The past few years have seen a notable rise in the number of companies auditing their sustainability data. This trend is largely a response to increasing pressure from various stakeholder groups for assurance on the reliability of corporate sustainability data. The rules about sustainability auditing are much less stringent than those that govern the auditing of financial data, and, accordingly, the extent and scope of an audit of sustainability data often varies significantly among companies in a given industry. This is because sustainability reporting is still largely a voluntary as opposed to mandatory activity, characterized by a lack of agreed-upon scopes and standards available to assurance providers.

As shown in the above chart, featured in Corporate Knights Capital’s 2014 World Stock Exchange Report, the number of large listed companies that conducted a sustainability audit grew from 237 in 2008 to 1,087 in 2012, an increase of 359%. Still, the 1,087 companies that conducted a sustainability audit in 2012 constitute only 24% (1,087/4,609) of the large listed companies included in this year’s study.

Assuring a sustainability report may be safely deemed a minority practice, but the trend line is clearly on an upward trajectory.

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This high growth is partly explained by the eagerness of Asia’s developing countries to catch up on infrastructure and capacity building. Gross capital formation, which measures the value of additions to an economy’s fixed assets – including land improvements such as fences, ditches, and drains; plant, machinery and equipment purchases; and the construction of roads, railways, and buildings – averaged 30% of the GDP of Asia’s 10 largest economies last year.

In China, for instance, gross capital formation accounted for almost half of the Chinese economy in 2013. For comparison, the gross capital formation of the United Kingdom during the Industrial Revolution was around 12% of GDP.

Bhutan, a country of just over 750,000 inhabitants that are landlocked between India and China, had the largest gross capital formation last year at 69.3% of GDP. In fact, gross capital formation in Bhutan has averaged 52.7% over the 10 years between 2004 and 2013.

Such a rapid build-up, however, is too often achieved at the expense of the natural environment and society. A good example is the extreme conditions suffered in 2013 by the residents of Beijing when a sandstorm and smog hit the city. This was blamed on the massive deforestation that occurred from the 1950s when trees were felled to serve as fuel for the steel-producing furnaces.

So which Asian countries are balancing economic, social and environmental prosperity? The Corporate Knights’ Sustainable Asia Scorecard has assessed 50 countries in the region using 25 quantitative indicators covering economic, social and environmental performance. Of these indicators, 15 measure the size, quality and efficiency of inputs and 10 gauge the quality of outcomes to rank the 50 Asian countries on their sustainable development performance.

Singapore came out on top, with strong performance on most of the 25 equally weighted indicators, obtaining top marks on six categories – water productivity ($GDP per use of one cubic metre of water), rule of law, regulatory quality, preservation of natural resources, gender equality and transparency. Japan, South Korea, Hong Kong and Israel round up the top five. China closes the top 10 with strong performance on national savings but (not surprisingly) among the weakest on GHG Productivity ($GDP per tonne of GHG emitted).

While the scorecard is most useful to inform policymakers as to where areas of strengths and weaknesses lie, it can also be useful for investors with an opportunity to benchmark best practices. Bond investors, for instance, seeking exposure to Asian economies and who at the same time want to “green” their sovereign bond holdings, will pick sovereign bonds issued by countries that have achieved a balance between economic, social and environmental development. Likewise, equity investors concerned with sustainable development would want to invest predominantly in stocks of companies operating in the countries at the top of the scorecard.

The scorecard can also be of use to multinationals to identify areas of opportunities for business growth. For instance, a country with strength in the percentage of energy from renewable sources might be an interesting growth market to a clean technology company. With water becoming an increasingly limited natural resource generally, a country experiencing low water productivity would be a candidate for utilities management companies to set up shop. A healthcare company would be well advised to expand its presence in a country experiencing a low life expectancy and high urban air pollution score as these are leading indicators of chronic need for better health care services. A high rate of gross capital formation represents an opportunity for infrastructure companies to line up for projects in those countries. Yet another application will be in terms of a country’s performance on occupational injury and fatality, which act as an indication of a potential need for workplace safety consultancy services.

