Pat Nie Woo, Partner, Business Reporting and Sustainability, KPMG China, argues that making improved environmental, social and governance (ESG) performance an economic necessity will be our path to a more sustainable future.
With United Nations reports containing escalating warnings on the seriousness of the climate crisis, how do you rate the significance of threat we face globally and locally?
‘We conducted a global CEO survey this year and climate change climbed to number one on the risk radar of global CEOs, which was surprising for us. I think there is a lot happening in the investment space and it impacts how CEOs and their companies look at it.
400 different climate records were broken in the northern hemisphere over this summer. How are we to meet the Intergovernmental Panel on Climate Change (IPCC) trajectory for the next 12 years if there aren’t significant changes in regulation and in the cost of capital? Pressure is coming not only from investors but also from the regulators, as well as those who provide capital, the banks, insurance companies and finance companies. As the situation gets more severe, the outcry will increase, and governments and corporates will need to react.’
Do you see real commitment from the board level downwards?
‘Though we have companies that are doing well or catching up, at this stage of the game Hong Kong remains at the box-ticking phase. This is because boards and the C-suite do not quite connect why this is relevant to their business and are struggling to understand that investors are starting to ask more pertinent questions. Look at general board composition in Hong Kong – not many directors understand ESG.
The cost of capital is also going to push the drive on ESG. HSBC this year initiated two schemes with Walmart and Puma whereby the score given to the suppliers of these two corporates will in turn determine the terms they will obtain from HSBC. Essentially, if a supplier is laggard in sustainability it is going to be harder to roll over existing terms and more expensive.
The regulators are also getting involved. For example, the Hong Kong Monetary Authority has made announcements on sustainable banking and is expected to require the industry to change its view of sustainable banking and green financing. If regulators start to put pressure on banks to initiate these measures, it would become a funding advantage for companies to increase their sustainability commitment. That really is when the message is going to start hitting home.’
What role can sustainability indexes play in driving better ESG performance?
‘If you want to get to the premier league, getting on these indexes is important as financial media like Bloomberg, major asset owners like pension funds and institutional asset managers will take a lot more notice of your organisation once you are on these ESG indexes.’
There are many indexes with different rating systems. Do we need a more standardised rating system?
‘There is a lack of correlation. We are still at the initial stages of this development and it is sporadically used right now. However, as more people use the ratings there will be streamlining, and eventually we will get to the point of integrating and standardising these things. Look at financial accounting – it has been 200 years in development. Things move a lot faster now and it is still evolving. ESG elements have only become important in the last 10 to 15 years, and even more recently in Hong Kong.’
What has been the impact of the Task Force on Climate-related Financial Disclosures (TCFD)?
‘The TCFD is ultimately a game changer because it is effectively looking at the financial risk of the financial institutions relating to climate change. They have to look at their loan books, their investments. Insurance companies have to look at their investments and the projects that they are financing. They will need a governance framework, a strategic framework, a risk assessment framework, on all of their core businesses. When that happens, any laggards on ESG that they are providing capital to, whether it involves investments, insurance or just plain loans, becomes a problem for them. Essentially, the TCFD will drive a lot more initiatives similar to the HSBC one mentioned above regarding Walmart and Puma, whereby financial institutions will not want to keep laggards on their books.’
TCFD is not just about the risk, it is also about opportunities. Are companies aware of the opportunities out there?
‘I think companies are looking at opportunities and the better companies will be able to capture financing a lot more easily. There are many blue ocean strategies out there. Look at the automotive industry: countries have come out to say that they are going to eliminate petrol cars by a certain year. However, you have to look at not just the car manufacturers but the whole supply chain that supports it. Take Volkswagen for example, which is promoting its new apparently ‘carbon-neutral’ car. How can they make a carbon-neutral car if their supply chain partners are not also doing the same thing?
We are at that climate emergency phase. We have known about this for decades but progress has been very slow. We have seen Extinction Rebellion, people going on strike, these things are just going to increase. The pressure on the investment community, the corporates, the banks, will just escalate over time. It would be foolhardy for anyone to think that they are immune to it.’
How would you tackle the issue of boilerplate sustainability reports?
‘As the investment community matures, you can tell very quickly whether people are serious about ESG. Investors are starting to go directly to the top, to the CEOs and CFOs, to assess whether the C-suite are in tune with their ESG strategy and how it relates to their business.
The latest ESG consultation of the Hong Kong Stock Exchange (SEHK)focuses on the governance aspects of ESG. It asks how closely directors and senior managers are engaged in these issues. Do they understand their non-financial risks? Do they understand the ESG opportunities out there? Do they understand the difference between physical risk and transition risk? When you talk about climate change, most people only think about the physical risks of typhoons and floods etc, rather than the risk to business models. We see change coming as the cost of lending to carbon-heavy operations is going to significantly increase over time.’
Should company secretaries be pushing ESG issues at board meetings?
‘There still needs to be a lot of education. We have been doing a number of board training sessions with our clients. It is really the next generation of leaders that is asking for this as they see the importance of getting the message across. The message has to correlate with their core business or the older generation will not be able to hear it as they will only hear it from a compliance standpoint. That is where the education needs to be – the developments in the investment community, the TCFD and how that is going to impact financing, as well as the costs of not doing anything due to physical and transitional risks due to climate change.’
