November 15, 2016


Substantial Change toward Expansion: The Sustainable Investment Market in Japan

Keywords: Money Newsletter 

JFS Newsletter No.170 (October 2016)

Image by RaphaelaFotografie.

Having used to be limited to individual investors, Japan's sustainable investment market is quite small, accounting for less than 0.1 percent of the global market.

Current Status of SRI and Related Issues as It Expands in Japan

The Japanese Financial Services Agency (FSA), however, launched a Japanese version of the "Stewardship Code" in February 2014 and established a "Corporate Governance Code" in June 2015, creating momentum toward expansion of sustainable investment by institutional investors.

In this issue, we introduce the latest on Japan's sustainable investment market, which is changing dynamically toward expansion as reported in the Executive Summary of the White Paper on Sustainable Investment in Japan released March 31, 2016, having obtained permission from its authors, the NPO Japan Sustainable Investment Forum (JSIF).

Japan Sustainable Investment Forum

Chapter 1: Trends of Institutional Investors

Chapter 1 discusses the trends of institutional investors. The Japanese responsible investment market started with a single fund back in 1999 and, following a long period of stagnation, began to show signs of expansion once again following the introduction of Japan's Stewardship Code in 2014. Japan's Stewardship Code and Corporate Governance Code, which was introduced shortly thereafter, are like two wheels on an axle, and have the role of guiding the relationships between Japanese investors and corporations toward change.

One of the authors featured in Chapter 1, Mr. Kanai, explains, "for a long time, corporations and investors in Japan have shared relationships based on mutual non-interference." Japanese corporations have [traditionally] held a reserved stance toward the procurement of funding from capital markets, and investors experience little sense of "ownership," to the point where the relationship between the two can be described as a tacit policy of non-interference. The extent to which Japan's Stewardship Code may be able to change this, therefore, is a highly anticipated topic.

Of course, the addition of the Japanese Government Pension Investment Fund (GPIF), the world's largest pension fund by assets under management, to the list of Japan's Stewardship Code and Principles for Responsible Investment (PRI) signatories, is sure to exert an influence on the Japan's responsible investment markets, which have been left adrift by global tides.

Moreover, the stance expressed by the U.S. Department of Labor regarding the U.S. Employee Retirement Income Security Act (ERISA), stating that "where ESG is directly related to the economic and financial value of investment, it should be taken into consideration in the management of assets," is also likely to have a significant influence on Japanese institutional investors.

This is because, according to ERISA's interpretation of fiduciary duty to date, and as the author has expressed, "SRI has traditionally been seen as the enemy to disciples of ERISA," and the traditional interpretation in Japan was "fiduciary duty has represented a dark cloud that has covered over the heads of ESG advocates." GPIF's signatory to PRI is expected to be instrumental in lifting this cloud in Japan, and it has been emphasized that standards are now in place to allow public and corporate pensions to start making a genuine commitment to responsible investment.

If we take into account the actual state of Japanese pension funds, however, we can see that there are many issues that are yet to be overcome. Going forward, these funds, which do not manage funds directly, will be faced with the challenge of to what extent they are able to select asset management institutions with a penchant for ESG investment processes as partners, as well as monitor and manage these institutions. They must also take on the challenge of changing their traditional interpretation of ESG as [simply] one form of active investment, and instead work toward the incorporation of ESG into their investment processes through "ESG integration."

This chapter introduces various examples of ESG integration at Mitsui Sumitomo Trust Bank and responsible investment initiatives at Resona Bank, presented by Resona Bank's Minoru Matsubara, as case studies of initiatives at Japanese asset management firms. The chapter also features a column by Takeshi Mizuguchi, a professor at the Takasaki City University of Economics who has spent many years researching sustainable investment, which discusses the perspectives of overseas observers pertaining to trends in sustainable investment in Japan.

Chapter 2: Trends of Individual Investors

Chapter 2 explores the trends of individual investors in terms of Japanese SRI investment trusts. The chapter is a focal point of this JSIF white paper, which represents the only one of its kind in Japan by presenting data related to the trends of SRI investment trust markets over the last 16 years, adding analysis, and making this information available to the world.

