Hong Kong's Securities and Futures Commission is proposing to change its Fund Managers' Code of Conduct to require fund managers to take climate-related risks into consideration when managing risks and investments. It also wants to oblige them to make various disclosures to satisfy family offices’ growing demand for information about 'climate risk' and to combat 'greenwashing.'

Underpinning the regulator's efforts, of course, is the Hong Kong Government's desire to make the city a regional hub for environmental, social and governance-related (ESG) investment management.

The recently-released consultative document mentions the acronym ESG 63 times. It wants fund managers to disclose how and the extent to which they take ESG factors into account when managing risks and investments. To support its agenda, it has already conducted a survey of the "sustainable investment practices" of asset managers and asset owners in Hong Kong which looked at their interest in ESG and the processes by which they invested money and kept their investors informed about it. Most fund managers do take these factors into account but not in a consistent way. Pointing to no broken regulatory rules at all, the SFC decries this and says that it falls short of asset owners' expectations, but this statement is slightly disingenuous.

The survey - published in December - only gauged the attitudes of 14 institutions that owned assets and not HNW/retail owners, although family offices were among the institutions that it consulted. (The rest were sovereign wealth funds, pension funds and financial institutions.) It also contained no mention of how the institutions made their "expectations" known to the fund managers, thereby opening the door to the possibility that they merely formed these "expectations" privately, or perhaps to please the regulators when they spoke to them.

Meanwhile, 68% of the 660 asset management firms in the survey signed on the dotted line when the regulator asked them to state that ESG factors "could" be a source of financial risk and have an effect on investment portfolios. This was the figure that the SFC was looking for - so much so that the survey contained a gigantic pie chart showing only that figure. AuM size appears to have nothing to do with whether a firm has an ESG investment process that relates to research and portfolio management.

ESG at the exchange

The Stock Exchange of Hong Kong is already ordering the issuers of securities to publish statements that set out their boards' ESG-related considerations, to follow four reporting principles when preparing ESG reports, to divulge the processes they use to identify specific entities or operations included in the reports and to disclose significant climate-related issues which might have affected them. They are now allowed to publish their ESG reports online, whereas for some unexplained reason they used to be forbidden to do so.

Picking apart the jargon

The SFC believes that there are two main types of requirements or standards in the world for promoting "sustainable development," as it calls it. One focuses on ESG or "sustainability factors" (it cites the European Union's regulation for sustainability-related disclosures and a trade body's guidelines for ESG in the investment and risk management of pension funds) while the other concentrates on climate change or environmental factors (e.g. some recommendations from the TaskForce on Climate-related Financial Disclosures or TCFD, a body set up by the Financial Stability Board in Basel). Never once in the consultative document does it say what it thinks the word "sustainable" means, although it uses it to describe types of finance, investment, development, returns, economics and activities.

Principles, standards and the DFM exemption

The SFC proposes to amend the code of conduct to contain vague principles and varous standards in a circular to be published later. To begin with, it wants to apply the new rules to fund managers that manage collective investment schemes, irrespective of whether they have delegated their investment management functions to other intermediaries or not. This is because collective investment schemes account for a great deal of AuM.

There is to be no such compulsion for discretionary fund managers, except in cases where clients have asked their DFMs to take climate-related risks into consideration in their investment mandates.

The consultative document stops maddeningly short of laying out the "principles" that the regulator wants firms to follow, but it hints darkly that the seven principles to be found in a TCFD report from 2017 (which contains its aforementioned recommendations) are the ones that the SFC favours. These (themselves based on the FSF's general banking "enhanced disclosure principles" of 2012) are as follows.

Principle 1: Disclosures should present relevant information. The firm in question ought to provide information specific to the potential effect of climate-related risks and opportunities on its markets, businesses, corporate or investment strategy, financial statements and future cash flows. When a particular risk or issue attracts the attention of investors and markets, the TCFD says that it may be helpful affirm that the risk is not significant. Disclosures should be presented in sufficient detail. The firm should provide information that relates to the effect of the climate on value creation, avoiding generic or boilerplate disclosures that do not help users to understand issues.

Principle 2: Disclosures should be specific and complete. Reports should provide a thorough overview of firms' exposure to climate-related effects; the potential nature and size of such effects; the firms' governance, strategies, processes by which they manage climate-related risks and performance with respect to managing climate-related risks. Disclosures should contain historical and future-oriented information. Forward-looking quantitative disclosures should be compatible with data that the firms use to manage risks and make decisions about investments. Any "scenario analyses" should be based on such data.

Principle 3: Disclosures should be clear, balanced, and understandable. Firms should write them to communicate financial information that serves the needs of a range of financial sector users (e.g., investors, lenders, insurers etc). This requires reporting at a level beyond compliance with minimum requirements. The disclosures should be sufficiently granular to inform sophisticated users, but should also provide concise information for the less specialised. Terms used in the disclosures should be explained or defined.

Principle 4: Disclosures should be consistent over time. This principle calls for consistent formats, language and figures to allow people to compare various things from one period to the next. Changes in disclosures and formats (due to shifting climate-related issues and evolution of risk practices, governance, measurement methodologies, or accounting practices) can be expected because climate-related disclosures are relatively immature. Any such changes should be explained.

Principle 5: Disclosures should be comparable among organisations within a sector, industry, or portfolio. Disclosures should allow for meaningful comparisons of strategy, business activities, risks, and performance between organisations and within sectors and jurisdictions. "Benchmarking of risks across sectors and at the portfolio level" should be possible.

Principle 6: Disclosures should be reliable, verifiable and objective. The small print of this principle states that "disclosures should provide high-quality reliable information," opening the door to heavy punishments for slight infractions. It also says that disclosures should "use best-in-class measurement methodologies," another potential source of impulsive punishment. For future-oriented information, this means that the assumptions that each firm uses ought to be traceable back to their sources.

Principle 7: Disclosures should be provided on a timely basis. No timeframe at all is mentioned here.

The report, incidentally, was addressed to Mark Carney, who at the time was doing "double duty" as both the Governor of the Bank of England and the chairman of the FSB. It was sent to him on behalf of the TaskForce on Climate-related Financial Disclosures by one Michael Rubens Bloomberg, the newswire businessman and former mayor of New York City.

As is well known, regulators tend to be enthusiastic about the prospect of new and vague principles, because they can adapt them or reinterpret them to punish practically any firm they please.