Growing risks from ESG/SDGs brought on by a wave of digitalization
- ESG investments will have a limited impact in the short term in terms of profitability (returns). However, the world has continued to make more ESG investments. As shown in Figure B, the Global Sustainable Investment Alliance (GSIA) announced in July 2021 that global ESG (environment, social and corporate governance) investments during 2020 amounted to USD 35.3 trillion (about JPY 3,900 trillion) (up 15% from 2018). Japan saw an increase of 32%, which translates to USD 2.9 trillion (about JPY 310 trillion).
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Source: Prepared by Deloitte Tohmatsu Group based on details from GSIA’s "Global Sustainable Investment Review 2020”
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- Why do ESG investments continue to see this much growth despite not outperforming other investments? One theory is that the risks from not proactively engaging in ESG/SDGs has grown. In recent years, a wide range of corporate scandals that include not only environmental issues, but also issues such as child labor and personal information leaks, have continued at an incessant rate. These scandals have not only resulted in simple penalties/compensation, but have also damaged the brand image of these companies, which has had an immeasurable impact on their profits. If there is a greater risk associated with investing in companies that do not conform to ESG standards, more ESG investments are likely to be made based on a risk-versus-return perspective, even if these investments have no impact on returns.
- For example, looking at which risks companies are focusing on (Figure C) reveals that, with the exception of COVID-19, risks stemming from climate change and workforce availability have significantly risen. Risks associated with climate change include not only physical, but also financial and reputational risks. As for risks associated with workforce availability, companies are facing growing risks not only from inhumane labor conditions (which is best exemplified by child labor), but also from the fact that workers are increasingly taking into account a company’s purpose (raison d’etre) and environmental/social contributions in selecting their workplace.
Source: Prepared by Deloitte Tohmatsu Group based on five years' worth of surveys (2018 to 2022) from Allianz Global Corporate & Specialty’s “Allianz Risk Barometer”
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- The number of ESG-related lawsuits has seen an increase in recent years, and the market for D&O insurance, which insures corporate directors and officers against damages, is on the rise. So-called “litigation funds” that provide funds for large-scale class action lawsuits against companies have emerged overseas, and the flow of funds to ESG lawsuits cannot be ignored. Tokio Marine & Nichido Fire Insurance revealed in November 2021 that it will consider utilizing ESG scores to determine D&O insurance premiums.
- In fact, the recent wave of digitalization has played a large role in exacerbating these risks from an ESG perspective. As written above, addressing social issues with a public goods aspect will contribute little in terms of returns. This leads to a dynamic in which the logical strategy is to leave the resolution of such issues to others, presenting a sort of “prisoner’s dilemma” from an economic sense. The main method to resolve such a “prisoner’s dilemma” and encourage cooperation would be to expose betrayal and to enforce stronger penalties. The former is especially effective because we live in a world where digitalization has allowed us to expose and document any corporate activity that works against ESG, as well as facilitate the quick spread of information. This will also leave a digital tattoo on companies that will not be forgotten for some time. An example of this could include a case in which a photo taken from a satellite reveals environmental damage, which in turn damages the value of the company. Our world is growing less tolerant of such betrayals due to greater public scrutiny brought about by digitalization, in addition to a growing demand to disclose more information from ESG-related initiatives.