Role of Finance in a Sustainable Society

Copyright JFS

Lecturer: Eiichiro Adachi, Head of ESG research center, The Japan research

I'd like to talk about the relationship between sustainable society and finance. Particularly in Japan, we have not actively discussed this link until recently. When I talk to people who are involved in finance, most do not think they are involved in the sustainability issue. They often say things like "We are not discharging smoke or using hazardous chemicals" or "If you ask us to care about environmental problems, there is little we can do because our business fluctuates frequently."

However, if you look overseas, environmental problems and financial actions are considered to be closely related. In the book Environmental Finance (written by Sonia Labatt and Rodney R. White; John Wiley & Sons, Inc.) published in 2002, the new concept Environmental Finance was described as the key in addressing the environmental issues of the modern industrial society, while ensuring the businesses continue to profit.

I have been attempting to bridge the above gap in Japan. Of course, the situation cannot be changed immediately, but I aim to educate young people going out into the world about the role of finance in a sustainable society.

When we think of the links between a sustainable society and finance, we can broadly consider "deposits or loans", "investing" and "insurance." I would like to talk about the former topics, "deposits or loans" and "investing."

Where do deposits go?

Most of you probably have a savings account at a bank, and the bank probably pays out a little bit of interest on your savings. When you need money, you can withdraw and use cash from your account. But is the money you save simply sitting in a safe at the bank? The answer is no. The bank pays out money to companies or individuals in the form of loans. For example, individuals borrow money from banks as home mortgages. Before lending money, the bank may require collateral to cover any remaining balance if the loan is not repaid. In addition, companies and individuals pay steady interest to the bank, and they pay the original principal within the assigned timetable. In fact, the interest for the savings you receive from the bank is part of the interest that the bank receives from loan customers. The bank makes a profit because the interest they receive is greater than the interest they pay out.

Introducing "Eco Bank"

Banks normally do not disclose detailed information about their customers. Of course, they conduct thorough researches to avoid problems such as bankruptcy and missed payments among their borrowers. But in principle, banks provide financing to whatever companies or individuals are planning to use the money, provided that the desired use is not illegal and that there is a good chance of repayment.

However, there are banks that conduct research into how money loaned will affect the environment. These banks also try to provide financing for activities that benefit environmental conservation. I first learned about these banks in 1992. Ms. Mineko Imaizumi, who lived in Freiburg, Germany, wrote a story in the magazine Global Net. The title of the article was "Bank for the Environment--Eco Bank." The article was about a bank called "Eco Bank", which was established in 1988 in Frankfurt, Germany. This bank only lent money to companies or projects that contributed to environmental conservation, while appealing to environmentally conscious depositors. The bank boasted about 30,000 depositors three years after it was founded. Before learning of this bank, I had not realized that such an approach was viable, but the story of "Eco Bank" helped me see the light.

Securities Investments and Mutual Funds

When individuals and companies want to maximize their wealth, they purchase company stocks. When you hold company stocks, and the company makes profits, you receive dividends. Furthermore, if the stocks are listed on the stock market, they can be bought and sold. The listed stock prices fluctuate daily depending on the relationship between people who want to sell the stocks and people who want to buy them. If you buy stocks at a low price and sell them at a high price, you will earn a profit. This is called price appreciation. Many of the investors come into the market seeking this. However, there is no guarantee that stock prices will rise as you expect. In fact, they also decline in value. If you buy stocks at a high price and you sell them at a low price, you lose money. This is a feature of stock investments.

It is difficult for individuals to find companies that will pay dividends in the future, or will experience increases in stock prices. Therefore, they buy and sell stocks through financial institutions, called asset management firms. In this case, fluctuations in assets are reduced by holding different classes of stock. This is the basic concept of mutual funds.

Eco-Fund and Socially Responsible Investment

When deciding which company's stocks to buy, some mutual funds carefully consider to what extent the company is carrying out activities for environmental conservation or activities related to the following social issues: corporate governance; fair economic trade; honesty to clients; labor practices; support for balancing work and life; accurate responses to global markets; and active involvement in social activities. Such investments are known as eco funds or socially responsible investment (SRI) funds.

Eco funds and SRI funds are based on the notion that increases in dividends or stock prices are expected, and there is a lower risk of turbulent stock prices in companies making great efforts in environmental conservation or that are willingly meeting social expectations.

Sales of mutual funds at bank counters began in 1998, and the banks involved conceived a unique product. This was the eco fund, which is a mutual fund involving investments in companies with excellent reputations for working in environmental issues. Although this was not the first financial product of its kind in Japan, the first eco fund bought and sold at bank counters was established in 1999. In this case, we researched the companies, the UBS (Switzerland) arranged and managed the funds, and Sumitomo Bank, Limited, sold the stocks.

