HKEx Consults on Introduction of “Comply or Explain” Environmental, Social and Governance Reporting

Introduction

The Stock Exchange of Hong Kong Limited (the Exchange) has published a Consultation Paper (see archive) on proposed changes to its Environmental, Social and Governance (ESG) Reporting Guide (the ESG Guide or Guide) which is set out in Appendix 27 to the Main Board Listing Rules and Appendix 20 to the GEM Listing Rules. The ESG Guide was introduced in 2012 to apply to listed issuers with financial years ending after 31 December 2012. However ESG reporting is currently voluntary: issuers are “encouraged to include” the information set out in the ESG Guide in their annual reports, or as a separate report by Main Board Listing Rule 13.91 (GEM Listing Rule 17.103). When the ESG Guide was originally introduced, the Exchange stated its intention to raise the voluntary obligation to a “comply or explain” mechanism in 2015 which would be the subject of a public consultation.

The key change proposed by the Consultation Paper is to amend the Listing Rules to require issuers to state in their annual report or ESG report whether they have complied with the “comply or explain” provisions of the ESG Guide for the relevant financial year. If they have not, they must give considered reasons for not complying. The other major changes proposed are to:

• Revise the Guide’s introductory section to give more guidance on reporting and bring this more in-line with international standards;
• Re-arrange the ESG Guide into two subject areas: Environmental and Social, from four in the current ESG Guide;
• Upgrade the general disclosure under each aspect of the Guide to “comply or explain” and align the wording with the directors’ report requirements under the Companies Ordinance (Cap 622) (incorporated in Appendix 16 to the Main Board Listing Rules);
• Upgrade the key performance indicators under the “Environmental” subject area to “comply or explain”; and
• Revise the wording of the recommended disclosure to bring it more in line with international standards by incorporating disclosure of gender diversity.

Subject to responses to the consultation, the Exchange aims to implement the amended Listing Rules and the revised Guide for financial years commencing on or after 1 January 2016 whereupon issuers would need to start gathering the necessary information for the purpose of publishing their ESG reports under the new ESG Guide in 2017.

Parties interested in responding to the consultation should complete the Questionnaire which is available at http://www.hkex.com.hk/eng/newsconsul/mktconsul/Documents/cp201507.pdf (see archive) and submit it to the Exchange no later than 18 September 2015.

The Consultation Paper emphasises the importance of guarding against imposing undue regulatory burden on issuers. It fears that setting the reporting bar too high prematurely may have an adverse effect on the overall quality of ESG reporting by issuers, e.g. by encouraging box-ticking or treating non-compliance as a norm.

Background

The Current ESG Guide

The Guide is currently a recommended practice, and so reporting in accordance with the Guide is voluntary. It is organised into four ESG Subject Areas, with each Subject Area containing various Aspects. For each relevant Aspect, an issuer may report on the General Disclosures and key performance indicators (KPIs) that demonstrate its performance.

The issuer is encouraged to identify and report on relevant ESG Subject Areas, Aspects and KPIs that have material environmental and social impacts, both in terms of the impacts that the issuer’s operations have on the environment and society, and vice versa.

The Guide clearly states that it does not provide a definition for each KPI. Instead, the issuer is encouraged to explain how it calculates the KPIs and include information that is necessary for interpreting the KPIs. The Guide provides a basic framework to facilitate ESG disclosure so that investors and stakeholders can understand the issuer’s ESG performance and practices, and respond accordingly.

The Exchange believes that although surveys indicate that just under half of issuers are reporting, with the changing regulatory landscape, and as more issuers begin to see the positive effects of ESG reporting, the level and standard of reporting will improve.

Previous Consultation Paper (August 2012)

In the original consultation proposing introduction of ESG reporting, the Exchange stated that the Guide (compliance with which is currently voluntary) was intended for issuers looking for a starting point from which to begin work on ESG reporting. It was also indicated that, subject to consultation, the level of obligation of some recommended disclosures would later be raised to “comply or explain”.

International Practice

The Consultation Paper summarises the practice in Mainland China, the European Union, the United Kingdom, Australia, the United States, South Africa, and other Asian countries. There has been a marked increase in recent years in the amount of policy and regulation calling for ESG reporting. Most countries with policies in this area adopt a combination of laws, listing rules, “comply or explain” and/or voluntary guidelines to regulate the disclosure of ESG information. However, these policies are increasingly subject to higher levels of obligation (i.e. “comply or explain” and/or mandatory).

Standpoint of the Exchange

The Exchange believes that, on balance, the long term benefits that ESG reporting can bring to issuers, as well as to the quality, sustainability and reputation of the Hong Kong market, outweigh the disadvantages which include increased costs and a greater administrative burden, particularly for smaller issuers. The Exchange also considers it important for Hong Kong to align itself with international best practice in this area.

The low response rate of the ESG survey is acknowledged but the Exchange insists that market feedback indicates that many issuers are waiting for the recommended disclosures of the ESG Guide to be upgraded to “comply or explain” before they begin to report.

It thus considers that it is now appropriate to consider imposing a higher level of reporting obligation on issuers. This is further supported by recent developments in Hong Kong and other jurisdictions with regard to ESG disclosure.

Aims of the Consultation Paper

1. To strengthen environmental, social and governance disclosure requirements and enable issuers to formulate policies, measure relevant data, monitor progress and report to investors and other stakeholders on their work in this area.

2. The proposals seek to encourage more widespread and standardised ESG reporting amongst issuers, and to help issuers meet greater demand and expectations for non-financial information from investors and other stakeholders.

