Reflections on responsible investment market developments in Japan

Momentum is building for sustainable finance in Japan, with topics such as transition finance and human rights rapidly rising up the agenda, says Arisa Kishigami.

The responsible investment landscape in Japan is rapidly evolving, as is the universe of ESG professionals. It was inspiring to observe, at this year’s Responsible Investor Japan conference, a growing number of junior and Gen Z sustainable finance practitioners among the 700 or so attendees.

Four years have passed since I made the transition to an independent ESG thought leader and consultant after feeling that that there was a limited pool of subject matter experts locally. This gives me hope that the depth and breadth of the community is improving.

Recent market developments, alongside key themes that emerged in discussions at RI Japan show that Japan is becoming a real contender in the sustainable finance space.

Transition finance

Transition finance was centre stage at RI Japan this year, and the topic drew robust conversation. Let’s face it, investing more, not less, into “hard to abate sectors” is generally not a popular argument among global investors, with some openly opposed to the idea. However, it is key to achieve some measure of consensus, particularly here in Japan, where the government’s overarching Green Transformation (GX) strategy is built around the concept.

It is broadly accepted that achieving carbon neutral economies will be easier for countries with service-oriented markets, while industrial countries like Japan face an uphill challenge to transition legacy carbon-intensive business models. Divestment is not the answer, and investors may need to balance the appetite for rapid portfolio decarbonisation against the need to support a successful transition of all economic activities in the longer term.

The Ministry of Economy, Trade and Industry (METI) along with the industry has so far identified key technologies that need to be financed and developed to achieve carbon neutrality for eight key sectors, and this is to be further refined on an ongoing basis.

To an extent, the current approach is one of trial and error: it allows the market to trial broader untested technologies including those related to the usage of hydrogen.

Perhaps the question that needs to be asked is whether these technological roadmaps are sufficiently useful guides and provide the best climate outcomes, or what measures are needed to prevent a huge pile of greenwashing and climatic disaster in the long-term?

And crucially, questions remain around who should bear responsibility when a small number of markets provide essential, yet carbon-intensive products for the rest of the world.

Regulatory push vs innovation

Regulators are moving at speed to intervene in sustainable finance markets all around the world and Japan is no exception. But at times this can be hard to navigate due to the fragmented nature of local policymaking.

Oversight of labelled bond securities is just one example. The Ministry of Environment (MoE) currently oversees the standards for green and sustainability-linked bonds and loans; METI is responsible for transition bonds, while financial regulator the Japanese Financial Services Agency (JFSA) keeps tabs on social bonds. However, the government’s GX strategy suggests that there will be more joined up thinking and co-ordination down the line.

A notable development in this regard has been the creation of the JFSA’s Expert Panel on Sustainable Finance in 2020, which includes representatives from across the financial, corporate and academic community.

To date, it has delivered on several recommendations including the world’s first Code of Conduct for ESG evaluation and data providers, introducing ESG disclosure requirements for investment funds and listed companies. It has also launched a parallel working group that is developing guidelines for the financial sector transition. Status updates and details for each initiative are available as part of the panel’s third annual report.

In a fast-moving regulatory environment, recent policy developments related to sustainable investment and finance in Japan have generally taken a “comply or explain” or similar voluntary approach. This is partly to reduce implementation costs as similar codes and frameworks are being developed globally, and partly to leave room for market innovation. These intentions are both appreciated, but also leave the challenge of uncertainty and unstandardised disclosures.

Social issues and human rights

Last year’s publication of government guidelines on managing human rights issues within supply chains last year, and new rules on human-capital related disclosures for companies, have seen social factors climb up the agenda of Japanese investors.

Sessions on those topics were close to capacity at RI Japan, while they would likely have been much less popular even a year ago.

Back in 2014, the simultaneous update of the Japanese Corporate Governance Code and the launch of the Japanese Stewardship Code were often referred to locally as the two wheels of a bicycle, as it created an effective environment for dialogue between investors and companies to achieve responsible ownership and sustainable business practices.

Now in 2023, similar synergies could be expected in relation to simultaneously addressing human rights (put simply, the risk) and human capital (the opportunity). This has the potential to engage those who traditionally considered addressing human rights solely as a costly and “washing your dirty clothes in the public” exercise.

Admittedly, it has been the wider global stakeholder concern towards Japan’s approach (or rather the lack of) to human rights that spurred initial action, including the publication of the first National Action Plan in 2020. Japanese companies and investors alike will likely face a steep learning curve in tackling these issues.

Whether this leads to better human rights risk management both domestically and throughout the global supply chain remains to be seen. However, at a time when investors globally are grappling to find resources to address the complex matrix of climate change and sustainability issues, perhaps this dual approach and momentum building is, at minimum, a good starting point.

The next generation in focus

Alongside recognising the need to address human rights risks and human capital within the investment decision-making process, there has been a growing sense of urgency to develop the talent pipeline within sustainable finance.

The topic was a key theme during the JFSA’s Expert Panel meeting in December and was echoed in various discussions during RI Japan.

Following a successful inaugural panel last year, a panel that focuses on next generation talent and sustainable finance practitioners was again introduced. While younger panellists were received with slight trepidation and doubt by some of the senior participants last year, a positive shift in attitude within the audience was noticeable.

It is clear why. While many large investment houses and companies are scrambling to find the right talent, one panellist within the “future leaders” session noted that they had a constant stream of high-calibre individuals knocking on their door, hungry for opportunities to make positive impacts through investment activities.

So, has there really been progress in the past few years? Anecdotally, many international participants at RI Japan appeared pleasantly surprised at the detailed actions discussed by several of the Japanese speakers. These included discussions around addressing biodiversity, the development of technological roadmaps and addressing human rights. It is true that with the increased focus on effective dialogue and engagement, actions which were previously lost in translation are now better articulated by the government, corporates and investors alike.

With both the regulators and the financial sector building momentum, now might be the opportune time for investors to increase their engagement with Japan as one of the key hubs for sustainable and transition financing.

Arisa Kishigami is an independent thought leader and consultant, and is a member of the FSA’s Expert Panel on Sustainable Finance.