Climate Change and Sustainability Services
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E-Newsletter Spring 2019
It is with great pleasure that I share our first newsletter of this year. As Japan has entered a new era, it is a fitting moment to look back at how far we’ve come in the past years in promoting corporate sustainability in Japan. At the same time, I am reminded of the need to keep looking ahead at global sustainability trends and build on existing momentum.
We are excited to share the results of our latest Investor Survey ‘Does your nonfinancial reporting tell your value creation story? ’, which exemplified the need to keep building on this existing momentum. More than ever investors are using ESG factors in evaluating company's nonfinancial disclosures as part of investment decision making (97% of those surveyed). In particular, risks related to governance, supply chain, human rights and climate change were the ESG factors most likely to impact investments. And yet, investors raised that there is a long way to go for companies to fully understand what is material, what is relevant and how best to report it.
We believe the work of the Task Force on Climate-Related Financial Disclosures (TCFD) is one of many initiatives focused on bridging this gap, consequently receiving strong corporate interest in Japan and globally. We hope the TCFD recommended disclosure framework will be utilized by companies to steer that interest into strong action.
Looking further ahead, with Japan hosting the G20 for the first time in June, and Tokyo 2020 just around the corner, the global spotlight is on Japan. This will be our chance to showcase leading examples of how Japanese businesses are innovating to tackle complex global challenges, an essential requirement for meeting the Sustainable Development Goals.
We would like to thank you for all your continuous support and hope to meet these challenges together over the coming year.
EY Japan CCaSS, Associate Partner
2018 Investor Survey
EY’s 2018 Global Climate Change and Sustainability Services study of institutional investors reveals a notable consensus globally that ESG information is critical to investor decision-making. Investors around the world expect more abundant and more standardized reporting of nonfinancial performance information that is material to valuation. Both investors and issuers are increasingly using such information to assess the risks and opportunities that drive the creation of long-term value for their companies.
Over the last 10 years, investors have come to place ever-greater importance on the role that environmental, social and governance (ESG) factors play when evaluating companies in which to invest. ESG factors have now become integral to the investment decision-making process for institutional investors around the world. Companies should issue “a holistic collection of material disclosures that provide investors with insights they need to understand the future of a business and the quality of corporate management’s handling of the opportunities and challenges ahead,” says Jonathan Bailey, Head of ESG Investing at Neuberger Berman (US$299 billion under management).
This message has been the central theme of the fourth edition of EY’s research on institutional investor’s attitudes towards ESG and nonfinancial reporting, and its role in their decision-making. Below we set out six key findings from our latest survey:
(1) An increasing reliance on ESG disclosures
In a dramatic increase from our 2017 survey, 97% of investors surveyed say they conduct an evaluation of target companies’ ESG disclosures; leaving just 3% globally now saying they conduct little or no review. The proportion of investors’ clients that are asking about ESG and expecting it to be integrated into mandates is also increasing. Furthermore, ESG information plays an increasingly important role in the investment decision-making process, and 96% of investors surveyed say that such information has played a pivotal role. In interviews, investors stressed the importance that ESG disclosures play in appropriate market valuation.
(2) A demand for more and more consistent data
Investors are requesting more and higher-quality ESG data from public companies, and seeking consistent, investment-grade information to support their decision-making. “It’s not helpful if companies are disclosing different types of information and using different metrics,” says Glenn Booraem, Principal and Investment Stewardship Officer, Vanguard (US$5 trillion under management). “The real value for us is consistency on a cross-industry and long-term basis.” The most useful ESG reports come from companies that understand the notion of materiality and can identify which nonfinancial factors are most important to their business model. Also often missing are measures of accountability.
(3) Disclosure has improved, but remains uneven
It is clear from responses that corporate disclosures are improving. Investors surveyed report that, while they believe most companies are adequately disclosing the ESG risks that could affect their current business models, the disclosure is unbalanced: governance risk leads reporting, with social and then environmental risks being less well reported. Investors say that most companies are able to assess the materiality of governance factors but, in interviews, investors say there is a long way to go for companies to fully understand what is material, what is relevant and how best to report it. Investors report that, governance aspects aside, the main ESG factors in investment decision-making are related to supply chain, human rights and climate change risks (Figure 1).
Figure 1: Top-four nonfinancial triggers that cause an investor to avoid an investment※1
(4) More concern over physical risk of climate change
Investors say they are currently more concerned about disclosures in relation to the physical implications of climate change risk than the transitional risk tied to adapting to new regulations, practices and processes. However, in interviews, investors say they pay close attention to both aspects, depending on the type of investment under consideration.
(5) Wanted: investment-grade accounting standards
Investor demand for prescriptive nonfinancial accounting standards is rising: 59% of investors surveyed say that accounting standards for nonfinancial information would be very beneficial to investment decision-making, a dramatic uptick of 26 percentage points over our last survey. Respondents also say that nonfinancial data must be standardized to create a useful basis of comparison, to establish benchmarks and to mark trends.
