It is certainly a 'bullish' outlook for environmental, social and governance ("ESG") investments.
High interest rates in the United States and Europe have presented new opportunities for ESG funds in Asia. Climate-related funds in China and Japan have raised more than US$6.5 billion in ESG Exchange-Traded Funds that invest in the APAC region, while existing ESG funds in Europe are allocating incrementally more to investments in Asia.1
Over in South Africa, ailing coal power plants have brought about crippling power cuts, severe power rationing, volatile commodity prices and weak economic growth. Africa's largest fund, the Public Investment Corporation (PIC), has committed to growing its investments in renewable energy beyond its existing US$854 million portfolio in photo-voltaic, concentrated solar power and wind technology.2
These examples are just the tip of the iceberg. With ever-increasing concerns over ESG issues globally, we are seeing a growing appetite for everything and anything that is ESG-related. Opportunistic investors are willing to pay "Greeniums" (ie., premium rates over "green" investments) in hopes of realising financial returns and fund managers are consequentially chasing the 'green' dollar. Others simply want to make the world a better place.
However, before you take the plunge into ESG investing, here are 3 important factors you should consider:
1. Evolving ESG disclosures and reporting standards
The ESG industry is nascent, and regulators globally are at different stages of developing regulatory approaches.
Singapore
The new Circular No. CFC 02/2022 on Disclosure and Reporting Guidelines for Retail ESG Funds was issued by the Monetary Authority of Singapore ("MAS") to specifically mitigate against greenwashing among authorised or recognised schemes lodged on or after 1 January 2023 (the "Circular").3
In addition to clarifying how requirements under the Code on Collective Investment Schemes and the Securities and Futures (Offers of Investments) (Collective Investment Schemes) Regulations apply to ESG funds, MAS further imposed enhanced reporting and disclosure requirements in respect of annual reports; ESG methodologies; sources and use of ESG data; due diligence; and stakeholder engagement policies. In particular:
- Where a scheme's name includes or uses ESG-related or similar terms (e.g. "sustainable", "green"), the scheme should reflect such an ESG focus in its investment portfolio and/or strategy in a substantial manner. In assessing whether it has done so "substantially", MAS will consider factors such as whether the scheme's net asset value ("NAV") is primarily invested in accordance with the scheme's investment strategy. Where it is impractical or impossible for a manager to determine the proportion of a scheme's NAV that is invested in accordance with ESG investing approaches, MAS expects the manager to explain in the offering documents how the scheme's investments are substantially ESG-focused.
- The scheme's prospectus should disclose its investment objective, focus, approach and risks of investment.
- The annual report of an ESG fund should disclose information including (i) how and the extent to which the scheme's ESG focus has been met during the financial period (and if any, a comparison with the previous period); (ii) the actual proportion of investments that meet the scheme's ESG focus; and (iii) actions taken by the scheme in attaining the scheme's ESG focus.
The Circular defines 'ESG fund' broadly as a scheme which (i) uses or includes ESG factors as its key investment focus and strategy and (ii) represents itself as an ESG-focused scheme.
Hong Kong
A revised circular published by the Securities and Futures Commission came into effect on 1 January 2022 which provides guidance to managers on enhanced disclosures for authorised funds that incorporate ESG factors as a key investment focus. The key requirements include the naming of funds to reflect such investment object or strategy; disclosure of ESG features in its offering documents; annual assessment of how the fund has attained its ESG focus. Managers are required to regularly monitor and evaluate the underlying investments to ensure that ESG funds continue to meet the stated ESG focus and requirements.
In April 2023, the Hong Kong Stock Exchange ("HKEX") also published the Consultation Paper on Enhancement of Climate-Related Disclosures under The Environmental, Social and Governance Framework wherein the HKEX proposes to mandate that all issuers make climate-related disclosures in their ESG reports (i.e. an upgrade from the current 'comply or explain' regime).
Japan
An amendment to regulations under the Financial Instruments and Exchange Act came into effect on 31 January 2023, which requires all public companies to make ESG-specific disclosures in their securities registration statements and annual securities reports for the fiscal year ending on or after 31 March 2023.
