Hong Kong has not been known as the biggest advocate of environmental, social and governance (ESG) principles. The city is notorious for the pollution that often leaves its skyline a haze, while its energy is largely dependent on coal-fired power plants based in China.
But the Hong Kong Monetary Authority (HKMA) is trying to change all that.
The de-facto bank of the special administrative region of China is spearheading efforts to promote ESG and green finance, both in its investment activities under its Exchange Fund and via its ability to influence banks as a regulator.
Kim Chong, head of risk management and compliance for the Exchange Fund Investment Office at the HKMA, told AsianInvestor this is a deliberate effort as part of the HK$4.16 trillion ($531.61 billion) portfolio's recognition of the encompassing impact of climate change.
There is broad scientific consensus that extreme climate events such as typhoons and forest fires will rise with the global temperature, and all signs indicate that efforts of the Paris Climate Agremeent of 2015 to prevent the global temperature from rising by more than 2 degrees Celsius appears increasingly unlikely to be met.
That is set to have a big impact on asset owners' investment portfolios.
“Climate risk is something serious and not something you can brush off,” said Chong. “In Asia you see a lot of climate instances, such as flooding and typhoons."
The evidence and expert views indicate that climate risk is real, he noted, "and transpires in the form of physical risk and transitional risk".
“There are sizeable physical risks where your investments are in low-lying regions, which leave them sensitive to flooding," Chong added. "But it’s not just about buildings you own directly. What about buildings of your suppliers? Flooding can cause your supply chains to be disrupted. Then there’s water stress, which is also an issue.”
The potential impact of such climate risk on asset owners is hard to assess, but it is likely to be sizeable.
In 2011 the International Finance Corporation, part of the World Bank, conducted a report with investment consultant Mercer and several asset owners (including GIC of Singapore) on the impact of climate change on institutional investor portfolios. It came to a disturbing conclusion: failing to consider climate change risks could hurt their portfolio value by up to 10% by 2031.
Mercer released a more recent report this year, which estimated that investor investment returns could suffer an annualised negative impact of 0.14% a year if the global temperature is on track to rise 4 degrees Celsius. Those sort of risks are persuading more asset owners like HKMA to seek to manage their investments from an ESG perspective.
“We could see that from a risk perspective there is a risk of losses if you don’t properly manage climate-related risks associated with your investments, and there is also associated reputational risk if you invest heavily in polluting industries,” said Chong.
On the other hand, there are positive benefits to pursuing it too.
“We have understood E, S and G in terms of the investment benefits and risk mitigation that it offers if you look at it the proper way,” he noted. “We think it’s a way to avoid long-term risks as well as to uncover long-term value in investment opportunities."
As HKMA moves forward, Chong said it will view all its investments in this manner.
“All we can do to counteract this is to look at investments through the ESG lens. In the past, we have put our money in projects with sustainable features such as renewable energy, green buildings as well as green bonds,” he said. “We are also studying ESG-themed mandates in equities investments.”
The Exchange Fund is effectively four investment funds combined. Of these, the Long Term Risk Portfolio focuses on private equity and overseas real estate, while the Investment Portfolio is focused on public assets. They are likely to be the most impacted by this ESG focus.
SETTING AN EXAMPLE
HKMA has been gradually touting its ESG commitment over the past couple of years. It conducted its second Green Finance Forum in May, during which it declared that "we have a guiding principle that if there are two projects with comparable long-term returns on a risk-adjusted basis, the one with a high ESG content will prevail and be selected,” said Chong.
In addition, the central bank participated in the second Hong Kong Green Finance Association annual meeting in September. Former chief executive Norman Chan, his replacement Eddie Yue and deputy chief executive. Arthur Lau have made public speeches about HKMA’s commitment to ESG investing and encouraging banks to participate in green finance.
HKMA also signed up to the United Nations Principles for Responsible Investment on August 29, becoming only the second central bank to do so, while joining the Central Banks and Supervisors Network for Greening the Financial System in September.The latter is an organisation of mainly central banks that aims to encourage green finance and lending in their domestic financial systems.
Chong feels ESG makes sense for HKMA in that it helps to quantify how well run its investee companies are, and how exposed they may end up being to regulatory and legal steps being taken to combat climate change.
“Risk-adjusted returns are important over the long-term,” he said. “Besides environmental risks, governance risks and social risks also matter; they can flare up if a company or entity does not properly manage them. And we are a long-term investor; we don’t look at returns on a quarter-by-quarter basis.
“From a shareholder value perspective the coal industry can be lucrative, but we would think carefully about investing into it because of the environmental impact of it, and the risk of stranded assets in the years to come,” he added.
By this Chong is referring to the fact that rising concerns about climate change may not just cause onerous new rules for high-carbon-emitting carbon industries, but also prove detrimental for asset owners that are willing to invest heavily into them.
Add to this the HKMA’s efforts to promote green finance in its banking sector, and the central bank is acting as one of Asia’s newest advocates for responsible investing
Look out for the coming Winter 2019 edition of AsianInvestor magazine, which contains an indepth feature considering the risk of climate change on Asian asset owners.