ESG is new buzzword for listed fims, investors in HK, Asia as regulations tighten

For many fund managers in Asia, investment decisions were often based on returns and had nothing to do with factors like environment, social and governance.

But ESG may no longer be just a concept as policymakers and regulators around the world are increasingly using it as a criteria to gauge listed companies, while asset managers are using it to maximise investment returns.

Starting next year, listed companies in Hong Kong will have to make mandatory public disclosures about company policies and how they intend to deal with the operational risks that have far-reaching implications for the environment and the wider society.

Though ESG data is a valuable tool for maximising fund performances, it has been slow to take off in Asia. Most of the asset managers are not yet ready for the big leap, while companies are still in the preparatory stages of disclosures.

Stephen Tong, an investment consultant at global professional services firm Towers Watson, said ESG criteria is increasingly being used for portfolio development in many overseas markets.

“It is an integral part of the market DNA,” he said. “However, in Asia it is more of an academic thing and very few know how to do ESG evaluation … [although] they know it is a trend that they have to incorporate soon.”

China has grown in power, but at a terrible cost to environment

Favourable response during public consultation last year saw the Hong Kong Exchanges and Clearing (HKEX), the operator of the local bourse, making it mandatory for listed firms to make general disclosures on their ESG policies and whether they are in compliance with laws and regulations for the financial years starting January 1 or later this year.

For the financial years beginning January 1 or later next year, firms will need to make ESG disclosures on measurable key performance indicators like targets and achievements. The HKEX has also stipulated that firms need to give proper explanations if they fail to adhere to these norms. That is a stark departure from the past, when such disclosures were only recommended and voluntary in nature.

On the environmental front, aspects covered include emissions and use of resources, while social issues comprise employment, health and safety, training and development, labour standards, supply chain management, product responsibility, anti-corruption and community investment.

According to HKEX and findings from index compilers, share prices of companies that score high on ESG issues often outperforms the wider stock market.

The HKEX’s consultation paper said “numerous studies” have found increased ESG regulation to be “value-enhancing” despite higher compliance costs, citing benefits from improved risk management, access to capital, supply chain management, reputation, employee loyalty, and cost savings from more efficient resources usage.

S&P Dow Jones Indices, the leading benchmark indices provider, said that the 1,200 constituents of its S&P Global 1200 ESG Index achieved annualised returns of 6.44 per cent during the last five years on the basis that all dividends are reinvested into the index constituents, outperforming 6.27 per cent of the entire S&P Global 1200 Index. The S&P Global 1200 Index consists of 1,200 blue chip stocks in 31 nations, covering 70 per cent of the global stock market capitalisation, weighed by their freely-traded market capitalisation.

Officials in China have to take environmental concerns seriously

The S&P Global 1200 ESG Index tracks the same stocks, but they are weighed based on their ESG performance and appraised by corporate sustainability assessor RobecoSAM, besides market capitalisation.

In Hong Kong, indices provider Hang Seng Indexes has launched five corporate sustainability indices since 2010. The Hang Seng Corporate Sustainability Index, which tracks 30 Hong Kong-listed stocks selected based on their market capitalisation, turnover, listing history and sustainability performance, recorded an average 1.2 per cent annualised return in the five years to last year, outperforming the negative 1.99 per cent return of the Hang Seng Index that has 50 constituents.

For mainland-listed stocks, the Hang Seng (China A) Corporate Sustainability Index that follows 15 stocks, had an average annualised return of 6.59 per cent over the same five years, higher than 2.78 per cent of the Hang Seng China A Industry Top Index with 49 constituents.

Priscilla Luk, senior director of global research and design at S&P Dow Jones Indices, said the company has helped Canada Pension Fund, manager of the state-run pension fund, and Singaporean sovereign wealth fund manager GIC to produce benchmark indices covering firms that focus on long term investment and growth.

It has also produced an index for the Bank of Japan to facilitate its investment in firms that have good track record and future plans on physical assets and human capital investment.

“So far, we haven’t seen much interest from Hong Kong asset managers for ESG indices … it will be hard to push them in the retail investor market, perhaps large institutional funds like those managed by the Hong Kong Monetary Authority (HKMA) and the Hospital Authority could take the lead,” she said.

Asked if its fund managers use ESG criteria for making investment decisions, the HKMA spokesman said: “We do not comment on the details of our investment strategies.”

Heman Wong, executive director of Hospital Authority Provident Fund Scheme which manages over HK$58 billion of assets for its members, told the Post that the scheme supports the principles of ESG investment and has asked fund managers to divest all tobacco-related investments.

But he said it has faced difficulties in implementing other ESG investment criteria and assessing the results, due to their often qualitative and sometimes controversial nature.

