By Fiona Donnelly
The effects of climate change are physically and compliance-wise, ALL around.
Not only are we contending with increasing impacts brought about by climate change – such as floods, disruption to supply chains and infrastructure failures – regulators, standard-setting bodies, and asset owners, among others, are requesting corporates and investment managers to systematically consider and disclose more details about how climate affects their business.
This is creating a very mixed response from fund managers (FMs) around the world and particularly in Hong Kong, where there is quite a hubbub regarding the first application of the Securities and Futures Commission’s revised Fund Manager Code of Conduct (FMCC), which applies to different fund managers with effect from August and November 2022[i].
The revised FMCC in essence requires affected FM’s “to take climate-related risks into consideration in their investment and risk management processes and make appropriate disclosures”. It’s interesting and hopefully helpful to reframe this new ask from a more universal standpoint:
Driven by science
This global focus on climate is being driven by the increasing knowledge and understanding by scientists that forecasts of the future, based on the latest data and understanding, look very different from projections based on the past. The same science shows there is also an urgent need to reduce global warming to ensure the ongoing stability and viability of the planet. Per the recent Intergovernmental Panel on Climate Change (IPCC) report compiled by 278 scientists and other experts, and with reference to over 18,000 scientific papers: “The evidence is clear: the time for action is now.[ii]”
So, why should this matter to business? These facts matter in two broad ways:
Business affects climate change eg carbon emissions, like those emitted from transport[iii], affect global warming, which in turn contributes to changes in the ferocity and frequency of extreme weather events; and
Climate change can affect business, eg carbon taxes, which are becoming more widespread and often include mandatory staged carbon price increases[iv], which could undermine the commercial viability and financial sustainability of affected enterprises.
These examples show another way to consider climate: so-called physical matters arising such as extreme weather, and how they impact assets and operations; as well as transition matters being man-made developments in anticipation of or as a reaction to climate and concern policy, market preferences, new technologies and more.
Climate is a complicated interrelated topic involving diverse factors that often vary according to location and jurisdiction. We are learning more and more about it. Scientists, now, are better placed than ever before to help us understand what the future holds, so climate can be better assimilated into business and investment decisions. And we desperately need it to be.
Identify and assess – the minimum action required of climate
Yet some FMs are not embracing the new climate compliance demands citing reasons such as “if we didn’t sell the fund around climate, so why do we need to factor it in now?” and “We are not nor do we want to be ESG or impact investors, so why does this apply to us?”.
These compliance changes are not trying to convert investors to adopt a different investment philosophy, challenge and change their investment strategy, or in any way narrow their investment universe. They are more about highlighting the fact we know increasing amounts about the future, climate-wise, so best practice would be to consider where climate shows up in your investment strategies, assets and instruments, and give it deliberate, ongoing and systematic consideration.
Basically, ‘climate’ could be seen as a collective term for a category of risks (and opportunities) that we now better understand, that are becoming increasingly complex and significant so more relevant to more investees and are therefore worthy of identification and assessment by FMs, as part of routine investment analysis.
For FMs in Hong Kong that remain unconvinced and see the FMCC as just another compliance burden, we offer 5 further perspectives and a view of what a knock-on effect to FM’s could be (indicated after “>>”):
1. Asset owners are increasingly seeing the opportunities presented by transitioning the economy to low carbon (and threats if they do not) and the vital importance of their role to direct finance to create more positive real-world impacts. Today, and per just one collective body – the UN-convened Net-Zero Asset Owner Alliance – there is estimated to be “US$10.4 trillion assets under management, delivering on a bold commitment to transition our investment portfolios to net-zero greenhouse gas emissions by 2050”[v].
>> FMs reluctant to address climate could find themselves losing mandates from asset owners to FMs who do.
2. Boards of companies realise that a deeper understanding and stakeholders’ expectations around climate present commercially strategic risks and opportunities that vary per geographic location and sector/industry. So enterprises are factoring in climate more, as is evidenced by the growing uptake of TCFD – the Taskforce for Climate-related Financial Disclosures, being the international de facto standard for climate governance and disclosures – which now claims supporters with a combined market capitalisation of over US$25 trillion, a 99% increase in the year to October 2021[vi].
>> FMs could find themselves to be out of alignment with their portfolio companies.
3. Globally there is an increasing understanding, appetite and urgency in some quarters, like in particularly vulnerable countries, to learn more about climate, so this theme is not going to go away. Far from it. More data is being collected in a more granular way and tools for predictions, analysis and more will continue to become more sophisticated.
>> FMs that do not seek to factor in climate could find themselves to be global laggards, and out of alignment with a macro shift in the sector.
4. Ethics and morality – investors, managers and boards need to ask themselves for how long they are comfortable to take financial returns with no regard to the planetary impact of their decisions. How important Is a short-term smooth earnings curve if this is arising from a business that is contributing to a catastrophic planetary trajectory? FMs that are driven by short-term financial returns only are likely, sooner or later, to fall foul of activist investors and employees, and all the reputational fallout that ensues.
>> success for FMs is increasingly being measured beyond the traditional short-term financial measures.
5. Systematic risks and opportunities – climate change can be considered as another collection of risks that warrant identifying, assessing, managing and monitoring alongside the other risks that are deemed to be significant to an organisation. Therefore, on the most basic level, FMs not considering relevant and material climate issues could find themselves in breach of the fiduciary duties[vii] they owe asset owners.
>> FMs could be held personally negligent for not identifying and assessing climate risks.
To disregard climate is really no longer an option – living in denial or with a ‘head in the sand’ will not suffice for many stakeholders. Those that do not take steps to understand the sensitivity to the climate of their business will be under deepening scrutiny, and ultimately, potentially be side-lined or worse. Given the various potential upsides for value preservation and creation, we thoroughly recommend a climate review is undertaken – why wouldn’t you want to better understand and take into consideration where climate-related business opportunities and risks may lie?
This article is for information only and is not intended to be a comprehensive review. Obtain direct and tailored advice before applying anything contained in this material to a specific scenario. For more information, contact Red Links. External links are included for readers’ convenience. The inclusion of these sources is neither an endorsement of that provider nor intended to provide readers with any assurance as to the completeness or accuracy of the particular material linked.
Cover Image Credit to Colin Prior
[i] https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/intermediaries/supervision/doc?refNo=21EC31 [ii] https://report.ipcc.ch/ar6wg3/pdf/IPCC_AR6_WGIII_PressConferenceSlides.pdf [iii] https://www.nationalgeographic.org/media/transportation-and-climate-change/#:~:text=In%202017%2C%20the%20U.S.%20transportation,percent%20of%20emissions%20each%20year. [iv] https://blogs.imf.org/2021/06/18/a-proposal-to-scale-up-global-carbon-pricing/ [v] https://www.unepfi.org/net-zero-alliance/ [vi] https://www.fsb.org/2021/10/2021-status-report-task-force-on-climate-related-financial-disclosures/#:~:text=TCFD%20supporters%20now%20span%2089,99%25%20increase%20since%20last%20year. [vii] https://www.redlinks.com.hk/post/esg-and-the-risk-of-director-negligence