The Hong Kong Monetary Authority (the HKMA) has published a white paper outlining its initial views on the supervisory expectations for authorized institutions (AIs) in addressing climate-related issues. The development of the supervisory expectations forms part of the work envisaged under phase 2 of the three-phased approach introduced by the HKMA in May 2019, which is aimed at encouraging the adoption of green and sustainable banking in Hong Kong.

The HKMA is proposing to launch a formal consultation in the first half of 2021 on the supervisory expectations. In addition, the results from the first round of assessment under the Common Assessment Framework[1] (to be received in August 2020) and industry feedback from relevant working groups will also facilitate the HKMA in refining its supervisory expectations.

The HKMA has distilled its supervisory expectations into nine guiding principles across four categories, covering (i) governance, (ii) strategy, (iii) risk management and (iv) disclosure. The guiding principles are intended to be applicable to all AIs, having regard to the AI’s size, nature of business, complexity of operations and stage of development in its capability in addressing climate-related issues.

The guiding principles are outlined below, together with some of the key recommendations put forward by the HKMA.  The white paper also includes good practices observed within the industry, and AIs are encouraged to review these as a useful benchmark.

Guiding principles for building climate resilience

(i) Governance

Principle 1 – Board’s accountability in climate resilience

The board has primary responsibility for an AI’s climate resilience. It should have sufficient understanding of the climate-related issues in determining the AI’s approach to address them. 

  • The board and senior management should have sufficient knowledge to consider the impact on the AI, and define clear roles and responsibilities for the AI’s approach to addressing climate-related issues. At this stage, the HKMA’s supervisory expectations will remain focused on an AI’s management of climate-related risks only.
  • While the board remains ultimately responsible for the AI’s climate resilience, it may delegate authority to board-level committees. Such delegation should be made formally with the relevant roles and responsibilities, governance structure, and escalation/ reporting procedures clearly outlined and documented in the mandate (or charter, terms of reference etc.).

Principle 2 – Board’s oversight of climate strategy development and implementation

The board should exercise oversight of the development and implementation of the AI’s climate strategy, including embedding climate-related risks into the AI’s risk appetite framework.

  • The board should have specific roles for overseeing the development and implementation of the AI’s climate strategy e.g. ensuring that the AI’s strategic climate goals are in line with its vision.
  • The board is responsible for setting the AI’s overall risk appetite and approving the risk appetite statement (RAS) recommended by senior management. The consideration of climate risks in the RAS may be qualitative in the initial stage, but it should be regularly reviewed and enhanced in light of the evolving impacts arising from climate change.
  • Taking into account the AI’s specific circumstances (e.g. strategic climate goals, risk-taking capacity and results of any materiality assessment), the board should review and consider whether climate risks should be integrated into the risk appetite framework. If deemed appropriate, climate risks should be properly reflected in the RAS in a proportionate manner, whether explicitly or implicitly (i.e. as a part of general risk management).
  • It is not currently the intention of the HKMA to draw up mandatory requirements related to the setting of business targets on sustainable finance, incentives or remuneration, however, the HKMA would encourage AIs to consider setting targets in developing their CSR initiatives and sustainability-related businesses in address climate-related issues.

(ii) Strategy

Principle 3 – Formulation

Climate considerations should be embedded throughout the strategy formulation process, from strategy assessment to action plan development.

  • The formulation of climate strategy should be based on a long-term view, underpinned by a proper strategic assessment process which could include an assessment of relevant internal factors (e.g. an AI’s risk management structure and data systems to support management of climate-related risks) and external factors (e.g. government policies and regulations), engagement with relevant stakeholders of the AI (e.g. regulators, investors, depositors, clients, creditors, counterparties etc.), and scenario analysis.
  • Following the strategic assessment process, the AI may devise an action plan that targets climate resilience in line with its strategic goals. Such plans should be regularly reviewed and refined as appropriate.
  • An AI which is a locally incorporated subsidiary or operates in Hong Kong as a branch may adopt the strategy of its group or parent in addressing climate-related issues. Such AIs should ensure that such strategy fits local circumstances. If any local conditions are not sufficiently addressed by the group or parent strategy, it should be escalated to the group or parent for a possible solution or alternatively, the AI could choose to address them locally.

Principle 4 – Implementation

Organisational structures, business policies, processes and availability of resources should be reviewed and enhanced to ensure effective integration of climate strategy into the operation and corporate development of an AI.

