCO signs contracts/agreements that effectively give the WFOE (and hence the SPV) effective control and economic benefits.

 The China based WFOE owns the intellectual property and is owned by the SPV.

 Investors purchase shares in the SPV, which retains only the contractual rights to the assets.

Note 1: Registered Owners are PRC nationals and often the controlling shareholders of the SPV. Note 2: OPCO is incorporated in the PRC Source: Hong Kong Exchanges & Clearing (HKEX).

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

RISK OF ONSHORE PARTIES NOT HONORING CONTRACTUAL OBLIGATIONS RECENT LEGAL DEVELOPMENTS There is a risk that the operating company could sever its ties with the holding A consultation conducted by the Ministry of Commerce on amendments to company, leaving the foreign investors with no access to the assets in the Foreign Investment Law 2 in January 2015 was supposed to deal with VIEs, question and the value of their investments vulnerable to litigation risk. but did not do so when amendments to the these laws were made in September 2016.3 The legislative process is still under way and uncertainties Case Study: Alibaba’s transfer of Alipay remain. In 2011, Jack Ma became involved in a public dispute with Alibaba’s then In a recently reported case by the Supreme People’s Court (SPC), the co- largest outside shareholder, Yahoo. This followed the decision in July 2009 to operative framework agreement between the PRC operating company and transfer a majority of Alipay to a Chinese entity controlled by Ma. Ma the wholly-foreign owned company was affirmed by the SPC. While the SPC indicated that the separation was a result of new Chinese government acknowledged the effectiveness of the co-operative agreement, it did not regulations on ownership of third party payment services. fully endorse the legal validity of the VIE structure. The subject matter of the case involved PRC legislation on Sino-Foreign collaboration of education The terms of the transfer were later negotiated, with an agreement that enterprises. The SPC decision sidestepped the question as to whether the Alibaba would receive 49.9% of the earnings of Alipay until such time as an framework agreement (or for that matter the VIE) infringed the provisions of IPO of Alipay would take place. Further, if Alipay sold shares to the public, the relevant legislation.4 Alibaba would receive some $6bn.

The case raised questions as to the corporate governance standards at Alibaba and highlighted some of the risk of the VIE structures for minority investors, with these investors particularly exposed to risks in relation to the transfer of some or all of the businesses within the VIE structure.

2 www.mofcom.gov.cn 3 www.npc.gov.cn 4 www.sohu.com/a/128199948_481806

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

AGGRESSIVE ACCOUNTING AT VARIABLE INTEREST ENTITIES – RELATED TO THE VIE STRUCTURE?

5 MSCI ESG Research’s proprietary accounting risk model, AGR, shows that  In the Asset/Liability Valuation group, 9 of 16 were flagged for low Asset Chinese companies (ex-VIEs) generally adopt a slightly more conservative Turnover (overvalued assets may be responsible for a low asset turnover approach than MSCI ACWI Index constituents generally. figure). However, the picture for VIE companies is the reverse. Across the entire The accounting treatments (including consolidation of accounts) have universe of coverage for AGR, the top 10 percentiles are identified as previously been challenged by regulators including the Securities and demonstrating ‘Very Aggressive’ accounting practices. VIE companies were (as Exchange Commission (SEC). In a 2012 case the SEC had scrutinized the at July 27 2017) three times more likely to be flagged for ‘Very Aggressive’ accounting treatments by New Oriental Education & Technology, an MSCI accounting practices, according to the model.6 China Index company utilizing the VIE structure. The SEC investigation concluded in September 2014, without any enforcement action being WHAT ACCOUNTING RATIOS ARE FLAGGED FOR VIES? recommended. Two items stand out as having both high impact and occurring frequently Figure 9 | AGR Ratings of Variable Interest Entities among VIEs: 60%  11 of the 16 companies were flagged for high or rapidly rising Prepaid 53.0% 50% Expenses/Operating Expenses (The company may erroneously capitalize 45.0% 43.8% expenses, such as "prepaid expenses", which artificially decreases operating 40% expenses and increases net income). 31.1% 31.3% 30% 25.6% 25.0% 20% 12.8% 14.5% 5 AGR Methodology 9.4% 8.5% 10% Within each geographical region (North America, Western Europe, Japan, Asia-Pacific and Emerging 0.0% Markets) we report the AGR in percentiles from 1 to 100, worst to best and also classify them as: 0%  Very Aggressive – highest risk companies, comprising 10% of the total universe Conservative Average Aggressive Very Aggressive  Aggressive – high risk companies, comprising 25% of the total universe  Average – moderate risk companies, comprising 50% of the total universe MSCI ACWI Index MSCI China Index - Ex VIE MSCI China Index - VIE  Conservative – low risk companies, comprising 15% of the total universe Source: MSCI ESG Research. Data as at 1 August 2017 For an overview of the MSCI ESG AGR methodology please see https://www.msci.com/documents/1296102/1636401/MSCI_ESG_AGR_factsheet_July2015.pdf/1276 MSCI ACWI Index n=2322; MSCI China Index – VIE n=16; MSCI China Ex-VIE n=117. AGR b028-aee5-40e5-b1ad-85a2ac664841. ratings are not available for all companies in the MSCI ACWI Index and the MSCI China The detailed MSCI ESG AGR Methodology Document is available to MSCI clients on ESG Manager. Index. 6The AGR scores for these companies do not appear to be driven by the unusual structure of the VIEs per se. Because of the consolidated reporting made for these group accounts, flags for aggressive accounting do appear to be related to actual accounting practices of the operating companies.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

MARKET CHARACTERISTIC | STATE OWNERSHIP NOTABLE DEVELOPMENTS | ANTI- CORRUPTION CAMPAIGN In contrast to VIEs, which dominate the MSCI China Index in terms of capitalization but represent a small Management or board reshuffles happen often in the number of companies, about 90 companies in our dataset (59.7%) are State-owned. MSCI ESG Research telecommunications and energy sectors. One of the identifies State-owned firms as being those where the State directly or indirectly controls at least 10% of the possible reasons for shuffling the boardroom decks is voting rights or has the right to appoint a majority of the directors. While State ownership is a well known to prevent any individual from developing characteristic of the Chinese market, the governace risks facing investors can vary. entrenched patronage bases, which the Chinese Communist Party (CCP) believes contributes to corruption. The anti-corruption campaign, started by ORGANISATION OF STATE OWNED ENTERPRISES IN CHINA the Chinese government in 2013 under the auspices In China, some 102 central state-owned enterprises (SOEs) are supervised by the State-owned Assets of the Central Commission for Discipline Inspection (CCDI), has investigated and removed from office Supervision & Administration Commission (SASAC). SASAC appoints and provides training to the directors of many SOE senior officials/board members in many these central SOEs. It decides on their remuneration and sets profit targets for these SOEs. There are also strategic sectors. However, the institutional mass of local SOEs supervised by local bureaus of SASAC in the various different provinces/municipalities (see Figures the SOEs did not appear to be significantly affected. 10, 11, 12 and 13). BIGGEST CONCERN |PETROCHINA Figure 10| Relationship between Chinese Government, SASAC , SOEs, Huijin and MOF Related party transactions are the biggest concern for State Council of SOEs with a controlling shareholder, notably the National PetroChina Company Limited (“PetroChina”) where Peoples' Congress the controlling parent China National Petroleum Corporation holds more than 86% of the China Local Ministries SASAC Investment shareholding. Given the dynamics between the Governments Corporation controlling parent and the listed subsidiary, RPTs between the two are regular occurrences in SOEs. This brings into question whether the board of Ministry of Central Huijin Central SOEs Local SASACs Finance Investment directors of the listed SOEs or the board committees (e.g. related party transaction committee or corporate governance committee set up to review Subsidiaries or Financial these transactions) are able to protect the interests Financial Local SOEs Institutions Departments Institutions of minority shareholders (hence global investors), and not allow the parent company’s interests to dominate these China SOEs. Subsidiaries or Departments

