CSj interviews Julia Leung, Deputy Chief Executive Officer and Executive Director, Intermediaries, Securities and Futures Commission (SFC), on the potential for developing Hong Kong as a green finance centre.

What is the underlying rationale for pushing green financing for Hong Kong? Is it a global trend and what are you seeing globally?

‘Globally, green finance has gathered momentum since the Paris Agreement (the 21st Conference of the Parties Agreement under the United Nations Framework Convention on Climate Change, concluded in Paris in December 2015), which calls for “making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development”. This is particularly relevant since the Paris Agreement also applies to Hong Kong, and Mainland China has made green finance an important priority as it transitions to a sustainable economy. Mainland China and Europe have been taking the lead in pursuing a common goal of establishing a green financial system. It is important that these initiatives are coordinated at the global level. If a coalition of the like-minded forms a large enough block, it can drive the change better. As China’s international financial centre, Hong Kong is well positioned to connect green finance flows between the Mainland and the rest of the world, and complement the Mainland’s green finance development. Given the expansion of the mutual market access, we recognise that Hong Kong needs to properly align itself with the Mainland’s ambitious initiatives on green finance. It is imperative for Hong Kong to have a good grounding to develop green finance locally, and to enhance its green finance cooperation with the Mainland and overseas jurisdictions. This would require Hong Kong to be at the forefront of global development in green finance, and to go beyond green bond issuance.’

In Hong Kong, which is the main policy bureau in charge of this area? What are the policy initiatives and the complementary role of the SFC in this connection?

‘Green finance is an area that requires multidisciplinary expertise from different sectors. As a result, the government, along with various authorities and organisations, have been playing their part to develop supporting policies and initiatives. These include the government’s Green Bond Programme and Hong Kong’s Climate Action Plan 2030+, which was prepared by the Environment Bureau in collaboration with members of the Steering Committee on Climate Change, such as the Financial Services and Treasury Bureau. Other efforts have also been crucial. These include the focus on green bonds by the Hong Kong Monetary Authority; the updated How to prepare an ESG report? A step-by-step guide to environmental, social and governance (ESG) reporting, issued by Hong Kong Exchanges and Clearing Ltd (HKEX); the Green Finance Certification Scheme of the Hong Kong Quality Assurance Agency; papers by the Financial Services Development Council regarding Hong Kong as a regional green finance hub and its ESG strategy; and the establishment of the Hong Kong Green Finance Association. The SFC has been working closely with the government, relevant authorities and other organisations to exchange ideas on how to further develop green finance in Hong Kong. As a first step, we published the SFC’s Strategic Framework for Green Finance last September to complement and move beyond Hong Kong’s current focus on green bonds. In alignment with the green finance initiatives of major securities market regulators, we specifically focus on two crucial areas that are interrelated and reinforce one another. The first is listed companies’ disclosure of environmental information and climate change–related risks and opportunities. The second is asset managers’ integration of environmental and climate risk factors into the investment and risk management processes, based on information disclosed by companies that they invest in. Other areas of focus include enhancing the transparency and comparability of green/ESG investment products offered to retail investors. In view of the innovative green finance initiatives by leading stock exchanges worldwide, we are also in discussion with HKEX on how it can develop and promote the listing and trading of green financial products such as bonds, indices and derivatives. Together with the Investor and Financial Education Centre, we are also planning to increase investor understanding of green finance.’

Can you explain the approach you have taken to put Hong Kong on a path to becoming a green finance hub?

• ‘As a regulator, we approach green finance a bit differently from others. A few years ago, one would say it’s a corporate social responsibility (CSR) to invest responsibly or to reduce pollution. There has been a shift – increasingly, severe weather, climate events and environmental degradation are demonstrably posing a financial risk to companies and their investors. Questions are being asked along these lines on green finance.
• Should capital flows be orientated towards green investment in order to achieve sustainable growth?
• If the environment and climate change are giving rise to financial risks, are those risk factors being properly assessed and managed?

