What is ESG investing?
Core points
ESG investment takes into account the financial return and the environmental, social and corporate governance factors of the enterprise.
ESG investment is becoming an important key word in the capital market
Some studies have shown that ESG investment can produce higher returns and lower risks.
The deficiency of ESG investment lies in the lack of unified evaluation criteria and the lack of long-term data support.
Detailed explanation of concept
ESG investment is a form of socially responsible investment. Traditional investment usually only focuses on corporate profit and financial return, but neglects social responsibility, while ESG investment takes financial return into consideration with the influencing factors of Environmental, Social and Governance.
Among them, E represents the impact of the enterprise on the environment, such as whether the enterprise complies with the environmental protection policy in the production process, whether it pollutes the environment, whether it deals with harmful chemicals reasonably and so on.
S represents the influence of the enterprise on the society, including the concern of the enterprise to the employees, customers, suppliers and other stakeholders, the responsibility to the community, and whether the enterprise has established a good corporate image in the society.
G stands for corporate governance, including board independence, executive compensation, leadership diversification and other issues.
Development status
At present, ESG investment is in the ascendant and has become a new trend. More and more investors are integrating environmental, social and corporate governance into investment decisions as indicators of corporate sustainability. In the context of the epidemic and carbon emission reduction, ESG investment has also become an important keyword in the capital market.
In China, there has been a surge in the number of ESG products issued by various asset management agencies this year. Data show that in 2020, three public offering funds under the name of ESG were issued in the Chinese market, while in the first half of 2021 alone, this number increased to eight. At the same time, the scale of related products issued by commercial banks in China has reached nearly 10 billion yuan.
In the American market, the development of ESG investment is more mature, and the size of assets is also increasing day by day. According to statistics, as of June 2020, the size of ESG index funds in the United States has reached 50 billion US dollars, which is a significant increase compared with 4.1 billion US dollars 10 years ago.
More and more studies have shown that ESG investment can produce higher return on investment and lower risk of withdrawal. For example, between 2014 and 2018, companies in the top 1 ESG 5 of the S & P 500 performed more than 25 per cent better than those in the bottom 1, while companies with the top ESG also had relatively little volatility.
shortcomings
1. Lack of unified ESG evaluation criteria.
With regard to the evaluation indicators of ESG, at present, a unified standard has not been formed around the world, and each organization has formulated an evaluation system according to its own considerations. Mingsheng Index （MSCI）， FTSE Russell, Bloomberg and other well-known institutions have compiled their own ESG evaluation index system, and launched the relevant index, of which MSCI ESG Index constituent stocks more than 1500.
The lack of uniform standards for ESG performance evaluation results in inconsistencies between ESG portfolios and funds. Some funds may even hold tobacco stocks based on some one-sided evaluation criteria.
2. ESG investment lacks long-term performance data.
ESG investment has sprung up rapidly in recent years and has shown higher-than-average excess returns. However, due to the short time of its rise, ESG investment is currently not supported by long-term performance data and is still not enough to attract some investors who are fully focused on financial returns. ESG investment remains to be tested over time, but the direction of the tide is clear.
What is ADR and ADS?
Before explaining ADR/ADS, let’s first understand the issuance rules for non-US companies listing on US stock exchanges.
According to relevant US government policies, companies registered outside the US are not allowed to list directly in the US. Therefore, if overseas companies want to raise funds in the US market, there are two paths:
Direct listing: Register a company in the US and then package the listing entity under a US company.
Indirect listing: List through ADR/ADS.
Compared to places like Cayman Islands and the British Virgin Islands, the US government has much stricter regulations on listed companies, with longer listing times, higher costs, and heavier taxation. Therefore, many companies choose the indirect listing method, that is, listing through US depository institutions issuing ADR/ADS.
What is ADR?
ADR, or American Depository Receipts, are issued by US depository banks and sold to US investors and traded on US stock markets. Each ADR represents a certain number of shares of the corresponding listed company according to the corresponding exchange rate.
For example, assuming that ABC Company （a fictional Australian company） trades on the Australian Securities Exchange at a price of 6.7 Australian dollars （5 US dollars）， a US bank buys a certain quantity of ABC Company stocks at a ratio of 2:1 and sells ADRs. Therefore, each ADR represents two shares of ABC Company’s stock and should be sold at a price of 10 US dollars.
ADRs are held in the insurance warehouses of the U.S. banks that issue them. ADRs simplify the process of trading foreign stocks: because only receipts are traded, investors do not need to worry about any exchange rate differences or the need to open a specialized brokerage account, and they enable investors to receive all dividends and capital gains.
What are ADS?
ADS, or American Depository Shares, are the actual underlying stocks represented by ADRs.
You can think of ADRs as proof of ownership of ADS for investors, just as a property certificate is to a house. When trading, the property certificate is transferred, there is no need to move the house. However, typically one property certificate can only represent one house, whereas one ADR can represent multiple quantities of ADS.
For example, a British company XYZ Company can conduct ADR trading on the New York Stock Exchange. These ADRs can be issued at a ratio of 5 ADRs to 1 American Depository Share （5:1） or any other ratio chosen by the company.
What is the difference between ADR and ADS?
1. In terms of face value:
The face value of ADS is mostly only a fraction of the face value of the underlying stocks used as collateral, while ADRs mostly represent several units （such as 10 shares） of the underlying stocks as one unit of ADR.
2. Different ways of initiation:
ADS is initiated by stock issuing companies that wish to attract American investors without being listed on the US market. ADR represents the equity of foreign stocks that can be purchased by American citizens and is initiated by banks and brokerage firms.
3. Different principals:
ADS is issued in the US by authorized trustees of foreign companies. ADR is a transferable certificate issued by US commercial banks to assist foreign securities in trading in the US.