Source: MSCI ESG Research

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

HOW MUCH EQUITY IS HELD BY THE STATE? COMPETING COMPANIES UNDER COMMON CONTROL The state typically holds a majority stake (MSCI ESG Research and It is common for competing companies to be controlled by the same entity. Four of the major local regulations both utilize 30%+ of the voting rights as the banks are controlled by the Ministry of Finance and Central Huijin Investment Ltd. threshold for a majority stake). Figure 12 | Common Control in Banking Sector Figure 11 | Percentage of State Holdings at MSCI China Index SOEs

Ministry of Finance / Central Huijin Investment Ltd 2.2% 14.6%

30.3% 79.2% 69.3% 64.6% 57.3% 19.1%

Agricultural Bank of Industrial and China Construction Bank of China Ltd China Commercial Bank of Bank China 33.7%

10 - 30% 31-50% 51 - 60% 61 - 74% 75+% Source: Company Annual Reports.

Source: MSCI ESG Research. Data as at 27 July 2017 Figure 13 | Shareholding Structure of Industrial and Commercial Bank of China

Percentage WHICH STATE ENTITY ARE THE SHARES HELD BY? Percentage Name of Total Number of of Total A Type of Shares of Share  In the financial sector Central Huijin Investments Ltd (Huijin) is a Shareholder Shares Held + H Shares Class (%) holding company set up by the Chinese government to manage its (%) ownership in financial institutions. Huijin is a wholly-owned A Shareholders: A shares 269,612,212,539 100.0 75.6 subsidiary of China Investment Corporation, China’s sovereign fund. Central Huijin A shares 123,717,852,951 45.9 34.7 MOF A shares 123,316,451,864 45.7 34.6  The Ministry of Finance (MOF) holds direct shareholdings in financial H Shareholders H shares 86,794,044,550 100.0 24.3 Total of A & H institutions, e.g., banks and insurance companies, very often A & H shares 356,406,257,089 100.0 alongside Huijin. shareholders Data based on the register of shareholders as at 31 December 2016. Source: Company annual reports  Both Huijin and MOF send government director representatives to their investee boards.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

RISK – MISALIGNMENT OF INTERESTS IN SOE FIRMS

Figure 14 | 5-Year Total Return MSCI China Index SOE Subset versus MSCI China Index  Shareholder returns at Chinese SOEs underperform relative to both other

MSCI ACWI Index SOEs and other MSCI China Index constituents, given 1000 possible misalignment of interests within SOEs. 800  The SOE reform program represents an effort to address this possible 600 misalignment in the long term. The previous 2013-14 reform initiatives 400 have shown limited progress to date. SASAC set three key goals for listed 200 227 85.4 86.6 SOE companies in 2017, a sign of continued focus on the SOE reform 0 process. MSCI China Index SOE MSCI China Index ex SOE MSCI ACWI SOE ex China -200

 One of the SOE reform tracks is to make boards more autonomous. In general High Low Average Chinese SOE boards include government representatives and sector expertise, but most boards do not have a majority of independent directors, n. MSCI China Index SOE = 80, n. MSCI China Index (ex. SOEs) = 48, n. MSCI ACWI Index SOE while 75% of chairman roles are executive positions. (ex. China) = 179. As an ownership structure, SOEs are characterized by lower shareholder Source: Ownership Structure/TSR Data - MSCI ESG Research and Thomson Reuters Data as returns – given possible misalignment of interests within SOEs,7 and China at 30 August 2017, Company Reports SOEs are no exception. Our analysis shows that MSCI China Index SOEs slightly underperformed compared to the MSCI ACWI Index ex China SOEs, and 8 In our June 2015 paper “Ownership Forms & Governance Control.” we significantly underperformed the MSCI China Index ex SOEs. explained that: “[T]he most salient feature of state owned enterprises (SOEs) is their explicit obligation to a much wider group of stakeholders than other listed companies, including customers (low prices), employees (higher wages and benefits, and long- term employment security), and to what might best be characterized as “the public good.” SOEs are often public utilities or central banks, and are by definition heavily dependent on local political priorities. They also tend to proliferate in industries that the government of that particular nation perceives as ‘strategically important,’ which can vary widely between countries. … Evaluating governance practices at SOEs can be especially difficult. While equity investments in such companies are generally low risk due to the explicit backing 7 “Ownership Forms & Governance Control” by Ric Marshall (June 2015) at pages 11-12 https://www.msci.com/www/research-paper/ownership-forms-governance/0254448434 8 https://www.msci.com/www/research-paper/ownership-forms-governance/0254448434

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

and support of government, regardless of their corporate governance practices,  Giving company boards more autonomy to make decisions, segregating party these companies also tend to be low reward. Quality of management, overall control and management/board control under the legal framework. board skills and effectiveness, combined with strong internal controls and  Mergers in strategic sectors including railways, telecommunications, energy accounting transparency, are by far the most important corporate governance (e.g., coal and power companies), shipping and steel. considerations at state owned enterprises.”  Increasing dividend payouts by SOEs. SOE REFORM – A MEASURE TO IMPROVE GOVERNANCE In our June 2015 report “China’s Economic Transformation: A New Era of ESG For some twenty years, China has been implementing state-owned enterprise Opportunity,” we highlighted that the new round of SOE reform would aim to reform. The central government had tried to rely on SASAC as the answer to enhance corporate efficiency through mixed ownership and incentivized pay. corporate profitability in large SOEs. The listings of SOEs overseas, e.g., in However, progress has been limited to date. Hong Kong and the U.S. are also a measure that the China government uses to improve the governance of the SOEs. Management Of Capital SOE dominated sectors (e.g., telecom, energy) are usually those with a This measure seeks to create new state-owned capital investment and state- monopolistic structure. In the event of financial failure, these stocks are seen owned capital operation corporations. These then function as a platform to by some investors as having a de facto state guarantee. make equity investments in private enterprises with high potential for growth and development in the public services, new technology, environment and 2013-14 SOE REFORM INITIATIVES strategic industry sectors. The most notable example is the State Development and Investment Corporation, which retains equity holdings in Since the November 2013 third plenum of the Central Committee of the CCP, Zhejiang Hisun Chemical Co Ltd and China Bohai Bank, among others. While SOE reform has been on the agenda for the Chinese government. However, originally established in 1995, it has taken a piloting role in the transition to instead of wholesale financial reform, the SOE reform process has been one the new holding company structure. of incremental changes, using the various approaches below. One of the themes of SOE reform has been to change state control from Mixed Ownership Reforms management of company to management of capital. Mixed ownership reform began at the third plenum of the CCP Central  Management of Capital: establishing state-owned capital investment and Committee in November 2013 and is defined as “…cross holding by, and operation companies, transferring the equities in SOEs from SASAC to these mutual fusion between, state-owned capital, collective capital and non-public companies. capital.”9 It began substantively in 2014 with reforms relating to CITIC, Sinopec, Sinopharm and China National Building Materials Group. In April  Mixed ownership reform, allowing non-state capital to share ownership of 2017, the China authorities announced that central SOEs in seven sectors, SOEs together with SASAC-controlled state-owned parents, with a view to namely electricity, oil, natural gas, railway, civil aviation, telecommunications sharing board control with non-state interests.

