Investors in Japanese companies have been discouraged at the slow progress on long-term thinking and ESG integration. However, a new call for evidence and information by Japan’s Ministry of Economy Trade and Industry (METI) regarding the relationship between companies and investors should prove to be a catalyst for change. The call is outlined in METI’s “Competitiveness and Incentives for Sustainable Growth: Building Favourable Relationships between Companies and Investors” project, launched in July 2013 and currently being organised by stakeholders including Japanese companies, asset managers, think-tanks and academics. There are three reasons why this call can be an inflection point of long-term thinking and ESG integration in Japan:
1. ESG integration into corporate competitiveness and METI’s leadership
METI’s consideration of long-term growth suggests, on the questions of 1) (see the METI recommended subjects for evaluation at the end of the article, which correspond to these numbers) definition of sustainable growth and 2) companies achieving sustainable growth, that companies and investors should take for granted the integration of ESG factors into corporate competitiveness. In Japan, this is the best way to achieve mainstreaming of ESG factors, since companies are not willing to act on sustainability without a financial imperative. Japanese companies adopt the view of management guru Peter Drucker that business should disregard social responsibility if it could result in a loss of the performance capability of the business. METI has a politically strong influence on Japanese companies, since it has responsibility for economic and industry policy, and top-down governance plays well in Japan. Other stakeholders have tried to make corporate conduct more sustainable in the past few years in Japan including “The Guideline on Responsible Investment
of Workers’ Capital” by RENGO (Japanese Trade UnionConfederation), “Options to Improve the Governance and Investment of Japan’s Government Pension Investment Fund” by the OECD and “The Principles for Financial Action towards Sustainable Society (Principles for Financial Action for the 21st Century)” by Japan’s Ministry of the Environment. But these one-way initiatives made little improvement except as an implied background to the current METI project.
2. Focus on incentives
The METI project highlights incentives issues for companies and investors on the questions of 3) incentives for boards and executives of companies, 5) alignment of interest, incentives and management policies for corporate value creation between company management and investors, 6) incentives for investors, and 10) conflicts of interest. This broad approach is likely to be more effective for progress in the relationship between companies and investors than past initiatives. The reason is that companies and investors do not always conduct business ethically or rationally, but rather based on skewed incentives. A familiar example is variable executive pay linked to total shareholder return. The pay scheme motivates senior management to maximise short-term profits and shareholder return, but undervalue corporate investment in R&D necessary for long-term growth and consideration of environmental and social externalities (eg, pollution and human rights abuse) which over time potentially damages corporate value. The Donnella Meadow Institute, an organisation famous for sustainability and systems thinking in the UK, agrees that intervening systematically in incentive systems is an effective way of changing economic and financial markets to become more resilient and long-term.
3. Investment value chain and fiduciary duty
The METI project examines fiduciary duty in the investment value chain in points number 7) challenges for analysts, 8) role and organisation of institutional asset owners, 9) promoting mid-to-long term
investments, 11) short-termism (companies, investors, market players) and 14) how dialogue and engagements are conducted. This illustrates an advancement in the recognition of ESG integration in Japan since 2003 when Noboru Terada, former Executive Investment Officer of Japan’s Government Pension Investment Fund, said that ESG investment was against fiduciary duty and should be separated from mainstream investment purely based on corporate financial performance. His view kept institutional investors (except for a few) away from ESG investment in the 2000s despite the Freshfields Report published in 2005 and despite environmentally positive-screen funds and ESG investment funds becoming familiar product for retail investors. The METI project encourages Japan’s asset owners and managers to act on fiduciary duty with sustainability thinking aligned to their beneficiaries’ long-term interests. This is why the call requests information on a wide variety of factors in the investment value chain. Japan’s Financial Services Agency (FSA) shares this view and launched the Council of Experts Concerning the Japanese Version of the [UK] Stewardship Code in August 2013. Synergies of both projects and an improvement in the investment stewardship approaches of Japanese asset owners and managers are expected.
*Kazutaka Kuroda is Social Media Director at Network for Sustainable Financial Markets (SFM).*h5. After holding four meetings since its launch in July 2013, the METI project identified and summarized the main recommended subjects for evaluation as below.
1) Definition of sustainable growth
2) Companies achieving sustainable growth
3) Incentives for boards and executives of companies
4) Capital discipline
5) Alignment of interest, incentives and management policies for corporate value creation between company management and investors
6) Incentives for investors
7) Challenges for analysts
8) Role and organization of institutional asset owners
9) Promoting mid-to-long-term investments
10) Conflicts of interest
11) Short-termism (companies, investors, market players)
12) Challenges concerning corporate disclosure and reporting
13) Disclosure for mid-to-long-term dialogues
14) How dialogue and engagements are conducted
The METI consultation is available here.
The METI project has also developed a short paper explaining the public consultation, which is available here.
Submissions to the project are due on 10 December 2013.