Policy revamp is key to ESG market development

This article appeared originally in the Hong Kong Economic Journal on 14 February 2020 
Authors: Stephen Wong, Deputy Executive Director, and Johnson Kong, Researcher at Our Hong Kong Foundation

Under the gloomy shadow of exacerbating global warming and widening inequality rift, Environmental, Social and Governance (ESG) has become a growing focus of global investments and received significant attention from central banks and regulators.

ESG investing is rapidly on the rise in Europe, the USA and Japan, and globally its scale exceeded US$30 trillion in 2018. In Hong Kong, however, ESG market development has been way behind its international peers.

ESG investment practices below expectations

Findings from a recent survey by the Securities and Futures Commission (SFC) indicated that the ESG performance of Hong Kong’s asset management companies fell far short of asset owners’ expectations. Among the 794 active asset management companies surveyed, only about 29% had systematically incorporated ESG factors into their investment and risk management process, although over 80% indicated they had considered at least one ESG factor in their investments.

Most of the asset owners interviewed expected asset management companies to be able to identify, evaluate and manage investment risks associated with climate change, yet only 19% of the asset management companies had set up processes to manage climate risks and barely any discussed climate risks with their clients. Climate change remains a peripheral issue in the city’s asset management industry despite its increasingly felt financial impacts.

The lack of transparency also fueled worries about greenwashing. Nearly 70% of the asset management firms which claimed to consider ESG factors admitted that information about their actual ESG practices was not available; even more did not disclose climate risk assessments. Asset owners expected ESG disclosure to go beyond empty marketing narratives and include useful contents such as evidence of ESG impact and rigorous analysis of ESG risks.

The apparent discrepancy between asset owners’ expectations and asset managers’ practices is hardly negligible. With that, financial regulators must step up to protect asset owners and meet their expectations for ESG investment.

Right direction, yet clearer signals needed

Launched in May 2019, Our Hong Kong Foundation’s ESG advocacy report includes 13 recommendations for policymakers and regulators to speed up ESG market development. Among the three near-term measures proposed by the SFC, namely setting expectations of asset management companies, providing guidance and trainings, and setting up an industry group, the latter two are in line with our recommendations to address the needs for capacity building and cross-sector coordination.

For the first measure, while it is encouraging to see the SFC’s resolution to craft ESG standards for aspects ranging from governance to disclosure, a clear vision of the standards remains missing. Instead of reinventing the wheel, we believe the SFC should develop the new standards or extend the existing Principles of Responsible Ownership (PRO), which for now focuses solely on corporate engagement on ESG issues, based on the United Nations Principles for Responsible Investment (PRI), which is characterized by the full integration of ESG considerations in the investment process.

It is also unclear how stringent the ESG standards would be applied to asset management companies, as the SFC uses a rather vague and loose phrase – “set expectations”. The SFC’s voluntary PRO has failed to catalyze significant market development given a lack of internal driving forces, and it is unlikely that another voluntary code would lead to a different result. The SFC should adopt at least a “comply-or-explain” approach, which is a baseline among European ESG regulations, when applying its upcoming ESG standards.  

A more proactive role of the Government needed

Regulators, including the SFC, the Hong Kong Stock Exchange and the Hong Kong Monetary Authority, have been the major drivers of Hong Kong’s ESG development. While the Hong Kong Government’s efforts in boosting Hong Kong’s green bond development should be recognized, it has been passive in other green finance areas such as ESG investment. The absence of measures for ESG development in the Policy Address last year is inevitably disappointing, given the Government’s pivotal role in nurturing a thriving ESG ecosystem.

The indispensable role of the Government can be elaborated with one of the SFC’s measures. While setting up an industry group could facilitate the exchange between the SFC and industry experts, the effort could contribute only so much to wider planning for Hong Kong’s ESG development. Since all parties in an ESG ecosystem, including corporates, investors, asset owners, service providers and policymakers are interrelated and interdependent, the development of an effective and comprehensive ESG strategy would take effective communication and coordination among all these parties, including those among regulators and policymakers. In this process, the Government is well positioned to play the role of facilitator, a role that can hardly be played as effectively by any regulator.

In July 2019, the British Government published a comprehensive “Green Finance Strategy”, where its interdisciplinary Green Finance Taskforce had played a key role in designing the national blueprint. In light of the experience, the Hong Kong Government should follow suit and set up a similar cross-sector steering committee, so as to draw an overarching blueprint for Hong Kong’s ESG development.