9 https://ftalphaville.ft.com/2013/11/18/1696812/third-plenum-cheat-sheet/?mhq5j=e1

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

and military industry, are projected to undergo mixed ownership reform.10 More Autonomous Boards The first batch of SOEs in these sectors include China Unicom, a MSCI China Decision-making on significant matters at SOEs is basically in the hands of the Index company. Chinese Communist Party (CCP), which operates through the SOE’s twin Figure 15 | Mixed Ownership Reforms governance structure, the legal structure of the board of directors and supervisory board, and the political structure of the party committee in the ISSUER Mixed ownership & 13 asset restructuring SOE. The reform plan is to gradually move away from this dual structure. China Everbright Ltd  China Mobile   Government Involvement In Board Appointments China National Building Materials Group  China Resources Beer  However, it is likely that even with the various elements of reform – see page China Telecom  15 above - SASAC is not yet ready to fully convert to a management of capital China Unicom  CITIC  model in the short-term. As mentioned above, SASAC, Huijin and/or MOF Shanghai Electric  make decisions on the appointment of directors to the SOEs. In addition they Sinopec  Sinopharm  may, especially in the case of SASAC, decide on the remuneration of the Source: MSCI ESG Research, company data directors.  In the energy sector Sinopec underwent mixed ownership reform in The nomination process at SOEs is in not undertaken by the board or the September 2014, when 25 domestic and foreign investors subscribed for a nomination committee, but through SASAC, MOF or Huijin (depending on the total 29.99% shareholding in Sinopec’s (then unlisted) marketing segment sector of the SOE). This runs the risk of the directors’ priority being the called “Marketing Co.” It is engaged in the purchasing, allotment, implementation of the policy objective of the government, and not the distribution, settlement and optimization of refined oil products produced by company and its shareholders. Another phenomenonpractice among SOEs is Sinopec for sale at petrol oil stations (listing plans for this unit were management and/or directors being rotated among the various SOEs in the 11 announced in April 2017). However, in this case mixed ownership reform same sector e.g. telecommunications. has not added much to the participation of global investors via Sinopec as a listed company, given the “guest list” for the placement of shares in Earlier in 2017, some 30 Hong Kong-listed SOEs amended (or proposed to Marketing Co is comprised of entities already active in China.12 amend) their articles of association to clearly set out the core role of the party committee in the SOEs. The party committee (or related party working organs) is described by some companiesas to “play the role of the leadership core and political core” of the SOE.14 The board of directors of the SOEs is expected to seek the advice of the party committee on key matters such as

10 China Daily, April 25, 2017, www.chinadaily.com.cn the direction of reform and development, the appointment of management 11 http://www.scmp.com/business/companies/article/2092287/why-chinas-sinopec-and-saudi- aramco-cross-paths-international 13 The Political Logic of Corporate Governance in China’s State-owned Enterprises by Jiangyu Wang 47 12 http://www.scmp.com/news/china/economy/article/2072196/massive-loss-chinas-sinopec-unit- Cornell Int’l L.J. 631 (2014) at 667-668 raises-tough-questions-state 14 Sinopec Articles of Association revised at the AGM held on June 28, 2017, article 9

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

personnel, and decisions on “material issues.”15 The impact of these amendments on the firms involved remains to be seen, as previous reforms Case Study – China Vanke Takeover Battle have instead favored increased board autonomy. China Vanke (a property company listed in Mainland China and Hong Kong)  Employee Incentive Scheme Reform and Pay Performance Alignment underwent a year-along shareholder battle on control. Baoneng Insurance Group and later Evergrande Group both tried to seize control, and Baoneng At companies where management and ownership are separated, moved a resolution to replace the whole board in June 2016, but did not performance-related pay is a tool often used by pay committees to foster a succeed. PRC regulators stepped in and took regulatory action against the closer alignment of interests, in an effort to improve company performance. insurance affiliates of Baoneng and Evergrande, shutting down their financing. At Chinese SOEs however, efforts to better align interests have been more China Resources, China Vanke’s state-owned enterprise shareholder, difficult as individuals are not allowed to own state shares. announced in January 2017 the sale of its shares to state-owned Shenzhen In November 2014 SASAC announced pay structure reforms, most notably the Metro Group (SMG), increasing its stake to 15.3%, with SMG eventually set to introduction of employee incentives schemes. However, in 2015 SASAC become the largest shareholder. Vanke also filed a lawsuit against Baoneng in February 201717 and delayed its annual directors election to 30 June 2017 to reduced the salaries of SOE management significantly across the board, 18 16 maintain its current board. Founder Wang Shi stepped down from his role as without reducing financial targets. From a pay performance alignment Chairman at the AGM on June 30, 2017.19 perspective, these reforms represent a step in the right direction, but their actual effect in practice may (at least in the short to medium-term) be The China Vanke shareholder battle illustrates how dynamics can play out in counter-productive, as they potentially could require SOE boards to mixed ownership in China SOEs. The acquisition of shares by Baoneng and improve/maintain performance while being paid less (and arguably having Evergrande highlighted to a certain degree the potentially complicated more accountability). Employee incentive reform, however, may potentially dynamics and inevitable challenges of mixed ownership in a state-controlled address pay performance alignment in the long term. entity. China Vanke satisfies the definition of a SOE under MSCI criteria, given the shareholding owned by the China Resources group, an SASAC-supervised Figure 16 | Employee Share Schemes SOE; and the local Shenzhen SASAC also declared in March 2017 that China 20 ISSUER Employee share Vanke was officially an SOE under its auspices. incentive schemes Bank of Communications  China Mengniu  China Merchants Bank  Sinopharm  Source: MSCI ESG Research, company data

17 http://www.scmp.com/business/article/2068854/china-vanke-files-lawsuit-invalidate-ownership- rights-majority-shareholder 18 http://www.scmp.com/business/article/2082478/vanke-delays-board-re-election-hold-baoneng-bay 15 China Railway Group Limited Articles of Association revised in June 2017, article 155 19 http://asia.nikkei.com/Business/AC/China-Vanke-founder-makes-way-for-right-hand-man 16 http://www.chinadaily.com.cn/business/2015-06/05/content_20913400.htm 20 http://mp.weixin.qq.com/s/i-yMU3Vlt9gxeNQDZS70xw

