Toxic Waste to Toxic Assets

By Taylor Brown, Shen Xin 7 November, 2013

SynTao's Brown & Xin on the impact of rescent pollution scandals on market value & the need for disclosure

Versions of this article were originally published in China ESG Monitor (August 2013) — a monthly newsletter highlighting ESG trends and research relevant to sustainable investment in China. The article, entitled “From Toxic Waste to Toxic Assets: Investors Flee from a Lead-Acid Battery Producer” was written by Taylor Brown, ESG Intern at SynTao. The other one, entitled “Pangang Group’s Environmental Scandal Ought to Raise Investors’ Concern” was written by Shen Xin, ESG analyst at SynTao.

Recent corporate environmental scandals and the resulting impact on market value have highlighted the need for investors and regulators alike to pay much closer attention to how companies implement their publicly disclosed Environmental Social Governance (ESG) risk management strategies. Whilst many companies periodically release information concerning their compliance with China’s environmental laws, the absence of substantive ESG and CSR reporting standards means that existing disclosures require far greater scrutiny to ensure core business risks are fully accounted for.

Examples of Bad ESG = bad market performance: 

Investors flee from a lead-acid battery producer

“Tianneng Power’s dumping of waste lead …
…[resulted in] a one day 20% trading loss before share sales were suspended by the Hong Kong Stock Exchange”

On 2 August 2013, China’s state media network CCTV aired a special report detailing Tianneng Power’s (HKG:0819) dumping of waste lead in communal lands and water supplies that surround the company’s largest lead-acid battery factory. The investigation, titled “Hide and Seek: Lead Pollution”, found that lead toxicity levels in blood samples taken from local residents could be up to a hundred times higher than national public health and safety standards.

Following fears that the facility in question, responsible for producing almost half of Tianneng’s battery products, might be shut down by government authorities, the company experienced a one day 20% trading loss before share sales were suspended by the Hong Kong Stock Exchange.

Pangang group’s environmental scandal raises investors concerns

Shortly after that, on 11 August, entrepreneur Ren Zhiqiang posted on his micro blog that Chongqing Titanium Industry Co. (000515) was pouring untreated sewage directly into the Yantze River with a pollutant concentration nearly 100 times more than the legal limit. With over 15 million followers, Ren’s post immediately aroused attention from Chongqing Titanium’s parent company, Pangang Group Steel Vanadium & Titanium Co., Ltd (000629).

Pangang stated that it would suspend share-sales, in compliance with the Shenzhen Stock Exchange regulations, should any previously undisclosed information concerning its subsidiary eventually appear in the media in order to give the company time to release a statement concerning the accusations.

Implications for investors:

ESG & financial performance

If we look at the Tianneng example, faced with large short-term debt obligations, a consolidating domestic market, dividend commitments, and slowing demand growth for its main product, Tianneng may have opted to cut planned expenditures on pollution controls in order to maintain its bottom line.

“The modest capital expenditure required to have prevented this incident now seems considerably small in the face of the USD 100 million in market value Tianneng has lost “

The modest capital expenditure required to have prevented this incident now seems considerably small in the face of the USD 100 million in market value Tianneng has lost since 5 August 2013; subsequently erasing gains made against a 6 month slump in share prices.

Chaowei Power, on the other hand, has continued to release significant information on the development of its environmental safety protocols since its 2010 IPO, and posted a 5% gain following news of Tianneng’s pollution scandal.

The Chaowei Power example is backed up by recent research conducted by Harvard Business School, which has indicated that companies can bring about greater financial performance as their environmental, social and governance performance improves. Investors should increasingly consider environmental factors and their influence on a company’s financial performance when making investment decisions.

Institutional investors have begun to consider ESG factors as three significant non financial indicators that can affect the performance of investment portfolios and are increasingly incorporating ESG considerations into investment analysis, due diligence, and investment decision-making. In addition, the UN PRI asks every signatory to incorporate ESG concerns into their investment strategies. Currently, 1,213 investment agencies have signed the initiative, with total assets under management of USD34 trillion.

