East Capital’s Hirn: “Being state-owned is not the issue”
Karine Hirn, co-founder at East Capital Holdings and CEO of East Capital Asia, talked about the time and attention required to properly assess and manage the risks involved in sustainable investments. She also shared the journey that the Stockholm-based asset manager took to enter the Asian market and the decision-making process behind investing into Chinese ESG-focused companies.
The following key points were discussed:
- Governments are still the ones pushing for regulations on company disclosure in several countries.
- East Capital created its ownscorecard to identify valuable ESG data.
- China emits the most carbon emission but also championsgreen solutions.
- Investors, asset owners and managers align via Climate Action 100+ to improve ESG reporting.
- Governance issues, such intellectual property rights and labour law, in China will lessen with regulation in place.
- COVID-19 fast-tracked changes in financial markets and investment behaviours.
Below is the edited transcript of the interview.
Foo Boon Ping (FBP): Good morning, everyone, and welcome to this RadioFinance session for Wealth and Society. Today we're very happy to be speaking with Karine Hirn, who is the co-founder and partner at East Capital Holdings. She is also the CEO of East Capital Asia, an East Capital subsidiary based out of Hong Kong. East Capital is an active asset manager that is focused on emerging and frontier markets, and especially focused on the area of environmental, social, and corporate governance (ESG) and sustainable investments. East Capital Holdings was founded in 1997. It's got over 22 years of experience. We understand it sells mainly to institutional and private investors out of Europe, specifically, Eastern Europe and ESG is an area that you're increasingly focused on. Tell us, how are you integrating ESG into your investment portfolio? And what kind of interest is it driving among your investors?
Karine Hirn (KH): We founded the company in 1997 in Stockholm, Sweden. At the time and up until 2010, we were only investing in Eastern Europe and we're still today, among the largest investors in many countries in Eastern Europe, including Russia, but also the part of Eastern Europe, which is now part of the European Union. Then in 2010, we decided to expand our investment universe and started investing in China, then the rest of Asia, with a focus on emerging and frontier Asia. By that I mean, the Southeast Asian countries and Indian markets, but also the fast-growing frontier markets such as Vietnam, Bangladesh, Pakistan and Sri Lanka. By 2021, East Capital Group is also investing in other markets. But for the brand East Capital, we also have the Global Emerging Markets Sustainable Fund, which invests in across all continents, and a Global Frontier Market Fund.
You asked me about ESG and it's a topic I like to talk a lot about. Everyone is speaking about it because it is indeed extremely important. For us at East Capital, it actually started on day one, because in 1997, when we started investing in Russia, we were at the time challenged as a minority shareholder investing in markets where there was not a long tradition of equity investments. There was not a long tradition of even understanding what it is to be a shareholder in a listed entity. There was also not a lot of regulation to protect investors. Our ESG journey started with making sure that, we in terms of corporate governance, do understand, properly assess, and properly manage the risk we take by investing in these companies. We always spend a lot of time, effort, and resources in specifically understanding the ownership. Who is behind the company? We're going to be owning shares in the management. What kind of people are driving and running this business and topics related to capital allocation and the quality of the board, and so forth.
At East Capital, we have a saying that the best investments we made are the ones that we didn't make. Usually, we didn't make them because it was very bad corporate governance. Throughout the years, we have developed and refined our approach. Now we spend a lot of time and attention on the environmental and social aspects of companies we are investing in.
FBP: From the outset, there's been this focus on proper corporate governance, the quality of the board on this general capital application and those are important decisions in making the investments as ESG evolved to include the other elements of environment and social factors as well. Now, when we look at ESG in totality, what has been the interest of investors to have ESG as part of their investment decision making? We know it's been a journey, especially driven increasingly by governments and authorities. In Europe, you have ESG integration, disclosure requirements where all asset managers have to disclose ESG risk in your portfolio. How much of ESG investment is part of your portfolio currently? You talked about the Global Emerging Market Sustainable Fund. When we looked at the income that you generated from it, based on your latest financial, it is still a rather small part of your portfolio. Tell us, how will this grow?
Push and pull in sustainable disclosure
KH: First, the interest is huge and it has always been there for us. In Northern Europe, in Sweden, there's always been a lot of focus on these topics. A lot of asset managers in Sweden were leaders and pioneers in assessing the portfolios, looking at coal in this ESG investment sphere, norm-based screening and controversy screening. The point is to check the portfolio holdings as in what way these are or not complying to international norms and conventions, such as the one that are listed in the United Nations (UN) Global Compact: anything related to corruption, labour rights, human rights, environmental protection.