For example, it is often said that climate change gives rise to two main financial risk factors. The first is physical risks, which are related to specific weather events (such as heat waves, floods, wildfires and storms). The physical impacts of extreme weather and climate events are increasingly apparent. They disrupt resource availability, production capacity and supply chains, increase operational and maintenance costs, and impair asset values and investment returns. The second risk factor is transition risks that could lead to reappraisal of prices of the entire sector – the transition towards a green, low-carbon economy presents business opportunities but also poses risks to those who fail to adapt (for example, Mainland China shuts down highly polluting factories). This transition also affects energy and commodity prices, corporate bonds, equities and certain derivatives contracts. Another question is whether there should be greater transparency of these risks and greater disclosure on how these activities are being handled by companies. To put Hong Kong firmly on the path to becoming a green finance hub, there is a need to move beyond CSR, and for the public, private sector and regulators to give more thoughts to these strategic issues and work out a coordinated action plan. It’s not solely about issuing green bonds but about changing investment behaviour, measuring environmental and climate risks and directing capital flows to sustainable investments.’

How many SFC-authorised funds are there currently with an investment focus on climate, green, environmental or sustainable development, or some other yardsticks under the green banner (and what are these yardsticks)?

‘Currently, there are over 20 SFC-authorised funds with an investment focus on climate, green, environmental or sustainable development. The SFC’s preliminary review of these funds shows that although most funds have disclosed ESG-related elements in their investment objectives or strategies, a majority do not specifically disclose how investment managers integrate ESG factors into the criteria used in the investment selection process for the fund portfolio. It is important to note that the Code on Unit Trusts and Mutual Funds stipulates that, if the name of the fund indicates a particular objective, the fund should invest primarily (that is, at least 70% of its assets) in investments to reflect the particular objective which the scheme represents. In addition, the offering documents of the fund should contain full and proper disclosure of the investment policy and strategy with sufficient details necessary for investors to be able to make an informed judgement of the investment.’

Are you seeing an increase in the number of new fund applications adopting, or applications for a change of investment strategy to adopt, a green theme?

‘We have seen a noticeable increase during 2018 in the number of new fund applications and applications for a change of investment strategy to adopt an ESG investment theme.’

For listed companies, your Strategic Framework for Green Finance highlights a number of potential challenges for green finance in Hong Kong, for example areas for enhancement in listed companies’ disclosure of environmental information. How does the SFC intend to tackle this problem?

‘Principle 16 of the International Organisation of Securities Commissions (IOSCO) Objectives and Principles of Securities Regulation states that issuers should provide “full, accurate, and timely disclosure of financial results, risk, and other information which is material to investors’ decisions”. ESG matters, though sometimes characterised as non-financial, may have a material short-term and long-term impact on the business operations of issuers, as well as on risks and returns for investors and their investment and voting decisions. We see a momentum building up elsewhere in the world that environmental and climate risks are being regarded and managed as any other financial risk, as opposed to CSR. For listed companies, there needs to be a fundamental transformation in governance and thinking: from completely ignoring environmental degradation and climate change or getting the sustainability department to deal with it, to managing it as a major strategic risk and opportunity management issue. As a priority, the SFC is working with HKEX to enhance listed companies’ reporting of environmental information emphasising climate-related disclosure, taking into account the Mainland’s policy direction to target mandatory environmental disclosure, and aiming to align with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). HKEX, as the frontline regulator of the listing rules, also updated its Step-By-Step Guide to ESG Reporting and Frequently Asked Questions on its ESG-related listing rules in November 2018, taking into account recent international climate-related disclosure recommendations and with an emphasis on the issuer’s governance structure for ESG reporting. It is also planning to review its disclosure framework and have informal discussions with stakeholders with a view towards consulting the market in mid-2019 on proposed changes to its rules.’

For asset managers, how does the SFC intend to tackle the issue of insufficient disclosure by asset managers of the metrics behind sustainable investing? For example, how can regulators or investors know that it is not just ‘greenwashing’?