The framework for this new mandatory ESG disclosure follows the Task Force on Climate-related Financial Disclosures ("TCFD"). Before this amendment, the Corporate Governance Code of Japan required companies listed on the Prime Market of Tokyo Stock Exchange to enhance the quality and quantity of disclosures based on TCFD recommendations or equivalent standards. Now, this requirement is expanded to all listed companies and other companies which are subject to continuous disclosure obligations in Japan.
Across Singapore, Hong Kong and Japan, the regulators have tightened ESG reporting and disclosure requirements. Annual reports and/or assessments are now commonly required and 'tag' on to existing reporting obligations.
We await to see if the 'comply or explain' regime might evolve to strict mandatory disclosures in Singapore and Hong Kong, while Japan has led the pack in implementing mandatory obligations from the get-go.
2. Due diligence
ESG investing reflects the desire to see that investments are ethically and sustainably placed. Therefore, the success of an ESG-focused investment hinges on whether the chosen ESG goals will or have been achieved. To this end, ESG due diligence and discussions with your advisors is crucial to:
- unearthing and assessing potential 'red flags' in your investment;
- understanding how ESG factors can be incorporated into investment advertising, fund raising and fund structuring to supplement traditional indicators of success;
- structuring deals and arrangements to best reflect investor and growth expectations; and
- avoiding unnecessarily complex deal structures and extensive negotiations.
3. Regulation of performance evaluation indicators
There is currently no universally adopted standardised performance evaluation indicators. This gives rise to varying methodologies in assessing of the success of ESG investments.
The Final Report on ESG Rating and Data Product Providers published by the International Organization of Securities Commissions (IOSCO) in November 2021 revealed among other observations, the following deficiencies with the current state of ESG rating and data products:4
- insufficient clarity and alignment on definitions, including on what ratings or data products intend to measure;
- a lack of transparency about the methodologies underpinning ratings or data products; and
- concerns about the management of conflicts of interest between the rating/ data provider and the subject of evaluation.
In response to these deficiencies, regulators in some Asian jurisdictions have introduced guidelines to promote transparency and accountability in ESG fund management.
Singapore
Where appropriate, the Circular requires additional information regarding an ESG Fund, its manager or index providers to be disclosed to current or prospective investors by appropriate means (eg. on the manager's website). This include, for example:
- how the ESG focus is measured and monitored, and a description of the internal and external control mechanisms in place to monitor compliance with the scheme's ESG focus on a continuous basis (including methodologies used);
- information relating to the sources and usage of ESG data, or any assumptions made where such data is lacking;
- the due diligence carried out in respect of the ESG-related features of the scheme's investments; and
- stakeholder engagement policies (including proxy voting) that can shape corporate behaviour of companies that the scheme invests in and contribute to the attainment of the scheme's ESG focus.
In conjunction with these enhanced disclosure requirements relating to performance evaluation indicators and building upon the IOSCO's recommendations for good practices, the MAS on 6 December 2023 published its finalised Code of Conduct for ESG Rating and Data Product Providers (the "CoC")5 and an accompanying checklist for providers to self-attest their compliance to the CoC (the "Checklist").6
The CoC and the Checklist are implemented on a "Comply or Explain" basis and some of the best practices stated in the CoC include:
- ensuring that where an ESG rating is prepared on an issuer-paid basis, the ESG rating provider and its personnel should not: (i) enter into any contingent fee arrangement for providing ESG rating services nor (ii) selectively disclose any information that are not publicly available about the ESG rating, possible future issues or revisions of any ESG rating by it, except to the issuer of the capital markets product or its designated agents;
- initiating a review of the ESG rating and revising it as appropriate upon becoming aware of any public information that may reasonably be expected to result in a revision or termination of the ESG rating;
- maintaining records to support every ESG rating and data products that is issued;
- assessing whether the ESG rating provider is able to devote sufficient personnel with the necessary skill sets to make a proper ESG rating assessment and whether its personnel will likely have access to sufficient information needed in order to produce the ESG rating; and
- making clear in a prominent place if the ESG rating is based on limited data.
