The vast array of potential environmental, social and governance (ESG) indicators for disclosure encompasses several hundred across various standards and guidelines. Streamlining and prioritizing these indicators is essential for effective oversight and management, especially as Hong Kong regulators have designated ESG oversight as a board responsibility. This case study investigates the process by which Link Asset Management Limited (Link), by referencing the exposure drafts of the proposed IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and IFRS S2 Climate-related Disclosures (IFRS S2) published by the International Sustainability Standards Board (ISSB), streamlined over 600 ESG indicators down to 33 for management oversight and ultimately 11 for ongoing board oversight. This framework should be more readable and understandable for reporting corporates and experienced accountants and auditors to review.
The ISSB expects to release the final IFRS S1 and IFRS S2 towards the end of June this year. These standards will take effect from January 2024. Given the pace at which sustainability reporting is evolving in major economies around the world, Hong Kong-listed companies must prepare for disclosing material information about significant sustainability-related risks and opportunities.
Although the proposed ISSB standards are new, they align with common disclosures employed by other standard-setting bodies, catering to general-purpose financial reporting users. The objective is to identify sustainability-related risks and opportunities and provide relevant disclosures. Such bodies include the European Financial Reporting Advisory Group, Global Reporting Initiative, Sustainability Accounting Standards Board, and the Greenhouse Gas Protocol.
Both the IFRS S1 and S2 exposure drafts adopt a four-pillar core content framework, mirroring the Task Force on Climate-related Financial Disclosures (TCFD) recommendations to which many entities have aligned their reporting. The TCFD disclosure framework emphasizes significant climate-related risks and opportunities, encompassing physical risks from climate change and transition risks to a lower-carbon economy. Scenario planning is crucial for identifying and quantifying these risks.
For Hong Kong-listed companies, the anticipated ISSB standards are particularly pertinent due to the region’s focus on ESG reporting. The Hong Kong Stock Exchange (HKEX) has implemented mandatory ESG disclosure requirements, progressively reinforced over the years. HKEX’s Appendix 27 mandates that the board is responsible for effective governance and oversight of ESG strategy and reporting, while the Securities and Futures Commission has emphasized the integration of climate-related risks into investment strategies and risk management processes for fund managers operating in Hong Kong. In Link’s view, adopting ISSB standards by regulatory bodies would enable alignment with international best practices and attract a broader investor base.
Materiality is paramount in the reporting process, as it is determined based on the information required by users of financial reporting and metrics, such as investors, financiers, and creditors. Material information includes risks and opportunities arising from an entity’s dependency and impact on resources and business relationships. For example, an entity with water-dependent operations may consider water security or downstream user impacts as key material issues. These risks could expose the entity to increased governmental regulation of water access or negative reputational effects, potentially impacting the organization’s enterprise value.
Link’s materiality assessment focuses on identifying critical ESG issues for its business case and operations, including energy efficiency, emissions, water management, tenant well-being, and governance practices. More innovatively, Link’s approach also takes into account material issues that business partners have identified and prioritized as affecting their own operations. Doing so enables alignment and streamlining of mitigation efforts across the Link ecosystem, an approach which Link articulates as “Business as Mutual.”
Link employs the following criteria to determine key ESG issues for reporting:
The process identified 33 ESG key performance indicators (KPIs) for ongoing monitoring by Link’s Sustainability Committee and management team. This approach enables allocation of the appropriate resources and personnel to address risk exposure while developing targeted strategies that enhance performance and capabilities. It is also supported by a deliberate strategy to engage and communicate more with stakeholders to ensure alignment and common direction.
Complementing the focus on materiality is the exposure drafts’ enterprise value concept, which encourages companies to establish risk appetite thresholds when managing both financial and non-financial risks. This approach is particularly useful to streamline and prioritize management of non-financial indicators, such as climate risk, employee well-being, and governance, ensuring existence and alignment of critical ESG strategies with long-term business objectives and stakeholder expectations. This concept is essential for boards to diligently fulfill their ESG responsibilities spanning medium and long-term horizons.
Refining the reporting strategy includes:
Integrating financial and non-financial factors:
Identifying the connections between ESG issues and Link’s financial performance, such as how energy efficiency measures can reduce operating costs or how robust governance practices can minimize legal and reputational risks. Recognizing these connections helps prioritize material issues that directly contribute to the company’s enterprise value.
Evaluating long-term impacts and opportunities:
As a real estate investment trust, we focus on assessing the long-term implications of material ESG issues on our asset portfolio, growth potential, and competitive advantage. In the real estate sector, two key issues arise with the potential to impact property valuation: a) Climate resilience, particularly adaptive building designs to mitigate risks from extreme weather events, such as typhoons and flooding, protecting long-term property values and ensuring operational continuity, and b) Evolving tenant preferences, especially the demand for sustainable and healthy spaces by incorporating energy-efficient systems, green building certifications, and wellness amenities, catering to environmentally conscious tenants, and enhancing the property’s long-term marketability and value.
Aligning material issues with strategic goals:
Ensuring that the prioritized material issues align with the company’s overall strategic goals and contribute to value creation. This alignment can help optimize resource allocation and enhance the company’s long-term financial and ESG performance.
In addition to enterprise value, two supplementary secondary criteria – the ability of the indicator to monitor greenwashing and changes to Link’s social license to operate – were added. Incorporating these criteria is crucial for long-term risk management, as it ensures genuine sustainability efforts and fosters stakeholder trust, preventing potential repercussions such as reputational damage, fines, and regulatory backlash. Following this, ultimately 11 ESG indicators were consolidated and recommended to the board for ongoing monitoring and management and which will undergo annual assurance.
Identifying and monitoring ESG KPIs is not enough. Transparently disclosing the company’s approach to material issues and their contribution to enterprise value, supported by performance metrics, is crucial to the reporting process. Demonstrating the integration of ESG factors into decision-making and strategic planning can build trust and credibility among stakeholders, such as investors, tenants, and employees, and enhance the company’s reputation and license to operate. Moving forward, Link’s 11 core ESG indicators will be disclosed in the Strategic Report of its annual integrated report while the broader 33 ESG indicators covering Link’s wider range of material issues are reported through the Sustainability Compendium.
In conclusion, utilizing the ISSB exposure drafts’ enterprise value concept enables organizations like Link to prioritize material issues by recognizing the interplay between financial and non-financial factors, assessing long-term impacts and opportunities, aligning with strategic objectives, and effectively communicating value creation to stakeholders. This approach offers industry colleagues a clear direction on significant ESG issues and steps to enhance long-term performance, ultimately creating value for stakeholders.
Early adoption of the ISSB exposure drafts has proven beneficial in prioritizing critical ESG issues and can provide a refined, comprehensible framework for experienced accountants and auditors. Although the content may change in the final standards, our experience with the drafts facilitates smoother future adjustments, showcasing our ESG commitment and fostering long-term value and a competitive advantage.
This article was contributed by Calvin Lee Kwan, Director of Sustainability and Risk Governance at Link Asset Management Limited, and member of the Institute’s Sustainability Committee.