CGj assesses whether the much-anticipated sustainability disclosure standards issued by the International Sustainability Standards Board (ISSB) in June this year will be the game- changer they aim to be, and what impact their launch will have on companies in Hong Kong.

Companies, not just in Hong Kong but globally, have been grappling with multiple sets of standards and frameworks on sustainability disclosures and there has been a growing demand to have better aligned standards with specific focus on climate change disclosures. On 26 June 2023, the ISSB issued its finalised global Sustainability Disclosure Standards – IFRS S1 and IFRS S2 (the Standards), but will the new Standards provide the intended convergence of disclosure practices globally and what impact will their launch have on companies in Hong Kong?

‘For companies starting out on sustainability reporting,’ says Tina Chang, Sustainable Investing Associate Director, Fidelity International, ‘the new Standards will be an opportunity to shortcut the noise. Companies can now base their learning curve on the IFRS’s S1 and S2.’

First up – what are the Standards?

The ISSB is the independent standard-setting body set up by the IFRS Foundation. It was formally launched on 3 November 2021, at COP26 in Glasgow. As part of its mandate, the ISSB developed two IFRS sustainability disclosure standards as a comprehensive global baseline of sustainability disclosures focused on the needs of investors and financial markets.

1. IFRS Standard 1 (S1) – General Requirements for Disclosure of Sustainability-related Financial Information. This requires disclosure about sustainability-related risks and opportunities that could reasonably be expected to affect an issuer’s cash flows, access to finance or cost of capital over the short, medium, or long term.
2. IFRS Standard 2 (S2) – Climate-related Disclosures. This incorporates the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and requires disclosure of material information about an issuer’s climate-related risks and opportunities that could reasonably be expected to affect an issuer’s cash flows, access to finance or cost of capital over the short, medium or long term. The four pillars are:

• governance: the governance processes, controls and procedures used to monitor and manage climate-related risk and opportunities
• strategy: which climate-related risks/opportunities could enhance strategy; what management information is provided on them; current and anticipated effects on the business model; those risks/opportunities that could be reasonably expected to affect cash flows; access to finance and cost of capital in the short/medium/long term and resilience of strategy to climate risk
• risk management: how climate-related risks and opportunities are identified, assessed and mitigated, and
• metrics and targets: metrics and targets used to monitor performance.

The Standards were drafted to work in conjunction with IFRS accounting standards. They are designed to ensure that companies provide sustainability-related information alongside financial statements in the same reporting package. The Standards have four key objectives:

1. to develop standards for a global baseline of sustainability disclosures
2. to meet the information needs of investors
3. to enable companies to provide comprehensive sustainability information to global capital markets, and
4. to facilitate interoperability with disclosures that are jurisdiction-specific and/or aimed at a broader stakeholder group.

How will the new Standards impact companies in Hong Kong?

The ISSB standards have received significant support from investors, regulators, governments, companies and other capital market participants. Moreover, the alignment of Hong Kong’s ESG regime with the Standards will have significant implications for listed companies and the governance professionals advising them.

Hong Kong’s current ESG rules and regulations are contained within the ESG Reporting Guide (Appendix 27 of the Main Board Listing Rules and Appendix 20 of the GEM Rules). In April this year, Hong Kong Exchanges and Clearing Ltd (HKEX) launched a consultation (Enhancement of Climate-related Disclosures under the ESG Framework) proposing, among other things, to rename the ESG Reporting Guide the ESG Reporting Code (Code). The consultation also proposed a significant upgrading of the current requirements relating to climate-related disclosure to align Hong Kong’s regime with the new IFRS S2 Standard.

Dr Agnes KY Tai, Chief EC.ESG Investment Strategist at BlueOnion, points out that S1 has already largely been embedded in Appendix 27 as Hong Kong has been aligning with the TCFD approach for some time. Wai-Shin Chan, Global Head of ESG Research at HSBC, agrees. He points out that S1 serves as a governance framework for how sustainability should be done, and most jurisdictions, including Hong Kong, align with it generally.

The HKEX consultation closely follows S2, summarising key points and replicating some of the language, but there are differences. ‘The key phrase here’, emphasises Mr Chan,‘is align, not adopt’. Hong Kong was one of the first jurisdictions to announce that it would align with the ISSB standards, he says, however there is also the need to tailor the disclosure requirements to the Hong Kong markets.