We encourage the reader to examine the chapter while considering these market trends. SRI investment trusts were established in Japan in 1999 and, by 2007, their total investment balance had surpassed 1.0 trillion yen. This was reduced by half in the aftermath of the 2008 financial crisis, and since the second half of 2011, the figure continues to fluctuate between 210.0 billion yen - 260.0 billion yen. In the two years since the end of September 2013, however, the SRI investment trust balance experienced an 11.5% decline, from 244.0 billion yen to 216.0 billion yen.

In terms of the investment scope of SRI investment trusts, the percentage of net assets allocated to domestic stocks at the end of September rose to 54.5% from 42.4% two years ago, while the percentage allocated to international stocks fell from 50.0% to 40.2%. In terms of evaluation criteria, funds under the evaluation criteria of environment represented 58.6% at the end of September 2015, down from over 70% two years earlier.

Although the funds invested in international stock under the evaluation criteria of environment still represent the largest proportion of net assets, the composition has been gradually diversified.

If we examine newly established and amortized investment trusts, we can see that the number of SRI investment trusts peaked at the end of June 2010 at 94 before falling into a trend of decline. This trend later subsided and, as of September 2015, there were 74.

For over three years from the first half of 2011, there was a continuing trend of no new establishment. However, from the second half of 2014, we can see that newly established trusts have come to exceed amortized trusts.

When we observe trusts in terms of evaluation criteria, we may note the characteristic that, over the last two years, six out of ten newly established SRI investment trusts have been womenomics-focused. If we examine the capital flows of SRI investment trusts, we can see that net capital inflows are continuing to decline.

Until 2007, capital inflow was consistent with the establishment of funds. However, following the confusion of the global financial crisis, capital flows have continued to demonstrate net losses since 2010, regardless of trends pertaining to new fund establishment or amortization. This net decline has continued even since the second half of 2014, when the number of funds began to rise again.

Recent years have seen the investment environment remain relatively favorable, and we can see an increase in the net asset balance as a result of investment. However, this increase has been offset by the capital outflows from cancellations and redemptions and, on the whole, the total net asset balance has remained stagnant with little to no increase or decrease. The analysis featured in this section was contributed by the author, Masaru Otake, and various data were provided by QUICK Corp.

Moreover, Chapter 2 also touches upon the trends of social impact bond markets. In Japan, the first social impact bonds for individual investors were made available in March 2008 and, in 2014, aggregate total sales exceeded 1.0 trillion yen. The total sales and issue balance as of the end of September 2015 were 1.121 trillion yen and 564.2 billion yen, respectively (calculated at the exchange rate when figures were published; excluding balance decline due to incomplete sales).

In comparison with figures from the end of September 2013, total sales rose by 327.9 billion yen, the issue balance rose by 89.6 billion yen, and, even after seven years since they were first introduced in 2008, social impact bonds continued to show a trend toward growth. Moreover, in November 2013 the International Finance Corporation (IFC) issued the "Banking on Women Bond," which represented the first gender-themed social impact bond to be issued in Japan.

The author of the chapter, Ken Tokuda, highlights three elements that are central to the renewed growth and movement of social impact bonds:

1) alignment with stakeholders;
2) a simple composition and high interest currencies; and
3) the promulgation of "best effort" management.

Meanwhile, if we consider the issue and sale of bonds by institutional investors, we can see that life insurance companies in particular have begun to use investment in social impact bonds as a form of growth investment, reflecting positive movement on this front also.

Green bonds have also started to be issued by Japanese banks, including the Development Bank of Japan (DBJ) and Sumitomo Mitsui Bank, and we can see model cases arising from the perspectives of both investors and issuing bodies.

CHAPTER 3: Shareholder Advocacy

Chapter 3 touches upon shareholder advocacy. Japan's Stewardship Code was established in February 2014, and at the end of November 2015, 201 institutions, including overseas institutions, were signed up. Most of the main asset management companies in Japan are signatories, in addition to asset owners such as public pension funds including GPIF, corporate pension funds, life insurance companies, and other associated institutions.

