Climate change mitigation and adaptation are issues as relevant to businesses as they are to governments. CSj takes a look at what governance professionals can do to help businesses address the coming climate storm.
The climate ‘storm’ of this article’s title may not necessarily be one of those extreme weather events related to climate change that have been much in the news recently. Another climate storm is brewing for businesses in the shape and form of much higher expectations, both regulatory and stakeholder-driven, regarding their climate-change obligations.
While weather prediction is a famously treacherous undertaking, there are aspects of this storm that are not hard to foresee. The shift, for example, to a zero-carbon world, will necessitate major changes to most existing business models. As the severity of the risks associated with global warming have become clearer, governments have responded by implementing more ambitious targets to reach carbon neutrality – this is achieved when carbon dioxide emissions are equal to the amount of carbon dioxide being removed from the atmosphere.
Hong Kong has set a target for carbon neutrality by 2050, while the Mainland has pledged to achieve peak carbon by 2030 and carbon neutrality by 2060. This puts companies under increasing pressure to align their business models with the shift to a low-carbon economy and net-zero emissions.
Another predictable aspect of the coming storm is the adoption of mandatory reporting on climate-related risks and opportunities. Such reporting has been a relatively neglected area in Hong Kong, but climate-related disclosures aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) are likely to be mandatory for financial institutions and listed companies in Hong Kong by 2025.
Reporting requirements in this area were recently upgraded when Hong Kong Exchanges and Clearing Ltd (HKEX) revised its Environmental, Social and Governance (ESG) Reporting Guide (Appendix 27 of the Listing Rules) in 2019 to require listed companies to disclose the significant climate-related issues that have impacted or may impact their businesses and the actions they have taken to manage them. This requirement, key performance indicator (KPI) A4.1, was one of many revisions to the ESG Reporting Guide, including new requirements for a statement setting out the board’s consideration of ESG matters and the disclosure of targets relevant to all environmental KPIs. The new requirements became effective for financial years beginning 1 July 2020.
David Simmonds FCG FCS, Institute Vice-President, Membership Committee Chairman, Company Secretaries Panel Chairman, Technical Consultation Panel – Competition Law Interest Group Chairman and Investment Strategy Task Force member; Group General Counsel and Chief Administrative Officer at CLP Holdings Ltd, points out that the pressure for better transparency relating to climate-related risks and impacts is ultimately coming from investors. ‘Climate change has gone from being an issue raised occasionally by certain socially conscious groups, to a mainstream investment issue. It’s now almost every meeting we have with investors where the first question that they ask is what we are doing in this area,’ Mr Simmonds says.
The time to prepare is now
Regulators in Hong Kong are keen to ensure that financial institutions and listed companies disclose the financial impact of climate change on their businesses in line with the TCFD framework. The TCFD was created by the Financial Stability Board in 2015 to develop consistent climate-related financial risk disclosures.
‘I think this is a very good development, because the financial sector itself can be a really significant driver of change. It is critical for companies and their investors and financiers to understand the risks and opportunities they face from climate change, whether that be the physical risks to their business directly or on their supply chains, or the indirect impacts from changing regulations or customer preferences in response,’ Mr Simmonds says.
There are now over 2,000 signatories of TCFD worldwide. As of September 2021, 28 organisations in Hong Kong have officially registered as supporters, including professional services firms, asset managers, utilities and real estate businesses, as well as financial services. CLP is one of the supporters of TCFD and ‘my advice to companies on TCFD reporting is to start now,’ Mr Simmonds says.
He explains that it was the realisation of the seriousness of the risks that pushed CLP on its sustainability journey. ‘The energy sector is responsible for around 40% of global emissions, so we realised that there is no solution to climate change if the energy sector isn’t involved. Also, decarbonising electricity supply can enable other industries, such as transport, to reduce their emissions by supplying them with clean power. Taken together this tells us that our industry will change dramatically and we want to be ahead of the curve on that,’ Mr Simmonds says.
In recognition of the need to accelerate decarbonisation efforts globally, CLP has recently updated and strengthened its climate targets. CLP has committed to transition its business to net-zero emissions by 2050 and supported that with a commitment to nearer-term science-based decarbonisation targets and to phase out coal from its portfolio by 2040 at the latest.
Addressing climate change has become an essential part of risk management and of positioning companies to take up the opportunities that will come in a decarbonised world, but Mr Simmonds adds that the immediate risks of climate change have already arrived. This has become painfully evident to businesses all around the world with the rising frequency and intensity of extreme weather events, including to CLP in last year’s fire season in Australia when wildfires posed risks to a power station run by the company. ‘I don’t think we can describe climate change as a long-term issue anymore,’ Mr Simmonds says.
Aligning ESG reporting standards
Corporate reporting has been shifting away from purely financial reporting into non-financial areas like ESG. As it has done so, an increasing number of international ESG reporting standards – such as those of the Global Reporting Initiative (GRI) and Sustainability Accounting Standards Board – have emerged.
‘In the last two decades, various sustainability reporting standards have been developed and, while these have helped companies to have a better understanding of the reporting process, it is hard for investors to compare companies using different standards,’ says Brian Ho, Partner, Climate Change and Sustainability Services, EY.
This is because the standards don’t use the same metrics for measuring ESG impacts and performance. Moreover, the KPIs in ESG reports may be measured according to local rather than international standards. This, Mr Ho points out, not only makes assurance work difficult but also has implications for the growing trend towards more integration of financial and non-financial data. ‘Achieving effective disclosure will be more challenging if reporting standards are not standardised,’ Mr Ho concludes.
