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Japan – land of the rising ESG

Investors globally are increasingly focused on environmental, social, and corporate governance (ESG) for their investment decisions. The global market for ESG investments is growing rapidly – with Japan surpassing the rest of the world in terms of growth. While responsible investment took a while to get going in the country, the Japanese government has been adopting various new policies and regulations to boost ESG integration.

And the potential is huge. While Japanese ESG investments represent only about 8% of the global market, it registered a 5.8-fold increase from $0.5 tn in 2016 to $2.9 tn in 2020, according to data compiled by the Japanese Ministry of the Environment. The global market for ESG investments grew to $35.3 tn in 2020 from $22.9 tn in 2016, registering a 1.5-fold increase.

Japan’s ESG-pro policies

The Japanese government and regulators have been working towards providing one of the niche markets for green finance and responsible investing in Asia.

The Financial Services Agency (FSA) has recently taken measures to keep a watch on listed Japanese companies that are claiming to be environmentally friendly. Therefore, to give investors more clarity on insights into listed companies, the FSA has proposed a climate regulation that could compel Japanese companies to make mandatory climate risk-related disclosures. This could take effect by 31 March 2022 at the earliest.

Additionally, the Japanese financial regulator plans to look into new rules for financial products that are marketed as being ESG or sustainability-focused in order to protect investors from greenwashing.

At the recent COP26 climate summit, Prime Minister Kishida has reaffirmed the country’s goal to achieve carbon neutrality by 2050, and reduce greenhouse gas emissions by 46% in 2030. The country’s ultimate decarbonization target has led to a plethora of announcements on new ESG policies as well as revisions in old goals.

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The central bank, Bank of Japan (BoJ), confirmed plans in October to soon start purchasing green bonds using its foreign reserves, joining a trend among global investors to tackle climate change. With this, Japan became the first G-7 nation to include ESG as a factor for all new foreign asset investments. 

In efforts to push the largest Japanese banks’ transition towards a green future, the BoJ also plans to conduct climate-scenario analysis to urge them to make climate-related financial disclosures.

Furthermore, in mid-July, the central bank followed the footsteps of other major central banks and unveiled a new strategy to offer one-year, zero-interest loans to those Japanese financial institutions that extend funding to energy-transition projects via green loans and bonds, sustainability-linked loans and bonds. The scheme is expected to be in place until at least March 2031. 

Fitch Ratings said in a note that it expects the recent policies to certainly help give the country a much-needed boost in its efforts to achieve its climate goal. 

CGC revised to drive Japan’s ESG and sustainability push

To increase disclosures on climate risk and diversity, Japan’s corporate governance code (CGC) was revised in June 2021. This was the second revision, the first CGC was enacted in 2015 and presented the fundamental principles of corporate governance and focussed on retaining the global competitiveness of Japanese companies. Later, the code was first revised in 2018, to add ‘guidelines for investor and company engagement’.

Besides incorporating new principles of governance for listed companies, the 2021 revisions included other aspects such as enhancing board independence, promoting diversity, presenting policy initiatives on the company’s sustainability as well as enhancing climate-related disclosures.

According to Moody’s Investors Service, the revisions will increase the quantity and quality of climate-related disclosures, improving the data availability of ESG initiatives. 

As per Kei Okamura, Director of Japan Investment Stewardship at Neuberger Berman, the pace of change is accelerating in Japan. According to the analyst, these new measures by the government aim to reinforce the role of sound governance and capital efficiency in enhancing shareholder value and are expanding their scope to issues such as diversity and climate change.

“These potential changes could help to push companies to embrace good corporate governance as part of a long-term strategy to raise corporate value.”

Japanese companies and ESG disclosure

The government’s actions on ESG are reflected in companies’ increasing efford towards sustainable reporting. The KPMG Survey of Sustainability Reporting‘ reported that integrated reporting is currently a majority practice in Japan and the country has seen a surge in growth in integrated reporting since 2017.

The study conducted in December 2020 found that Japanese companies have the highest rate of sustainability disclosures in the Asia Pacific region, with 100% of the top 100 Japanese companies by revenue-producing a sustainability report. Not only that, but 96% of these companies include sustainability information in their annual reports.

Kazuhiko Saito, Partner at KMPG said, “It has long been commonly understood in Japan that companies of a certain size should report on sustainability. Now, this understanding is increasingly extending to integrated reporting.”

He added that Japanese companies “are eager to adopt the sustainability trends that are developing elsewhere in the world.”

However, in a worldwide comparison, Japan’s ESG market integration is still lacking behind. According to a survey by Willis Towers Watson, only 15% of Japan’s top 100 companies by market capitalization implement the use of ESG metrics in executive incentive plans. But this is less than 5% of the 2,000 companies listed in the first section of the TSE.

This is in comparison to 52% of S&P 500 companies and 63% of constituents of major indices in Europe. On the other hand, initiatives that link ESG metrics to long-term incentives plans are far less common in Japan (15% in European indices and 3% in S&P 500 companies).

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