Risk Management Framework
In order to reinforce its framework for managing business risks for the entire Group, Sumitomo Forestry has created the Risk Management Basic Regulations and has appointed the President of Sumitomo Forestry as the highest authority on risk management for the Sumitomo Forestry Group, Executive Officers in charge of Head Office Department and each Division have been appointed authorities on risk management of their department, and general managers have been appointed to promote risk management. The Regulation encompasses risks in environmental, social, and governance aspects, comprehensively.
In addition, the Risk Management Committee comprised of Executive Officers as members is held once every three months in accordance with the Regulation to identify and analyze management risks as well as share and discuss plans to respond to those risks that have been formulated. A Compliance Subcommittee and a Business Continuity Management (BCM) Subcommittee have also been established under the command of the Risk Management Committee to carry out specific activities for increasing effectiveness of responses to compliance and business interruption risks regarded as cross-sectional risks affecting the Group. The Board of Directors receives reports on these activities while management has put in place a system to reflect this in business execution, such as the implementation of management reviews. In fiscal 2022, Risk Management Committee was held four times, Compliance Subcommittee was held twice, BCM Subcommittee was held twice, and reports to Board of Directors were made four times respectively.
We keep developing specific activities to improve the effectiveness in our response to environmental, social, and governance risks and emerging risks described in Sumitomo Forestry Group Code of Conduct. With respect to climate change, for example, international trends are considered together with the business condition of each Division in order to evaluate risks and opportunities that are thought to have a severe financial impact at the corporate and divisional levels. Since fiscal 2019, each Division joined together in conducting TCFD-based scenario analyses.
The Sustainability Committee discusses items determined through this process to be priority risks in the medium to long term, reports to the Board of Directors about its activities in the same way as the Risk Management Committee, and reflects this into business execution.
Risk Management Structure of the Sumitomo Forestry Group
Risks in Operations
The following risks have been identified in operations as stated on the Security Reports.
- Risks related to trends in housing and real estate markets worldwide
- Risks related to procurement and sales of raw materials, timber and building materials
- Legal and regulatory risks
- Foreign exchange risks
- Quality assurance risks
- Credit facility risks of business partners
- Overseas business risks
- Risks of mountain forests and plantation forest operation locations held and managed
- Risks involving information security
- Risks in accounting retirement benefits
- Risks regarding the environment including climate change
- Risks of emergency situations caused by natural disasters, etc.
Risks associated with quality assurance
Sumitomo Forestry Home Tech (Home Tech), which is undertaking a reform project, announced its Non-Conformance to Building Standards Act (This Case) in the extension work of detached houses on September 18, 2019. Home Tech conducted an on-site examination of the extension works to the detached houses in the prefectures of Aichi, Mie and Gifu (the "Three Tokai Prefectures") that it had contracted for in the past. Furthermore, on September 27, 2019, Home Tech established a special investigation committee composed by members including outside experts (the "Special Investigation Committee") and requested that the Special Investigation Committee investigate the facts, analyze the causes of the Incidents and propose recurrence prevention measures, and received "Report" ("This Report") from the Special Investigation Committee on August 11, 2020.
Based on the contents, Board of Directors of Home Tech held on the 12th of the same month confirmed the cause of This Case and resolved the countermeasures to prevent its recurrence, and are proceeding with the response.
Outline of the results and progress of investigation by Home Tech
Certain input from outside parties gave rise to a suspicion that non-conformance with the building standards laws and regulations (the “Legal Non-conformance”) existed in part of the properties in the Three Tokai Prefectures whose extension works had been contracted for by Home Tech. In response, Home Tech conducted an exhaustive investigation of all of the 361 properties that had received construction confirmation, from among the detached houses in the Three Tokai Prefectures regarding which Home Tech had contracted for extension works since April 1997, when Home Tech started its business as a company specialized in renovation, in order to identify whether those properties conformed to the building standards laws and regulations as of the survey date (the "Legal Conformance").
As a result of the investigation, we confirmed that 219 of the 347 cases for which the case inspection was completed as of December 31, 2022 had Non-conformance with the Act, and 129 of them had been repaired. These Legal Non-Conformances were all caused by the fact that the design work that should be adapted to the Building Standards Act had not been properly implemented, and the work necessary to conform to the Act had not been incorporated into the design. Home Tech will endeavor to promptly carry out the necessary repair works with respect to which the Legal Non-conformance has been confirmed.
The impact of the Incidents on our results of operations has already been reflected in the consolidated financial statements disclosed in the annual securities report of Sumitomo Forestry for the 80th term that was filed with the Director of the Kanto Local Finance Bureau on June 23, 2020.
Causes of the Incidents
On the basis of the analysis of the causes of the Incidents contained in the Report and the results of the investigation of the properties conducted by Home Tech, Home Tech believes that the combination of the problem indicated in (4) below with the existing problems specified in (1) through (3) below was the main cause of the occurrence of the Legal Non-conformance in part of its extension works to detached houses in the Three Tokai Prefectures.
