Environmental, social and governance (ESG) reporting has quickly become a focal point in the world’s major financial markets. Hong Kong, which is one of the fastest-growing green finance markets, made significant headway by updating its ESG Reporting Guide in 2019.
The Hong Kong Exchanges and Clearing Limited (HKEX) referred to the world’s leading ESG disclosure standards and incorporated key Task Force on Climate-related Financial Disclosures (TCFD) elements, which significantly strengthens the board’s role in ESG management. These requirements were very forward-looking at the time.
However, other financial markets have quickly followed suit. Taking the United States as an example, though its ESG reporting requirements have been considered lagging other major financial markets, the US Securities and Exchange Commission (SEC) proposed in March this year to require public companies to disclose certain climate-related information in their audited financial reports. This includes disclosing risks that climate change may pose to the company, and providing information on the board’s governance of these risks in their audited financial statements. Although the SEC has not yet published the final rules, the proposal’s announcement alone demonstrates the US’ commitment toward enhancing ESG disclosure.
The EU’s ESG industry is always the market to be reckoned with. In April this year, the European Financial Reporting Advisory Group released exposure drafts of European Sustainability Reporting Standards, which integrate the reporting framework of the TCFD and provide very clear and concise requirements focusing not only on climate but social aspects as well. The proposal’s public consultation period was ended in August this year and will be finalized very soon. The standards to be adopted will advance global ESG standards to new heights.
The UK and Singapore are two other economies with sophisticated ESG developments. The UK has imposed mandatory requirements on large listed and nonlisted companies to report on climate-related information based on the TCFD framework. Singapore has similar mandatory requirements but they are only applicable to listed companies in the financial industry, agriculture, the food and forest-products industry, the energy industry, the materials and buildings industry, and the transportation industry.
As for the Chinese mainland, a distinct element of environmental disclosure requirements compared to other markets is the penalty. Although this regulation does not apply to all listed companies, the Ministry of Ecology and Environment clearly sets out penalties for violations of regulations. With more concrete enforcement, the regulatory impacts on emissions control could be more significant if compared to other economies.
The growing trend of ESG mandates seems to imply that regulators have to intervene because companies are not paying attention to the impacts of climate change, but it is not the case. In fact, private companies and investors have long been environmentally and socially conscious — with these commitments reflected in a spectrum of early movements such as impact investment, socially responsible investment, benefit corporation, and the like. Such initiatives target corporate culture to change from the bottom up.
Many large international companies, such as Puma and Apple, have been voluntarily disclosing supply chain information — a disclosure requirement of the future. Also, Yvon Chouinard, founder of the well-known outdoor brand Patagonia, announced this September that all the company’s profits, after reinvesting in the business, will be channeled to environmental efforts against climate change. Patagonia has dedicated years of continued commitment to the environment in various aspects of its business. More importantly, Patagonia is not listed and, thus, all the company’s environmental protection activities are voluntary, and not for compliance with any listing rules. Therefore, a company’s ESG performance is not an outcome of regulation alone, with business culture also playing an important role.
Whether the city plans to adopt stricter standards such as the ISSB’s Climate Standard is only a matter of time. Therefore, Hong Kong enterprises, large or small, should act now, turning disclosure requirements into opportunities and contributing to the environment and society
The current blossoming of ESG markets is the result of joint efforts from public and private sectors. The TCFD framework (jointly promoted by Mark Carney, the then-governor of the Bank of England, and Michael R Bloomberg, co-founder of Bloomberg LP), which has had far-reaching implications on global ESG standards, is the result of cooperation between regulators and the business community.
While the TCFD framework has been the anchor of ESG developments over the past few years, the focus of the future is on the framework proposed by the International Sustainability Standards Board (ISSB), established by the International Financial Reporting Standards (IFRS) Foundation. IFRS is one of the mostly adopted accounting standards in the world. Therefore, the ISSB framework, currently in its consultation stage, has already received widespread support from major financial markets including Hong Kong. The main difference between the TCFD and ISSB frameworks is that the former is mainly principles-based, while the latter is more rules-based, and is more rigorous and precise. Therefore, ESG reporting requirements will only become more stringent in the future.
While current ESG standards largely focus on listed companies or large companies, small to medium-sized enterprises (SMEs) will be affected by the ripple effect of future ESG regulatory development as well. Such requirements may increase the compliance cost of listed companies, but for SMEs, it may also bring more opportunities.
For example, until now, most ESG reporting standards only require disclosures of Scope 1 and Scope 2 greenhouse gas emissions. That is, the company only needs to know the direct emissions made by its operations (Scope 1) and the emissions made indirectly by its electricity consumption (Scope 2). However, future disclosure requirements will require Scope 3 emission data, which covers upstream and downstream emissions along the company’s entire value chain.
Once reporting standards include Scope 3, companies must pay attention to the ESG practices of other businesses as well. SMEs that are part of these value chains — and want to continue to be part of it — can gain a competitive edge by preparing now for provisions of ESG information to their customers who are listed companies. This is a challenge for ordinary SMEs because establishing an effective ESG data-collection mechanism and reducing emissions measures requires additional resources. Yet if the requirements are successfully met, the chances of obtaining service contracts can be increased.
SMEs can start preparing by leveraging on existing resources, such as the HKEX’s ESG Academy which offers ESG materials and training. This includes the Guidance on Climate Disclosure, detailing step-by-step guidance in preparing TCFD-aligned climate change reporting.
ESG reporting standards have become an irreversible global trend representing both an inflection point and a catalyst for Hong Kong businesses. Whether the city plans to adopt stricter standards such as the ISSB’s Climate Standard is only a matter of time. Therefore, Hong Kong enterprises, large or small, should act now, turning disclosure requirements into opportunities and contributing to the environment and society.
The author is deputy chairman of the Panel on Financial Affairs of the Legislative Council.
The views do not necessarily reflect those of China Daily.