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By Grace Hui, Head of Green and Sustainable Finance, HKEX

Hong Kong’s listed companies are coming under increased scrutiny by environmental, social and governance (ESG) rating companies, and many companies are surprised by the less than favourable grades they are receiving. The first step towards improvement is to learn about ESG ratings and how they influence your investors.

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New mandatory environmental, social and governance (ESG) disclosure requirements introduced by Hong Kong Exchanges and Clearing Limited (HKEX) came into effect on July 1. The result of these enhanced ESG reporting requirements is that there will be more public information made available to rating agencies to score the company on, and therefore companies are more likely to receive an ESG rating.

These unsolicited ESG ratings are causing an unpleasant surprise for some companies. Executives are surprised when they see their rating is lower than that of their peers, and they are unsure why they have been rated as such, or what they can do to improve.

This is all part of the learning and growing process, for issuers as well as investors, as more and more asset owners and managers and investors integrate ESG performance into their investment strategies.

Many of the more than 2,500 companies listed in Hong Kong are relatively small companies with localised investor bases, and some have not previously been subjected to unsolicited third-party analysis. Now, they are being analysed on ESG metrics which they are still coming to grips with themselves.

HKEX has launched STAGE as a next-generation ESG platform, providing both issuers and investors with an information portal with increased transparency and guidance on green and sustainable finance as impact investing is gaining momentum in global capital markets.

There is strong demand for ESG ratings from investment managers and therefore reliable, measureable and comparable ESG data from corporates is essential, since ESG ratings will become a more important feature of investor relations going forward. It is important for listed companies to learn more about ESG ratings, and what they mean for their investors and other stakeholders.

 

Credible Data

The first question most listed companies ask is, how do rating agencies produce their ESG ratings? The answer is that rating agencies generally use both public disclosure and questionnaires to judge ESG performance. Public disclosure includes a company’s annual reports, ESG reports, data sets from relevant government agencies, NGOs, news announcements and media sources.

Listed companies that want to improve their ESG performance must start by producing credible data that accurately reflects the ESG impacts of their operations. HKEX’s new ESG rules provide a basic starting point from mandatory disclosure requirements such as a board’s statement setting out the board’s consideration of ESG matters; disclosure of significant climate-related issues which have or may impact the company; disclosure of relevant environmental targets to disclosure of all social KPIs on a comply or explain basis.

Companies seeking to meet international best practices need to follow international ESG reporting standards. However, one of the greatest challenges in ESG reporting today is that there are many different reporting frameworks and standards. They include Global Reporting Initiative (GRI), Task Force on Climate-related Financial Disclosures (TCFD) and the Sustainability Accounting Standards Board (SASB). Some companies use one framework, others use one or more for different reasons or business areas. There are also numerous ESG rating agencies, with varying indicators, methodologies, and weightings for ESG scores, while some organisations are focused on specific industries or particular ESG issues.

For a Hong Kong SME at the start of their ESG journey, it can feel like navigating an impenetrable jungle. Our ESG and green finance portal, STAGE, is a good place to start, providing companies with information on how to improve their ESG performance.

A structured and well-thought out approach to ESG reporting helps identify a business’ strengths and weaknesses, as well as recognise and mitigate material ESG risks. Enshrining ESG principles in business strategy makes a company more agile and better prepared to deal with sudden change.

For example, due to the market disruptions related to Covid-19, some companies are looking at their supply chain in greater detail to ensure that they have a certain and sustainable operational model. This focus on ESG factors within supply chain management is a critical part of good business planning and ESG preparedness for almost all businesses.

 

Engagement

The ESG performance of listed companies is becoming an important investment decision factor for investors. This is largely due to the growing number of signatories to the Principles for Responsible Investment (PRI), which promote the incorporation of ESG factors into investment decision-making. Currently the PRI has over 3,000 participating institutions which together have over US$100 trillion assets under management. This presents an excellent opportunity for listed companies, because if they address their ESG risks, they can improve their ESG scores, and in this way support their investment story. Responsible investment managers review ESG ratings from agencies before making investment decisions. Large global asset managers may also ask rating agencies for bespoke ESG scoring of companies in their portfolio or companies they are targeting for investment.

It is therefore in the interest of listed companies to engage with institutional investors (and other key stakeholders) to better understand what they are seeking in terms of ESG performance, and which areas the company needs to improve on. Companies should also look to share their ESG strategy and the steps that are being taken towards improvement.

Rating agencies often send questionnaires to listed companies, seeking additional information on ESG standards and performance. We are strong advocates of companies participating in such information gathering. Companies can also initiate conversations directly with rating agencies in order to better understand the criteria, standards and weighting of their scores, and tackle the issues behind the low scores that they have received.

Producing credible, measurable and comparable data is important, but engaging with investors and rating agencies is crucial to help a company grow and mature in its ESG performance.

 

Get Started

It is important for companies and new issuers to get started in engaging with investors and rating agencies, and then begin making improvements on their ESG disclosure and ratings as they gain experience. Document the progress of the company, and share that information as evidence of the company’s commitment to building a more sustainable business.

Once companies begin their ESG journey they will find that investors, analysts, and other stakeholders are eager to help them along the way. Here at HKEX, we will certainly be their champions!

 

Credit: This article first appeared in HKEJ on 26 August,,2020