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• ESG factors examine a company’s adaptability and durability in the face of future changes in the game’s very premises. Traditional financial analyses sometimes took these factors into account, but the analyst’s focus was always on a company’s competitiveness and attractiveness at a certain moment in time.
• Child labor, worker exploitation, and other abusive labor practices are a major problem in many emerging markets. Yet traditional financial analysis offers no means of evaluating a company in terms of the role such practices play in its cost-cutting strategy. Without ESG expertise, it is impossible to judge whether a company should get high marks for cost cutting or low marks for human rights issues.
• Why is ESG important? Because there is a need to scrutinize corporate practices for their potential impact on society.2 Figure 2 illustrates the relationship between ESG and financial figures. Using capital from investors and lenders, each corporation hires personnel (S), builds offices and plants in compliance with local rules and regulations (E, S), and uses energy and resources (E) under a unified management policy (G) for the purpose of providing goods and services at a profit (F).
Financial results (F) that investors watch closely are thus the outcome of ESG contributions. Yet until fairly recently, it was impossible to obtain data regarding each of these contributing factors, and in the absence of information to judge their impact on financial results, companies were evaluated on the basis of financial data alone. However, as companies began to incorporate CSR policies and programs into their management strategies and publishing CSR reports, more information became available from the companies themselves. Armed with this data, PRI sigSeiichiro Uchi, “ESG toshi no nami” (The Wave of ESG Investing), summary of presentation to MSCI pension seminar, Tokyo, December 6, 2013.
Figure 2. Relationship Between ESG and Financial Results Source: Daiwa Institute of Research.
natories have been able to identify the ways in which ESG factors affect profit and risk, and investors have become increasingly interested in the correlation between ESG and long-term performance.
ESG and Long-Term Strategy This trend has received a recent boost from the 2013 publication of the International Integrated Reporting Framework, compiled by the International Integrated Reporting Council, or IIRC. The framework defines integrated reporting as “a process... that results in a periodic integrated report by an organization about value creation over time and related communications regarding aspects of value creation” and defines an integrated report as “a concise communication about how an organization’s strategy, governance, performance, and prospects, in the context of its external environment, lead to the creation of value in the short, medium, and long term.”3 The International IR Framework identifies six forms of capital that contribute to the creation of value: financial capital, manufactured capital, intellectual capital, human capital, social and relationship capital, and natural capital. Students of economics and business who have been inculcated with the notion that there are three categories of capital may find it difficult to adjust to the idea of expanding the definition to include ESG factors, represented by the last three items. Classical http://www.theiirc.org/ 3
economics treated water and air as free goods and did not recognize society or the community as capital. But given the growing global water shortage and the air pollution crisis affecting many parts of China, it is increasingly clear that clean water and air are finite assets that come at a price. The notion of human capital is perhaps less foreign, since classical economics classifies labor as an asset, and the idea of human resources as the core of a business’s nonfinancial value has become commonplace in recent years. By focusing on these “six capitals,” the International IR Framework helps clarify the connection between ESG and the process of value creation in order to facilitate decisions regarding sustainable investment using ESG criteria.
For fiscal 2014, more than 100 companies intend to prepare integrated reports, according to the IIRC. As a result of such initiatives, more and more companies can be expected to disclose key elements of their long-term business strategy, and such nonfinancial data can be expected to play an increasingly prominent role in investment decisions. Whether this trend bears fruit in Japan will depend on how well each company is able to integrate CSR into its strategy for long-term value creation.
Insights from the Tokyo Foundation Survey
What insights can the Tokyo Foundation’s Survey on Corporate Social Responsibility provide when ESG is regarded as part of a company’s long-term business strategy?
The survey asked businesses about their initiatives for nine social issues and the benefits of those efforts to the company. The responses overall indicate that most companies place low priority on areas in which CSR efforts are thought (by the CSR officer) to be of little benefit to the company or on areas with no clear connection to the company’s core business.
Topping the list in terms of CSR initiatives and perceived benefits were domestic and overseas programs aimed at environmental sustainability, followed by domestic efforts to raise the status of women. The emphasis on these two areas is not difficult to understand. Fifteen years ago, when the Kyoto Protocol was adopted, environmental efforts were still regarded as an aspect of social philanthropy. Nowadays they occupy a more central place in business strategy, functioning not only to reduce a business’s environmental burden and to cut costs but, in many cases, to spur the development of new goods and services for the global market.
The focus on women’s empowerment can be explained by such factors as the current administration’s goal of boosting women’s participation in the labor force,
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the large gap between the status of women in Japan and in the rest of the industrialized world, and the growing realization among many businesses that henceforth women must be part of any sustainable strategy for securing and developing human resources.
By contrast, only 31 of the companies surveyed reported that they were engaged in efforts aimed at fighting poverty and hunger in Japan, while 175 indicated that they were not. Those supporting programs to fight poverty and hunger overseas, on the other hand, numbered 74. This gap may reflect a view that poverty is a serious problem only in other countries, not in Japan. Or it may stem from a sense that the company has little to gain from domestic anti-poverty initiatives or that domestic poverty has little bearing on the company’s businesses. In any case, given the growing problem of the working poor in Japan and rising concerns over schoolchildren unable to pay the fee for their school lunch program, one cannot but feel that this is an area in need of greater attention.
