September 2021
AAM Magazine
September 2021

ESG index investment strategy in China's bond market

I. ESG investment is on the rise in China

Global sustainable investment continues to grow. According to the “2018 Global Sustainable Investment Review” released by the Global Sustainable Alliance, the world's top five regions had US$31 trillion in sustainable investment assets in 2018, representing 33% of global assets under management. Of this total, 51% was invested in equity products and 36% in fixed income products.

In recent years, China's public fund industry has also been exploring sustainable investment. According to WIND data, there were 117 ESG investment funds in China as at 30 June 2020 with a total value of 102.5 billion yuan, including four ESG ETFs worth a combined 3.342 billion yuan. However, up to now ESG investment strategies mainly cover equities only. Bond products are not yet included and so offer great market potential.

The main reason for the temporary absence of bond ESG fund products in the domestic market is that available ESG evaluations have not been able to fully cover Chinese bond issuers, resulting in investors not being able to obtain effective valuations or investment benchmarks. As more third-party evaluation institutions begin to provide ESG evaluation services for bond issuers, more and more new fixed income ESG investment opportunities will arise.

II. Pioneering ESG investment strategy in China's bond market

In recent years, ESG ratings services have been introduced in China. Since 2019, domestic institutions such as university research institutions, ratings companies and index issuing companies, have studied and published ESG ratings and indices covering domestic listed companies and some bond issuing entities.

On 30 October 2020, ChinaBond Pricing Center Co., Ltd. (hereafter referred as CBPC) issued an in-house developed ESG evaluation system covering all public listed bond issuers in the Chinese bond market.

  • Introduction to ChinaBond ESG Evaluation

The ChinaBond ESG Evaluation system has five characteristics:

  1. It is consistent with the international evaluation framework. The system fully incorporates internationally-recognized methods and experience, with reference to relevant regulations and international academic research.
  2. It takes into account China's policy environment and bond market characteristics. Indicators reflect the development context of domestic industries, bond markets and information disclosure, and focus on strong accessibility, good comparability and Chinese characteristics.
  3. The system considers industry differences, covering more than 60 sets of evaluation indicators including general indicators and specific sub-industry indicators.
  4. Key parameters are set scientifically according to the development plan of each industry, clean production standards and other national policies.
  5. Fintech is used to integrate a large volume of unstructured and alternative data. The evaluation method involves 14 evaluation dimensions, 39 evaluation factors, more than 160 underlying calculation indicators and more than 300 ESG elements.

ChinaBond ESG Evaluation’s maximum score is 10 points, with 1 point being the lowest. Each point scored represents a tier, with a higher score indicating that the issuer's performance is better.

The evaluations cover all relevant aspects for the majority of publicly-offered credit bonds in the Chinese bond market dating back to 2017 and will be continuously updated according to the latest developments in the bond market.

  • The launch of the world's first Broad base RMB credit bond ESG Factor Index

Using the ChinaBond ESG Evaluation as a basis, CBPC compiles the ChinaBond ESG Select Credit Bond Index, which represents the performance of bonds with a market value of more than 6 trillion yuan.

The index constituents include domestic publicly-issued and listed bonds with remaining life of not less than one month, ChinaBond Market Implied Ratings of not less than AA grade, excluding bonds issued by issuers with ChinaBond ESG Evaluation below 4 points. Then the index selects only the top 30% ChinaBond ESG Evaluation scored bonds within each group so as to enhance the ESG performance of the index. If issuers have the same ChinaBond ESG Evaluation scores, priority is given to newly issued bonds.

  • Findings of ChinaBond ESG Evaluation and the Index

Chinabond ESG Select Credit Bond Index is used to assess the ESG investment strategy performance in the Chinese bond market. Preliminary studies show that ESG evaluation is a useful complement to corporate credit assessment, improves investors' risk management capabilities, enables more stable returns and helps investors practise sustainable investment.

  1. ESG evaluation can complement enterprise credit ratings and help investors to defend against risk. Analysis of domestic market-wide credit bonds shows that the ChinaBond ESG Evaluation score usually show an overall downward trend as the credit rating of bonds[1] However, AAA bonds (including 176 issuers) score slightly lower than AAA- mainly due to limited information disclosures by some AAA rated issuers which affects the effectiveness of the ESG evaluation and lowers the average performance of that grade. Considering that the number of AAA bonds is relatively small, there is no significant impact on overall trend.