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

Mergers in Strategic Sectors Figure 17 | Required Dividend Payments at SOEs

Strategic sector mergers have been focused on central SOEs in areas vital to Required % of Post-Tax Profit Applicable Companies the national economy and national security. Such sectors include defence, as Dividends to the State nuclear power, basic communcations infrastructure, power grids, oil and gas 25% China National Tobacco Corporation 21 pipelines, and strategic material reserves such as oil and grain. Already, 14 companies, including energy companies such as China there have been some mergers in the railway and shipping sectors. 20% Petrochemical Corporation and telecom carriers such as China Mobile  In December 2015, the state approved the merger of Sinotrans and CSC into fellow ports operator China Merchants Group.22 70 companies, including railway-related companies such as 15% China Railway Engineering Corporation and resources  Earlier in 2015, SASAC approved the merger of China Ocean Shipping companies such as Aluminum Corporation of China Group and China Shipping Group to form the world’s fourth-largest 23 10% 30+ firms, including nuclear energy and culture companies container shipping firm. This more complicated transaction involved a reshuffling of assets with the two groups’ four listed entities, each of Source: MOF data (www.mof.gov.cn) which focused on different lines of business – container shipping, shipping financial services, shipping terminals and oil and gas 2017 – REVISED SASAC GOALS FOR SOES transportation. During the March 2017 meetings of the National People’s Congress and Chinese People’s Political Consultative Conference, SASAC’s leadership held a Increasing Dividend Payments media conference regarding SOE reform, where it identified three key goals In 2014 MOF raised the ratio of profits to be handed over by SOEs to the for listed SOE companies with a view to them playing a better market government. More than 120 SOEs administered by the central government stabilizing role:25 would pay 5 percentage points more of their profits.The plan divided the SOEs 1. Central government owned enterprises should strengthen market value into five categories that would be required to pay between zero and 25 management for their listed companies and consider this as a major percent of after-tax profits as a dividend to the government.24 responsibility. 2. Listed SOE companies should further improve their dividend payout mechanism and make it consistent with a value investing philosophy.

21 July 2016 “Guiding Opinions of the Office of the State Council on the Restructuring and 3. Listed SOEs should be responsible to shareholders and central SOEs should be Reorganisation of Central State-Owned Enterprises” role models for other listed companies on transparency and shareholder 22 http://www.scmp.com/business/companies/article/1896390/another-shipping-conglomerate-born- commitment. beijing-approves-merger 23 http://www.scmp.com/business/companies/article/1896390/another-shipping-conglomerate-born- beijing-approves-merger 24 http://www.globaltimes.cn/content/858820.shtml 25 http://www.chinadaily.com.cn/china/2017-03/10/content_28500955.htm

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

There have been some immediate developments at a company level: ROLE OF GOVERNANCE STRUCTURES IN MINORITY PROTECTION  Eight days after the press conference China Shenhua Energy (Shenhua) Given the ownership structures and typical controlling shareholding of SOEs, announced its special dividend payout scheme. In addition to a 36% there is a limit to how far SOE governance structures like the board can help dividend payout, Shenhua declared a special dividend of RMB 2.51/share, mitigate governance risks. However, some measures with a long-term implying a dividend yield of 20%. However, given the controlling parent perspective are noted below. Shenhua Group Corporation owns about 73% of Shenhua, most of the increased dividend represented transfer of cash from the listed SOE to  Overall board skills and effectiveness the state parent; and it is inconclusive as to whether the policy of SOEs can move toward better governance by structuring the board to add 26 improved dividend payout represents real progress in reform. On 28 value, and by ensuring a long-term approach. Further, SOE boards should August 2017, SASAC announced that Shenhua Group Corporation would ensure independence when considering strategic mergers “foisted” on them merge with China Guodian Corporation, another SOE in the utilities by the state or the controlling shareholder, to ensure fair merger ratios. 27 sector. However, the overall effectiveness of independent directors regarding  In November 2016, China Unicom announced that China Unicom Group minority protection in the APAC region, especially in controlled companies, joined the special topic meeting on state-owned enterprise mixed- has considerable room for improvement. ownership reform pilot convened by the National Development and  Inadequate board independence Reform Commission. Implementation of the reform plans has been confirmed in an announcement in April 2017,28 with subscribers of the With the controlling shareholder Chinese SOEs invariably the parent company shares of China Unicom under the mixed ownership reform formally under the auspices of SASAC and/or MOF (or Huijin), the boards of SOEs are announced on 20 August 2017.29 rarely independent. For SOEs listed in Hong Kong, the requirement for boards is a minimum of three directors and one third independent directors, meeting the independence standards set out by HKEX. Independent directors are often academics who may lack the authority to exercise oversight over the executive members of the board (Figure 18).

26 https://ftalphaville.ft.com/2017/03/24/2186349/for-the-brave-china-soe-reform-optimists-out- there 27 https://www.ft.com/content/0ee2659e-9855-3516-9445-98fe945b13d0

28 http://www.scmp.com/business/companies/article/2085682/ownership-reform-rekindles-investor- interest-big-china-companies 29 https://www.ft.com/content/0dd0b152-8659-11e7-bf50-e1c239b45787

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

Figure 18 | Board Independence at SOEs leadership structure and may constrain the ability of the CEO to implement improvements. The role of Lead Independent Director is filled at fewer than 4% of companies.

32.6% Figure 19 | Board Leadership at SOEs Majority Minority Combined with CEO 15.7% 67.4% 23.6% Executive

1.1% Non-executive, Independent Source: MSCI ESG Research. Data as at 27 July 2017 Non-executive, Not 59.6% Independent BOARD LEADERSHIP

At Chinese SOEs, the role of chairman is often an executive position serving Source: MSCI ESG Research. Data as at 27 July 2017 alongside the CEO. This raises concerns as to the efficacy of the board

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

RISK – MISAPPROPRIATION VIA RELATED PARTY TRANSACTIONS

 Shareholders face elevated governance risks where the state In cases where one party plays the roles of both controlling shareholder and plays each of the roles of controlling shareholder, lender and lender, and engages in related party transactions of a revenue nature for the company, minority shareholders face particularly high governance risks. (directly or indirectly) the biggest customer of a company. Where the party concerned is the state, as here, this may be offset somewhat  The Audit Committee plays a key role in the oversight of related by the implicit state guarantee. party transactions, but as with other Chinese companies, almost In Figure 20, those SOEs where the state is a lender and which generate the a third are not fully independent. greatest percentage of revenue from the state are identified. The pervasive nature of the related party transactions at these companies presents a higher Chinese SOEs are often subject to related party transactions, very often with level of governance risk. At these companies, the presence of a majority the controlling shareholder parent. Indeed, each SOE that is a constituent of independent audit committee to oversee the transactions may be the one the MSCI China Index has been involved in related party transactions. governance mechanism that minority shareholders can expect to protect their STATE AS OWNER, LENDER AND LARGEST CUSTOMER interests.

