Trends in ESG Information in Integrated Reports in Recent Years
Since last year, I have served as a judge for the World Intellectual Capital/Assets Initiative (WICI) Japan Integrated Report Awards. It is generally known that greater emphasis has been put on ESG information in integrated reports in recent years. However, I feel that specific evaluations of ESG disclosure have still only just begun. The amount of information has certainly been increasing. Although more and more business enterprises are publishing ESG information in their reports, investors have been unable to keep pace with this information. In our discussions in the review committee for the Integrated Report Awards, all of the participating members have a very strong ability to understand and judge the disclosure of financial data, management plans and the like, which have been given the strongest emphasis in reports over the years. These members have been finding a new type of information in these reports. It is called non-financial data, and involves the disclosure of CO2 emissions data as well as data on matters such as women’s participation in the workplace. And there are many financial experts who believe they can evaluate the disclosure based on this data alone. However, we cannot simply be satisfied by seeing the disclosure of numerical ESG data; we must also understand and interpret those numbers. While the notion of “ESG” comprises the Environmental (E), Social (S) and Governance (G) elements into a single concept, we must still interpret and process a vast amount of information. For example, when considering the Environmental (E) aspect, global warming may be the only aspect that comes to mind. However, the environmental aspect also encompasses recycling, chemical substances management, biodiversity, water resources, mineral resources and much more, and each of these components are quite profound. For investors who cannot understand and interpret ESG information to this extent, ESG investing may indeed appear to be only a passing fad. Yet this only shows that they are completely oblivious to the essential problems and threats facing humankind and society right now. Put differently, something is going awfully wrong with Planet Earth, which plays host to all of our economic activities. Only a handful of investors are aware of this fact. I am not exaggerating by any means.
Will Economic Growth Deplete Earth’s Resources?
Ever since the Industrial Revolution, humankind has achieved economic growth in step with mass-consumption of the Earth’s resources. The global population increased from 3.7 billion in 1970 to 6.9 billion in 2010. That represents a 1.86-fold increase. Meanwhile, global GDP expanded from US$15.4 trillion in 1970 to US$51.7 trillion in 2010. This 3.35-fold increase means that global GDP growth has far outstripped the global population growth rate. On the surface, it seems as if humankind has become more affluent. But global resource consumption has increased from 22.0 billion tons to 70.0 billion tons. You can see that the more affluent people have become, the more resources they have consumed. After all, we are consuming 1.6 times more resources per person than we did 40 years ago.
There is an index called the ecological footprint (a number that indicates the impact of human activity on the environment as a multiple of the capacity needed to replenish resources and remediate waste). In 1961, the ecological footprint stood at 0.7, but it had increased to 1.6 by 2016. This signifies that humankind is currently consuming 1.6 times more resources than what life on Earth is able to produce. Faced with this reality, it would be strange not to feel a sense of urgency.
A Bigger Problem Than Mass Consumption
Moreover, based on global resource consumption in 2010, the world’s most developed countries consumed 25 tons of resources for every 0.1 of a ton consumed by the world’s most impoverished nations. With such a large and growing gap in resource consumption between wealthy and poor countries, can we truly say that the world is a prosperous place?
The problem is bigger than resource consumption. Global forest area decreased by 3.1% from 4,128 million hectares in 1990 to 3,999 million hectares in 2015. To put these numbers into perspective, in terms of the global population, this decline represents a 25% decrease in forest land per person. What does this mean? It means that ecosystems will collapse and climate change will occur on a global basis. The deforestation of tropical rainforests will reduce rainfall, spurring desertification and accelerating global warming further. Around 20% of the Amazon rainforest has already been destroyed. If deforestation continues at this pace, some experts believe that the southern and eastern parts of the Amazon region may turn into a savannah.
Global Warming Is an Ongoing Phenomenon
Extreme weather events are happening all around the world. California saw a drought continue for six years. In contrast, central and southern parts of China experienced major floods this year. In Japan, summers have been marked by a steady succession of heavy rains and extremely high temperatures. This is not just a temporary spike in extreme weather over the past few years. It is actually considered to be the outcome of global warming that experts have been warning us about all along. The First Assessment Report of the Intergovernmental Panel on Climate Change (IPCC) published in 1990 had already stated that greenhouse gas emissions from human activities must be reduced by 60% immediately. That was 27 years ago. The Kyoto Protocol was ratified in response to that report, but its enforcement was feeble. As a result, CO2 emissions continued to increase, contributing to an increase of 0.85℃ in the global average surface temperature over the 132 years from 1880 to 2012.
