Investment Watch | China : Synonymous with innovation

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    Synonymous with innovation
    Synonymous with innovation
    20 May 2021

    Key highlights

    • China punches above its weight in terms of innovation and there are indications that China’s innovative streak is strengthening.
    • In addition to household names such as Huawei and Tencent, Chinese substantial global reach in innovations extends to batteries for new-energy vehicles (NEVs) and photovoltaic & solar cells in sustainable energy applications.
    • China will continue to climb the innovation ladder due to an increase in research and development (R&D) expenditure under the latest Five-Year Plan.
    • Investor access to Chinese listed companies will increase with a rise in weightage of China A-shares in major indices over the next few years.

    China's ranking in the Global Innovation Index has risen from the 35th spot in 2013 to 14th in 2020 (Figure 1). It currently ranks 1st among 37 upper-middle-income economies. In fact, China remains the only middle-income economy among the top 30 most innovative countries in the index. A deeper look into the 80 innovation indicators shows that China takes the pole position in eight of them including the scale of the domestic market; formal training at companies; patents by origin and creative goods exports, among various other indicators. China filed 58,990 international patents in 2019 making it the top patent applicant over the incumbent US, according to the World Intellectual Property Organization's 2020 report (Figure 2). While overall international patent applications grew 5.2% in 2019, applications from China surged 10.6%. In terms of patents in force, China is closing the gap (2.7 million patents) with the US (3.1 million). The quality of China's research papers has also been improving, ranking 2nd in the Nature Index, which tracks the quality of global research output.

     

    China exceeds level of innovation expected at current stage of development
    (Figure 1)

    Global Innovation Index 2020

    Source: Global Innovation Index 2020.

     

    Top International Patent Applicants
    (Figure 2)

    WIPO Statistics Database, September 2020

    Source: WIPO Statistics Database, September 2020.

     

    The World Bank estimates that China's research and development (R&D) "expenditures as a share of GDP are multiples above what is common for a country at China's level of development." More is to come, as China is boosting its already high R&D expenditure, underpinned by the most recent national Five-Year Plan which aims to increase R&D outlays by 7% or more each year over the period.

    China has thriving innovation centres in various cities such as Hangzhou, which hosts Alibaba's headquarters and which has a vibrant start-up community centred around e-commerce, fintech and other online services. Shenzhen is home to Tencent, the parent company of the ubiquitous WeChat, and many other high-tech companies.

    While China's innovations in payments, financial services and e-commerce are well known, several other innovative sectors with significant potential are less renowned and these include batteries for new-energy vehicles (NEVs), photovoltaic (PV) cells for solar energy generation and medical devices. The medical technology industry is clustered in three main regions – the Beijing-Tianjin Bohai Rim region is home to R&D activities; while the Yangtze River and Pearl River delta regions host manufacturing companies.

     

    Electrifying the globe

    The adoption rate of new-energy vehicles (NEVs) both in China and the rest of the world hinges a lot on their driving range, which is determined by how quickly NEV batteries can be charged. Most NEV batteries currently take as long as 12 hours to charge up fully. If the charging time could be improved, the adoption rate of NEVs would be higher. As Elon Musk tweeted, "Battery cell production is the fundamental rate-limiter slowing down a sustainable energy future."

    Eve Energy, a major battery manufacturer in China, is addressing this issue by producing, in partnership with an Israeli company, a battery that could be fully charged within five minutes, which is a potential game changer in the NEV industry.

    China is already the world's largest exporter of lithium-ion batteries and components used in NEVs, and when NEV adoption rates accelerate, it will benefit the main Chinese battery manufacturers such as Eve Energy and Contemporary Amperex Technology. Both companies are currently suppliers to global vehicle manufacturers such as Daimler, BMW and Hyundai-Kia.

    In the domestic market in China, the government's concerted efforts to replace traditional combustion-engine vehicles with NEVs is gaining ground and these efforts will boost demand for NEV batteries. In 2017, the government initiated a dual-credit policy for carmakers in which manufacturers can accumulate credits by producing vehicles with lower fuel consumption. Officials at the Ministry of Industry and Information Technology estimate that this credit system will raise the production of NEVs to 20% of total vehicles manufactured in China by 2025.

    China currently accounts for 55% of global NEV sales. In September 2020 alone, sales of NEVs in China rose 67.7% year-on-year, compared with an 8% growth of overall passenger vehicle sales in the country. As an example of the pervasiveness of NEVs in China, 60% of the country's buses have been replaced with NEVs, as of October 2020, according to data from the Ministry of Ecology and Environment.

