GPIF tightens up on ESG index and ratings providers, questions passive fee structure

Japanese pension titan questions ‘human judgement’ of ESG calculations and 'black box state' of index fees

Japan’s giant Government Pension Investment Fund (GPIF) is ramping up its due diligence on index providers and ESG ratings companies “to ensure the continuity, transparency and neutrality of ESG evaluations”, turning particular attention to firms’ governance systems and conflict of interest management.

The $1.6trn pension fund, which outsources all its asset management, said in a report published in Japanese on its website this week that it was undertaking strict checks on ESG ratings houses and index providers for “any business that could lead to conflicts of interest…looking at relationships with stakeholders (shareholders and major clients), their decision-making processes (such as whether or not the board is independent, and past board discussions), and consulting services for companies”.

"Asset owners have to evaluate the index provider or ESG ratings agency the same way they would an asset management company"

The fund explained that, in the case of ESG indices “there is space for human judgement on the part of analysts who devise ESG calculations and index construction methods”, as opposed to the quantitative calculations underpinning traditional indexes.

GPIF uses bespoke ESG indices from FTSE, MSCI and S&P.

The report continued: “When it comes to ESG indices, asset owners have to evaluate the index provider or ESG ratings agency the same way they would an asset management company. In passive management, it can be said that index companies, not asset managers, are actually selecting stocks.”

“Firms whose global indices link to funds exceeding hundreds or thousands of trillions of yen have the power to change the flow of international capital and require high accountability for their decisions.”

GPIF has been shaking up its approach to index providers for a while now: last year, RI reported that it was developing a platform – since named IDEAS (the Index Data Entry and Accumulation System) – to efficiently gather and analyse index information, including ESG factors. The pilot has seen the fund consider ideas for foreign equity ESG indices, foreign equity diversity indices, and domestic and foreign green bond indices.

Index fees and contracts

The report also reveals that GPIF is rethinking how it enters into index licensing contracts, the fee for which it says has so far been in a “black box state”.

According to the paper, index licensing contracts have in general been between index providers and external managers, with GPIF left with a “weak contractual relationship” and a lack of clarity as to how much it is paying towards index licensing fees.

GPIF said that paying the index license fee directly to the index provider would establish “transparency of the passive manager’s profit structure” and ensure management fees are paid “according to manager contributions in terms of management and active ownership”.

Index license fees correspond to the amount of assets under management and can represent significant costs, the paper said.

The move would broaden the existing scrutiny on asset manager fees. In 2018, the fund introduced a performance-based fee structure in which loss-making active asset managers are paid a reduced base fee rate equivalent to passive management fees. CIO Hiro Mizuno has called for other asset owners to do the same and make the approach “industry practice”.

The report concluded: “Efforts to upgrade GPIF’s operations are only just beginning.”