June 2014 08

Cover Story
June 2014 09
Cover Story
The ESG challenge
How to prepare a business review
In March this year, with the implementation of the new Companies Ordinance, Hong Kong
imposed its rst mandatory environmental, social and governance (ESG) reporting requirement.
Hong Kong-incorporated companies, unless exempted, will need to comply with the business
review requirement of the new Companies Ordinance for nancial years beginning on, or after,
3 March 2014, inclusive of ESG concerns. This article takes a look at what is required and what
guidance is available to help companies with their compliance programmes.
T
here is an increasing trend for
businesses to produce information on
the environmental, social and governance
(ESG) aspects of their operations.
Historically, this disclosure has been
made on a voluntary basis, but now an
increasing number of jurisdictions, in
both developed and emerging markets,
have brought in mandatory ESG reporting
requirements. Here in Asia there are
mandatory ESG disclosure requirements
in place in Mainland China, Hong Kong,
India, Indonesia, Malaysia and Taiwan.
In Australia, ESG reporting is subject
to a comply or explain enforcement
mechanism.
Hong Kong is the latest recruit to this
group it upgraded its ESG disclosure
requirements in March this year with the
implementation of the new Companies
Ordinance (Cap 622). Under Section
388 of the new law, companies, unless
exempted, need to include a business
review in the directors report section
of their corporate reports. The requisite
contents of the business review are set
out in Schedule 5, and must include
a number of ESG areas such as the
company's environmental policies
and performance, and the company's
key relationships with its employees,
customers and suppliers and others
that have a signicant impact on the
company. Interestingly, this also means
that Hong Kong-incorporated listed
issuers may have additional compliance
requirements over and above those
incorporated under other jurisdicitons,
as the ESG Reporting Guide under the
listing rules is not as yet mandatory.
The ESG challenge
For companies already well versed in ESG
reporting the business review requirement
will probably not have much impact, but
for companies new to ESG reporting the
new requirements will be a signicant
compliance challenge. In particular,
among other things, it will require
companies to:
1. quantify non-nancial factors using
key performance indicators (KPIs)
Highlights
the new business review requirement is a signicant escalation of Hong
Kongs ESG disclosure requirements because it is the rst time such
requirements have been made mandatory
the new business review requirement will require companies to quantify
non-nancial factors using key performance indicators, and provide
contextual and forward-looking information
directors are advised to include a caveat in their business review advising
readers that any forward-looking information should be treated with
caution given the uncertainties involved
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2. provide context for their corporate
reports, and
3. report forward-looking information.
These three aspects have historically
been major hurdles for companies
embarking on ESG reporting. Companies
need to acquire the skills to use the
metrics for quantifying non-nancial
factors and there is often a concern that
providing contextual and forward-looking
information may expose the company to
the threat of litigation.
In addition, a recent report by the Global
Corporate Governance Forum (GCGF)
Emerging Trends in Environmental, Social
and Governance Data and Disclosure:
Opportunities and Challenges points
out that ESG reporting often requires
more fundamental changes to the way
companies are run. Firstly, it requires
the adoption of a stakeholder, rather
than a shareholder, model of the
corporation. This shift effectively implies
commitments to strategic investments
in employees, customers, suppliers,
communities and the environment
in ways that produce rewards for
stockowners as well as for these
stakeholders, says the GCGF report.
Secondly, ESG disclosure also means
shifting to a long-term focus since it
requires companies to monitor matters
relating to the future sustainability of the
environment and society.
Given the above, the cost of ESG reporting
will clearly be an issue, although the
business review requirement is targeted
at larger companies which are likely to
have already embarked on ESG reporting
and are generally better positioned to
absorb the extra costs involved. Under the
new Companies Ordinance, companies
which are eligible for simplied reporting
are exempted from the business
review requirement and the criteria
for companies to qualify for simplied
reporting have been relaxed.
Guidance on compliance
For companies not exempted from the
business review requirement there are
a number of guides, both globally and
locally, to help with compliance. Probably
the best-known international guide is the
latest generation G4 of sustainability
reporting guidelines produced by the
Global Reporting Initiative (GRI).
Awareness of the G4, which comprises
underlying principles on content and
quality of reports as well as standard
disclosures, would assist reporting entities
under Section 388 of the Companies
Ordinance to prepare the business review,
says the team at SusDev Global, a Hong
Kong-based sustainability reporting
service provider.
