Fund houses to struggle with new HK ESG disclosure rules
Hong Kong’s move towards forcing companies and investors to make mandatory environmental disclosures in 2025 is likely to leave fund managers struggling to comply over the short- to medium-term, due to choppy levels of industry expertise in quantifying climate-related risks, say analysts.
Industry experts also say that ESG disclosure could be difficult to gain from portfolio companies that are generally not used to such high levels of transparency.
When the initiative was launched earlier this year, Hong Kong’s Securities and Futures Commission chief executive Ashley Alder warned there would be major data challenges for asset managers over the coming months.
“The ultimate goal is to produce disclosures which reveal considerably more about what is being financed – especially the volume of carbon dioxide emissions, whether investment portfolios are climate-aligned and how fund managers address climate risks,” Alder said.
Yvette Kwan, executive adviser at the Asia Securities Industry & Financial Markets Association, told AsianInvestor that while requirements for listed companies to provide certain sustainability and climate-related disclosures have been in place since July 1, 2020, regulations are set to increase..
“It’s been announced that climate-related disclosures aligned with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations will be mandatory across relevant sectors including financial institutions no later than 2025,” she said. She added that details were not yet available, but it is expected that the obligation for disclosure is likely to fall more heavily on financial institutions.
“So basically, other pieces of regulation are coming into place to help get investee companies to disclose, with a greater role for stewardship as asset managers engage on sustainability issues with investee companies.”
Kwan believes many such companies, which typically issue stocks or bonds that fund managers buy, lack the internal expertise to comply with the breadth of disclosure requirements linked to ESG.
“It will be tough to get investee companies – especially the small- and mid-sized companies – to disclose as it requires a review of existing governance processes as well as an assessment of operations and assets,” she said. “This will require different ESG capabilities across various levels of the organisation from the board down.”
Asked whether clients were likely to pull back from fund managers that did not have the resources to offer ESG analysis or capabilities, Kwan said there was likely to be a “capability versus cost consideration” going forward.
Despite the new level of pain from mandatory disclosures, she noted that she does not expect the regulators to soften ESG rules anytime soon. “The current global trend is towards greater regulation. As capabilities, including scenario modelling become more mainstream, I imagine that such costs could come down, however,” she added.
SFC's Alder had earlier said the SFC was working on ways to allow funds to monitor climate risk in ways “both meaningful and decision-useful”.
“For example, investment funds will need to calculate the carbon footprints of their portfolios by disclosing weighted average carbon intensity at the fund level,” he said. “These calculations are highly data-dependent, so the changes we propose will depend on access to the right data as well as the reliability and comparability of that data.”
COST OF TRANSPARENCY
Industry experts say it is an open question about the extent to which asset managers and asset owners have the resources to retrieve this data and the cost of getting third-party assistance – especially for smaller operators.
The higher levels of transparency required under mandatory reporting could also prove a sticking point for portfolio companies.
“Not [being] used to the transparency, as you rightly point out, is only the tip of the iceberg,” Penelope Shen, investment funds partner at law firm Stephenson Harwood in Hong Kong, told AsianInvestor.
“The Hong Kong asset management market is diverse – while many global asset managers are ahead at evaluating and incorporating climate change, green/ESG or sustainability factors in their governance and investment mandates, often driven by investor requests, others will undoubtedly struggle to even start assessing the relevance and materiality of climate risk.”
She said most fund managers outside of the large global institutions lack the resources to sufficiently invest in this area. As a result, they lack ESG training and understanding, reliable data on evaluating climate risk, plus analytical tools, unified standards and incentives.
“Also, there is a lack of professionals/experts who can provide sterling service in the area, not to mention additional costs and time involved in making the disclosures.”
That said, Shen believes the market will plug these gaps in the near-term.
“Over the next few years, I think you will see a lot more professional firms and consultancies offering such expertise and, slowly, a lot of managers will come to rely on them,” she said. “In the future, managers will take on one or two such professionals in-house and that’s how climate assessment becomes part of the industry DNA. It’s an exciting time for the green funds movement.”
She noted that there is not one-size-fits-all solution for asset managers or asset owners struggling to amp up their ESG monitoring capabilities. While the governance part of ESG should be relatively easy to comply with, as long as regulations are followed, the environment and social aspects are more complex and abstract to quantify.
“In my view asset managers will inevitably have to incur additional costs at varying levels, depending on their extent of ESG integration in their daily operations,” Shen said.
“I believe the regulator is already trying to be encouraging by rolling out mandatory requirements gradually, starting with just climate-risk disclosure. They also adopted the principle of proportionality to the draft policy, meaning the bigger and more complex the business is, the more detailed the disclosures will have to be."
While this is set to become an additional cost and burden, as asset managers are forced to seek more information, Shen said it is likely unavoidable for markets that want to tout their ESG credentials.
"If Hong Kong, as with many other jurisdictions and key financial hubs, is aiming for a net zero carbon footprint, green fiscal policies are a must-have," Shen said. "Market forces, e.g. investor demand, are important, but regulatory implementation is an inevitable and crucial step to formalising market standards.”
Hong Kong’s steps towards mandatory disclosure follow major initiatives in the Asia Pacific region: Japan, South Korea and Hong Kong have all pledged to achieve carbon-neutral emissions by 2050. Mainland China, meanwhile, the biggest emitter of fossil fuel carbon dioxide (CO2) emissions, aims to meet the same target by 2060.
While mandatory environmental-risk reporting for investment managers is gaining traction across the Asia Pacific (India has seven instruments with a mandatory status and China seven regulations that act as instruments of mandatory disclosure) problems remain.
Critics argue there is a lack of consensus on whether reporting should be mandatory or voluntary, plus no industry-specific standards, and that mandatory disclosures largely exclude small and medium-sized enterprises (SMEs).