Reaping the benefits of a greener China

Author:John Barnes

The Chinese government is determined to create a greener path to growth. Companies that are slow to respond could be at risk. But organisations that embrace change and the environmental businesses that move in to support them could gain a valuable competitive edge. More broadly, the success of China’s environmental drive could be crucial to sustainability worldwide. So how can corporations navigate through this new phase in China’s development, and what are the implications for global environmental policy?

Sustainability is now firmly on the corporate agenda in China. This is reflected in the development of Environmental Health & Safety (EHS) Guidelines, corporate social responsibility (CSR) reporting, energy conservation and emissions reduction (SOx/NOx/water contaminants) and greenhouse gas (GHG) reduction programmes.

Moreover, there is growing consensus that actions to date have not been nearly ambitious enough to tackle the environmental challenges the country faces. This is spurring the Chinese government to accelerate the pace of change with the introduction of new policies, regulations and initiatives. The government push is creating a truly dynamic and evolving market for companies operating in China, in which risks and opportunities go hand in hand. Companies that are adaptive and resilient will be able to respond quickly and positively to the new requirements of this market, and survive and grow. Those that don’t will find themselves marginalised by the operating requirements of the green economy and thus in danger of falling behind.

The focus on sustainable business in China is being driven by both domestic and international considerations. Domestically, growing environmental problems, fears over energy security and social unrest emanating from health, food security and other environmental concerns have resulted in much greater awareness among both policymakers and the general public of the implications of unsustainable business operations on the country’s citizens and its environment. Internationally, pressure brought to bear on multinational companies (MNCs) in their home markets is being felt right across the global supply chain, including in the ‘factory of the world’—China. For many MNCs, this means embedding change across their whole operations, including China. This is having a knock-on impact on Chinese companies. At the very least, their continued licence to operate is going to depend on their ability to defend their reputations and respond to both peer and market pressure to adopt more sustainable business practices.

Striking out on a new path

In many respects, the largest challenge for China in making the shift to a green, sustainable economy is that the country will need to tread a new pathway to get there. For the first time, there is no defined road map for China to follow and instead it must strike out at the same point as other countries in defining the rules for sustainable economic growth. Choosing ‘growth first and clean up later’ is no longer an option. Instead, China has to increase efficiency and de-carbonise itself while continuing to industrialise. With the largest population in the world and second-largest economy, the pressure on China to succeed at this transformation is immense.

The price of failure

If China fails, the environmental implications for the rest of the world are immense. The country’s ever-increasing energy use, together with its position as the world’s biggest greenhouse gas emitter, will have a huge impact beyond its own borders and will have a key influence on the world’s ability to limit global warming.1 Moreover, if China fails, the progress made in many developed countries may lose some of its positive impact as their sustainability success is partly due to shifting their polluting industries offshore, to China and other developing nations. If China is not able to address the detrimental impact of these industries on the environment through the development and enforcement of effective policy and regulation, then its environmental problems will become the world’s problems. There is also the danger that China may take a similar approach to that of the West as it expands investment into Africa and other developing countries.

The prize for success

However, if China’s ambitious plans succeed, this could create a model of sustainable economic growth that can be mirrored in many other developing nations. As China makes continued progress in diversifying its energy mix, innovating with green technologies, implementing laws and regulations around pollution control, and moving its manufacturing sector up the value chain, it will stand as a great example for many other developing nations on how to achieve sustainable economic growth, and how to avoid pitfalls.

Monitoring and enforcement

Making rules and regulations is one thing. Making sure they are enforced is another.

China has no shortage of environment-and sustainability-related policies, regulations and legislation. These stretch from environmental laws focusing on air, water and waste, energy efficiency, renewable energy and carbon intensity targets in the country’s Five-Year Plans (FYPs), to green finance guidelines, CSR reporting recommendations and numerous locally announced regulations. Multiple layers of central, provincial and municipal governments are involved in developing and implementing policy and regulations. On paper they form a complex yet fairly well-defined regulatory system covering most aspects of sustainability and good environmental practices. While the regulatory landscape continues to evolve and gain greater definition, the key problem associated with the Chinese regulatory environment is not one of policymaking. Rather the challenge lies in how these policies are implemented and enforced, the effectiveness of which will be crucial in generating significant and sustainable behavioural change within companies.

