Investors should make it a point to know how the board of directors and management conduct their businesses and manage all sorts of risks and opportunities. Similarly, it is also important to know what products the fund manager invests in and what factors the fund manager considers when investing in a fund.

Environmental factors, such as climate change in particular, may also impact how the business operates and its profitability. However, investors in general cannot obtain such important information from financial statements. The company has to disclose additional information on ESG (environmental, social and governance) and climate as recommended by the TCFD (Task Force on Climate-related Financial Disclosures) to investors.

Understanding ESG

ESG are considered key factors in the sustainable development of an enterprise and they generally comprise the following items. As each company has different businesses and places of business, their ESG disclosures are inevitably different.

Environmental (E) Social (S) Governance (G)
  • Environmental pollution
  • Biodiversity
  • Climate change
  • Deforestation
  • Ecosystem services
  • Energy efficiency
  • Hazardous materials
  • Land degradation
  • Resources depletion
  • Waste management
  • Water scarcity
  • Customer satisfaction
  • Customer information and privacy protection
  • Diverse society
  • Equal opportunity
  • Employee relationship
  • Government and community relationship
  • Human resources management
  • Human rights and indigenous rights
  • Labor standards
  • Marketing
  • Product safety and liability
  • Mis-selling
  • Supply chain management
  • Accountability standards
  • Anti-competition activities
  • Structure of audit committee
  • Board composition
  • Anti-corruption
  • Commercial ethics
  • Executives remuneration
  • Risk management
  • Independence of board chairman
  • Succession planning
  • Whistleblower scheme

Reference: Principles for Responsible Investment

Companies listed in Hong Kong must provide ESG reports to enable investors to understand how they manage relevant risks. In order to enhance the awareness of listed companies on the importance of ESG disclosure, listed companies are required to disclose environmental and social information in compliance with the “comply or explain” principle since 2016. As investors are increasingly concerned about ESG factors, many asset management companies will disclose their ESG policies and indicate that they will consider ESG factors in the investment process and decisions.

TCFD recommendations

A majority of companies listed in Hong Kong currently prepare their accounts in accordance with universal financial reporting standards, such as Hong Kong Financial Reporting Standards (HKFRS) or International Financial Reporting Standards (IFRS), to facilitate investors in comparing the financial information of different companies. However, there are currently no universal standards on the preparation of ESG information, including the information on climate change. The ESG information of different companies cannot be easily and directly compared and the quality of the information varies.

The TCFD established by the Financial Stability Board under the G20 made recommendations in 2017 to assist companies in assessing financial risks and opportunities in climate change and disclosing relevant information to investors. The TCFD recommendations mainly focus on four areas, namely governance, strategy, risk management and metrics and targets.

Governance How companies manage risks and opportunities on climate change
Strategy The actual and potential effects of climate change on companies’ business and finance. The TCFD recommends that companies use scenario analysis to understand the resilience of their strategies and financial plans across a range of climate change scenarios
Risk management The process in which companies identify, assess and manage risks on climate change
Metrics and targets Metrics and targets used in assessing and managing climate-related risks and opportunities

 

The TCFD recommendations can be seen as a set of framework or as a set of standards and requirements. Mainland China is putting the TCFD recommendations into trial use and has introduced the policy direction to target mandatory environmental disclosure by 2020. The Securities and Futures Commission in Hong Kong also supports the TCFD recommendations and will require listed companies to strengthen their environmental disclosures, in particular on climate change in the future to make it consistent with the TCFD recommendations.

Investors may consider that the results and dividends of a company are the most important factors when investing in the stock of a company. However, the ESG report can provide indication on the governance and whether the company’s board of directors and management value investor communication in the way they provide disclosure in the ESG report.

 

14 March 2019