Application of the climate-related risks requirements under the Fund Manager Code of Conduct (FMCC)

These Frequently Asked Questions (FAQs) aim to provide guidance on the application of the climate-related risks requirements under the Fund Manager Code of Conduct (FMCC) and the baseline requirements and enhanced standards set out in the Circular to licensed corporations – Management and Disclosure of Climate-related Risks by Fund Managers (Circular) (collectively referred to as the Requirements). These FAQs should be read in conjunction with the FMCC and the Circular. They may be updated to provide additional guidance as needed.

A. Applicability of the Requirements

Q1 : How should Fund Managers determine the applicability of the Requirements?

Governance, investment management and risk management requirements
To determine the scope and applicability of the requirements (ie, governance, investment management and risk management), Fund Managers should first consider whether they have discretion over the investment management processes as illustrated in the Flowchart under Appendix 1 of the Circular. If the answer is affirmative, these requirements are applicable based on the relevance and materiality of climate-related risks to the investment strategies and funds managed by the Fund Managers, and to the extent of a Fund Manager’s role. For example:

- If a Fund Manager is delegated with the overall investment management function of a collective investment scheme (CIS), it shall observe the governance, investment and risk management requirements irrespective of whether the fund is distributed in Hong Kong.

- If a Fund Manager is delegated with investment discretion but subject to the risk management framework, process and parameters implemented at the delegating entity, it would only need to adhere to the governance and investment management requirements, but not the risk management requirements.

- In the event a Fund Manager is delegated with investment discretion for a portion of a CIS, it should comply with the requirements proportionate to its circumstances, ie, limited to the portion of assets under its management and the role assigned to it. Hence, in a situation where a Fund Manager only has discretion to manage a portion of the fund and is not responsible for the entire fund’s investment and risk management functions, that Fund Manager is required to comply with the requirements only for the portion of assets under its management and it will not be expected to be responsible for managing climate-related risks at the fund level.

- If a licensed corporation acts as an investment advisor for a CIS without having any investment management discretion, then the licensed corporation will not be expected to comply with the Requirements. The same applies to situations where a licensed corporation only acts as the distributor of a CIS.

The SFC wishes to reiterate that if a Fund Manager has overall investment management discretion for a CIS and it has subsequently delegated its investment management or risk management function to its group entities or third-party delegates, the Fund Manager shall retain the responsibility for ongoing monitoring of the competence of group entities or delegates to ensure that the principles of the requirements are followed¹.

Disclosure requirements
The disclosure requirements will be applicable to those Fund Managers who are responsible for the overall operation of funds², but will not be applicable to those who manage only part of a fund.

B. Threshold for defining Large Fund Managers

Q2 : Is a Large Fund Manager required to comply with the enhanced standards in the following reporting year if its monthly CIS AUM³ do not equal or exceed the $8 billion threshold for any three months in the current reporting period?

A: If a Fund Manager’s monthly CIS AUM no longer meets the threshold for any three months during the current reporting year, it is not mandatory to comply with the enhanced standards in the following reporting year. However, the Fund Manager is encouraged to observe the enhanced standards voluntarily to maintain consistency and facilitate comparison.

C. Investment and risk management

Relevance and materiality assessments of climate-related risks

Q3 : Can the SFC provide guidance on how Fund Managers can identify relevant and material climate-related risks?

A: Given the broad spectrum of climate-related risks and the wide range of financial assets and investment strategies in the market, the SFC considers that it is more appropriate to take a pragmatic approach and allow Fund Managers the flexibility to determine whether climate-related risks are relevant and material based on their investment strategies.

When identifying climate-related risks, Fund Managers are encouraged to look beyond their usual investment horizon in particular when portfolio assets will be reinvested in similar investments. Physical and transition risks which are not likely to have a material impact in the short term may become material in the medium or long term if the portfolio assets are reinvested in similar sectors or asset classes. Fund Managers should consider how such risks may affect their strategies and can be factored into their investment management processes if they may become material over time.

