Can China’s impact investing ecosystem expand beyond green energy and ESG?

Guest Author

Dan Keeler

ImpactAlpha, April 17 – China manufactures more batteries than the rest of the world combined, by far. The country’s spending of $546 billion last year on solar, wind, electric vehicles and other low-carbon technologies represents nearly half of the world’s total. It led the world in green bond issuances in 2022, at more than $76 billion, and could float another $100 billion in 2023. 

Elon Musk is building a “megapack” battery factory for large-scale energy storage in Shanghai, Tesla’s first such plant outside the U.S.

But for all its ambitions in green energy and its embrace of environmental, social and governance, or ESG investing, China has frustrated the expectations of those working to develop a bigger market for private investments with explicit social and environmental impact. In general, ESG approaches consider risks to investment portfolios, while impact investments are made with the intention to generate positive, measurable social and environmental benefits. 

“Impact investors are few and far between, short on successful case studies, and work needs to be done on educating investors,” Tao Zhang, founder and managing director of impact investing firm Dao Ventures said in a recent landscape report on China’s impact investing sector.

The reasons vary from a misunderstanding of impact among Chinese investors to a lack of transparency that has scared off foreign investors. China’s impact investing sector is “filled with confusion and lack of clarity over basic principles and practices, which will deter the healthy development of the industry if standards are not established,” the foundation noted in the report.  

The US-based Global Impact Investing Network views China as a key future destination for impact investing.

“As the GIIN’s understanding of impact investing in China grows, so too does our belief that China presents a tremendous opportunity to activate more capital at scale for impact investing to meet the challenges facing people and the planet,” the group said in a statement to ImpactAlpha

In the GIIN’s 2022 report on the worldwide scale of the impact investing sector, however, China didn’t merit a single mention. 

Green growth

China’s Xi Jinping set the stage for a surge of interest in sustainable investing in the country in late 2020 when he promised to peak emissions by 2030 and become carbon-neutral by 2060. Achieving those goals will require up to RMB 4 trillion ($570 billion) in investment annually. 

The expected influx of private investors was welcomed by impact pioneers in the country. 

“We actually need more people,” Bo Bai, chairman of China’s Asia Green Fund told ImpactAlpha back in 2021. “If we have more people working on [carbon neutrality], we have a bigger ecosystem.” Bai’s firm manages the half-billion dollar U.S.-China Green Fund, which opens channels into Chinese markets for U.S. and European cleantech ventures.

More than 50 Chinese climate tech funds and ETFs were launched in 2021, attracting more than $11 billion worth of inflows that year alone, according to Morningstar.  The CSI Jinsinan Climate Friendly Index, launched in January, tracks 100 publicly traded Chinese companies whose main business involves climate solutions. 

In the two years since Xi’s so-called “dual carbon” pledge, environmental, social and governance, or ESG, investing in China, especially that with a focus on green finance, has grown strongly. 

Solid performance by Bai’s Asia Green Fund, which has around $2 billion under management and claims a 21% internal rate of return in its renminbi-denominated fund, has helped fuel the sector’s growth. 

Despite its success, Asia Green Fund remains an anomaly in China. The past few years have seen just “a steady trickle of new entrants,” the report notes. Many early impact investors have ceased operating in the country. 

Impact obstacles

Shanghai-based Ehong Capital was an early convert, having first adopted an impact investing strategy in 2012. The firm’s focus areas include sustainable agriculture, clean energy, waste, health and elderly-care, and quality education. 

In recent years, though, raising capital has become increasingly challenging, says Chao Zhang, vice president for impact investment at the firm.

The pandemic has been a factor. So has China’s human rights record and crackdown on tech moguls. More recently, China’s frayed relationship with the US, says Zhang, has “sapped interest from foreign investors, and created a generally tough environment for private equity in China.”

Another obstacle to the adoption of impact investing is the same government policy promoting green development. Although China’s leadership is committed to promoting sustainable and equitable development, the government’s involvement in supporting initiatives to tackle such issues–both directly and indirectly through the efforts of state-owned enterprises–can effectively crowd out the private sector. 

“From my own experience, we do not have a lot of room for private organizations,” Zhang told ImpactAlpha.

ESG to impact

That is frustrating impact-focused investors in China. With a GDP approaching $20 trillion, China is the world’s second biggest economy and its government-supported focus on sustainable growth should provide a powerful tailwind for the expansion of impact investing. 

Ong Pei Yeing, chief investment officer of Singapore-based DVF Impact Holdings, argues that China is an ideal testing ground for impact investing, given its huge market size, large pool of investable capital, high-quality infrastructure and educated population. 

“If we could stimulate the entrepreneurs’ sense of social responsibility, it is easy to turn the Chinese market into an active impact investing market,” he told the China Alliance of Social Value Investment in a 2021 report on impact investing in the country. 

The key, DVF Impact’s Ong Pei Yeing believes, is clarity: “If we clearly define impact investing, this will lead people who get involved to clearly understand the concept and they will easily seize the original intention.”

Whether they will find enough space to operate in, though, remains an open question. The alliance is one of a handful of groups trying to build an ecosystem supporting sustainable finance in China. Others include the China Social Enterprise and Impact Investing Forum (CSEIF), set up by more than a dozen Chinese foundations, and the China Impact Investing Network (CIIN), which is modeled on the GIIN.   

Proponents of impact investing in China believe the current focus on ESG could open the door to wider adoption of impact investing. 

While many impact investors in the West take great pains to explain how impact is different from ESG investing, supporters of impact investing in China are actively blurring the line between the two. 

Even the word “impact” has complicated connotations in China, where it is seen as referring to influence, such as political or financial power, says Lilian Lin at the China Impact Investing Network, which promotes the growth of impact investing through seminars, media training and awards programs. When she talks to mainstream investors, who are unlikely to have heard of impact investing, she uses ESG to get their attention. 

“ESG investing is actually very trendy in China, so if you interpret impact investing as one of the strategies of ESG investing, it can attract attention from the mainstream investors,” Lin says. “Otherwise, if you talk about impact investing people will think of it as like a donation, or that you have to sacrifice financial return to create impact.”

Government guidance

Chinese regulators are expected to release ESG rules that could go into effect by the end of the year. The formal regulations would follow voluntary guidelines developed last year by state think tanks and some of China’s biggest companies. The standards include more than 100 metrics  that generally align with those developed by the International Sustainability Standards Board, tweaked for the Chinese market. Already, most of China’s largest companies publish some sort of ESG report.

The China Impact Investing Network is pinning its hopes on the state’s emphasis on a green transition for China. 

“A lot of venture capital firms, including top players such as Sequoia China and Hillhouse, are setting up green funds to invest in clean tech or clean energy, and this group has very good potential to turn into either impact investors or become the LP of impact investors,” Lin says. “Almost all major VC and PE firms either have a green fund or invest in green projects,” she adds.

TPG Rise, the $12 billion US-based impact investing fund, invested in microfinance lenders Baidu Financial Services Group and China Foundation for Poverty Alleviation. TPG led a $210 million Series D round for Beijing-based edtech company Meishubao in 2021. 

Following the government’s lead can be crucial for fund performance, says Ehong’s Chao Zhang. 

“We closely follow the government’s guidance on the economic development sectors,” he says. “Renewable energy, recycling and also climate change, for example, under the guidance of the government support, and that generates a lot of meaningful financial returns.”

Some conventional venture capitalists are finding they have to incorporate ESG into their strategies if they want to attract foreign investors – and the China Impact Investing Network  hopes that could happen with impact, too.

“If Western impact capital can work the same way,” Lin says, “it will definitely help to build China’s impact community.”