Environmental Risk Management (“ERM”) – Financial Institutions (“FIs”) Are Encouraged to Go Green to Save the Planet

Environmental Risk Management (“ERM”) – Financial Institutions (“FIs”) Are Encouraged to Go Green to Save the Planet

Introduction and Background

Back in July 2020, the Monetary Authority of Singapore (“MAS”), hot on the heels of a continuing global dialogue on battling climate change and the effects that it has on the globe, released a consultation paper in an effort to tackle the issues on hand and be part of the global solution. Conversations on climate change have been going on for the better part of the last decade and longer, as the world faces unprecedented weather changes, the increasing heat which resulted in various natural wonders e.g., Arctic ice caps being sorely affected causing rising of sea levels across the globe.

Noting this, the Singapore regulators published three (3) guidelines addressing responsibilities and ethical conduct for banks, insurers and asset management sectors here in the city-state. Since its initial consultation stages, the MAS has sought public feedback and opinion and responded to hot button questions from major institutions across Singapore. And finally, in January 2021, the MAS released the finalized version of the Environmental Risk Management (“ERM”) much to the anticipation of all Financial Institutions (“FIs”) who are expected to implement the Guidelines within their organization.

Again, the goal from the regulators on the subject matter is to ensure the city-state achieves its vision of becoming an environmentally sustainable economy.

What It Means for Asset Managers?

Specifically for the fund management companies in Singapore, the Guidelines will apply to Licenced Fund Management Companies (“LFMCs”), Registered Fund Management Companies (“RFMCs”) and Real Estate Investment Trust Management Companies (“REITs”) in Singapore. There are, however, minor relief for a sub-set of managers that fall out of scope – which are those that do not have discretionary authority over the investments of the funds/mandates they are managing.

Within the Guidelines, the regulators define environmental risk as risks that arise from the potential adverse impact of changes in the environment on economic activities and human well-being. Equally, environmental issues that are of concern include climate change, loss of biodiversity, pollution and changes in land use. These environmental challenges call for urgent collective actions to address environmental risk. The Guidelines therefore encompass risks beyond climate change alone.

What does the Guidelines Highlight in a Nutshell?

The impending framework also highlights three (3) risk channels in which the authorities would like companies to address i.e., physical, transition and reputational risks.

• Physical risk arises from the impact of weather events and long-term or widespread environmental changes.
• Transition risk arises from the process of adjustment to an environmentally sustainable economy, including changes in public policies, disruptive technological developments, and shifts in consumer and investor preferences.
• Reputational risk can arise when asset managers invest into companies that carry out business activities which have a negative impact on the environment.

This current framework is generally aligned with the Recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”), which focus on climate-related risks. It principally recognizes the physical and transition risks, with the MAS electing to also include a standalone “reputational risk” category. Many jurisdictions around the world, including Hong Kong and New York, are increasingly referring to the TCFD Recommendations in climate-related risk management guidance.

The Guidelines address environmental risk management practices in the following categories:

1) Governance and Strategy: The Guidelines require for asset managers to identify, address and monitor material environmental risks 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.

2) Research and Portfolio Construction: Asset managers should include 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 and TCFD) when considering transition and physical risks at an individual asset and/or portfolio level. There are examples for asset managers to refer within the Guidelines when considering the materiality of environmental risk for different asset classes.

3) 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. They should develop capabilities in scenario analysis to evaluate portfolio resilience under different environmental risk scenarios and engage in capacity building by providing environmental risk management training to staff.

4) Stewardship: Asset Managers are to exercise sound stewardship of investee companies, influencing those companies to transition to sustainable business practices and independently gather information to supplement investee companies’ own environmental risk disclosures. Asset managers should actively shape the corporate behavior of their investee companies through engagement, proxy voting and sector collaboration.

5) 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.

What Are the Next Steps?

Now, the question on every manager’s mind, when does the MAS expect these Guidelines to be implemented? As this guidance are new to all FIs in Singapore, the MAS have provided a longer transition period from 12 to 18 months, ending June 2022. Therefore, managers should take the extra lead time and begin working on addressing the requirements as soon as practicable.

Equally, 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.

In our opinion, asset managers should begin formulating and putting in place an environmental risk management framework and any other supporting policies where applicable as a start, both on an enterprise level and with respect to portfolios the managers manage.