In some circumstances, a Fund Manager may assess that climate-related risks are irrelevant to its investment and risk management processes owing to the nature of a fund’s investments or strategy (eg, a quantitative fund, macro strategy fund, index tracking fund, forex fund or managed futures fund), or the time horizon of the investments (eg, day trading). The Fund Manager could exercise its professional judgement by making reference to the publications and standards of other organisations. The Fund Manager should ensure its conclusions are justifiable and maintain appropriate records explaining why climate-related risks are irrelevant. The Fund Manager should also disclose the types of investment strategies or funds for which climate-related risks are considered irrelevant to enable investors to distinguish these funds. This disclosure could be made at an entity or fund level.

When assessing the materiality of the impact of climate-related risks on an investment strategy or a fund, Fund Managers should adopt an approach which is appropriate and proportionate to their circumstances. The approach can be qualitative, quantitative or some combination of both. Fund Managers can make reference to the publications and standards of international organisations⁴ which focus on climate change or sustainability in assessing the materiality of climate-related risks and developing their policies and procedures. Fund Managers should maintain appropriate internal records to demonstrate that they have assessed the materiality of the risks. In addition, when incorporating climate-related risks into investment management processes, a Fund Manager should not only focus on green-related investments but also monitor and manage the climate-related risks associated with high carbon intensity assets in order to properly manage the fund’s overall risk exposures.

The SFC expects that reviews or assessments be made on a regular basis and when triggered by any major changes such as to a fund’s investment strategy.

Passive strategies

Q4 : Can the SFC provide guidance on how passive Fund Managers adhere to the Requirements?

A: Funds adopting a passive investment strategy would not automatically be carved out from the Requirements. Fund Managers should assess the method used to replicate the underlying index. A full replication methodology which requires buying all the index constituents may justify being carved out. However, Fund Managers could adopt different methodologies for partial replication methodologies and enhanced passive strategies. For example, the United Nations-supported Principles for Responsible Investment (PRI) suggests that passive Fund Managers identify investee companies with high sustainability risks or poor ESG ratings and adjust the weights of portfolio constituents accordingly, or else exclude them from the portfolio within an acceptable tracking error range⁵. Fund Managers may adopt the aforementioned suggestions to the extent they are permissible according to the fund’s mandates and restrictions.

While Fund Managers may be constrained from deviating from a reference benchmark or index in their investment processes, they can manage the material climate-related risks of the underlying investments in various ways such as through exercising stewardship (eg, proxy voting) or engaging with index providers to enhance ESG considerations in index design. The SFC encourages Fund Managers to engage with the investee companies if possible as this could improve companies’ information disclosures and enhance their strategic and business resiliency to climate change.

D. Disclosure

Q5 : Fund Managers are required to make climate-related disclosures (with the exception of quantitative disclosures) to investors at the entity level. What is the SFC’s expectation if different governance structures, investment or risk management approaches are adopted across different strategies and funds?

A: The requirement to make disclosures at the entity level is designed to reduce the compliance burden of Fund Managers to disclose information if the same policies and processes apply consistently across different strategies and funds. If different governance structures, investment and risk management approaches are adopted across different strategies or funds, Fund Managers may elaborate on the strategy at the fund level as appropriate.

To help investors better understand the information disclosed, Fund Managers are encouraged to provide examples to illustrate how they implement their governance, investment and risk management policies and procedures.

Q6 : How should Large Fund Managers adhere to the enhanced standards in relation to engagement policy disclosure?

A: Given that Fund Managers have their own strategies and limitations⁶, the SFC is mindful to allow Fund Managers the flexibility to develop their engagement policies. While Large Fund Managers are required to disclose their engagement policies to investors, they have the discretion to determine their level of engagement having regard to the circumstances of each case. The SFC encourages Fund Managers to actively engage with investee companies, exercise their proxy voting rights on climate-related issues and disclose the voting records.

Disclosure of where climate-related risks are not relevant

Q7 : If a Fund Manager assesses that climate-related risks are irrelevant to its investment and risk management processes owing to the nature of a fund’s investments or strategy, can SFC provide guidance on (a) how should the Fund Manager disclose such exceptions; and (b) what are the documentation standards expected from the Fund Manager?

A: When climate-related risks are assessed to be irrelevant, the Fund Manager is required to disclose the types of investment strategies or funds for which climate-related risks are considered irrelevant to enable investors to distinguish these funds. The Fund Manager has the flexibility to make disclosures either at the entity or fund level. To facilitate comparison, for example, Fund Managers may consider stating at the entity level the types of investment strategies or funds for which climate-related risks are not relevant. On the other hand, some Fund Managers may prefer to disclose this in the fund documents to make it clearer to investors.