Figure 20| State as Owner, Lender and Related Party AUDIT COMMITTEE AND OVERSIGHT OF RELATED PARTY TRANSACTIONS The audit committee independence levels of SOEs is broadly in line with that % of Revenue as RPTs 80% of the index as a whole. While a majority of audit committees are 66.8% 70% 66.3% 64.1% independent of management, many also include government representatives. 60% With the state or other state controlled firms typically being the related 50% 46.2% parties, this may impair the ability of the audit committee to adequately 37.2% 40% protect the interests of minority shareholders when reviewing proposed 30% related party transactions.

20% 11.0% Figure 21 | Audit Committee Independence at SOEs 8.1% 7.9% 6.6% 10%

0% MSCI China Index - SOEs 60.7% 39.3% 0.0% CNOOC AviChina China CRRC SINOPEC Chongqing China Aluminum China Limited Industry & Longyuan Corporation Engineering Changan Everbright Corporation Telecom Technology Power Limited (Group) Co., Automobile Bank of China Corporation MSCI China Index 61.7% 37.6% 0.7% Company Group Ltd. Co., Ltd. Company Limited Limited Limited Corporation Limited Limited 0% 20% 40% 60% 80% 100% Fully Independent Not fully Independent None

Source: MSCI ESG Research. Data as at 27 July 2017 Source: MSCI ESG Research. Data as at 27 July 2017

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

APPENDICES  Exchanges APPENDIX A | REGULATORY DEVELOPMENTS Shanghai Stock Exchange www.sse.com.cn/ AUDIT & ACCOUNTING Shenzhen Stock Exchange  The Ministry of Finance issued provisional regulations in May 2015 on foreign auditors working in China on a temporary basis. www.szse.cn/main/ The new rules, the Interim Provisions on Accounting Firms' Provision of Auditing Services for the Overseas Listing of Enterprises in Chinese Mainland (the Interim Provisions), came into force in July 2015. The rules require that domestic firms that want to  Regulators work on overseas listings must both register with foreign regulators (e.g., the US Public Company Accounting Oversight Board, China Securities Regulatory Commission “PCAOB”) and comply with laws, regulations and both domestic and foreign auditing standards. (‘CSRC’) REGULATORY www.csrc.gov.cn/pub/newsite/  Investor Associations  China Banking Regulatory Commission (CBRC) introduced a new set of rules for commercial banks in March and April 2017, with a view to enhancing the overall regulation and supervision of the banking sector. The rules seek to address key corporate Asset Management Association of China governance risks of banks including structural shortcomings of the board of directors, directors and senior management failing www.amac.org.cn/ to completely fulfill their duties and responsibilities, and shortcomings in remuneration management and payment systems.  Stewardship Code  A review of China’s Corporate Governance Code (2001) was announced by China Securities Regulatory Commission (CSRC) in None as yet. August 2016. Despite introducing its code ahead of many APAC peers in 2001, Chinese regulators had not updated the code for more than 15 years, leaving many of its provisions outdated and behind best practices.  Corporate Governance Code

 The Supreme People’s Court issued its fourth draft judicial interpretation on the company law in April 2016. This was the first http://www.csrc.gov.cn/pub/csrc_en/ne wsfacts/release/200708/t20070810_692 interpretation since the company law was significantly revised in 2013. The draft can be regarded as an attempt toward 23.html protecting minority shareholders, consumers, employees and other vulnerable parties from parties such as majority shareholders that otherwise may exploit their dominant commercial position.  Company Law

 The Shanghai and Shenzhen Stock Exchanges issued new guidelines on voluntary stock suspensions in May 2016 to address http://www.gov.cn/flfg/2005- 10/28/content_85478.htm situations where a number of companies abused the voluntary suspension mechanism as a shelter to avoid further collapse of their share prices during the stock crisis in August 2015. Share suspensions of listed companies involved in major asset  Takeover Rules restructuring cannot exceed three months, and companies conducting private placements cannot be suspended for more than http://www.csrc.gov.cn/pub/zjhpublic/zj one month. The new rules were introduced with a view to "curb[ing] stock suspensions at will and to regulate suspensions," h/200804/t20080418_14505.htm according to the Shanghai Stock Exchange.30

30 http://english.sse.com.cn/aboutsse/news/newsrelease/c/4121069.shtml

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

 The CSRC issued a new rule in July 2016 to cool the overheated purchase of November 2014 and Shenzhen-Hong Kong Stock Connect in December 2016 shell companies in July 2016. The new rule barred companies from raising (see Figure 22). funds in the domestic stock market via reverse merger deals. Under such a reserve merger deal, or back-door listing, an unlisted firm normally buys a H-SHARES VERSUS A-SHARES – A TALE OF UNEVEN INVESTOR PROTECTION controlling stake in a public company before injecting its own assets into the  The minority protection provisions in the Hong Kong regulatory regime, as listing vehicle. After becoming listed, the companies can offer new shares in provided by the companies and securities legislation (Companies Ordinance refinancing deals to raise public funds. The Chinese government is drafting a and Securities and Futures Ordinance) and the Listing Rules of Hong Kong more market-oriented Securities Law which may come into effect in 2017. Exchanges and Clearing (HKEX), are generally considered to be superior. As  In April 2017, the PRC national legislative body reviewed the draft revised companies with Chinese incorporation that have listed securities in both the PRC Securities Laws which includes: Mainland (A-shares) and Hong Kong (H-markets) markets must adhere to the regulatory requirements of both markets, there is no possibility of regulatory • new provisions on information disclosure; arbitrage . However, for Chinese companies only listed in one of these two • expansion of the definition of “insiders” for the purposes of the insider markets (i.e., A-share or H-share only), it is conceivable that Chinese trading provisions, enhancing China’s requirement that an investor’s companies listed in Hong Kong (H-shares) will have better standards for securities trading activities must be carried out in its own real-name investor protection than Chinese companies listed in Mainland China only (A- accounts and prohibiting disguised trading carried out in third-parties’ shares). accounts; COMPLICATIONS OF STOCK CONNECT SCHEMES • creating a standalone chapter on investor protection; and  The situation has become more complicated after the implementation of the • for the first time introducing suitability obligations on the part of selling Shanghai and Shenzhen Stock Connect schemes. Via the Stock Connect institutions at the level of law. mechanisms, global investors have access to A-shares traded in the Mainland, MUTUAL MARKET ACCESS REGULATORY DYNAMICS and Mainland China investors also have access to H-shares in Hong Kong, and there is thus the possibility of arbitrage. The regulators on both sides, i.e., the  With the mutual market access between the China and Hong Kong markets China Securities Regulatory Commission (CSRC) and the Hong Kong Securities becoming increasingly important, potential complications in regulatory and Futures Commission (SFC) have attempted to address the regulatory and dynamics and possibilities for regulatory arbitrage also emerge. This issue is enforcement challenge by entering into a Memorandum of Understanding on highlighted by the implementation of Shanghai-Hong Kong Stock Connect in mutual enforcement.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

Figure 22| Guide to Different Share Classes and Different Regulatory Regimes of China Home Market Companies31

