PRIMER: HKEX’s new ESG disclosure rules

Author: Karry Lai | Published: 7 Feb 2020
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HK finance

Hong Kong SAR’s stock exchange is changing its rules on environmental, social and governance (ESG) reporting to improve corporate governance.

IFLR’s latest primer looks at how, following similar rule changes in the US and EU, Hong Kong SAR is changing its listing rules to increase transparency and the accountability of listed companies.

What are the HKEX’s new ESG disclosure rules about?

Under HKEX’s new mandatory disclosure requirements, which will be effective July 1 2020, companies will need to provide: a board statement setting out its consideration of ESG matters, disclosure of significant climate-related issues which have impacted and may impact the issuer, disclosure obligation to comply or explain key ESG performance indicators, and published ESG reports within five months of the financial year-end.

"The new rules are not just about reporting specific indicators," says Mervyn Tang, senior director, global head of ESG research at Fitch Ratings. "Companies have to demonstrate how they assess and manage ESG issues, and the role and expertise of the board in this process. In particular companies have to disclose how climate-related issues could impact their business."

See also: ESG now a key factor in M&A

The latest requirements expect a shift in corporate attitudes towards ESG from a box-ticking exercise to embracing it to drive long-term value, which can be challenging for many companies, according to Hermes Investment Management’s Janet Wong. For example, the requirements emphasise the importance of forward-thinking in ESG reporting through target-setting.

To set meaningful environmental and/or social targets, companies need to first have a good understanding of their internal operations. "That often requires dedicated resources to define, collect and analyse quantitative data," says Wong. "Buy-in throughout the organisation – not only from senior management but also other departmental and business heads – is also essential. Companies that have not established a proper governance structure to manage ESG issues may struggle to live up to the latest expectations."

See also: ESG: asset managers vary in enthusiasm

What has driven the HKEX to change its reporting requirements?

ESG considerations have recently become a key element of fiduciary duties for many asset owners, and an important part of investment product marketing for asset managers. Those who cannot demonstrate ESG integration in the investment process are increasingly being asked why not.

The availability of ESG data has become essential for asset managers to demonstrate their sustainable credentials. The HKEX’s requirement for ESG disclosure will help asset managers to demonstrate ESG integration and increase investor demand for HKEX-listed securities.

According to Roman Novozhilov, head of ESG at New Development Bank, asset managers are actively addressing the demand by developing and marketing specific products to access ESG-conscious investors and demonstrate strong financial returns following ESG integration.

"A positive impact of the new requirements is that this will facilitate the inclusion of HKEX-listed issuers into the universe of ESG-conscious investors and asset managers," says Novozhilov.

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What aspects will listed companies find most challenging to comply with?

Market participants believe that the new requirements will not present a significant challenge for large companies who regularly issue, since many aspects are aligned with the regulatory requirements they’re already subject to. But for smaller issuers, this will likely require creating a new data collection system across various business lines, as well as additional resources to implement the disclosure.

"ESG industry leaders are already undertaking most, if not all, of the revised ESG reporting requirements – however, there will likely be a larger gap for smaller companies or companies less engaged with ESG issues," says Gabriel Wilson-Otto, head of stewardship, APAC at BNP Paribas.

Wilson-Otto adds: "Areas that companies may find challenging are the requirement for more strategic engagement with material ESG issues, and increased disclosure requirements. This is due to the potential for capability gaps, including ESG expertise on the board or more broadly within an organisation, and resource constraints."

For many company boards, ESG has not been on the radar until recently. "Our previous research showed that a majority of boards have not been paying enough attention to ESG," says Brian Ho, climate change and sustainability partner at EY. "Where now ESG risks should be, in some way, discussed in board meetings, this implies that capacity-building on ESG topics is required for the board."

Wong adds: "Devoting sufficient time and resources to ESG issues can be challenging for board directors in Hong Kong, especially when many have an already-busy schedule."

According to a CLSA report in March 2019, 94 people occupy six or more listed company board seats each in Hong Kong SAR.

Another potential issue is greenwashing. "To ensure the validity of the data and avoid the temptation to greenwash, companies will need to establish corporate data collection and validation procedures," says Novozhilov. Without these procedures in place, businesses will face reputational issues if the validity of disclosure is questioned.

Ho adds: "A very limited number of issuers do set quantifiable targets, such as energy and water consumption and carbon emissions. For most, readiness to set and communicate these targets is low."

The majority of issuers may not have conducted ESG risk identification properly, including the involvement of relevant stakeholders in the process. "Many issuers will have to conduct a stakeholder engagement exercise for ESG risk identification for the first time – and the market has limited knowledge on how to do this," says Ho.

Additionally, issuers can be exposed to shareholder pressure if their disclosed ESG data is found to be erroneous, insufficient, or if its targets are not deemed ambitious enough. "Such gaps can potentially attract scrutiny and activist shareholder campaigns," says Novozhilov.

Another challenge will be to ensure consistency of reported ESG disclosure data across different businesses operating in different jurisdictions.

See also: ESG survey: no need to accept lower returns over long term

How do the new reporting rules compare with those in other jurisdictions?

According to Wilson-Otto, in Asia, regulation has played a large role in improving ESG disclosure – but for many companies, this has not led to increased engagement with the underlying issues. Essentially, ESG disclosure has been treated as a compliance requirement by some companies, and not as part of a strategic assessment of risks and opportunities.

"Additional requirements to provide detailed information on management and strategy of ESG is consistent with the direction of change in many countries, as investors pay more attention to ESG issues," says Tang. "Investors will judge companies on the strength and coherence of their ESG strategy, along with the execution of that strategy."

Singapore has a similar ESG disclosure framework. The local exchange (SGX) requires issuers to make statements indicating that company boards have overseen the management and monitoring of the material ESG issues, and have considered sustainability issues as part of their strategic formulations. "Unlike HKEX, the SGX has not prescribed any particular sustainability reporting framework, so issuers can select the framework which is suited to its industry and business model, and explain its choice," says Ho.

However, the latest HKEX rules have a relatively light touch on social framework and indicators, which has been a key topic in other markets, according to Wong. For example, the European Commission’s non-binding guidelines reference international frameworks like the OECD due diligence guidance for responsible supply chains from conflict-affected and high-risk areas and the UN guiding principles on business and human rights. These are not discussed or covered in the latest reporting requirements.

Plus, some social key performance indicators remain input-based instead of outcomes-based. For example, companies are required to disclose anti-corruption training provided to directors and staff, which is an input proxy to measure a company’s ESG performance.

Globally there have been increased expectations on outcomes-based measurements. In the UK, the revised 2020 stewardship code has placed a strong focus on activities and outcomes of stewardship. Wong believes this will be the trend in future.

Market observers generally agree that there’s a lot of room for ESG to grow in Asia, and companies should expect to see increased compliance requirements. "The mainstreaming of ESG in Asia-Pacific financial markets is still in its infancy, and I expect an ongoing trend towards further enhancements to ESG disclosure requirements and increasing convergence of ESG standards and classifications," says Wilson-Otto.

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