Asia Insight: Yearly ESG Review & Outlook of the Xi-Li Administration in China SUN Xi March 2014 About Sustainalytics Sustainalytics supports investors around the world with the development and implementation of responsible investment strategies. The firm partners with institutional investors, pension plans, and asset managers that integrate environmental, social and governance information and assessments into their investment decisions. Headquartered in Amsterdam, Sustainalytics has offices in Boston, Bucharest, Frankfurt, London, Paris, Singapore, Timisoara and Toronto, and representatives in Bogotá, Brussels, Copenhagen, New York City and San Francisco. The firm has 150 staff members, including more than 80 analysts with varied multidisciplinary expertise and thorough understanding of more than 40 industries. In 2012 and 2013, Sustainalytics was voted best independent sustainable and responsible investment research firm in theThomson Reuters Extel’s IRRI survey. 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Sustainalytics www.sustainalytics.com For general enquiries: [email protected] Table of Contents Key Takeaways..........................................................................................4 Introduction.............................................................................................5 Economic Reforms and Political Conservatism............................................6 Box 1: Profiles of Key Reformers.....................................................................7 Box 2: A Brief History of Third Plenums............................................................8 Intensified Anti-corruption Campaigns.......................................................9 Box 3: The Bo Case.......................................................................................9 Anti-competition Practices and Monopolies..............................................10 Sustainable Development Strategy............................................................12 Box 4: Case Study: Air pollution in Beijing and North-eastern China.....................13 Adjusted Urbanization Plan.....................................................................16 Enhanced Food and Drug Safety Governance.............................................17 Box 5: Stricter Enforcement: The Floating Swine Carcasses Incident....................18 Endnotes................................................................................................21 Key Takeaways The Xi-Li Administration, China’s fifth leadership generation, has been in power for just over a year. This Insight reviews the administration’s activities in 2013 and highlights those developments most relevant to investors trying to navigate China’s complex economic and political system. These changes to government policy may alter both the risk and opportunity profiles of certain companies and industries, and have implications for investors. This Insight outlines six material issues: 1 Economic Reforms and Political Conservatism In the wake of a slowing economy, the government has launched essential economic and administrative reforms, but has ruled out major political or democratic reforms. This political conservatism is reflected in Xi’s frugality campaigns, launched in an effort to curb extravagant spending by government officials and regain public trust. The austerity measures introduced by the Xi-Li administration have had a significant impact on the high- end restaurant, alcohol and tobacco industries. Companies such as Kweichow Moutai Co Ltd, Luzhou Laojiao Co Ltd, Wuliangye Yibin Co Ltd, Quanjude Co Ltd and Beijing Xiangeqing Co Ltd face financial risks as a result of the government’s spending restrictions. 2 Intensified Anti-corruption Campaigns Stricter anti-corruption campaigns and a greater emphasis on the rule of law in 2013 have increased exposure to regulatory actions for companies in the pharmaceutical and oil and gas industries. Companies at risk include GlaxoSmithKline plc, Sanofi, Eli Lilly & Co, PetroChina, Sinopec Limited and CNOOC Limited. 3 Anti-competitive Practices and Monopolies Anti-competitive activities, such as price-fixing, have triggered significant public discontent in China. Combating anti-competitive behaviours and corporate monopolies is at the top of the Chinese government’s agenda and any resulting regulations could have an impact on the following industries: banking, telecommunications, and pharmaceuticals. Companies at risk include Industrial and Commercial Bank of China, China Construction Bank, China Mobile Limited, China Unicom, Merck & Co., Inc., Boehringer Ingelheim GmbH, GlaxoSmithKline plc. 4 Sustainable Development Strategy In China’s 12th Five-Year Plan, seven emerging industries were highlighted as strategic priorities: energy-saving and environmental protection; new-generation information technology; biology; high-end equipment manufacturing; new materials; alternative energy cars; and alternative energy. The government will purportedly invest RMB 10 trillion yuan (USD 1.5 trillion) in these seven industries by 2015. Companies that may benefit from such government investments include Beijing Capital Co Ltd, Fujian Longking Co Ltd, Shanghai Canature Environmental Products Co Ltd, Tianjin Capital Environmental Protection Group, Alibaba.com Limited, Tencent Holdings Ltd, Baidu Inc, Jiangsu Hengrui Medicine Co Ltd. 5 Adjusted Urbanization Plan In 2013, Premier Li actively promoted a program aimed at urbanizing about 400 million rural residents. Amid concerns about the environmental and social impacts of these massive projects, Li has adjusted his plan to incorporate low-carbon development and environmental 4 protections. Companies such as Beijing Capital Co Ltd, Fujian Longking Co Ltd, Tianjin Capital Environmental Protection Group, TBEA Co Ltd may benefit from this adjusted urbanization plan. 6 Enhanced Food Safety and Drug Governance In 2013, the Xi-Li administration strengthened the supervision of the Chinese food market to ensure food safety, a major source of concern in China. Companies such as China Resources Enterprise Ltd., China Foods Limited, Uni-President China Holdings Ltd, and Want Want China Holdings Ltd, which have relatively good food safety management systems are better prepared to meet higher food safety standards. Conversely, Synear Food Holdings Limited, Ajisen China and Henan Shuanghui Investment & Development Co, which recently experienced serious food safety-related scandals, are facing greater exposure to regulatory risks. Introduction China’s fifth leadership generation, Xi Jinping and Li Keqiang (Xi-Li Administration), succeeded President Hu Jintao and Premier Wen Jiabao respectively following the 18th National Congress of the Chinese Communist Party (CCP) in November 2012 and the 12th National People’s Congress in March 2013. In October 2012, Sustainalytics published, What Does China’s Leadership Transition Mean for ESG, a report which highlighted some key environmental, social and governance (ESG) related risks and opportunities facing China’s industries under the Xi-Li administration. A few of the major anticipated changes were as follows: • The CCP will retain its absolute control over China. Human rights – including fundamental political rights – will remain limited and labour unions will continue to be led by the CCP; • The concept of “rule of law” will be strengthened and companies will be protected via the judiciary system, coinciding with a tightening of regulation and enforcement with respect to corruption and insider trading; • Reforms for state-owned enterprises (SOE) will further reduce the dominance of monopolies in sectors that are not considered strategic by the government; • China’s economic policies will continue to be influenced by scientific development and will emphasize sustainability and quality of growth over pace of growth; • Rural and agricultural issues will receive more attention in an effort to promote social cohesion and a more equitable distribution of benefits from economic growth; • The Xi-Li administration will regulate and address food safety issues with rigour. In general, the trends that we had anticipated have all started to materialize. With the absence of democratic reform, China’s new leadership has instead imposed more economic and social reforms. Numerous