The relationship between Japanese banks and ESG issues has been complicated.
Japan has been hit harder than many by a changing environment. In only the last few years, the country has been hit by a number of natural disasters that, for many in the country, have underlined the need to address climate change. In 2018, regional floods in western Japan “forced two million people to evacuate their homes” and “claimed over two hundred lives.” The average temperature of Tokyo has risen by 2.9 degrees Celsius since 1900, more than three times faster than the global average increase. Osaka, Japan’s third largest city after Tokyo and Yokohama, is estimated to have assets worth over $200 billion that are threatened by rises in the sea-level. All of this has increased public demand for greater action on climate change and, particularly in the wake of the UN Development Goals outlined in 2015, has pushed banks such as Nomura to consider ESG investments in more detail.
As Kazuyuki Aihara, Head of the Sustainability Finance Section in Nomura’s Debt Capital Markets Department, stated: “Due to events such as Typhoon Hagibis, Japanese people are awakening to the fact that global warming is at their doorstep […] today’s investors see a massive stake in investing in green and social sustainability products.”
Despite this, Japanese banks have traditionally trailed those of Europe and America in ESG investing. In large part this is because of Japan’s dependence on conventional forms of energy like coal. After a range of safety blunders in nuclear power stations, including the disaster at Fukushima, most nuclear reactors – which produce far cleaner energy – have remained closed. This has limited Japan’s ability to cut carbon emissions and has important implications for banks exposed to associated markets.
The wider east Asian region itself is also largely dependent on thermal coal for the generation of electricity. Many countries in the region do not presently have an easy alternative to oil and coal, even if they did wish to invest in green energy. The transition to nuclear, hydro or solar power in east Asia will be challenging for this reason. This has proved to be a major issue in ESG investing in recent months as investors grapple with the difficulty of investing in environmentally-friendly forms of energy which are also economically viable.
Economic stagnancy has also reduced the ability (or desire) of companies to invest in green alternatives. Japanese companies have long been wary of investing and prefer to sit on piles of cash, reducing both innovation and the amount of investment that is pumped into green transformation. Government public works have only done so much.
There are signs, however, that a shift in approach could be on its way. Companies and banks are facing increasing pressure from shareholders and the government to commit to the ESG agenda.
In March, Mitsubishi UFJ Financial Group and Sumitomo Corp both faced climate resolutions from activist shareholders at their AGMs. This followed a similar such resolution at the AGM of Mizuho Financial Group the year before, the first time a listed company had held such a vote. In the case of Mizuho, the “proposal to align Mizuho’s business with the 2015 Paris climate accord was defeated” but with “support for the resolution at 35% [this] showed Japanese attitudes were changing.”
To an extent, we can ascribe this increased shareholder activism to former President Abe’s corporate governance reforms. The “third arrow” of Abenomics consisted of a “rush to accountability” that reworked Japanese boardroom structure. With initiatives such as the Japanese Stewardship Code, set out by the Japanese Financial Services Agency, and the Corporate Governance Code, established by the Tokyo Stock Exchange, modern corporate governance principles have been changed in the hope of redirecting the priorities of major companies. Abe was seeking to make Japanese companies both more responsive and more palatable to a new generation of investors, who expect social and environmental issues to be at the heart of modern investing.
Actions taken by the Japanese government have also made ESG investing an economic necessity for any fund with an exposure to the Japanese markets. The Government Pension Investment Fund (GPIF), which has $1.5tn in assets under management and is the biggest such fund in the world, made what Nomura branded a “game-changing pivot to ESG bonds” in 2019. In that year, GPIF invested more than $3 billion in green, social and sustainability bonds. In 2020, there were 50 green bond issuances in Japan worth $6.34 billion – up from just one issuance in 2016.
In addition, GPIF has been tracking more and more ESG-based indices. This started in 2017, when “GPIF selected three ESG indices for Japanese equities and commenced passive investment tracking those indices.” This means these funds only select indices with strong ESG credentials. Asset managers are required to analyse potential investment in close reference to ESG criteria. In some sense, this prioritises ESG-friendly companies for public money. It sets a higher standard for those companies seeking to benefit from public investments. GPIF has in this way lead the Japanese market when it comes to ESG issues, and it is therefore little surprise that large institutional investors, such as Japan Post Insurance, are following.
Perhaps partly because of such action, “sustainable investing assets in Japan quadrupled over the period 2016-18, from 3% of professionally managed assets to 18%.” Though starting from a low base, this clearly represents a significant increase and suggests practice is, to an extent, changing. Should this trend continue, corporations will increasingly need to demonstrate their ESG credentials, and back this up with firm action, to remain attractive (even viable) as investments.
This trend is being backed by central bank policy. At the latest meeting of the Bank of Japan (BOJ) in July, policymakers discussed the BOJ’s policy of offering “zero-interest funds to financial institutions making loans and investments to tackle climate change.” This was outlined as a policy that would help the country reduce carbon emissions – aiding the government’s target of reaching net-zero by 2050 – without intervening directly in the markets in a distortive fashion. In other words, a way of guiding the market towards eco-friendly policies whilst maintaining its integrity. As one committee member put it:
“In Japan the economy is largely dependent on fossil fuel, and indirect financing has a major role. If the bank directly intervenes in addressing climate change, various distortions may occur in the financial system. This can be avoided with the new fund-provisioning measure, which will support investment or loans that financial institutions make to address climate change based on their own decisions.”
The BOJ and public institutions are therefore leading the Japanese markets towards a more ESG-focused future. Without distorting the markets, public money is being pumped into the companies and financial products that could finance the path to a net-zero future – in the process making ESG considerations an economic and business necessity. Perhaps this action on the part of public institutions was necessary as the market itself was always unlikely to innovate, in this regard, off its own accord. This is a result of the tendency for businesses to sit on cash rather than invest, as well as the country’s dependence on fossil fuels that make a transition to net-zero economically difficult and unattractive, at least in the short-term. This is why intervention on the part of institutions like GPIF was so crucial, and potentially so transformative.
The Japanese approach to ESG is clearly changing. Those with an exposure to Japan will increasingly have to consider companies with strong ESG credentials, and an ever-wider range of green products, if they wish to take full advantage of the country’s markets.
Author: Harry Clynch
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