How to Mitigate Climate-Related Risk in Funds

Published on September 23, 2021 by Pooja Mukherjee

In August 2021, the Securities and Futures Commission (SFC) issued amendments to the Fund Manager Code of Conduct (FMCC) and released a circular defining the climate-related to be factored in while making disclosures. These requirements focus primarily on setting standards for fund managers actively managing collective investment schemes.

In this article, we take a look at SFC’s conclusions on the proposed climate-related risk management and disclosure requirements for fund managers. These conclusions set out SFC’s analysis of the responses to the consultation and the final amendments to the FMCC. The commission will require fund managers to implement these climate-related practices as early as 20 August, 2022.

Overview:

The amendments to the FMCC seek to implement the Recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) for Hong Kong’s fund management sector. Fund managers will have to comply with a set of baseline requirements on climate related governance, investment management, risk management and disclosures; these include the following:

• Ensuring board and management-level oversight of climate-related issues
• Identification of climate-related risks relevant to their investment strategies
• Addition of climate-related risks to risk management procedures and
• Addition of climate-related risks to risk management procedures and

While smaller fund managers are not required to disclose certain climate-related data, large fund managers must comply with additional comprehensive enhanced standards, which require them to stringently address climate-related risks.

Enhanced standards on risk management-related disclosures at entity or fund level:

• Large fund managers need to provide a description stating the engagement policy at the entity level and preferably provide examples to illustrate how material climate related- risks are to be managed and how the engagement policy would be implemented
• They should also provide details on the carbon footprint of the portfolio, allowing a reasonable estimation of Scope 1 and Scope 2 greenhouse gas (GHG) emissions associated with the funds, and indicate the calculation methodology, underlying assumptions and limitations, and the proportion of investments (e.g., in terms of the net asset value of funds) assessed or covered

Key takeaways:

• Considerably higher threshold for large fund managers
• Previously, the SFC’s threshold for assets under management (AUM) at large fund managers was USD4bn; this has now been raised to USD8bn, in any three months of the previous reporting year. Given this increase, a fewer number of Hong Kong fund managers would be subject to the enhanced standards requirement.
• Leveraging of group resources by local entities
• The SFC clarified that local fund managers may leverage group resources in the management of climate-related risks; however, the group’s local management would retain the responsibility to ensure local entities comply with the SFC’s requirements.
• Concerns about obtaining climate-related data
• The SFC recognises that it might be difficult to obtain climate-related data; a lot of the data may also be inaccurate for future decision making. In such scenarios, the SFC has offered some flexibility to fund managers; for example, large fund managers need to adhere to the enhanced standards, putting in reasonable effort to disclose certain specific emissions data, but if this data (such as climate-related information and statistics) is not available internally, they can obtain it from external data providers to generate an estimated result.
• Implementation of scenario analysis where relevant
• Large fund managers must take steps towards implementing scenario analysis (i.e., contingency planning), focusing on climate-related risks that are assessed as relevant and material for an investment strategy or the funds they manage. As this is done in the initial stage, the fund managers are expected to assess the relevance of the scenario analysis and accordingly develop a plan to implement it within a reasonable time frame.
• GHG disclosure metrics
• The SFC had initially proposed that large fund managers should disclose the weighted average carbon intensity (WACI) of their respective portfolios. However, in the Consultation Conclusion document, the SFC has recognised that industry participants, including the Task Force on Climate-Related Financial Disclosures (TCFD), are now delving into GHG disclosures in terms of enterprise value. Therefore, it has revised this proposal to allow large fund managers to take reasonable steps to identify the carbon footprint of a portfolio, determine the Scope 1 and Scope 2 GHG emissions of a fund’s underlying investments and disclose these as enterprise value-based metrics. The calculation used to determine the portfolio’s carbon footprint has been mentioned under Annexure E of the Consultation Conclusion document. This is a value based metric, expressed as tons of carbon dioxide (CO2) equivalent per million dollars invested, as against WACI, which is revenue based as it is expressed in terms of CO2 equivalent per million dollars of revenue generated by portfolio companies.
• Timelines for implementation
• The SFC has extended the implementation timeline; all fund managers, including large fund managers, have a 12-month transition period to comply with the baseline requirements; in addition, large fund managers have a 15-month period to comply with the enhanced standards.

We believe that the climate-related requirements set by the SFC can help asset managers channel the investment capital of companies towards sustainable development, facilitating the transition to a low-carbon economy.

Originally published at https://www.acuitykp.com.

About the Author

Pooja Mukherjee, Associate, has over 4+ years of experience in compliance and Investment banking having worked for PwC previously. Her expertise spans across compliance and risk sector, focusing on compliance reviews of marketing/advertising materials and Code of Ethics. At Acuity Knowledge Partners she is part of the Corporate Compliance team and specializes in marketing material reviews. Pooja is a Bachelors of commerce graduate and holds a Masters of Commerce degree from Shri Shikshayatan College Kolkata.