ESG CHALLENGES AND OPPORTUNITIES IN JAPAN

Summary 

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• ESG Opportunities and Challenges for Japanese Companies: Japanese companies have long considered their social responsibility and the civic-oriented corporate mindset of Japanese companies fit very well with the spirit of ESG investing for which long-termism is core. Japanese government is also promoting ESG in the country with initiatives and regulatory pressures.
  • Environment: Japanese government committed to net zero emissions by 2050 and launched Green Growth Strategy, a set of industrial policies to achieve the ambitious target. Together with Japan’s Nationally Determined Contributions (NDCs), this translates to an annual GHG emission reduction of 3.4% CAGR by 2030, and 14.6% CAGR between 2030 and 2050[1]. However, GHG reductions achieved to date fall short of the required reductions with delayed transition to electric vehicles and its decarbonization plans missing commitment to phase-out coal-fired power plants (except for inefficient ones). While Japanese companies proactively disclosing their climate activities based on government targets and Tokyo Stock Exchange rules, investors need to look carefully at company commitments and actions to determine whether such comments or actions are feasible and effective.
  • Social: One of the largest issues the country has is shrinking, aging population. Many Japanese companies are highly reliant on human capital, and therefore companies need to pay close attention to human capital development. Japanese government is now discussing to set new rules for company disclosures for these aspects. Gender diversity is also a significant problem in Japan where women make up only 13 percent of management boards of Japanese companies[2]. 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 with a more than 20 percent of gap between men and women. While Japanese companies seem to be leading ‘S’ performance in issues such as data security, human rights, supply chain labor standards, health and safety, etc., they need to continue investing in the workforce of the future.
  • Governance: Japanese standards lag compare to that of global peers. They often lack an independent board majority, and many have combined CEO/Chair roles which may have other management governance risks. They have long been struggling in lower profitability compared to their global peers which is often attributed to stagnant ROE. With Japanese Stewardship Code introduced in 2014 and updated Corporate Governance Code in 2021, the country is in a process to improve corporate governance standards. One new trend in the EU and the US are introductions of sustainability aspects into corporate governance. Leading companies in Europe and US are establishing Sustainability Committee in their Board of Directors and linking ESG performance to senior management compensations. Japanese companies can improve their overall focus on sustainability in a way that enhances their strategy and corporate values by making clearer incentives to Board of Directors to work on sustainability.
• ESG for SMEs in Japan: 80 percent of listed companies in Japan are SMEs[3] and there are rich investment and ESG impact opportunities with them. While many Japanese SMEs are now realizing the importance of incorporating ESG into their business SMEs are often starting at low base, so there is potential for large improvements in ESG performance. Also, Investor engagements tend to have a larger effect to SMEs than to larger companies by influencing overall company structure and strategy as SMEs are often involved in single and domestic businesses. At the same time, they are often in lack of resource and expertise in ESG and struggle in effectively communicating with investors and other stakeholders about their ESG activities. Investors can support SMEs for these aspects. Going forward, we foresee more focus on ESG investments that lead to concrete and measurable results as well as increased transparency. Japanese SMEs are world-leading companies in many areas, still looking to fully develop their financial and ESG potential.

ESG Investments by Japanese Financial Institutions:  With these ESG initiatives and opportunities, ESG investments by Japanese financial institutions are getting substantial presence. ESG investments in Japan are 24 percent of total managed assets in the country. The Government Pension Investment Fund (GPIF) has focused on ESG integration, stating in its ESG Report that “GPIF promotes ESG integration throughout all of our investment process”. Yet, Japan’s Financial Service Agency (FSA) has already flagged concern of “green washing”. In the report published by the FSA in 2022, of the 37 major asset management companies that has ESG funds, almost one third of them do not even have dedicated ESG expertise[4]. Financial institutions need to dive deep and engage seriously with companies to catalyze positive changes in Japan’s private sector

[1] 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)

[2] MSCI ESG Research “Gender Diversity in Japan Report 2021”, December 2021

[3] Out of the approximately 4,000 listed companies in the Japanese stock market, Small and medium-sized companies with a market capitalization of less than 100 billion yen (USD724Mil, 138yen/usd) account for 79%  (Bloomberg data as of July 2022)

