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I EXECUTIVE SUMMARY 1,II INTRODUCTION TO ESG INVESTMENT ECOSYSTEM 5. III THE VALUE PROPOSITION 9,Enhance risk adjusted returns 9. Lower funding cost 12,Attract new sources of capital and AuM 12. IV CURRENT STATE OF HONG KONG MARKET 14,Demand for ESG integration 14. Supply of ESG disclosure 16, Is Hong Kong ready to capitalise on the expanding ESG investment market 17. V RECOMMENDATIONS 19,VI CONCLUSION 27,I EXECUTIVE SUMMARY. 1 Sustainable investment has been one of the fastest growing areas in recent years and. has shifted from a niche area of investment into the mainstream According to the. Global Sustainable Investment Review 2016 1 assets managed under sustainable. investment strategies totaled US 22 9 trillion a 25 or US 4 6 trillion increase. since 2014 representing more than 1 in every 4 under professional management. In Japan alone assets managed under sustainable investment strategies have increased. from US 7 billion in 2014 to US 474 billion in 2016 Hong Kong is at risk of being. left behind if it does not foster the development of an ESG ecosystem to capitalise on. this opportunity, 2 What is ESG investing ESG or sustainable investing generally refers to investment. approaches that take into account environmental social and governance ESG. factors ESG factors see Table 1 for examples influence almost every aspect of a. company s operations,Table 1 A non exhaustive list of ESG factors. ENVIRONMENTAL SOCIAL GOVERNANCE, Air water pollution Customer satisfaction Accounting standards. Biodiversity Data protection privacy Anti competitive behaviour. Climate change Diversity equal opportunities Audit committee structure. Deforestation Employee attraction retention Board composition. Ecosystem services Employee engagement Anti bribery corruption. Energy efficiency Government community relations Business ethics. Hazardous materials Human capital management Executive remuneration. Land degradation Human rights indigenous rights Risk management. Resource depletion Labour standards Independence of Chairman. Waste management Marketing communication Succession planning. Water scarcity Product mis selling Whistleblower mechanism. Product safety liability,Supply chain management, Adapted from Principles for Responsible Investment PRI 2. Global Sustainable Investment Review 2016 Global Sustainable Investment Alliance April 2017. ESG Monitoring Reporting and Dialogue in Private Equity Principles for Responsible Investment 2018. 3 Globally there is a wide spectrum of approaches to ESG investing see Diagram 1. that range from fundamental integration that aims to maximise risk adjusted returns. to value based investment where risk adjusted returns are balanced by the impact or. alignment of the investment with investors values In this paper we focus on ESG. integration as the most broadly applicable approach for businesses in Hong Kong. and highlight the opportunity for businesses to maximise risk adjusted returns lower. funding costs and attract new sources of capital, Diagram 1 Globally recognised approaches to sustainable investing. Adapted from PRI 3, 4 By integrating ESG factors into the decision making process from portfolio. selection to management investment managers and investee companies as the key. stakeholders within the ESG investment ecosystem are able to enjoy the following. i Enhance risk adjusted returns through identification mitigation or. management of key risks A Goldman Sachs investment research report found. Understanding the impact of your investments Measuring environmental and social performance. Principles for Responsible Investment 23 October 2013. that the share price of companies in Asia ex Japan with low ESG scores. underperformed sector peers by c 100 basis points per annum 4. ii Lower funding costs High ESG rated companies generally experience lower. levels of beta and thus lower costs of capital both in terms of cost of debt and. cost of equity capital as supported by Deutsche Asset Wealth. Management 5 and MSCI studies 6, iii Attract new sources of capital and assets under management AuM. Globally financial investors have increasingly expressed commitment to adopt. ESG integration which opens unprecedented sources of capital and assets to. companies with a strong ESG profile, Many developed economies have come to realise the importance and the potential of. ESG investment yet Hong Kong has seemed to be lagging behind in developing a. robust ESG investment ecosystem to capture the associated benefits. 