Then you asked about the weights. It's working and it's very different from country to country. Clearly, Europe has been going quite far and it's going quite fast as well in terms of regulating and putting these requirements for asset managers and asset owners. And we'll be talking more about Sustainable Finance Disclosure Regulation (SFDR) in Europe. We do hope that this is something as well that will be happening in Asia. It’s difficult to just generalise everything, but in quite a few countries, there are still more of what we call, ‘a push’ instead of ‘a pull’. The push means it's the government enacting requirements, not only for asset managers and asset owners and investors, but also for issuers, for companies which are listed on the stock market, that they have to disclose. This week, we had very important news out of India, that starting from 2022, the 1,000 largest listed companies in India would have to report on ESG, with a big focus on Sustainable Development Goals, which is really good. Because today, only 20% of Indian companies have any kind of disclosure on ESG and that makes our work a bit harder because then we need to do a lot of digging by ourselves.
Then to finish on your third question, our Global Emerging Markets Strategy was launched at the beginning of 2019. It's definitely not our largest fund, but it's been growing fast. When we think about ourselves and the way our investors see us as well, we're not only saying that while we have this one fund, because it's called sustainable, all our assets are actually run and managed with a very thorough and very deep ESG integration. And with this new European regulation that just came out, Article 8, we also promote ESG in our portfolios, and portfolio holdings. Then these global emerging markets sustainable is on Article 9, which means that we also have sustainability as an investment objective.
FBP: What is the latest, in terms of how big the overall assets under management (AUM) is and the proportion of that? In line with regulation, a hundred percent of it has to be integrated, right? So more or less, the entire portfolio is to some extent, with Article 6, Article 8, on some level of integration. But how big is your total investment?
KH: Our total assets today are $5.286 billion (EUR 4.5 billion). As a signatory to the United Nations principles for responsible investment (PRI) since 2012, when you are signing up to the PRI, you commit to a number of things. One is the integration of ESG in your investment processes. We are a hundred percent covered by that. We integrate ESG in all our strategies.
FBP: Talking about Asia, where you are now based, and now specifically for Asia, you have these funds, the Global Emerging Markets Sustainability, partly is invested in Asia. In China, you have the China Asia Fund. The Global Frontier Market Strategy is in Vietnam, Bangladesh, and so on. Earlier, this was known as the China East Asia Fund and the China Fund, with the China Fund specifically investing in Chinese companies in Hong Kong.
KH: Well, no. This fund is actually investing in A-shares. So, there are Chinese companies not listed in Hong Kong, but listed on the mainland, in Shanghai or Shenzhen. We were the first asset manager out of Northern Europe to get Qualified Foreign Institutional Investor (QFII) licence, which was what we needed to have at the time to enter and access the A-shares. Then we launched our first strategy in 2013-2014 and now we are operating using the Stock Connect programme. Basically, it's much easier now. You don't require a specific licence, you don't require a specific quota, you can just buy into these A-shares through the Hong Kong Stock Exchange.
FBP: You were based out of Shanghai and in 2013, you moved to Hong Kong. That was a strategic decision to look at the bigger Asia market.
KH: Exactly, even though China remains a very important market for us and for most investors around the world, because it provides a large exposure. We don't follow any indices, but if you look at the index composition, it's already a big exposure, a big weight in the Morgan Stanley Capital International (MSCI) Emerging Markets (EM) index, and it's just increasing as the A-shares are step by step increasing in terms of the inclusion factor into the index. It was very important for me and for us at East Capital to spend a few years in mainland China to understand that it's a very complex market, a very interesting market and not an easy one to get into.
Hong Kong was a great place for us to be in because in normal times, pre-COVID-19, it was very easy for us to travel from there. Basically 45 minutes away from here, we have Shenzhen, and then we have the wall of Guangdong where you have some of the most exciting and fast-growing companies in the world. It is really a great place and a great connection to the rest of China.
FBP: You mentioned three funds, the China Asia Fund, the Emerging Market, and the Frontier Sustainable Funds. Now, in total, what was the exposure to Asia? Your main investor remains to be mainly in Europe. Are you also building an investor base in this part of the world? Or this is really where some of the investments are allocated to?
KH: Our funds are not registered for distribution in Asia. But clearly, the idea is to be here, to make sure that we can find great investments for our clients and have a relationship with them. In general, the bulk of our assets, in terms of the origin of clients, come from Europe and the Middle East.For the global emerging market strategy, we more or less follow the index exposure to countries because this fund is really much more about being bottom up, looking and searching for great companies that can provide solutions to the Sustainable Development Goals (SDGs), and we don't make any macro bet. For the global frontier market strategy, Asian markets used to be quite big, if you look at the index as well. They've gone smaller and we now have more exposure to other regions in the world, including India and the Middle East.
