Rethinking ESG: from compliance to value creation
Alaya Consultings second annual survey of the ESG performance of Hong Kongs top 200 listed companies finds that 99% of the companies surveyed are in compliance with current ESG reporting requirements. The survey also indicates, however, that few companies are getting the full benefit of a sustainability structure that is aligned with the companys core business.
Environmental, social and governance (ESG) reporting has been a new area of compliance for Hong Kong listed companies, with rising expectations from stakeholders including investors on corporate social responsibility. While some companies have published outstanding reports on their
ESG performance, others have treated their reporting process as a compliance exercise.
Alaya Consulting has been tracking compliance by Hong Kongs top 200 listed companies with the ESG requirements set out in the Hong Kong Exchanges and Clearing (HKEX) ESG Reporting Guide for two years. Its second annual survey finds that the levels of compliance vary among the companies surveyed, reflecting different levels of commitment, scope of engagement and whether this is an integral goal of value creation.
99% of the companies surveyed were in compliance with the requirement of the Guide for listed companies, on a comply-or-explain basis, to report on all aspects of ESG listed under the General Disclosures section. However, this requirement has now been extended to include 12 environment-related key performance indicators (KPIs). As companies will have to comply with this new requirement in their upcoming annual reports, now is a good time for companies to rethink the value of ESG and to truly kick-off their journey to sustainability.
Governance is key
When it comes to ESG disclosure, emphasis is currently placed on reporting relevant environmental and social KPIs. Establishing an effective ESG governance structure is not high on the agenda for most companies under the study. However, just as corporate governance brings business value, ESG governance helps formulate relevant strategies to create environmental and social value.
Only 63 of the 200 companies (31.5%) established a governance structure, for example a committee, that specifically oversees the companys sustainability, and only approximately half of those directly report to the board of directors, showing the lack of management attention to this matter. However, if we rank the companies according to their overall ESG disclosure and performance, among the 50 companies with the highest scores, 80% of them have an ESG governance structure. The indication is that companies adopting a more structured approach usually perform better in ESG compared to the rest of the sample. Analysis also reveals a significant correlation between having a sustainability committee and the quality of ESG disclosure, showing that having such a committee benefits the level of ESG disclosure significantly.
Given the interdisciplinary nature of sustainability risks, a governance structure is necessary to bring together various company functions. By bringing sustainability discussions to top management levels, a governance structure helps construct a system for sustainability initiatives to be translated into day-to-day practices at the operational level.
Communication and coordination between different departments constitutes one of the challenging tasks throughout the ESG reporting process. Sustainability governance is not just a matter of ensuring that the right information is disclosed, it is also about pushing for strategies and measures to be formulated to improve both compliance and performance on each material aspect.
Environmental KPI disclosure
As mentioned above, 99% of the companies surveyed met the requirement for companies to report on the ESG aspects listed under the General Disclosures section of the Guide. In the current reporting period, that requirement has been extended to include the 12 environmental KPIs listed in the Guide and companies need to prepare themselves for this.
Our study found that 17% of the companies surveyed reported on all of these environmental KPIs and 81.5% reported on some of them (see Figure 1). Amongst the 12 environmental KPIs, the disclosure level of the six qualitative KPIs is generally higher than the seven quantitative KPIs (see Figure 2). This reflects the fact that many companies have yet to set up a management system to measure and collect relevant data, leading them to disclose more narrative information, such as energy saving measures, than quantitative KPIs.
Determining the reporting boundary and ensuring the accuracy of the data collected are critical processes that demonstrate the reports reliability to investors as well as other stakeholders. There is no doubt that ESG governance plays a crucial role in this respect. Since data collection might appear to be challenging for some companies depending on their size and business nature, establishing effective governing mechanisms are necessary to pool resources and efforts to strengthen disclosure and eventually improve performances in environmental aspects based on the data collected.
Social KPI disclosure
As expected, the disclosure of social KPIs is generally low as this remains a recommended best practice. However, some social aspects have a high level of disclosure, for example 96.5% of companies surveyed disclosed their focus areas of community investments KPIs (B8.1); while other social aspects have a high level of non-disclosure, 86% of companies surveyed failed to disclose their product recall KPIs (B6.1) and 70.5% failed to disclose their days lost due to work injury KPIs (B2.2).
Although companies may lack incentives to gather data at this stage, issues such as labour rights, occupational health and safety and product safety are attracting increasing attention from stakeholders. Due to the complexity of social impact of businesses, a company with an overall sustainable strategy and leadership on sustainability helps in managing the reporting process and responding to stakeholders concerns.
