In August 2021, the Hong Kong Securities and Futures Commission (“SFC“) published the conclusions of the consultation on the management and disclosure of climate-related risks by fund managers (“Conclusions of consultations“)¹, which sets out the SFC’s expectations of how fund managers should consider climate-related risks in conducting investments and managing risk, and how to disclose them appropriately. The publication (i) is part of the SFC plans, as defined in the 2018 strategic framework for green finance², improve the consideration and disclosure by asset managers of ESG factors, in particular environmental and climate risks; and (ii) reflects the conclusions of the SFC, as set out in the SFC circular dated March 2019 on the investigation into the integration of environmental, social and governance factors and climate risks in asset management³, that climate-related risks are a source of financial risk that must be considered and managed by fund managers.

The requirements proposed in the conclusions of the consultation (the “New requirements“) will apply to all fund managers licensed in Hong Kong and will be reflected as amendments to the Code of Conduct for SFC Fund Managers. This briefing note provides a summary of the new requirements in the consultation findings. The new requirements are effective as of August 20, 2022 for large fund managers (as defined below) and November 20, 2022 for all other fund managers.

1. Scope and applicability

The new requirements will apply to approved Type 9 (asset management) companies that exercise discretionary management of investments on the assets of investment funds (“Fund managers“), including authorized and private funds (eg private equity, private credit, mutual funds and hedge funds). Fund managers that only manage discretionary accounts are currently out of reach .

The new requirements are formulated in two levels, and the fund managers concerned will need to determine to what extent the new requirements will apply to them. “Basic requirements“will apply to all fund managers and”Improved requirements“will apply in addition to the basic requirements to fund managers who qualify as”Large fund managers“⁴.

2. Governance

Basic requirements

The new requirements require a fund manager to ensure that its board of directors and management are committed to mainstreaming climate risks throughout the fund manager’s organization. The board of directors of the fund manager should be responsible for overseeing climate-related risks and their integration into the investment management and risk management processes of the fund manager. At the management level, the fund manager should also ensure that it has sufficient technical and human resources, as well as governance structures (e.g. internal controls and written procedures), to manage climate-related risks. and continued respect for these governance structures.

The conclusion of the consultation also clarifies that while a fund manager belonging to a group of entities can leverage the resources and staff of the group (for example through the policies and procedures of the group) and can rely on the procedures group, provided that these procedures meet the new requirements, the fund manager retains full responsibility for complying with the new requirements.

3. Investment management

Basic requirements

The conclusions of the consultation require that a fund manager ensure that climate-related risks are taken into account in investment management processes. In particular, a fund manager will:

• identify the relevant physical and transient risks related to the climate for each investment strategy and fund it manages;
• where appropriate, consider significant climate-related risks in the investment management process. For example, a fund manager may integrate climate-related risks into their investment philosophy and investment strategies, as well as integrate climate-related data into their research and analysis process; and
• take reasonable steps to assess the impact of these risks on the performance of the underlying investments.

To the extent that a fund manager considers climate-related risks to be irrelevant and irrelevant to the investment management and risk management processes of the strategies it manages, it should disclose the basis for this determination in its offer documents. This assessment should be reassessed at least once a year and the information to be provided should be revised accordingly, if necessary.

4. Risk management

Basic requirements

The SFC views climate-related risks as a financial risk and expects climate-related risks to be treated in the same way as other significant risks, such as market and liquidity risks. Therefore, a fund manager is required to consider climate-related risks in risk management procedures and to ensure that appropriate actions are taken to identify, assess, manage and monitor relevant climate-related risks. and important to each investment strategy and fund it manages. Appropriate tools and metrics, including carbon footprint metrics, forward looking metrics, and physical climate metrics, should be used as part of the baseline requirements.

Improved requirements

In addition, large fund managers should adopt more robust and systematic approaches to managing climate-related risks. In particular, if climate risks are assessed and considered important for an investment strategy or a fund managed by a large fund manager:

• the Manager of the Large Fund must make reasonable efforts to acquire or estimate the weighted average carbon intensity of Scopes 1 and 2 greenhouse gases (“GHG“) for the funds it manages. The large fund manager is also encouraged to include Scope 3 GHG emissions (if data is available) in its calculations; and
• the large fund manager should also assess the relevance and usefulness of scenario analysis to assess the resilience of investment strategies to climate-related risks along different pathways and keep an internal record of the assessment. Such scenario analysis should involve an analysis of the risks and opportunities arising from climate change, and an assessment of the exposure of investment strategies to these risks and opportunities in different scenarios. If the outcome of the assessment is deemed relevant and useful, the manager of the large fund should develop and implement the scenario analysis in a manner commensurate with its size and the nature of its business within a reasonable timeframe.

5. Disclosure

Basic requirements

A fund manager responsible for the overall operation of an investment fund is required to provide adequate information, such as in its offering documents, regarding climate-related risks to enable investors to make informed judgment on their investments in the fund, including (i) its governance arrangements for monitoring climate-related risks; (ii) the respective roles and oversight of the board and management; and (iii) how it takes climate-related risks into account in its investment and risk management processes, including the tools and measures used to identify, assess, manage and monitor risks. If climate-related risks have been assessed and are deemed irrelevant for certain types of strategies, then the fund manager should disclose these exceptions.

Improved requirements

In addition to the basic requirements, a significant fund manager must also comply with the following additional disclosure requirements:

• describe the entity-level engagement policy and preferably provide examples to illustrate how significant climate-related risks are managed in practice, including how the fund manager’s engagement policy is implemented; and
• at a minimum, provide the carbon footprints of the portfolio of scopes 1 and 2 GHG emissions associated with the underlying investments of the funds at the fund level (when data is available or can be reasonably estimated), and indicating the calculation methodology, the underlying assumptions, its limits and the proportion of investments (for example, in terms of the net asset value of funds) that are valued or hedged.

Implementation schedule

Large fund managers will have until August 20, 2022 to comply with the basic requirements and until November 20, 2022 to comply with the enhanced requirements. Fund managers who are not large fund managers will need to comply with the basic requirements by November 20, 2022.

In the meantime, fund managers who are also subject to Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on information to be provided in relation to sustainable development in the financial services sector, such as amended by Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment (“SFDR“) should also consider whether an integrated approach to investment and risk management processes, as well as disclosure will be justified.

Conclusion

The new requirements will have a significant impact on the fund managers concerned. It is important to note that the new requirements apply to all fund managers, not just those who follow “sustainable” or “ESG” strategies. In addition, the SFC clarified in the consultation findings that a ‘comply or explain’ approach will not be accepted, so all fund managers will need to consider the extent to which the new requirements will apply to them.

Although Fund Managers have until Q3 and Q4 2022 to comply with the Basic Requirements and Enhanced Requirements, where applicable, the obligations are detailed and potentially complex for Fund Managers who have so far not not affected by climate or ESG regulations. Fund managers are advised to start reviewing policies and processes now to ensure they are able to comply with mandatory basic and enhanced requirements. This may require finding service or data providers (eg on GHG emissions) before deadlines.

Footnotes

1) The conclusions of the consultation are available here.

2) The 2018 Green Finance Strategic Framework is available here.

3) The March 2019 circular is available here.

4) Large fund managers are defined in the conclusions of the consultation as fund managers with assets under management (“AT M“) of HK $ 8 billion or more for three months in the previous 12 months (excluding assets under management of discretionary accounts).