It’s no secret that markets like comparable data.
The Financial Accounting Standards Board in the US recognises that “more comparable standards have the potential to reduce costs for both users and preparers of financial statements and make worldwide capital markets more efficient.”[i] Similarly, the IFRS Standards are driven by a goal of “enhancing the international comparability and quality of financial information, enabling investors and other market participants to make informed economic decisions.”[ii] At least one study has even found that investors attach a higher value to reported earnings when firms exhibit greater accounting comparability than industry peers.[iii]
Unfortunately, for sustainable investment, the non-financial information covered within various ESG factors is currently more difficult to compare than its financial counterpart.
Investors turn to a plethora of standards and frameworks for guidance on what ESG information to report and how to report it. From the SASB Standards for financially material ESG information to CDP for impacts on climate, water and forests, there is no shortage of options. This variety reflects the multifaceted nature of ESG factors, but there is little oversight and it is not unusual for issuers to cherry-pick disclosures within and among various standards and frameworks.
The result is a fragmented landscape in which the metrics reported by one company are often difficult to compare with the metrics reported by another. This has hindered trust in sustainable investing and is no doubt contributing to some of the current backlash against ESG in places like the US.
In Hong Kong, regulators and market participants are coalescing around a few ESG standards and frameworks that promote the comparability of ESG-related information. When these standards and frameworks become mandatory, the result should drive the continued uptake of sustainable investment in the region. This article highlights some of these standards and frameworks to show how one of the world’s most important international financial centres is moving towards a more comparable, trustworthy and efficient future for sustainable investing.
Recommendations Of The Task Force On Climate-related Financial Disclosures
The Task Force on Climate-related Financial Disclosures (TCFD) was created by the Financial Stability Board in 2015 to develop recommended disclosures to help market participants assess and price risks related to climate change. Released in 2017, the TCFD recommendations are now regarded as the leading standard for climate-related financial disclosures across four areas: Governance, Strategy, Risk Management and Metrics and Targets. In its most recent review of reports from 1,434 public companies, the TCFD found over 80 per cent disclosed information that was at least partially in line with their recommendations.[iv]
The TCFD recommendations have attracted the attention of regulators worldwide, as well. TCFD-aligned disclosures are now mandatory for over 1,300 large UK companies,[v] and the recommendations underpin the US SEC’s most recent proposal for climate-related disclosures.[vi]
In December 2020, a group of Hong Kong regulators, the Green and Sustainable Finance Cross-Agency Steering Group (Cross-Agency Steering Group), committed to making the TCFD recommendations mandatory for “relevant” sectors, including banks, asset managers, insurance companies and pension trustees, by 2025. [vii]
In 2021, the Securities and Future Commission (SFC) took a step towards that goal and amended its Fund Manager Code of Conduct (FMCC) to require certain fund managers to address climate-related risks. Covered fund managers must comply with a set of “baseline requirements” broadly aligned with the four areas of the TCFD recommendations:
In addition, covered “Large Fund Managers” with AUM of HK$8 billion or more must meet other “enhanced requirements”, which may involve adopting climate-related scenario analysis and identifying the carbon footprints of their portfolios.[viii]
Hong Kong Clearing and Exchanges Limited (HKEX), which operates Hong Kong’s stock exchange, recently published a proposal to make reporting aligned with the TCFD recommendations mandatory for listed companies via the IFRS Sustainability Disclosure Standards, as discussed below. Going forward, other members of the Cross-Agency Steering Group may implement TCFD-aligned requirements for other regulated entities in Hong Kong, developing the climate-related disclosure landscape around this leading standard.
IFRS Sustainability Disclosure Standards
With comparability in mind, the IFRS Foundation established the International Sustainability Standards Board (ISSB) in November 2021. The ISSB is tasked with developing standards “that will result in a high-quality, comprehensive global baseline of sustainability disclosures focused on the needs of investors and the financial markets.”[ix] The group has moved quickly, publishing exposure drafts of General Sustainability-related Disclosures (IFRS S1) and Climate-related Disclosures (IFRS S2 - which is also aligned with the TCFD recommendations) in March 2022. With the imprimatur of the IFRS Foundation and widespread support from market participants around the world, the IFRS Sustainability Disclosure Standards could fast become the most widely used sustainability reporting standards in the world.
Upon the release of the exposure drafts, Hong Kong’s Cross-Agency Steering Group encouraged “the financial sector, listed companies and all interested stakeholders to participate in the ISSB consultation.” The statement also included a commitment by the SFC and HKEX to engage “key stakeholders to evaluate and gather feedback on how the ISSB’s proposed disclosure requirements can be applied in Hong Kong.”[x]
More recently, HKEX referred to the IFRS Sustainability Disclosure Standards in a review of its ESG disclosure regime for listed companies. Since 2015, HKEX’s Listing Rules have included an ESG Reporting Guide with both mandatory and “comply or explain” disclosure obligations. Listed companies must disclose ESG-related information on governance topics including how boards manage ESG issues and monitor progress against ESG goals and targets. In addition, “comply or explain” requirements cover specific metrics on topics like climate change, anti-corruption and community investment.
