ESG and the CCP: Why Investors Should Care about the Chinese Communist Party Incorporated
On September 27, 2011, I stood on the balcony of the New York Stock Exchange alongside the CEOs of Corporate Responsibility Magazine’s top 10 corporate citizens to close the trading day. I had overseen the magazine’s “100 Best Corporate Citizens” list, helping set the standard for environmental, social, and governance (ESG) assessment of corporate behavior. The 100 Best list measured transparency and disclosure: how well and how thoroughly a company discloses its ESG impact. Since that time, ESG has grown in importance and value, moving beyond a niche set of investors to large institutional investors and hitting a watershed moment three years ago when BlackRock CEO Larry Fink, the world’s largest institutional investor, declared in his annual letter that companies should get on the right side of ESG or get out of the BlackRock portfolio.
This largely reflects an improved understanding among investors of how to measure risk. Simply put, companies that do a bad job managing ESG expose investors to unnecessary risk, especially over the long term. Unmitigated environmental impact, lack of diversity and inclusion, or poor relations with the communities in which companies operate often turn into lawsuits, regulatory fines, or loss of the license to operate. While capital markets have gotten better at “pricing-in” these risks and rewarding companies for effective ESG management, they have also become a conduit for capital flows to a relatively new player, the Chinese Communist Party (CCP). The CCP acts as both regulator and investor in numerous industries and companies throughout China and beyond and has benefited from investment by both domestic Chinese and foreign investors in Chinese companies and bourses. In fact, today the CCP owns or controls 12 companies in Fortune's Global 50 list, representing $2.557 trillion in revenues. At the same time, it has also become a source of opacity, obscuring long-term ESG risk. This needs to change.
The CCP sees its dual role as a strength. In any other industrialized nation, it would be considered a flaw in governance and a conflict of interest. Often referred to as “the policy dividend” in China’s business schools, the CCP rewards companies that align with its industrial and economic growth plans by investing in or lending to them through China’s murky financial system with favored contracts, or by looking the other way on regulatory enforcement, especially on ESG issues. Just recently, the CCP has exercised both formal and informal power to punish businesses and executives it felt risked its grasp on power. Earlier this year, the CCP scuppered what would have been the world’s largest $37 billion initial public offering of Alibaba’s Ant Financial because of remarks CEO Jack Ma made criticizing state-owned banks and regulators. Similarly, retailer H&M found many of its products removed from Chinese e-commerce sites shortly after Western countries imposed sanctions on Chinese officials over the alleged use of forced labor in Xinjiang’s cotton industry. Even more recently, the CCP has once again extended its grip beyond its borders, attempting to influence the Academy Awards, signaling to cinemas in China and state owned media to “tamp down coverage of the Oscars . . . after the controversy over [the nomination of Nomadland director Chloe] Zhao,” who made unflattering remarks about China in 2013, “and the nomination of a documentary about the Hong Kong protests.” The CCP’s ability to use state power, influence, and ownership represents a significant blind spot and undisclosed risk for investors and companies seeking to do business with Chinese firms.
China’s massive and breakneck economic growth over the past few decades has lifted millions out of poverty, and the CCP rightly lauds its success. This growth, though, has come at significant ESG costs: the air in most of China’s largest cities has become nearly unbreathable, huge groups of people have been forcibly displaced to make room for the CCP’s industrial plans, and growing evidence points to a looming “#MeToo” problem for many Chinese executives. The CCP has kept many of these issues at bay by exercising its prerogative as a sovereign. But make no mistake: these bills will eventually come due, and when they do—precisely because the CCP is a sovereign—those bills will not be paid by the state but by investors, especially foreign investors.
In 1991, those bills came due for Nike. Up until that point, Nike did not feel responsible for its second and third tier suppliers. Nike, and many other companies, reasoned that they had responsibility only for the actions of their own employees, and at most for their immediate, first-tier suppliers. When consumer advocacy groups found out that Nike’s third-tier suppliers used forced sweatshop labor, Nike and its investors had to pay to clean up the supply chain. Companies that rely on Chinese suppliers have a similar undisclosed bill coming due. Increasingly, the CCP makes brands choose between supply chain ethics and pleasing China and its consumers. Unfortunately, too often, “It’s capitalism meets forced labour, and the brands are choosing unfettered capitalism.” This sets up an uneven playing field in which investors and regulators hold American, European, and other OECD-based companies to a higher standard and China-based firms to a lower. It also results in negative ESG outcomes for China’s own consumers, workers, and investors. For that reason, it becomes ever more imperative that investors help companies by:
- Insisting on similar ESG standards and disclosures from suppliers, including disclosures of ownership and sources of debt, as they would of any other publicly traded firm from Organization for Economic Cooperation and Development countries;
- Until these firms comply, pricing in a risk premium when assessing ESG-related risk for any company with ties to the CCP or the People’s Liberation Army; and
- Divesting from or ceasing to do business with firms that fail to meet ESG standards or found to have violated fundamental ESG principles, for example, use of underage and forced labor.
What the CCP calls a “policy dividend” is in fact a risk deficit for companies and investors. But it does not have to be this way. As we rang the closing bell at the New York Stock Exchange 10 years ago, I stood there because I firmly believed then, and still believe today, that free markets have done more than any force in human history to alleviate misery and improve lives. For that reason, I welcome China and the contributions its strong economic growth have made to global prosperity and to the prosperity of many of China’s people. But growth always comes at a cost. I helped jump-start the ESG movement precisely because I wanted to ensure we all—everyone in society but especially corporate, civil society, and government leaders—had a clear sense of those costs. Now is the time for companies, their investors, and the CCP to disclose these costs and begin to deal in an open and transparent way with managing them, before these bills come due. Now is also the time for investors, especially large institutional investors like BlackRock, to own all three letters: E, S, and G, and to require all the companies in their portfolios to adhere to a common set of standards and act as good stewards of the environment, society, and good governance. If that happens, it will certainly benefit foreign companies and investors, but the real beneficiaries will be the Chinese people and the CCP itself.
Richard Crespin is a senior associate (non-resident) with the Project on Prosperity and Development at the Center for Strategic and International Studies (CSIS) in Washington, D.C.
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