SFC guidance on enhanced disclosures for ESG funds

This article was written by Leonie Tear.

The Securities and Futures Commission ("SFC") has recently issued a circular to provide guidance on its expectations on enhanced disclosure for environmental, social and governance ("ESG") funds. The new guidance covers the following:

esg-funds This alert summarises the new guidance, which supersedes a 2019 SFC circular on the same topic ("2019 Circular").[1]

Why has the circular been issued?

The number of ESG linked funds offered to the public in Hong Kong has more than doubled since 2019. The SFC's focus on ESG has featured as a prominent agenda item in all major speeches given by Ashley Alder in recent months, placing emphasis on establishing harmonised disclosure standards and the avoidance of "greenwashing" (the practice of exaggerating the green credentials of a fund).

"Making sustainability-related disclosures more transparent, comparable and consistent will help investors identify suitable ESG funds and reduce opportunities for greenwashing," Ashley Alder, the SFC's Chief Executive Officer.[2]

Which funds must comply with the requirements under the circular?

The circular was issued to SFC-authorised funds which incorporate ESG factors as a key investment focus ("ESG Funds"). The SFC maintains a list of such funds[3] compiled based on confirmations and representations provided by the respective fund managers. There are currently around 60 funds on the list. The circular will take effect on 1 January 2022.

What are the naming requirements?

The product name must not be misleading. Reference to ESG or similar in the name or marketing materials must accurately reflect the ESG features of the fund without exaggeration.

What are the requirements for offering documents?

Fund offering document must provide information necessary for investors to be able to make an informed judgement of the investment. The new guidance sets out what this means for ESG Funds, as described below.

Disclosure	Requirement
ESG focus	A description of the ESG focus through a clear description of the aim and a list of ESG criteria (eg filters, third party ratings) used to measure the attainment of the ESG focus. For example, the BlackRock Global Funds "Nutrition Fund" (ARQ483) offering document listed on the SFC webpage, includes the following statement: "The three major sustainable nutrition trends in focus are: the promotion of healthy and sustainable eating choices, delivering efficiencies across global food supply chains, and enabling less resource intensive farming.
ESG focus	Specific to funds claiming to be climate focused ("Climate Funds"): SFC examples of acceptable focus areas are: primarily investing in companies which contribute to climate change mitigation or adoption, seeking a lower carbon footprint as compared to a reference benchmark, contributing to reduction of greenhouse gas emission, achieving positive impact to mitigate or adapt to climate change, and facilitating transition to a low carbon economy. SFC examples of climate related indicators are: carbon footprint, weighted average carbon intensity, greenhouse gas emission, revenue or profit generated from or capital or operating expenditure commitment in activities that favourably contribute to climate change mitigation or adaption.
ESG investment strategy	A description of the investment strategy adopted by the ESG fund, the binding elements and significance of that strategy in the investment process, and how the strategy is implemented in the investment process on a continuous basis. A summary of the process of consideration of ESG criteria which may include methodologies in measuring ESG criteria and sequencing those criteria in order of importance. A description of whether an exclusion policy is adopted and the types of exclusion. For example, the HSBC Global Investment Funds "Global Equity Climate Change" (AQC936) offering document includes the following: "ESG and Lower Carbon Criteria, which together with fundamental qualitative company analysis, are used to determine the sub-fund's investible universe, may include, but are not limited to: excluding issuers involved in low ESG rated sectors such as, but not limited to, weapons and tobacco. excluding issuers who derive more than 10% of revenue from thermal coal activities. excluding issuers considered to be breaching the United Nations Global Compact Principles."[4]
Asset allocation	The expected or minimum proportion of securities that are commensurate with the fund's ESG focus.
Reference benchmark	Where a fund is tracking an ESG benchmark (eg an index fund) for the purpose of attaining the ESG focus, details of the benchmark and an explanation of how the designated reference benchmark is relevant to the fund.
Reference benchmark	Specific to Climate Funds, the disclosure should include an explanation of how any climate benchmark is continuously aligned with or relates to the funds climate-related focus and why and how the designated index differs from a broad market index, where appropriate.
Additional information	An indication of where investors can find additional information about the ESG Fund.
Risks	A description of the risks or limitations associated with the ESG focus must be disclosed. For example, the BNP Paribas Funds "BNP Paribas Funds Energy Transition" (BAC421) offering document includes the following: "The lack of common or harmonized definitions and labels integrating ESG and sustainability criteria at EU level may result in different approaches by managers when setting ESG objectives. This also means that it may be difficult to compare strategies integrating ESG and sustainability criteria to the extent that the selection and weightings applied to select investments may be based on metrics that may share the same name but have different underlying meanings."