5 The slow uptake of the ESG integration momentum could also undermine Hong. Kong s competitiveness in the long run as a leading international financial centre. According to a research firm Corporate Knights Hong Kong Stock Exchange was. ranked the 24th in 2017 among 45 stock exchanges based on the Hong Kong listed. companies ESG reporting a drop from its 2014 ranking at the 17th 7 London came in. 4th from 9th and regional counterpart Singapore came in 16th from 22nd inducing a. warning to Hong Kong s competitiveness in the waves of the growing awareness of. ESG among global investors With this in view this paper aims at presenting the. urgent importance for Hong Kong to develop a robust ESG investment ecosystem. within which both the private and public sectors should have a key role to play. 6 A major challenge to ESG integration often lies on the difficulty in changing. corporate behaviour To tackle this challenge most of the developed markets have. chosen to apply a combination of carrots and sticks i e incentives and regulations. ESG in GEMs An emerging source of Alpha for EM PMs Goldman Sachs September 2017. Sustainable Investing Deutsche Asset Wealth Management June 2012. Foundations of ESG Investing Part 1 How ESG Affects Equity Valuation Risk and Performance MSCI. ESG Research November 2017, Measuring Sustainability Disclosure Corporate Knights September 2017. While bearing in mind that there is no easy solution to achieve the optimal balance. between incentives and regulations we have formulated the following ESG strategy. for Hong Kong on the part of the policymakers We recommend. i The Government to take the leadership role in encouraging public funds. support for ESG integration, ii The Hong Kong Monetary Authority HKMA to scale up ESG. requirements on their external investment managers. iii The Mandatory Provident Fund Schemes Authority MPFA to incorporate. ESG factors into its trustee approval and monitoring process and to encourage. trustees to take into account international ESG standards. iv The Securities and Futures Commission SFC to strengthen the emphasis. on ESG through upgrading the Principles of Responsible Ownership to at least. comply or explain, v The SFC and the other regulators to provide more guidance on ESG thematic. investment products and, vi The Stock Exchange of Hong Kong SEHK to strengthen the emphasis on. ESG for both listing applicants and listed companies. II INTRODUCTION TO ESG INVESTMENT ECOSYSTEM, 7 In the ESG investment ecosystem there are three main groups of key stakeholders i. financial investors ii investee companies and iii policymakers Each plays an. important and distinct role Within such ecosystem a large cluster of services. providers including sell side research brokers ESG index publishers and ESG. analysis providers also critical in ensuring the ESG standards and needed support are. in place see Diagram 2, Diagram 2 Relationships between key stakeholders in the ESG investment ecosystem. Financial investors, 8 Financial investors in the ESG investment space are a broad term that covers both. asset owners and asset managers both public and private In recent years an. escalating number of investors have placed heavier focuses on a company s ESG. information when considering whether to commence or continue an investment in it. 9 Globally institutional investors are becoming strong supporters for ESG investments. The reasons for institutional investors to integrate ESG vary some are appealed by. the long term financial performance some due to better risk management and others. because they take a view about their social role Meanwhile institutional investors in. some jurisdictions are subject to certain levels of regulatory obligations or fiduciary. duty to consider ESG factors in their investment process. 10 The institutional investors that factor in ESG to their investment process include some. of the world s largest for example Norway s Government Pension Fund Global. GPFG and Japan s Government Pension Investment Fund GPIF The. Norwegian GPFG has requested the 9 100 companies in which it holds stakes to. submit data on issues such as water use and climate effects to the London based non. profit organisation CDP in hopes of strengthening the companies reporting 8 Its. policies such as restricting investments in coal companies pose significant influence. on both the companies and other investors as GPFG owns on average 1 4 of all. listed shares worldwide 9 Japan s GPIF being the largest public institutional investor. in the world has committed 3 of its stock portfolio i e US 8 9 billion to ESG. related index fund GPIF s president Norihiro Takahashi also made it clear publicly. that the Fund is planning to increase its ESG contribution to 10 in the long run. around US 29 billion Other examples of ESG conscious investors include the. largest Australian superannuation fund Australian Super and the largest US pension. fund CalPERS both have clear ESG policies and dedicated ESG headcount. 