Regulatory bodies cracking down on environmental violations

“regulatory bodies are now utilizing multiple measures, including legislative and administrative regulations along with a mixture of economic incentives, to encourage change.”

The two major reasons that companies are willing to violate environmental regulations are that environmental supervision remains poor and the costs of breaking the law are low. Thus, it is paramount for government to better balance economic development with environmental protection needs while pursuing of deeper economic reform.

Fortunately regulatory bodies are now utilizing multiple measures, including legislative and administrative regulations along with a mixture of economic incentives, to encourage change. Faced with the increasing regulatory pressure, combined with the public’s environmental concerns, corporations are gradually integrating environmental issues into their assessment of operational risks.

• • Environmental Information disclosure mechanisms will force companies to confront environmental problems and exert pressure on highly polluting companies

Currently the MEP’s environmental information disclosure policy requires the 15,000 companies under its supervision to disclose relevant environmental information through the Ministry’s public information platform through the Ministry’s public information platform. Additionally, the Shanghai and Shenzhen Stock Exchanges now encourage public companies to release CSR or environmental reports.

• • Green credit and green bonds set environmental requirements for corporate financing

The green credit and green bonds policy implemented by the MEP in 2008 make environmental concerns a key factor in impeding further capitalization and financing of highly polluting and energy-inefficient industries. An example of this can be seen in the IPO process. The Titanium-dioxide powder industry is considered to be a heavy polluter, and the IPO application of Lomon Corporation, one of the largest companies within its sectors, was rejected by the China Securities Regulatory Commission recently. In other words, environmental policy has become a key success factor for companies during the IPO process.

Investor Activism

In a market where many listed companies face material ESG risks, the lesson is clear. IPO prospectuses and continuous monitoring efforts can offer useful insights into baseline industry risks. The main remaining question is how the investment community should build on insights gained from existing disclosures.

“Tianneng’s and Pangang’s poor ESG performance has ultimately had a significant material impact on their shareholders.”

All of this should suggest to investors that greater emphasis on material environmental capital expenditures are needed to sustain ongoing compliance needs. As markets have demonstrated throughout August, Tianneng’s and Pangang’s poor ESG performance has ultimately had a significant material impact on their shareholders. Fundamentally investors will be well advised to carefully crosscheck stated prospectus challenges against ongoing disclosures to avoid similar compliance gaps in the future.

Further Reading:

• More Power to Enforcement – Environmental protection was a central theme of the recent Beijing Forum, here Debra Tan discusses how this along with recent policy developments seem to signal that China’s environmental protection legislation has grown some teeth and that she is firmly on the path to more enforcement
• Investors Value Fuller Disclosure – PwC partner, Gayle Donohue argues that existing corporate reporting with undue focus on financial aspects of the business model is outdated, and outlines research which shows fuller disclosure of ESG information could translate into more BUY recommendations
• Investors Say: Water Risk is Beyond Pricing – NBIM, APG, GIC, HSBC and APG on why it is important to measure the impact of the environment on business as the value of water lies in business continuity & value of brands rather than water pricing
• China’s Water Watchdogs – China’s new breed of water watchdogs are emerging, with rising concerns over pollution. Pacific Environment’s china Program Director, Kristen McDonald tells us why we should take notice of their action
• Investors Beware: Blackholes & Blacklists – Debra Tan reviews key risks to the textile sector and argues that they should be priced into brand valuations – holdings of top institutional funds in polluting fashion brands reviewed
• Enforcing China’s Planned Green Economy – Can China achieve its planned RMB4.5trn energy-saving & environmental protection industry? HSBC’s Wai-Shin Chan on incentives, changes in environmental law, more regulatory muscle and what this means for water
• MEP Shamed 56 Companies for Polluting North China Plain with Seepage Wells – MEP shames 56 companies in 5 provinces for polluting the North China Plain with seepage wells and pits with no anti-leakage protection