Climate change reporting – Are you prepared for Hong Kong’s emerging regulatory regime?
A new report published jointly by the Institute, KPMG China and CLP Holdings Ltd in July this year will be a welcome resource for governance professionals eager to prepare themselves for the imminent arrival of tougher regulatory requirements relating to climate change reporting.
The increasing urgency for listed companies in Hong Kong to prepare for a much tougher regulatory regime relating to climate change reporting has been impacting a wide range of professionals. Governance professionals, however, are in the front line of these developments, not only in their role as compliance specialists, but also because they are increasingly relied upon by boards to provide a wide range of advice in this area.
In this context, the Institute has made climate change reporting and performance, and the roles governance professionals can play in assisting organisations adapt to the emerging regulatory regime in Hong Kong, a focus of its training and research work. A new report published jointly by the Institute, KPMG China and CLP Holdings Ltd offers guidance in this complex area. Climate Change Reporting: Imminent, Challenging & Mandatory – The Opening Moves (the Report), published on 12 July 2022, is both a primer on the regulatory regime emerging in Hong Kong as a result of international developments in the sustainability reporting space, and a practical guide on what steps need to be taken now to prepare for its arrival.
Are you prepared?
As the Report’s title suggests, the emerging regulatory regime in Hong Kong relating to climate change reporting is imminent, challenging and mandatory. Global developments in this space have been moving fast. These include the convergence of ESG and sustainability reporting standards around the recommendations of the Task Force on Climate-related Financial Discloses (TCFD) and the new standards due to be finalised by the end of this year by the International Sustainability Standards Board (ISSB), set up by the International Financial Reporting Standards (IFRS) Foundation.
The new standards will become the IFRS Sustainability Disclosure Standards and, if adopted in Hong Kong, they would require a much finer grained reporting regime regarding companies’ relevant risks and opportunities. Regulators in Hong Kong have already made it clear that they intend to transition the local regulatory regime to keep up with international standards. For example, a consultation is expected to be released by Hong Kong Exchanges and Clearing Ltd (HKEX) soon, proposing specific areas where the local and the global standards can converge.
In an Institute webinar held on 5 May this year – Climate Change Reporting: Changes Are Coming Quickly – Kelly Lee, Vice-President, Policy and Secretariat Services, Listing Division, HKEX, identified some of these areas. In particular, Hong Kong is likely to adopt tougher requirements for listed companies to report on their transition plans to a low-carbon economy.
It may also include a recommendation for companies to use scenario analysis to assess their exposure to climate-related risks and opportunities. Scenario analysis is a tool that can help companies assess a range of climate change outcomes. It usually involves looking at various future climate scenarios, based on different bands of temperature rise, and assessing how they would impact the company from a physical and a transitional risk perspective.
The emerging regime is also likely to address the metrics and targets used by companies in their climate change reporting. HKEX is considering, for example, whether to follow the TCFD/ISSB approach of requiring companies to report on their Scope 3 emissions. ‘Scope 3’ greenhouse gas (GHG) emissions are those resulting from activities and assets indirectly impacted by the company via its value chain. Alignment with international standards here would significantly expand the scope of climate reporting required of Hong Kong listed companies.
A new regulatory regime incorporating at least some of the aspects discussed above is expected to be in place in Hong Kong by 2023. This begs the question of whether listed companies are ready for the tougher requirements soon to be in place. The 5 May webinar mentioned above (Climate Change Reporting: Changes Are Coming Quickly) gave some indications of an answer. It surveyed the 125 respondents, primarily governance professionals from Hong Kong, of the webinar audience about their organisations’ preparedness for the new regime and the results were not encouraging. For example, only 17% of respondents had performed a climate-related scenario analysis. Moreover, 86% of respondents stated that their companies had not set a climate transition plan and 47% considered that their companies would be unlikely to set one. In this context, the Report makes the point that preparing for the new regulatory regime should be a matter of urgency for listed companies in Hong Kong.