The HKEX consultation proposals relating to S2 would represent no small change to the current regulatory requirements. For example, listed companies would be required to disclose:

• their Scope 3 greenhouse gas (GHG) emissions
• the resilience of their strategy and operations to climate-related changes assessed by means of scenario analysis
• the capital deployed to address climate risks and opportunities, and
• their executive pay policies linked to climate considerations.

‘The big challenge for Hong Kong corporates abiding by Appendix 27,’ says Ms Chang, ‘is its uniform expectation on all listed companies regarding climate. While under the new ISSB standards, one first identifies material topics under S1 and then refers to S2 when climate is considered material, under the HKEX consultation proposals, many aspects of S2 focusing on climate would become a mandatory requirement for all listed companies in Hong Kong. This could be challenging for companies with other pressing ESG material issues, such as human rights, in terms of how to prioritise and allocate resources to climate disclosures versus other topics.

What will be the key compliance challenges?

Disclosing Scope 3 GHG emissions

The requirement for listed companies to disclose their Scope 3 GHG emissions will require them to quickly work with their supply chains to gather data and get both suppliers and customers on board. Dr Tai points out that this will be difficult enough for the larger listed companies, and for many listed SMEs it will be a significant challenge. Most of the 2,600 listed companies in Hong Kong are SMEs, and Dr Tai emphasises the value of training and of guidance for these companies going forward.

Nevertheless, the specific emissions disclosure requirements in Hong Kong are not as comprehensive as those of S2. Ms Chang points out that S2 sets out more detailed requirements relating to GHG emissions disclosure. For example, companies need to specify whether they are using carbon offsets and whether the disclosed emissions data has been verified by third parties. These disclosures are only required for target-setting but not for current GHG emission disclosures despite the fact that investors, Ms Chang points out, are looking for this type of data.

‘When we look at emissions data, we need adequate background information in order for us to understand the nuances and come to useful conclusions. The more information we get about how the numbers have been calculated, the less time we spend on fact finding during engagement and focus on strategy discussion,’ she says.

The Hong Kong proposals also factor in a longer interim period for Scope 3 disclosures. The one-year interim period suggested by ISSB has been extended to two years from January 2024 – the date the revised Appendix 27 goes into effect. In effect, Mr Chan points out, the interim period is greater than two years since companies will need to ensure their corporate reports published in 2027 (covering fiscal year 2026) are fully compliant. He adds that this will give companies time to address capacity constraints.

Using climate scenario analysis

The proposed Hong Kong requirements relating to disclosures of companies’ resilience to climate-related changes assessed by means of scenario analysis are broadly aligned with S2. The HKEX consultation has adopted S2’s approach and will provide a two-year interim period for companies to provide such disclosures commensurate with their resources.

Dr Tai points out that ‘quantifying physical and transition risks is a tall order for less resourced companies’. She adds that it will be very much up to each individual company to decide which tools or service providers they should use to get up to speed.

Providing quantitative data on the financial effects of climate change

The ISSB recognises the challenges for companies of providing quantitative data on the current or anticipated financial effects of a climate-related risk or opportunity. Under S2, an entity need not provide such data if it determines that:

• those effects are not separately identifiable, or
• the level of measurement uncertainty involved in estimating those effects is so high that the resulting quantitative information would not be useful.

Ms Chang points out that this safety valve – offering companies struggling to quantify the financial impacts of climate change a degree of flexibility – is lacking in the proposed HKEX requirements. Bearing in mind that HKEX’s consultation and proposals were published before the final ISSB standards, which contained material changes from the draft standards, HKEX needs to consider and align the ESG Reporting Code with the material changes under the published standards.

Assessing materiality

Ms Chang points out that, in defining materiality, the Standards make reference to stewardship or voting activities. In essence, ‘information that can affect voting behaviour can also be considered material under S1 and S2’, she explains. This may seem to be a minor point, but companies would do well to bear in mind, she suggests, that there could be topics that should be considered material, not because of immediate direct financial impact but because such issues matter to the users of their reports. Just one isolated incident could cause reputational risks which could affect voting even though the incident itself may not be financially material in the short-term, she says.

Disclosing a company’s internal carbon price

The Standards require the disclosure of a company’s internal carbon price, while the HKEX consultation would only require companies that have an internal carbon price to disclose it. Dr Tai highlights the difficulties with this approach. The rules would effectively mean that companies with a carbon price would be subject to greater scrutiny. Will they therefore disincentivise companies from having an internal carbon price – arguably an important part of responsible ESG management? Moreover, a company may have reasons, for example wanting to withhold competitor-sensitive data, not to reveal publicly its internal carbon price. Dr Tai emphasises the importance of making the rules clearer. ‘If it is mandatory, make disclosures mandatory, and if voluntary, then make this clear too,’ she says.

