HK voluntary code for data provider ESG rating

By Rossana Chu, Yang & Yang Solicitors
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The Securities and Futures Commission of Hong Kong (SFC) is sponsoring the International Capital Market Association (ICMA) to form a working group tasked to develop a voluntary code of conduct for environmental, social and governance (ESG) rating and data product enterprises providing ESG products and services in Hong Kong.

Greatest concerns

Rossana Chu, Yang & Yang Solicitors
Rossana Chu
Partner
Yang & Yang Solicitors

In 2022, the SFC conducted a survey to understand business concerns over ESG products and services. Their report, published in October 2023, had certain findings worthy of attention, with highlights including:

  • 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.
  • Major concerns of asset managers and other ESG product users are also data quality and coverage, including insufficiency of data on private companies and emerging markets.
  • Another challenge facing asset managers is lack of transparency on the part of ESG service products such as 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 own in-house ESG specialists, responsible for analysing information provided by ESG service providers, meaning they are not wholly relying on the service providers before making investment decisions.
  • Some asset managers may formulate ESG ratings for internal use, or for their clients, by utilising their own methodologies.
  • Conflict 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 was established to address concerns by introducing a “voluntary” code of conduct. This approach is also taken by the UK, Singapore and Japan, while the EU elects to expand its regulatory remit to cover ESG service providers.

Tackling the issue

The SFC is sponsoring 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 (HSIL). The Hong Kong Monetary Authority and the Insurance Authority sit as observers.

Objectives of the working group include:

  • Developing a globally consistent voluntary code of conduct for ESG rating and data product enterprises providing products and services in Hong Kong; and
  • Setting out baseline best practices governing the conduct of ESG service providers, based on recommendations of the International Organisation of Securities Commissions’ (IOSCO) coverage of 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 it may help them better communicate with covered entities and ESG product users in terms of their transparency, quality and reliability of products.

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

According to 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 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 reflecting best practices and addressing 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.


Rossana Chu is a partner at Yang & Yang Solicitors

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Yang & Yang Solicitors
2803 & 2803A, China Resources Building
26 Harbour Road, Wanchai, Hong Kong
Tel: +852 2816 6888
Fax: +852 3797 3835
Email:

rossana.chu@east-concord.com.hk

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