11 The wind of change is also blowing across private financial investors A number of. the leading global asset owners have indicated their support towards the rise of. sustainable investments 10 Demand and interest from retail investors in other OECD. jurisdictions such as Australia Canada and the US is also strong and growing. 12 Global interest among institutional investors in ESG investment is increasing yet the. degree varies across regions According to the 2017 survey result published by. Schroders while 33 of Asia s institutional investors and 48 of global institutional. https blogs thomsonreuters com sustainability 2018 03 04 wealth fund goes green norways firms struggle. For example BlackRock Chairman and CEO Larry Fink recently emphasised the importance of boards in. articulating the long term strategy which includes ESG and diversity factors. https www blackrock com corporate investor relations larry fink ceo letter Legal and General. Investment Manager one of the largest managers of institutional assets in the UK adopts ESG integration. approach across all of its assets i e for all of their funds http www lgim com uk ad press 2018 lgim. launches a future world fund for uk retail investors html. investors had increased their sustainable investment in the past five years Hong. Kong s figure was only 7 11, 13 The varied level of interest and awareness of ESG also happens among investee. companies or other companies in general Some companies are seen to have adopted. ESG reporting and or ESG integration in a serious manner yet there are cases where. ESG reporting is considered a box ticking exercise Amongst these larger companies. appear to allocate more resources on improving their ESG performance and reporting. than smaller sized companies, 14 In Hong Kong ESG reporting has become more widespread in the last few years. mainly due to the upscale of the regulatory requirements Despite the increasing. uptake ESG reporting among the companies is of diverse quality board s. commitment to ESG and the companies materiality assessment are often cited as the. key differentiating factors,Policymakers, 15 Governments regulators and stock exchanges from almost all developed economies. are also seen to play a crucial role in building the ESG investment ecosystem may it. be in the form of laws regulations and or other incentives According to a 2016. research report 12 there are now over 400 laws and regulatory standards in 64. countries requesting some sort of corporate sustainability reporting a big leap from. the 180 laws and regulatory standards identified in 44 countries in 2013 These laws. and regulatory standards create not only the regulatory expectation that ESG reporting. is becoming a mainstream but also a recognition that the disclosure of ESG. information is to a meaningful extent useful to the market players. 16 Beyond corporate reporting a number of jurisdictions also have formulated pension. fund regulations and stewardship codes to encourage investors to consider ESG issues. Schroders Institutional Investor Study Institutional perspectives on sustainable investing 2017 Schroders. September 2017 The study was carried out via a global survey during June 2017 covering 500. institutional investors from 15 different countries. Carrots Sticks Global trends in sustainability reporting regulation and policy KPMG GRI United. Nations Environment Programme and Centre for Corporate Governance in Africa May 2016. As of 2016 at least 23 jurisdictions have or are developing some form of rules. regarding pension funds and ESG criteria 14 jurisdictions have or are developing. guidelines on investors exercise of ownership in the pursuit of long term sustainable. 17 In Hong Kong corporate governance reporting has over a decade of history while. ESG reporting could be said to become formally required since March 2014 when. the new Companies Ordinance Cap 622 came into effect The Ordinance requires all. Hong Kong incorporated companies unless exempted to include in the business. review section of their annual directors reports a high level discussion of ESG. matters 14, 18 Taking this further the SEHK requires listed companies to publish ESG reports on an. annual basis under its ESG Guide effective for the financial year starting 1 January. 2016 15 An ESG report should cover the listed company s ESG management approach. strategy priorities and objectives and explain how they relate to the business A listed. company must report on the comply or explain provisions of the ESG Guide. 