Introduction
The 2024 United Nations Climate Change Conference (COP29) will take place from 11 to 22 November in Baku, Azerbaijan. The development of better functioning international carbon markets pursuant to Article 6 of the Paris Agreement (Article 6) requires the delegates at COP29 to reach an agreement on a range of key issues including the environmental integrity of carbon credits, transparency within international carbon markets, and the prevention of double counting.
Background
In its November 2021 report, the International Organization of Securities Commissions (IOSCO) identified four key areas for reform in relation to ESG ratings and data products: (i) transparency, (ii) governance, (iii) systems and controls, and (iv) management of conflicts of interest.
In November 2022, IOSCO published a further report entitled “IOSCO Good Sustainable Finance Practices” which called on financial markets voluntary standard setting bodies and industry associations to promote the adoption and implementation of the good practices stemming from the IOSCO recommendations amongst their members.
On 3 October 2024, the International Capital Market Association (ICMA) published the Hong Kong[1] voluntary Code of Conduct for ESG Ratings and Data Products Providers (Code of Conduct).[2]
Sponsored by the Hong Kong Securities and Futures Commission (SFC), the Code of Conduct was developed in response to IOSCO’s November 2021 report which recommended that regulators focus more attention on the use of environmental, social, and governance (ESG) ratings and data products including through the development of voluntary industry standards.
In October 2023, a working group comprising representatives from Hong Kong, Mainland China,[3] and international ESG ratings and data providers, was established to develop the Code of Conduct.[4]
The Code of Conduct does not take into account any Hong Kong specific considerations. It is therefore based on those recommendations made by IOSCO in its November 2021 report that specifically relate to ESG ratings and data providers.[5]
By signing up to the voluntary Code of Conduct, ESG ratings and data providers agree to publish and keep updated (on an annual basis) a self-attestation document[6] which lists the principles and actions that they agree to adhere to and explains how they are being implemented within their organisation.
Publication of the Code of Conduct is important not only to the development and upscaling of voluntary carbon markets within Mainland China and Hong Kong but also to:
- the ability of Mainland China and Hong Kong to participate in international carbon markets pursuant to Article 6 mechanisms; and
- the ability for businesses in Mainland China and Hong Kong to manage and mitigate the extraterritorial impact of schemes (such as Europe’s Carbon Border Adjustment Mechanism (CBAM)) that are designed to equalise the cost of carbon across borders and prevent carbon leakage.
Overview of Regulatory Requirements relating to ESG Disclosure in Hong Kong
In June 2023, International Sustainability Standards Board of the IFRS Foundation (ISSB) published its inaugural standards[1] for disclosing the effect of climate-related risks and opportunities on a company’s prospects (ISSB Standards). The ISSB Standards serve as a global baseline of sustainability reporting standards with the aim of aligning the sustainability disclosures made by entities worldwide.
In March 2024, the Hong Kong Government announced its vision to align local sustainability disclosure requirements with the ISSB Standards, with the ultimate goal of requiring ISSB-aligned sustainability reporting by Hong Kong listed issuers and regulated financial institutions in Hong Kong. An overview of the new disclosure requirements is set out in the table below. Such requirements make clear the expectation of The Stock Exchange of Hong Kong Limited that company boards and senior management should drive the promotion of sustainability throughout the organisation and closely assess, report, monitor and manage climate-related risks and opportunities.
In this article, references to ‘Hong Kong’ are references to the Hong Kong Special Administrative region of the People’s Republic of China.
https://www.icmagroup.org/sustainable-finance/icma-and-other-sustainable-finance-initiatives/the-hong-kong-esg-ratings-and-data-code-of-conduct-working-group-2/
In this article, references to ‘Mainland China’ are references to the People’s Republic of China excluding the Hong Kong Special Administrative region, the Macau Special Administrative region, and Taiwan.
A full list of working group members and observers can be found in Annex 1 of the Code of Conduct.
IOSCO recommendations 2, 3, 4, 5, 6, 8 and 9.
The form of the self-attestation document is set out in Annex 2 of the Code of Conduct.
The ISSB Standards comprise the IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and IFRS S2 Climate-related Disclosures (IFRS S2) published by the International Sustainability Standards Board of the IFRS Foundation
Scope 1 emissions are direct greenhouse gas emissions that occur from sources that are controlled or owned by an organisation (e.g., emissions associated with fuel combustion in boilers, furnaces, vehicles). Scope 2 emissions are indirect greenhouse gas emissions associated with the purchase of electricity, steam, heat, or cooling. Although scope 2 emissions physically occur at the facility where they are generated, they are accounted for in an organization's GHG inventory because they are a result of the organisation's energy use.
Scope 3 emissions are the result of activities from assets not owned or controlled by the reporting organisation, but that the organisation indirectly affects in its value chain. An organisation’s value chain consists of both its upstream and downstream activities. Scope 3 emissions include all sources not within an organisation’s scope 1 and 2 boundaries. The scope 3 emissions for one organisation are the scope 1 and 2 emissions of another organisation. For further details refer to https://ghgprotocol.org/sites/default/files/standards/Corporate-Value-Chain-Accounting-Reporing-Standard_041613_2.pdf.