‘Regulators’ mandate is investor protection. If it is generally accepted that climate and environment degradation pose financial risks, and if that is material, it follows that such risks be disclosed. Last December, European Securities and Markets Authority (the European Union’s regulator for public and private fund managers) put out consultation papers on how to integrate sustainability risks and factors in investment funds in the EU. Those papers consult on the high-level principles that obligate fund managers to assess and manage the relevant financial risks stemming from climate change and to foster transparency of these activities. Other aspects that are covered include product governance and clients’ ESG preferences, which gets into suitability areas. It’s too early to say whether these proposals should be adopted in Hong Kong. As part of our Strategic Framework for Green Finance, we are preparing a survey to better understand the ecology, current practices of asset managers and asset owners on how they integrate environmental and climate factors into their commitment, investment and risk management processes, post-investment ownership practices and disclosure. The survey will cover asset managers of different types and sizes, as well as those using different investment strategies. Based on the survey outcome, we will consider appropriate policies, codesand guidance.’

Do you think there needs to be more comparability of green finance information and data? For example, would you like to see convergence to a single, international reporting framework for ESG disclosures?

‘Enhancing the comparability of green finance information would be particularly helpful to asset managers, analysts and other users of information along the investment value chain and to prevent greenwashing. Currently there is no shortage of standards but the many different standards available make comparison difficult. When one talks about disclosure, is there a common language of what is sustainable investment? The European Union is taking a lead in developing a unified classification system for sustainable economic activities. Globally, the convergence of ESG disclosure standards already appears to be the direction of travel. For example, major reporting frameworks such as the Global Reporting Initiative, Carbon Disclosure Project and the Sustainability Accounting Standards Board, have announced a joint effort aimed at simplifying reporting standards to align with the TCFD recommendations. This is an area where regulators could work further with the industry.’

Do you think the TCFD framework is a good model to follow?

‘The TCFD is a sophisticated disclosure framework for both the financial and non-financial sectors. Traditionally, companies have often focused on disclosing how their business or operation impacts the environment, whereas the TCFD focuses the other way around, that is, how companies’ businesses or financial position could be affected by risks and opportunities arising from climate change. Not only is this useful information for companies to plan their short-, medium- and long-term strategies, it also helps investors make investment decisions. This is important if we want environmental and climate risks to be managed as any other financial risk, rather than viewing them only as corporate social responsibility issues.’

Generally, can green finance succeed where governments are failing to ensure against the risks of climate change – for example with the US under the Trump Administration?

‘The SFC as a regulator looks at green finance from the perspective of investor protection, rather than froma political angle. Beyond a firm’s impact on the environment and climate change, there is increasing attention on the reverse direction of such interactions, that is, the growing financial impact of the environment and climate change on firms, investment portfolios and capital markets. Among financial regulators, companies and asset managers, awareness has been growing internationally to enhance risk management and information disclosure. This falls within the remit of the SFC, given that ensuring risk management and proper disclosure are key to our regulatory objectives to maintain efficient and transparent markets, and to protect the investing public. Our approach to regulating the market has always been forward-looking, meaning that we expect firms to guard against current risks and those that could plausibly arise in the future. This strengthens and protects the integrity and soundness of Hong Kong’s securities and futures markets, which we regulate for the benefit of investors and the industry.’

What do you think will be the likely trend in green finance in Hong Kong and Mainland China in the future? And how can professional institutes like The Hong Kong Institute of Chartered Secretaries help in this regard?

‘Mainland China has made green finance an important priority as it transitions to a sustainable economy. This is a valuable opportunity for Hong Kong to fully leverage its position as China’s international financial centre to complement the Mainland’s green development ambitions and to connect green finance flows between the Mainland and the rest of the world. Hence, any credible plan for Hong Kong to develop green finance would need to be comprehensive and far reaching. Various authorities and organisations in Hong Kong have been contributing their part to develop supporting policies and initiatives to green the financial market. Given the increasingly important role of Chartered Secretaries in businesses, The Hong Kong Institute of Chartered Secretaries is well placed to provide training and encourage its members to start integrating environmental and climate change considerations into every aspect of their companies’ strategic direction, governance, management of risks and opportunities, and disclosure.’