Introduction

In 2015, the Financial Stability Board launched its Task Force on Climate-Related Financial Disclosures (“TCFD”) which aims to develop a more sustainable, lower-carbon economy by helping companies to manage their opportunities and risks related to climate change. Subsequently in 2017, the TCFD released its recommendations on climate-related financial disclosures (“TCFD Recommendations”). With effect from July 2020, HKEX’s ESG Reporting Guide was amended to incorporate certain TCFD Recommendations. As HKEX expects mandatory TCFD-aligned climate-related disclosures by 2025, HKEX encourages listed issuers to commence reporting in accordance with the TCFD recommendations at their earliest possible. Thereby, HKEX released a Guidance on Climate Disclosures (the “Guide”) in November 2021 to provide practical guidance and illustrative examples to help listed companies in their compliance with the TCFD Recommendations.

HKEX has divided the Guide into eight chapters which helpfully lead companies step-by-step in developing, monitoring and disclosing their climate-related metrics and targets, financial impacts and strategies. This article will provide an overview for the eight steps.

1.    Governance structure

Companies are required to cover four main areas in their disclosure regarding governance structure: 

1.       board’s roles and responsibilities, which includes: 

a.       leadership in the management process of climate-related issues;

b.       process and frequency of evaluation and management of climate-related risks;

c.       integration of climate-related issues into long-term business strategy; and 

d.       monitoring long-term climate-related metrics and targets.

2.       management's roles and responsibilities, which includes:

a.       leadership on operation and execution level;

b.       provision of support to enable board’s oversight; and 

c.       coordination among different departments to manage climate-related issues.

3.       board’s oversight - the governance structure in overseeing climate-related issues; and

4.       readiness of the board and management, including their knowledge of the impacts of climate-related risks and their accountability.

The board’s role is to approve and monitor policies and mechanisms to manage climate-related issues and to ensure adequacy of resources, whilst the management’s role is to implement the policies and mechanisms in an efficient and effective manner. For more examples of a board’s and a management’s responsibilities and different types of governance structure, one may refer to Chapter 1 of the Guide.

2.    Formulate climate scenarios

Companies are required to cover three main areas in their disclosure regarding climate scenarios:

1.       parameters used for conducting scenario analysis, and their respective significance to the company’s operation;

2.       assumptions made by the company; and

3.       analytical choices, including the scope and boundaries of the scenario, description of the selected scenario, time horizon, and source of supporting data. 

Scenarios refer to hypothetical pathways of development of how the future might look if certain trends continue or certain conditions are met. Scenario analysis helps companies to identify and assess potential implications of climate-related risks on business performance from a range of plausible future conditions. Upon selecting the appropriate scenarios, companies will have to identify physical and transition risks parameters which affect their business operations by considering their business nature and geographical location. Physical risks refer to risks related to physical impacts of climate change such as floods and typhoons, whilst transition risks refer to risks related to the transition to a lower-carbon economy which entail policy, legal, technology and market changes. Typically, physical risk may affect a company’s operations and its labor or supply chain, whilst transition risk may affect a company’s compliance, operational cost, depreciation of assets or revenue.

3.    Identify and prioritise climate-related risks

Companies are required to cover in their disclosure process of risks identification and prioritization and a list of material risks. The Guide has helpfully highlighted five areas of common climate-related risks. In relation to policy and legal risks, HKEX recognized that climate-related risks may lead to increased carbon pricing, enhanced emissions reporting obligations, mandatory regulation of existing products and services, and exposure to litigation. Other areas include market and technology risks, reputation risks, acute physical risks, and chronic physical risks. Upon identifying the risks, companies have to priorities them by employing certain criteria, such as likelihood of occurrence, seriousness of impact, time and effort required for adapting, and time and costs for recovering a business.

4.    Business mapping with material risks

Companies are required to cover in their disclosure (1) impact assessment process which includes methods of mapping relevant business activities to material risks, major business activities that are assessed, and impact assessment methods employed, and (2) impacts of material risks on a company’s business. Upon identifying the climate-related risks, companies would have to assess the impacts of the material risks on the company’s business. To do so, companies will have to first map their business activities with a value chain, which is the chain of business activities required to create a product or service. After mapping, companies should evaluate the impacts of identified climate-related risks on each component of their value chain from six different perspectives, namely (1) the financial capital, (2) the manufactured capital, (3) the intellectual capital, (4) the human capital, (5) the social and relationship capital, and (6) the natural capital. Details of the interactions between different perspectives and climate-related risks could be found in the Guide.

5.    Choose metrics, indicators and targets

Companies are required to cover in their disclosure (1) climate-related indicators (including types of measurement used and methodologies), and targets of the companies (including the scope, baseline, time horizon, absolute or intensity targets, near-term and long-term targets, and actions taken to achieve the targets). It is expected that these metrics, indicators and targets will allow companies to measure and monitor their climate-related risks and facilitate the assessment of the company’s potential risk-adjusted returns, ability to meet financial obligations, general exposure to climate-related issues and progress in managing or adopting to those issues.

6.    Formulate climate action plan

Companies are required to cover in their disclosure (1) their overall climate action plan for responding to climate-related risks or targets, implementation, and monitoring the progress, and (2) details of key actions for achieving such climate action plan.

7.    Financial impact assessment

Companies are required to cover in their disclosure relevant financial items which will be affected by the climate-related issues so as to reflect the impact of climate-related risks on a company’s financial performance and position. For instance, greenhouse gas emissions may increase compliance cost due to stricter climate-related regulations imposed by the government and thus affecting the operating expenses in the income statement of a company.

8.    Integrate climate-related impacts into business strategy

Lastly, companies should also include in their disclosure how climate-related impacts are incorporated into business strategies of a company, including how the company can avoid or mitigate climate-related risks through strategic actions such as transforming its business model or adopting a different investment or divestment plan. For instance, it is believed that in light of investors’ growing demand for information regarding a company’s management of climate-related issues, a company’s business strategy shall be modified to handle investors relations with care when dealing with external communication that touches upon climate-related issues.

Takeaways

It is expected that listed companies will have to comply with mandatory TCFD-aligned climate-related disclosures from 2025. The Guide is helpful in providing practical tips and step-by-step guidance to assist issuers in preparing TCFD-aligned climate change reporting by assessing their response to risks arising from climate change. As environmental issues are of a growing concern globally, it is expected that economic activities will be more intertwined with environmental issues and companies should be well-prepared for it.