The Paris Agreement of 2015 seeks to hold the increase in the global average temperature to well below 2℃ above pre-industrial levels. You might be tempted to believe that if the average temperature increased by only 0.85℃ over 132 years, then things would probably still be fine. That is not the case. According to the IPCC Fifth Assessment Report, the global average temperature is predicted to increase by 0.3℃ by 2100 under the most optimistic RCP2.6 scenario and by 4.8℃ under the most pessimistic RCP8.5 scenario. Based on predictions issued by the Ministry of the Environment in 2014, the data shows that Japan’s average temperature will increase by anywhere between 1.1℃ and 4.4℃ by 2100. In the worst case scenario, Sapporo would experience as many days with daytime high temperatures of 30℃ or above as Tokyo does today, and Tokyo would also experience the same number of such days as Naha does today. In fact, Naha will experience daytime highs of 30℃ or above for around half the year. This means that torrential downpours will strike with no warning, droughts will happen, and major flooding will afflict regions that had never seen such events before. Still fresh in memory is the extremely poor harvest of potatoes in Hokkaido last year, which led to cutbacks in potato chip production in Japan. It can be hard enough to cope with a poor harvest of potatoes, but we might also start to see poor harvests of wheat and corn on a global scale in the near future. Humankind is entirely to blame for all of these events. They are the consequences of spurring global warming without taking effective mitigation measures and continuing to destroy the natural environment by consuming the planet’s resources such as minerals as well as plant and animal life.
What value can there be in focusing only on the financial performance of companies and making short-term investments using next year’s earnings or a three-year medium-term plan as decision-making criteria, without looking at the situation faced by planet Earth?
Nations Are Starting to Take Action
Looking at current global developments, a paradigm shift is now under way to transform these aspects of the economy. More specifically, in September 2015, the United Nations General Assembly adopted the Sustainable Development Goals (SDGs), which comprise 17 targets for transforming our world. The Government of Japan also embraced the SDGs. As an initiative by the financial sector to take steps to accomplish the SDGs, the Government Pension Investment Fund (GPIF) of Japan signed the UN’s Principles of Responsible Investment (PRI). This was a landmark development. As long as the GPIF is committed to ESG investing, few asset management firms can afford to remain ignorant of ESG data. In practice, the GPIF’s signing of the PRI has triggered a fundamental structural transformation in the financial sector. For example, asset management firms have started incorporating ESG evaluations and ESG indexes into their mandates. Indeed, ESG investing is anything but a passing fad.
Business Enterprises Have Developed a Stronger Awareness of Sustainability Than Investors
Japan has very few natural resources of its own, so it relies primarily on imports from foreign countries to obtain resources in short supply. This signifies that the Japanese people and Japanese companies have responsibilities that extend beyond its borders. This applies not only to energy, but also to the food self-sufficiency rate and materials. For example, Japan has one of the highest forest coverage ratios of any developed country, following Sweden and Finland. However, Japan’s lumber self-sufficiency rate remains at only around 30%. Although it is a country covered by abundant forests, Japan is essentially buying wood from other countries with less forest cover. Japan also imports massive amounts of palm oil, which is known to be a main culprit behind the destruction of the world’s tropical rainforests. Malaysia and Indonesia, which are exporters of palm oil, burn tropical rainforests to clear the land and build plantations for the mass production of palm oil. The PRI annual conference was held in Singapore last year. Many investors attended the on-site tour of tropical rainforest destruction held as a side event. The question of how to stop deforestation was an important theme of the conference. And naturally, more and more business enterprises in recent years have been turning their attention to sustainability, instead of doing business that will harm the planet.
For example, Toyota Motor Corporation has adopted the Toyota Environmental Challenge 2050. Under this vision, Toyota has announced its initiatives to achieve zero CO2 emissions in three kinds of business activities, along with its initiatives to address environmental issues, such as establishing a recycling-based society and systems, by the year 2050.
Kirin Holdings Company, Limited has drawn up the New Kirin Group Vision 2021 (New KV2021), a long-term management vision. Under this vision, Kirin Holdings has announced its commitment to pursue the creation of economic value and social value through its business activities.
Apart from this, there has been a steady and sustained increase in the number of companies that are able to effectively articulate their initiatives aimed at Creating Shared Value (CSV) as part of their business strategies. Examples of these initiatives include Hitachi Social Innovation, which was unveiled by Hitachi, Ltd., and Digital Co-creation, which was announced by Fujitsu Limited. These activities seek to balance the sustainability of ecosystems and communities, and business activities.
Investors Must Change Their Mindset
Until now, many business enterprises have undertaken environmental protection activities and social contribution initiatives under the banner of CSR activities. That said, these initiatives were often treated as separate from their main business activities, and were often evaluated mainly as secondary publicity-driven activities. However, today, it is these initiatives that are becoming integral to the main businesses of those business enterprises.
Looking at global developments, there is an initiative called Renewable Energy (RE100) that is committed to undertaking business using 100% renewable energy only. RE100 currently has 102 member companies, led by Apple, Google and Microsoft, which are the world’s top three companies in terms of market capitalization, as well as Walmart, the world’s largest employer, and other companies. At present, the only Japanese company that has joined RE100 is Ricoh Company, Ltd. However, RE100 shows that quite a large number of major global corporations, with companies spanning all manner of industries and functions, such as information and communications, finance and insurance, and real estate, as well as both manufacturers and suppliers, are seeking to realize a sustainable recycling-based economy from a long-term perspective. For example, Apple is requiring suppliers to conduct production using renewable energy, and IBIDEN CO., LTD. has answered this call. These developments are not a passing fad by any stretch of the imagination.
People who clearly see the current state of the global environment recognize that promoting sustainability in economic activities and investing is an urgent priority, and they understand that sustainability has already become a well-established global trend. I strongly believe that investors should keep up with business enterprises by changing their mindset. I am also convinced that ESG investing will not end as a passing fad—it is very much here to stay.