Some rank-and-file investors who thought they were putting money into socially responsible companies may in fact have been funding parts of an Orwellian surveillance regime — in China.

A number of ESG-oriented money managers — those who employ environmental, social and corporate-governance screens to identify investments — hold shares of China-based Hangzhou Hikvision Digital Technology Co. A favorite among Wall Street in the past few years, the security-camera maker has been accused by human-rights groups of providing some of the tools used to surveil members of the Uighur Muslim minority, up to a million of whom, according to researchers, are being held in mass internment camps.

On top of that, recent reports say the Trump administration was contemplating blacklisting Hikvision, and Congress has banned the U.S. government from using its cameras.

“It is unclear as to why index providers continue to include Hangzhou Hikvision within ESG-focused funds, given allegations with regard to its failure to respect consumers’ right to privacy and related human-rights concerns,” said Marija Kramer, managing director at proxy adviser Institutional Shareholder Services.

“Hikvision takes these concerns very seriously and has engaged with the U.S. government regarding all of this since last October,” said a Hikvision spokesperson.

Companies like Hikvision highlight the challenges adherents of ESG investing confront as they attempt to influence corporate behavior as they ferret out ethically palatable assets that offer attractive returns. The ESG-oriented investment world in the U.S. boasts roughly $12 trillion in assets as of 2018, having climbed from about $8 trillion two years ago, according to data from the Forum for Sustainable and Responsible Investment.

Launched primarily to help investors steer clear of tobacco and gun-related stocks, conscience-oriented investing has expanded to cover companies that are responsibly managed, promote human rights and achieve low carbon footprints, among other factors.

So why would Hikvision end up in ESG funds? The answer may come down to financial performance.

Since Hangzhou Hikvision 002415, -1.44% started trading on the Shenzhen exchange in 2010, its stock has risen more than fivefold to 25.19 yuan USDCNY, -0.00% (or $3.65) from around 4.50 yuan. This compares with gains in China’s broad-market CSI 300 index 000300, +0.05% of some 20% over the same period.

Hikvision maintains lucrative government contracts throughout China. Its cameras dot street corners, lampposts and office buildings throughout Beijing, Shenzhen and other major Chinese cities.

A number of ESG investors such as Aberdeen Standard Investments and Comgest have amassed holdings in Hikvision, whose market capitalization has surpassed $33 billion, despite alleged human-rights issues. Around $388 million in Hikvision shares was held among 34 ESG-focused funds, identified through Morningstar Direct, which trawled recent regulatory filings to catalog investors ostensibly buying only shares of companies that adhere to social-responsibility criteria.

AFP/Getty Images

‘Big Brother’ tactics?

While Hikvision is the biggest surveillance-camera manufacturer in the world, investors may find it notable that its cameras are reportedly to be found positioned in streets, mosques and the government-backed detention facilities in Xinjiang Province in which up to 1.5 million Uighurs are housed, according to Adrian Zenz, a researcher of the internment camps.

IPVM, a publication that focuses on the video-surveillance industry, reported that Hikvision had secured contracts worth more than $200 million since 2016 to provide security equipment to surveillance projects including these detention centers in Xinjiang, dubbed “re-education camps” by Beijing.

Uighurs make up around half of the population in Xinjiang, an autonomous region neighboring largely Muslim countries in Central Asia such as Kazakhstan, Kyrgyzstan and Tajikistan. In its push to deal with ethnic unrest, Beijing has reportedly cracked down on the religious freedom of the Uighurs, and has been accused of carrying out forced assimilation.

Hikvision’s links to the Chinese government extend in other directions, too. Regulatory filings show China’s supervisory body for state-owned enterprises holds a 42% stake in Hikvision via the China Electronics Technology Group (CETC), which, in turn, runs the Integrated Joint Operations Platform, a predictive-policing platform.

IJOP, the predictive-policing platform, serves as an interface that allows local police and public-safety officials to bring together a range of personal information, including license-plate numbers, camera footage, thumbprints and even blood samples to monitor the movements of Uighurs in China, according to Human Rights Watch.

“Anything part of the data-collection effort, you have to think about how the data is being used and for what purpose,” said Michael Posner, director of the Center for Business and Human Rights at New York University’s Stern School of Business.

“There should be some accountability,” said Darren Byler, an anthropologist at the University of Washington. “Hikvision has a moral obligation to track forms of injustice that disproportionately target minority peoples.”

The role of the ESG

Some say ESG investors, by dint of their investment philosophy, should be activists.

Do such investors have a duty to sell shares if a company fails to show sufficient headway in correcting any unethical practices identified?

Andrew Davenport, chief operating officer of RWR Advisory, a risk-management firm, says the answer is simple: yes.

Davenport told MarketWatch that it may be understandable that many funds hold shares of Hikvision, but for investors that are “in the ESG community, that are supposed to be ahead of the curve on human rights and other nonfinancial risk factors, it’s certainly less explainable — and less defensible.”

Police patrol a night-time market near the Id Kah Mosque in Kashgar in China's Xinjiang Uighur Autonomous Region. AFP/Getty Images

To sell or push for change?

Some investors say they can do more good by maintaining stakes in Hikvision and shaping its actions from within, instead of divesting outright. They point to how Hikvision has looked to assuage investor concerns around its commercial ties with Xinjiang’s authorities in recent months, even as some doubt the company’s willingness to follow through on its assurances.

“[Hikvision] stressed that in the majority of cases they sell their products to a general procurement function rather than to specific locations, and that they are therefore unaware of the purposes for which their products are used after they are sold,” said an Aberdeen Standard Investments spokesperson.

