Incorporating environmental, social and governance (ESG) factors into business valuation is no longer a niche consideration but a fundamental expectation of modern financial analysis. This shift is propelled by global regulatory developments, such as the new Hong Kong Financial Reporting Standards S1 and S2 (HKFRS S1 and S2), and explicit direction from professional valuation standards to consider material ESG factors.
This article summarizes these developments to facilitate CPAs’ understanding and navigation of this evolving landscape.
Updated valuation standards and resources
Global valuation standards have been formally updated to require the consideration of ESG factors.
The International Valuation Standards (IVS) published by the International Valuation Standards Council (IVSC), effective from 31 January 2025, explicitly define ESG and state that "the impact of significant ESG factors should be considered in determining the value of a company, asset or liability". The IVS further elaborates that “ESG factors may impact valuations both from a qualitative and quantitative perspective and may pose risks or opportunities that should be considered”.
In addition, IVS states that “ESG factors and the ESG regulatory environment should be considered in valuations to the extent that they are measurable and would be considered reasonable by the valuer applying professional judgement.” In practice, this means ESG criteria must now be considered alongside traditional factors like profitability, cash flow, risk, size and quality in valuation.
ESG information request list for valuation
These principles are reinforced by major professional bodies which are Valuation Professional Organizations. The American Society of Appraisers, Chartered Business Valuators Institute, Royal Institution of Chartered Surveyors, and the Institute of Valuers and Appraisers, Singapore have jointly released a publication to support valuation professionals in gathering and assessing ESG information. This guidance, developed with the IVSC, provides practical tools to integrate ESG insights, supporting consistency and alignment with the IVS.
For effective integration of ESG, the following structured information request list is essential for a robust valuation engagement to obtain relevant and decision-useful information for risk and opportunity assessment in next step.
Governance and strategy
- Board-level oversight of ESG risks and opportunities.
- ESG-related policies, targets (e.g. net-zero), and management incentives.
- Materiality assessment process for identifying key ESG factors.
Risk and opportunity analysis
- Identified physical and transition climate risks per HKFRS S2/ Task Force on Climate-Related Financial Disclosures (TCFD).
- Scenario analysis assessing business resilience under different climate pathways.
- Analysis of ESG-driven market opportunities (e.g. green products).
Performance metrics and data
- Historical and projected Greenhouse Gas (GHG) emissions (Scope 1, 2, and 3 where material).
- Key performance indicators for other material “E”, “S”, and “G” factors.
- Data collection methodology and any third-party assurance reports.
Financial integration
- Capital allocation to ESG initiatives (research and development, capital expenditure).
- Identification of ESG-related assets/liabilities, contingencies, or impairments.
- Analysis of ESG performance on cost of capital, revenue, or operating expenses.
Compliance and reporting
- Adopted reporting frameworks (e.g. HKFRS S1/S2, TCFD).
- Timeline and plan for meeting upcoming mandatory disclosure requirements.
- Past ESG reports and communication to investors.
The regulatory imperative: HKFRS S1 and S2
Hong Kong’s adoption of HKFRS S1 and S2 as set out in the Roadmap on Sustainability Disclosure in Hong Kong published by the Hong Kong government marks a pivotal step in standardizing sustainability and climate-related disclosures, directly affecting the information available for valuation.
This regulatory shift moves ESG data from voluntary, inconsistent disclosures toward assured, comparable metrics. For valuers, it enhances the reliability of data for cash flow projections, risk assessment, and comparable company analysis, while also raising the professional expectation to utilize this newly standardized information.
ESG factors integration into valuation models
With standardized information in hand, the valuer’s critical task is to adjust the valuation model appropriately. The Accounting for Sustainability, an organization that aims to drive financial leaders to adopt sustainable business models, introduced a five-step valuation framework to integrate related risks and opportunities into valuations: Identify, Assess, Filter, Integration and Triangulate.
These five steps can be integrated into the three generally adopted valuation approaches as follows:
- Income approach: ESG factors can be integrated by adjusting future cash flows or the discount rate. Quantifiable impacts, such as higher compliance costs or revenue from green products, should directly affect cash flow projections. Broader, unquantified risks that affect a company’s overall risk profile may warrant an adjustment to the discount rate.
- Market approach: Under the updated IVS, ESG is a specific factor in the market approach. Relative ESG performance can be considered in evaluation of valuation multiples derived from comparable companies to the extent relevant to the specific industry before application to the valuation subject. The enhanced disclosures under HKFRS S1 and S2 will make these comparisons more reliable over time.
- Cost approach: ESG factors may affect the replacement cost or induce obsolescence in assets. This includes estimating costs for environmental remediation, retrofitting for energy efficiency, or accounting for regulatory penalties.
Conclusion
The integration of ESG into business valuation is being structurally reinforced from two sides: regulated corporate disclosure and professional valuation standards. HKFRS S1 and S2 are transforming ESG data from a patchwork of voluntary claims into a stream of auditable, comparable financial information. In tandem, the IVS and joint professional guidance mandate valuers to actively seek and incorporate this material information. For valuation professionals, developing expertise in interpreting this data and applying it within rigorous valuation frameworks is no longer optional but essential to delivering credible, future-relevant valuations.
A webinar will be held by the Institute on 10 February this year, featuring the author as a speaker to further explore how ESG performance may interact with long-term company value.
This article was contributed by Wiley Pun, member of the Institute’s Sustainability Committee, Course Director of the Institute’s Business Valuation Programme, and Advisory Partner of Grant Thornton Hong Kong Limited.