China’s Five-Year Plans

China’s Five-Year Plans (FYPs) are blueprints laid out by the central government setting out its overall objectives and goals as they relate to social and economic growth and development, and industrial planning in key sectors and regions. As their names suggest, they are issued every five years, with those announced in early 2011 being the 12th cycle of FYPs. These documents reflect the complex process of Chinese policymaking and contain hundreds of targets, objectives and initiatives, all of which undergo continuous revision, refinement and review throughout the five-year cycle.2

Taking the energy-efficiency targets of the FYPs (the box below explains the role of these crucial policy frameworks) as an example, little information is given in terms of how the national target is to be split and allocated across provinces and cities and even further down to the industry or sector level. Nor is there any detail as to how the government will measure and monitor the achievement of these targets or penalise missed goals. This is particularly troublesome for foreign companies, as many of them don’t know what targets they should be trying to meet. The fluidity of the enforcement process can also mean that loosely defined targets announced in one year may become more rigorously and retroactively enforced in the next. The Chinese government is beginning to address this problem. The Ministry of Environment (MoE) recently established four regional Supervision Centres for Environmental Protection, specifically targeting improvements in the monitoring and evaluation of environmental regulation implementation. However, the lack of clarity that remains in the market still requires companies to have appropriate contingencies built into their business plans to manage possible regulatory risk exposure. Looking into the future, it is expected that the regulatory environment supporting sustainability considerations in China will continue to mature rapidly, requiring companies to foresee upcoming changes and consider the corresponding risks strategically when making business decisions. For instance, while China currently does not have a soil contamination law, draft legislation has been under review by the State Council for several years and is likely to be published soon. Companies acquiring new land will need to consider soil contamination risks during the due diligence process and correctly reflect this in the deal structure at the time of contract. Otherwise they may face the possibility of significant compliance costs as a result of pollution liability once the law is announced.

Political spotlight

China has been in the spotlight of global climate change debates since it overtook the US as the largest greenhouse gas emitter in the world a few years ago, and is increasingly playing a pivotal role together with other BRICS (Brazil, Russia, India, China, South Africa) countries in international climate change negotiation. The global negotiation process lost some momentum following COP15 in Copenhagen in 2009 when the gathering failed to achieve hoped-for globally binding commitments on emissions reduction. But since then China has become much more active and open in tackling domestic climate change challenges. Actions of note include the announcement of a carbon intensity target to be achieved by 2020, together with ambitious shorter-term energy efficiency and renewable energy targets in the 12th FYP; the development of more than a dozen low-carbon cities and zones were kicked off; seven carbon market pilots will start trial runs next year and a carbon tax may also be announced within the next three years; and, finally, a climate change law is also under development.

All this progress has huge implications for business. The heyday of emissions-cutting Clean Development Mechanism (CDM) projects may have passed, but the knowledge and know-how gained through their development in China about carbon accounting, verification and trading have been hugely beneficial. Many Chinese companies have started to develop in-house carbon trading capabilities and are building their carbon emission inventories in preparation for the upcoming carbon pricing mechanisms. Renewable energy, energy efficiency and low-carbon technology industries are taking advantage of preferential policies and incentives to grow quickly in China, attracting foreign investors, service providers and customers. In the long term, climate change-related sectors will be an area of growth in generating business opportunities for both Chinese and foreign players.

So too will the ambitions of the Chinese government in moving up the value chain—moving away from an economic model dominated by labour-intensive manufacturing industries and developing more value-added industry sectors, which can contribute to the government’s goal of a harmonious economy. President Hu Jintao has stated ‘economic growth should not be achieved at the expense of the livelihood of people and the environment’. And, more recently, the president has emphasised the importance of resource conservation and environmental protection in China in his talk at the opening of a provincial and ministerial officials training workshop in July 2012,3 all of which demonstrates a clear shift in direction, right at the top of government.

