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China's New Mandatory Sustainability Disclosure Aligns with EU's "Double Materiality"

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In February 2024, the People's Republic of China (PRC), the world's second-largest economy, implemented a mandatory sustainability disclosure requirement for its three largest stock exchanges. From 2026, large corporations listed on the Shanghai, Shenzhen, and Beijing Stock Exchanges will be obligated to reveal a diverse array of sustainability data encompassing environmental, social, and governance (ESG) categories.

 

Significantly, this strengthened regulation not only covers direct emissions metrics and energy transition plans but also incorporates data on Scope 3 value chain emissions. Additionally, it emphasizes the second and third pillars of ESG criteria—Social and Governance reporting—with a robust focus on ecosystem and biodiversity preservation, circular economy practices, supply chain integrity, rural revitalisation, and anti-corruption and anti-bribery measures, among others. Although the new rule will affect fewer than 500 companies, these companies collectively represent about half of the listed market value or US$4.7 Trillion.

 

So why has the PRC adopted the 'double materiality' model of the EU, requiring mandatory disclosure of both climate-related financial risks/opportunities and a company's impact on people and the environment?

 

One economic argument stems from the substantial trade relationship between the PRC and the EU. With approximately US$560 billion worth of goods exported to the EU, it stands as the PRC’s second-largest export market. Given the EU's recent introduction of the Carbon Border Adjustment Mechanism (CBAM), which imposes a tax on carbon-intensive goods entering the EU, along with the Corporate Sustainability Reporting Directive (CSRD), the PRC’s alignment with mandatory frameworks appears pragmatic.

 

Moreover, by adhering to international standards prevalent in Europe, the PRC aims to attract foreign investment, particularly from institutional investors. This endeavour becomes crucial following a three-year decline in institutional investments in China-domiciled ESG funds, plummeting by approximately 34% to US$39 billion in 2023. The PRC anticipates that adopting these new guidelines will enhance its environmental credentials.

 

Nonetheless, the collective GDP power of both the PRC and EU, amounting to USD$38 trillion (nominal), wields considerable influence over the trajectory of ESG sustainability frameworks. This shift from voluntary disclosure to economic imperative serves as a wake-up call to other Paris Agreement signatories and securities exchanges to take action. As we progress towards global net-zero targets, "double materiality" appears poised to become the prevailing norm.

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