“Many pension funds have still not worked out a better way to adopt a formal implementation process, the industry is still discussing this,” he said. “It will be some time before the industry can come to a standard or agreed means of implementation.”

Wong cited the example of producers of genetically modified food.

“Is [such food] ESG [friendly] or not? One could argue it feeds more people. Others could argue it disrupts the environment and post a threat to food [security] due to a lack of diversity. Take another example, is nuclear power generation an ESG [friendly] investment?”

A silver lining in the cloud over China’s environmental challenges

Pension funds in Europe have been at the forefront of ESG investments. They usually use a customised benchmark such as an ESG-compliant stock index, or employ an investment consultant or agent to assist them.

The European Union Council has since September 2014 urged listed firms with over 500 employees to make environmental, employee, human rights, anti-corruption and board of directors’ diversity disclosures.

In the United States, listed firms must make filings on their environmental control spending and risks.

Within Asia Pacific, Australia made ESG disclosures mandatory since 2014.

“Asia is still lagging in ESG disclosures compared to Europe, but things are starting to change,” Fiona Reynolds, managing director of the United Nations-backed Principles for Responsible Investment, (PRI) told the Post.

The PRI is an international initiative that has attracted 1,500 signatories from the investment community and accounts for US$60 trillion of assets under management. These firms have committed to report on their ESG implementation annually, although they are “voluntary and aspirational.”

Stock exchanges including those in India, Sri Lanka, Malaysia, South Korea, Vietnam, Thailand have become members of the United Nations-backed Sustainable Stock Exchanges Initiative, by committing to promote long-term sustainable investment and improve ESG disclosure and performance of listed firms.

Reynolds said varied economic development across regions has led to divergent opinion on ESG policy making.

While acknowledging that China needs time to transition from a highly fossil-fuel dependent and energy-intensive economy to a more environmentally-friendly one, she said the PRI disagreed with Beijing’s practise of allowing coal-related projects that reduce carbon emissions to be labelled “green” and allowed to be financed by green bonds whose issuers enjoy more latitude on the size of issuance.

“I can’t see how investment in coal could [be given] a green bond label … it is easy for people to call things green, but [green bond funds] should serve the right purpose,” she said, adding it would be better for China to replace its coal consumption with greener options such as oil, natural gas and renewable energy.

She said the PRI would convey to China its messages via the G20 major economies’ green finance study group co-chaired by China and the United Kingdom, which aims to mobilise private capital for an estimated US$90 trillion of projects required in the next 15 years to achieve global sustainable development and climate change mitigation and avoidance.

The PRI has opened an office in Hong Kong and plans to expand its presence in mainland China and Asia in the next few years to promote ESG reporting and investing.

According to a 2014 study by research firm Corporate Knights, Hong Kong ranked 17th on sustainability disclosure among 46 stock exchanges on the basis of listed firms’ ESG reporting, up from 23 in the previous year, which the HKEX said may be related to the implementation of the ESG guidelines.

“It is important for Hong Kong to align itself with international best practises in this area,” it added.

In a June 2014 survey sent by the bourse on ESG disclosures of listed firms, only 21 per cent responded with around two-thirds of them indicating that they were yet to report their ESG performance.

Last year, a study by Bloomberg on randomly-selected 330 Hong Kong-listed firms found that 46 per cent had reported their ESG performance for their 2013 financial year. Among those with market capitalisation of over HK$10 billion, some 80 per cent have done so, compared to 36 per cent with less than HK$1 billion of market value.

Finding a balance between economic and environmental sustainability

The disclosure ratio among mainland-incorporated H-shares was 83 per cent, much higher than the 38 per cent among Hong Kong-incorporated firms, partly due to mainland exchange requirements.

The Shanghai and Shenzhen stock exchanges had mandated that some listed firms must make ESG disclosures from 2008, including 300 constituents of the Shanghai stock exchange corporate governance index, the Shenzhen 100 index, financial firms and those with overseas listed shares.

A 2008 directive by the State-owned Assets Supervision and Administration Commission “strongly encouraged” the 106 central government-administered firms to publish social responsibility or sustainability reports.

In Singapore, the stock exchange had earlier sought public opinion on making it mandatory for listed firms to issue sustainability reports covering ESG issues starting from the 2018 financial year, within five months of their annual filings. Companies that failed to adhere to these regulation need to come up with sufficient explanations and a revised regulation on these grounds is expected soon.

In New Zealand, investors and listed firms were split on the stock exchange’s proposal for ESG disclosures, with most companies preferring to report on a voluntary basis, citing the added burden of mandatory reporting, while institutional investors wanted listed firms to disclose measurable ESG policies. Another round of consultation in this regard is expected in the third quarter.