The golden letters of China Development Bank headquarters’ sign
The ETF weighting to China Development Bank bonds is almost identical to the comparable figures for the average of three non-ESG Chinese government bond ETFs © Bloomberg

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The UK’s largest asset manager has denied accusations of “greenwashing” in relation to a fund investing purely in securities issued by wholly Chinese government-owned entities that is presented as being in line with environmental, social and governance (ESG) principles.

Legal & General Investment Management’s ESG China CNY Bond Ucits ETF (DRGN) holds a portfolio of debt issued by the Chinese government and three policy banks — Agricultural Development Bank of China, China Development Bank and the Export-Import Bank of China — all 100 per cent owned by the Chinese state.

Alan Miller, chief investment officer of SCM Direct, a wealth manager, accused LGIM of indulging in “Extra Strong Greenwashing” by claiming that the £444m ETF is ESG compliant.

“It is hard to be shocked by the brazen sleight of hand of some fund management companies, who are dressing up funds in an ESG cloak, covering up that there is really very little difference to their traditional, non ESG funds,” Miller wrote in a blog post.

His criticism of the fund has two broad thrusts. Firstly, that the Chinese government falls short on alignment with the UN Global Compact corporate sustainability principles, which include support for, and protection, of human rights; labour market standards, such as freedom of association; and environmental standards.

Secondly, that DRGN holds bonds issued by exactly the same government and quasi-government entities as non-ESG funds, such as the iShares CNY Bond Ucits ETF (CNYB), but merely tilts the respective weightings to reflect their disparate ESG scores.

“What fundamental ESG difference does it make if you simply tilt between four different issuers of bonds, all of which are 100 per cent Chinese government-owned?” Miller asked.

However Howie Li, head of ETFs at LGIM, defended the fund, saying that “within a restricted universe like a single country, we, as asset managers, can only consider what we are capable of influencing when investors task us to invest in that specific universe.

“Accordingly, we can apply ESG integration so that we can try to achieve a better portfolio outcome for investors on a relative basis, ie an improved ESG footprint relative to a non-ESG portfolio in that same country.

“By allocating more capital towards issuers that score better on ESG metrics, LGIM, along with the rest of the asset management industry . . . can help influence the thinking of government debt issuers so that they, over time, consider how ESG metrics may aid their ability to raise money in capital markets.”

In the case of DRGN, Li said that by over- or underweighting specific issuers, LGIM was able to improve the ESG score of the overall portfolio by 10 per cent, based on a methodology developed by JPMorgan, the provider of the underlying index, and data sourced from RepRisk and Sustainalytics.

As a result DRGN has a higher double-B ESG rating from MSCI compared to the non-ESG equivalent portfolio, which scores only single-B, Li said.

The extent of its divergence is somewhat limited, however. DRGN has 55.8 per cent of its portfolio in Chinese government bonds, 19 per cent in ADBC paper, 18.8 per cent in CDB and 6.4 in ExIm Bank. The comparable figures for the average of three non-ESG Chinese government bond ETFs from other providers, which are 55.1 per cent, 14.4 per cent, 18.9 per cent and 11.3 per cent respectively.

Moreover, Miller noted that five of the six comparable non-ESG ETFs available to UK investors also had double-B ESG ratings.

Some industry figures took a more nuanced view of the spat.

Peter Sleep, senior portfolio manager at Seven Investment Management, said he “would like to see detailed evidence of L&G’s engagement with the issuers of this ETF, otherwise they get an ‘F’ for Fail”, but added that applying ESG ratings to sovereigns and quasi-sovereigns was “fraught”. 

“How would you score the US after the President Trump, the Me-Too movement, voter disenfranchisement or Black Lives Matter movement?” he asked.

Amin Rajan, chief executive of Create Research, a consultancy, believed Miller “had a point”.

“From a purist perspective, China and ESG are worlds apart. China’s corporate governance practices and environmental record are at variance with the core principles of ESG investing,” he said.

However Rajan, who regarded LGIM as “one of the leaders in the engagement field,” argued that “the only way we are going to change China is through constructive engagement. If you exclude them because they don’t come up to your standards they are never going to change.”

Moreover, Rajan said that, under the EU’s Sustainable Finance Disclosure Regulation, LGIM “is not violating the law” by classing the ETF in the “light green” Article 8 category for funds that “promote E or S characteristics but do not have them as the overarching objective”.

The Central Bank of Ireland, the regulator of Dublin-domiciled DRGN, and JPMorgan declined to comment.

The spat comes as the Financial Conduct Authority, the UK regulator, said it had seen “numerous” applications for authorisation of ESG or “sustainable” funds that “often contain claims that do not bear scrutiny”, adding that it “expect[ed] to see material improvements in future applications”. There is no suggestion it was referring to LGIM.

“We receive a high volume of applications for authorisation of funds with a sustainable focus. Many of these applications are poor quality and fall below our expectations,” the FCA said.

Sustainability has become a gold mine for asset managers, with the combined assets of ESG-branded ETFs rising tenfold to $280bn from the end of 2018 to May this year, according to ETFGI, a consultancy. ESG funds tend to command higher fees than their plain vanilla equivalents.

Sleep said ETF issuers’ “capacity to keep up with their intentions have not kept pace with their growth in new products and assets,” and called on regulators to clarify what they mean by ESG “otherwise the public will lose confidence in the market”.   

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