Public markets and ESG: The bourse bites back

Once confined to overlooked small print, environmental, social and governance (ESG) disclosure is now writ large in the consciousness of those seeking public listings in Hong Kong. This change in sentiment is the product of a gradual tightening in the regulator's hold over the exchange (HKEx).

In recent years, passage to the main board has been halted by requests that companies ensure the green credentials highlight in their IPO prospectuses have a basis in fact. Failure to produce documentary confirmation has seen offerings are at best delayed, at worst abandoned - bad news for any private equity backers looking for a liquidity event.

This tougher line is indicative of Hong Kong's desire to match its global peers on ESG disclosure standards. It will soon extend from IPO applicants to listed companies. HKEx's ESG reporting guide was published in 2012 as a voluntary measure. It is now in the process of being upgraded to "comply or explain" whereby companies are still not mandated to make an annual ESG disclosure, but must explain why they choose not to do so. The next step would be the introduction of compulsory disclosure.

They can't just say ‘we don't have sufficient resources, or we don't have enough time to do it.' It may indicate that the company is not well-prepared for a listing - Jeffrey Mak

"In recent years, the listing division that processes IPO applications has become much more vigilant about ESG-related issues, both from a reporting standpoint in the prospectus and from a standpoint of being able to confirm compliance. If there are material issues, it encourages or requires proactive disclosure in the prospectus," says Melisa Brown, a partner at Daobridge Capital, a sustainability-focused investment and advisory firm in Asia. She previously served on the HKEx listing committee.

Ensuring a company is compliant with ESG requirements has become a tried and tested part of the trade sale process for many private equity investors in Asia - it is critical to getting a multinational buyer interested in a business. On the public markets side there hasn't been the same level of impetus.

However, with major exchanges now attaching greater importance to ESG, compliance is increasingly important. After all, Asian stock exchanges have been the exit route of choice for more than 2,100 PE-backed companies since 2006. Hong Kong is the fourth most popular jurisdiction in the region after the mainland, Japan and Korea.

"There is a real pressure for some listing candidates, or listed companies, to comply with the rules because they don't want to explain why they aren't complying," says Jeffrey Mak, a Hong Kong-based partner at DLA Piper. "They can't just say ‘we don't have sufficient resources, or we don't have enough time to do it.' It may indicate that the company is not well-prepared for a listing. Coming up with valid reasons is difficult, so we expect a lot of listed companies to start publishing ESG reports from 2017."

Raising the bar

Many of the leading exchanges globally have ESG reporting requirements. They were introduced in part because large institutions increasingly factor such criteria into their investment decisions, especially groups from Europe and the US.

Within Asia, Malaysian listed companies must publish an annual corporate social responsibility (CSR) report and Singapore is in the midst of a consultation process that could see its voluntary sustainability reporting policy replaced by a "comply or explain" approach. Taiwan, meanwhile, launched a five-year corporate governance roadmap in December 2013 that requires 203 listed companies in the food, chemicals and financial sectors - provided they have at least NT$10 billion ($330 million) in assets - to issue corporate social responsibility (CSR) reports. The requirement comes into effect this year.

ESG reporting rules were introduced to China's A-share market in 2008, with a strong focus on environmental protection. Under a series of "green regulations," listed companies must disclose information on their environmental records. Furthermore, those operating in heavy-polluting industries have to include environmental review opinions by the Ministry of Environmental Protection in IPO documents.

"In some instances it has been a rather painful and expensive process for companies. If a GP is looking to hit a particular IPO window and a company is told it must first get sign off and documentary proof of compliance from environmental authorities at municipal and provincial level, that is complicated and expensive," Daobridge's Brown says.

As for regular ESG reporting, listed Chinese companies are not subject to any requirements; they are encouraged to issue reports on a voluntary basis. So while on the face of it there is a higher standard of reporting than Hong Kong, for example, regulators have yet to fully implement the regime and then enforce it.

"If there is an environmental incident that could potentially impact a listed company's stock price, it must disclose ESG-related issues according to the existing environmental laws and listing rules. But this is a different type of disclosure and I don't consider it to be the kind of responsible ESG reporting we're talking about," explains Leo Lou, a Shanghai-based partner at Fangda Partners.

Hong Kong's status as a late mover is in part due to the nature of the companies on its bourse, industry participants say. There are many small and medium-sized enterprises (SMEs), a large proportion of them in the services sector, and they are generally not considered high risk.

Under the current rules, voluntary ESG reporting should cover four key areas: workplace quality, environmental protection, operating practices and community involvement. In each of these areas, companies must consider specific ESG aspects, processes for disclosing information on them, and key performance indicators (KPIs) that tie this information to particular goals.

"The main difference between the mainland and Hong Kong approaches is that the former is more flexible. For example, if a company wants to comply with certain industrial standards it can be quite generic when reporting such matters. In Hong Kong, however, the regime tends to require the listing candidates to collect analytical data relevant to their industries as well as their business operations," says DLA Piper's Mak.

Nevertheless, companies still have a degree of freedom in terms of how they focus their reporting. They are not obliged to cover every KPI, which would be costly and time-consuming. Rather, companies can pick one or two out of six items, provided they relate to the nature of the business and specific data can be provided. It means heavy industry players that produce a lot of pollutants aren't necessarily required to concentrate on carbon emissions. That said, KPIs specific to operating practices will be introduced in three to five years' time.

"Companies should think about the coming changes not as something with which they should try and avoid compliance, but as something that can showcase their focus on sustainability and ESG issues to investors," Mak adds. "Companies can take action in ways that would not cost them a lot of money."

Best practice

At the same time, HKEx has taken steps to comply with international standards. When the voluntary guidelines were introduced three years ago, local conglomerates such as Swire and CLP Holdings had been releasing sustainability reports of their volition for approximately a decade. These companies petitioned the exchange, suggesting that its requirements fall in line with what already exists as international best practice, notably the Global Reporting Initiative (GRI) guidelines.

HKEx acted on this feedback and made references to GRI and other international standards in its ESG guide.

Jeanne Ng, director of group sustainability at CLP, one of the two major electric power generation companies in Hong Kong, notes that the need for greater transparency is more ingrained in companies that are used to dealing with the complexities of major infrastructure projects. When constructing a power plant, CLP has to engage with a multiple stakeholders and the public expects to remain informed.

"As a result, many big brands particularly those in heavy industry or infrastructure, tend to be more experienced in ESG reporting compared to service industries," she says. "But these days, even services industries such as banking are moving on ESG reporting as well."

Although the regulatory framework is evolving, the market remains bifurcated in terms of ESG disclosure: large conglomerates lead the way, in part because of they have more international blue chip investor bases, while the rest of the market is under no real pressure to follow suit. This state of affairs may change as Hong Kong cranks up the regulatory pressure, but enforcement - in this and other markets - is key.

"Disclosure at IPO is sometimes very good. What we haven't had is a process that would obligate companies when they are listed to follow up with regular reporting. We have tended to see decent reporting at IPO and on event-related issues or price sensitive events that relate to ESG," Daobridge's Brown says in reference to Hong Kong. "What they are going to address now is the burden of ongoing reporting."

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• Topics
• Greater China
• Investments
• Exits
• Hong Kong (China)
• IPO
• ESG
• Exit
• Asia