Why Hong Kong Companies Are Embracing ESG Factors – And What They Can Hope to Gain

September 17, 2021

If even a mere 1% of the world's listed companies made their annual general meetings ("AGMs") virtual, they could not only reduce the usage of tons of paper but also improve the efficiency of managing an AGM. The virtual AGM demonstrates how a consideration of environmental, social, and governance ("ESG") issues can benefit all stakeholders: the company, shareholders, and the planet. Embracing ESG can shape positive outcomes for all.

 

The Concept of ESG Investment

ESG investing – a term first introduced by the United Nations Global Compact in a landmark 2004 study, Who Cares Wins – has seen a significant rise in popularity.[1] Businesses are increasingly aware that the impact of their activities stretches beyond a one-dimensional focus on profit and loss. In a 2020 survey on sustainable financing and investing, 49% of investors said that adherence to ESG factors could improve returns and lower overall risk.[2]

Investors adopt various approaches when integrating ESG elements into the decision-making process. For example, ESG data is often classified in the "non-accounting" column because it captures valuation components that are not traditionally reported in companies' financial accounts.

ESG metrics provide insights into these intangibles. For example, Environmental (E) covers themes such as climate challenges, finite natural resources, pollution and waste, and environmental opportunities; Social (S) includes labor issues and product liability, and risks such as data security and stakeholder opposition; Governance (G) encompasses items relating to corporate governance and behavior, such as board quality and effectiveness.

 

Heightened Disclosure

Amid growing awareness of the need to invest sustainably – so that society meets the needs of the present without compromising the ability of future generations to meet their own needs – companies face increasing ESG reporting requirements. The Green and Sustainable Finance Cross-Agency Steering Group includes the Hong Kong Monetary Authority and the Securities and Future Commission, plus other local regulators and government departments. In December 2020, the Group announced that it would make climate-related disclosures aligned with the Task Force on Climate-Related Disclosure (TFCD) mandatory across relevant sectors no later than 2025. This includes banks, asset managers, insurance companies, and pensions trustees.[3]

Partly in response to this, the boards of listed companies in Hong Kong have grown aware of the importance of ESG management. Indeed, Hong Kong companies' regard for sustainability is not surprising, given the attitude of investors. The China Securities Regulatory Commission conducted an ESG survey in 2019. Among the 794 active asset management companies interviewed, more than 80% said they had considered at least one ESG factor in the investment process. A global survey of asset managers by Russell Investments in 2020 found that 78% of managers considered ESG factors when making investments – a five percentage point increase on 2019.[4]

 

Will Financial Returns Be Compromised?

A white paper by the Morgan Stanley Institute for Sustainable Investing, based on an exhaustive analysis of 10,723 funds between 2004 and 2018, found that sustainable funds provided returns comparable with traditional funds but with lower downside risk.[5] More recent research by the institute goes further: it found that in 2020, US sustainable equity funds outperformed their peers by an average of 4.3% – again, with lower investment risk.[6] Companies that score highly on ESG issues tend to be favored by sustainable funds because ESG performance is one way of measuring how compliant their business practices are. Moreover, an academic paper that analyzed more than 2,000 studies of ESG performance over the years found that nearly half showed companies with good ESG performance did better as companies, measured by items such as profitability. Only 11% of studies analyzed suggested that companies with good ESG practices did worse.[7]

Companies that do well on ESG issues often outperform their peers because they offer:

  • Less risk. Enterprises with poor ESG scores are three times more likely than their high-ranking peers to suffer a catastrophic share price fall of 95% over the next three years.[8]
  • Appeal to consumers. Younger generations are much more value and principle-led when making their daily decisions. In a 2020 report, retail experts First Insight found that 50% of millennials and 54% of Gen Z were willing to pay 10% more for sustainable products.[9] In a 2019 report, Nielsen noted that 62% of Gen Z preferred to buy from sustainable brands.[10]
  • New business opportunities. The International Energy Agency has estimated that annual global investment in clean energy needs to double for the world to attain net-zero carbon emissions, giving an even chance of limiting global warming to 1.5 degrees Celsius – the goal outlined in the international Paris Agreement on fighting climate change. By the same token, reliance on fossil fuels needs to fall sharply. For example, Finnish oil company Neste has adapted to the changes and grasped the new opportunities to become the world's largest renewable diesel and jet fuel producer. This pushes it ahead of most other oil and gas companies in the E, or Environmental, part of ESG.
  • Greater competitiveness. Introducing new business solutions, such as the virtual AGMs mentioned above, makes the process cheaper and more efficient, as well as more sustainable in comparison to conventional options.

Most companies also realize that if the environment is damaged, their businesses will be too. However, there are still some laggards in the transition to low-carbon business. Some companies may still have a limited understanding of ESG issues, believing that the change will be prohibitively expensive.

 

Practical Improvements: Enhance the Low-Carbon Transition

One way of improving ESG practices is to stimulate employees to incorporate ESG into daily operations. Driving behavioral change can be challenging, but committed employees are crucial to enhancing ESG practice. For energy companies, the transition must go far beyond investment in infrastructure – it depends heavily on the skills of their employees in adapting to technological change. These companies also need to address social, economic, and environmental challenges during the changeover. In particularly, people are the most vulnerable to the transition. To ensure a Just Transition[11], Companies should offer re-skilling opportunities for their employees, and facilitating employment opportunities in new sectors and those in transition.

At the management level, meanwhile, senior executives should:

  • Think about how to integrate ESG into the company's operations and strategy.
  • Prepare employees for the changes in the business.
  • Regularly review the ESG disclosure requirements.
  • Understand the nature of the ESG investment trend, including what ESG-focused investors want.

 

An ESG-Focused Future

Investors and regulators are placing increasing priority on ESG issues. Companies will inevitably have to respond to the growing global demands in this area. The COVID-19 crisis will reinforce the importance of ESG matters because it has exposed the shortcoming of our economies and societies. More investors look favorably in ESG investing, and this tendency will become stronger. Companies that perform well in ESG terms are going to outperform their competitors through better risk management, greater operational efficiency and adaptation to new business opportunities.

 

[1] “Who Cares Wins – Connecting Financial Markets to a Changing World” by The Global Compact

[2] HSBC Sustainable Financing and Investing Survey 2020: https://www.gbm.hsbc.com/solutions/sustainable-financing/sfi-survey-global

[3] https://www.globalcompliancenews.com/2021/03/10/hong-kong-green-and-sustainable-finance-how-governmental-authorities-are-navigating-climate-risks-24022021/

[4] https://russellinvestments.com/uk/blog/2020-esg-manager-survey

[5] https://www.globalcompliancenews.com/2021/03/10/hong-kong-green-and-sustainable-finance-how-governmental-authorities-are-navigating-climate-risks-24022021/

[6] https://www.morganstanley.com/press-releases/morgan-stanley-sustainable-reality-report-reveals-u-s--sustainab

[7] Friede, Busch & Bassen (2015), Journal of Sustainable Finance & Investment, cited in https://www.fidelity.com.hk/en/start-investing/learn-about-investing/esg-investing/esg-benefits

[8] https://www.msci.com/www/blog-posts/has-esg-affected-stock/0794561659

[9] https://www.firstinsight.com/white-papers-posts/gen-z-shoppers-demand-sustainability

[10] https://www.forbes.com/sites/gregpetro/2020/01/31/sustainable-retail-how-gen-z-is-leading-the-pack/?sh=1c4eacf2ca31

[11] https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal/actions-being-taken-eu/just-transition-mechanism_en

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