Corporate initiatives to fight childhood poverty are likewise primarily undertaken overseas. On the other hand, initiatives pertaining to community involvement and the preservation of local culture were more prevalent in Japan, with 154 companies indicating that they had domestic programs in place but only 70 reporting such activities overseas. Among those respondents that claimed to be actively considering a community initiative of some sort, 129 said that the focus of the proposed initiative was domestic, and only 58 were considering such a program overseas. Perhaps this discrepancy stems from a relative lack of familiarity with and understanding of local customs in foreign countries.
In terms of how CSR activities benefit the companies that engage in them, most respondents emphasized the contribution to employee education, securing of qualified human resources, and corporate image. Very few reported a positive impact on business earnings from any CSR initiatives save those pertaining to the environment in Japan or overseas. In short, the economic impact of CSR policies on Japanese corporations thus far has been limited mainly to enhancement of overall corporate health, as discussed above, through improvements in human resource development and brand value that lead to value creation over the long term. The challenge facing Japanese CSR officers now is to convert such basic improvements into concrete performance.
Generally speaking, Japanese corporations seem eager to pursue mainstream themes that are easy for their CSR officers to grasp and that are already widely embraced by Japanese society. Issues that are serious but have a lower social profile are much less likely to receive attention from Japanese companies, even though programs targeting such issues might be of greater potential value to society. Even
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if the officers in charge of CSR recognize such an issue’s importance, they need the support of the people around them in order to mobilize the organization’s resources. And gaining that support is difficult unless the problem has escalated to a level where it can no longer be ignored.
Japanese society today faces a number of emerging issues, including child labor and other human-rights abuses, that have thus far received little attention yet pose serious long-term risks if not confronted and addressed. Inhumane treatment of animals is another emerging issue; in late January 2014, a convenience store chain suspended sales of a box lunch containing foie gras (a decision that drew lively debate on the Internet) following accusations of cruelty to animals.4 The latter development highlights the need for greater awareness on the part of Japanese CSR officers of new horizons in corporate ethics—especially in the West, where rights issues increasingly apply to animals as well as human beings—and the need for companies to map out a clear policy in response to new issues and changing values.
The results of the Survey on Corporate Social Responsibility lead one to the unsurprising conclusion that Japanese companies are working fairly hard on the “easy” initiatives—that is, those that already enjoy a high level of public awareness and corporate support—but that they are less actively engaged in other areas. Instead of merely following the leader and ignoring low-profile issues on the grounds that no one else is tackling them, CSR departments need to focus on problems that are still relatively small in scale. Once a problem has spread and escalated into a major social issue, no one needs the CSR department to explain its importance.
I believe that one of the most critical jobs of a CSR officer is identifying and following emerging issues and their potential impact on the company. Henceforth an increasingly important aspect of CSR management will be identifying risks in previously overlooked areas of corporate responsibility. The companies that succeed in doing so will have the best chance of boosting and creating new value over the long term.
october 26, 2015 Japanese CSR in the Age of Responsible Global Investing Hiroshi Komori R ecent years have witnessed important milestones in the global trend toward sustainable investment. In May 2013 the Global Reporting Initiative released the G4 Sustainability Reporting Guidelines at the Global Conference on Sustainability and Transparency in Amsterdam. And in December that year, following a period of public comment, the International Integrated Reporting Council published the final draft of its International IR Framework. In the following, I would like to discuss the challenges facing Japanese companies amid these developments, as seen from the perspective of the foreign institutional investors with whom I have worked for more than a decade. Note that the opinions expressed here are my own and do not reflect those of any organization or institution.
Institutional Investors and CSR Reporting
Institutional investors consist broadly of two types: asset owners, such as pension funds and foundations, which provide the funds to be invested; and asset managers, to whom the asset owners delegate the management of their funds.
Of the foreign institutional investors who invest in Japanese equities, only a very small portion actually read the individual corporate social responsibility reports published by Japanese corporations. One reason for this is limited resources.
Investment firms with global portfolios hold shares in a huge number of companies: between 1,000 and 2,000 in the case of midsized asset managers, and 5,000 or more in the case of the big management firms. These days most of the larger asset management firms have departments dedicated to ESG (environmental, social, and governance) risk assessment, but even so, reviewing the CSR report of each and every listed company is physically impossible.
Hiroshi Komori Associate General Manager, Stock Transfer Agency Business Advisory Department, Sumitomo Mitsui Trust Bank, Ltd.
Who, then, is reading them? The most important readers of CSR reports are ESG rating agencies. These are organizations that analyze and rate the ESG performance of stock-issuing companies on behalf of institutional investors, mostly on the basis of data from the companies’ environmental, social, and governance information in CSR reports, along with answers to questionnaires and, occasionally, interviews and observation. These agencies may bring their own special research methods to bear, and virtually all global investors depend on them for ESG information.
In these ratings, Japanese companies as a whole fall somewhere between the middle and bottom of the global rankings, and there has been no appreciable change in this position over the years. In the environmental component, Japanese corporations rank near the top. However, in the social component they rank in the middle or lower, and when it comes to corporate governance, they are near the bottom. These results are consistently seen among all the reports compiled by these agencies.
New Trends in Institutional Investing