The Fund Manager is expected to exercise professional judgement in assessing the relevance of climate-related risks to an investment strategy or fund. The Fund Manager should ensure its conclusions of irrelevance are justifiable and maintain appropriate records explaining why climate-related risks are irrelevant in case of enquiries by investors or for compliance review purposes.

Fund Managers are expected to reevaluate the relevance of climate-related risks at least annually and update the disclosures as necessary.

Fund Managers can refer to the flowchart shown in Appendix 1 of the Circular for their obligations after making the relevance disclosure.

Quantitative disclosure of Greenhouse Gas emissions (GHG emissions)

Q8 : What is the SFC’s expectation on Large Fund Managers when making quantitative disclosures of GHG emissions as part of the requirements under the enhanced standards?

A: Large Fund Managers should make reasonable efforts to disclose available Scope 1 and Scope 2 GHG emissions data and state the calculation methodology, underlying assumptions and limitations. If data is not available for some assets under the fund, Large Fund Managers are expected to state the proportion of investments which are assessed or being covered by the metric disclosed. The SFC also welcomes Large Fund Managers to disclose Scope 3 GHG emissions alongside Scope 1 and Scope 2 emissions, if available.

Large Fund Managers may adopt different methods to collect climate-related data or information. For example, they could make reference to issuers’ published reports, engage with issuers directly or create estimates using official statistics and climate-related information from data providers. Some international organisations, such as the Partnership for Carbon Accounting Financials (PCAF), have provided options for Large Fund Managers to estimate the GHG emissions of their investments.

The SFC expects that the availability of climate-related data will improve over time. This information is essential for investors to assess the impact of climate-related risks and evaluate the performance of Fund Managers’ climate-related management practices.

The SFC also acknowledges reliability issues around calculating GHG emissions for a number of asset classes such as derivatives, sovereign debts and short positions. Our current approach has provided adequate flexibility for Large Fund Managers to deal with a situation where the industry has not yet developed a consistent and widely acceptable approach by allowing them to state their methodologies, limitations and coverage.

When assessing a Large Fund Manager’s compliance with the quantitative disclosure requirement, the SFC will adopt a reasonable and practical approach and focus on whether the Large Fund Manager has established proper procedures to obtain the required information and adhered to them.

Q9 : Can Large Fund Managers disclose GHG emissions metrics using different basis, such as revenue-based instead of enterprise value-based?

A: No. To promote consistency and comparability among different funds, the SFC requires Large Fund Managers, at the minimum, to follow the formula in the Circular to disclose the portfolio carbon footprint of the Scope 1 and Scope 2 GHG emissions of a fund’s underlying investments. Large Fund Managers can make reference to PCAF Standard⁷ in their calculation. Large Fund Managers could disclose additional climate-related metrics such as revenue-based, asset class specific⁸, forward looking or other enterprise value-based to investors where appropriate.

¹Paragraph 1.10 of the FMCC
² For the meaning of a Fund Manager responsible for the overall operation of a fund, please see answer to question 1 of the FAQs on the FMCC.
³ Assets under management
⁴ Fund Managers can also refer to the International Financial Reporting Standards Foundation, Sustainability Accounting Standards Board, the Principles for Responsible Investment (PRI), Task Force on Climate-related Financial Disclosures, the Climate Disclosure Standards Board, the Global Reporting Initiative, the International Integrated Reporting Council, and Partnership for Carbon Accounting Financials (PCAF).
⁵A Practical Guide to ESG Integration for Equity Investing, PRI, 2016.
⁶For example, a Fund Manager may not be able to engage with an investee company because it only invests in derivatives to gain exposure or only holds a very small position in the company.
⁷Global GHG Accounting & Reporting Standard published by PCAF
⁸For example, in the case of real estate funds, the industry generally regarded metrics such as LEED (Leadership in Energy and Environmental Design) ratings, NABERS (National Australian Built Environmental Rating System) and GRESB (formerly known as Global Real Estate Sustainability Benchmark) to be more decision-useful for investors.

Last update: 20 Aug 2021