With many multinationals seeking to establish a presence in Asia, the Scorecard can also serve to inform a company’s decision for locating their offices. For example, with a high rate of education expenditure, rate of innovation and tertiary enrolment rates in Korea, this country could be a prime target for locating a company’s R&D facilities.

Most will argue that as a country goes through a phase of rapid industrialization, imbalances in economic, social and environmental development are unavoidable. However, as a country becomes wealthier, and its population aspires for higher standards of living, it can evolve towards a more balanced and sustainable growth. The developed world today went through such transformation and it is only a matter of time before Asia has its turn.

In fact, China’s CO2 emissions per US$ of GDP have already gone down from 1.72 kg in 2008 to 1.07 kg in 2012, a sign that economic activities in China are gradually becoming less carbon intensive. It’s a real indication that this transformation has begun. For this, business opportunities ranging from clean energy technologies, low-carbon intensive transportation to sustainability consultancy services are expected to grow significantly.

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Most of the disasters cited were of the kind expected to become more severe and frequent due to climate change – damage and life loss associated with flooding, storm surges and high winds. Flooding rivers alone are expected to affect 380 million people globally, most of them in Asia.

Developing countries in this area of the world, by many measures, are at a crossroads. Together, they are home to a majority of the world’s poor. According to the Asian Development Bank (ADB), more than 600 million still have no access to electricity and nearly two billion still use highly polluting firewood and charcoal to cook food and heat homes.

At the same time, these countries are growing fast – and we’re not just talking population. Myanmar, which we profile on page 54, has seen its GDP grow 6 per cent to 10 per cent annually since 2000. That range of growth, shared over the past decade by economic titans such as China and India, is expected to continue as Myanmar opens up its economy to the world.

Such growth has its consequences. For one, it has created an insatiable appetite for energy, demand for which is growing faster than GDP. By 2035, developing Asia is projected to account for 56 per cent of worldwide primary energy use. That’s up from 34 per cent in 2010, according to ADB. Where that energy comes from – renewables, nuclear or fossil fuels – has huge implications for the climate and global sustainability.

The impact on public health also cannot be overstated. The Lancet, one of the world’s most respected medical journals, recently dedicated an entire issue to what it called a health “time bomb” ready to go off in China. Rising standards of living have also driven an increase in obesity and substance abuse. This, along with environmental pollution caused by a fossil-fuel dependent energy system, has boosted rates of cancer, heart disease and diabetes. Such chronic diseases, according to an editorial in the journal, “are now China’s number one health threat.”

Change is happening. Geothermal is being developed in Indonesia. Growth in coal use in China is starting to fall. India has embraced solar. Myanmar is working to put more social and environmental safeguards in place. And island nations like the Maldives, which we spotlight on page 54, are pursuing aggressive adaptation strategies. But is it enough? Is it happening fast enough?

Clearly, when it comes to sustainability performance, some countries in the region are doing better than others. Perhaps not surprisingly, Singapore ranks at the top of the list. This is according to Corporate Knights’ first Sustainable Asia Scorecard, which ranks all countries in Asia (as defined by the United Nations Statistics Division) across 25 sustainability indicators.

These indicators cover a lot of ground – from each country’s natural, human and social capital to health, quality of life, education and gender equality.

[highcharts chart=’4264′ performer=’ALL’ measurement=’Total’ order_field=’Total’ order=’DESC’]

To download an Excel sheet of the data used to calculate this year’s ranking, click here.

Of the 50 countries assessed, it is no surprise that the Top 5 (and six of the Top 10) are considered by the International Monetary Fund to be “advanced” economies – Singapore, Japan, South Korea, Hong Kong and Israel, in that order, with Cypress coming in ninth.

The rest would be considered “developing” or “emerging” economies. Of these, Malaysia ranked highest (sixth place) followed directly by Turkey and Thailand. China just squeezed ahead of Indonesia to take 10th spot.

