Satoshi Ikeda, Chief Sustainable Finance Officer at Japan’s Financial Services Agency, is targeting increased action among asset owners.
Japan has been leading the charge on ESG for hundreds of years. The Japanese concept of Kyosei – which translates as co-living and promotes a world in which individuals and organisations live and work together for the common good – has been embedded in Japanese social and corporate culture since the 17th century.
These long-held principles of sustainability have filtered down to the world of investment.
According to figures published by The Global Sustainable Investment Alliance in 2021, Japan’s total sustainably invested assets stood at US$42,874 billion in 2020, representing a more than fivefold increase from 2016.
Such high levels volumes in the ESG investment space partly reflect the lead taken by the country’s policymakers and financial regulators.
The pace has quickened further in 2022 in response to then Prime Minister Yoshihide Suga’s April 2021 announcement that by 2030 the country’s emissions would reduce by 46% relative to 2013 levels.
Climate Action Tracker described the amended goal a “significant step forward from the previous 26% reduction target” but said a 60% reduction was needed to put Japan on a 1.5°C pathway.
Suga’s pledge was followed up at COP26 last November when current Prime Minister Fumio Kishida promised US$10 billion over the next five years to support Asia’s migration from fossil-fuel-fired to zero-emission thermal power, such as ammonia and hydrogen.
In December 2020, the Japan’s Financial Services Agency (FSA) set up an Expert Panel on Sustainable Finance comprising business, financial and academic experts with observers of officials from pertinent ministries and agencies.
This July the panel released its second progress report, revealing extent of progress.
In 2021 the FSA updated the Corporate Governance Code, asking listed companies – on a comply-or-explain basis – to address sustainability issues, including climate change and other global environmental priorities, “positively and proactively”.
Then in April this year, the FSA imposed mandatory reporting for Japan’s 4,000 largest companies in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), making it one of the first countries in the world to do so.
This July, Japan also became the first country to respond to International Organisation of Securities Commissions’ (IOSCO) call for greater scrutiny of ESG ratings and data providers by introducing a code of conduct for the sector.
In line with IOSCO’s recommendations, the code is designed to improve the transparency of ratings and data providers’ methodologies, ensure procedures for managing conflicts of interest are appropriate, and improve communication channels between providers and the entities covered without undermining their impartiality.
Satoshi Ikeda, Chief Sustainable Finance Officer at the FSA and Co-chair of the IOSCO workstream that developed the recommendations, says: “We’ve been trying to lead industry and financial sector discussions on [climate change] since the Paris Climate Accord was signed [in 2015]. We have been focused on how the financial markets in Japan can mobilise capital towards managing climate risk, and we have been trying to establish a certain framework and infrastructure to do that.”
A significant part of Ikeda’s brief lies in directing capital towards sustainable projects. In 2020, the FSA tightened the Stewardship Code to redefine responsibilities and explicitly instruct institutional investors “to consider sustainability (medium- to long-term sustainability including ESG factors) according to their investment management strategies in the course of their constructive engagement with investee companies”.
Work remains to be done. A progress report published in May found that “some asset management firms do not adequately disclose their basic approach to ESG investment and their relevant initiatives in reports or other materials for investors”.
Adequate disclosure is critical if the ESG funds are to avoid “being ridiculed as “greenwashing”, it said.
Any firm claiming to take ESG factors into account, “should improve the investment process and enhance the quality of disclosure so that it can clearly explain how the ESG factors affecting corporate values are identified and evaluated in the ESG funds, how it use ESG factors in portfolio decisions, and how engagement and the exercise of voting rights are conducted to improve ESG-related business opportunities and reduce business risks, while building the necessary organisational structure including the recruitment of personnel with expertise”.
Is a voluntary code sufficient? Ikeda says Japan’s asset managers are resistant to legislation like the EU’s Sustainable Financial Disclosure Regulation, favouring instead Singapore’s Disclosure and Reporting Guidelines for Retail ESG funds scheduled for implementation in 2023.
“We are working on moving from a comply-or-explain to a mandatory approach for certain ESG disclosure by asset managers. We haven’t formed a view on how the regulations will work in future, but we will probably finalise them by early next year,” he says.
Asset owner oversight
While the FSA is focusing on improving ESG disclosure from asset managers and the companies in which they invest, the regulator has less authority over asset owners.
Ikeda notes that unlike the European Insurance and Occupational Pensions Authority, which regulates insurers and occupational pension funds, the FSA’s remit only extends to the former.
“In Japan, a pension fund is often considered part of the compensation scheme for employees which can create problems because they are run by human resource experts not financial ones. Because the HR department may not be familiar with portfolio management, they need to gain general financial knowledge well before going into the ESG space.”
But with the help of the £1.205 trillion Japanese Government Pension Investment Fund (GPIF), which is the world’s’ largest retirement fund and a staunch and early advocate for sustainable investment, the FSA is attempting to bring the more asset owners up to speed.
“We are convening asset owners with life insurance companies and major pension funds like GPIF to discuss how and why ESG issues need to be incorporated into the investment decision-making process.”
Ikeda hopes GPIF’s policy of asking all its external asset managers to take ESG into consideration will drive more asset owners to take a similar approach.
“I really hope that the asset owners in Japan will share the sense of urgency and make steady steps toward adopting the ESG issues in their investments,” he says.
Advocates for nature
The FSA’s collaborative approach also extends to participating in the Taskforce on Nature-related Disclosures (TNFD), with Japan making up one of the eight countries in the Consultative Group of the TNFD.
The Expert Panel on Sustainable Finance says the FSA, with other regulators and in cooperation with relevant ministries and agencies, “should deepen the knowledge [on biodiversity and natural capital] through participating in the international discussions for developing the conceptual framework of relevant risks and opportunities and those for corporate disclosure at the TNFD forum”.
Ikeda says: “There is a very strong interest among the Japanese corporate and financial sectors for adapting to TNFD because the Japanese people generally love nature which creates certain problems when moving to green power. Obviously, the landscape of nature will be altered, and they want to protect their natural biodiversity.”
But this love of nature does not mean the S of ESG is overlooked. Ikeda says there is “huge support” in Japan for the UN Sustainable Development Goals (SDGs), particularly those linked to managing social risks, and says the current administration “sees the value in expanding disclosure around human capital as a way to meet the UN SDGs”.
In October 2021, the FSA published its Social Bond Guidelines (SBGs), intended promote the credibility of these instruments while reducing the cost to and administrative burden on issuers, which they hope will promote issuance from the private markets.
Ikeda also hopes that human capital and social issues will be “the priority topic” for the International Sustainability Standards Board (ISSB) once it has climate disclosures in place.
Ikeda expects ISSB’s climate and general sustainability disclosure standards to be widely adopted worldwide, once verified by IOSCO, although he adds: “How speedy that adoption process will be is anyone’s guess.”
ISSB climate disclosures are likely to play a role in the future deliberations of the International Platform on Sustainable Finance (IPSF), the international forum responsible for developing the Common Ground Taxonomy.
Ikeda is Co-chair of the IPSF’s Transition Finance Working Group, which is due to report soon.
Given the amount of work Ikeda has put in both nationally and internationally to managing ESG risks, he is sanguine about the pace of progress.
“I’m not sure the major economies can achieve their emissions targets by 2030, but I believe we are working pretty close to meeting the net targets by around 2050. To achieve that, we need to ensure that a vast amount of finance will be mobilised using a framework designed for an orderly transition to net zero.”