Hong Kong regulators must act to boost interest in ESG investment

This article appeared originally in the China Daily on 11 June,2019.
Authors: Stephen Wong, Deputy Executive Director and Head of Public Policy Institute at Our Hong Kong Foundation, Gloria Luo and Johnson Kong, Assistant Researchers at Our Hong Kong Foundation

The financial sector is critically linked with how the real economy functions. That is why, as the risks posed by climate change to economic and financial stability loom large on the horizon, the global financial system is being reshaped by the urgent needs of sustainable development.

Most notably, central banks and financial supervisors formed the Network for Greening the Financial System (NGFS) in 2017 to better manage climate change as a financial risk. NGFS has grown to 36 members and six observers across five continents, including the European Central Bank, the Bank of England, the People’s Bank of China, the Singapore Monetary Authority and the World Bank. To date, multiple central banks have conducted surveys and stress tests, or issued policy guidelines related to climate risks.

As these rather conservative institutions are making major strides in future-proofing our financial systems, the urgency of climate action speaks for itself and has climbed up the global agenda.

This sets the stage for the rapid rise of environmental, social and governance (ESG) investment as a major financial tool for climate action. Channeling global capital toward ESG assets is believed to incentivize the widespread development of green technologies and sustainable business models. This will be a crucial step forward toward preventing global warming from getting even worse and becoming an unstoppable disaster in the near future.

According to Global Sustainable Investment Alliance, about 1 in every 4 dollars under professional management was managed with ESG considerations beyond traditional financial analysis in 2016, and its size has surged to over $30 trillion in 2018. ESG investment has taken off mostly in Europe and the United States, adding up to over 90 percent market share worldwide in 2016.

Hong Kong, despite its status as an international financial hub, is dwarfed by global peers given its mere share of 0.06 percent in 2016, and still falls short of Japan’s 2.07 percent in the Asian context.

Our Hong Kong Foundation’s (OHKF) recent report cast light on the stymied growth of ESG investment in Hong Kong. ESG reporting is the cornerstone of ESG investment. Yet many companies are not disclosing what investors need for informed decision-making since reporting is simply treated as a “box-ticking” exercise and ends up with a diverse range of quality.

Investors may find it difficult to apply any ESG strategy to investment processes when ESG disclosures are “limited” with little hint of materiality assessment, assurance, comparability, or integration into business strategy, despite the overabundance of information and data. But if investors are not confident or interested in ESG integration, companies may lack the incentives to divert resources into compiling high-quality ESG reports and enhancing ESG performances, which perpetually inhibits the growth of ESG investment.

The crux of solving this predicament faced by companies and investors in Hong Kong lies with the timely and necessary policy interventions to strengthen the ESG regulatory regime that is currently lax in nature.

On the reporting side, Hong Kong Exchanges and Clearing (HKEX) is uniquely positioned to bridge the communication gaps between companies and investors toward greater transparency and efficiency of capital flows. HKEX should seek to influence reporting practices among issuers in line with the latest international developments, such as the Task Force on Climate-related Financial Disclosure, and has a role to play in facilitating issuers to internalize ESG considerations toward more strategic-driven reporting.

One of the key directions that OHKF advocates for regulatory improvement is to strengthen the role of board in ESG oversight and require disclosures on aspects such as ESG strategy and management systems, and the process of materiality assessment. We are happy to see that this aligns with one of HKEX’s proposals in its current market consultation to enhance ESG disclosure requirements.

Disclosure requirements should also be refined and narrowed in a sector-specific manner so that issuers can focus on reporting the most material indicators that come in handy for investor decisions. While the sector-specific focus was not addressed in HKEX’s consultation, we believe materiality will continue to be a crucial dialogue that requires coordinated efforts from all market participants toward maximized effectiveness and efficiency of ESG reporting.

On the investment side, the HKSAR government as one of the world’s largest asset owners should lead by example to enhance investors’ adoption and disclosure of ESG integration into investment analyses and decision-making processes.

In particular, the Securities and Futures Commission should consider upgrading the Principles of Responsible Ownership so that asset managers would have to disclose their ESG integration throughout the investment processes, or explain “why not”, in comparison to the current voluntary approach. Hong Kong Monetary Authority and Mandatory Provident Fund Schemes Authority can also exert influence on their external asset managers in promoting the integration of ESG factors into investment decisions, as an effort to incentivize the market to follow suit.

The market sentiments around ESG are becoming growingly positive in Hong Kong. The first half of 2019 has seen a series of actions launched by regulators, including HKMA introducing key measures on sustainable banking and green finance, SFC launching a survey on ESG integration in asset management and HKEX’s ESG consultation mentioned earlier.

As China embraces green finance in its strategic agenda and is ready to mandate corporate environmental disclosure by 2020, Hong Kong can play a strategic role as a pioneering platform for green projects and businesses while aligning China’s capital markets with international standards. To unleash its potential, Hong Kong needs to build a regulatory regime conducive to facilitating integration of environmental and social considerations into business and investment decisions.