The good news here is that there have been initiatives globally to harmonise existing reporting standards. These include the proposal of the International Financial Reporting Standards Foundation to establish an International Sustainability Standards Board to develop a common set of global sustainability standards.
‘I do think that we will get to a point, hopefully sooner rather than later, where ESG reporting is as single-stranded as financial and risk reporting,’ says Pat Dwyer, Founder and Director of The Purpose Business, a Hong Kong-based consultancy that helps organisations in Asia embed purpose and sustainability into business strategy and operations. ‘That will make it easier for all of us reading company reports to understand what good looks like and what we should be holding companies accountable for,’ she adds.
An industry-specific approach
While a harmonised global standard for ESG reporting will be hugely beneficial in terms of encouraging the disclosure of consistent and comparable ESG data, Dr Calvin Lee Kwan, Head of Sustainability and Risk Governance at Link REIT, points out that it should nevertheless be adaptable to different industries. ‘A global reporting standard would help industries move forward, because then everybody can compare apples to apples – especially on key, common indicators such as carbon intensity. This would improve the understanding of where businesses stand. However, the call for global standardisation should also balance differences in reporting norms across industries and geographies,’ he says.
While the global standards have helped many businesses to get started in ESG reporting, some of the reporting aspects may not be applicable to specific sectors. The issue of hazardous waste and chemicals, for example, typically would not be as applicable to a retail focused real estate investment trust like Link REIT as compared to a manufacturing company, Dr Kwan points out. Similarly, he adds, the risks associated with climate change vary depending on where in the world you are based – low lying countries, for example, are most at risk from rising sea levels or fluvial flooding.
‘So what we are seeing right now is that industries are gathering and articulating the relevant climate-related risks related to certain sectors,’ Dr Kwan says. ‘For the real estate sector, one of the easiest physical risks to consider is flooding – whether from sea level rise or torrential rain. Flooding from seasonal rain can create significant damage and, if not mitigated, can lead to lower property valuations. Many industries are working together to define what climate-related financial disclosures are most relevant to their particular sector.’
This process is also reflected in some of the existing global standards. The GRI Standards, for example, are developing standards for 40 different sectors that will be targeted to the material reporting aspects for organisations in those sectors (more information on the GRI Sector Program is available at: www.globalreporting.org/standards/sector-program).
The role of governance professionals
Another predictable aspect of the coming climate storm will be higher expectations relating to the board’s role in identifying and evaluating relevant risks and opportunities. This has already been a noticeable trend in ESG generally. ‘Pushing board members for greater board-level commitment is really important. We’re at a point where this is not the Chief Sustainability Officer’s problem alone, it’s not even the CEO’s problem alone. If the board is really the cornerstone of purpose, vision and strategy about where the business is going, it must equip itself with a lot more knowledge around ESG,’ Ms Dwyer says.
This, she adds, is an integral part of the board’s responsibility for risk management, and company secretaries can play a key role in ensuring that ESG issues are on the board’s agenda and that directors are adequately informed of the relevant issues. ‘Governance professionals hold the key to elevating ESG as part of risk management,’ she explains. ‘It is on governance professionals to normalise discussions about emissions, water risk, waste and resource management. Until that happens, ESG is just going to sit on the sidelines.’
She adds that governance professionals also have a role to play in ensuring effective communication of ESG strategies to stakeholders. This, she says, should be focused on ensuring that the communications are understandable and relevant to the target audience. ‘If you want effective communication, you have to understand who you are talking to. If you want to attract investors, or if you want to unlock a new ESG fund, or if you are primarily concerned with your social licence to operate in a local community that you’re opening a factory in, you need to tailor your messages,’ she says.
Mr Ho echoes this thought. ‘I believe that companies cannot use one ESG or sustainability message for all stakeholders, as their understanding and perception of the topics discussed will likely be very different. For example, investors focus on your risk and opportunities, whereas consumers may expect companies to be more value-driven. Some companies think they are doing ESG communication just by publishing an ESG report, but that is not the case. It is important to make ESG communication more targeted.’
A new concept of value creation
The coming climate storm is not, of course, the only threat organisations are dealing with at the moment. Mr Simmonds points out that the Covid-19 pandemic is changing our previous conceptions of what is and what is not possible for businesses to achieve and that has reinforced the need to respond to longer-term sustainability issues.
‘For a long time, ESG was seen as a very big G, a medium-sized E and a very small S, but people will look through Covid-19 and see that it has accelerated a range of existing trends driving changes that will have very significant impacts on lives and livelihoods. That has raised the importance of addressing both environmental and social issues and if companies don’t rise to these challenges, they will lose customers and they will lose supporters in the communities in which they work,’ he says.
He adds that the era in which businesses can simply focus on short-term financial gains has passed. ‘I think the governance model has changed and there is a wider scope of considerations at play beyond the shareholders and short-term interests to how a company can continue to operate in the long term.’
Ms Dwyer echoes this thought. ‘All of the ESG indicators coalesce around a concept of value that is no longer defined for just one stakeholder – the shareholder,’ she explains. ‘If businesses truly redefine their concept of value, and use their strategy and their operations to create a positive impact for the future, this will benefit shareholders as much as it will employees, suppliers and the local community they work with.’