    NEV adoption should further gather pace in the coming years, supported by plans for consolidating construction of infrastructure such as charging stations as well as policies to expedite the use of NEVs in the public sector.

    This NEV thrust could lead to the emergence of a battery recycling sub-sector over the next few years, as smaller vehicles must replace their batteries every seven to 10 years and for larger ones, every three to four years. With China already having the largest number of NEVs in the world, and pushing for an even wider NEV adoption, the country will have a growing stockpile of expired batteries that need to be recycled. The repurposing NEV batteries is not straightforward due to the complex chemical processes involved and if it's not handled properly, it could result in lead contamination and significant fines for breaking China's increasingly robust environmental regulations. This situation calls for innovative technologies and processes to address the chemical and environmental challenges. Several global as well as Chinese manufacturers, such as BYD, see an opportunity in this emerging sub-sector and are working toward creating a market for recycled NEV batteries.

     

    China is projected to have the largest battery repurposing and recycling market in the world (Figure 3)

    Bloomberg and Institute for Energy Research

    Sources: Bloomberg and Institute for Energy Research.

     

    As some countries anticipate achieving grid parity around 2021 and as the recent blackouts in Texas in March draws attention to the need for greater stability in sustainable energy production, distributed generation is coming to the forefront. In distributed generation, energy production is dispersed and is located closer to energy consumers such as households and industries, thereby improving energy availability while reducing distribution inefficiencies. Distributed energy calls for cost-effective, smaller and easy-to-install, yet robust, energy-generating equipment such as solar panels.

    One major Chinese sustainable-energy company, LONGi Green Energy Technology, sees distributed generation as a major trend and is delivering innovations to meet the global market's needs. LONGi had launched the Hi-MO 4, a series of photovoltaic (PV) modules suitable for distributed generation in 2019. It has reported 10GW of global shipments within a year. In February 2021, the company expanded the Hi-MO 4 series by launching PV modules that are suitable for residential rooftops as well as commercial and industrial premises.

    Underpinned by its robust innovations, LONGi's sales of high-efficiency solar wafers and modules currently account for about one-quarter of global sales. The Renewable Energy Test Centre (RETC), an independent test and certification laboratory for PV and renewable energy products based in California, publishes the annual PV Module Index (PVMI) Report, which presents PV products' test results based on reliability, performance and quality. The 2020 edition of the PVMI Report called out LONGi for commendable results in all indicators of the test. For instance, LONGi's modules were subjected to 2,000 hours of a damp-heat test and the modules demonstrated a loss of power of less than 2%. Other major certification standards have lower requirements, namely a 1,000-hour damp-heat test and a degradation allowance of 5%. Passing RETC's more stringent test "represent(s) excellent robustness and quality in delivered performance," the report noted. Another test subjected the PV modules to simulated environmental stresses. LONGi was the only manufacturer that demonstrated less than 1% degradation in power over the course of this test.

     

    Innovation in medical devices

    In a circular dated 19 March 2021, the Chinese State Council said it will "give priority to medical device innovation" and noted that it should "improve an innovation system, support basic and application research of medical devices, and promote new technology."

    China's efforts are not stopping at innovation and will go further to improve the governance and supervision of the entire ecosystem of medical devices, including ensuring that advertisements of such devices are accurate and are not misleading. One step in that direction is the requirement of medical device dealers to use their real names when marketing their products on online shopping platforms. This augurs well for the credibility of China's innovative medical device industry, and will likely lead to greater acceptance among consumers, thereby increasing the commercial viability of innovations.

    Another boost to the medical device innovation industry comes from China's attempt to expedite approval processes for medical equipment. Since the enhanced approval process began in 2014, 64 high-value, domestically produced medical devices have been approved including an interventional heart valve, according to the National Healthcare Security Administration. Even though price controls could reduce medical technology companies' margins, the healthcare industry's trend toward bulk purchasing could provide respite in the form of sales volume as well as lower marketing and distribution costs.

    To sum up, innovation is pervasive in China's rapidly recovering economy. Investor access to the country's innovative sectors and companies will improve as China A-shares are increasingly included in major stock indices such as the MSCI and FTSE Russell series of indices.

     

    Learn more about the United China A-shares Innovation Fund:

    United China Shares

     

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