In keeping with the remit of all of the Institute’s publications, however, the Report does not confine itself to identifying the problem – it presents a number of practical recommendations on how companies can prepare themselves.
Practical guidance
As its title suggests, the Report is designed primarily as a guide to the necessary ‘opening moves’ companies can consider in preparation for the new regulatory requirements relating to climate change reporting in Hong Kong. In particular, it identifies five focus areas where the new disclosure standards are likely to require additional work by companies and governance professionals to ensure they remain in compliance.
1. Adopting an ‘enterprise value’ approach to materiality
The Report points out that the draft ISSB standards, published for consultation in July this year, take an ‘enterprise value’ approach to the identification of materiality. Sustainability-related financial information is material if it influences assessments of the company’s enterprise value (the total value of the company).
Furthermore, the reporting boundary will quite likely be broad under the new standards. Companies will be expected to disclose information, for example, about parties outside the company when such information affects the assessment of enterprise value. For instance, a company may determine that information about sustainability risks and opportunities arising from suppliers is material to an assessment of its enterprise value.
Nevertheless, the ISSB has not taken the ‘double materiality’ approach to climate reporting. Other sustainability reporting frameworks, for example the Global Reporting Initiative (GRI), require disclosure of climate-related issues that impact the company, and also those issues relating to the company’s impact on the environment and society. The ISSB approach has been to focus on the former rather than the latter.
2. Quantifying the current and anticipated financial effects of climate issues
The ISSB approach focuses on the need for companies to disclose quantitative information about the financial effects of climate-related risks and opportunities. This includes how the company expects its financial position and financial performance to change over time, given its strategy to address these risks and opportunities.
Directors often have legal liability concerns about disclosing forward-looking information however, and climate change is likely to have significant effects far into the future, well beyond the typical business planning timelines. Moreover, even where such concerns are overcome, obtaining the relevant data might be a challenge.
Despite these challenges, the emerging regulatory regime in Hong Kong, following the TCFD/ISSB approach, is likely to require companies to disclose much more granular quantitative data on the climate-related risks and opportunities they are exposed to. In this context, the Report suggests that companies should consider getting their finance function more involved in sustainability reporting. Another speaker at the 5 May webinar – Pat-Nie Woo, Partner, KPMG China, and Head of Environment, Social and Governance, Hong Kong and Global Co-Chair, Sustainable Finance, KPMG IMPACT – made the point that companies need to build cross-functional teams to address climate change. Such teams should certainly involve personnel from the finance function, but should also include legal, research and development, and sustainability personnel.
3. Conducting climate-related scenario analysis
Many of the caveats mentioned above relating to quantifying the current and anticipated financial effects of climate issues would also apply to any requirement for companies to use climate-related scenario analysis. How should companies determine what time horizons to use in the analysis? Also, how reliable will any judgements be about the likelihood of different future climate scenarios – given that these are dependent on a complex interplay of policy decisions, macroeconomic and energy use trends, and technology developments?
On the other hand, getting an idea of the potential impacts of flooding on a business, for example, based on different projected sea level rises, or the fire risk based on different ranges of temperature changes, will be highly useful to both investors and companies themselves. At the initial stage, use of this tool is therefore likely to be a voluntary recommendation – this would mirror the ISSB approach that has been to recommend the use of climate-related scenario analysis ‘unless a company is unable to do so’.
The Report makes the point that scenario analysis is a valuable tool for organisations to understand the resilience of their business models and strategies to climate change. ‘Such an analysis allows a company to explore and develop an understanding of how climate-related risks and opportunities may impact its business, strategies and financial performance over time,’ the Report says.
4. Formulating a climate transition plan and setting targets
In 2015, at the United Nations (UN) conference of parties summit in Paris, all parties to the UN Framework Convention on Climate Change (UNFCCC) agreed to work towards the central goal of limiting global warming to well below 2°C, and preferably to 1.5°C, relative to pre-industrial levels. This agreement was adopted (though not ratified) by all 196 parties to the UNFCCC and was the first time all such parties had agreed to commit to a decarbonisation pathway.
