New Hong Kong fund rules collide with China’s poor ESG data

Under proposed rules, funds will need climate risk data from investee firms, many of them Chinese

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Hong Kong asset managers fear that under rules proposed by the territory’s securities regulator, they will face a next-to-impossible task: disclosing their portfolios’ exposures to climate risk without knowing the climate performance of many companies in those portfolios.

Funds point the finger at the poor quality of environmental, social and governance (ESG) reporting by companies in mainland China, which is a major investment target for Hong Kong’s asset managers.

“Carbon emissions data is one of the most important materials for managing climate risk, but many disclosures of listed companies in China are inadequate and I don’t think we are going to be able to get good-quality data on them, at least in the very near term,” says Thomas Kwan, chief investment officer of Harvest Global Investments, a Hong Kong firm with $121 billion under management.

An in-house lawyer at a European asset manager is more blunt about the problem caused by patchy corporate disclosures in any country. “We invest all over the world, including in China, and if listed companies are not producing the figures we need, how can we analyse our ESG risk?” the person says.

In a consultation paper last year, Hong Kong’s Securities and Futures Commission said fund managers would be required to take climate-related risks into account in their investment process, as well as provide climate risk information to meet investor demand and to combat greenwashing.

“Fund managers should understand and monitor how investee companies deal with climate change and, where appropriate, encourage them to develop policies for handling the climate-related risks inherent in their businesses … through active engagement rather than merely reducing the fund’s exposure to climate-related risks through divestment,” the SFC wrote.

But monitoring companies in this way is difficult since the quality of ESG disclosures by Chinese companies remains poor, as noted in a June 2020 report by China’s Ping An Insurance.

Without a unified set of guidelines, companies lack clarity on [what is] the most material information for their shareholders
Chex Yu, Ping An Insurance

“On average, the scope and quality of ESG disclosures among CSI 300 companies in mainland China rank the lowest among companies that are part of major stock market indices,” the report said. The CSI 300 is the index of the 300 largest and most liquid A-shares – shares of companies based in mainland China that are traded on the Shanghai and Shenzhen stock exchanges.

Funds blame this, at least in part, on a lack of clear guidelines about the kind of ESG information mainland companies should provide.

The companies’ ESG disclosures are governed by a jumble of compulsory and voluntary standards on some aspects of sustainability, such as pollution control and use of natural resources. Another example is found in China’s corporate governance code, which says listed companies should disclose “environmental information and social responsibility-related matters … in accordance with laws and regulations and the requirements of competent authorities”.

Chex Yu, an executive at Ping An Insurance, comments: “Without a unified set of guidelines, companies lack clarity on [what is] the most material information for their shareholders. This can be detrimental to investors due to selective disclosures and lack of comparability. Most companies also have little to no process for collecting high-quality climate risk and ESG-related data.”

The latest regulatory push towards better ESG reporting in China came in February, when the China Securities Regulatory Commission proposed amendments to investor relations guidelines. The revised guidelines said listed companies should regularly provide investors with information on their environmental protection efforts, social responsibility and corporate governance – however, there were no further details. The consultation closed in March.

The CSRC declined to comment on whether it planned more measures on climate-related disclosures.

Engage, don’t divest

While, as things stand, Hong Kong funds will struggle to meet the proposed SFC requirements, the very existence of the rules may eventually make that easier. The rules will compel asset managers in Hong Kong to focus on climate risk, forcing them to engage more with mainland companies, and this could in turn improve ESG disclosures by the firms.   

“The size of our capital markets in Hong Kong means we can take a leadership role in global climate finance and at the same time help successfully reduce emissions in China, in line with its national goals,” says Ashley Alder, SFC chief executive. China has committed to reach net zero emissions by 2060.

Suen Son Poon, chief operating officer of Income Partners, a Hong Kong-based asset manager specialising in fixed income, echoes this sentiment, noting the SFC’s emphasis on engagement rather than divestment in its proposed rules.

“If enough of us ask the same questions, eventually the [mainland] companies and their investment relations departments will have to adapt,” he says.

But he adds that it would be helpful if the regulator defined engagement.

The SFC declined to say whether it planned to issue further guidance on how asset managers should engage with the firms they invest in. Poon suspects that the ambiguity over engagement may be deliberate as the commission may prefer funds to use their own judgement on this rather than be too prescriptive.

Chinese companies are not alone in lacking transparency on their climate risks. Only about a third of companies in Asia-Pacific make disclosures recommended by the Task Force on Climate-related Financial Disclosures, which was set up by the Financial Stability Board. That is still the second-highest share globally (see chart 1).      

 

 

For now, investors in mainland companies have to mine a variety of sources for ESG information. For instance, Fidelity International, one of the largest asset managers in the world and a keen investor in China, uses estimation models as part of its climate risk management framework to deal with markets where corporate disclosures are inadequate.

“[These] can be used to extrapolate the emissions profiles of companies,” says Jenn-Hui Tan, global head of stewardship and sustainable investing at the firm. “You can look at things like revenue streams, number of employees, production volume and use that data to work out expected emissions for a company of a particular size in a particular industry.”

Another way to gain an insight into a company’s climate risk is to source data from third-party providers. But this option is not without its challenges.

Harvest’s Kwan says the data on offer varies widely across different providers, with some taking a specialised focus and others covering a broad range of ESG metrics. Data providers use their own proprietary methods to process and standardise the data, which makes it difficult to compare like-for-like across different vendors.

The SFC consultation closed in January.

Additional reporting by Blake Evans-Pritchard, editing by Olesya Dmitracova

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