A Growing Focus on Sustainability in China

In recent years, Environmental, Social, and Governance (ESG) considerations have taken center stage in global business strategies. At Klappir, our main focus has been on making sustainability software solutions to facilitate compliance with ESG-related regulatory developments in the European Union, most notably the Corporate Sustainability Reporting Directive and ESRS-standards. Though it can be argued that Europe blazed the trail with regards to legislation to meet the global goals of the Paris climate agreement, other key players have also set things in motion on the global stage. China, with its rapidly growing economy that is already larger than the EU’s and second only to the United States, is no exception.

The People’s Republic of China has sometimes, perhaps overly simplistically, been described as a “state capitalist” economy. This label refers to systems where the government exerts significant control over the economy through state-owned enterprises, while still allowing for market forces to play a role. This applies to the Chinese market model, where the state has a strong influence on key industries and strategic sectors, but private enterprises and market mechanisms also play crucial roles. Since China began to open up and reform its economy in the late 1970s its economy has seen constant GDP growth. China's economy, the world's second-largest, has in recent years and decades transitioned from a manufacturing-driven model to one increasingly focused on services and technology, but faces challenges such as slowing growth, high debt levels, and demographic shifts. Despite recent setbacks, including the impact of global trade tensions and COVID-19, China remains a critical player in global supply chains and innovation. China’s transformation and rapid ascent in the past decades show that its economy is no stranger to change, and give reason to be optimistic about their ability to execute large scale plans that they have in store to reach their targets.

The Role of Government Policy

In a 2020 speech at the UN General Assembly, President Xi Jinping announced that China’s ambitions are to peak emissions by 2030 and reach carbon neutrality by 2060 (United Nations). In comparison, the EU’s goal is reduction of emissions by 55% compared to 1990 levels by 2030, and net zero emissions by 2050. While it remains to be seen whether any state or power will achieve its goals, actions speak louder than words and policies being enacted are better indicators of the future. Further, the “beautiful China”

China has greatly expanded its renewable energy capacity in recent years. The aim is that wind, solar and hydroelectric power phase out carbon heavy energy sources. China has set a policy to cap coal production to limit its use, especially in heavily industrialized regions (source). China's environmental policies have become more stringent over the years. The Chinese government has been a key driver in promoting ESG practices. Initiatives like the Green Finance Development Committee and the establishment of the national carbon trading market underscore China's commitment to reducing its carbon footprint and fostering sustainable growth. These policies aim to integrate ESG considerations into the constant economic development. Throughout the years, economic growth has typically been reliant on abundant cheap energy, and China has not been an exception. China is currently both the world’s largest producer and importer of coal. (S&P Global). World powers need to strike a long-term balance between economic growth and sustainability. With that in mind, China hopes to dial down its coal output,, focusing on structural reforms to shift the economy away from heavy industry and reduce reliance on coal. This approach is part of a broader strategy to prioritize sustainability and align with global efforts to combat climate change (Reuters).

World’s Largest Carbon Trading Market

China's carbon trading market, launched in 2021, is the world’s largest in terms of covered emissions, estimated to cover around 5 billion tCO2 and accounting for over 40% of the country’s CO2 emissions.

The China national Emissions Trading System (ETS) oversees over 2,000 companies in the power sector, with annual emissions exceeding 26,000 tons of CO2. This includes combined heat and power plants, as well as captive power plants from other sectors. Companies within the system are required to surrender allowances for all their emissions, with allocations based on intensity benchmarks and actual production levels. Allowances are currently freely allocated. Compliance requirements vary depending on the type of power generation, but the system is expected to extend its coverage to additional sectors in the future (ICAP).

New Sustainability Reporting Requirements

In May 2024, China introduced mandatory ESG reporting for companies listed on the Shanghai, Shenzhen, and Beijing stock exchanges. These requirements introduce a double materiality approach assessing both financial and broader societal impacts, with full compliance expected by 2026. This should be viewed as an important first step, as the requirements are not as stringent as those that large and listed European companies deal with under the CSRD. China’s three major stock exchanges are tasked with issuing and implementing more detailed disclosure rules in conjunction with the China Securities Regulation Commission (Linklaters).

The question of how familiar or unfamiliar these standards will look is largely unanswered but there are some clues. On the one hand, while the draft Guidelines do not explicitly reference the ISSB global disclosure framework, which has not been implemented by China, but do say that disclosures should be made in accordance with measurements and methods recognized by international or domestic standards. On the other hand, the inclusion of a double materiality requirement might be seen to indicate that China is looking to align its reporting requirements with the European CSRD.

Challenges and Opportunities

While China's progress in integrating ESG principles and advancing sustainability is definitely noteworthy, the road ahead remains challenging. The People's Republic’s ambitious targets, including carbon neutrality by 2060 and mandatory ESG reporting for listed companies by 2026, signal a strong commitment to change in the same way we have seen in the EU. However, the scale of these initiatives and the complexities of balancing economic growth with environmental responsibility require careful navigation. As China continues to develop its sustainability frameworks, businesses and investors should keep an eye on both the challenges and opportunities that a constantly evolving landscape entails.