The SFC’s survey on integrating ESG factors and climate risks in asset management – what’s now and what’s next?

Environmental, social and governance (ESG) funds continue to be under the regulatory spotlight of the Securities and Futures Commission (SFC). On 16 December 2019, the SFC released findings of its industry-wide survey (Survey) of type 9 licensed asset management firms and institutional asset owners conducted from March to September 2019. The Survey aims to ascertain how and to what extent asset managers and institutional asset owners consider ESG risks, in particular climate change risk. This article highlights key market trends, common ESG practices, expectation gaps between asset managers and asset owners and the SFC’s three deliverables in relation to ESG issues.

Market trends

  • Of the 794 firms surveyed, 83% (660) of those actively involved in asset management (Firms) took into account at least one ESG factor as part of the investment and risk management process.
  • 64% of the Firms plan to develop or enhance their ESG practices in the next two years.
  • Asset management firms of various sizes in terms of AUM have put in place ESG investment processes, contrary to the general perception that ESG practices tend to be dominated by larger market players.

ESG practices

Of the 660 Firms:

  • 63% practice responsible ownership (e.g. voting and corporate engagement) in a bid to influence ESG management of the investee companies; and
  • 35% implement a consistent and systemic approach in ESG integration such as formulating an ESG policy, which typically outlines specific ESG factors to be considered and other ESG-related governance and oversight measures such as designating board members to focus on ESG issues. Risk management controls such as incident monitoring mechanisms to flag major ESG incidents for portfolio adjustments had also been implemented.

The Survey also revealed negative/exclusionary screening as among the most common ESG investment strategies. Other methodologies include norms-based screening and thematic investing, etc.

Expectation gaps between asset managers and asset owners

  • A majority of asset owners surveyed indicated that discussion of climate risks is almost non-existent in client engagement and suitability assessments, pointing to insufficient, or even the lack of, understanding of a client’s ESG investment preferences.
  • Asset owners also expect asset managers to identify, assess and manage climate risk; however only 23% of the 660 Firms have processes in place to manage the financial impact of specific climate risks.
  • All the asset owners surveyed agreed that enhanced disclosure under a prescribed framework is necessary in order to reduce “greenwashing” (false or misleading claims or representations of commitment to ESG principles) and to better identify asset managers with stronger ESG practices. Yet, 68% of the 660 Firms indicated information about their own ESG practices are not available.

What’s next?

Following the Survey, the SFC aims to achieve the following three outcomes in the near term:

  • to set expectations of asset management firms in areas such as governance and oversight, investment management, risk management and disclosure, focusing on environmental risks with an emphasis on climate change;
  • to provide practical guidance, best practices and training in collaboration with the industry and relevant stakeholders to enhance the capacity of asset management firms to meet the SFC’s expectations; and
  • to establish an industry group to exchange views amongst the SFC and experts in environmental and climate risk, as well as sustainable finance.

The above add to the SFC’s array of existing measures in regulating ESG funds, including laying down specific disclosure requirements for ESG funds in a circular issued on 11 April 2019 (see our previous article here) and setting up a central database on the SFC’s website of ESG funds authorized for retail distribution in Hong Kong (see here). Other regulators including the Hong Kong Stock Exchange and the Hong Kong Monetary Authority have also rolled out publications on ESG issues (see our previous article here).