Hang Seng Composite LargeCap Index constituents.
Issuers listed on the Main Board of The Stock Exchange of Hong Kong Limited.
Issuers listed on the Growth Enterprise Market (GEM) of The Stock Exchange of Hong Kong Limited.
Aims of the Code of Conduct
Publication of the Code of Conduct is an important step for the strengthening and development of sustainability-related disclosure and governance in Hong Kong.
The Code of Conduct aims to create a trusted, efficient and transparent market through voluntary adherence to a clear set of standards for ESG ratings and data products providers that are designed to:
- improve the availability and quality of information provided to investors;
- increase market integrity through transparency and good governance; and
- improve competition through better comparability.
The Code of Conduct is not intended to prescribe a singular approach. Signatories are free to comply with the Code of Conduct in a way that aligns with their organisation’s business model and structure. After signing up there is an implementation period of six months (for ESG ratings providers) or twelve months (for ESG data product providers).
Targeted Outcomes of the Code of Conduct
The Code of Conduct is structured around four key outcomes:
- transparency: make adequate public disclosure in relation to ESG ratings and data products, including methodologies and processes;
- good governance: ensure adequate governance arrangements are in place to uphold the Code of Conduct;
- systems and controls: implement policies and procedures designed to ensure the high quality of ESG ratings and data products; and
- managing conflicts of interest: identify, avoid/manage, mitigate, and disclose actual or potential conflicts of interest that may compromise objectivity.
Application of the Code of Conduct
The Code of Conduct relates to “ESG ratings/data product providers” being entities whose activities involve the provision of ESG ratings and/or ESG data products.
For the purposes of the Code of Conduct:
- an “ESG data product” is a product provided, or marketed as providing a specific or holistic ESG focus, or a combined focus on a combination of E, S or G factors, in respect of one or more entities, financial instruments, products or companies ESG profile, characteristics, or exposure to ESG, climate-related or other environmental risks or impact on society and the environment; and
- an “ESG rating” is a product that is provided, or marketed as providing an opinion, score or other ranking issued using an established and defined ranking system, regarding the E, S or G characteristics or risks in relation to one or more entities, financial instruments, or products or one or more companies ESG profile, characteristics, or exposure to ESG, climate-related or other environmental risks or impact on society and the environment.
The Code of Conduct is designed to have broad application and extend to entities that opine on the ESG credentials of a particular business or project and entities that provide alert services highlighting the controversial ESG issues. Such entities are encouraged to:
- evaluate the reliability of public data sources, and providing transparent information as to the hierarchy of such sources;
- apply a measure of materiality reflecting the overall weight and relevance of the controversy to the organisation;
- have regard to the length of time passed since the date of the original controversy and its continued relevance; and
- have regard to the level of responsibility that the named organisation can take for the controversy versus industry-wide issues.
It is important to note that the Code of Conduct:
- is not intended to supersede or overlay existing regulated activities for which formal rules and guidance already exist; but
- is intended to be interpreted and applied in a proportionate manner having regard to the nature, scale and complexity of the activities or business being undertaken.
Six Key Principles
A brief (non-exhaustive) overview of the six key principles in the Code of Conduct is set out below.
Understanding the impact
The ways in which ESG related risks are managed and mitigated, and the extent to which ESG related opportunities are promoted and realised, are integral to business health and longevity. The level of scrutiny that businesses face in respect of their ESG policies and credentials will continue to increase as countries around the globe strive to achieve their carbon reduction and sustainability goals.
Combatting fragmentation is a key issue as regards the development and expansion of sustainable finance and sustainable economies. ESG ratings and data products can help reduce fragmentation but only if they are developed, determined and applied in a manner that is transparent and consistent so that they are easy to understand and have integrity (e.g. avoid greenwashing).
Although compliance with the Code of Conduct is voluntary, businesses, investors, and other financial market participants will quickly become intolerant of ESG ratings/data products that are deemed to be opaque or misleading. In addition, we expect that questions will be asked of ESG ratings/data product providers that do not sign up to the Code of Conduct noting, by way of example:
- the Code of Conduct is aligned with IOSCO’s recommendations
- there is scope in the self-attestation document for organisations to explain (and justify) their approach as regards implementation of the Code of Conduct;
- the increasingly international impact of domestic legislation relating to the measurement and reduction of CO2e emissions within supply chains;
- the global trend towards aligning standards relating to ESG ratings and compliance;
- an increasing demand from investors and credit rating agencies for forward-looking data relating to sustainability and the transition to a low carbon economy; and
- increasing global sensitivity to greenwashing risks, including reputational damage and litigation.
We are keeping a close eye on developments relating to ESG in Hong Kong, Mainland China and across the wider APAC region.
Please do not hesitate to get in touch if there is anything that we can help you with.