What are the requirements for disclosing additional information?

An ESG Fund should disclose on the fund manager's website or "by other means":

how the ESG focus and performance is measured and monitored throughout the lifecycle of the ESG fund;
ESG due diligence procedures in respect of the fund's underlying assets;
the engagement approach, including proxy voting; and
the ESG data sources and processing or relevant assumptions where data is not available.

Specific to Climate Funds, the methodologies for measuring climate indicators should include the metrics used and their calculation basis or formulas, the relevant data sources, any assumptions or estimations made and their limitations.

What are the periodic assessment and ongoing monitoring requirements?

An ESG Fund should conduct a periodic assessment, at least annually, to assess how the fund has attained its ESG focus. The below should then be disclosed, for example through annual reports.

Disclosure	Requirement
ESG focus	How the ESG focus has been attained including: the actual proportion of underlying investments commensurate with the fund's ESG focus; the actual proportion of the investment universe that was eliminated or selected as a result of the fund's ESG-related screening; a comparison of the performance of the fund's ESG factors against the designated reference benchmark (if any); actions taken in attaining the fund's ESG focus. For example, shareholder engagement activities or proxy voting records of the ESG Fund with respect to its investee companies; and a catch all - any other information, considered necessary by the fund manager.
ESG focus	A Climate Fund could demonstrate the attainment of its climate-related focus by comparing the funds climate indicator(s) against those of the previous assessment period or the reference benchmark or the investment universe.
Basis of assessment	A description of how the ESG focus attainment has been assessed, including any estimations or limitations.
Comparison information	A comparison to the previous assessment period (where applicable).

Fund managers must regularly monitor and evaluate underlying investments to ensure the ESG focus continues to be met. If ESG is no longer the focus of a fund, investors and the SFC must be informed as soon as reasonably practicable. Such a fund may be removed from the SFC list as appropriate. This may lead to regulatory action by the SFC for any compliance failings including failure to meet the stated investment objective or strategy in the offering documents.

What is the impact on UCITS funds?

The SFC has considered the European regulations on sustainability-related disclosures (SFDR) and states that UCITS funds will be ESG Funds if they incorporate ESG factors as their key investment focus and reflect that focus in their investment objective or strategy. UCITS ESG Funds which meet the disclosure and reporting requirements for Article 8 or Article 9 funds under the SFDR will be deemed to have generally complied in substance with the SFC's disclosure requirements.

Next steps

Fund managers should:

establish an ESG governance structure;
review existing ESG policies or if none, adopt a clear ESG policy;
review existing disclosures for any ESG Funds;
ensure staff and management understand ESG commitments and risks;
provide ESG training to relevant staff.

Reach out to us for assistance with ESG compliance, applications to the SFC or, if there are concerns regarding compliance to date, SFC engagement and regulatory enforcement action. We offer full life-cycle regulatory assistance in relation to all aspects of ESG finance.

* All quotes from offering documents in this alert are snippets only and do not constitute full statements or disclosures from the fund documents and are not to be taken as any form of endorsement by King & Wood Mallesons.

[1] Available here: https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=19EC18

[2] https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=21PR67

[3] Available here: https://www.sfc.hk/en/Regulatory-functions/Products/List-of-green-and-ESG-funds

[4] Available here: