Japan’s corporate governance stymies sustainable investing

Japan’s investing institutions are in an initial fad stage of integrating environmental, social and governance (ESG) factors into their investment analysis. But all the excitement may end up as little more than “greenwashing” that does not increase sustainability and profits. Why? Because Japan has begun its ESG road trip but the corporate governance driver is still largely asleep at the wheel.

Certainly, Japan has made substantial progress since 2014. The Ito Review identified sustainable value creation and constructive dialogue between corporations and investors as crucial to raising Japan’s sluggish productivity growth. Japan’s Financial Services Agency published a stewardship code and a corporate governance code.

But the biggest problem remains: many of the asset owners at the top of Japan’s investment chain have not been mobilised to hold boards and executives accountable.

Japan’s massive national pension fund, the GPIF, is doing its part. In its recently announced stewardship principles, it mentioned “the corporate governance codes of different countries” for the first time, and asked its asset managers to vote shares in line with the principles of those codes. It will require them to disclose their voting records.

The problem is in the private sector. Although hundreds of institutions (mainly fund managers) have signed the voluntary stewardship code, the signatory list includes only one non-financial corporate pension plan. Such “asset owner” investors are among the biggest customers of fund managers and, as such, can most influence their analysis, engagement and proxy voting practices by switching funds to the managers who are most dedicated.

Oddly, Japanese companies pride themselves on the strength of their covenant to employees, yet neglect employees’ pensions by failing to sign the stewardship code and report how they have handled those funds.

Why is this? Quite simply, Japanese companies are afraid that if their pension funds become more proactive, those same governance and proxy voting practices might come back and hit them in the face at their own shareholders meeting.

Recently, a study group set up by the Ministry of Health, Labour and Welfare ministry and the Pension Fund Association for the express purpose of “encouraging corporate pension funds to sign the stewardship code” issued its report. As a result, it is rumoured that the huge pension funds of two big companies, Toyota and Panasonic, are now considering signing the stewardship code. If they sign, others will follow, because it would be embarrassing to employees not to sign. As it should be.

This is progress but three years after the creation of the stewardship code, the pension regulator, the MHLW, should be doing a lot more than writing reports. Corporate pension funds should be required to include a statement of their policy about stewardship in their investment policies and to explain to employees each year why they have not signed the stewardship code, if they have not.

For reasons such as this, the “Japan Roadmap”, published by PRI, the UN Environment Programme Finance Initiative and the Generation Foundation, advises that Abenomics needs to stiffen its resolve so as to focus on behavioural change.

There needs to be enhanced reporting by investing institutions that have signed the stewardship code. The Financial Reporting Council in the UK has conducted a “tiering” exercise of reporting against its stewardship code — grouping signatories into three categories, based on the quality of reporting against the code. Japan’s FSA should do the same while also setting out clearer rules for collective engagement.

There is also a role, which many investors support, for the FSA and MHLW to assertively clarify that fiduciary duty for institutional investors in Japan should require ESG analysis. Such clarification has been effective in other markets.

At the same time, employee beneficiaries need to be able to sue pension plan trustees, sponsors and fund managers, or seek regulatory redress, if pension funds are not being professionally managed or oversight is insufficient.

For Japan’s ESG journey to be effective, continuously improving the investment chain and corporate governance substance must be the highest priority — building on lessons from other markets and adapting them. The upcoming revisions of the Company Law and the corporate governance code need to act as an upward ratchet. Policy must also lead to the reduction of cross-shareholdings by Japanese corporations, which weaken corporate accountability to shareholders.

Nicholas Benes proposed Japan’s Corporate Governance Code and is representative director of The Board Director Training Institute of Japan

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