The latest Hong Kong Stock Exchange consultation you mentioned proposes to make board oversight of ESG a mandatory disclosure – will this help to raise ESG up the board agenda?
‘On how the board gets involved, we need to emphasise the ‘how’. Of course you are going to get boilerplate disclosures. The company secretary needs to highlight this to the board in some way or form. Board education needs to be organised around it, explaining what this all means, and why the SEHK is doing it. I do see a gap in the understanding of ESG at the board level.
We just issued a sustainability report for the Fashion Summit. We looked at 43 original signatories to the UN Fashion Charter, all of whom had committed to a 30% carbon reduction by 2030, but hardly any of them had disclosed supply chain data. The supply chain is the biggest impact on all of these brands and a lot of these supply chain companies are based in this part of the world.’
What role will technology play in all of this?
‘The technological solutions are all out there and have been for a long time. It has always been about making economic sense and economies of scale. Renewable energy is now at the price of carbon-heavy solutions – why? Because economy of scale is increasing. Why is the petrol car cheaper than electric cars? It is the economy of scale. The solutions are there, but the challenge is to make it economically viable because people always go for the cheaper option. That is where the TCFD comes in, making it more expensive for some, but less expensive for those who are ready for it. I do not think it is a technological problem, it is definitely an economic and scale challenge.’
If governments alone cannot hope to raise the necessary funds to transition to low-carbon infrastructures globally, can green finance fill the financing gap?
‘Green financing is definitely one of the good options out there. We have seen a growth in that market though it is still not seen as more competitive than the traditional bonds. Again this is because of scale, because the whole debt market amounts to trillions of dollars compared to 300 billion for green bonds. Over time as demand starts to outstrip supply the economics will start to work. Both public or private finance can be used as a vehicle to help with greening of infrastructure. The Mainland has gone through a similar process.’
Is there sufficient audit of green finance projects to ascertain that they are genuinely having a positive environmental impact?
‘The standards are there, ISA 3000 for instance, but there isn’t the regulatory framework to ensure that it is conducted properly. There has to be a minimum standard that people have to reach to be able to issue these reports; at the moment any company can write a non-financial assurance report.
The ESG consultation of the SEHK mentioned assurance from a best practice standpoint. They are mentioning assurance to indicate that this will be a mandatory requirement sometime in the future. Before assurance becomes mandatory, what needs to be developed now is the regulatory framework. The question of who has oversight, the standards that are going to be used, and other details such as trust and transparency are critical.’
How do you expect ESG regulation to evolve in the next few years?
‘I am optimistic because I think that the asset owners are the juggernaut that directly impacts the asset management industry, which then impacts the corporates, which then impacts the supply chain and the like. There are precedent cases: look at what happened in Japan. The government pension fund announced they were going to start using ESG as part of their investment decisions and the ESG investment industry grew from US$8 billion to US$2 trillion in four years. It is always economics that drives it. When the economics and the incentives are in line, people will do it without being asked.’
With the additional costs of outsourcing, how does this impact smaller companies?
‘First of all, anybody can do a sustainability report in-house. You do not need to outsource it; there are a lot of boutique firms that can help you with that at minimal cost.
Yes, it is a burden because there is more that you need to do, but the question is, how much is it going to cost you if you do not do it? As I mentioned earlier, the direction the financial institutions are moving in may mean your sustainability practices might not qualify you for their facilities. If that means you end up going to the secondary market that is going to be a lot more expensive. If you are positioning yourself to get your financing from the financial institutions your business model must be sound, even if your business is small.’
Do you think ESG performance will increasingly become a ‘social licence to operate’ issue – that is, companies will need to do the right thing by their community?
‘To the millennials, yes this is important, but it all comes back to day-to-day behaviour, at the supermarket, at the clothing store. Is that consistent with what you are doing here? Where you put your money is effectively giving your vote on how you want the world to be run. Until you burn a hole in someone’s pocket, you are really not going to change things much. In the 12 years I have been doing this, I have tried the ‘this-is-the-right-thing-to-do’ argument and it does not work. The bottom line is what matters. Can we steer money to work for the better?’
Could you tell us about your own career and what steered you towards your role in sustainability?
‘I am an accountant by training but left accounting in 2004 to work in the textile supply chain. That was when I started thinking about stewardship. It is not just about here and now, it is really about the future as well. I have kids and that became a driver to understand what it means to look out for the environment and society. It has been an essentially self-taught journey.
Let me share an anecdote. In 2008, my company issued a Global Reporting Initiative report and won an award from the Association of Chartered Certified Accountants. However, the reason we won was because we were the first supply chain company to have entered an ESG report in that category. I was very surprised. We were in the Pearl River Delta, the factory of the world, yet we were the first company to produce such a report. I still also remember a gloomy day in January 2009 when nobody touched an ESG report we did for a fashion event in New York. I asked myself then if I was barking up the wrong tree. But I slogged on.
Those were hard years without which I would not be here talking to you now. Even as recently as 2018 we were not hearing a lot about ESG, but now everyone is talking about it and these practices are starting to make economic sense. Ultimately I think it has all come from personal conviction and I had to go through that trial by fire to get to this point.’
Pat Nie Woo was interviewed by Sharan Gill, writer and lawyer, and Mohan Datwani FCIS FCS(PE), Senior Director and Head of Technical & Research, The Hong Kong Institute of Chartered Secretaries.