19 The SFC s Principles of Responsible Ownership 16 also contains some relevance to. ESG investors should encourage their investee companies to have ESG policies. investors should also engage with investee companies if they have concerns about. social and environmental matters With a particular focus on green finance the SFC. also has issued a strategic framework in September 2018 outlining its action agenda. in five interrelated areas including corporate environmental and climate change. related disclosure ESG integration in investment process as well as product. disclosure listing and trading 17, Global Guide to Responsible Investment Regulation PRI and MSCI 2016. The requirement is applicable to financial reporting years beginning on or after 3 March 2014 This. disclosure requirement has also been incorporated into the Listing Rules of the SEHK which apply to all. listed companies in Hong Kong, Appendix 27 to the Main Board Listing Rules and Appendix 20 to the GEM Listing Rules. It is in a similar nature to what is called a stewardship code in other jurisdictions The SFC s Principles of. Responsible Ownership is non binding and is voluntary. Strategic Framework for Green Finance SFC 21 September 2018. III THE VALUE PROPOSITION, 20 ESG investment has been gaining major traction globally in the last several years. According to the Global Sustainable Investment Review 18 from 2014 to 2016 the. total sustainable and responsible investment assets rose from US 18 trillion to almost. US 23 trillion with Europe taking over half of the portion US 12 trillion and. Japan achieving the substantial growth in the past two years 6689 6 see Table 2. Table 2 Growth of Socially Responsible Investment SRI assets by region 2014 2016. Region Performance in 2014 Performance in 2016 Growth. US billion US billion,Europe 10 775 12 040 11 7,United States 6 572 8 723 32 7. Canada 729 1 086 49 0,Australia New Zealand 148 516 247 5. Asia excl Japan 45 52 15 6,Japan 7 474 6689 6,Total 18 276 22 890 25 2. Source Global Sustainable Investment Review 2016,Enhance risk adjusted returns. 21 For many investors return is the single most important focus when making. investment decisions However return alone is only part of the equation a higher. return in efficient markets is only possible by accepting higher risk This may not be. the desired investment strategy for all investors, 22 ESG integration plays an important role in risk identification mitigation and. management Throughout this process company management and their boards are. able to identify value creation opportunities A series of research papers have. provided mounting evidence academic and empirical to support this claim In a. joint study carried out by the University of Oxford and an investment management. See footnote 1, firm Arabesque Partners over 200 of the highest quality academic studies were. investigated and it was found that companies that neglected ESG factors were. exposed to tremendous risks and hence subject to potentially substantial negative. financial impacts 19 According to the study as of March 2015 the 10 largest fines in. history settled by corporates concerning ESG related issues had amounted to US. 45 5 billion Their findings suggested that companies with strong sustainability scores. show better operational performance and are less risky and that investment strategies. that incorporate ESG issues outperform comparable non ESG strategies. 23 A study conducted by the Bank of America in 2017 found a similar relationship. between ESG and risk management companies that adopt good ESG practices exhibit. lower risks in terms of price volatility earnings volatility and bankruptcy risks. Amongst other findings companies with the highest ESG ranking only has a 32. median change in earning per share EPS volatility over the next five years which. is a stark contrast to the worst performing ones with 92 median change see Table. Table 3 Subsequent five year median change in EPS volatility by overall ESG percentile ranks. Overall ESG Rank Long term Dividend Yield Median change in. from worst to best Growth Rate EPS volatility over. next 5 years,1st 20th percentile worst 6 0 92,21st 40th percentile 8 1 64. 41st 60th percentile 8 1 65,61st 80th percentile 9 2 37. 81st 100th percentile best 9 2 32, From the Stockholder to the Stakeholder How Sustainability Can Drive Financial Outperformance. Oxford University and Arabesque Partners September 2014. ESG Part II A Deeper Dive Bank of America Merrill Lynch Global Research June 2017. 