(6) Collaboration critical to closing information gap
70% of investors surveyed say that national regulators are best suited to lead efforts to close the gap between investors’ need for nonfinancial information and the information actually provided by issuers. In addition, investors interviewed for this report are looking for intelligent collaboration among themselves, regulators and organizations such as trade groups and non-governmental organizations (NGOs) to establish appropriate and effective reporting standards.
Investors’ increasing demand for reporting on nonfinancial assets reflect a more sophisticated understanding by investors of the link between performance and ESG factors. This means that, alongside your financial reporting, there should be a coherent and strategic story on how you are seeking to grow intangible value to help your business to thrive. Having this framework and the data may help support your organization’s position to have conversations with investors and prepare for future regulatory development.
In particular, we believe there are four main areas organizations should consider:
- Establishing a structured materiality analysis process
- Measuring and reporting social and environmental outcomes
- Measuring and reporting long-term value
- Reporting more comprehensively on all climate risks and engaging with stakeholders, including investors
For more information about the results of the survey and next steps for organizations to consider, please refer to the full report, Does your nonfinancial reporting tell your value creation story? Currently the report is only available in English. We are working towards sharing the results in Japanese as soon as they available.
2018 United Nations Business and Human Rights Forum Highlights
In November 2018, the 7th Annual Forum on Business and Human Rights was held at the United Nations headquarters in Geneva, Switzerland for three days. In this forum, various companies’ human rights due diligence practices were highlighted. For companies, implementing and disclosing human rights due diligence efforts are becoming essential to reducing their general management risk and maintaining competitiveness. In this newsletter, Masataka Nagoshi, a manager of EY Japan’s Climate Change and Sustainability Services who participated in this forum, will introduce the highlights of this forum.
The 7th Business and Human Rights Forum, like the previous, had over 2000 attendees registered. Among attended registrants, the ratio of corporate stakeholders has increased in recent years (25% in the previous forum, 29% in the 7th forum). Prior to holding this forum, the UN Working Group on Business and Human Rights published a report on evolving companies’ human rights due diligence※1 practices (Corporate human rights due diligence - emerging practices, challenges and ways forward) after the adoption of the United Nations Guiding Principles on Business and Human Rights ( “the Guiding Principles”) in 2011. Governments and companies around the world made presentations on human rights due diligence initiatives. From Japan, representatives of more than 10 Japanese companies, including the Global Compact Network Japan Secretariat and Global Compact signatory companies participated in the Forum. Also, as panelists, a lawyer from the Japan Federation of Bar Associations discussed the possibility of human rights due diligence within M&A processes, and a representative of the Japan Business Federation explained how the Guiding Principles are being rolled out in Japan.
Normalization of Human Rights Due Diligence
The UN Working Group on Business and Human Rights highlights the increased awareness of human rights due diligence, as human rights due diligence is incorporated into guidelines and policies created for companies by various international organizations, and laws and practices in each country are starting to be in place.
Internationally, the OECD published their DUE DILIGENCE GUIDANCE FOR RESPONSIBLE BUSINESS CONDUCT in 2018. This guidance requests companies to reduce ESG risks within its own value chain based on the due diligence-related concepts of the Guiding Principles. The status of implementation of this guidance is agreed to be monitored by 48 countries at the ministerial level.
At the country level, following the California Supply Chain Transparency Act (2010) and the UK Modern Slavery Act 2015, the French Duty of Vigilance Law (2017) came into effect, and the Australian modern slavery act was also established in the end of 2018. The German government requests companies with more than 500 employees that are based in Germany to implement a human rights due diligence process and has started monitoring the implementation status every year since 2018. The aim is that at least 50 % of all the monitored companies in Germany will have incorporated the elements of human rights due diligence into their corporate processes by 2020※2.
Practical examples of human rights due diligence (spreading due diligence to entire value chains)
Various efforts to reduce human rights risks in upstream raw material supply chains were highlighted in the Forum. For example, artisanal small-scale mining is still prevalent in cobalt mining. Demand for cobalt is increasing as the demand for electric cars and smart phones on the rise, and the risks of accompanying child labour and occupational health and safety were being pointed out. As an example to alleviate human rights risk in regard to cobalt mining in the Democratic Republic of Congo, Trafigura cooperated with a NGO (Pact) and a local mining company (Chemaf) to construct a mining and procurement mechanism from manageable designated areas (Concession Area).
In the leisure industry, Hilton explained that it is expanding its due diligence efforts to human rights risks other than the issue of "sexual exploitation" in the hotel industry. Specifically, in recent years, Hilton has created a human rights policy based on the Guiding Principles. They have been working to reduce human rights risks such as forced labour by improving their recruitment and employment practices, drawing on standards and human rights risk management mechanisms (such as RBA) of other industries.
On the issue of exploitation of migrant workers,NXP (automobile related product manufacturer) talked about their ethical employment practice of migrant workers from Indonesia at their own factory in Malaysia. To prevent migrant workers from paying expensive recruitment fees, NXP developed their "employers pay policy", and limited their large number of intermediary brokers to two agencies, and shifted to the conclusion of direct employment contract between migrant workers and NXP. In addition, the mining company Rio Tinto discussed how they addressed an issue of labor exploitation of workers (migrant workers) on their chartered-ferry that transported their products, and emphasized the necessity of human rights due diligence in their value chain.