  • An AI’s strategic climate goals should be properly reflected in its business policies. Each business and functional unit taking part in the climate strategy implementation should have their roles and responsibilities clearly defined. An inter-departmental working group may be established to facilitate communication and co-ordination.
  • AIs are expected to incorporate climate risk considerations into their existing risk management framework, with effective risk management processes to identify, measure, monitor, report, control and mitigate climate-related risks. As a first step, AIs should assess how and to what extent climate change would affect their assets (including lending portfolios and proprietary investments) and operations (including any outsourcing arrangements).  If necessary, AIs should then develop concrete plans to enhance the existing risk management function in areas such as decision-making authority and resource allocation.
  • Day-to-day climate-related risk management activities should be carried out by the AI’s existing risk management function, independent of the risk-taking activities and operational units it reviews. In line with the usual risk governance arrangement, the responsibilities of managing climate-related risks could be allocated among three lines of defence.

(iii) Risk management

Principle 5 – Identification

AIs should identify the transmission channels and assess the impacts of physical and transition risks arising from climate change on their business, and on their clients’ businesses. Concrete plans should be devised to address any information and data gaps.

  • AIs should consider the impact of physical risks on both their own operations (as part of the business contingency planning process) and their clients.
  • Initial identification of key risk areas of an AI’s business affected by climate change may focus on geographical locations and industry sectors that are most vulnerable to physical or transition risks.

Principle 6 – Measurement

AIs should build capability over time to measure climate-related risks using various methodologies and tools, among which scenario analysis should be actively explored.

  • At the initial stage, AIs may start with simple metrics (e.g. greenhouse gases emissions and carbon intensity of projects financed by the AI) as a basis for tracking, although AIs could build their capabilities in risk measurement as they gain more experience.
  • Scenario analysis could serve as a technique for testing resilience of AIs to climate stress (although noting its limitations), using both long and short term horizons. AIs are encouraged to conduct pilot analysis on sectors of higher risks, referencing the scenarios developed by relevant international organisations e.g. the Intergovernmental Panel on Climate Change, the Task Force on Climate-related Financial Disclosures (TCFD), and the Central Banks and Supervisors Network for Greening the Financial System.

Principle 7 – Monitoring and reporting

AIs should implement processes to monitor and report exposures to climate-related risks to ensure that such exposures are consistent with their risk appetite, and that timely and regular updates are provided to the board and senior management.

  • Monitoring processes should be regularly updated to keep pace with the latest developments on climate change e.g. emission path and environmental policies.
  • As an initial step, AIs may focus on certain risk factors and monitor to what extent their portfolios may be affected. For those high risk sectors where the AI has significant exposure, it is recommended that AIs take further steps to monitor these risks.

Principle 8 – Control and mitigation

AIs should carry out measures to control and mitigate exposures to climate-related risks to ensure effective management of these risks.

  • AIs may implement measures to impose limitations or a tilting policy on their exposures to sectors which do not align with their climate strategy or risk appetite. Such measures, together with any climate considerations or assessment criteria, could be set out in relevant sector policies to facilitate consistent implementation and risk assessment.  Apart from sectoral exposure policies, AIs may also consider applying more stringent lending terms such as shorter tenor and a lower loan-to-value limit.
  • At the client level, AIs may consider (e.g. in their client selection, credit assessment, annual review and ongoing monitoring processes) whether the business activities of their clients are in line with their own climate strategy or risk appetite, taking into account the client’s climate strategies.
  • AIs should consider taking control or mitigation measures with regard to physical risks. AIs may take into account the location factor in formulating such measures, by assessing whether clients’ operations or properties are located in areas which are prone to physical risk, such as coastal areas with a higher flooding risk.

(iv) Disclosure

Principle 9 – Disclosure

AIs should develop an appropriate approach to disclosing climate related information to enhance transparency.  When considering the information to be disclosed, AIs should take the TCFD recommendations as the core reference.

  • The scope of disclosure could include both risks and opportunities posed by climate change. An AI may report on how it responds to climate change in its business model, policies and processes, risk management, and targets.
  • The HKMA recommends that AIs initially prioritise disclosing certain climate-related information such as the AI’s governance and oversight of climate-related risks, and the relevant risk management processes. If the AI does not make such disclosures, it should be prepared to explain to stakeholders, including regulators, the rationale and key considerations for such a decision.
  • For AIs which are the local subsidiaries or branches of foreign banks, climate disclosures may be centralised at the group or head office level, with the information of the subsidiary or the branch integrated into the relevant report. To promote transparency, the HKMA encourages AIs that are local subsidiaries to make specific express disclosures concerning their approach to climate-related risks and mitigating actions for their Hong Kong operations. For local branches, the need to make specific disclosures about their Hong Kong operations appear less compelling as there may not be a standalone governance framework and strategy for the Hong Kong operations.
  • AIs are also expected to have a plan in place setting out how their climate disclosure will be progressively enhanced.

A copy of the white paper is available here.

[1] To read our previous blog on the rollout of the Common Assessment Framework, please click here.