Locally in Hong Kong, the Environmental,
Social and Governance Reporting Guide
published by Hong Kong Exchanges and
Clearing (HKEx) provides an excellent
introduction to ESG reporting, but there is
now a new guide specically targeted at
helping companies comply with the new
business review requirement. Published by
the Hong Kong Institute of Certied Public
Accountants (HKICPA), the Guidance for
the Preparation of a Business Review under
the Hong Kong Companies Ordinance
Cap 622 (HKICPA Guide) is available in
Accounting Bulletin 5 on the HKICPA
website: www.hkicpa.org.hk.
The guide, while only in draft form, not only
claries what disclosures will be required
by the new Companies Ordinance, it is
also accompanied by an Implementation
Guidance which provides highly practical
guidance on specic issues companies may
encounter in their compliance programmes.
For example, the Implementation Guidance
has useful advice about the three aspects
of ESG disclosure mentioned above
quantifying non-nancial factors using
KPIs, and providing contextual and
forward-looking information.
1. Quantifying non-nancial factors
using KPIs
The Implementation Guidance provides
illustrative examples of the KPIs in non-
nancial areas (such as those relating to
water and energy use, waste production,
CO
2
emission and employee health and
safety), which should be disclosed in
a business review. A retail company
should, for example, be disclosing its
waste production due to packaging. This
should include the amount of waste
arising from packaging (measured, for
example, in kilograms of packaging waste
per HK$1,000 of products sold). Another
example given is that of the KPIs a
ESG disclosure requires the adoption of
a stakeholder, rather than a shareholder,
model of the corporation
June 2014 11
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company in the mining industry should
be disclosing relating to lost-time injury
frequency rate (measured as the number
of lost-time injuries per million hours
worked).
The Implementation Guidance emphasises
that reporters should:
explain the calculation methods
disclose the source of underlying
data and, where relevant, explain the
assumptions
highlight where information
from the nancial statements has
been adjusted for the purposes of
computing a KPI, and provide a
reconciliation
disclose corresponding amounts
for the nancial year immediately
preceding the current year where
available, and/ or
identify and explain any signicant
changes to the calculation
method used to compute the
KPIs compared to previous
nancial years, including signicant
changes in the underlying
accounting policies adopted in
the nancial statements.
The HKICPA Guide emphasises that KPIs
and other information in the business
review should be prepared and presented
consistently from one year to the next.
Where consistency is maintained, it
suggests that directors should include
a statement to this effect, such as: no
changes have been made to the source of
data or calculation methods used over the
periods shown.
Finally, reporters should bear in mind
that the ultimate purpose of including
these KPIs is to take the rst step
towards improving performance in
the relevant areas. The HKICPA Guide
recommends, therefore, that reporters
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Online resources
The Guidance for the
Preparation of a Business
Review under the Hong Kong
Companies Ordinance Cap 622,
published by the Hong Kong
Institute of Certied Public
Accountants (HKICPA),
is available in Accounting
Bulletin 5 on the HKICPA
website: www.hkicpa.org.hk.
The Environmental, Social
and Governance Reporting
Guide, published by Hong
Kong Exchanges and Clearing
(HKEx), is available on the HKEx
website: www.hkex.com.hk.
The G4 generation of Global
Reporting Initiative (GRI)
guidelines can be found on
the GRI website:
www.globalreporting.org, or
directly at:
https://g4.globalreporting.org.
The BEC Handbook:
Understanding Materiality for
Environmental, Social and
Governance Reporting,
published by the Business
Environment Council (BEC), is
available on the BEC website:
www.bec.org.hk.
review should both complement and
supplement the nancial statements
in order to enhance the quality of
disclosure. In complementing the
nancial statements, the business review
provides useful nancial and non-
nancial information about the business
and its performance that is not reported
in nancial statements but which, in the
directors' judgement, may be relevant to
the members' evaluation of past results
and assessment of future prospects, the
HKICPA Guide states.
This might include commenting on the
events that have impacted the reporting
entity over the reporting period. It might
also include changes in market conditions
which have had a signicant impact on
the development and performance of
the reporting entity during the period.
Every company is affected by its external
environment. Depending on the nature of
the business, the business review should
include discussion of matters such as
the reporting entity's major markets and
competitive position within those markets
and the signicant features of the legal,
regulatory, macro-economic and social
environment that inuence the business,
the HKICPA Guide states.