Board independence and diversity
Our research went further to examine whether companies are aiming for best practices on board independence and gender diversity. The listing rules specify that independent non-executive directors (INEDs) should make up at least one-third of the board, but there are no requirements on INED representation on the three main board committees, namely the audit, remuneration and nomination committees. While 58% of the companies surveyed had an audit committee comprised exclusively of INEDs, only 9% of them had all three committees comprised exclusively of INEDs.
In terms of gender diversity, while 62% of the companies had at least one female director on board, on average only 9 out of 100 board members are female.
Female directors remain a small minority on boards and forging gender diversity is yet to be a top priority when appointing directors.
Board independence and gender diversity have been identified as indicators of a companys corporate social responsibility as it allows more openness and stakeholder-oriented approach in decision-making. Better governance is largely dependent on incorporating more opinions and perspectives, which in turn brings more robust business performance.
Performing better in ESG
Moving a step further from the previous years research, this year our study developed a scoring mechanism to rank companies based on both the level of disclosure and ESG performance. This more comprehensive approach assesses the overall management structure and the outcomes of a companys sustainability initiatives. In addition to the level of disclosure, four other factors including corporate governance, sustainability governance, target setting and reporting standards have been taken into consideration.
With reference to the practices of the top five scoring companies (Swire Properties, CLP Holdings, HKEX, HK Electric Investments, and the Hongkong and Shanghai Hotels), below are three suggestions for improving your ESG performance.
1. Good governance and practices
To make ESG work in a company requires effective practices to be embedded and routinised in each level of daily operation. Once the top management has decided to take the lead, mechanisms are then introduced to implement board strategies at the business operation level. This should increase effectiveness and efficiency in ESG reporting, but going beyond that, good governance aims to transform the companys mindset so
that sustainability becomes a core value of the company.
2. Aligning with international sustainability standards and goals
Striving for sustainable growth has become a global business trend, especially with increased attention towards socially responsible investment where more investors are seeking greener and more ethical businesses to invest in. Adopting international sustainability standards and initiatives is more than a display of commitment but an opportunity to achieve greater progress, accuracy and credibility in ESG reporting and performance.
24% of the companies were willing to take a step further, adopting the Global Reporting Initiative frameworks for ESG reports. It is encouraging to see companies committed to respecting international standards but this is not the only purpose of ESG reporting. The sustainable development goals (SDGs), a set of 17 goals agreed by all 193 member states of the United Nations, invites the private sector to join forces with governments and civil society to tackle global challenges, and to sustain economic growth with environmental and social needs being met. While some leading multinational corporations have actively responded to the SDG initiative, only 6% of the companies surveyed in Hong Kong have integrated SDGs into their ESG reports.
Though some believe there has to be a trade-off between profit and sustainability, the fact is that most companies implementing sustainability measures achieve higher profits and faster growth rate than their peers. Transforming business models, such as developing greener products with beneficial social impact saves costs, increases efficiency and eventually gains competitive advantage.
3. Target setting
The benefits of target setting are significant. This enables organisations to assess their actual environmental and social impacts, identify related risks and opportunities and eventually establish measures to mitigate such risks. Target setting is also one of the useful tools for organisations to monitor their ESG performance and communicate to stakeholders about ESG. Establishing targets in the long-run helps to set out strategies and a roadmap towards sustainable growth, for example by looking deep into the product life-cycle and supply chain to create innovative ways to improve the products and services provided.
Less than 20% of the companies surveyed set environmental and social targets, with a carbon target (19%) as the most popular one, followed by water consumption (16%), energy reduction (16%), waste (9%) and occupational health and safety (9%). Companies are yet to realise the advantage of setting SMART (specific, measurable, attainable, relevant and time bound) and effective targets as a driving force in ESG, and integrating these into the companys business strategy.
Sustainability is sometimes viewed as a costly investment. However, companies that perform well in sustainability issues, such as employee satisfaction, often achieve a stable and higher stock price, beating the market in the long-term. More investors wish to invest in companies that earn higher returns, do less harm to the environment and are of benefit to society. Moreover, other stakeholders such as customers and communities are also demanding better ESG performance.
Hong Kong listed companies have taken the first steps towards sustainability but there is a long and challenging journey ahead. Companies with good ESG performance, those at the top of our ranking, are mostly companies with 5-6 years of experience in sustainability reporting. With more experience gained in ESG reporting over the next few years, Hong Kong companies should gradually advance beyond the compliance stage and enter the next phase where they incorporate their sustainability strategies into their core value proposition.
Tony Wong, Founder
Regina Tai, Consultant
Alaya Consulting is a Hong Kong-based firm that advises companies on non-financial reporting and sustainability process improvement. For the full research report discussed in this article, please contact Regina Tai: email@example.com.