Proposals

The proposed new Guide will continue to give issuers flexibility due to the nature of the “comply or explain” provisions. An ESG report may be presented as information in the issuer’s annual report, in a separate report, or on the issuer’s website. Issuers may also use international standards or guidelines that they consider appropriate. Furthermore, disclosures may be provided at the group level, rather than by each subsidiary within a group. Issuers should carefully consider the practice that best suits them and explain their choice in their ESG reports.

Proposed Amendments to Main Board Rule 13.91

The Consultation Paper proposes amending Main Board Rule 13.91 (which encourages issuers to disclose information set out in the ESG Guide either in the annual report or in a separate report) to state that the issuer must disclose in its annual report or ESG report whether it has complied with the “comply or explain” provisions in the ESG Guide for the relevant financial year. Where the issuer deviates from the “comply or explain” provisions, it must give considered reasons in its ESG report. Issuers will be encouraged, but not required, to report on the recommended disclosures of the ESG Guide.

It is also proposed that issuers must disclose ESG information set out in the ESG Guide on an annual basis regarding the same period covered in their annual reports.

An ESG report may be presented as information in an issuer’s annual report, in a separate report, or on the issuer’s website. Issuers will be required to publish the ESG report as close as possible to, but in any event no later than three months after, the publication of the issuer’s annual report.

Proposed Amendments to the ESG Guide

1. Revamping the introductory section of the Guide

The Consultation Paper proposes to divide the introductory section of the Guide into four areas:

1. The Guide;

2. Overall Approach;

3. Reporting Principles; and

4. Complementing ESG discussions in the Business Review Section of the Directors’ Report.

The revised introduction will:

1. give guidance on the format, timing and frequency of ESG reporting and will encourage issuers to publish the ESG report on the websites of the issuer and the Exchange;

2. stipulate that issuers’ boards bear responsibility for ensuring that effective ESG risk management and internal control systems are in place;

3. reword the “Reporting Principles” (which will relate to Materiality, Quantitative, Balance and Consistency) to provide greater clarity and align them with international guidelines. Issuers are not required to “comply or explain” each of the individual principles, but should demonstrate in their ESG reports that due consideration has been given to the principles; and

4. link the ESG Guide to the new rule in Main Board Appendix 16 which will require issuers to discuss ESG matters in their directors’ reports. Paragraph 28(2)(d) of Appendix 16 requires an issuer’s directors’ report for a financial year to contain a business review in accordance with Schedule 5 to the Companies Ordinance. The business review must include, to the extent necessary for understanding the development, performance or position of the issuer’s business: (a) a discussion of the issuer’s environmental policies and performance; (b) discussion of the issuer’s compliance with relevant laws and regulations that have a significant impact on the issuer; and (c) an account of the issuer’s key relationships with its employees, customers and suppliers and others having a significant impact on the issuer and its success. The introduction will clarify that the Guide calls for a greater level of detail, including data relating to the company’s environmental and social performance, whereas Appendix 16 requires a high level discussion in the business review section of the directors’ report. Thus disclosure under the Guide should complement rather than duplicate the information contained in the business review.

2. Re-arranging the Guide

The proposal is to re-arrange the ESG Guide into two Subject Areas: Subject Area A. Environmental and Subject Area B. Social. The current Subject Areas “Workplace Quality”, “Operating Practices” and “Community Involvement” will, with some modifications, come under Subject Area B.

The Consultation Paper proposes to change the heading “Workplace Quality” to “Employment and Labour Standards”.

3. Upgrading the General Disclosures

The Consultation Paper proposes to upgrade to “comply or explain” the General Disclosures for each Aspect of the ESG Guide. Each General Disclosure requires issuers to set out their policies or information on their policies in respect of the relevant Aspect. Some General Disclosures additionally require information on “compliance and material non-compliance with standards, rules and regulations …” relating to the relevant Aspect. Some language in the General Disclosures will be modified to align with the recent changes to the CO and related amendments to the Rules.

Issuers should explain in their ESG report if any particular General Disclosure is not relevant to them. General Disclosures are narrative in nature and do not require any collection or analysis of data.

4. Upgrading the KPIs in Subject Area A. Environmental

Subject Area B (Environmental Protection) is proposed to be moved to Subject Area A and the heading will be revised to “Environmental”. The Consultation Paper proposes to upgrade to “comply or explain” the proposed new Subject Area A, including all of the KPIs.

Proposed Subject Area A comprises three Aspects:

1. Emissions (current Aspect B1, renumbered Aspect A1) – This will contain recommendations for disclosure concerning emissions and wastes. Issuers will be encouraged to use international accounting tools for reporting greenhouse gas emissions (i.e. the Greenhouse Gas Protocol Corporate Accounting and Reporting Standard developed by the World Resources Institute and World Business Council for Sustainable Development).

2. Use of Resources (current Aspect B2, renumbered Aspects A2); and

3. The Environment and Natural Resources (current Aspect B3, renumbered Aspect A3) – there will be only one KPI, asking for description of the significant impacts of activities on the environment and natural resources and actions taken to manage them.

5. Gender Disclosure

The Consultation Paper proposes to amend the wording of the existing ESG Guide to incorporate gender disclosure in proposed Subject Area B, under the sub-heading “Employment and Labour Standards”. These proposed amendments relate only to the voluntary provisions of the Guide (i.e. the recommended disclosures) that are not proposed to be upgraded to “comply or explain”.

The “Comply or Explain” and recommended disclosures for each Subject Area are summarised in the table below.