Evolving climate and ESG risk

The unprecedented rainfall seen in Hong Kong last September highlighted the urgency of climate change. The financial services sector plays a crucial role in mitigating climate-related risks and helping Hong Kong achieve its goal of carbon neutrality by 2050. This involves offering green and sustainable products and guiding customers through the carbon-reduction transition.

Climate risk is a major ESG-related concern for banks in Hong Kong. Over the past year, banks have been preparing for the HKMA’s Climate Risk Stress Test, due in June 2024. This follows a pilot stress test in 2021 and aims to provide the regulator with a comprehensive understanding of banks’ climate resilience, focusing on both physical risk and transition risk.

As part of the exercise, banks examined a short-term scenario to 2027, incorporating both climate-related shocks and an economic downturn. They also explored longer-term scenarios up to 2050, considering the impacts of a slow transition to a low-emission economy with more extreme climate events. The HKMA is currently analysing the test results and will provide feedback to the banks in due course.

While banks have met the stress test deadline, there is no room for complacency. The HKMA expects banks to continue integrating climate risk considerations across their operations, including decarbonisation, net-zero transition and prevention of greenwashing.

Some banks are already embedding climate risk components into their daily operations, such as KYC requirements.  Many banks are also incorporating ESG elements into their mandatory training programs and including climate risk in KPIs for staff.

Although the longer-term risks seem less immediate, banks should consider taking proactive measures to enhance their future climate resilience, such as managing exposures to non-sustainable large customers in their portfolios.

In other ESG areas, there have been significant developments in Hong Kong providing clearer guidance for banks and businesses. Notably, the HKMA’s recent taxonomy for sustainable finance references taxonomies from the EU and Mainland China. A lack of consistency in green and sustainable definitions has been a significant issue in sustainable finance, so this global convergence of standards is a welcome development.

This taxonomy will facilitate the greater adoption of sustainable finance in Hong Kong. With clearer definitions of green products and assets, banks can more easily determine the sustainability of products like green loans.

From an investment product perspective, the HKMA issued a circular in November 2023 on sales and distribution, providing further guidance on preventing greenwashing through clear policies in selection criteria, due diligence and monitoring of service providers.

The HKEX also finalised its consultation on requirements for Hong Kong-listed companies regarding product labelling, development and disclosures. This will help banks understand the sustainability of the companies they engage with.

Looking ahead, Hong Kong’s government and regulators issued a vision statement in March this year on developing a sustainability disclosure ecosystem. Hong Kong aims to be one of the first jurisdictions to align its local sustainability disclosure requirements with ISSB Standards. These standards will be applicable across sectors, including listed companies, banks, fund managers and insurance companies, and will be implemented in phases.

More broadly, the government and financial regulators are keen to support banks in using emerging technological solutions to enhance efficiency and reduce costs while advancing their sustainability efforts.

Banks face challenges in meeting evolving regulatory and government expectations, including a shortage of talent with relevant ESG expertise and the difficulty of long-term climate-related planning. However, opportunities are also emerging for banks to innovate and create new ESG-related products and solutions.

Hong Kong is already a regional leader in ESG. Through their ongoing activities, the government and regulators are demonstrating their commitment to reinforcing the city’s status as a sustainability hub, sending a clear signal to international investors and enhancing the competitiveness of businesses across Hong Kong.