The Securities and Futures Commission of Hong Kong (SFC) is sponsoring the International Capital Market Association (ICMA) to form a working group to develop voluntary code of conduct for environmental, social and governance (ESG) ratings and data products providers to provide ESG products and services in Hong Kong.

Greatest concerns

In 2022, the SFC conducted a survey to understand the business concerns over ESG products and services. In the SFC’s report on such survey published in October 2023, certain findings worthy of attention were highlighted such as:

• ESG service providers use different approaches in sourcing data. Some also employ unique and proprietary methodologies to bridge any data gap or derive their ratings products. Therefore, ESG products from different providers for the same covered entity may not be correlated and comparable with each other.
• Data unavailability and the quality of data being disclosed by covered entities are the most common challenges for ESG service providers.
• There is, generally, a lack of standardised corporate sustainability disclosure standards in the market.
• The major concerns of asset managers and other users of ESG products are also data quality and coverage, including the insufficiency of data on private companies and emerging markets.
• Another challenge facing the asset managers is the lack of transparency on the part of ESG service products, e.g. their methodologies, assumptions, sources of raw data and pricing frameworks. Thus, asset managers have to conduct due diligence on the ESG service providers.
• Certain asset managers even have their in-house ESG specialists, responsible for analysing the information provided by ESG service providers (i.e. not wholly relying on the service providers) before investment decisions are made.
• Some asset managers may formulate ESG ratings for internal use or for their clients by utilising their own methodologies.
• Conflicts of interest is another concern. Some asset managers worry about the possibility that an ESG service provider downgrades a covered entity’s ESG rating, while its business line subsequently solicits business with the downgraded entity.

The SFC concludes that the data availability and reliability issue stems from the lack of a standardised corporate sustainability disclosure framework. In this regard, the SFC envisages that the introduction of the International Sustainability Standards Board (ISSB) sustainability-related corporate disclosure standards and its collaboration with local stakeholders (including the Hong Kong Stock Exchange) to develop a comprehensive roadmap for adopting the ISSB standards in Hong Kong will help narrow the data gap gradually. However, these efforts may not address the lack of data on private, unlisted enterprises which do not have to attract investments from funds or asset managers.

The working group is established to address the other concerns by way of introducing “voluntary” code of conduct. This approach is also taken by the UK, Singapore and Japan, while the European Union elects to expand its regulatory remit to cover ESG service providers.

Tackling the issue

The SFC is the sponsor of the working group, while the ICMA acts as the secretariat. Its members include ESG service providers, asset managers, financial institutions and Hang Seng Indexes Company Limited. The Hong Kong Monetary Authority and the Insurance Authority sit as observers.

The objectives of the working group include:

• developing a globally consistent voluntary code of conduct for ESG ratings and data product providers which provide products and services in Hong Kong; and
• setting out baseline best practices governing the conduct of ESG service providers based on the recommendations of the International Organisation of Securities Commissions’ (IOSCO) which cover four key elements, namely, (1) transparency including disclosure of the source of data and underlying methodologies used, (2) governance, (3) systems and controls, e.g. ensuring the issuance of high-quality products, protecting all non-public information received; and (4) management of conflicts of interest.

ESG service providers will be encouraged to adopt the voluntary code of conduct going forward, as the code may help them better communicate with covered entities and ESG products users in terms of their transparency, quality and reliability of products.

Also, a self-attestation document will be appended to the voluntary code. ESG service providers will be encouraged to complete and publish (e.g. on their websites) the self-attestation in order to foster greater transparency.

According to the terms of reference of the working group, the first draft of the voluntary code will be made available for public consultation in the first quarter of 2024. The working group will then consider the public responses and prepare a final version for publication approximately one month after the end of public consultation.

The voluntary code of conduct will be periodically reviewed by the working group to continue to reflect best practices and address concerns raised by market participants.

Positive impacts

The voluntary code of conduct is expected to provide a streamlined and consistent basis for various types of stakeholders (including covered entities, asset managers and other users of ESG products) to better understand the ESG service providers in terms of their data source, methodologies and governance. At the same time, it may reduce the ESG service providers’ burden in responding to due diligence or assessment requests from their clients.

When the voluntary code of conduct is finalised, the SFC plans to issue principles-based guidance to licensed corporations on using the voluntary code of conduct for their due diligence and on-going assessment of ESG service providers. 

This material has been prepared for general informational purposes only and is not intended to be relied upon as professional advice. Please contact us for specific advice.