On 24 March 2020, Japan’s Financial Services Agency (FSA) finalized and published the second revised version of Japan’s Stewardship Code (the Code). The revised Code (the Revision Code) is intended to progress the Japanese government’s corporate governance reform, one of the key pillars of Prime Minister Abe’s economic revival program, following revisions to Japan’s Corporate Governance Code in 2018.
Overview of the Code
The Code was first released by the FSA in February 2014. It sets out the principles for institutional investors to fulfil their responsibilities for sustainable growth of investee companies and enhancing the medium- to long-term investment return, for their clients and beneficiaries, through constructive engagement or purposeful dialogue. The Code was revised in 2017 to specify the role of asset owners, such as pension funds, and to encourage asset managers to strengthen their governance and management of conflicts of interest. The number of signatories to the Code has been increasing, and as of 13 March 2020, 280 institutional investors have signed up to the Code.1
Since its initial release, the Code has continued to adopt the following approach:
- Soft Law Approach – although the Code is not legally binding, the FSA encourages institutional investors to voluntarily adopt the principles of the Code by disclosing a list of institutional investors who have become signatories.
- Principles-Based Approach – the Code adopts a principles-based approach (instead of a rules-based approach) so that the way in which the Code’s principles are applied in practice, can differ depending on factors such as the investor’s size and investment policies, as long as the purpose and spirit of these principles are followed.
- “Comply or Explain” Approach – the Code adopts a “comply or explain” approach under which an institutional investor can either disclose its intention to comply with a principle or provide sufficient explanation as to why it is not suitable to adopt such principle.
Key changes in the Revision Code
The Revision Code consists of eight principles and guidance for each. Key changes reflected in the Revision Code include the following:
Focus on sustainability including ESG factors
There was no mention of sustainability or ESG in the previous version of the Code. In light of the increasing focus on sustainability and ESG factors in corporate valuation, one of the main purposes of the Revision Code is to address issues of sustainability including ESG factors. The Revision Code redefines “stewardship responsibilities”2 and explicitly instructs institutional investors to consider sustainability (medium- to long-term sustainability including ESG factors) according to their investment management strategies in the course of their constructive engagement with investee companies.3 The Revision Code also requests that institutional investors clearly explain, in their stewardship policies, how they consider sustainability issues according to their investment management strategies.4 Furthermore, it explicitly states that in case of dialogue with investee companies, with respect to sustainability issues, institutional investors should ensure that such dialogue is consistent with their investment management strategies and leads to the medium-to long-term increase in corporate value and sustainable growth of investee companies.5
Disclosure of reasons for votes on agenda items
The previous version of the Code stated that institutional investors should, in principle, disclose voting records for each investee company on an individual agenda item basis, noting that it would contribute to the enhancement of visibility for institutional investors, explicitly to explain why they voted for or against an agenda item. The Revision Code has taken this position further and specifically instructs institutional investors to disclose their voting rationale, whether they voted for or against agenda items, that are considered important from the standpoint of constructive dialogue with investee companies (including those perceived to give rise to a conflict of interest or those that need explanation in light of their voting policy).6
Application of the Code to asset classes other than listed shares
The previous version of the Code stated that the Code primarily targets institutional investors investing in Japanese listed shares. While that remains unchanged, the Revision Code explicitly adds that it may also apply to other asset classes, as far as it contributes to fulfilling stewardship responsibilities as defined in the Code.7
Stewardship activities of asset owners such as corporate pension funds
To help corporate pension funds understand stewardship activities set forth in the Code, the Revision Code clarifies stewardship responsibilities of asset owners. The Revision Code instructs asset owners to encourage asset managers to engage in effective stewardship activities accordingly to their size and capabilities, in order to secure the interests of the beneficial owners. When asset owners manage funds and exercise their voting rights by themselves, they should engage in stewardship activities such as holding dialogues with investee companies accordingly to their size and capabilities.8
Principles applied to service providers for institutional investors
The Revision Code adds Principle 8, which states that service providers for institutional investors, such as proxy advisors and investment consultants for pensions, should endeavour to contribute to enhancing the functions of the entire investment chain by appropriately providing their services, so that institutional investors can fulfil their stewardship responsibilities.9 The Revision Code instructs service providers for institutional investors to establish and disclose clear policies on how to effectively manage circumstances that may give rise to conflicts of interest.10 The Revision Code notes that other principles of the Code (i.e. Principles 1 - 7), including the guidance, also apply to service providers for institutional investors as long as these principles do not conflict with Principle 8.11
For proxy advisors, the Revision Code expects them to develop appropriate and sufficient human and operational resources, including setting up a business establishment in Japan, in order to provide asset managers with proxy recommendations based on accurate information on each company.12 Proxy advisors should also disclose the voting recommendation process such as their primary information source or whether (and how) they conduct dialogue with investee companies to ensure transparency.13 Additionally, the Revision Code recommends that proxy advisors actively exchange views with companies as necessary. This may contribute to assurance of transparency, as proxy advisors provide investee companies with opportunities to confirm accuracy of information, on which their proxy recommendations are premised (if requested by investee companies), and provide the opinions submitted by such companies to their clients together with their own recommendations.14
Comparison with the revision to the UK Stewardship Code
It is also worth comparing the Revision Code with the revised UK Stewardship Code (the UK Code), which took effect on 1 January 2020.