However, climate change will continue to be a controversial political issue in China, at least until a legally binding global agreement is reached post-Kyoto. The National Development and Reform Commission (NDRC), one of China’s leading policymaking agencies, holds most power with respect to climate change-related issues and is reluctant to concede this influence to other departments and local government. China will continue to emphasise ‘common but differentiated responsibilities’ with respect to its climate change responsibilities and is unlikely to approve any aggressive actions at sector or local levels, concerned they may jeopardise its negotiating position. The recent Civil Aviation Administration of China (CAAC) ban on Chinese airlines taking part in the EU Emissions Trading Scheme is a clear signal. Foreign companies operating in or entering China need to consider such political risks. This includes how they may be treated under new climate change-related initiatives. For example, Will the government allow foreign players to enter the domestic carbon market as verification or advisory service providers? Will foreign businesses’ low carbon products and services be eligible for preferential policies and incentives? Will their GHG emissions be included in any of the carbon market pilots? In the long run, there are certainly significant business opportunities, and those companies entering early and anticipating and managing the political risks well are likely to enjoy strong competitive advantages.

Public scrutiny

Non-governmental organisations (NGOs) haven’t had a big impact on the policymaking environment in China. Until recently, there were only a handful of officially registered NGOs throughout the country. But the power and energy demonstrated by Chinese NGOs and volunteers during the Wenchuan earthquake in 2008 means that NGOs are seen in a new light. Since then, the government has become more attuned to the beneficial role NGOs can play in society and consequently relaxed their grip on the NGO community to some limited extent, enabling the establishment of many new grassroots, environmentally focused NGOs. In addition, much improved public awareness regarding sustainability and greatly accelerated information flow thanks to social media have led to growing public scrutiny of businesses and their environmental performance. NGOs have played significant roles in identifying and raising public awareness about pollution scandals and monitoring the cleaning process. Chinese companies are finding it harder to ignore their obligations to the local communities in which they operate and are increasingly being forced to address social and environmental concerns as part of their business operations.

NGOs in China potentially have an even bigger role to play in sustainable supply chain management, as so many globally reputable brands source their products from China and are under constant scrutiny from international customers. While they may be able to exempt themselves from legal liability in instances of a breach by one of their suppliers, they are no longer able to avoid reputational damage and the impact of lost business. There are very few companies globally that don’t have a link—large or small—through their supply chains into China. To manage this element of their business well, traditional supplier audit and compliance programmes are not proving comprehensive enough to adequately cover the myriad social, ethical and environmental considerations that businesses must now factor into their operations. Companies now have to work closely with their suppliers, and even contemplate collaboration with their competitors, to collectively improve a supplier’s performance and help them drive change down to their secondary and tertiary subcontractors. The challenges of sustainable supply chain management are heightened by the fact that many suppliers are already operating on very thin margins and any additional compliance requirements may be beyond the feasibility of their existing business model, creating incentives for non-compliance.

On the front foot

As an emerging risk in an emerging economy, sustainability risk management for businesses operating in China needs to be dynamic and considered comprehensively from identification and assessment through to mitigation. The key to success is collaboration, particularly for MNCs. They should seek to actively engage in the policymaking process and work closely with local business partners. It is also important for them to interact with NGOs, government agencies and other key stakeholders so that they can understand and contribute to the development of sustainability best practices in China, while at the same time being able to stay on top of the highly unpredictable and volatile risks. Many MNCs with global sustainability programmes may need to give more autonomy and flexibility to the local team in enabling them to play a key role in adapting global programmes to local needs. Many globally designed sustainable supply chain programmes or codes of conduct are not necessarily appropriate to the local situation, and local sustainability teams are often relegated to the role of implementer with limited say in the development of the strategic programme. This can create a gulf between central and local risk management.

Sustainability risks and opportunities are increasingly important to business performance. Businesses that act quickly and proactively will improve operational efficiency, enhance their reputation and reap the business benefits.

1 Vicki Ekstrom, ‘Report: China’s actions are crucial on climate change’, MITNews, May 24 2012.
2 ‘China’s 12th Five-Year Plan: How it actually works and what’s in store for the next five years’, APCO Worldwide, 10 December 2010.
3 ‘Chinese president urges unswervingly carrying forward reform, opening-up’, July 23 2012.

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Reaping the benefits of a greener China