It is clear that we are at a tipping point. As the world grapples with Covid-19, investors, corporations, and stakeholders are increasingly focusing on environmental, social and governance (ESG) issues, and their legal and reputational implications. This has been reinforced in recent months with multiple significant developments, including the US re-joining the Paris Agreement, a Dutch court ordering Shell to accelerate carbon emission cuts to comply with the Paris Agreement, and New York City’s lawsuit against major oil companies over their climate change claims. In Asia, pledges by Hong Kong, Japan and South Korea to become carbon neutral by 2050 and by China to do the same by 2060 have also driven ESG into the limelight.
Here are five selected reasons why ESG should be top of mind for Hong Kong businesses, investors and their legal advisors:
1. Tightening reporting requirements for Hong Kong listed companies
Following a 2019 market consultation on the board’s role and accountability in ESG matters, the Hong Kong Stock Exchange has implemented new proposals which include upgraded reporting requirements for listed issuers, encouragement to seek independent assurance on ESG disclosures, and shortened timeframes for ESG reporting. The Stock Exchange has also developed guidance material to help directors develop ESG awareness and expertise.
There are no signs of slowing down, as the Stock Exchange has launched another consultation in April 2021 with a view to potentially enhancing corporate governance rules and strengthening the linkage between corporate governance and ESG. Proposals include amendment of the Corporate Governance Code to clarify that the board should have governance and oversight of ESG matters and risks, and pushing up the publication timeframe for ESG reporting to be simultaneous with annual reports. If this proposal passes, listed companies must plan time and resources well in advance if they are to satisfy the Corporate Governance Code and maintain reporting quality.
2. New requirements proposed for fund managers
In January 2021, the Securities and Futures Commission (“SFC”) wrapped up a consultation regarding the management and disclosure of climate-related risks by fund managers. The SFC has proposed to amend the Fund Manager Code of Conduct to enhance requirements in the four key areas of: governance, investment management, risk management and disclosure, with additional requirements for large fund managers with over HK$4 billion in assets under management. Although the consultation conclusions are still pending as of the date of writing, Hong Kong fund managers should start to consider potential implications on their operations and the industry expertise required to comply.
3. Increasing shareholder pressure
Shareholder activism is not a new phenomenon, with fund managers and other investors using their shareholding power to create change. ESG gives investors another channel to engage with companies on climate change and other issues. A recent high profile example is hedge fund Engine No. 1 getting three directors onto the 12-member board of NYSE listed Exxon Mobile Corp, in response to recent poor financial performance by Exxon. Although the fund only holds a 0.02% stake, it gained backing from large institutional investors including BlackRock. Shareholder activism remains rare in Hong Kong, with one local example being Elliott Management’s reported battle with the Bank of East Asia; nonetheless, companies should proactively manage risks by reviewing their ESG standards and practices and identifying any weaknesses open to challenge.
4. Growing trend of ESG due diligence in M&As
We note that potential acquirers are increasingly integrating ESG elements into their due diligence and decision-making, including in areas such as ethics and anti-bribery, environmental compliance, health and safety, and data privacy. Private equity firms, asset managers and corporations each have their own considerations for doing so, but in any case, business owners should prepare for related questions if they are contemplating a sale, and should take stock of their own ESG readiness with the aim of a smoother and quicker sale process overall.
5. Rising investor appetite for green/sustainable finance
There are multiple studies suggesting a positive relationship between stronger ESG standards and better financial performance. As a result, ESG has captured investor attention and Hong Kong has enjoyed strong growth in green bonds and loans, with names such as Wheelock, Langham Hospitality, Link REIT and Swire Properties announcing billions of HKD in sustainability-linked loans. Such demand will continue to drive borrowers to perform against sustainability metrics. On the other hand, companies with poor ESG performance may risk being screened out by concerned investors.
THE WAY AHEAD
Given the broad range of issues that ESG entails, the above is merely a brief overview of where things stand. ESG will be a long-term fixture in the business world. Finding the right expertise and complying with increased regulatory, investor and public expectations will no doubt be both a challenge and an opportunity for businesses today, but for those that are able to stay on top of the rapidly changing ESG landscape, they may well find that this has become a lasting competitive advantage.