Hong Kong
The HKEX has also published guidelines in respect of ESG issues for companies listed on the HKEX. Appendix C2 of the Listing Rules being the Environmental, Social and Governance Reporting Guide (the "Guide") sets out two levels of disclosure obligations: (a) mandatory disclosure requirements and (b) 'comply or explain' provisions.
The Guide is organised into two ESG subject areas, Environmental and Social. Corporate governance is addressed separately in the Corporate Governance Code. Each subject area comprises various aspects, and each aspect sets out general disclosures and key performance indicators ("KPIs") for issuers to report on in order to demonstrate how they have performed.
In addition to the 'comply or explain' matters set out in the Guide, the Exchange encourages an issuer to identify and disclose additional ESG issues and KPIs that reflect the issuer's significant environmental and social impacts; or substantially influence the assessments and decisions of stakeholders. In assessing these matters, the issuer should engage stakeholders on an ongoing basis in order to understand their views and better meet their expectations. The board has overall responsibility for an issuer's ESG strategy and reporting.
It is certainly a 'bullish' outlook for environmental, social and governance ("ESG") investments.
High interest rates in the United States and Europe have presented new opportunities for ESG funds in Asia. Climate-related funds in China and Japan have raised more than US$6.5 billion in ESG Exchange-Traded Funds that invest in the APAC region, while existing ESG funds in Europe are allocating incrementally more to investments in Asia.1
Over in South Africa, ailing coal power plants have brought about crippling power cuts, severe power rationing, volatile commodity prices and weak economic growth. Africa's largest fund, the Public Investment Corporation (PIC), has committed to growing its investments in renewable energy beyond its existing US$854 million portfolio in photo-voltaic, concentrated solar power and wind technology.2
These examples are just the tip of the iceberg. With ever-increasing concerns over ESG issues globally, we are seeing a growing appetite for everything and anything that is ESG-related. Opportunistic investors are willing to pay "Greeniums" (ie., premium rates over "green" investments) in hopes of realising financial returns and fund managers are consequentially chasing the 'green' dollar. Others simply want to make the world a better place.
However, before you take the plunge into ESG investing, here are 3 important factors you should consider:
1. Evolving ESG disclosures and reporting standards
The ESG industry is nascent, and regulators globally are at different stages of developing regulatory approaches.
Singapore
The new Circular No. CFC 02/2022 on Disclosure and Reporting Guidelines for Retail ESG Funds was issued by the Monetary Authority of Singapore ("MAS") to specifically mitigate against greenwashing among authorised or recognised schemes lodged on or after 1 January 2023 (the "Circular").3
In addition to clarifying how requirements under the Code on Collective Investment Schemes and the Securities and Futures (Offers of Investments) (Collective Investment Schemes) Regulations apply to ESG funds, MAS further imposed enhanced reporting and disclosure requirements in respect of annual reports; ESG methodologies; sources and use of ESG data; due diligence; and stakeholder engagement policies. In particular:
- Where a scheme's name includes or uses ESG-related or similar terms (e.g. "sustainable", "green"), the scheme should reflect such an ESG focus in its investment portfolio and/or strategy in a substantial manner. In assessing whether it has done so "substantially", MAS will consider factors such as whether the scheme's net asset value ("NAV") is primarily invested in accordance with the scheme's investment strategy. Where it is impractical or impossible for a manager to determine the proportion of a scheme's NAV that is invested in accordance with ESG investing approaches, MAS expects the manager to explain in the offering documents how the scheme's investments are substantially ESG-focused.
- The scheme's prospectus should disclose its investment objective, focus, approach and risks of investment.
- The annual report of an ESG fund should disclose information including (i) how and the extent to which the scheme's ESG focus has been met during the financial period (and if any, a comparison with the previous period); (ii) the actual proportion of investments that meet the scheme's ESG focus; and (iii) actions taken by the scheme in attaining the scheme's ESG focus.
The Circular defines 'ESG fund' broadly as a scheme which (i) uses or includes ESG factors as its key investment focus and strategy and (ii) represents itself as an ESG-focused scheme.