(1) Building designers lacked sufficient knowledge and experiences and had a low regard for ensuring the Legal Conformance;
(2) No organizational checks had been conducted to ensure the Legal Conformance of design work;
(3) The managing architects stationed at each of the branches, who were supposed to supervise the technical matters in the architectural office, were not in a condition to fulfill their functions to oversee the design work by the architects belonging to their respective branches; and
(4) With respect to checking of the Legal Conformance of the design drawings, the scope of the tasks outsourced to independent architectural offices was not clear, and the deliverables of the outsourced tasks had not been sufficiently checked.
Recurrence prevention measures based on the Incidents
Home Tech takes seriously the Special Investigation Committee's proposals for prevention of recurrence as described in the Report and will seek to implement the following recurrence prevention measures:
Raising of awareness of compliance of design work with laws and regulations, acquisition of pertinent knowledge and accumulation of relevant experiences;
Reinforcement of organizational checking systems to ensure the Legal Conformance of designs;
Improvement of outsourcing to independent architectural offices; and
Enhancement of communications between the head office and branches as well as sharing and accumulation of technical and technological information.
Risks Associated with Illegal Logging and Conversion Timber
Illegal logging is recognized as a crucial issue globally, and progress is being made to strengthen related laws and regulations in a number of countries and regions. Japan has announced the Act on Promotion of Use and Distribution of Legally-Harvested Wood and Wood Products (The Clean Wood Act) on May 20, 2016, which was enacted on May 20, 2017. Addressing stronger control of illegally harvested wood not only responds to the requirements of the world but it is also extremely important for the Sumitomo Forestry Group to continue businesses sustainably. Fiscal 2020 results of departments and affiliated companies registered by the Sumitomo Forestry Group have been reported to each registration agency certified by the Japanese government. In addition to legality of the procured timber and wood products, sustainability of forests that produce wood has been in question recently. "Conversion timber" is timber generated during the conversion of natural forest areas to non-forest use (such as oil palm plantation). While the conversion to farm land is often discussed from the commodity side (oil palm, soy, rubber and cattle), conversion timber now poses sustainability risks to forestry industry.
Impact on the Sumitomo Forestry Group
The Sumitomo Forestry Group could jeopardize its own businesses that handle wood resources if it neglected its duty and dealt in illegally logged timber. Moreover, these actions would harm the image of the Company and could directly damage our business performance such as compensation for damage and turnover.
The Sumitomo Forestry Group has been committed to responsible wood procurement, pioneering legislation in Japan and having established the Timber Procurement Philosophy and Policy in 2005, to bring contributions to a sustainable society via business activities of “wood” -a renewable resource. In 2015, Timber Procurement Philosophy and Policy was extended beyond wood and became subject to procurement of building materials, raw materials of products, and end products, and reestablished as Sumitomo Forestry Group Procurement Policy. We have also been engaged in responsible wood procurement activities since 2018, formulating the Timber Procurement Management Regulations and Timber Procurement Due Diligence Manual among other measures. Sumitomo Forestry has drafted and is executing an action plan to accomplish by the end of fiscal 2021 founded in the fiscal 2019 actions for strengthening due diligence through the Timber Procurement Committee and diffusing the use of sustainable forests and wood to promote the procurement of timber from more sustainable forests.
Risks Associated with Carbon Accounting on Biomass Fuel
Biomass power generation using wood chips and wood pellets as fuel has been considered as "carbon neutral" and as clean energy. However, since burning wood fuel generates methane (CH4) and nitrous oxide (N2O), making it not "GHG neutral," it is only required to report emissions other than CO2. However, SBT initiative announced its updated criteria in April 2021;
Direct emissions from the combustion of biomass and biofuels, as well as GHG removals associated with bioenergy feedstock1, must be included alongside the company's inventory and must be included in the target boundary when setting a science-based target and when reporting progress against that target. If biogenic emissions from biomass and biofuels are considered climate neutral, the Company must provide justification of the underlying assumptions. Emission of N2O and CH4 by bioenergy raw materials must also be included in the Company inventory and targeted range.
Nevertheless, detailed information is not yet available from the initiative, nor the guidance on what could be the justification for biomass to be considered climate neutral.
Impact on the Sumitomo Forestry Group
Sumitomo Forestry operates five wood biomass power generation plants in Japan and is currently planning to add another in 2023, which would generate total of 251.6MW.
If it is required to add CO2 emissions to currently reported methane (CH4) and nitrous oxide (N2O) from the biomass power generation operation, Sumitomo Forestry Group's SBT emission reduction target would be extremely challenging.
Climate-related regulation changes in each regions/countries are unpredictable and may cause the Company additional payment if carbon pricing incurs additional tax payment. Sumitomo Forestry's corporate brand image of being an environmentally friendly company may also be negatively impacted.
Sumitomo Forestry continues to strive to reduce carbon emissions based on its Mid-term Sustainable Targets for each business units. Also, Sumitomo Forestry is becoming more active in lobbying through the Forest Solution Group of the WBCSD (World Business Council for Sustainable Development) and CDP Japan Club, where Sumitomo Forestry serves as member.
