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Japan’s revised stewardship code seeks structural change

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Japanese regulator the Financial Services Agency (FSA) has published a revision to it stewardship code in a move that aims to increase pressure on investors and companies to foster sustainable growth.

The code describes the stewardship responsibilities of institutional investors towards their clients, beneficiaries and companies when they engage with corporates.

The principle-based code has a ‘comply or explain’ approach, and commitments from over 280 signatories; consisting of asset managers and asset owners.

Its second revision, after one prior amendment in 2017, was initiated after an expert council (convened by the FSA and the Tokyo Stock Exchange) called for further changes.

To increase the code’s impact, the council emphasised the importance of proxy advisors and investment consultants to provide support and advice to institutional investors, as well as the necessity to improve the quality of engagement dialogues between investors and companies.

Key changes

The amended code explicitly asks signatories to consider medium- to long-term sustainability, including environmental, social and governance (ESG) factors, in their engagements.

Other central changes seek to combat conflicts of interest in voting decisions.

In particular, institutional investors should disclose the rational for their votes, “including those [votes] perceived to have conflicts of interest or those which need explanation in light of the investor’s voting policy”.

It also focuses on service providers by adding a new principle, which says: “Service providers for institutional investors should endeavour to contribute to the enhancement of the functions of the entire investment chain by appropriately providing services for institutional investors to fulfil their stewardship responsibilities.”

Proxy advisers and company dialogue

Nicola Takada Wood, portfolio adviser at RWC Partners, explained that, “according to the revised code, the onus is on the service provider to specify potential conflicts of interest such as these, and to have a policy in place to effectively manage them”.

Takada Wood also emphasises that the guidance suggests that “proxy advisors should base their recommendations on corporate disclosure”, while the company dialogue is only needed in certain complex cases.

“One would presume that an ‘active exchange’ of views with companies would take place mainly when opinions of the proxy adviser differ from that of the management, ie when they are advising investors to vote against resolutions tabled by corporate managers,” she added.

“The knock-on implication of this is that, in what will be an essentially adversarial argument, the advisers should be asked to fully explain and justify their reasons for advising a vote against the management line.”

Sachi Suzuki, engagement professional, EOS at Federated Hermes, praised the code for adding considerations of sustainability and for its proxy adviser principle.

Suzuki said that “proxy advisers should exchange views with companies to ensure accuracy of information”, but cautioned against some of the wording being overly prescriptive.

“Providing voting rationale is important not only to ensure accountability of investors but also to send the correct messages to companies,” she said.

As examples, she explained: “An investor may vote against a board member due to concerns about a lack of diversity or an inadequate response to climate change at a company that is performing well financially or otherwise, in which case it is important that they explain their voting rationale correctly.”

Time constraints

Emmet McNamee, senior policy analyst at the Principles for Responsible Investment, said that the updated code is a step forward for stewardship in Japan, but warned that it could have unintended consequences because of existing time constraints in the AGM season.

While there is a possibility to postpone AGMs, he argued that time constraints during the proxy season could mean that “requiring consultation with companies would risk introducing further delays and preventing investors from accessing independent advice that could inform their decision-making”.

“This measure would also encourage deference to management, as advisers could effectively avoid delays by not making recommendations that would displease management,” he said, which could mean that the new code will do more harm than good.

McNamee also emphasised that the code could strengthen its escalating measures, including on points such as voting against management proposals or through collaborative engagement to seize the scale and urgency of the challenge that sustainability issues pose.

Conflicts of interest

By targeting conflicts of interest, Takada Wood believes that the code is seeking to tackle a root problem in the Japanese business world.

“Much of Japan Inc has been criticised in the past for being beholden to conflicts of interest, arising from cross-shareholdings, the prevalence of Zaibatsu and their group companies and a myriad of less formalised but equally restrictive business relationships.

“Any effort to minimise these, or at least have company management be accountable for them, is a positive move towards a healthier and more sustainable business environment in Japan,” she said.

Elena Johansson

Senior Reporter

Part of the Bonhill Group.