FBP: Now, going into the meat of the subject in terms of ESG opportunities and performance in Asia. We know China is a big part of that portfolio. A lot of it is driven by the commitment to be carbon neutral by 2060, to have their carbon emission peak before 2030. There's a lot at the government level to push ESG, also in terms of ESG adoption. But a lot of it is at the company level. Not a lot of push in terms of reporting a mandatory requirement, a lot of it is still voluntary. That is not very clear in terms of ESG and corporate social responsibility (CSR). Tell us in terms of the trends that you see and the opportunities. There is also a bit of a backlash against China lately. There's been a lot of negative news from its human rights record to the role that the technology company plays in terms of data. Tell us how is that impacting your strategy?
ESG data as good as financial data
KH: Throughout the years, the environmental and social sites are becoming extremely important. But when you invest in emerging and frontier markets, this question of disclosure or the absence of disclosure is there. We've always been challenged by the fact that companies do not necessarily disclose enough information or the right kind of information. Second, we embarked on an interesting journey for us to be able to quantify this risk, even though a lot of the things related to ESG are actually by nature, more qualitative: quality of management, the board, owners, and a lot of other features. But we wanted to find a way to quantify. We looked around and tried to check and compare what we could find on the market of ESG data. What was striking was that there was still quite poor coverage of intel for all markets, and it's still the case even though it has improved. If you invest in the US, everything is being analysed and you get a lot of information. But for these markets we're investing in, including China, A-shares, there was very little coverage. Then when there was coverage, there were a lot of, maybe it's not right to put it as inconsistencies, but there was a lot of divergence in the way the different data providers or rating agencies will be judging.
ESG data is as important a material as financial data, then of course, you need to be a hundred percent sure about the quality of the data. We decided not to buy any external data, and instead, create our own. We introduced our proprietary scorecards, which go through the questions that are for us, the ones that really matter in this market, and these are different compared to developed markets. We created our own scorecards system and it's a fantastic tool for us because when we use it, we have to speak to the companies first. We get a lot of insight into these companies. Then once we have done it, we can then identify the weaknesses in terms of ESG. We will then work on that with the company, engage with the companies and make sure that they're improving, which they eventually will, and it will be good for the company itself, and for us as a shareholder in this company.
Looking into China, indeed, a lot of companies in China are lagging behind in terms of disclosure. But in a way, it's sometimes better that they are lagging behind in terms of disclosure, but actually doing good things, than the other way around. Because the other way around immediately creates a problem in terms of greenwashing. That's actually an issue with a lot of external ESG data where they just do the ‘tick the box’ exercise. On the environmental side in China, we are still looking forward to the rules that were supposed to materialise last year – but were probably delayed because of COVID-19 – on being stricter, more demanding, and more thorough in terms of the environmental disclosure of companies because clearly this would be needed. The very ambitious target of decarbonisation by 2060 and peaking emission by 2030 is a huge step for China and of course, these are the greenhouse gas emitters. They would have to do their part so they would have to work on that.
Environmental dilemma in China
FBP: The whole point of having reporting disclosure requirements is to drive a change in behaviour. The Chinese authorities, to their credit, have been very specific in terms of the environmental issues requiring certain sector, energy sector, for example, in order to drive that change in behaviour and to meet the goals that they have set out.
KH: China boasts the largest emitter on the planet so you could call it the largest polluter but also a champion in terms of green solutions and clean tech. You find amazing companies in almost across all segments for renewable energy or different clean tech solutions. These are companies from China that both have scale innovation, market share and these are listed so it's actually an amazing place to invest when you are looking for this clean tech solutions. The idea of launching a national carbon emission trading system market would also be very important. In the case of China, it's a bit of a dilemma. You both have the largest polluter and the champion of in terms of environment but one thing which I like to mention and remind is that one of the reasons you have this clean champion is not that that the Chinese would have been better at understanding climate change challenges but there are, they have been, and still are victims of terrible environmental conditions: air pollution, water stress, water pollution, soil contamination, you name it.
FBP: In China itself, if you look at the governance factor, there are also challenges for Chinese companies especially now where there is increased focus on sustainable supply chain, for example, supply chain manufacturing processes that come into sharp focus and a lot disclosure requirement have to be made and that's impacting China. On the other issue, the makeup, the ownership of a lot of Chinese companies, especially the state-owned enterprises, there's a lot of public or government ownership of companies that are state owned. Now with increasing focus on ESG, obviously it will drive some changes. How hopeful are you now towards those areas where China will come to more international norm?