Looking at all the data, Corporate Knights walked away with the following observations:

• Hong Kong scored highest on energy and greenhouse-gas emissions productivity, while Singapore got top marks for water productivity. Being among the most resource-deprived countries in Asia, the need for them to embrace efficiency of resource use makes sense as a matter of survival.
• In places like South Korea, we saw a direct correlation between rates of education enrolment and number of patents per unit of labour. Generally, the higher the education rates, the more patents produced per capita.
• More advanced Asia economies tend to have a greater inequality gap.
• There is generally a direct relationship between higher GHG productivity and life expectancy.
• The Philippines, which at 14.6 per cent has the highest percentage of non-hydro renewable power in its mix, scored second best on the air pollution indicator

Perhaps our most surprising observation is that there is no obvious relationship between urban air pollution and life expectancy. Deaths are probably caused by a host of other environmental, social and demographic factors.

Click here to go back to the ranking landing page.

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What distinguishes the Global 100 from many other sustainability rankings is the nature of its methodology. Instead of relying on analyst judgment or rolled up “black box” sustainability scores, the Global 100 is driven exclusively by how companies perform on a set of 12 metrics covering resource, financial and employee management. Coupled with this “data driven” approach, every aspect of the project, including how each metric is calculated, and how the starting universe of about 4,000 stocks is whittled down to 100, is detailed on the Global 100 website.

This transparency has been a critical factor in the Global 100’s success. In the often murky world of corporate sustainability reporting, stakeholders take a certain comfort level in being able to replicate the Global 100 using the same data inputs as those available to Corporate Knights.

Over the years, the Global 100 has granted its coveted number one position to several recognized leaders in corporate sustainability, including Umicore, Novo Nordisk and Statoil. While the Global 100 is unique in the sense that it uses a data-driven approach to measure something as outwardly nebulous as corporate sustainability performance, from an investor standpoint it is simply a portfolio of 100 global stocks that turns over annually. Given mounting evidence about the long-term connection between sustainability and financial performance, it is worth examining how an investment strategy built around the Global 100 would have fared.

Let’s pretend an investor had purchased one share of each company in the inaugural 2005 Global 100, held those shares for one year, and then replaced them with shares in the next Global 100, then buying and selling shares subsequently to reflect each and every successive annual Global 100 ranking to date.

This strategy, running from February 1, 2005 to October 31, 2013, would have generated a total return of 87.9 per cent. The MSCI All-Country World Index (MSCI ACWI), an appropriate benchmark for a global large-cap equity portfolio, returned 81.1 per cent over the same period. This means the Global 100 has outperformed its benchmark by 6.8 per cent on a cumulative basis since inception.

As most fund managers can attest, beating the benchmark is not easy. It is widely known that most actively managed portfolios fail to consistently beat their benchmarks over time. That the Global 100 – a portfolio of 100 stocks selected using only corporate sustainability data – has outperformed its benchmark since inception makes it doubly interesting.

If we extend this experiment to consider other globally focused “conventional” stock indices, the story does not change. Over the same period, the Global 100 outperformed the FTSE Developed Index by 13.5 per cent and the S&P Global Broad Market Index (S&P Global BMI) by 25 per cent.

Let’s look under the hood of the current crop of Global 100 companies to better understand where some of this performance is coming from. Looking at year-over-year results, Alcatel-Lucent (EPA: ALU) is the top performing stock in the 2013 class. In the first nine months since the release of Corporate Knights’ 2012 ranking, Alcatel-Lucent shares generated a return of 115 per cent.

Novo Nordisk (CPH: NOVO-B) is another success story. First, it is one of only nine companies (the others being Adidas, Centrica, Intel, Kesko, Ricoh, Royal Bank of Canada, SAP and Unilever) that have managed to remain on the Global 100 every year since 2005. Second, it is the single greatest contributor to the cumulative total return of the Global 100. In the nearly nine years since the inception of the ranking, Novo Nordisk’s contribution to the total return of the Global 100 stood at 270 per cent. Based in Denmark, the health care company has long been recognized for its focus on the “triple bottom line” and embedding a broad and long-term view into its organizational strategy.

The Global 100 has gained credibility in the business world because it uses clearly defined indicators and the overall ranking process is transparent. And it turns out that these indicators could serve as proxies for outperformance in the markets. More research is needed to fully flesh out this thesis, but on its merits the financial performance of the Global 100 is difficult to ignore.