Eight years have passed since the birth of the Guiding Principles and efforts made by corporations on human rights due diligence are also evolving. Challenges such as human rights risks within upstream supply chains and modern slavery risks have started to be addressed by governments and companies. In addition, the Forum also discussed human rights risks in other value chains and relevant practices to reduce them. Laws and regulations and the expectations of stakeholders around human rights due diligence are evolving, and actions like those discussed in the forum are beginning to be essential for companies to grow sustainably. Readers of this newsletter are also encouraged to participate in the annual forum on business and human rights next time to be held on o 25-27 November 2019 to witness the most up-to-date trends on human rights.
Regulatory trends on microplastics
In 2018, microplastics received significant media attention amid growing concerns on their health and ecosystem impacts. Within Japan this was, in part, prompted by the draft release of the Plastics Resource Strategy by the Japanese Ministry of Environment (MOE), as well as several high-profile restaurant chains announcing their intention to phase-out use of plastic straws. Additionally, the European Union’s (EU) first-ever Strategy for Plastics in a Circular Economy was adopted in 2018, establishing regulations to promote recycled plastics, and outlining concerns on the increasing rates of microplastics. Japanese companies trading plastic raw materials or products with the EU must understand the changing regulatory requirements, and take action to comply with the new requirements in a timely manner.
Although there is no globally standardized definition for microplastics, they are typically considered to be plastic particles smaller than 5mm in diameter. Last year concerns related to health and ecosystem impacts of microplastics garnered significant public attention, culminating in several high profile restaurant chains announcing their intention to phase-out use of plastic straws. In June 2018, the Japanese government amended the Act on Promoting the Treatment of Marine Debris※1 aiming to reduce the spread of microplastics, and is currently drafting a Plastics Resource Strategy※2, which includes reducing single-use plastics.
Policy for a Circular Economy in the EU
As part of the EU’s first-ever Strategy for Plastics in a Circular Economy, the EU has begun to establish new regulatory measures to promote recycled plastic materials, in addition to regulating microplastics.
This strategy further supports the existing European Commission’s Circular Economy action plan, released in 2015 (Closing the loop - An EU action plan for the Circular Economy)※3 . The action plan establishes a waste hierarchy, with descending priority given to waste prevention, reuse, recycling, and energy recovery, through to disposal. The plan highlights that promoting non-toxic material cycles and better tracking of ‘Substances of Concern’ would enable improved recycling rates. The subsequent 2018 EU Strategy for Plastics in a Circular Economy※4 included measures on (explained further below):
- the link between hazardous chemicals regulation and waste regulation;
- the regulatory framework for plastics with biodegradable properties; and
- microplastics pollution.
Reporting Substances of Concern in products
The EU REACH regulation※5, one of the principle EU regulations controlling hazardous chemicals, establishes a Substances of Very High Concern (SVHC) list. To bridge regulations on hazardous chemicals and those on waste, the Waste Framework Directive (Directive2008/98/EC)※6 was amended to request article※7 suppliers to report article that contain SVHCs above a certain threshold. REACH regulation requires suppliers to communicate SVHC information to downstream operators, while the amendments to the Waste Framework Directive now request suppliers to also notify public authorities, in addition to downstream operators. The intention is for this information will be utilized by waste disposal vendors, enabling increased recycled material use.
Restriction on oxo-degradable plastics and microplastics
It is currently being reviewed whether microplastics and oxo-degradable plastics will be added to the existing list of restricted chemicals within the REACH regulations (under ANNEX XVII).
In January 2019, it was proposed to prohibit microplastics※8 from placing on the market, where a substance/mixture included a concentration equal to or exceeding 0.01w%. Furthermore, labeling, information communication and annual reporting were proposed for materials containing microplastics, with some proposed exemptions such as use in industrial sites. The proposed requirements are, however, subject to change.
Given concerns on the degradability of oxo-degradable plastics in natural environments, their use is also under consideration. Requests for research related to this was collected up until May 2018, with possible amendments planned to be announced in July 2019※9 .
Registry of restriction intentions until outcome
Norn FoR THE ArrnNrrox or Mn G. DANCET, Exncurrvrc DrREcroR, ECHA: Request to the European Chemicals Agency to prepare a restriction proposal conforming to the requirements of Annex XV to REACH
Impact on Japanese companies
Both the Japanese government and private sector are working towards reducing use of microplastics, while the EU presses forward with new regulations and actions plans for promoting plastics recycling and limiting microplastics. Plasticizer-related regulations, that is substances added to promote plasticity in plastic materials, are also becoming more stringent, in line with these global trends.
Japanese companies manufacturing and trading plastic raw materials and products internationally, in particular with EU countries, must understand the changing regulatory requirements, and take action to comply with the new requirements in a timely manner.
Over the last 10 years, investors have come to place ever-greater importance on the role that environmental, social and governance (ESG) factors play when evaluating companies in which to invest. ESG factors have now become integral to the investment decision-making process for institutional investors around the world. This message has been the central theme of the fourth edition of EY’s research on institutional investor’s attitudes towards ESG and nonfinancial reporting, and its role in their decision-making.
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