Risk Associated to Emerging ESG Mandatory Disclosures
In June 2023, the International Sustainability Standards Board (ISSB) released its inaugural standards which set out requirements for sustainability-related (IFRS S1) and climate-related (IFRS S2) financial disclosures (ISSB Standards) for business entities. The new standards consolidate the requirements of multiple other leading sustainability reporting frameworks and is expected to be mandated by regulatory authorities. While it is a welcoming trend for business in a long run with a globally unified standard to report against and lowering cost of sustainability disclosure, transitional period poses a great risk for companies to adopt to new mandates coming into forces on a different time scale in each country.
Impact on the Sumitomo Forestry Group
Sumitomo Forestry, headquartered in Japan and listed on the Tokyo Stock Exchange Prime Market, is required to follow the regulations by the Financial Agency of Japan, which plans to adopt the ISSB standards in 2025. In addition to Japan, the Group has its operations in, sources from and sell to about thirty countries, and each jurisdictional decision would affect the Group. These sustainability disclosure requirement trends coincide our rapid growth in overseas operations through merges and acquisitions and collecting and managing especially social aspects of non-financial data and measures poses challenges to the Group.
While Scope 3 disclosure has already been realized and been updated, among already known requirements, below are time consuming and cost rising items we need to adopt; simultaneous reporting with the financial statement, connected information to sustainability-related risks and opportunities linking to the financial reporting information, and potentially broader third-party assurance to name a few. With IFRS intention to expand the disclosure content, biodiversity, human rights in supply chain and human capital development are in scope for the future requirements. Failing to meet these disclosure requirements or disclosing incorrect information would risk our access to market, which jeopardizes the fundraising.
Sumitomo Forestry Group has been conducting Internal Sustainability Survey since 2012 to collect non-financial data, review sustainability readiness of each Group entity and to implement any necessary measures to mitigate risks. Building up on these initiatives, we plan to incorporate necessary measures in the upcoming mid-term sustainability target.
New Business Plan Risk Assessment
All new business and project plans that are brought for deliberation to the Board of Directors and the Executive Committee, which is the advisory body to the president, Sumitomo Forestry conducts risk assessment for the following categories, considering the entire supply chain. If a risk is confirmed, a report is made regarding the risk and measures to deal with it, which is used to determine implementation. In addition, the same risk assessment is recommended for new business projects that are not brought for deliberation to these meetings because they can be implemented under the jurisdiction of the respective Division or affiliated company. In fiscal year 2022, 35 new businesses and projects were discussed.
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Understanding and Assessing Housing and Real Estate Development Risks
Properly understanding the geological and geographical risks unique to each property is vital in the development of housing and real estate. The Sumitomo Forestry Group has put in place the necessary systems to verify whether there are any issues through careful surveys at the assessment stage of development in addition to other multistage checks done before determining how to implement a project.
In overseas development, for example, we first select the land to develop and then outsource soil and environmental surveys to external research firms to fully understand the risks from an objective standpoint. We not only ask local affiliated companies to give their input on risks but the Sumitomo Forestry head office also conducts property inspections and environmental and social impact studies using its own sustainability risk assessment sheet for projects larger than a certain scale. Management also provides feedback through meetings at the Sumitomo Forestry head office to analyze risks from diverse multistage perspectives. We only engage in projects determined to be acceptable through this process.
Construction also comes with the risk of occupational accidents during the construction phase. Sumitomo Forestry complies with occupational health and safety laws and works to prevent occupational accidents at local affiliated companies and also puts in place systems to immediately report any accident that occurs to the headquarters so it can quickly understand what happened as well as plan and execute measures to prevent recurrence.
We not only provide risk management and compliance training when Executive Officers and employees join the Company but also conduct e-learning for all Group Executive Officers and employees every year to enhance the risk sensitivity of Sumitomo Forestry Group Executive Officers and solidify it in our corporate culture.
In addition, we are periodically conducting training on corporate law and corporate governance, including those of Sumitomo Forestry's independent Board of Directors and external statutory auditors.
Rapidly Comprehending and Dealing with Risks
The Sumitomo Forestry Group operates Two-hour Rule system designed to quickly and accurately communicate information to management in the event of an emergency situation that may have a grave impact on company management. In addition to the regular reporting line, it utilizes communication via the Division responsible for risk management. Through this system, management can take the best decision speedily, ensuring an initial response which avoids loss and controls the situation. Moreover, it serves a role in collecting and accumulating reported cases and assists in improved business practice and prevention of recurrence.
At our overseas offices, too, there are examples of employees providing feedback with regard to the details of risk assessments. For example, this includes the process where each department identifies latent risks during risk assessment activities and reports them through weekly safety meetings or the presence of reward systems that provide a reward to proposals when a near miss occurs, such as an event that could lead to a serious accident. Through this initiative, we are raising awareness among employees to make it easier to discover risks.
Furthermore, the structure is organized so that, by sharing information with the public relations departments, important situations are disclosed to stakeholders properly and in a timely manner.