ESG Country Snapshot: Japan — land of the rising ESG

This article is the second in Responsible Investor’s new Country Snapshot series.

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Responsible investment took a while to get going in Japan, but with increasing interest from government, the financial regulator and key market players, the stars seem to be aligning towards a tipping point.

It’s now one of the fastest growing markets for responsible investment, and efforts from its mammoth Government Pension Investment Fund (GPIF) coupled with Abenomics – Prime Minister Shinzo Abe’s economic agenda designed to revitalise the country’s economy – have resulted in greater market awareness about stewardship and corporate governance, which has made for fertile ground for ESG.

ESG ambition from pension behemoth

Japan is home to the single largest pension fund in the world with over $1.5trn in assets. Set up in 2006, GPIF was charged with supplementing Japan’s pension payments for the next 100 years. With the country’s working age population dwindling in a “demographic time bomb” – it’s no wonder GPIF has a keen sense of its position as a “super long-term investor”.

Its journey into ESG started in 2015, when it published its investment principles and signed the Principles for Responsible Investment (PRI). But 2017 was when it really kicked into gear, when it started allocations of a huge planned shift of ¥3trn ($26.7bn) into shares with strong ESG characteristics by moving ¥1trn ($8.8bn) into three ESG indices: the FTSE Blossom Japan Index; MSCI Japan Select Leaders; and the MSCI Japan Empowering Women Index. The latter comprised of firms deems to encourage women to into the workforce – an aim linked to the government’s scramble to keep up with the country’s rapidly ageing population. GPIF pushed on the next year with a further ¥1.2trn ($10bn) allocation to its first low-carbon indices.

GPIF asks all its external asset managers to take ESG into consideration, which it sees as a level of ESG integration across all its assets. In 2017, it revised its evaluation criteria of external asset managers, weighting more heavily towards stewardship and ESG-related activities. It also revealed that it will be analysing external manager pay.

Last year GPIF conducted a study in collaboration with the World Bank Group into integrating ESG into fixed income, but a spokesperson for the giant pension fund tells RI that this has yet to be implemented. “We need more detailed research as for the specific way to integrate ESG into various assets, from fixed income to alternative assets, so we are still working on it.”

GPIF’s size means its moves into ESG have begun causing ripples in Japan and Asia more widely. Arisa Kishigami, Head of ESG, Asia Pacific at FTSE Russell, says the way GPIF went about implementing its changes was key. “GPIF were very visible about how much assets they were allocating, which indices they were basing their investments on, and ensuring the whole methodology to be transparent, too. I think it all helped create a movement.”

A GPIF survey of listed companies in Japan found that nearly all companies above and including medium-cap were aware of the fund’s ESG indices, and with many having changed their organization structure in response. Minako Takaba, Executive Director of ESG Research at MSCI, says that although understanding of ESG ratings on the corporate side is still in its infancy, interest among top level management in corporates across all industries and sectors mean they are increasingly going to MSCI for advice on how to approach ESG: “What rating they’re getting is really important to them.”

The rest of the market hasn’t been as bold as GPIF, but there’s been a consistent increase in assets that consider sustainability. A survey by the Japan Sustainable Investment Forum (JSIF) found that total sustainable investment balance in Japan rose to €1.8trn in 2018, from €6.2m in 2014. Some asset owners (such as corporate pension funds or life insurance companies) may not have a separate mandate, but are utilising various ESG-related products, whether mutual funds or ETFs. These trends may not be as easy to spot, but expect to continue.

Investors have tended to approach ESG through integration, with negative screening only recently hitting the agenda, as larger asset managers begin to see mandates containing exclusion criteria and commit to removing at least cluster munitions, with some shifts away from new fossil fuel investments.FTSE Russell’s Kishigami says banks are increasingly using ESG information to help inform lending practices. One notable example of this is Sumitomo Mitsui Banking Corporation, which used FTSE Russell’s ESG data to inform the development of syndicated loans for a company – a process that can provide an introduction to ESG to local banks participating in the syndication. “It’s kind of an entry-level ESG knowledge building for the regional banks. That’s where the ecosystem is growing beyond investing.”

Stewardship and corporate governance as a backbone to ESG efforts

Japan became one of the first Asian markets to adopt a Stewardship Code in 2014, the result of the Ito Review, which identified investor-corporation dialogue as crucial to boosting growth. The seven-principle code was designed to encourage investors – long seen as too passive – to promote sustainable returns and growth by using shareholder voting and engagement.

On its heels followed the Corporate Governance Code, and though neither code focused specifically on ESG, FTSE Russell’s Kishigami says they were instrumental in laying the groundwork for the practice to take root. “Thinking about long-term stewardship responsibilities meant that you couldn’t ignore environmental and social factors,” she says. “So I think the ESG integration journey really started from there.”

The 2017 revision of the code further ramped up expectations of transparency and engagement, adding that collaborative investor engagement would be “beneficial”. One of the first instances of Japanese investors undertaking collective engagement has been Climate Action 100+ (CA100+), the investor coalition targeting climate change. Japanese signatory investors include the likes of Sumitomo Mitsui Trust Bank, Asset Management One, MUFG, Sompo Japan Nipponkoa AM, Resona Bank, Fukoku Capital Management, and Nikko AM.

Rebecca Mikula-Wright, who heads up the Asia Investor Group on Climate Change (AIGCC) and is on the CA100+ global steering committee, says that, compared to international peers, this form of engagement is in the process of being understood in Japan. The Institutional Investors Collective Engagement Forum has been set up to help investors conduct collaborative stewardship.