Hong Kong
A revised circular published by the Securities and Futures Commission came into effect on 1 January 2022 which provides guidance to managers on enhanced disclosures for authorised funds that incorporate ESG factors as a key investment focus. The key requirements include the naming of funds to reflect such investment object or strategy; disclosure of ESG features in its offering documents; annual assessment of how the fund has attained its ESG focus. Managers are required to regularly monitor and evaluate the underlying investments to ensure that ESG funds continue to meet the stated ESG focus and requirements.
In April 2023, the Hong Kong Stock Exchange ("HKEX") also published the Consultation Paper on Enhancement of Climate-Related Disclosures under The Environmental, Social and Governance Framework wherein the HKEX proposes to mandate that all issuers make climate-related disclosures in their ESG reports (i.e. an upgrade from the current 'comply or explain' regime).
Japan
An amendment to regulations under the Financial Instruments and Exchange Act came into effect on 31 January 2023, which requires all public companies to make ESG-specific disclosures in their securities registration statements and annual securities reports for the fiscal year ending on or after 31 March 2023.
The framework for this new mandatory ESG disclosure follows the Task Force on Climate-related Financial Disclosures ("TCFD"). Before this amendment, the Corporate Governance Code of Japan required companies listed on the Prime Market of Tokyo Stock Exchange to enhance the quality and quantity of disclosures based on TCFD recommendations or equivalent standards. Now, this requirement is expanded to all listed companies and other companies which are subject to continuous disclosure obligations in Japan.
Across Singapore, Hong Kong and Japan, the regulators have tightened ESG reporting and disclosure requirements. Annual reports and/or assessments are now commonly required and 'tag' on to existing reporting obligations.
We await to see if the 'comply or explain' regime might evolve to strict mandatory disclosures in Singapore and Hong Kong, while Japan has led the pack in implementing mandatory obligations from the get-go.
2. Due diligence
ESG investing reflects the desire to see that investments are ethically and sustainably placed. Therefore, the success of an ESG-focused investment hinges on whether the chosen ESG goals will or have been achieved. To this end, ESG due diligence and discussions with your advisors is crucial to:
- unearthing and assessing potential 'red flags' in your investment;
- understanding how ESG factors can be incorporated into investment advertising, fund raising and fund structuring to supplement traditional indicators of success;
- structuring deals and arrangements to best reflect investor and growth expectations; and
- avoiding unnecessarily complex deal structures and extensive negotiations.
3. Regulation of performance evaluation indicators
There is currently no universally adopted standardised performance evaluation indicators. This gives rise to varying methodologies in assessing of the success of ESG investments.
The Final Report on ESG Rating and Data Product Providers published by the International Organization of Securities Commissions (IOSCO) in November 2021 revealed among other observations, the following deficiencies with the current state of ESG rating and data products:4
- insufficient clarity and alignment on definitions, including on what ratings or data products intend to measure;
- a lack of transparency about the methodologies underpinning ratings or data products; and
- concerns about the management of conflicts of interest between the rating/ data provider and the subject of evaluation.
In response to these deficiencies, regulators in some Asian jurisdictions have introduced guidelines to promote transparency and accountability in ESG fund management.
Singapore
Where appropriate, the Circular requires additional information regarding an ESG Fund, its manager or index providers to be disclosed to current or prospective investors by appropriate means (eg. on the manager's website). This include, for example:
- how the ESG focus is measured and monitored, and a description of the internal and external control mechanisms in place to monitor compliance with the scheme's ESG focus on a continuous basis (including methodologies used);
- information relating to the sources and usage of ESG data, or any assumptions made where such data is lacking;
- the due diligence carried out in respect of the ESG-related features of the scheme's investments; and
- stakeholder engagement policies (including proxy voting) that can shape corporate behaviour of companies that the scheme invests in and contribute to the attainment of the scheme's ESG focus.
