A perspective on corporate reforms and sustainability in Japan

posted by Marsha Vande Berg on January 6, 2020 - 12:00am

The evidence is still out but hopes are high that Japanese institutional investors focused on sustainability and corporate governance reforms can convince Japan Inc. to comprehensively embrace reforms designed to improve productivity and ultimately deliver higher returns. Corporate governance reforms, a cornerstone of Abenomics, started taking hold in 2014. Today, GPIF, the world’s largest pension scheme is among their most vocal champion in linking reforms to a holistic emphasis on long-term sustainable investment strategies.

GPIF’s success and that of others in the upper echelons of government and industry as well as finance will depend on their ability to win the hearts and minds of mainstream investors and corporate Japan. The path forward is not straightforward, complicated by developments like recent limits on foreign investment in Japanese equities. Still progress is incremental, and the reforms being championed appear here to stay with the promise of long-term impact for Japan’s social agenda, her corporate governance and sustainability as well as the country’s ranking as the world’s third largest economy.

Two sets of circumstances support the point. First, Tokyo is pinning its reputation as an international economic powerhouse to initiatives designed to attract foreign interest and investment at the same time it is advancing the global cause of stewardship and sustainability. In addition to Abenomics’ emphasis on Japan’s competitiveness, environmental sustainability is central to the “discover tomorrow” thematic for the Tokyo 2020 Olympics, underway come July. At the same time, Tokyo’s intention is to be premier among Asia’s leading financial centers in its emphasis on sustainability practices in finance.

Second, the country’s new and revised Stewardship and Corporate Governance codes, although voluntary, link explicit references to investor responsibility and corporate governance with social and environmental sustainability. Principle 2.3 of the revised Corporate Governance Code states, “Companies should take appropriate measures to address sustainability issues, including social and environmental matters.”

GPIF is clearly in the lead as an advocate of investing based on sustainability practices and precepts together with the reforms that are intended for Japan’s corporate and investment culture. Under the leadership of its star chief investment officer, Hiro Mizuno, the pension fund is directing the investment of retirement monies of Japan’s seriously aging population inclusive of an emphasis on sustainability.

Mizuno defines GPIF as a “100 percent, long-term investor over 100 years or more”. To succeed, he is undertaking a multi-prong effort to require that asset managers who are contracted to manage his fund’s portfolios invest in line with sustainability factors together with the principles laid down by the new Stewardship and Governance codes and sets of guidelines which among other things, encourage active engagement with investee companies. Engagement gives institutional investors like GPIF more latitude in making their case for reforms directly with corporate managers and directors.

And Mizuno is not stopping there. Since joining the fund in 2015, a year after Japan’s first round of corporate governance reforms under Abenomics, the GPIF CIO initiated the pension scheme’s visible and pronounced shift to responsible and sustainable investment. His approach is noteworthy.

Not only is he investing GPIF’s asset directly in environmental, social and governance-related (ESG) investments, he also is directing his portfolio managers to holistically integrate ESG factor-analysis into the investment selection process. He enforces this mandate by linking performance fees to successful ESG-related outcomes. He is building a green bond and fixed income portfolio as well as broadening GPIF’s use of ESG-related indices. By tracking positive-screening ESG indices, the fund intends to coax companies into paying greater attention to sustainability, to be more forthright about what they disclose about their environmental and social impact, and to conduct their overall business more sustainably.

In 2015, Mizuno prominently signed GPIF up as a signatory to the United Nations-supported Principles for Responsible Investment, obligating the fund to apply PRI’s responsible investment principles across its investment strategies. He also has since joined the Board of Directors of PRI, a prominent international advocate. Meanwhile, he is integrating application of the UN’s Sustainability Development Goals (SDGs), a set of standards designed to reset the global commons more equitably.

Along these same lines, GPIF also is advocating that Japan Inc. incorporate in their sustainable assessment and disclosure practices a set of international recommendations for taking account of a fund’s or corporation’s carbon footprint. Promulgated in 2015, the Task Force on Climate-related Financial Disclosures (TCFD) guidelines offers a set of international standards for measuring environmental impact. Their importance is as a set of credible standards against which companies can assess the material impact of their carbon-related activities on enterprise value. As of late spring 2019, 80 Japanese companies had supported application of the TCFD framework, including global brand, Toyota.

Despite the comprehensive advocacy, the campaign for greater emphasis on sustainability as an extension of corporate governance has yet to captivate the interests of mainstream Japan Inc. While institutional investors elsewhere are pulling the phenomenon off the sidelines and into the mainstream, GPIF’s success and that of the others still bear the markings of early steps. Ultimate success will require a wider, more comprehensive embrace inclusive of the rank and file manager,

Ultimate success will require a holistic approach to sustainability not only as an extension of corporate governance but as representation of a new corporate culture that integrates sustainable principles as cornerstone to enterprise value. “I think the tipping point for ESG will likely happen when ESG is integrated into investment analysis and tied to performance,” Mizuno told a Bloomberg interviewer in May 2019.

Japan is still some way away from reaching Mizuno’s tipping point even though it does rank in the top five regions in terms of assets committed to sustainable investment. According to the Global Sustainable Investment Review 2018 (GSIA), Japan, the United States, Europe, Canada, Australia and New Zealand are the top five regions responsible for $30.7 trillion in sustainable assets under management globally. Japan’s ranking reflects an all-inclusive definition of sustainable investment as well as the influence of both the reforms to date and the powerful organizations that are in support, including government ministries like the Ministry of Economic Trade and Industry (METI) and influential business and industry organizations, including the Keidanran (Japan Business Federation) and the Japan Securities Dealers Association.

The lack of pick up by the mainstream is the focus of a report released late last year by the private Japanese foundation, The Sasakawa Peace Foundation (SPF). The findings report a disconnect between an increase in sustainable investing in Japan and its comprehensive uptake by investors. It laid the blame on insufficient information about what is sustainable investment and how it’s done. Myths are pervasive, including thinking that ESG-factor investing is a fad destined to pass, the report said. Consequently, investors reason there is little value in devoting time and resources to integrating sustainability in strategies for which the competitive track record also is in question.

The report, “Sustainable Investing in Japan: Agenda for Action” was co-authored by Steven Lyndenberg and William Burckart, also the co-founders of The Investment Integration Project (TIIP). Their bottom line is to recommend that Japan’s officialdom undertake a comprehensive campaign to raise awareness, including tapping influential advisors from Asia and elsewhere who can help advance Japan’s visibility on the sustainability front.

It remains to be seen whether their recommendation is taken up in any meaningful way – or whether the ultimate push to get to Mizuno’s tipping point of full integration of sustainability factors continues to be slow-paced and incremental. Taking time to overcome resistance to such sweeping corporate cultural change is to be expected, and hence the commitment at the upper echelons of power and authority will be critical either way.

While making reforms mandatory and enforceable by regulators instead of on a voluntary basis could have been the most helpful, soft rules backed by powerful sources of influence can succeed in pushing forward sweeping change. At the end of the day, it’s changing hearts and minds and hence entrenched cultural behaviors that is at stake. What’s important is that change continues to evolve with import for Japan’ social agenda, its standing as a global economic power as well as its corporate governance.