On 8 December 2020, the Monetary Authority of Singapore (MAS) issued Guidelines on Environmental Risk Management (the Guidelines) tailored to financial institutions (FIs) in three sectors: asset management, banking and insurance. The Guidelines are intended to drive the transition to an environmentally sustainable economy by enhancing the integration of environmental risk considerations in FIs' financing and investment decisions and promoting new opportunities for green financing.
We previously covered the initial MAS proposals for the Guidelines as they related to asset managers and insurers. This Legal Update will focus on the final Guidelines as they relate to asset managers and highlight key updates to the initial proposals.
Defining Environmental Risk
The MAS framework for environmental risk encompasses the following three risk channels:
- Physical risk arising from the impact of weather events and long-term or widespread environmental changes (e.g., water scarcity and the rising frequency and severity of extreme weather events, which can impair the value of assets and/or impact supply chains);
- Transition risk arising from the adjustment to an environmentally sustainable economy, including shifts in public policies, technological developments and shifts in consumer or investor preferences (e.g., the transition to a low-carbon economy can impair the profitability of companies in carbon-intensive businesses); and
- Reputational risk arising from investments in companies that have a negative impact on the environment, creating a negative perception of the asset manager that may adversely affect its ability to maintain or grow AUM (assets under management).
This framework is generally aligned with the Recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), which focus on climate-related risks only. The TCFD framework principally recognises physical and transition risks, with the MAS electing to also include a standalone "reputational risk" category described above. Jurisdictions around the world, including Hong Kong and New York, are increasingly referring to the TCFD Recommendations in climate-related risk management guidance.
Significantly, the Guidelines encompass risks related to a broader range of issues than climate change alone, including the loss of biodiversity, pollution and changes in land use. Asset managers applying a global risk management framework to comply with the Guidelines should keep this in mind and ensure processes applied in Singapore also address these additional risk areas.
With the multifaceted nature of environmental risk and the potentially significant impact it can have on asset values, the MAS notes that it is crucial for asset managers to ensure the resilience of their customers' investments against such risk.
The Guidelines will apply to fund management companies registered in Singapore, as well as the holders of a capital markets licence for fund management and real estate investment trust management in Singapore. Asset managers that do not have discretionary authority over the investments of the funds/mandates they are managing are not covered.
Importantly, the MAS confirmed in Consultation Responses that the Guidelines apply to all covered asset managers regardless of their investment strategies. Asset managers are permitted, however, to apply the Guidelines in a manner that is "commensurate with the size and nature of their activities, as well as the investment focus and strategy of their funds/mandates." For example, asset managers using passive investment strategies should use engagement and proxy voting to influence the behaviour of investee companies. Smaller asset managers can take "measured steps" toward compliance, including through environmental risk management capacity building efforts.
The Guidelines address environmental risk management practices in the following categories:
- Governance and Strategy: The Guidelines clarify that asset managers are required to identify, address and monitor material environmental risks pursuant to certain existing risk management regulations in Singapore. Accordingly, the board of directors and senior management should oversee the integration of environmental risk into existing risk management frameworks. Specifically:
- the board (or a committee thereof) is responsible for approving an environmental risk management framework and related policies, setting the roles and responsibilities of the board and senior management with respect to the framework and ensuring that management has adequate expertise and resources for managing environmental risk; and
- senior managers are responsible for developing, implementing and reviewing the framework, establishing an escalation process for managing environmental risk and allocating resources appropriately.
In its Consultation Responses, the MAS confirmed that a board of directors can delegate its duties to a committee, while asset managers need not designate directors and officers solely responsible for environmental risk. Further, asset managers may apply global or group governance structures and frameworks in Singapore, but local boards and managers must nonetheless oversee Singapore operations and the implementation of the responsibilities contained in the Guidelines.