In conjunction with these enhanced disclosure requirements relating to performance evaluation indicators and building upon the IOSCO's recommendations for good practices, the MAS on 6 December 2023 published its finalised Code of Conduct for ESG Rating and Data Product Providers (the "CoC")5 and an accompanying checklist for providers to self-attest their compliance to the CoC (the "Checklist").6
The CoC and the Checklist are implemented on a "Comply or Explain" basis and some of the best practices stated in the CoC include:
- ensuring that where an ESG rating is prepared on an issuer-paid basis, the ESG rating provider and its personnel should not: (i) enter into any contingent fee arrangement for providing ESG rating services nor (ii) selectively disclose any information that are not publicly available about the ESG rating, possible future issues or revisions of any ESG rating by it, except to the issuer of the capital markets product or its designated agents;
- initiating a review of the ESG rating and revising it as appropriate upon becoming aware of any public information that may reasonably be expected to result in a revision or termination of the ESG rating;
- maintaining records to support every ESG rating and data products that is issued;
- assessing whether the ESG rating provider is able to devote sufficient personnel with the necessary skill sets to make a proper ESG rating assessment and whether its personnel will likely have access to sufficient information needed in order to produce the ESG rating; and
- making clear in a prominent place if the ESG rating is based on limited data.
Hong Kong
The HKEX has also published guidelines in respect of ESG issues for companies listed on the HKEX. Appendix C2 of the Listing Rules being the Environmental, Social and Governance Reporting Guide (the "Guide") sets out two levels of disclosure obligations: (a) mandatory disclosure requirements and (b) 'comply or explain' provisions.
The Guide is organised into two ESG subject areas, Environmental and Social. Corporate governance is addressed separately in the Corporate Governance Code. Each subject area comprises various aspects, and each aspect sets out general disclosures and key performance indicators ("KPIs") for issuers to report on in order to demonstrate how they have performed.
In addition to the 'comply or explain' matters set out in the Guide, the Exchange encourages an issuer to identify and disclose additional ESG issues and KPIs that reflect the issuer's significant environmental and social impacts; or substantially influence the assessments and decisions of stakeholders. In assessing these matters, the issuer should engage stakeholders on an ongoing basis in order to understand their views and better meet their expectations. The board has overall responsibility for an issuer's ESG strategy and reporting.
Japan
On 15 December 2022, the Financial Services Agency of Japan ("FSA") published a 'comply or explain' code of conduct for ESG evaluation and data providers (ie., service providers which collect, provide, and evaluate information on companies' ESG initiatives; the eligibility of green bonds; and other ESG-related or ESG-labeled bonds and loans).
In March 2023, the FSA also amended its guidelines for the supervision of financial institutions and defined specific issues for reviewing disclosures related to publicly offered investment trusts. In response to growing greenwashing concerns, the new guidelines make it clear that only investment trusts which (i) use ESG a key factor in the selection of investment assets and (ii) describe the details thereof in their prospectus will qualify as ESG investment trusts. Other investment trusts should not have misleading terms in their names or nicknames such as "ESG", "SDGs", "green", "decarbonization", "impact", "sustainable".
The new guidelines also set forth internal organizations and resources that financial institutions should have in place in order to monitor its ESG related investments and make clear that they need to conduct appropriate due diligence.
Whether you are an investor looking to make ESG-focused investments, a fund sponsor looking to fundraise an ESG-focused fund, or a business owner looking to adopt ESG practices, our lawyers at Withersworldwide can help you navigate the challenges ahead.
Footnotes
1. "Unrelenting Fed Hikes Are Good News for Asia ESG Investors", Ishika Mookerjee (Blomberg, 29 September 2023). https://www.bloomberg.com/news/articles/2023-09-28/us-europe-funds-lose-to-asia-as-renewables-get-crushed-by-rates
2. "Africa's Biggest Fund Manager to Grow Green Energy Book Beyond $854 Million", Timothy Rangongo (Blomberg, 4 October 2023). https://www.bloomberg.com/news/articles/2023-10-03/africa-s-top-fund-manager-to-grow-renewable-energy-investment-beyond-854million?leadSource=uverify%20wall
4. https://www.iosco.org/library/pubdocs/pdf/IOSCOPD690.pdf
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
