Regulatory approaches to ESG diverging in Europe and Asia - TR

Regulators in Asia and Europe have taken divergent approaches towards marketing environmental, social and governance-related (ESG) investment funds in their respective jurisdictions.

The strategies reflect the different regulatory focus areas between authorities in various jurisdictions, as well as the local financial and economic priorities.

In the European context, the European Union wants to promote sustainable investment, said Eugenie Shen, managing director and head of asset management at the Asia Securities Industry & Financial Markets Association (ASIFMA).

“The disclosures under the Sustainable Finance Disclosure Regulation (SFDR) [from Europe] is very focused on how managers disclose their investments. What are the principal, adverse impacts or effects, or the negative impacts of investment decisions. So, they’re very focused on promoting sustainable investments,” Shen said.

“In Asia, our observation is that Asian regulators are more concerned with risk management. They’re not so much into promoting sustainable investment. Ultimately, they would like to do that but their focus is more on risk management.”

Environmental risk management in Asia

The Monetary Authority of Singapore (MAS) has launched environmental risk management guidelines for asset managers, as well as for banks and insurers. For asset managers, the guidelines set out MAS’s expectations on environmental risk management for all fund management companies and real estate investment trust managers.

Items covered in the guidelines include governance and strategy, research and portfolio construction, portfolio risk management, stewardship and disclosure of environmental risk information.

“This is why, for example, you see the MAS in Singapore come out with these environmental risk management requirements for asset managers,” Shen said.

“In Hong Kong, [regulators] narrowed to just climate-related risks. At some point they’ll probably expand it to environmental issues beyond climate. So, obviously the concern is really how fund managers and asset managers manage risks related to climate-related or environmental risk.”

Fund labelling

Two of the major focuses for regulators in Asia are investor protection and greenwashing, Shen said. MAS has rolled out guidelines to help reduce greenwashing risks and enable retail investors to better understand the ESG funds they invest in. The guidelines will take effect in January 2024. Greenwashing is the act of making false or misleading claims that products or investments are more environmentally sound, or green, than they are.

Investment funds under the ESG label will now have to provide relevant information to better substantiate the label. Some of the information required to be disclosed under the guidelines include details on the ESG fund’s investment strategy; the criteria and metrics used to select investments; and any risks and limitations associated with the fund’s strategy.

Such disclosures are required to be made on a continuing basis. Investors will also receive annual updates on how well the fund has achieved its ESG focus.

“You’ll see a whole slew of regulation on what is an ESG fund?” Shen said.

“In fact, in that sense Europe is lagging behind. It’s only now that the European Securities and Markets Authority (ESMA) is starting to look at fund labelling. But in Asia, we’ve already gotten both the Securities and Futures Commission (SFC) and MAS coming out with rules on what an ESG fund is.”

ESG funds in Europe and Asia

The EU sets out mandatory ESG disclosures requirements for asset managers. Under the SFDR, funds that promote environmental or social characteristics (light green) are categorised as “Article Eight funds”, while funds that have sustainable investment as their objective are categorised as “Article Nine funds”.

“In Asia, we don’t have that [Article Eight and Article Nine] distinction. It’s all focused on what is an ESG fund,” Shen said. “We’re seeing the trend between MAS and SFC is that ESG has got to be a key investment focus of the fund.”

In Hong Kong, an Article Eight fund can be marketed in the city without changing its name, which might include “sustainability” or “sustainable” or “green” etc. The SFC, however, requires a disclaimer to be added following the fund’s name clarifying that this is not an SFC-recognised ESG fund. In Singapore, an Article Eight fund cannot be marketed in the city-state.

“MAS thinks that it’s either an ESG fund or not an ESG fund,” Shen said. “So, in Asia, we don’t have an equivalent of Article Eight; we only have Article Nine type of funds.”

To be qualified as an ESG fund in Hong Kong, the fund should invest at least 70% of its net asset value in the companies that satisfy “green” or “sustainable” requirements. In Singapore, at least two-thirds of the fund’s net asset value should be invested in “green” or “sustainable” companies.

The European perspective is all about promoting sustainable investments while the Asian perspective is more focused on risk management.

“How do you take into consideration climate related environmental risk?” Shen said. “The European regulations tend to be much broader. It has a much bigger impact. For example, their proposed Corporate Sustainability Due Diligence Directive, which is…not only looking at their own sustainability situation, but the whole supply chain.”

The European Commission proposed the Corporate Sustainability Due Diligence Directive in February 2022. It is still moving through the EU legislative process and is unlikely to come into force until 2025 at the earliest, according to KPMG.

The directive highlights that sustainability can go beyond just climate-related issues. This means that businesses should play an important role in protecting both the environment and supporting broader issues such as human rights, which has caught the wider attention of politicians, investors, consumers and other stakeholders.

China’s concerns

China has committed to having carbon dioxide emissions peak by 2030 and achieving carbon neutrality by 2060. The country’s economic condition, in the meantime, just showed signs of recovery with the first quarter GDP growth rate hitting 4.5%, after the authorities had abruptly ended its draconian zero-Covid policy in late 2022. The pace of increase was the fastest in a year and beat the 4% rise forecast from analysts polled by Reuters.

Despite the positive reopening and the country’s pledge of net-zero commitment, the Asset Management Association of China, a self-regulatory association, told Shen during her recent mainland China trip that “they’re worried about their industries”.

“What they see is companies that [spend] a lot of money to become sustainable, that’s going to be costly to their corporates. There’s the question of whether they’re going to be able to generate a good return or profitability, and whether that gives a good return to retail investors,” Shen said.

“So, to me, I actually find this refreshing that they are kind of looking at all of this from different angles, and there’s a balancing of what it is…I wish regulators [in Hong Kong] would focus more on that.”

It is of utmost importance for asset managers that operate in multiple jurisdictions to have alignment and harmonisation in terms of regulations in their respective operating jurisdiction, Shen said. Asset managers tend to gravitate towards adopting the strictest rules.

“The [ultimate] challenge for asset managers is, depending on which jurisdictions rules are the strictest, we actually have to gravitate towards that,” Shen said. “So far, European standards are quite high. But now we’re really seeing Asia deviating [from Europe] and then coming up with some stricter rules than Europe.”

This article was written by Yixiang Zeng and first appeared on Thomson Reuters Regulatory Intelligence.