Share Class Country of Incorporation Market of Listing Trading Currency Primary Regulator Availability To Chinese Investors Availability to Global Investors

A PRC China CNY CSRC, SHSE, SZSE Yes QFII/RQFII; via Shanghai & Shenzhen Stock Connect

B PRC China USD CSRC, SHSE, SZSE Yes Yes

H PRC Hong Kong HKD SFC, HKEX QDII, via Shanghai & Shenzhen Stock Connect Yes

Red-Chip Non-PRC Hong Kong HKD SFC, HKEX QDII, via Shanghai & Shenzhen Stock Connect Yes (e.g., Cayman Islands, Bermuda, Hong Kong)

P-Chip Non-PRC Hong Kong HKD SFC, HKEX QDII, via Shanghai & Shenzhen Stock Connect Yes (e.g., Cayman Islands, Bermuda, Hong Kong)

S-Chip PRC/Non-PRC Singapore SGD MAS, SGX QDII Yes

N-Share Non-PRC United States USD SEC, NYSE, NASDAQ QDII Yes

31 Glossary of Abbreviations:

CSRC China Securities Regulatory Commission QFII Qualified Foreign Institutional Investors SEC Securities and Exchanges Commission SHSE Shanghai Stock Exchange RQFII RMB Qualified Foreign Institutional Investors SFC Securities and Futures Commission SZSE Shenzhen Stock Exchange HKEX Hong Kong Exchanges & Clearing SGX Singapore Stock Exchange QDII Qualified Domestic Institutional Investors MAS Monetary Authority of Singapore

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

Issue of Beneficial Ownership of Global Investors in A-Shares Minority Protection is a Function of the Laws of the Jurisdiction of Incorporation One additional challenge for investors accessing A-shares via the Stock Companies not incorporated in China, i.e., the Red chips or the P-chips, but Connect scheme concerns beneficial ownership, or the degree of legal listed in Hong Kong, are both governed by the companies legislation where certainty and enforceability of rights of “northbound“ investors holding A- they are incorporated, e.g., Hong Kong, the Cayman Islands or Bermuda; and shares acquired via Stock Connect. This is very important for global asset then also by the Hong Kong listing and regulatory regime of the venue of owners and managers. listing. Their minority protection standards will thus be no less favorable than the H-shares listed in Hong Kong. The northbound shares are held by HKEX’s clearing entity, the Hong Kong Securities Clearing Company (HKSCC), in an omnibus account held at Governance Standards on Specific Issues Depends on Listing Venue ChinaClear, the Mainland clearing agency. Chinese regulations recognize that shares held by the HKSCC are held on a nominee basis, meaning that they are For S-chips (whether incorporated in China or not) listed in Singapore or N- not assets of HKSCC but owned by the beneficial investors. However, there is shares (mostly not incorporated in China) listed in the United States, they will no stated mechanism in the Stock Connect scheme, in existing Chinese law essentially adhere to the respective legal and regulatory requirements in and regulations, or in the rules of the Shanghai or Shenzhen Stock Exchanges Singapore and the United States. A particular issue to illustrate the regulatory or ChinaClear, for recognizing or confirming the identity of the beneficial differences would be the mechanism of multiple share classes with different owners of the A-shares held by HKSCC. There remains some uncertainty as to voting rights. This feature is currently allowed in the United States regime how owners of the A-shares assert or pursue their minority protection rights (and Singapore has recently conducted a consultation with a view to allowing as shareholders in China. dual classes of rights with different voting rights; and published a statement of clarification on allowing dual classes of shares under the secondary listing CSRC Clarifications on Issue of Beneficial Ownership framework on 28 July 2017).32 However, neither the Hong Kong or Mainland China regulatory regime currently allow dual class shares with different voting The CSRC issued FAQs in May 2016 clarifying that it fully respects the rights in companies listed on the Hong Kong (see footnote 1, page 5), provisions of contracts defining the legal rights between the beneficial asset Shanghai or Shenzhen Stock Exchanges. owners and their asset managers as nominee holders, including the arrangements to segregate the beneficial owners’ assets from those of the asset manager nominee, as governed by the laws of the jurisdiction where they are entered into. However, whether the ultimate beneficial owners can fully exercise their proxy rights as minority shareholders is a question that has been not fully addressed.

32http://www.sgx.com/wps/wcm/connect/sgx_en/home/higlights/news_releases/SGX_clarifies_that_ existing_secondary_listing_framework_allows_dual_class_share_companies

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

APPENDIX B | CORPORATE OVERVIEW Shareholder rights are correlated to the jurisdiction of incorporation and the type of corporate entity that has listed or traded securities. The sector distribution across the market may offer insights to the broader economy and the exposure to market and commodity cycles.

Incorporation Corporate Types GICS Sectors

Just under half of the MSCI China Index All listed entities are public The 149 MSCI China Index constituents are overweight in industrials, information technology, real estate and constituents are also incorporated in companies. No limited utilities, and underweight in consumer staples, materials and telecommunication services. Companies in the China. The others are incorporated in partnerships, co-operatives or materials and energy sectors may be particularly exposed to the commodities cycle, where companies are offshore jurisdictions such as Bermuda, other types of corporate entities required to report write-downs due to the decreases in value of their assets due to cyclical commodity price the Cayman Islands and Hong Kong for are identified among MSCI China movements. a mix of privacy, tax and regulatory constituents. reasons.

Bermuda USA, 1% , 8% Hong Kong, 15%

Cayman 100% Islands, China, 29% 48% Public Company

MSCI China Index MSCI Emerging Markets Index MSCI ACWI Index

Incorporation, combined with the type of corporate entity, determines which Global Industry Classification Standard (GICS) is a four-tiered, hierarchical industry classification system jointly corporate laws apply to the company. Corporate law typical provides many developed by MSCI Inc. and S&P Global. It consists of 11 sectors, 24 industry groups, 68 industries and 157 sub- of the fundamental rights of shareholders. industries. Companies are classified quantitatively and qualitatively. Each company is assigned a single GICS classification at the sub-industry level according to its principal business activity.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

APPENDIX C | BOARD OVERVIEW Governance risks vary widely, depending on the nature of the company’s ownership and on the separation of ownership and management, and on the design of the capital structure and its impact on the voting rights of shareholders.

Board Types Leadership Independence Committees

The 71 constituents of the MSCI China Index with 23.5% of companies have combined chair/CEO Based on MSCI independence criteria, 75% of Most companies have established all three key Chinese incorporation have a board of directors roles, despite best practice recommendations. boards are minority independent of management. committees – audit, pay and nomination. Based on and a board of supervisors, as required by Chinese Lead independent directors are non-existent. However, many directors are characterized as not MSCI independence criteria , “independent of company law. Other companies have a unitary independent of other interests, being linked to management” excludes any “inside” or company board model with a board of directors only. major owners and/or the Chinese State. executive directors, and outside-related directors.

