Abe’s green arrow: the rise of ESG investing in Japan

One of the more unexpected outcomes of Japan’s “Abenomics” program, designed to stimulate growth and inflation in the nation’s stagnant economy, has been the surge in initiatives around Environmental, Social and Governance (ESG) objectives. This has created a market ripe for investment, with the added impact of social and environmental transformation.  

The corporate world reacts

According to the Global Sustainable Investment Alliance, sustainable investing assets in Japan quadrupled over the period 2016-18, from 3% of professionally managed assets to 18%¹. Whilst we shouldn’t imagine that this reflects a complete change in business practices for the companies concerned², it does demonstrate that many managers are moving to models that incorporate ESG strategies, and that corporations are increasingly emphasising their credentials in this area in order to remain attractive to the market.

The recent rush to accountability was sparked by structural reforms initiated under “Abenomics” - the so-called “third arrow” of the program – one of the objectives of which was to redirect the priorities of Japanese firms towards their shareholders and better orient them with the expectations of modern, global investors³. These intentions culminated in the Japanese Stewardship Code, initiated in 2014 by the country’s Financial Services Agency to guide the actions of institutional investors , and the Corporate Governance Code, established by the Tokyo Stock Exchange as a core set of principles for corporate governance at Japanese listed companies⁴.

Whilst initially aimed at improving governance standards and energising the country’s balance sheets, the focus has broadened to include environmental and social initiatives as well.

Institutional investors push long-term perspectives

At the vanguard of this transformation has been the Government Pension Investment Fund, the largest such fund in the world. In 2015, it became a signatory to the UN Principles for Responsible Investment (UN-PRI)⁵, and has since become a world leader in the space, playing a major role in the recent expansion of sustainable investing in Japan⁶. As a largely passively-managed pool of funds, it selects indices with strong ESG credentials⁷, and also requires its asset managers to integrate ESG criteria into their analysis and evidence their engagements⁸.

Other large institutional investors are following their lead, with Japan Post Insurance recently announcing an ambition to triple the ESG component of its domestic stock portfolio, focusing on firms with technological solutions to global problems⁹.

Challenges with widespread uptake

Large, diversified funds with long term outlooks have an obvious interest in such measures. As GPIF Chief Investment Officer Hiromichi Mizuno has said:

“We have become less vulnerable to daily volatility but more vulnerable to system failure…when the capital market system fails we are dead. So I have a very strong view that for the business of capital markets to be sustainable, the society to support it must be sustainable.”¹⁰

But not every investor shares the ultra-long-term outlook of the GPIF, and none share its scale, and the relatively small proportion of Japanese assets under management which were sustainably invested, compared to US and European markets, has been a cause for concern¹¹. However, the popularity of the green bond market with smaller investors in Japan shows a growing appetite for exposure to ESG-linked assets across the country’s investment landscape¹².

The long-term outlook

Under an environment of global headwinds and softening domestic output, Japanese corporations and fund managers could be forgiven for a momentary preoccupation with short term performance. However, for those who do look beyond the immediate horizon, there are proven benefits to ESG investing that extend beyond the feelgood factor, with the weight of evidence suggesting a positive relationship between ESG criteria and corporate financial performance¹³.

Even more exciting is the transformative potential of unlocking the world’s largest savings pool and harnessing it in the interests of sustainable value creation - restoring accountability to Japanese corporate culture and promoting investment strategies that benefit both the Japanese economy and the world around it.

¹Global Sustainable Investment Alliance (2019), Global Sustainable Investment Review, April 2019
²Eccles, R (2019), How to further accelerate sustainable investing in Japan: Taking it to mainstream asset managers, September 2019
³Goto, G. (2018), The Logic and Limits of Stewardship Codes: The Case of Japan, The University of ⁴Tokyo Business Law Working Paper Series, No. 2018-E-01
⁵Tokyo Stock Exchange (2018), Japan’s Corporate Governance Code, June 2018
Government Pension Investment Fund (2015), GPIF has become a signatory to the UN-PRI (Media Release), September 2015
⁶Riding, S. (2019), World’s biggest pension fund steps up passive stewardship efforts, Financial Times September 2019
⁷Plender, J. (2019), Norway and Japan show the conflicting approaches to ESG investment, Financial Times, June 2019
⁸Laidlaw, J. (2018), Green bonds are 'lose-lose product,' says Japan's GPIF exec, S&P Global Market Intelligence, November 2018
⁹Uetake, T. (2019), Japan Post Insurance eyes firms with tech edge in new ESG investment strategy, Japan Times, March 2019.
¹⁰Mizuno, H. (March 15, 2018), quoted in Morrow, R. (2018), Why GPIF’s Mizuno is focused on market sustainability, Asian Investor March 2018
¹¹The Investment Integration Project (2019), Sustainable investing in Japan: An agenda for action, September 2019
¹²Ueda, S. (2019), Japan's small investors make big ESG statements, Nikkei Asian Review, July 2019)
¹³Frieds, F., Busch, T. & Bassen, A. (2015), ESG and financial performance: aggregated evidence from more than 2000 empirical studies, Journal ofSustainable Finance & Investment, 5:4, 210-233