Aberdeen Standard Investments holds more than a $93 million stake in Hikvision through several funds, as of April 30. (Comgest and Aberdeen Standard both increased their holdings of Hikvision shares in the second half of 2018, as links between Hikvision and Xinjiang’s authorities came to light.)

However, Hikvision was aware some of its equipment was being supplied to government projects in Uighur-populated areas, with public bidding notices for two multimillion-dollar Hikvision contracts showing its products were destined for police in Xinjiang’s Pishan and Moyu counties, according to IPVM.

“Hikvision followed the open and regular bidding procedures to participate in Xinjiang projects. The bidding documents are public and available to anyone, including investors. Hikvision executives maintain regular, open, and transparent lines of communication with investors and have not withheld material information from them at any point,” said a Hikvision spokesperson.

Officials at Comgest SA, a money manager based in France, said its identification of human rights or other breaches of ESG guidelines would lead it first to talk with company management, selling its holdings in a company only as a last resort. It had asked Hikvision not to participate in future surveillance projects in Xinjiang.

Comgest SA holds around $265 million in Hikvision’s shares based on its most recent filings, according to Morningstar Direct.

Though divestments of stocks on principle are infrequent, investment funds do jettison shares of companies. Norway’s sovereign-wealth funds divested stakes in four energy companies including Energy Transfer Partners over oil pipelines built through U.S. indigenous lands.

Calvert Research and Management held Hikvision shares valued at $37 million as of March 31 but has since said it sold all of its exposure to the Chinese surveillance company.

Davenport conceded that investors could, at least in theory, exert greater influence on businesses from the inside, and potentially push companies to act in more ethical ways. He pointed to how New York public pension funds employed shareholder resolutions to great effect.

But he wasn’t certain of any capacity among foreign investors to guide the reform of a Chinese state-owned firm. “The argument that external shareholders will be able to persuade Chinese companies and the Chinese government not to follow through with their current approach to the camps in Xinjiang is questionable,” he said.

And if a company isn’t willing to change course, investors should establish a clear schedule for selling the stock, said Davenport.

“If you’re dealing with companies that you know have serious human-rights problems, you have an affirmative obligation to confront those problems, and evaluate what the companies do. And if the company simply says its too hard or it’s too expensive, you ought to make a decision to divest it, or put them on notice,” said Posner, conceding that efforts to assess and measure human rights remained in their infancy.

Security cameras are seen on a street in Urumqi, the capital of the Xinjiang region. AFP/Getty Images

ESG scoring

Being an ethical investor, perhaps, is made more difficult by the absence of clear, uniform investment criteria within the financial community. The Wall Street Journal reported that defining the environmental, social and governance approach isn’t easy and that ratings or scores for ESG can vary widely from investor to investor.

For example, Legal General & Investment Management, the biggest British fund manager, gave Hikvision a 1 rating on a 100-point scale where 1 is the lowest score. On the other hand, the database of credit-rating firm Fitch, in assessing how ESG issues can weigh on a company’s credit rating, shows such concerns having little impact on Hikvision.

“Human rights are considered within our social categories of ESG but are only highlighted if they impact our credit decisions,” a Fitch spokesperson said.

Legal General & Investment Management didn’t reply to MarketWatch requests for comment.

At the same time, the willingness of socially responsible investors to keep stakes in Hikvision may reflect how the ESG movement can often focus more on issues of corporate governance and environmental despoliation while playing down human rights.

That may be partly due to difficulties in quantifying how a company ranks on the social dimension, which, market participants observed, can range widely from workplace health and safety to the use of forced labor.

“It’s harder to come up with precise measures, unlike the environmental and governance factor; it’s almost impossible to just say you have a measure for the social factor if you’re looking at issues like human rights,” said Posner.

At least part of the thesis for investing in companies that are socially and ethically responsible is that investors can avoid regulatory fines or costs associated with missteps of leadership. Conversely, investing in controversial companies — a category into which many investors now place Hikvision — could prove risky to shareholders if damage to a company’s reputation results in profit-eroding expenses or charges.

“What a lot of this comes down to is that human-rights issues have always been, and continue to be, reputational issues,” said Julie Gorte, a senior vice president for sustainable investing at Pax, an ESG-focused money manager.

Attention from the U.S. government has already shown signs of hampering Hikvision’s business as Washington takes aim at Chinese tech companies in industries it views as crucial to national security. Members of the Senate including Marco Rubio, the Florida Republican, have called for sanctions on Chinese Communist Party officials and companies linked to human-rights abuses in Xinjiang.

Hikvision’s close links to Beijing and national-security concerns led Congress to ban the federal government from procuring its products in 2018. Over those 12 months, Hikvision’s sales in the U.S. fell 7.6%, according to FactSet data.

“Hikvision takes cybersecurity very seriously as a company and follows the laws and regulations in the markets we operate. The company has its products regularly tested for vulnerabilities and has received certifications for their cybersecurity standards,” said a Hikvision spokesperson.

The New York Times reported on Tuesday that the U.S. was considering adding the company to a blacklist, which could result in American companies having to secure regulatory approval to sell components to Hikvision. The company’s stock has fallen 23.4% this month, a bigger drop than the 6.4% loss in China’s CSI 300 index over the same period.

Hikvision’s stock has come under pressure FactSet

Some of the activism may have persuaded Hikvision to take greater notice of investor concerns.

The company told MarketWatch in a statement that it is reviewing its business practices. Hikvision also issued a report in April assessing its progress on ESG issues, and said it had commissioned a review of its projects that have flagged human-rights concerns.