ESG in Japan: Challenges and opportunities

日本のESG:挑戦と機会

2022年09月08日

Unearthing the potential and challenges for Japanese companies

Japanese companies have long been known for their long-termism, and for adopting purpose-driven missions that consider stakeholders’ benefits in their business activities. The country is home to more than 40 percent of the world’s companies with over a hundred-year-old history[1]. And the government continues to increasingly promote ESG and sustainability through incentives and regulatory moves. Japan is in a sense reaching an ESG tipping point.

The Environmental Push

The Japanese government committed to net zero emissions by 2050 and launched the Green Growth Strategy, a set of industrial policies to achieve the ambitious target. Together with Japan’s Nationally Determined Contributions (NDCs), this results in an annual predicted GHG emission reduction of 3.4% CAGR by 2030, and 14.6% CAGR between 2030 and 2050[2].

However, GHG reductions achieved to date fall short of the necessary pace. Also, the delayed transition to electric vehicles, and missing a concrete commitment to phase out most coal-fired power plants are some of the challenges for Japan.

With the challenges in restarting nuclear power plants, Japan is facing the difficult problem of simultaneously securing energy security and promoting decarbonization. Larger Japanese companies have embraced commitments to proactively disclosing their climate-related activities based on government targets and Tokyo Stock Exchange rules, but investors need to examine company commitments to understand if they are catalysts for feasible, effective actions.

Social Dynamics: Untapped Potential in Human Capital

One of the largest challenges Japan is facing is its shrinking, aging population. Many Japanese companies are highly reliant on human capital, and so companies need to focus even more sharply on human capital development, to retain the best and most productive talent.

The lack of gender diversity across the workforce, and especially in management, and in the board room, is a significant challenge, and a significant untapped source of growth. The government originally set a goal of ensuring 30 percent women in leadership position by 2020, but the goal has been postponed to “as early as possible in the 2020s”. Japan’s gender pay gap is still one of the largest among OECD countries, at 20%[3]. Japanese companies seem to be ahead of their peers on many other ‘S’ metrics, yet Japan Inc. must continue investing in the talent of the future.

Governance Matters

On average, Japanese companies still lag their global peers on governance issues. Companies often lack a majority of independent board members, and problems of “cross-shareholding”, interconnected portfolios of ownership by listed Japanese companies in each other, still remain. It is thought that Japanese companies’ relatively low ROE is often linked to governance deficiencies.

The country has taken recent positive steps, introducing a Stewardship Code (published in 2014, revised in 2017) and a new Corporate Governance Code (published in 2021). Also, setting up specific sustainability committees in Board of Directors, and especially linking ESG performance to senior management compensation could help Japanese companies improve their governance and overall focus on sustainability in a way that enhances their strategy and corporate values.

The potential for SMEs in Japan

There is even more room for growth, and more opportunity for SMEs in Japan – and such companies make up more than 80% of all listed corporates[4]. Most SMEs are early on in their ESG journey, with space for large improvement in ESG performance. Positive investor engagement tends to have a larger effect in SMEs too, as the companies are more nimble. Yet precisely because they are smaller, the SMEs may not have sufficient in house ESG expertise, and may sometimes struggle to communicate their improvements. And this is where savvy, expert and committed ESG investors can play a key role in valuing up ESG – and financial – performance.

Financial Institutions: The ESG Shift

Japanese financial institutions are in a middle of its ESG and sustainability journey, but is accelerating their activities. Sustainable investments, including ESG investments, in Japan are increasing and now total 24 percent of total managed assets in the country[5].

The Government Pension Investment Fund (GPIF) continues to explicitly emphasize ESG integration, stating in its ESG Report that “GPIF promotes ESG integration throughout all of our investment process”. At the same time the Government’s Financial Service Agency (FSA) has already noted its concern about ESG “green washing”.

The FSA noted that of the 37 major asset management firms that manage ESG-labelled funds, almost a third of them do not even have dedicated ESG expertise in their firms[6]. It is not just the companies and the government that need to do more – the financial institutions, the investors need to engage much more meaningfully – and with more leading-edge expertise – to catalyze lasting positive change.

Sasja Beslik, Chief Investment Strategy Officer, authored this insightful piece with contributions from Bradley Busetto, Co-CEO, and Shohei Maekawa, Chief Strategy Officer. Special thanks are also extended to Mr. Yoshihiro Tanaka, the Chief Operating Officer at Asuka Corporate Advisory, and his dedicated team for their valuable input.

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[1] Nikkei BP Consulting “世界の長寿企業ランキング、創業100年、200年の企業数で日本が1位”, March 2020 (https://consult.nikkeibp.co.jp/shunenjigyo-labo/survey_data/I1-03/)

[2] Columbia University SIPA Center on Global Energy Policy “TALLYING UPDATED NDCs TO GAUGE EMISSIONS REDUCTIONS IN 2030 AND PROGRESS TOWARD NET ZERO”, March 2022 (https://www.energypolicy.columbia.edu/research/report/tallying-updated-ndcs-gauge-emissions-reductions-2030-and-progress-toward-net-zero)

[3] OECD Gender Wage Gap, Employees, Percentage, 2021 or latest available (https://data.oecd.org/earnwage/gender-wage-gap.htm)

[4] Out of the approximately 4,000 listed companies in the Japanese stock markets, companies with a market capitalization of less than 100 billion yen account for 81%, 300 billion yen account for 91%, and 500 billion yen account for 94% (Bloomberg data as of September 2022) *100 billion yen = approx. USD 725 million (based on 138 JPY/USD)

[5] Global Sustainable Investment Alliance “Global Sustainable Investment Review 2020” (http://www.gsi-alliance.org/wp-content/uploads/2021/08/GSIR-20201.pdf)

[6] Financial Service Agency “Progress Report on Enhancing Asset Management Business 2022”, May 2022 (https://www.fsa.go.jp/en/news/2022/20220527/20220527_4.pdf)