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The factory collapse in Bangladesh back in April this year is an interesting example. That factory was supplying garments to several major clothing retailers around the world. Those suppliers have a material impact on a (retailing) company’s operations, with labour issues always representing a serious reputational risk. In the wake of that catastrophe, how would this hit the sustainability books of the retailer?

The newly-minted Global Reporting Initiative’s 4th generation guidelines, G4, may provide some answers. Departing from its previous iterations, G4 emphasizes the concept of materiality. This is defined as any issue – environmental, social and/or economic that is significant enough to influence the decisions of various stakeholders – both internal and external to the organization. Material issues usually pose significant risks for the organization, which expose them to tremendous short-term and long-term financial impacts. Indeed, that very factory collapse in Bangladesh caused at least one of the factory’s clients to pay a hefty sum to compensate for the loss of lives. According to the G4, sustainability reports are to contain information on performance regarding the most material aspects. So, if we accept the fact that sustained supplier operations do have a material impact on a retailer’s business, based on this principle, we would expect retailers to start reporting more extensively on the environmental, social and health & safety issues touching those suppliers. Furthermore, G4 now has an expanded list of indicators when it comes to reporting on labour practices. For example, indicator LA15 requires the disclosure of significant actual and potential negative impacts for labor practices in the supply chain and actions taken.

The other dramatic change brought forth by G4 is the way in which the reporting organization’s boundaries will be determined – part of what G4 calls “completeness”. Previously, an organization’s boundary was defined by the extent of the organization’s control or influence over a given entity – examples include a joint venture, a subsidiary or a contractor. If a given entity was beyond the reporting organization’s boundary as described above, performance reporting would generally not consider the figures from these entities. Under G4, boundaries are now determined by looking at where the material impacts occur throughout the whole supply chain. Therefore, if labour practices at the supplier level are a material issue for the reporting company, one would expect that it would be included in the reporting company’s sustainability report.

While all these developments are encouraging, we should remain realistic to the fact corporate sustainability reporting remain largely voluntary, with limited levels of assurance on the performance data being reported. Corporations tend to be transparent only to the extent that positive stories are told; the negative side of things are usually toned down if not omitted completely from corporate publications. The revised concepts of materiality and the determination of boundaries being more principles-based leave the door open to various subjective interpretations as to the applicability of one or more aspects to different reporters within the same industry. Furthermore, the G4 guidelines are a reporting framework and do not inform the reporting entities nor their stakeholders as to where the entity is at in terms of its journey towards sustainability – something that a standard or benchmark for sustainable business performance would be better equipped to handle.

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Corporate Knights applies a broader corporate sustainability lens to company tax payments. By measuring cash payments for taxes as a proportion of EBITDA, Corporate Knights is seeking to identify companies engaged in aggressive tax minimization strategies. Those avoiding paying their fair share of taxes are penalized for not upholding their end of the social contract. Facing increased government efforts to clamp down on tax minimization strategies, companies that are structured to minimize tax liabilities are facing increasing risks and may find themselves in an uncomfortable position should they be required to unwind their tax-efficient set-ups. The financial consequences of such an event would likely be harder to bear, compared to companies that do not need to significantly alter their organizational structures.

It is no surprise that the link between corporate tax payments and corporate sustainability has attracted the attention of the academic world. Dr. Prem Sikka of the University of Essex noted in a 2010 paper that there are considerable gaps between corporate claims of ethical and socially-responsible conduct and tax practices. Where such gaps exist, it is possible that those companies will also be engaging themselves in other non-ethical and socially-unacceptable behaviours such as paying bribes or industrial espionage. This topic is beyond the scope of this article, but may be an interesting area for future research.

When such “hypocritical” behaviours are exposed the company faces fines, imprisonment for some company executives and hostile press coverage. A company’s payment of its fair share of taxes can be viewed as a litmus test for claims of social responsibility. “The possibilities of social responsibility rest on the alignment of corporate culture with the social expectations that companies will honour their publicly espoused goals”, argued Dr. Sikka. While a number of companies fulfil their social commitment by paying their share of taxes, the majority of companies continue to not live up to social expectations when it comes to tax payments.

