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Finance & Investment
Investors Can No Longer Ignore China’s Lagging ESG Performance

For brands that pulled out of Russia after the invasion of Ukraine, the cost was in the billions. But Russia is a tiny economy compared to China; and the costs of inaction on ESG issues could be multitudes of magnitude bigger.

Over the past few decades, since China embarked on a series of economic reforms led by former Premier Deng Xiaoping, the world’s most populous country has become central to the supply chains of nearly every major global brand. Whether it was garment and apparel companies such as Nike and Adidas, technology giants Apple and HP, or carmakers including Ford and Toyota, Chinese suppliers — often subcontracted via complex supply chains — produced apparel, electrical components, auto parts and all manner of other products for export. To this day, no other country or region can match China’s productivity, labor force and high-quality infrastructure.

Unfortunately, in their quest for profits or market access, many brands turned a blind eye to the social and human rights costs that come with doing business with an authoritarian regime; and for the most part, investors did not care.

That, increasingly, is changing, says Matthew Zimmer — director of research at Newday Impact Investing — a financial services company focused on socially responsible portfolios.

“For a variety of reasons, Chinese companies score poorly on ESG metrics or fail to report such data altogether,” Zimmer told Sustainable Brands®.

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Why does this matter? Because we’re seeing ESG — a framework to understand how companies are managing risks and opportunities related to environmental, social and governance criteria — grow from a niche consideration to one central to investment decisions; the Securities and Exchange Commission has even proposed an ESG disclosure mandate for businesses.

“While issues like labor and environmental violations in Chinese supply chains ... have been present for some time, they are increasingly coming to the fore as investors demand more transparency about the impact of their investments,” Zimmer says.

This means global brands have to take their ESG efforts more seriously. And that means they need to reassess relationships with companies in China and their lagging ESG scores. And that is easier said than done.

How did this happen, and why were so many corporations so willing to build such strong relationships with a country known to be violating human rights? Back in the ’80s and ’90s, it was believed that economic progress would eventually lead to political liberalizations and increased civil and human rights in China. And for a time, it seemed to be happening — there was growing space for media and civil society in some parts of China; though, notably, not in regions such as Tibet or Xinjiang — homeland of the Uyghurs.

In recent years — and especially, since severe crackdowns after protests in Tibet in 2008 and Xinjiang the following year; and especially, after Xi Jinping came to power in 2013 — the trend has shifted for the worse. Independent media outlets have all but ceased to operate. Labor non-profits, too, have mostly been shut down.

As Michael J. Abramowitz, president of the nonprofit Freedom House explained in a press statement: “During Xi’s tenure, [the Chinese government] has systematically jailed and silenced critics, journalists and independent media; tightened restrictions on social media and access to internet outside China; cracked down on rights-focused NGOs; clamped down on religious practice; and committed heinous atrocities against the Uyghur population including mass arbitrary detentions and enforced disappearances.”

There might be a lesson in another global market where there were warning signs about poor ESG for years that were ignored by many global brands: Russia.

When Russia invaded Ukraine last year, numerous brands decided it was time to withdraw from the country. But the invasion was only the latest in a series of worrying provocations — including assassinations of journalists and critics; the attempted poisoning and subsequent jailing of the leading opposition figure, Alexei Navalny; and widespread allegations of discrimination against minorities, the LGBTQ community, and much more.

“In the past years, I have seen many cases when Russian human rights defenders were criminalized for their legitimate work and exercising the freedom of expression,” said the United Nations Special Rapporteur on the situation of human rights defenders, Mary Lawlor, in a press statement.

For brands that pulled out of Russia, the cost was huge — $59 billion in losses. But Russia, despite its size, is a tiny economy compared to China; and the costs of inaction on ESG issues could be multitudes of magnitude bigger.

Of course, China is not the only country where brands face labor, human rights and environmental risks in their supply chains. Bangladesh, Indonesia, Pakistan and the Democratic Republic of Congo are just a few that are known for being riddled with corruption and substandard working conditions, including documented worker deaths in facilities sourcing western brands.

But one thing that makes China different from these countries is the role of the government in perpetuating these abuses and limiting the impact of real ESG strategies. In 2021, China passed a law that restricted the sharing of corporate data with non-Chinese judicial or law-enforcement authorities, if it might “damage national security, public interest.” Some saw this as specifically limiting the ability of companies to share data about their supply chains, and potential labor violations, with those outside of China.

This, Zimmer says, could limit any future ESG push from within China.

“There have been proposals put forward for ESG standards in China, which could in theory improve the coverage and consistency of such reporting. However, if fidelity to such standards were to conflict with the government’s priorities, there is little doubt that the government would prevail,” he says.

Which brings up another point: Unlike in the United States, Europe or even much of Asia, there is a lack of independence when it comes to Chinese companies — which often have to allow for the government, or the Chinese Communist Party, to have a direct say in business decisions.

“In a country such as China, it is difficult to separate individual companies from the broader government,” Zimmer says. “The government ultimately calls the shots.”

Zimmer warns of an ESG reckoning, as companies lagging progress on diversifying their supply chains or dealing with issues such as Uyghur forced labor comes to a head with increasing ESG requirements and new due-diligence regulations in the US and Europe.

“Investors are demanding ... more transparency about impact,” Zimmer says. “They are [increasingly] looking at investing through an ethical lens and not solely focusing on expected returns.”