In a November 2022 review of the implementation of the ESG Reporting Guide, HKEX confirmed that it will “collaborate with other regulators in Hong Kong to work on a roadmap to evaluate and potentially adopt the new ISSB standards.”[xi] HKEX published its proposal with respect to IFRS S2 on climate-related disclosures in April 2023.[xii] The rules are proposed to become mandatory for listed companies in January 2024 and are generally aligned with IFRS S2, with additional time for issuers to disclose certain information including quantitative data on Scope 3 emissions. In the consultation paper, the HKEX noted that the existing ESG Reporting Guide is “consistent with the general features for reporting of sustainability-related information under” IFRS S1, but did not confirm whether additional rule changes with respect to general sustainability disclosures would be implemented.
Going forward, other regulators in Hong Kong may approach the IFRS Sustainability Disclosure Standards with a similar “climate-first” approach.
Common Ground Taxonomy
Sustainability taxonomies set out criteria by which market participants can determine whether an activity is sustainable or not. They are intended to promote consistency and comparability, but there is already a proliferation of national taxonomies in use and under development from Singapore to the UK. This risks creating even more fragmentation – what is sustainable in one country may not be sustainable in another.
Hong Kong’s SFC and the Hong Kong Monetary Authority (HKMA) are each part of the International Platform on Sustainable Finance (IPSF), a network of policymakers launched in 2019 that is addressing this issue. The IPSF’s goals are to share best practices and compare sustainable finance approaches and tools to make them more comparable. One of the group’s signature pieces of work has been the Common Ground Taxonomy (CGT), which is a technical summary comparing two highly influential taxonomies, the EU Taxonomy and China’s Green Bond Endorsed Catalogue.
The Cross-Agency Steering Group is currently working towards an initial proposal for a local sustainability taxonomy in Hong Kong.[xiii] Given the roles the SFC and HKMA have played in developing the CGT, it seems likely that a local Hong Kong taxonomy will be well aligned with other leading approaches – at a minimum, those in the EU and the Chinese Mainland. That comparability can help drive an international sustainable financial market for Hong Kong, in which cross-border investors can more easily align strategies in one jurisdiction with assets in another.
Sustainable Finance Disclosure Regulation
Comparability is also relevant at the ESG product level. The EU’s Sustainable Finance Disclosure Regulation (SFDR), which came into effect in March 2021, is one of the most influential ESG disclosure requirements to date. The SFDR sets out sustainability disclosure obligations for manufacturers of financial products and financial advisors, including regarding adverse impacts on sustainability matters at entity and financial product levels. Under the SFDR, funds are classified as Article 6 (non-ESG funds), Article 8 (funds that promote ESG characteristics with other characteristics) or Article 9 (funds with sustainable investment as their objective). These funds have been immensely popular – by one estimate, Article 8 and 9 equity funds have received nearly four times the cumulative inflows of their Article 6 (non-ESG) counterparts since 2019.[xiv]
In June 2022, Hong Kong’s SFC amended its own ESG fund disclosure requirements to reflect evolving standards and practices.[xv] Under the updated requirements, specific disclosures are required to market an ESG fund, including how the fund’s ESG focus is measured and monitored, due diligence is carried out and engagement is conducted.
The SFC specifically referred to the SFDR in its guidance on these updates – a UCITS Article 8 or 9 fund under the SFDR will be deemed to have generally complied in substance with certain SFC requirements. While the application to UCITS funds is subject to review and the SFC may request enhanced disclosure from such funds,[xvi] the SFC’s approach illustrates how comparability among product-level disclosures is also being used to promote cross-border sustainable investment.
Hong Kong is taking significant steps to create an environment in which non-financial information is readily comparable. Regulatory approaches should continue to develop around leading standards like the TCFD recommendations and IFRS Sustainability Disclosure Standards. Local requirements should also align with the EU Taxonomy, China’s Green Bond Endorsed Catalogue and the SFDR. With ESG comparability at the fore, markets in Hong Kong can continue to attract capital from sustainable investors worldwide.
[iii] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3626658; https://blogs.cfainstitute.org/investor/2020/08/18/dont-overlook-accounting-comparability/
Alexander Burdulia is an Associate Sustainability Director at Sedgwick Richardson in Hong Kong, where he focuses on sustainability and ESG projects for multinationals in Asia. His experience covers strategy development, materiality assessment, rating requirements, stakeholder engagement, governance, policies, benchmarking and reporting in multiple sectors including financial services and real estate. A former private equity lawyer, he helped develop Mayer Brown's ESG product group and was a member of the firm's global ESG Steering Committee. He also served as the Head of APAC Public Policy at Credit Suisse, where he covered sustainable finance and other financial services regulatory and policy matters across Asia. Alex holds a JD from the University of Pennsylvania, a BA from Rutgers University and a Certificate in Management from the Wharton School of the University of Pennsylvania.