Japanese Corporate Governance: A Response to Marsha Vande Berg

posted by Nicholas Benes on January 5, 2020 - 12:00am

This is a response to Marsha's piece here.

Just as Marsha writes, Japan is making progress. However, as is the case anywhere I the world, progress is nuanced. The GPIF’s push for ESG is very good over the long-term and well-intended, but in the short term it has been interpreted by many as a sort of PR opportunity for Japanese companies and investment institutions to “look good “ in Environmental and Social areas (E and S), while distracting attention from the fact that many companies are still weak in the area of  “G” (governance practice).  
Japan has ESG where the ES topics are in bold large cap fonts – a sort of a fad -, but G is in lower case, not bold font, still not discussed as much as is needed. But the reality is that this priority needs to be reversed, and more pressure for that needs to come from institutional investors.  Japan needs to focus most of all on first improving governance, because only then will boards seriously focus on the E and S factors that most affect both their financial performance and long-term sustainability, and continuously monitor a focused list of criteria so as to actually achieve those objectives. Otherwise, ESG is a bus without a driver; or the driver is not the board but rather IR companies that write glossy integrated reports that just try to make the company “look good” in general. This situation will not result in much consistent momentum towards true “sustainability”.
I outlined some of these concerns in my recent public comment to the FSA regarding revision of the Stewardship Code (SC) : which can be viewed here: https://bdti.or.jp/en/blog/en/nbsc20/.  Here, I also wrote: “The proposed revisions to the Stewardship Code do not make it clear enough exactly how corporate pension funds, or smaller pension funds of any type, can sign the Code and comply with it without bearing excessive cost, work, or confusion.  Because this is not sufficiently clear at present, to date only an extremely small number of the defined-benefit pension funds at listed non-financial companies in Japan have signed the Code (only about 10, out of a total of 700 or more such funds). As a result, a rather odd situation exists in that most Japanese companies claim to care for their employees deeply, but judging from their actions, do not seem to care much about employees’ investments or post-retirement quality of life – or even, to care about preserving shareholder value by reducing the cash infusions needed to keep their pension plan fully funded. This makes a mockery of the language in the Corporate Governance Code about stewardship (Principle 2.6 企業年金のアセットオーナーとしての機能発揮), and of the Stewardship Code itself.”  

The numbers “only about 10, out of a total of 700” are rather shocking. Oddly, the same MHLW which regulates the GPIF, is not on the same page as the FSA when it comes to stewardship. As you can read further down in my public comment, MHLW has done virtually nothing concrete to change this situation, in which pension fund resistance to signing the SC largely results precisely because of the very issues the Stewardship Code is trying to address:  many pension funds have inherent conflicts of interest with the sponsor company (which is not good for employees or pensioners) or the pension fund is a sort of “amakudari” post-retirement pasture for senior executives, and similar issues . MHLW is not properly protecting the interests of either pensioners or companies. Said simply, it is not doing its job.   (I write this because if better stewardship (e.g. without conflicts and better oversight of fund managers) results in higher returns for the pension fund, this will not only increase the chances that employees will receive what they are owed after retirement, but the company will have to inject less cash into the pension fund in order to keep it fully-funded.  This is a win-win circle.

Because it is politically not feasible for the GPIF itself to set forth clear  guidelines for governance practices on paper, it took me several years and a public viewpoint to encourage the GPIF to simply acknowledge the existence of Japan’s own Corporate Governance Code in its investment and proxy voting principles, let alone any statements about the specifics in it that they prioritize. Now they do so, but this started several years after I first proposed the CG Code to the government and it was put in place.  Mr. Mizuno and the GPIF  are in a difficult position in this regard.  At the same time, the GPIF refers to two “environmental” indices and one “social” index , it does not refer to any specifically “governance” indices or standards. It only creates ESG indices where the standards for the governance part are not very clear.  See page 3 of https://www.gpif.go.jp/en/investment/pdf/ESG_indices_selected.pdf .

At The Board Director Training Institute of Japan, we try to educate directors or directors-to-be on “what is ESG and why are investor interested in it? ”. What I emphasize as a key conclusion to this section, is that it is the combination of “good company ESG characteristics PLUS high and sustainable ROI” which generates a virtuous cycle.  In other words, if ROI is consistently low or negative, the company will not be very “sustainable”, even if its ESG characteristics “look good”.