[4] 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)

Summary

• ESG Opportunities and Challenges for Japanese Companies: Japanese companies have long considered their social responsibility and the civic-oriented corporate mindset of Japanese companies fit very well with the spirit of ESG investing for which long-termism is core. Japanese government is also promoting ESG in the country with initiatives and regulatory pressures.
  • Environment: Japanese government committed to net zero emissions by 2050 and launched Green Growth Strategy, a set of industrial policies to achieve the ambitious target. Together with Japan’s Nationally Determined Contributions (NDCs), this translates to an annual GHG emission reduction of 3.4% CAGR by 2030, and 14.6% CAGR between 2030 and 2050[1]. However, GHG reductions achieved to date fall short of the required reductions with delayed transition to electric vehicles and its decarbonization plans missing commitment to phase-out coal-fired power plants (except for inefficient ones). While Japanese companies proactively disclosing their climate activities based on government targets and Tokyo Stock Exchange rules, investors need to look carefully at company commitments and actions to determine whether such comments or actions are feasible and effective.
  • Social: One of the largest issues the country has is shrinking, aging population. Many Japanese companies are highly reliant on human capital, and therefore companies need to pay close attention to human capital development. Japanese government is now discussing to set new rules for company disclosures for these aspects. Gender diversity is also a significant problem in Japan where women make up only 13 percent of management boards of Japanese companies[2]. 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 with a more than 20 percent of gap between men and women. While Japanese companies seem to be leading ‘S’ performance in issues such as data security, human rights, supply chain labor standards, health and safety, etc., they need to continue investing in the workforce of the future.
  • Governance: Japanese standards lag compare to that of global peers. They often lack an independent board majority, and many have combined CEO/Chair roles which may have other management governance risks. They have long been struggling in lower profitability compared to their global peers which is often attributed to stagnant ROE. With Japanese Stewardship Code introduced in 2014 and updated Corporate Governance Code in 2021, the country is in a process to improve corporate governance standards. One new trend in the EU and the US are introductions of sustainability aspects into corporate governance. Leading companies in Europe and US are establishing Sustainability Committee in their Board of Directors and linking ESG performance to senior management compensations. Japanese companies can improve their overall focus on sustainability in a way that enhances their strategy and corporate values by making clearer incentives to Board of Directors to work on sustainability.
• ESG for SMEs in Japan: 80 percent of listed companies in Japan are SMEs[3] and there are rich investment and ESG impact opportunities with them. While many Japanese SMEs are now realizing the importance of incorporating ESG into their business SMEs are often starting at low base, so there is potential for large improvements in ESG performance. Also, Investor engagements tend to have a larger effect to SMEs than to larger companies by influencing overall company structure and strategy as SMEs are often involved in single and domestic businesses. At the same time, they are often in lack of resource and expertise in ESG and struggle in effectively communicating with investors and other stakeholders about their ESG activities. Investors can support SMEs for these aspects. Going forward, we foresee more focus on ESG investments that lead to concrete and measurable results as well as increased transparency. Japanese SMEs are world-leading companies in many areas, still looking to fully develop their financial and ESG potential.

ESG Investments by Japanese Financial Institutions:  With these ESG initiatives and opportunities, ESG investments by Japanese financial institutions are getting substantial presence. ESG investments in Japan are 24 percent of total managed assets in the country. The Government Pension Investment Fund (GPIF) has focused on ESG integration, stating in its ESG Report that “GPIF promotes ESG integration throughout all of our investment process”. Yet, Japan’s Financial Service Agency (FSA) has already flagged concern of “green washing”. In the report published by the FSA in 2022, of the 37 major asset management companies that has ESG funds, almost one third of them do not even have dedicated ESG expertise[4]. Financial institutions need to dive deep and engage seriously with companies to catalyze positive changes in Japan’s private sector

[1] 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)

[2] MSCI ESG Research “Gender Diversity in Japan Report 2021”, December 2021

[3] Out of the approximately 4,000 listed companies in the Japanese stock market, Small and medium-sized companies with a market capitalization of less than 100 billion yen (USD724Mil, 138yen/usd) account for 79%  (Bloomberg data as of July 2022)

[4] 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)

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