Hong Kong Monetary Authority publishes good practice for due diligence processes for green and sustainable products

On 9 December 2022, the Hong Kong Monetary Authority (HKMA) sent a circular (and annex) to authorised institutions (AIs) setting out some good practice guidance on due diligence and other processes relating to the development and ongoing management of green and sustainable products which resulted from a round of thematic examinations.

The thematic examinations mainly focused on AIs’ processes relating to the offering of green and sustainable products, including the approval and launching of products, clients due diligence and transaction approval, and post-offering reviews and controls in relation to the following products: green loans and green trade facilities, green mortgages, green personal loans, green deposits, sustainability-linked financing (including sustainability-linked loans and trade facilities), and green and sustainable investment products. The due diligence processes for a range of corporate and retail green and sustainable products of selected AIs were reviewed.

The driver for this continues to be greenwashing. We continue to see globally a focus on the need to tighten concepts and terms used in relation to green and sustainable products. This sits alongside increasingly granular expectations around how climate and environmental financial risks are identified and monitored.

The objective of this latest guidance from the HKMA is to ensure that the AIs have put in place proper systems of control to ensure that the products and the related funds are managed in a way consistent with their climate strategies, thereby reducing any potential exposures to greenwashing risks.

The good practices identified from the examinations covers five high-level principles, as follows:

• Setting up a robust product governance framework for green and sustainable products - A robust product governance framework for overseeing and managing green and sustainable products is essential to ensure the compatibility of these products with the institution’s climate strategies throughout their lifecycle.
• Conducting comprehensive “greenness assessments” of clients and transaction due diligence for green lending - Performing comprehensive greenness and climate-related risk assessments ensures the eligibility criteria for green and sustainable products are met.
• Performing post-offering monitoring and controls to ensure the proper management of green and sustainable products - Performing post-offering monitoring and controls helps to ensure that green and sustainable products remain green and sustainable throughout their lifecycle, thereby mitigating the potential risk of climate-related greenwashing.
• Enhancing transparency and accountability in respect of green and sustainable products - Enhancing transparency by disclosing more information about AIs’ green and sustainable business including their green initiatives, the projects being funded, and the allocation of relevant green proceeds is conducive to mitigating the risk of perceived greenwashing.
• Building appropriate expertise in product development and comprehensive due diligence processes - Dedicating sufficient resources to building appropriate expertise is essential to ensure AIs’ green and sustainable product due diligence and assessment of the associated risks are duly conducted.

This circular follows the report published by the HKMA on 21 November 2022 on “Greenwashing in the Corporate Green Bond Markets” which found that while corporate green bonds can help tackle climate change (confirmed by the lower average aggregate greenhouse gas (GHG) emission intensity since the corporates started issuing green bonds), about one-third of global corporate green bond issuers were found to have poorer environmental performance after their initial green bond issuance, suggesting green bonds may be being used as a greenwashing tool (as reflected by higher GHG emission intensity). The report states that this type of greenwashing’ behaviour poses a risk to financial stability if the market loses confidence in green bonds and other green asset classes and so impedes progress on tackling climate change. (As referred in the report, “Green bonds” are debt instruments that the proceeds are committed to fund assets and/or projects that would bring positive environmental benefit (Climate Bonds Initiative (CBI), 2020; International Capital Market Association (ICMA), 2021).)

However, the HKMA also found that the market does penalise greenwashing behaviour and firms seen as “greenwashing” are less likely to issue green bonds again, and if they do, will likely have to pay higher issuance costs.

Finally, the report highlighted that a well-defined green bond taxonomy and improvements in disclosure requirements could mitigate greenwashing behaviour. The Hong Kong regulators have been working towards proposing a local green classification framework for consultation with the banking industry and other stakeholders. In June 2022, the Green and Sustainable Finance Cross-Agency Steering Group (CASG) announced that it will, with the aim of aligning with the Common Ground Taxonomy (CGT), explore developing a green classification framework for adoption in Hong Kong which facilitates easy navigation among the CGT, China and the EU’s taxonomies. The work will be guided by principles of interoperability, comparability, and inclusiveness, taking into account other definitions of green, transitional activities, and local considerations and is likely to be key in the development of a sophisticated green bond market in Hong Kong.

Tackling green claims (i.e. false or misleading statements that products or services meet certain environmental standards) continues to be a priority for regulators (particularly financial regulators) in Hong Kong. In addition to this latest development by HKMA, the Securities and Futures Commission (the SFC) has also highlighted greenwashing as a key threat to the development of green and sustainable finance.

Firms in Hong Kong will need to think carefully about the steps they can take now to identify potential areas across their businesses for greenwashing, and how they can monitor, mitigate and ultimately try to prevent greenwashing. This includes developing a credible and consistent narrative around what greenwashing means, implementing robust internal procedures for scrutiny and developing disclosures in line with emerging (and converging) international standards. Listen to our webinar for more practical tips.