2023IFCII Review | The impact of newly issued ESG standards on Chinese companies

The International Sustainability Standards Board (ISSB), an organization under the International Financial Reporting Standards Foundation (IFRS Foundation) together with the International Accounting Standards Board (IASB), issued ISSB standards in June. The first two ISSB Standards include General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and Climate-related Disclosures (IFRS S2).

At the supplementary meeting on April 4th, the ISSB discussed further the one-year transition relief, which would allow an entity to report on only climate-related risks and opportunities in the first year and require the entity to provide information about its other sustainability-related risks and opportunities in the second year it applies the two Standards. The first two ISSB Standards will take effect on January 1st, 2024. So Chinese companies may face new ESG disclosure standards. How will the two standards affect them and how should they respond?

At the 3rd International Forum for China Impact Investing (IFCII) on June 6 th, Bing Leng, member of ISSB, Shizhong Huang, Former President of Xiamen National Accounting Institute, Yvonne Kam, Technical Partner of PwC, and Yonggang Zhao, Director of the ESG Department,China Securities Index Co., Ltd.(CSI) discussed the above issues.

Integrating ESG information into corporates’ long-term risk management

Leng points out that the establishment of ISSB is driven by the large demand of investors, fragmented sustainable information, and global politics. For example, it’s difficult to achieve a green low-carbon transformation merely by public funds; therefore, we need to leverage public funds to mobilize massive funds from the capital market. Obviously, the valuation system is crucial. We need something like the financial statement, so that we can simply input sustainability-related information into the standardized system, which should be comparable, mandatory, and instructive. Furthermore, ISSB should maintain political neutrality, and take emerging economies and developing countries into full account both within and outside the standards. Lastly, the logic of sustainability standards is different from that of accounting standards, so it’s difficult to incorporate sustainability-related information into financial statements.

Yonggang Zhao believes that two ISSB standards have broadened the common ground for country-specific ESG disclosure standards; meanwhile, the ISSB disclosure framework enables listed companies to disclose information such as strategy, governance, risk management, and performance indicators in a more standardized manner. Moreover, the international standards will draw companies’ attention to information that impacts and will impact their operations.

Zhao notes that there are two main reasons why ESG information is not strongly associated with corporate value. First, the current perception of companies remains confined to their economic value, instead of the social value. Second, the current valuation methods are inadequate to deal with environmental and social impacts, although they are quite mature when dealing with financial data.

In this regard, Zhao suggests that companies should take ESG as a reference for their long-term risk management instead of simply as a compliance consideration. Business behavior can play a catalytic role and sustainable consumer behavior can motivate businesses to move toward the right direction. Special valuation systems that take into account environmental and social impacts can be adopted at the infrastructure level.

Ten major challenges

"This year marks the inception of sustainability reports," Shizhong Huang states that as in this year, there are ISSB international standards, EU regulations, and maybe new U.S. disclosure rules. Huang also points out that the Ministry of Finance of China may introduce ESG disclosure standards that both align with international standards and consider China’s specific conditions before the end of the year. It is noteworthy that the Hong Kong Exchanges and Clearing Limited (HKEX) has been continuously updating ESG disclosure requirements since 2013, making Hong Kong an indisputable leader in this aspect in the global capital market. Yvonne Kam expects the issuance of IFRS S2 will pose some challenges to businesses, particularly in the following three aspects.

Firstly, data collection. Companies need to collect accurate and consistent data in time but most companies lack systems to record these data. Secondly, data verification. Top-level design, capacity building, and internal control are required to verify these data. Thirdly, the consolidation of financial and non-financial data. Multiple departments must collaborate to consolidate these data.

Furthermore, a consultation paper on enhancement of climate disclosure under the ESG framework published by the Stock Exchange of Hong Kong Limited (the Exchange), a wholly-owned subsidiary of HKEX, will have a significant impact on the determination and assessment of materiality and changes in estimations, as well as on the simultaneous release of the sustainability report and the financial report. "Both the sustainability report and the financial report are an integral part of the company; either report can give a full picture of the company." Kam also points out that both reports should be consistent. Transactions that meet recognition criteria should be monetized and incorporated in the financial statement, while those that have not should be disclosed in the ESG report first and later when they do, they should be moved to the financial statement. Therefore, the two reports are complementary to each other.

Huang summarized ten challenges that China may face in formulating and implementing climate disclosure standards:

1. GHG emission reduction goal-setting;

2. GHG emission data collection;

3. Selection of GHG accounting methods;

4. Financed emissions of financial institutions;

5. Climate adaptation analysis and assessment;

6. Climate change-related financial assessment;

7. Capacity building of climate governance institutions;

8. Climate disclosure of SMEs;

9. Independent verification of climate disclosure;

10. Application of climate information in investment decisions.