3. Reporting forward-looking
information
The HKICPA Guide also stresses the need
for the business review to report on the
main trends and factors that directors
consider likely to impact the future
prospects of the reporting entity. This
advice is supported by SusDev Global.
Financial reporting has conventionally
focused on presentation and analysis of
historical data. In contrast, sustainability
reporting frameworks, such as the GRI
sustainability reporting guidelines, are
designed to assist stakeholders to evaluate
how the long-term protability of any
organisation can go hand-in-hand
with social justice and protection of
the environment, says the team at
SusDev Global.
As mentioned above, many reporters
are reluctant to give forward-looking
information for fear that this may expose
the company to the threat of litigation.
The HKICPA Guide therefore advises
directors to include a caveat in their
business review advising readers that such
disclosures are made in good faith but
should be treated with caution given the
uncertainties involved and the difculty of
getting objective verication.
The signicance of the business review
requirement
The new business review requirement is
a signicant escalation of Hong Kongs
ESG disclosure requirements, not so much
in terms of the specic requirements
these reect standard ESG disclosure
best practice but because it is the rst
time such requirements have been made
mandatory in Hong Kong.
We will have to wait until next year (2015)
to assess the quality of disclosures in the
rst batch of business reviews included in
annual reports, but that quality will not
only depend on what is disclosed, but also
on how the disclosures are made. Will
the business reviews be written in a clear
and readily understandable style? Will
they provide readers with focused and
relevant information?
The SusDev Global team points out that
the G4 guidelines offer helpful guidance
here. Materiality is a key concept in G4
and the guidelines recommend that
reporters document the process for
dening report content. Inevitably the
should set and communicate its
performance targets and measure
whether they are achieving them.
2. Providing context
One of the principles emphasised by
the HKICPA Guide is that the business
June 2014 13
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process for dening report content
requires subjective judgements but
the organisation is expected to be
transparent about its judgements.
Accurate records enable the organisation
to explain its chosen approach to
reporting on some sustainability impacts
rather than others, importantly it also
facilitates independent assurance of the
process for dening report content, the
G4 guidelines state.
SusDev Global is concerned that
companies may have an opt out from
disclosing material issues since Schedule
5 of the new Companies Ordinance
specically exempts companies from
disclosing impending developments or
matters in the course of negotiation if the
disclosure would be seriously prejudicial
to the companys interest. They suggest
that the HKICPA Guide could encourage
reporters to adopt the approach taken by
the GRI guidelines to any such omissions.
In exceptional circumstances, if it is
not possible to disclose certain required
information, the report should clearly
identify the information that has been
omitted and explain the reasons why the
information has been omitted, SusDev
Global says. The GRI guidelines add
that, where the omission is due to the
unavailability of data, the organisation
should disclose the steps being taken to
obtain the data and the expected time-
frame for doing so.
Beyond compliance
With the implementation of the new
Companies Ordinance in March this year,
Hong Kong entered the era of mandatory
ESG reporting requirements. Robin Bishop,
Director of Corporate Responsibility,
Community Business, emphasises however
that there are huge gains to be made by
companies prepared to go beyond the
mandated requirements.
There is a solid business case for
companies to go beyond compliance when
it comes to ESG reporting. Organisations
increasingly nd that their prot and loss
statements are inuenced by parameters
that do not feature on the balance
sheet. These external parameters are
ESG or sustainability issues that could
be economic, environmental or social
in nature. Sustainability reporting gives
organisations a framework to identify these
sustainability issues, and to understand
their impacts on its business. There are also
direct benets which include enhanced
brand value or reputation, greater
success at attracting and retaining talent,
operational efciency, mitigation and/ or
reduction of risk, nancial impact as well as
the opportunity for organisational growth,
she says.
Kieran Colvert
Editor, CSj
The HKICS submission to the
Guidance for the Preparation
of a Business Review under the
Hong Kong Companies Ordinance
Cap 622', is available in the
Submissions section of the HKICS
website: www.hkics.org.hk.
Enquiries should be directed to
Mohan Datwani, Director, Technical
and Research by email:
[email protected]; or
by phone: 2881 6177.
ESG disclosure means
shifting to a long-
term focus since it
requires companies
to monitor matters
relating to the future
sustainability of
the environment
and society