0.7% 7.4% 5.4% 23.5% 37.6%

64.4% 75.2% 60.4%

55.7% 99.33% 94.6% 71 78 61.7%

32.2% 34.9% 19.5% 23.5% 1.3% 0.7% Chair Lead Director Independent of Independent of Audit Pay Nomination None Management Other Interests Combined with CEO Board of Directors Executive None Not fully Independent Fully Majority Minority None Non-executive, Not Independent Fully Independent Board of Directors & Board of Supervisors Non-executive, Independent

The China Corporate Governance Code (the The Code contains no requirement or best The Code recommends that boards include The Code recommends that the audit, pay and ‘Code’) identifies that the role of the board of practice recommendation for the appointment of independent members. For companies with nomination committees be chaired by an supervisor is to supervise the corporate finance, an independent chairman nor for a lead shares listed in Hong Kong, the HKEX Listing Rules independent director, and independent directors the legitimacy of directors, managers and other independent director. There is also no require at least three independent directors and should also constitute a majority of the three senior management personnel's performance of recommendation regarding the separation of the one-third of the board to comprise independent committees. duties, and to protect the company's and the role of CEO and chair. directors.

shareholders' legal rights and interests.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

APPENDIX D | GENDER DIVERSITY China has not specified rules or recommendations regarding gender diversity, in contrast to emerging markets such as India and Malaysia, which have both implemented gender quotas. MSCI ESG Research reviews global women on board trends on an annual basis, and limited progess on female board representation has been observed among Chinese companies in recent years.33 Our 2016 report showed a correlation between companies with three or more women on the board and superior corporate performance. Compared to the MSCI China Index as a whole, State Owned Enterprises underperformed, with more companies having zero female directors (42.7%) and only 7.8% of female board members on average. Similarly, 50% of VIEs had zero female directors and only 8.2% of directors at VIE companies were female. Among MSCI China Index consitutents, female directors were most prevalent at family firms (15.5%) and founder firms (12.9%). Figure 23 | Female Directors

% Female in Board Population Number of Female Directors Female Leadership

38.9% 40.6% 34.9% 30.6% 31.2% 17.3% 22.5% 23.4% 22.9% 9.7% 10.1% 17.1% 15.4% 16.1% 11.8% 10.7% 9.4% 9.4% 6.0% 6.1% 6.1% 2.6% 3.1% 3.8% % Female Directors as % Total Director Population

MSCI China Index 0 1 2 3+ Chairman CEO CFO MSCI Emerging Markets Index MSCI ACWI Index MSCI China Index MSCI Emerging Markets Index MSCI ACWI Index MSCI China Index MSCI Emerging Markets Index MSCI ACWI Index

Companies Where Tipping Point Reached (3+ Female Directors) Industrial And Commercial Bank Of China China Gas Holdings CITIC Ltd Minth Group Bank Of Communications China Merchants Bank Fuyao Glass Industry Group Shandong Weigao Group Medical Polymer Co China Citic Bank Corp China Resources Power Holdings Co Haier Electronics Group Co Sino Biopharmaceutical China Construction Bank Corp China Shenhua Energy Co Jiangsu Expressway Co Soho China

33 https://www.msci.com/www/blog-posts/the-tipping-point-women-on/0538249725

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

APPENDIX E | KEY METRIC OVERVIEW

Never Flagged Always Flagged Selected Problem Areas

A number of Key Metrics (noted below) are Due to the mix of jurisdictions of both Benchmarking MSCI China Index constituents against MSCI ACWI constituents globally never flagged at MSCI China Index constituents incorporation and listing among MSCI China identified areas of weakness in governance arrangements including board independence due to the mix of regulatory provisions in Index constituents, no trends of note are and board leadership. place. identified for this section. Board independence issues in this market reflect the absence of majority independent No MSCI China Index constituents feature a While a regular vote on executive pay has not boards at more than 70% of firms – unsurprising given that companies typically have only to pay committee where CEOs of other listed yet been introduced in China, some companies meet requirements to appoint three independent directors. companies make up a majority of the put forward votes on long-term incentive Related party transactions are pervasive in this market, reflecting the nature of the committee. plans. The Significant Votes Against Pay predominant ownership structures. Practices Key Metric has been flagged for a number of companies based on the votes cast The Controlling Shareholder Concerns Key Metric is most often flagged due to the presence in respect of such resolutions. of an Executive Chairman. For three companies, the flag is due to cross-shareholdings.

Pay Committee Concerns Figure 24 | Key Metric Outliers – MSCI China Index Oversized Board

Undersized Board 98.0% 99.3% 91.9%

72.5%

48.1% 49.4% 51.0% 41.6% 32.0%

10.2%

Controlling Independent Related Party Chair not Annual Director Shareholder Board Majority Transactions Independent & Elections Concerns No Independent Lead Director

MSCI China Index MSCI ACWI Index

Source: MSCI ESG Research. Data as at 11 September 2017.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

APPENDIX F | BEST AND WORST COMPANY SCORES

 Top Scores

Ownership & Company Score Overall Board Pay Accounting Relative Strengths Control China Shenhua Energy 7.2 Best In Class Above Average Best In Class Above Average Above Average Board Effectiveness, Pay Oversight, Pay Figures Company Limited China Merchants Bank Co., Ltd. 7.2 Best In Class Above Average Best In Class Above Average Average Board Skills & Diversity, Pay Oversight, Pay Figures China Telecom Corporation 7.2 Best In Class Above Average Best In Class Above Average Above Average Audit Oversight, Pay Oversight, Pay Figures Limited Sun Art Retail Group Ltd 7.1 Best In Class Average Best In Class Above Average Best In Class Board Effectiveness, Pay Figures, Accounting Risk Lenovo Group Ltd 7.1 Best In Class Best In Class Average Best In Class Average Board Independence , Board Skills & Diversity

 Bottom Scores

Ownership & Company Score Overall Board Pay Accounting Key Areas of Concern Control

Huaneng Renewables Board Ownership 2.8 Worst In Class Below Average Average Average Below Average Accounting Risk Corporation Ltd Independence Structure Board Skills & Board Netease, Inc. 2.7 Worst In Class Below Average Average Below Average Average Pay Figures Diversity Independence Board JD.COM, Inc. 2.1 Worst In Class Above Average Worst In Class Worst In Class Below Average Pay Figures Accounting Risk independence Board Board Skills & CTRIP.COM International, Ltd. 1.6 Worst In Class Worst In Class Worst In Class Average Worst In Class Pay Figures Independence Diversity Board Alibaba Group Holding Ltd 0 Worst In Class Worst In Class Average Worst In Class Worst In Class Pay Figures Accounting Risk Independence

Export the Full Set of Scores for MSCI China Index Constituents Using the Screening and Issuer Tabs on ESG Manager it is possible to export an updated dataset including all MSCI China Index constituents and/or a broader dataset, as required.

Company Rankings are assessed against other Chinese companies in MSCI coverage (includes non-ACWI constituents).