“Before, the conversation was taking place in an ESG frame, and not focusing specifically on climate at all,” she says. “It’s learning by doing – a practical application of collaborative engagement.” She says GPIF becoming a supporting signatory in October 2018 was important for the market, despite the fact that the fund is restricted from engaging directly with companies in the Japanese market. “It’s a very big signal that this is how we can move forward specifically on climate.”

FTSE Russell’s Kishigami attests to the fact that there’s been a dramatic shift in investor engagement since she started at FTSE in 2007. “At that point there was next to zero engagement in Japan, because engagement was considered a very aggressive activist approach. Going from there, to investors now who are trying to pitch how they’re engaging with companies, is quite a change.”

Government-sponsored green bond support initiatives

The Development Bank of Japan (DBJ) issued the country’s first green bond in 2014, the same year that the International Capital Market Association established the Green Bond Principles. Though issuance grew steadily over the next few years, growth was limited compared to other countries, prompting action from the Ministry of the Environment. In 2017 the MOE released green bond guidelines and outlined model cases, causing issuances to grow to 11 that year, up from four in 2016. In 2018, the MOE launched a project to further spur the market, giving a grant of up to JPY50m ($468,000) per issuer for external reviews and consulting for structuring green bonds. The scheme proved a success, with 33 issuances in 2018. The government plans to keep the system in place for the next fiscal year, although with possible restrictions for repeated issuers.

Towards becoming a big power in ESG finance
In 2018, the government-convened High Level Meeting on ESG Finance published a wide-ranging and ambitious set of recommendations in a report entitled “Toward becoming a big power in ESG finance”, touching on climate disclosure, engagement, regional ESG finance, improving ESG literacy, and developing ESG products across asset classes.

Takejiro Sueyoshi, Special Adviser at the UN Environment Programme and High Level Meeting committee member, said the most important takeaway was agreeing that Japan’s next phase of growth will be a shift towards a decarbonised society, based on the SDGs and Paris Agreement. “This means adding this understanding to the growth strategy promoted in Abenomics. Since 2015, what the world is turning towards is replacing an economic model based on mass production with one based on sustainability.” He concludes: “ESG investing will support the implementation of such a society.”

Fledgling TCFD efforts

Climate disclosure is still in its early stages in Japan, but it’s getting off the ground with support from the Ministry of Economy, Trade and Industry (METI), which started a TCFD study group last year, and in December it published TCFD Guidance for companies starting disclosure. The guidelines, to be updated in the future, include supplementary explanations, sector-specific guidance and model case studies.

Key players that have endorsed the TCFD include the Big Three banks, the Japan Exchange Group, insurers including Tokio Marine Holdings and Mitsubishi Corp, as well as some asset managers. An Asia Investor Group on Climate Change (AIGCC) report found that, while Japan was the only APAC country where asset managers addressed climate change in disclosures in 2018, the broad adoption of TCFD recommendations “still seems some way off”.

Though evidence of climate scenario analysis was scarce across all sectors, the report showed that Japanese companies recognise the need of such analysis on a level on par with European markets. For its part, the MOE has been known to provide subsidies for firms to conduct TCFD-based scenario analysis.

SDGs taking centre stage at G20 and beyond

Japan takes over the G20 presidency for the first time in June. Abe has said the summit will centre on realising “a free, open, and inclusive and sustainable future society”, development through the SDGs, and how energy and environmental solutions can thrive in tandem with economic growth.This promises to be an extension of long-standing government interest in sustainable development: its SDGs Promotion Headquarters have already approved the guidelines for Japan’s implementation of the goals as well as created an award to recognise pioneering private sector initiatives in the area.

Banks and insurers

Japan lags its international peers when it comes to phasing out coal. Coal development jumped in the wake of the 2011 earthquake and tsunami and subsequent closure of Japan’s nuclear power plants – which supplied around 30% of the country’s energy – and again in 2015. Government energy policy projects a continuing role for coal in Japan’s energy mix, predicting it will supply 26% of the country’s electricity by 2030. A previous goal had been to slash coal dependency to under 10%.

Accordingly, perhaps, banks and insurers have been slow to start managing exposure to fossil fuels, with Japan’s big three banks – Sumitomo Mitsui Financial Group (SMBC Group) , Mizuho Financial Group and Mitsubishi UFJ Financial Group (MUFG) – among the biggest funders of coal projects globally.

But the international agenda around climate change, as well as pressure from NGO campaigns, could finally be moving the dial in Japan. Last year Dai-ichi Life Insurance made the first announcement from a Japanese institution specifically around coal when it said it would not lend to any coal fired power plant internationally. Shin Furuno, who heads up NGO Japan, says that while the material impacts may have been small (Dai-ichi’s actual exposure to direct lending is negligible), it was a key moment Japan’s finance industry. “It definitely sent a message to the market. It opened up the floodgates, so to speak.”

Sure enough, Nippon Life Insurance followed with a similar announcement, and the big three banks revised their lending policies to limit funding to high efficiency coal. Leading Japan’s banking sector are commercial banks Sumitomo Mitsui Trust Bank (a separate entity to SMBC Group) and Resona Bank which have ruled out new finance for coal power projects regardless of the technology used. In September, having been refused funding from foreign banks such as Dutch Bank ABN AMRO, Japanese energy conglomerate Marubeni announced it would build no new coal plants and halve its ownership of coal-fired plants by 2030.

More activity in this area is expected, but Furuno says there’s much more work to be done, given that many of the policies allow for new coal development. has been calling for Japan’s finance industry to disclose carbon exposure, outline Paris-aligned strategies and targets, and cease all new coal lending, and this NGO pressure will not be tailing off any time soon.