Regulators and stock exchanges have introduced an array of environmental, social and governance (ESG) disclosure requirements in the key Asian markets over the past few years. They require certain types of companies, primarily large and/or listed corporations, to provide detailed reporting on their management of ESG risks. In our view, disclosures are supportive of the sustainable bond market as issuers need to prepare quantifiable data on their sustainable activities and assets, thus improving the data transparency for investors and market actors in assessing an issuer’s ESG risk exposures.
Nneka Chike-Obi, Director of ESG research, Sustainable Fitch, offers insights on the new ESG disclosure rules and explains their implications on the credit market.
1. Which countries in Asia-Pacific currently have ESG disclosure requirements?
Both the Singapore Exchange (SGX) and the Stock Exchange of Hong Kong (HKEX) require listed companies to disclose or report on certain ESG matters. In both cases, corporate boards are meant to take responsibility for sustainability policies and performance. A revision to Japan’s Corporate Governance Code will require some ESG disclosures for listed companies as of the current fiscal year ending April 2021. China’s financial regulator undertook a consultation in 2021 to determine whether to introduce ESG disclosure rules for all listed companies. More broadly in the region, some stock exchanges require selected companies to produce corporate social responsibility (CSR) reports or gender diversity data, but not a comprehensive sustainability report. Australia has a Modern Slavery law requiring large companies operating in the country to report on potential forced or child labour risks in their global supply chains.
2. What impact do these corporate disclosures have on the credit market?
For investors, they are an important tool for providing transparency on an issuer’s ESG risk exposures, although this varies widely depending on the level of detail provided. Under the UK Modern Slavery Act, several cases of labour abuses in Asia have been identified by British retailers in their supply chains, but these have not translated into credit actions by Fitch Ratings because no penalties were levied against the disclosing companies.
From a financing perspective, the collection of ESG data can help companies structure debt facilities based on their sustainability profile. In the absence of ESG data collection, a borrower has no way of knowing which areas it lags its peers, or which parts of its business have higher exposure to future regulatory or market risks. We have seen rapid development of the sustainability-linked debt market in recent years, which allows entities to reduce their borrowing costs based on achievements of certain performance targets.
A growing number of corporates in Asia have taken on sustainability-linked loans, including COFCO (Hong Kong) (A/Stable), Swire Properties (A/Stable), and Downer Group (BBB/Stable). Examples of targets include: reduction in greenhouse gas emissions, reduction in water use, increase in the percentage of female senior managers, and traceability of raw materials. In the bond market, there has been a continued rise in the issuance of both ESG use-of-proceeds bonds (e.g. green, social, sustainable) alongside the newer sustainability-linked bond format where funds can be allocated to any general corporate use.
3. What are the costs associated with ESG disclosures?
For companies new to sustainability reporting, meeting disclosure rules requires investment into human and system resources. Companies operating in markets where ESG reporting is mandatory will likely face additional costs as they no longer work on a “comply or explain” basis, meaning they have the option to explain why data is unavailable for disclosure. Within the apparel sector, two-thirds of purchasing executives surveyed by McKinsey in 2019 expected sustainable sourcing to add 1%–5% to their overall purchasing costs by 2025, and a similar share think sustainability will likely become the main criteria in the selection of new suppliers.
4. Who do these disclosures leave out, or what kinds of companies are not required to comply with the new rules?
Within Fitch’s rated universe, a large number of issuers are not subject to the types of disclosure regulations that have been introduced. These include: unlisted and/or private companies, smaller companies that fall outside of the revenue/size thresholds, project finance, structured finance, supranationals, sovereigns and other government entities. While many issuers publish annual sustainability reports in the absence of legal requirements or listing rules, many of the policies in place or in development exclude a large number of participants in the fixed income market.
5. How does Fitch consider ESG disclosures in the credit rating process?
Under our ESG Relevance Score framework, all ratings include an assessment of exposure to ESG risk based on the issuer type or sector. Detailed disclosures accompanied by increased awareness of how sustainability factors into a company’s operations increases the quality of our credit analysis. We find that governance risks are the most common ESG factors that contribute to a changed view on the creditworthiness of the borrower, and this is consistent across regions and in most sectors, with the exception of the retail, consumer and healthcare sectors, where social risks have more of a credit impact. As some of the disclosure rules place responsibility for sustainability at the board or senior management level, any gaps in sustainability policy with operational or financial impacts could also be considered a governance risk in our framework under the management strategy or governance structure.