Eco funds, SRI funds and thematic funds related to environmental conservation now account for nearly 800 billion yen of investments in Japan. As the funds we handle are increasing, half of my daily work accounts researching and reporting the environmental activities of listed Japanese companies.

Role of Finance in Sustainable Society

Let's summarize what I have talked about so far. What is an eco bank, eco fund and SRI fund? Essentially, they value and separate desirable and undesirable loan customers or investment destinations from the viewpoint of sustainability, and they direct actions of loan customers or investment destinations by creating a flow of money with favorable terms for desirable customers and with unfavorable conditions for undesirable customers.

For example, for companies or individuals wanting to obtain loans from a bank, it is a matter of great concern whether they can obtain the loan, and whether the interest rates are excessively high. If they cannot obtain the loan or if the interest rates are high because the actions of the companies or individuals harm the environment, they might change their actions. If company stock gets purchased because of their activities related to environmental conservation, thereby increasing the price of their stock, fundraising costs would decrease and this may motivate the company to more actively work toward environmental conservation.

In this way, finance activities can accelerate the establishment of a sustainable society. This is the principle role for finance in a sustainable society.

Concept of Market Evolution

Needless to say, companies are always evaluated at the market. If consumers do not purchase products that heavily burden the environment, companies will make greater efforts to produce environmentally friendly alternatives. If employees do not work for companies where safety and health are neglected irrespective of how well they are paid, companies will try hard to create environmentally friendly workplaces. When an evaluation criterion enters the market and becomes dominant, companies will try to correct their actions to gain higher evaluations from this new point of view.

The concept "Evolution of the Market", which was recommended by Keizai Doyukai (Japan Association of Corporate Executives) in 2000, discusses this notion and says that companies have a responsibility to improve social value and human value, as well as economic value. When value at the market is biased toward economic efficiency, it provokes a results-first policy or shareholder profit-first policy, and this tends to increase the distance from social demand or values that are reflected in Japanese culture, tradition and customs. For that reason, the market itself needs to evaluate companies from a comprehensive viewpoint, and companies should not only accept this evaluation from the market but also actively promote their beliefs in the market and society, demonstrating their initiatives to move in this direction. It is very interesting that such concepts were brought up by business managers. Eco banks, eco funds and SRI funds are concrete examples of such "evolution of the market".

UNEP Finance Initiative

The United Nations Environment Programme Finance Initiative (UNEP FI) was formed in 1992 by the European finance organizations and UNEP, headquartered in Nairobi, Kenya, which addresses world's environmental issues.

Finance organizations in Europe and the U.S. started becoming more conscious of the relationship between finance and environmental issues in the late 1980s, when concerns over emerging liability issues by the so-called Superfund Act appeared in the U.S. Thus, awareness of the role of finance in a sustainable society has existed overseas longer than in Japan.

The UNEP FI aims to determine ideal ways to operate by considering the environment and sustainability at every level for financial organizations, and spreading and promoting these ideas. In terms of concrete actions, they have organized the "International Roundtable on Finance and the Environment", in which opinions on the balance between economic development and environmental conservation are exchanged, and technical survey analyses directly linked to operations in the financial industry are announced. Recently, they have taken up themes focusing on global warming and investment in sustainable development.

The UNEP FI comprises over 170 financial organizations from around the world, and recent additions bring the total number of Japanese organizations to 18.

In Conclusion

Today, I talked about the financial roles in a sustainable society, focusing on eco banks, eco funds and SRI funds. I pointed out that when an evaluation criterion from the viewpoint of sustainability enters financial activities, companies are pressured to correct their actions. Today, we can see an increasing number of actions that try to create money flows in required areas, including nonprofit organization banks, citizen's green funds, local limited public issues, and microfinancing.

However, it is unclear at this time whether such financial activities will continue to increase without further social pressure. It is said that depositors or investors believe that environmental problems will become more serious in future, and so it is acceptable to loose their economic earnings; thus, such financial activities will become more common. On the other hand, it is also said that if depositors and investors do not want to sacrifice their economic earnings, provided that financial activities like eco funds are less profitable than existing activities, they will not become more common. Moreover, some believe that as financial organizations themselves are trying to carry out thorough risk control and capture new business opportunities before depositors and investors act, such new financial activities will increase without any further social pressure.

Which direction will the world go? I will finish up today by asking you to watch for results.

Profile

Eiichiro Adachi received his bachelor's degree in economics from Hitotsubashi University in Japan in 1986. He worked for Mitsubishi Research Institute during 1986-1989 as an industrial analyst. He is a senior researcher at The Japan Research Institute Limited, which was founded in 1989 and sponsored by companies in the Sumitomo group. Mr. Adachi is now engaged in CSR screening of listed Japanese companies for UBS Global Asset Management, Sumitomo Trust and Banking Co., Ltd, STB Asset Management Co., Ltd and Daiwa Asset Management Co. Ltd. He is also a project manager of research works regarding environmental finance and CSR that several ministries entrusted.