KH: I might surprise you by the statement but I will say that having a partly state-owned company is not an issue as such. You can have very good owners, being state-owned entities in China, though not in all places. I’m French and I can tell you that in general, if you’re French, having a state-owned entity as your owner or as your landlord for instance is not necessarily a good thing. There are a lot of inefficiencies.But that's the case and you know it's not necessarily well-organised and efficient.
In China, when we assess an investment opportunity, it's not like we go ‘Be careful, it's a state-owned entity.’ With the anti-corruption drive that President Xi Jinping initiated in 2012, there's been a lot of focus on these topics. It's not black and white but let's not think that ‘state-owned is bad; privately-owned is good.’ Because privately-owned could also be pretty bad because you have some entrepreneurs out there who do not necessarily understand yet that if you listed your company, you're no longer a hundred percent in control. You have the stock market and investors to consider so that's really quite important. One of the main sources of concern for us in terms of corporate governance in China has more to do with the boards. Because around the world, boards have very important functions. And here, the quality of the board is not necessarily bad in terms of competencies and skills. We are a minority shareholder company so we would like to find independent directors who are champions to support us and to make sure that we have the same aligned interests as a long-term shareholder, also protecting the rights of the minority shareholders whereas if you look at it, it's a huge country with a lot of companies so we cannot generalise. But there are still many companies where the independent directors of the board could be people coming from the academic world.
Another issue in terms of governance in China is really gender diversity which is really poor. I would like a call to action to China because there's no reason, the Chinese society as such, is actually more equal than many other countries. It was said that women hold half of the sky but they definitely do not hold half of the sky in the boardrooms in China. It's one of the countries in the world with the lowest number of directors being female, only 13%. So that's something that we would like to see improvements on if we think it's really important in terms of different perspectives.
FBP: What improvement do you hope to see in terms of ESG reporting? According to the World Economic Forum, only 27% of all A-share companies actually do some form of ESG reporting, whereas a more kind of selected group of CSI 300 A-share companies, up to 86% of them have some form of ESG reporting. There's been some movements among the Shanghai Stock Exchange coming out with draft consultation paper on ESG reporting. How soon do you see a kind of rudimentary reporting requirement?
KH: It's going to come. It will probably be quite comprehensive. But what is important is the work we do as a foreign shareholder and investor, but also the work that local Chinese investors do. It's very important and interesting to mention a couple of numbers. For instance, UN PRI, this association for principles for responsible investment. In 2017, there were only seven supporters of the PRI or signatories to the PRI in China. Now, we're approaching 60. So that is a commitment. You have to integrate ESG and you have to have that from year to year. Investors will also be the one requesting it, and that's why I'm talking about this pull that we want to see coming. It's a push and pull at the same time. I think it will come definitely, quite soon and that would be a very good thing.
FBP: You see a lot of that pushing coming from the domestic asset owners and asset managers, your local counterpart in China.
Climate change initiatives
KH: Yes, we see that, definitely. This is something that is in the world of ESG and responsible investing. We used to have opportunities to cooperate with other shareholders, but only when it was a very specific issue, often like a conflict. Whereas now, you have a lot of very interesting initiatives around the world. One of the important ones, in terms of climate change, is Climate Action 100+, where you have investors, asset owners and asset managers get together to make companies which are on the list of the top polluters – in terms of top emitters of greenhouse gas around the world – align with the TCFD, the Task Force on Climate-related Financial Disclosures. It is really important that we work together, we can’t do this on our own. We also get to see more of this happening in China. Companies themselves will realise that they really have to do get their act together, because it's going to be requested more and more by the authorities, by the stock market. Basically, a call to action for any shareholder, any investor in China.
FBP: In tandem with reporting, there are quite a number of standards out there currently if we are a signatory of PRI for example, that’s their requirement, there is the global reporting initiative. The World Economic Forum is also pushing something called measuring stakeholder capitalism. Where do you see a convergence in terms of reporting requirements and how do you see that taking shape in China? Materiality is very important in terms of the impact in companies in China. How do you think that will evolve?
KH: There are some standards that we are pushing for that have already emerged as important. There are two in in relation to climate: the TCFD, and the carbon disclosure project (CDP), an initiative with investor net as well. We participate in different ways so CDP is about requesting companies to disclose not only about carbon but also about water and forests so that's really important.