Getting assurance of sustainability disclosures

Assurance of sustainability information is still at a relatively early stage of development in Hong Kong. The current Listing Rules, for example, only require disclosure where assurance of ESG disclosures has been obtained. This is in contrast to the position taken by the EU and Singapore. Neither ISSB nor the HKEX consultation requires assurance.

Mr Chan notes, however, that with the passage of time, in the usual way with disclosure regimes, the rules may move from voluntarily to ‘comply or explain’ and even to a mandatory requirement. Ms Chang adds that during this evolution all parties, companies and investors included, will benefit from more guidance on how assurance works with sustainability disclosures in practice.

Finally – will the ISSB standards be a game-changer?

There can be little doubt that the world was badly in need of a global baseline for sustainability disclosures – the presence of multiple sets of standards and frameworks was only increasing the potential for confusion and greenwashing. Nevertheless, the Standards are voluntary and regulatory requirements in jurisdictions around the world still vary. This may significantly hamper their ability to deliver on the goal of achieving global consistency and comparability in sustainability disclosures.

So has the hype regarding the potential impact of the Standards been misleading? ‘No standard is perfect,’ says Mr Chan, ‘but as more companies align with the Standards, this should ultimately minimise the potential for greenwashing.’

He adds that the Standards will have the benefit of encouraging companies to consider more deeply the way they collect ESG information. He points out that the idea behind upgrading the disclosure requirements in Hong Kong is not only to provide information to investors but also to enable the reporting companies themselves to be better able to make informed climate-related decisions. In particular, companies need to be aware of the carbon intensity of their business activities, whether upstream or downstream, in order to make better decisions for the future.

Perhaps there needs to be a degree of realism, then, when considering the potential impact of the Standards. Their goal is to encourage companies to meet the strong demand from investors for consistent and comparable sustainability-related data and information. They are not going to ensure that companies are more sustainable overnight and they have come in for criticism for their single materiality approach (focusing on the financial impact of climate change on companies rather than also reporting on the company’s impact on the environment). This is in contrast, for example, to the approach taken in the EU where proposed rules on ESG disclosure take a double materiality approach on the basis that, to many stakeholders, the impact of companies on the environment is the primary concern. The current reform will result in Hong Kong’s disclosure requirements being based on traditional matters for  the pre-reform items that the market is familiar with, but single materiality for post-reform items. There are also more standards to come, for example, relating to biodiversity.

Nevertheless, if the reform encourages companies to report on sustainability issues in a more consistent and transparent way, this is already a significant achievement. The ultimate focus of the IFRS, Mr Chan points out, in contrast to the broader approach of the European markets, is on financial disclosure with materiality made clear from the outset. ‘This is where the ISSB standards come in’, he says, ‘as best practice global disclosure standards and companies need to be prepared for this.’

Sharan Gill
Associate Editor, CGj

SIDEBAR: Disclosing the role of the board

In general, as the main article demonstrates, Hong Kong intends to propose alignment with IFRS S2 on climate disclosures. Regulators in Hong Kong have been proactive in enforcing board responsibility and accountability in addressing climate risks disclosures and has no doubt informed the market of the approach taken to this issue.

The Standards make reference to which individuals on the board have oversight of these matters, points out Mr Chan, but in Hong Kong the rules require more specific information on what the board is doing, not just who has oversight. ‘This is a subtle, but relevant difference,’ he says. 

Moreover, while S1 only refers to the need to disclose companies’ governance frameworks, Appendix 27 makes direct reference to the role of the board as well as management. It is expected that HKEX will provide more clarity on S1’s application, which has not been formally adopted under the reform.

This is of course also an issue of particular interest to investors. Ms Chang points out that investors are looking to understand the value the board brings in providing oversight to companies on climate strategy and its competence in acting as a check and balance mechanism. She adds that it is important for companies to go beyond general statements and address the key questions.

Dr Tai adds that director training will be key to companies getting an effective governance framework for climate issues. She believes Hong Kong should make it mandatory for board directors to be educated on ESG issues and disclosures, pointing out that this is the case in  Singapore and Malaysia. In Hong Kong, even general CPD training is not mandatory for board directors. There is guidance on best practice, but she points out that that is not the same as compulsory training in sustainability and climate-related disclosures.