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

APPENDIX G | ILLUSTRATIVE STRUCTURE OF STATE-OWNED ENTERPRISES

 Telecommunications Figure 25 | Shareholding Structure of telecom companies

Holding company State Holding? China Unicom (Hong China United Network Communications 75.3%(pre- State, via SASAC Kong) Limited Group Company Limited reform)

China United Network China Mobile Communications China Telecommunications China Mobile Limited China Mobile Communications 72.72% Communications Group Corporation Corporation Company Ltd Corporation

China Telecom China Telecommunications Corporation 70.89% China Unicom (Hong China Telecom China Mobile Ltd Kong) Ltd Corporation Ltd Corporation Limited

Source: Company Annual Reports.  Energy

Figure 26 | PetroChina Company Limited Shareholding Structure

SASAC

PetroChina Company Limited China Central SOEs National Petroleum Corporation 86.17% China Shenhua Energy Company Limited

CNPC Shenhua Group Corporation 73.06% China Petroleum & Chemical Corporation Public 13.83% PetroChina 86.17% China Petrochemical Corporation 70.86% Shareholders Company Ltd Limited Source: Company Annual Reports.

Exploration & Refining & Natural Gas & Marketing Others Production Chemicals Pipelines

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

AMERICAS

+ 1 212 804 5299

EUROPE, MIDDLE EAST & AFRICA

+ 44 2 7618 2510

ASIA PACIFIC

+ 612 9033 9339

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

ABOUT MSCI ESG RESEARCH PRODUCTS AND SERVICES

MSCI ESG Research products and services are provided by MSCI ESG Research LLC, and are designed to provide in-depth research, ratings and analysis of environmental, social and governance-related business practices to companies worldwide. ESG ratings, data and analysis from MSCI ESG Research LLC are also used in the construction of the MSCI ESG Indexes. MSCI ESG Research LLC is a Registered Investment Adviser under the Investment Advisers Act of 1940 and a subsidiary of MSCI Inc.

ABOUT MSCI

For more than 40 years, MSCI’s research-based indexes and analytics have helped the world’s leading investors build and manage better portfolios. Clients rely on our offerings for deeper insights into the drivers of performance and risk in their portfolios, broad asset class coverage and innovative research. Our line of products and services includes indexes, analytical models, data, real estate benchmarks and ESG research. MSCI serves 98 of the top 100 largest money managers, according to the most recent P&I ranking. For more information, visit us at www.msci.com.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

This document and all of the information contained in it, including without limitation all text, data, graphs, charts (collectively, the “Information”) is the property of MSCI Inc. or its subsidiaries (collectively, “MSCI”), or MSCI’s licensors, direct or indirect suppliers or any third party involved in making or compiling any Information (collectively, with MSCI, the “Information Providers”) and is provided for informational purposes only. The Information may not be modified, reverse-engineered, reproduced or redisseminated in whole or in part without prior written permission from MSCI.

The Information may not be used to create derivative works or to verify or correct other data or information. For example (but without limitation), the Information may not be used to create indexes, databases, risk models, analytics, software, or in connection with the issuing, offering, sponsoring, managing or marketing of any securities, portfolios, financial products or other investment vehicles utilizing or based on, linked to, tracking or otherwise derived from the Information or any other MSCI data, information, products or services.

The user of the Information assumes the entire risk of any use it may make or permit to be made of the Information. NONE OF THE INFORMATION PROVIDERS MAKES ANY EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION (OR THE RESULTS TO BE OBTAINED BY THE USE THEREOF), AND TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW, EACH INFORMATION PROVIDER EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING, WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.

Without limiting any of the foregoing and to the maximum extent permitted by applicable law, in no event shall any Information Provider have any liability regarding any of the Information for any direct, indirect, special, punitive, consequential (including lost profits) or any other damages even if notified of the possibility of such damages. The foregoing shall not exclude or limit any liability that may not by applicable law be excluded or limited, including without limitation (as applicable), any liability for death or personal injury to the extent that such injury results from the negligence or willful default of itself, its servants, agents or sub-contractors.

Information containing any historical information, data or analysis should not be taken as an indication or guarantee of any future performance, analysis, forecast or prediction. Past performance does not guarantee future results.

The Information should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. All Information is impersonal and not tailored to the needs of any person, entity or group of persons.

None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), any security, financial product or other investment vehicle or any trading strategy.

It is not possible to invest directly in an index. Exposure to an asset class or trading strategy or other category represented by an index is only available through third party investable instruments (if any) based on that index. MSCI does not issue, sponsor, endorse, market, offer, review or otherwise express any opinion regarding any fund, ETF, derivative or other security, investment, financial product or trading strategy that is based on, linked to or seeks to provide an investment return related to the performance of any MSCI index (collectively, “Index Linked Investments”). MSCI makes no assurance that any Index Linked Investments will accurately track index performance or provide positive investment returns. MSCI Inc. is not an investment adviser or fiduciary and MSCI makes no representation regarding the advisability of investing in any Index Linked Investments.

Index returns do not represent the results of actual trading of investible assets/securities. MSCI maintains and calculates indexes, but does not manage actual assets. Index returns do not reflect payment of any sales charges or fees an investor may pay to purchase the securities underlying the index or Index Linked Investments. The imposition of these fees and charges would cause the performance of an Index Linked Investment to be different than the MSCI index performance.

The Information may contain back tested data. Back-tested performance is not actual performance, but is hypothetical. There are frequently material differences between back tested performance results and actual results subsequently achieved by any investment strategy.

Constituents of MSCI equity indexes are listed companies, which are included in or excluded from the indexes according to the application of the relevant index methodologies. Accordingly, constituents in MSCI equity indexes may include MSCI Inc., clients of MSCI or suppliers to MSCI. Inclusion of a security within an MSCI index is not a recommendation by MSCI to buy, sell, or hold such security, nor is it considered to be investment advice.

Data and information produced by various affiliates of MSCI Inc., including MSCI ESG Research LLC and Barra LLC, may be used in calculating certain MSCI indexes. More information can be found in the relevant index methodologies on www.msci.com.

MSCI receives compensation in connection with licensing its indexes to third parties. MSCI Inc.’s revenue includes fees based on assets in Index Linked Investments. Information can be found in MSCI Inc.’s company filings on the Investor Relations section of www.msci.com.

MSCI ESG Research LLC is a Registered Investment Adviser under the Investment Advisers Act of 1940 and a subsidiary of MSCI Inc. Except with respect to any applicable products or services from MSCI ESG Research, neither MSCI nor any of its products or services recommends, endorses, approves or otherwise expresses any opinion regarding any issuer, securities, financial products or instruments or trading strategies and MSCI’s products or services are not intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Issuers mentioned or included in any MSCI ESG Research materials may include MSCI Inc., clients of MSCI or suppliers to MSCI, and may also purchase research or other products or services from MSCI ESG Research. MSCI ESG Research materials, including materials utilized in any MSCI ESG Indexes or other products, have not been submitted to, nor received approval from, the United States Securities and Exchange Commission or any other regulatory body.

Any use of or access to products, services or information of MSCI requires a license from MSCI. MSCI, Barra, RiskMetrics, IPD, FEA, InvestorForce, and other MSCI brands and product names are the trademarks, service marks, or registered trademarks of MSCI or its subsidiaries in the United States and other jurisdictions. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s. “Global Industry Classification Standard (GICS)” is a service mark of MSCI and Standard & Poor’s.