There are certain similarities between Japan’s Stewardship Code and the UK Stewardship Code. For example, the UK Code explicitly requires signatories to consider ESG issues to fulfil their stewardship responsibilities.15 The UK Code also encourages signatories to explain their rationale for some or all voting decisions, particularly where: (i) there was a vote against the board; (ii) there were votes against shareholder resolutions; (iii) a vote was withheld; or (iv) the vote was not in line with voting policy.16 The UK Code applies to asset classes other than UK stocks and asks investors to explain how they have exercised stewardship across asset classes, such as listed equity, fixed income, private equity, infrastructure investments, and investments outside the UK.17 The UK Code generally has an extended focus on asset owners, such as pension funds and insurance companies, and has a separate set of principles for service providers like investment consultants and proxy advisors.18
On the other hand, there are also notable differences. Particularly, the UK Code takes an "apply and explain" approach with clear reporting expectations and a strong focus on the activities and outcomes of stewardship, not policy statements. Additionally, the UK Code explicitly requires the integration of climate change and identifying and responding to systemic risk, including climate change. The explicit reference to climate change is significant as ESG frameworks do not always address climate risk adequately. While Japan has positioned itself as a leader in implementing climate-related corporate disclosures,19 the Revision Code does not mention climate change.
ESG trends in Japan
ESG is one of the main focuses of the Revision Code in light of recent global trends in ESG investment. According to the Global Sustainable Investment Alliance (GSIA), Japan has been the fastest growing region in the world in terms of sustainable investing assets amount, from 2016 to 2018. Specifically, sustainable investing assets in Japan quadrupled in that period, from USD474 billion to USD2,180 billion, and Japan is now the third largest centre for sustainable investing after Europe and the United States.20
Japan’s Government Pension Investment Fund (GPIF), the world's largest pension fund, has made significant contribution to the development of sustainable investment in Japan. GPIF has expanded ESG investment since it signed on to the Principles for Responsible Investment (PRI) in 2015. Its total investment in global environmental and other ESG indices reached JPY3.5 trillion at the fiscal end of 2018.21
The Revision Code will likely encourage such integration of ESG factors into investment and business practices in Japan by introducing sustainability and ESG factors in an investor’s risk assessment and evaluation of corporate value.
Institutional investors who have signed up to the previous version of the Code are expected to update and publish disclosure items, in accordance with the principles of the Revision Code, within six months after it becomes effective (i.e. by the end of September 2020).22
1 Please also see the FSA website.
2 In the Preamble of the Revision Code, the term “stewardship responsibilities” refers to the responsibilities of institutional investors to enhance the medium- to long-term investment return for their clients and beneficiaries (including ultimate beneficiaries) by improving and fostering the investee companies’ corporate value and sustainable growth through constructive engagement or purposeful dialogue, based on in-depth knowledge of the companies and their business environment, and consideration of sustainability (medium- to long-term sustainability including ESG factors) consistent with their investment management strategies.
3 See Guidance 1-1 of the Revision Code.
4 See Guidance 1-2 of the Revision Code.
5 See Guidance 4-2 of the Revision Code.
6 See Guidance 5-3 of the Revision Code.
7 See Preamble of the Revision Code.
8 See Guidance 1-3 of the Revision Code.
9 See Principle 8 of the Revision Code.
10 See Guidance 8-1 of the Revision Code.
11 See Preamble of the Revision Code.
12 See Guidance 8-2 of the Revision Code.
13 See Guidance 8-2 of the Revision Code.
14 See Guidance 8-3 of the Revision Code.
15 See Principle 7 of the UK Code.
16 See Principle 12 of the UK Code.
17 See Principle 7 of the UK Code and the website of FRC.
18 See Principles for Service Providers.
19 As of December 2019, more than 200 Japanese companies supported the Task Force on Climate-related Financial Disclosures (TCFD), bringing Japan to the top of the TCFD league table. Japan hosted the first TCFD Summit in October 2019.
20 2018 Global Sustainable Investment Review.
21 GPIF ESG Report.
22 Details can be found on the FSA website.