Corporate governance has been a particular hot button issue in Japan for some time, and there is a lot of momentum as reforms move from ideas to actions.
Kathlyn Collins, vice president and head of responsible investing and stewardship at Matthews Asia, has just returned from a week in the country as a delegate of the Japan Working Group of the Asian Corporate Governance Association.
Based on her experience, interest in reforms has broken out beyond corporate governance specialists or activists. “Some domestic asset managers, for example, have put in place more aggressive proxy voting guidelines than ISS, one of the most influential proxy advisors globally,” she says.
Collins points out this enthusiasm did not begin overnight. “There has been a focus in Japan on corporate governance which took hold under Abe in about 2012 and has continued,” she says. These actions have included:
- ITO Review 2014
- Stewardship Code 2014
- CG Code 2015
- Revision to Companies Act 2015
- GPIF mandates stewardship for external managers
- Revision of CG Code 2018
- Revision of TSE segments 2020
- Revision of Stewardship Code 2020
- TSE Guidance on cost of capital 2023
Investors groups have also been pushing for change, including the Asian Corporate Governance Association, the International Corporate Governance Network, the Japan Stewardship Initiative, and others.
But the most recent actions have been government-led amid concerns for Japan’s future. “There is an overall fear of the country losing competitiveness in global markets and a strong push for corporates to step up and attract investors,” Collins says.
Government organised ‘Japan Weeks’, held between September and October, invite foreign investors and asset managers to hundreds of events to promote Japan’s attractiveness as a financial and capital market. Most of the events are focused on sustainable finance, Collins points out.
On the environment, Japanese corporates “have been long ahead of the curve in terms of environmental reporting”, says Collins, who expects them to continue to be at the forefront of this with the adoption of the IFRS Sustainability Standards likely in 2025. But, she adds, their operating environment has been “challenging” given the energy mix at the country level.
“Renewables are expensive, and it’s hard to change upstream companies in the chemical space,” she says.
That is not to say change isn’t happening. “The government has made bold pledges, even recently coming out with a sustainable aviation fuel (SAF) mandate of 10% by 2030,” says Collins.
Some companies have come out with ambitious emissions reduction plans. “These necessitate a lot of capex to achieve so monitoring incremental progress is key,” says Collins. She believes biodiversity is the next big theme for Japanese corporates.
Sustainable investment opportunities in Japan
Sustainability remains a “compelling destination for investors’ capital”, says Lewis Grant, senior portfolio manager for global equities at Federated Hermes, despite disappointing returns in 2023. But with fear playing an increasing part in the behaviour of markets, fundamentals – particularly long-term fundamentals such as sustainability – are being ignored by many, he says.
However this is having the effect of making good companies cheap, and creating opportunities for investors. “In Japan, we see a structural growth advantage to the large export driven businesses who have leading positions in the electric vehicle and battery markets and consider current valuations highly attractive,” says Grant.
With the efforts of the Tokyo Stock Exchange (TSE) earlier this year to promote capital efficiency, Matthews Asia’s Collins sees a new Japan emerging, and with it, a more attractive corporate environment for investors.
Today, Collins points out, around half of listed companies on the prime market, and 60% in the standard market, have return on equity levels below 8% and price-to-book ratios below 1. However, earlier this year, the TSE and PM Kishida made a plea for Japan’s ‘last chance’ and asked listed companies to bring in a management system conscious of the cost of capital and stock price.
“In response, 31% of prime market companies have disclosed some information related to the cost of capital,” says Collins. In addition, the volume of share repurchases hit a peak in May 2023, as this is how most companies responded.
Collins is also seeing a bolder Financial Service Agency, which has come out with an action program focused on management issues including an awareness of cost of capital, sustainability, the role of independent directors, board committee effectiveness and investor dialogue, better disclosure, and resolving legal and market environment.
The Japanese financial regulator is also seeking to fix the concert party rule, an area the Asian Corporate Governance Association (ACG) has pushed strongly as “it has stifled stewardship and has been contradictory to the principles in Japan’s Stewardship Code”, says Collins.
“After the adoption of the corporate governance code in Japan, many companies have made significant progress,” Collins says. “Many listed companies today recognise the importance of the board and practical dialogue with investors.”
Challenges for sustainable investors
The distinct lack of progress in Japan towards addressing the UN sustainable development goals and to meeting the 2030 climate goals of the Paris Agreement is “concerning”, says Lewis Grant, senior portfolio manager for global equities at Federated Hermes.
This year’s Green Transformation Basic Policy in Japan placed more emphasis on economic growth and energy security than decarbonisation, says Grant, “and does not reassure us that the political environment is supportive of sustainable investments”.
If globally we are to reach these lofty ambitions, politicians and leaders will need foster public support, and here Japan lags, says Grant, pointing to a 2021 Pew Research Centre survey that indicated the percentage of the Japanese public willing to make “some” or “a lot of” changes to help reduce the effects of climate change lags behind other developed peers.
“Further, the percentage of the Japanese public who were ‘very concerned’ about being personally harmed by climate change had dropped over the prior six years,” says Grant.
On corporate governance, Mathews Asia’s Collins says disclosure in Japan “remains thin in many areas such as compensation, is often highly fragmented, and behind best practice”.
“The biggest issues remain ineffective and uneducated outside directors, cross-shareholdings and conflicts of interest, parent-subsidiary listings, and gender diversity,” Collins says.
On the issue of companies with price-to-book ratio less than 1, today those that may be above that threshold may have less incentive to continue to make reforms, she adds.
“Cross shareholdings remain a huge issue. Friendly shareholdings remain extremely high and companies feel the need to negotiate with partners before disposing of such shares,” says Collins.
While companies have started to shed shares in allegiant companies, progress is slow, Collins adds, and some companies are shifting the classification of such holdings from cross-held shares to ‘pure investment’, meaning less disclosure is required.
Board demographics is another cause for concern as many boards are still dominated by old(er) male inside directors and directors in general are lacking financial literacy and training. There are also no tenure limits on outside directors in Japan.
“The goals around gender are fairly weak and focus only on the prime market listed companies,” says Collins. The government has said that all listed companies on the prime market should strive to appoint at least one female exec by 2025 and have the ratio of female execs at 30% or more by 2030 (auditors, directors, other equivalent executive roles).
“The share of female executives in Japan has been rising but there is still a considerable gap between Japan and other G7/OECD countries,” says Collins.
In 2022 the rate of executives was 9.1% for all listed companies in Japan vs the OECD average of 30% (G7 except Japan was 39%). Approximately 20% of companies listed on the prime market have no female executives. Many investors have expectations and targets of 30% out to 2030 and are ratcheting up their guidelines year by year.
Collins is optimistic, however, that Japan has the impetus to act. “The regulators fear an ageing society and a loss of competitiveness as well as an increasingly dominant passive investor presence in Japan,” she says, “if they are inactive in corporate governance reform, regulators told us that the country stands to lose huge value with reduced listed company growth”.