You mentioned materiality and it's a very important word. The way we work with our approach of having our own analysis of ESG standards and the weaknesses we identified would be related to material risk and then we will engage with the company for them to improve on things that are material. This materiality and this Sustainability Accounting Standards Board (SASB), these are quite important and we pay attention to norm-based behaviours of companies and how they're complying to the to the UN Global Compact and other international conventions. This is also something we encourage companies to be part of, this initiative.
FBP: With more reporting requirement, hopefully there'll be greater transparency. There's a lot of criticism about corporate practices in China regarding intellectual property. In the latest 14th Five-Year Plans, President Xi stressed the importance for domestic innovation in response to a lot of this criticism on how it's kind of stealing technology or borrowing technology from the West, do you see this greater reporting equal greater transparency and how valid are some of the perceptions today that the West has of Chinese corporates and how they arrived?
Protecting intellectual property rights
KH: Greater disclosure is to bring more transparency so that if you're an investor, you want to be able to properly assess the risks so that you can know how to manage these investments, so you need that. In terms of intellectual property rights, that's been a huge concern and a huge problem for a long time. Now there's actually more happening because the companies themselves in China, they realise that they want to be sure that they can protect their intellectual property rights so this is where it's happening. It will become less of an issue because you have regulations in place, you have greater awareness about this problem and also, to be fair, things have changed. The world has changed compared to 2010 when I moved to China. At the time, everyone thinking of innovation was looking to the United States. Now there's a lot of innovation happening in China in a way that is mind blowing. Of course, it's because the government is also putting a lot of money and support into the sectors. There are also great entrepreneurs that take advantage of the opportunities that they can benefit from and they can make, anything related to ecommerce, m-commerce and artificial intelligence. People from the US are now looking at China, not the other way around. Definitely the world has changed quite a lot and it does kind of change the positions here around the table in terms of when you discuss these topics.
FBP: There are two more areas that I want to discuss with you. One is COVID-19. How has COVID impacted the market for ESG and East Capital, specifically. We understand that amid COVID, there's been some impact in terms of your manpower in Hong Kong and also in terms of your licensing. You have given up the East Capital licence back to Hong Kong but you still retain licence as an investment advisor.
KH: Very briefly, in terms of our own licensing, it was just that we, as an entity, since we provide research services to our group, basically, we do not require a licence so that was one way of doing it. We don't have any funds for distribution in Asia and we don't have any kind of direct marketing or client activities in Asia.
COVID obviously changed the world and changed the way we work in terms of not being able to travel especially in Hong Kong, Singapore and like many places around the world, took a very steep and very drastic approach in terms of restriction. We've been able to operate like we do, we've always done a lot of video calls internally so there was no disruption as such. We've also gone through a number of crisis for the entire 23 years because investing in emerging markets and equity markets, there's a lot of volatility. When we started in 1997-1998, there was a very big crisis for us. Then in 2001 again, in 2004, 2008 so we’re quite resilient and can ride along nicely.
FBP: Despite all the operational challenges and no restriction on travel, the markets have been doing very well.
COVID-19 changed the world
KH: The markets have been doing well because there’s been a huge amount of money. It's been a very interesting time because one of the reasons we started this capital, and one of the reasons we enjoy what we do — investing in emerging and frontier markets, which are by nature fast changing and challenging and you have to be really alert. What happened last year with COVID was just like what people said, changes that would take 10 years, took three months. Now we’re all sitting here and I'm having this interview with you from my home. These changes have been remarkable and then you have to look at the portfolio and you go, which are the companies which are resilient? Which business model is actually going to completely be destroyed by that or instead which are the companies that will emerge as a champion? It's been a very exciting time for investors to navigate and we've done very well in terms of performance, so knock on wood, it's been good.
FBP: How do you see the next three years for ESG opportunities in Asia?
KH: It's going to accelerate. Clearly, this is not something that will go away and there is going to be definitely more focus on environmental topics. A lot of companies speak about 2050 but we already have a huge deadline, 2030 and it is really soon. So definitely more interest from investors, more disclosure, more innovation, more money going into this segment and it's all good because we are very well positioned for the future.
FBP: Great! Thank you Karine for speaking to us. This is only the start of the conversation, we can continue and in a lot of the markets in Asia, ESG is just at the very start and there's more that we can discuss and speak about in the months and years ahead.
Keywords: ESG, Sfdr, A-shares, SDG, Pri, Sasb, TCFD, MSCI, QFII, Shanghai Stock Exchange, Covid-19, China’s 14th Five-year Plan
Institution: East Capital Holdings, East Asia Capital, United Nations
Country: Singapore, Hong Kong, China, India, Vietnam, Pakistan, Sweden, Russia, Bangladesh
Guest: Karine Hirn, Foo Boon Ping, Xi Jinping