24 Through identification mitigation and management of key risks ESG integration is. increasingly seen as a tool to maximise the risk return trade off Kumar et al found. that companies incorporating ESG factors in their operation tend to deliver better risk. adjusted returns Assessing a total of 966 companies of which 157 were in the Dow. Jones Sustainability Index their research demonstrated that companies incorporating. ESG factors would see lower stock performance volatility than those that do not At. the same time while the degree of impact would differ from one industry to another. companies adopting ESG factors would also deliver higher returns 21. 25 Empirical figures provided by the global index company MSCI align with the above. findings According to the figures as of August 2018 both the MSCI ACWI ESG. Leaders best in class and the MSCI ACWI ESG Universal ESG weighted indexes. have outperformed the traditional parent market capitalisation index the MSCI ACWI. All Country World Index 22 Similarly a Goldman Sachs investment research report. found that the share price of companies in Asia ex Japan with low ESG scores. underperformed sector peers by c 100 basis points per annum between 2010 and 2017. over rolling 3 year holding periods 23, 26 The link between ESG and positive return is also of great relevance to fixed income. According to Barclays most of the portfolio pairs studied indicated a generally. positive return premium for the ESG factor in corporate bond markets 24. 27 These findings echoed the goal and construct of the United Nations supported. Principles for Responsible Investment UNPRI which considers that ESG issues. can affect investment performance and that the appropriate consideration of these. issues is part of delivering superior risk adjusted returns and is therefore firmly within. the bounds of investors fiduciary duties 25, ESG factors and risk adjusted performance a new quantitative model Kumar N C A C Smith L Badis. N Wang P Ambrosy R Tavares Journal of Sustainable Finance Investment 4 October 2016. MSCI ACWI ESG Leaders Index Factsheet and MSCI ACWI ESG Universal Index Factsheet MSCI. August 2018,See footnote 4, Sustainable Investing and Bond Returns Barclays 2016. The Principles for Responsible Investment United Nations Environment Programme Finance Initiative. Lower funding cost, 28 Deutsche Asset Wealth Management based on the aggregation of the findings and. data of 100 review studies concluded that strong corporate commitment to ESG is. positively correlated to a lower cost of capital including both cost of debt and cost of. equity capital 26, 29 Recent research from MSCI also provided similar indications Comparing the average. beta of ESG quintiles from 2007 to 2017 MSCI found that high ESG rated companies. experienced lower levels of beta and thus lower costs of capital in the context of the. capital asset pricing model Conversely companies with low ESG ratings were more. likely to experience major risks incidents such as major drawdowns and hence suffer. from higher costs of capital 27,Attract new sources of capital and AuM. 30 As explained above ESG integration has a positive correlation with the medium to. long term risk adjusted return of a company Because of this as well as other. reasons more and more investors especially those oriented in long term investments. such as pension funds sovereign wealth funds foundations real long term savings. are starting to or continuing to look for companies with a strong ESG profile to invest. in Earlier this year Morgan Stanley surveyed 118 large global asset owners and. found that 84 of them are at least actively considering integrating ESG criteria into. their investment process While public equities and real assets are seen as the sectors. with the most attractive ESG investing opportunities the interest in ESG investing. holds across different asset classes including fixed income and private equity 28. 31 Financial investors increasing commitment to ESG investment also presents a. compelling case that companies with a strong ESG profile have higher probability to. attract new source of capital and assets in addition to the conventional investment. portfolio As of September 2018 more than 2 000 asset owners investment managers. and service providers have become the signatories to the UNPRI representing over. Sustainable Investing Deutsche Asset Wealth Management June 2012. Foundations of ESG Investing Part 1 How ESG Affects Equity Valuation Risk and Performance MSCI. ESG Research November 2017, Sustainable Signals Asset Owners Embrace Sustainability Morgan Stanley Investment Management and. Morgan Stanley Institute for Sustainable Investing 2018.
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