Figure 1: Average ChinaBond ESG Evaluation scores vs ChinaBond Market Implied Ratings[2]

Source: CBPC 

  1. Enterprises with stronger sustainable development ability have a clear advantage as market volatility increases. Analysis of historical performance of the ChinaBond ESG Select Credit Bond Index indicates that the ESG Select Portfolio, which represents a stronger sustainable development ability, is not inferior in terms of return, especially over 2020. As overall volatility of the credit bond market has intensified, the overall trend of ChinaBond ESG Select Credit Bond Index applying ChinaBond ESG Evaluation screening has performed better.

Figure 2: Historical performance of various total return indices

Source: CBPC

Note: The basic reference universe[3] differs slightly from that of ChinaBond Credit Bond Index, and the comparison results are for informational purposes only

  1. The ESG level of a portfolio can be improved without sacrificing investment income. The index first does a negative cull to exclude bonds issued by issuers with a ChinaBond ESG Evaluation of less than 4 points. A positive screening is then applied to select the top 30% ESG Evaluation within each ChinaBond Market Implied Rating tier, so as to maintain market neutrality, access to the average market returns under the premise of effectively improving the ESG performance of the index. On this basis, investors will have the opportunity to earn a higher return on investment in their portfolios by combining ESG strategies with fundamental and/or factor investment strategies.

Figure 3 Distribution of ESG Evaluation of the Index constituents
(by quantity) as at 31 October 2020

Source: CBPC

Figure 4: Comparison of ChinaBond ESG Evaluation[4]
of index portfolios as at 31 October 2020

Source: CBPC

  1. The ESG Evaluation scores of bond issuers increase with increased market attention on ESG themes. As government and regulatory requirements for enterprises to disclose ESG information continue to evolve, ESG strategic investment products in the market have emerged, encouraging more and more enterprises to focus on and practise sustainable business. This has led to the market average ChinaBond ESG Evaluation showing a positive trend, so that the market has formed a virtuous circle.

Figure 5: Annual increases in average ESG Evaluation scores of bond issuers in the ChinaBond ESG Select Credit Bond Index

Source: CBPC

III. Difficulties and suggestions for ESG investment in China's bond market

In recent years, the concept of sustainable investment has been increasingly valued by government departments and related institutions, but there is still room for further development in information disclosure, evaluation framework standards and investor education.

  1. It is proposed to strengthen the ESG information disclosure mechanism of bond issuers and promote a transition from voluntary to mandatory disclosure. The quality and quantity of ESG information disclosure is the basis for the establishment and application of ESG evaluation system and related financial products. The authenticity, transparency and standardization of data has a direct impact on the accuracy of ESG evaluation of enterprises, thus further affecting the actual reference value of the evaluation index.
    It is suggested that the authorities consider establishing an ESG information orientation sharing mechanism to share ESG-related information submitted by enterprises with third-party ESG evaluation institutions with certain research capabilities and meeting regulatory requirements, so as to further improve the quality of ESG evaluation by third-party institutions for domestic bond issuers.
  1. Strengthen investor education and actively promote ESG investment at the market level. As far as China's capital market is concerned, although ESG investment products show a continuing growth trend, there is still considerable room for further growth given the total size of public funds.
    Domestic ESG investment is currently predominantly focused on equity-based investment. It is suggested to further strengthen investor education in the bond market, encourage more investors to choose low-cost, high-liquidity, more transparent ESG bond index investment products, to promote the sustainable development of the domestic bond market.
Read more about ChinaBond Indices

[1] The credit qualification of bonds is based on the ChinaBond Market Implied Ratings;

[2] In the statistical sample, bonds with ChinaBond Market Implied Ratings below AA- account for only about 10% of the total sample and so have been included as a single group;

[3] The basic reference universe consists of bonds that meet the basic screening rules of ChinaBond ESG Select Credit Bond Index but are not screened for the ESG evaluation, and are used only for statistical reference

[4] The ESG rating of bonds issued by index component securities is calculated according to the weighting of the total market value weight of the bonds issued in the index