Roman Lanis and Grant Richardson, from the University of Technology – Sydney and the University of Adelaide examined 408 Australian corporations for the 2008/2009 financial year. Using regression analysis, they found that the higher the level of CSR disclosure by a corporation, the lower the level of corporate tax aggressiveness was. The underlying assumption made here is that CSR disclosure is a proxy for the quality and level of commitment of the corporation’s CSR agenda. Other research papers conducted on the subject have displayed more mixed results. Perhaps the initiative by the Australian tax authorities in the early 2000 may in part explain the findings by Lanis and Richardson. Australian corporations were encouraged to embed a consideration of risks associated with tax and their effects into strategic decision-making at the board of directors level.

Corporate boards are increasingly intensifying their involvement in the corporation’s CSR activities, making it possible to infer that board influence may have impacted CSR activities, disclosure and attitude towards tax risks. “The linking to corporate governance and the enhanced involvement of the board of directors in the company’s tax strategy result in its becoming more sustainably geared to the longer-term corporate goals and being less aligned with short-term tax minimization,” argued Urs Landolf, Leader of PricewaterhouseCoopers tax and legal practice in Europe in 2006.

Efforts to establish the drivers of socially-responsible corporate tax payments have led to inconclusive results so far. What has become clear is that the traditional idea where corporations should adopt tax minimization strategies to satisfy short-term financial imperatives is increasingly being challenged by an emerging view that corporations should consider the long-term impact of their tax risk profile in order to ensure sustainable growth. Corporate Knights’ attempt to reward the socially-responsible corporate tax payer by measuring payments for taxes against EBITDA is a testament to that emerging wisdom.

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The other much anticipated event that is the advent of integrated reporting (IR). Spearheaded in late 2011 by the International Integrated Reporting Council (IIRC), a coalition of the accountancy profession, investors, businesses and regulators, IR is a process that results in communication about how an organization’s strategy, governance, performance and prospects lead to the creation of value over the short, medium and long term. Dubbed the “next step in the evolution of corporate reporting”, it is a holistic view of a reporting entity’s performance, risks and opportunities pertaining to six categories of “capitals”: financial, manufactured, human, intellectual, natural and social. The IIRC is set to release its first version of the Integrated Reporting Framework in December 2013, which is already stirring significant interest.

Since 2009, an increasing number of companies have published what can be loosely labelled as an “integrated report”. Perhaps the most notable step towards IR to date has been the adoption of mandatory integrated reporting requirements by the Johannesburg Stock Exchange in 2010 as a listing requirement. In Australia and the Netherlands, various studies and surveys have been published on the rate of adoption of IR by publicly-listed companies since early 2010. In our 2013 Global 100 Most Sustainable Corporations ranking, 18 companies published an integrated report.

In a prototype version of the IR framework released in November 2012, one of the four objectives of IR is to “inform resource allocation by providers of financial capital that supports long term, as well as short and medium term, value creation”. This commitment to inform investment decision-making has deep implications for Corporate Knights, and in particular its flagship Global 100 Most Sustainable Corporations Ranking (Global 100). Since its inception in 2005, the Global 100 has sought to identify the 100 leaders in terms of social, environmental, governance and financial performance. Indeed, as at 31 December 2012, the Global 100 companies have outperformed the MSCI All-Country World Index by 9.5% on a cumulative basis since 2005 (see figure 1).

A widespread adoption of IR will present significant opportunities for Corporate Knights’ Global 100 methodology. Over the years, Corporate Knights has brought a number of improvements to its Global 100 ranking methodology to better reflect changes in disclosure practices creating indicators that distinguish companies that are susceptible to long-term environmental, social and financial performance. It is interesting to note that the methodology employed for the Global 100 as it stands today shares a number of interesting similarities with some of the reporting requirements under the prototype IR framework introduced earlier.

As stipulated above, the IR framework is primarily geared towards responding to investor information requirement. THe similarity in some of the Global 100’s key performance indicators and the IR framework’s standards may imply that the Global 100 is well-equipped to assess companies for capital allocation decisions. IR is still an evolving concept and its implementation in South Africa is a source of learning opportunities; Corporate Knights will follow these developments closely.

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