The agreement allows each party to chart its own course and there is no formal system for ensuring compliance, but parties have signed up to their own Nationally Determined Contributions and have committed to revisit and increase their targets every five years. The Mainland aims to reach peak carbon emissions by 2030 and is committed to being carbon neutral by 2060. The Hong Kong SAR Government has pledged to achieve carbon neutrality by 2050 and set out its strategy to achieve this in its Climate Action Plan 2050.
To align with these goals, companies are expected to come up with their own transition plans outlining their targets and actions to transition towards a lower carbon business model. This will require disclosure of how they intend to reduce GHG emissions over time, the time horizons used, the metrics used to track progress and their assessment of how this transition will affect the company over time. The Report emphasises that disclosure of companies’ transition plans will enhance the credibility of their climate change commitments and recommends use of the guidance on transition plans and targets developed by the TCFD as a starting point.
5. Determining and reporting on the metrics such as Scope 3 emissions
As mentioned above, one of the key characteristics of the emerging regulatory regime relating to climate change reporting in Hong Kong is that companies will be required to disclose much more granular quantitative data on the risks and opportunities they are exposed to. The Report makes it clear that this is where most preparation work will be required and this is particularly true for reporting on Scope 3 emissions. What, for example, should companies do if reliable and sufficiently granular primary data relating to the company’s indirect value chain is unavailable?
In such cases, the Report recommends companies use ‘secondary’ data or industry-specific data. It points out that companies will be helped by the growing number of initiatives in this area. Relevant data relating to specific industries – particularly those with high exposure to climate change risks and opportunities – are increasingly available to companies in their reporting exercises. The industry-based metrics in the current ISSB proposals, for example, are derived from the SASB Standards.
The Report adds, however, that most SASB reporters are domiciled in the US (only 10.4% of SASB reporters were domiciled in Asia Pacific in 2021). The SASB Standards may therefore be relatively new to Hong Kong companies and they will therefore need to apply materiality judgements to these metrics and adapt their existing data compilation processes accordingly. The report reviewed in this article is available on the Institute’s website (www.hkcgi.org.hk).
SIDEBAR: Key recommendations
1. Educate the board. As the board takes accountability for monitoring and managing climate-related risks and opportunities, it should understand the latest developments in climate issues and the related reporting landscape, the company’s potential exposure to climate-related risks and opportunities, and the potential implications for the company’s strategy and business model. Governance professionals should educate the board about the emerging climate reporting requirements and the potential impacts and challenges. Various platforms such as HKEX’s ESG Academy and TCFD Knowledge Hub provide useful resources in this regard.
2. Integrate climate issues into governance structures. The board should integrate climate-related issues into strategy and decision-making processes and enhance board-level oversight over monitoring and management of climate-related risks and opportunities. This helps to secure commitment and support from the leadership. Governance professionals may assist the board in enhancing the current governance structure, including the roles of the board and management.
3. Establish a cross-functional team. A cross-functional team is important to both act on climate issues and report on the company’s climate responses. A diverse team helps to obtain buy-in and support from across the organisation. It also brings together different skill sets. For instance, sustainability professionals have an understanding of climate issues. Strategy professionals and risk management experts can advise on the impacts on strategy and business models. Finance professionals can help understand and quantify the financial effects, and connect climate and financial reporting. Governance professionals may assist the board in establishing the multidisciplinary team to implement the needed processes and tackle the relevant challenges.
4. Expand systems, processes and controls. Companies will need processes and controls to quantify the financial effects of climate issues, conduct climate-related scenario analysis and report on metrics. Companies should engage with current process owners to understand how information is being defined, captured and reported, and where there are data gaps and control gaps. The cross-functional team may need to assist the board in identifying these gaps and expanding existing systems, processes and controls to ensure data integrity and avoid duplication between different types of reporting.
Source: Climate Change Reporting: Imminent, Challenging & Mandatory – The Opening Moves