- Research and Portfolio Construction: Asset managers should embed environmental risk considerations in research and portfolio construction processes and are encouraged to refer to international standards and frameworks (e.g., the Global Reporting Initiative, CDP, SASB and TCFD) when considering transition and physical risks at an individual asset and/or portfolio level. The Guidelines provide illustrative examples for asset managers to reference when considering the materiality of environmental risk for different asset classes, including:
- fixed income investments, in which asset managers should consider environmental indicators from external data providers, in addition to such information provided by the issuer, to obtain a more holistic view of environmental risk; and
- direct real estate investments, in which asset managers should consider operational indicators (e.g., greenhouse gas emissions and energy, water and waste management data), extreme weather events, and the effects that both of these factors may have on tenant demand.
At all times, asset managers must also be mindful of limits that their customers may set on exposure to specific sectors or types of activities, like sector limits on investments in the fossil fuel industry or caps on portfolio-wide carbon emissions.
The MAS recognises in its Consultation Responses that asset managers may find it difficult to obtain relevant environmental data for research and portfolio construction purposes due to a variety of factors, including the continuing evolution of disclosure frameworks. It suggests smaller asset managers should use publicly available data to identify sector-specific risk, rather than more detailed granular analysis, to keep compliance costs down. For more information about ESG disclosure frameworks, please see our Legal Updates on recent developments from the UN Development Programme, World Economic Forum and CFA Institute.
In its Consultation Responses, the MAS also confirmed two important developments that will help bring greater consistency to environmental data in Singapore. First, the Singapore Exchange will soon include the TCFD Recommendations in its disclosure guidance to listed issuers. Second, the MAS is working with the financial sector to assess the potential of a taxonomy for Singapore-based FIs covering both green and transition activities.
- Portfolio Risk Management: Asset managers should monitor, assess and manage the material potential and actual impacts of environmental risk on both individual investments and portfolios on an ongoing basis. Further, asset managers should develop capabilities in scenario analysis to evaluate portfolio resilience under different environmental risk scenarios (e.g., with sensitivity to a diverse array of changes from temperature increases to sea level rise) and engage in capacity building by providing environmental risk management training to staff.
The MAS recognises in its Consultation Responses that the development of guidance for scenario analysis is in a nascent stage. Accordingly, the MAS will provide guidance to asset managers on relevant scenarios and risk factors in the future. In the meantime, asset managers are directed to the climate scenarios of the Network of Central Banks and Supervisors for Greening the Financial System, IPCC Intergovernmental Panel on Climate Change and International Energy Agency.
- Stewardship: Asset managers should actively shape the corporate behaviour of their investee companies through engagement, proxy voting and sector collaboration. Strategies for engagement include raising environmental issues with investee companies to increase their awareness of related risks and opportunities and independently gathering information to supplement investee companies' own environmental risk disclosures.
In its Consultation Responses, the MAS confirmed that the examples of stewardship in the Guidelines are illustrative, rather than prescriptive or exhaustive. Asset managers therefore have flexibility to determine appropriate stewardship approaches. For smaller asset managers, the MAS notes that both proxy voting and collaborating with other investors can be cost-effective approaches to stewardship.
- Disclosure: Asset managers should disclose their environmental risk management approach to stakeholders, and are encouraged to disclose the potential impact of material environmental risks with reference to quantitative metrics. Asset managers may refer to international reporting frameworks, like the TCFD Recommendations, when preparing such disclosures.
The MAS clarified in Consultation Responses that asset managers can make environmental risk disclosures in their annual reports, sustainability reports, investor reports and/or websites. For smaller asset managers, disclosures can initially be more qualitative in nature.
While the MAS initially proposed a 12‑month transition period, in its Consultation Responses the MAS recognises that asset managers may face initial challenges in implementing the Guidelines. Accordingly, the implementation timeline has been extended to 18 months. Asset managers may implement the Guidelines in phases, but are expected to demonstrate evidence of their implementation progress over the transition period. The MAS will start engaging with larger asset managers on their implementation progress beginning in Q2 2021.
Singapore's Sustainable Finance Journey
The Guidelines are a significant step in Singapore's sustainable finance journey, with more developments relevant to asset managers and other FIs to come. As noted in the Consultation Responses, the MAS is assessing a potential taxonomy for Singapore and the Singapore Exchange will soon implement the TCFD Recommendations in its reporting guidance for listed companies. Asset managers and other FIs will have plenty to look forward to as Singapore continues its journey on the road to becoming a worldwide leader in sustainable finance.