Meanwhile, Japan's Corporate Governance Code, which targets listed companies in Japan, took effect on June 1, 2015, and emphasizes that companies listed on both the first and second sections of the stock exchange have a duty to comply with, or otherwise explain their actions relative to, each principle. The style of corporate governance reports has changed in line with the introduction of the Code and, from June 2015, corporations are required to provide reports in the new style within six months of annual shareholder meetings. As of the end of November 2015, a total of 1,089 companies -- approximately 30% of listed companies -- have been submitting reports in the new style.

However, the Code is not enforced by law, and while the principle-based British system emphasizes the concept of "comply or explain," Ms. Yamasaki stresses that "until now, most Japanese corporations have operated on a rule-based system where regulations are decided and subsequently complied with. Consequently, there are many Japanese corporations that are simply not used to the concept of explanation yet."

The concept of "engagement," a theme common to both codes, is also arousing anticipation. Change continues to be apparent in the use of voting rights for ESG proposals by shareholders and at general assemblies, which represents one form of constructive dialogue.

For example, in recent years, proposals by individual shareholders acting autonomously, institutional investors, and major shareholders (individuals, investment companies, and municipal bodies) have become increasingly common. Many of these proposals aim to increase the involvement of shareholders in company management by enhancing transparency pertaining to the election and dismissal of outside directors/outside corporate auditors and corporate management. Constructive, purposeful dialogue by Japanese investors, or, in other words, dialogue that elicits change by enhancing corporate activities or structure is therefore a topic of rising anticipation.

CHAPTER 4: Sustainable Finance

Chapter 4 is entitled "Sustainable Finance" and discusses the emergence of various approaches to sustainable finance in Japan, including financing, community investment, environmentally friendly real estate, and private equity.

According to Keisuke Takegahara, who provides us with an introduction to principles for financial action, as of September 2015 the number of institutions signed up to the Principles for Financial Action for the 21st Century had expanded to 195, which extend across a wide sphere, from major banks, securities companies, and insurance companies, to regional and trust banks all over the country.

In this way, a formal foundation, which straddles the borders between industrial sectors, has been established to develop ESG-considerate investment and financing. To further develop ESG investment going forward, however, it is going to be necessary to work on encouraging financial institutions to take anonymous action, while addressing the issue of varying degrees of enthusiasm between signatories.

As stated by the author of "Community Investment and Crowdfunding," Shunji Taga, there were 25 NPO banks in Japan as of December 1, 2015, and as of the end of March 2015, the aggregate total of financing provided by those 25 NPO banks rose to 3.2 billion yen.

From a regulatory standpoint, the 2014 revision of the Financial Instruments and Exchange Act deregulated micro-investment funds, or investment crowdfunding, that utilize collective investment schemes, and from January 2016, discussions aimed at forming legislation pertaining to the use of dormant deposits are continuing to take place at regular Diet sessions.

According to a bill submitted at an ordinary Diet session in 2015, supporters of community investment represent "fund distribution organizations" for these dormant deposits. This section also includes a column by Masayuki Oki, which draws on his experience of investing in micro funds.

Environmentally friendly real estate is an area that is garnering attention from the sustainable investment sector. Until recently, there were hardly any buildings or projects in Japan that had been recognized by global real estate certifications (LEED, etc.). According to Hiroki Hiramatsu, however, there are now a number of projects in Japan that have successfully acquired such certification.

The environmental performance -- energy efficiency, for example -- of buildings in Japan is generally good. However, verification of this by globally recognized certification systems is appealing because it reflects the expansion of new opportunities to invest responsibly

There are 3.86 million companies in Japan, and as listed companies only represent 3,500 of these, the remaining 99.9% are unlisted. Some of these may well be selected to form part of investment portfolios, however, as Shunsuke Tanahashi emphasizes: "69.4% of all Japanese workers are employed at small- and medium-sized businesses, and these businesses are responsible for creating 53.3% of total added value. We can naturally assume, therefore, that thinking seriously about investment in the private equity segment is akin to thinking about the sustainable expansion of the Japanese economy."

Japan's responsible investment is still primarily focused on investments in listed stock, and this section discusses points to be taken into account when engaging in private equity investments to ensure the proliferation of responsible investment in this field.

From Executive Summary of the White Paper on Sustainable Investment in Japan 2015 by Japan Sustainable Investment Forum