[Exclusive] MSCI to Boost China Stocks Weighting Despite Low ESG Scores
Zhou Ailin
/SOURCE : Yicai
[Exclusive] MSCI to Boost China Stocks Weighting Despite Low ESG Scores

(Yicai Global) Oct. 30 -- Global index complier MSCI will move forward with plans to increase benchmark weightings to Chinese equities regardless of their relatively low scores on a key corporate metric, a senior executive told Yicai Global.

The comparatively soft scoring on environmental, social and governance standards, or ESG, by A share-listed companies recently added to Morgan Stanley Capital International indexes is normal, Guido Giese, the executive director of MSCI's Equity Applied Research team in Zurich, said in an exclusive interview with Yicai Global.

Big international institutional investors pay a lot of attention to ESG criteria, which help to flag risks and opportunities. Globally, USD85 billion of assets track MSCI's ESG criteria, with many institutions investing or comparing individual shares based on the ratings, which are not publicly available.

An ESG rating from New York-based MSCI consists of two parts. A third depends on information disclosed by listed firms. The rest come from independent third parties. The advantage of MSCI rating is that it doesn't just analyze whether a company has an environmental protection policy, impact from carbon emissions or governance risks. The company's business model and cash flow are also assessed, according to Giese.

MSCI has finished evaluating 423 A-share companies which make up the MSCI China A International Index. Some 86 percent rated below the median BBB. According to its website, a BBB rating is given to "a company with a mixed or unexceptional track record of managing the most significant ESG risks and opportunities relative to industry peers."

Incomplete Picture

Giese believes the low grade is connected to incomplete disclosure of information on the part of A-share companies. For example, a mere 2 percent publish CSR, or  corporate social responsibility, reports. The average for emerging markets is higher at 10 to 20 percent. MSCI hopes the Chinese companies can reveal more at least to a similar level with their emerging market counterparts, he said.

Corporate disclosure also needs to be more transparent, Giese said. A case in point is salaries. They should include payments and equity incentives since analysts need access to such data. Such disclosure also helps to boost a firm's ESG rating.

Investments based on ESG ratings of Chinese equities can help investors gain more downside protection and excess earnings, and avoid risks in a market with higher volatility and more downside risk, said Giese.

The MSCI Emerging Market ESG Leaders Index has higher annualized yields, lower annualized volatility and maximum retracement in the past three years, five years and 10 years.

For instance, the ESG research department at MSCI had lowered the rating of Hong Kong-listed Huishan Diary Holdings one notch to B -- second from bottom -- from BB in September 2016, long before the date which the company's earnings fraud was exposed. Before the Volkswagen emissions scandal and Facebook's data breach, MSCI's ESG ratings served as warnings.

Higher Weighting

MSCI said it will consider quadrupling the weighting of large-cap Chinese stocks in its global benchmarks from 5 percent to 20 percent in September. Chinese investors are keen to see if it can be done.

Investors think highly of the process and the Shanghai-Shenzhen-Hong Kong stock connect mechanism, MSCI Asia Research Director and Managing Director Xie Zhengbin to Yicai Global earlier.

Investor attitudes to the two possible weightings is markedly different. If the increment is raised to 20 percent, they will require better risk management such as derivatives like futures and options, Xie said, adding that different weightings have different problems.

Giese said MSCI has consulted with institutional investors, and their opinion varies. The final result is still unclear.

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Keywords: MSCI, ESG, Investment , Grade