While North American investors have traditionally perceived environmental, social and governance factors as a way of injecting personal philosophy into business practices, Japan’s business community has recently — and suddenly — begun to implement the concept and its uses in a different way.
“What’s really evolved is a different set of ESG criteria,” says Linda-Eling Lee, managing director and global head of environmental, social and governance research at MSCI Inc.
Japan, she notes, looks at how those factors “are going to impact the long-term risks and the return profile of your investments, regardless of what your personal beliefs might be as an investor.”
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That baggage-free perception is part of what has led both Japanese institutional investors and corporations to accept environmental, social and governance factors as just another useful tool in a short period of time, according to Lee.
Indeed, a focus of Prime Minister Shinzo Abe’s economic policy has been boosting the attention paid to the quality of corporate governance in Japan in order to make its companies more competitive and attractive to foreign investors, she says.
Pension funds have also been getting in on the action. A major event in setting the tone was the move by Japan’s Government Pension Investment Fund to follow the government’s stewardship code. Updated in 2017 from its nascent 2014 version, the code defines the principles responsible institutional investors should follow. It suggests they should have a transparent stewardship strategy that includes how they handle conflicts of interest, as well as how they monitor and engage with the companies they invest in. It also covers disclosure of voting activities and how investors use them as a stewardship tool.
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In Japan’s top-down culture, such a commitment by a government pension plan will make companies take notice, says James Hawrylak, the Tokyo-based director of institutional relations for Sustainalytics, a governance research firm. “It’s very powerful for a government ministry to do something like that, and it will add further momentum.”
Areas of focus
So what do the issues look like in practice? A diffuse concept, the environmental, social and governance issue can take many forms. But when it comes to social issues, the government has identified boosting the role of women in the corporate workforce as a key tool for growth, says Michael Jantzi, chief executive officer of Sustainalytics.
“You see a very big drop-off as women enter the workforce but then don’t proceed beyond, say, middle management,” says Lee.
“It’s a glaring lag in Japan,” she adds.
In its efforts to address those and other issues, the Government Pension Investment Fund announced in July 2017 it would be using MSCI’s Japan Empowering Women and Japan ESG Select Leaders indexes as benchmarks to track its progress and as a basis for passive equity allocations.
Re-auditioning on the world stage
Using and acting on environmental, social and governance analysis is allowing Japan to present a more attractive face to global investors, especially when it comes to transparency.
“There is an understanding that the way global investing is done today, companies simply need to be more transparent,” says Lee. “You’re no longer just playing to your domestic market.”
A mere two years ago, only 12 to 14 per cent of Japanese companies would expand upon publicly available information used by MSCI to compile its ratings, Lee estimates. Today, that number exceeds 50 per cent.
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The adoption of environmental, social and governance factors appears across multiple asset classes. While the focus has typically been on domestic equities, the Japanese approach considers environmental, social and governance factors when it comes to both equity and fixed-income investments and as part of both active and passive strategies, says Jantzi.
One example on the fixed-income side is the sudden robust activity in green bonds in Japan, which Hawrylak notes isn’t able to keep up with domestic demand. In 2015 and 2016, Sustainalytics provided an external review for only one Japanese green bond issuer per year. In 2017, that number jumped to six.
He notes, however, that even in the last six months, there has been closer scrutiny of how green bonds fit into an issuer’s broader environmental, social and governance plan. “There is the idea that a green bond issuance should not be a one-off, random event. Rather, it should be part of a long-term, wide ESG strategy that a company has in place.”
Test cases
So what qualifies an individual company as a leader? Among the companies highlighted by Sustainalytics is Konica Minolta, which manufactures and sells imaging products, printers and multi-functional devices for office and industrial use.
Among the company’s actions is a focus on human resources, which is a significant concern given the high global demand for the biotechnology and information technology professionals it will need to hire to achieve its ambitious revenue targets in 2019. To boost its competiveness, the company is actively tackling the lack of women in the workplace. The chief executive officer chairs the company’s women’s committee, the relative success of which is evident in the current percentage of female managers at 16.4 per cent. The result surpassed the company’s previous goal of five per cent by 2017. The Japanese average for 2016 was 12.1 per cent, according to Japan’s Ministry of Health, Labour and Welfare.
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Another company highlighted by Sustainalytics is Kao Corp., a chemical manufacturer with 40 per cent of its business in beauty care.
In 2013, the company recalled a skin-whitening product from one of its major brands, Kanebo Cosmetics Inc., that inadvertently caused thousands of customers to develop white splotches. As of January 2018, the company had settled with 17,798 customers over the incident, according to a statement from Kanebo Cosmetics.
Part of rehabilitating the company’s image included boosting its standards. Among the achievements, 95 per cent of Kao’s manufacturing plants have obtained 9001 certification from the International Organization for Standardization, a global standards body. As well, Kao has established stricter safety standards for its products and has been transparent about the incident, having committed to supporting those affected until they make a full recovery.
Developments on the pension side
While the progress the Government Pension Investment Fund has made has focused on domestic equities, the plan is eager to expand its approach, according to a spokesperson. It’s currently reviewing potential global environmental, social and governance indexes, and it revised its investment principles in October 2017 in order to expand its stewardship responsibilities to all asset classes. The fund is also developing a joint research program with the World Bank to explore solutions for integrating sustainability considerations into fixed-income portfolios.
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The spokesperson noted the goal of the fund’s environmental, social and governance strategy is to push the market in a more sustainable direction. “It is quite important for us that the whole market will grow sustainably, so as to receive [a] sustainable investment return for a long horizon,” the spokesperson noted.
“GPIF regards ESG as a very convenient tool to request external asset managers and investee companies to get rid of short-termism.”
Martha Porado is an associate editor at Benefits Canada.