Climate risk challenge for Hong Kong’s fund managers

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New Environment, Social and Governance (ESG) regulations require fund managers to consider climate-related risks in their investment decision processes.

Hong Kong’s first binding ESG standards on climate risk are set to have a material impact on asset managers. The two-tier system sets out baseline requirements for all fund managers, with large asset managers – those with assets of HKD$8bn or above – facing enhanced standards, including quantitative analysis and disclosure.

The Hong Kong Securities and Futures Commission (SFC) published the Consultation Conclusion on the Management and Disclosure of Climate-related Risks by Fund Managers in August 2021. It directly amends the Fund Manager Code of Conduct (FMCC) presenting a new compliance hurdle for all authorised companies. For the first time, all asset managers offering collective investment schemes (CISs) must incorporate climate risk considerations into investment decisions making and risk management.

While adherence to ESG principals has been voluntary to-date, a growing trend towards more sustainable investment practices has been on the rise in recent years. Even so, many asset managers may not be adequately prepared to comply with the incoming amendments and are therefore likely to require support from service providers with expertise in the field.

Specifically, asset managers must consider climate risk factors in the following areas:

  • Governance into their board, management and supervisory structures
  • Identification and management of climate risks in the investment process
  • Incorporation into risk management processes including fit for purpose tools and metrics to assess, measure and monitor climate risk
  • Ensuring appropriate disclosures are made to investors

The amendments are broadly based on the global-standard Task Force on Climate-related Financial Disclosures (TCFD) recommendations, which helps to align practices internationally and enables easy comparison. The initiative differs from the EU’s ESG-encompassing Sustainable Finance Disclosure Regulation (SFDR) in that it focuses exclusively on climate criteria. However, one should note that the SFC has advised that a wider ESG framework may be imposed at a later date.

Large managers

Beyond the baseline requirements, large managers are deemed to have sufficient resources to comply with enhanced standards. A core requirement is the calculation and disclosure of their portfolio’s greenhouse gas emissions (GHGs), taking into account carbon emission relative to the portfolio’s market value.

The requirement applies to both scope 1 emissions, those resulting directly from a company’s operations, and scope 2 emissions, those flowing indirectly from the products a company consumes, such as electricity. Fund managers are also encouraged to calculate scope 3 emissions, other emissions that they are indirectly responsible for across the value chain, like buying product from its suppliers. However, this is not a requirement under the regulation.

Large managers must also evaluate whether scenario analysis is useful and relevant in evaluating the resilience of their investment strategies, and if so, a plan for incorporation over time is required.

In its conclusion, the SFC acknowledges that one of the challenges for such quantitative analysis lies in the availability of quality data. Indeed, securing good quality data is perhaps the greatest challenge for managers, particularly in private markets. The extent to which emissions related data is available for private companies is likely to be minimal in many cases, moreover, the tools and methods needed to calculate these metrics may not be available internally.

Large fund managers must understand which data points are required and work with portfolio companies to ensure they are accurately represented. Partnership for Carbon Accounting Financials (PCAF) standards can be used for reference, but fund managers are permitted to take a flexible approach, utilising a range of tools and metrics.

Completing the task in-house would doubtless involve training employees up while implementing new policies and procedures. With the ESG industry still at a relatively early stage, appropriate talent may be difficult and expensive to acquire, leading more firms to leverage the expertise of a specialist external companies with ready-made solutions to tackle the challenge.

Apex Group is well placed to assist with tools such as our new Carbon Footprint Assessment service. It enables clients to identify, quantify and track three categories of emissions – scope 1, scope 2, scope 3 – that contribute to their overall carbon footprint. It guides asset managers on their journey to net-zero, from the data collection and reporting of carbon footprints to later reducing or offsetting emissions.

To find out more please get in touch with our team here.

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