From 2014 to 2018, Japanese sustainable investing assets had an astonishing 308 percent compound annual growth rate, vastly outpacing the growth rates in other global regions. Amid this explosion of sustainable investing, the RI Asia Japan conference last month convened hundreds of engaged participants to discuss progress on sustainable finance around the world and specifically in Japan. Long-time participants expressed enthusiasm that the conference had expanded tremendously, necessitating a move to a much larger venue. Much of the discussion addressed global themes, such as the need for more investor-grade environmental, social, and governance (ESG) data and the imperative for climate action.
From my own experience in working on ESG topics in North America and Europe, and arriving as a newcomer to the Japanese responsible investment (RI) community, three unique, Japan-focused dynamics stood out. These dynamics point to keys for adapting and applying global sustainable investment themes within Japan and ways the rest of the world can learn from Japan’s rapid uptake.
The Japanese private equity market is poised for growth—and sustainable investment will be essential for success.
After many years as a niche market, private equity in Japan may be poised for growth. As Private Equity International (PEI) noted in their recent special edition on Japan, the past few years have seen a significant increase in private equity activity, with many predicting that this time, the uptick is likely to continue. As global and domestic firms expand their investments in Japan, it will be vital to adapt and apply global approaches to responsible investing in private equity in the context of two unique market characteristics in Japan.
First, there is significant skepticism about the industry that has led to some negative public perceptions. Private equity in Japan is also highly relationship-driven, with word-of-mouth and referrals an “important source of dealflow,” according to PEI. Many investments are also expected to target the large pool of Japanese family-owned businesses. Taken together, these considerations mean that it will be crucial for private equity firms to build trust and demonstrate a commitment to responsible investing—as firms and in how they steward companies. As Shunsuke Tanahashi, head of the Japan office for Partners Group and a long-time leader in the Principles for Responsible Investment (PRI) community in Japan, notes, “Japanese buyout general partners (GPs) are, in many cases, helping Japanese companies that are suffering from succession issues. Successful GPs are having sincere dialogues with the presidents of those companies and trying to contribute solutions. Sometimes, GPs get investment opportunities even if they do not bid the highest price because their proposal is very sincere and reflects the president's interests. RI/ESG enables those GPs to show their sincerity and create positive feelings toward private equity.”
Another factor affecting sustainable investing in Japanese private equity is that many deals are also likely to target carve-out businesses from large industrial conglomerates. As those businesses become new, independent companies, firms will have to help them establish their own ESG-related policies, governance structures, and practices (rather than continuing to rely on a corporate headquarters to drive those efforts).
Institutional support for the recommendations of the Taskforce on Climate-Related Financial Disclosure (TCFD) illustrates the potential for regulators and asset owners to spur action and the opportunity for Japanese firms to pioneer successful approaches.
Several influential figures have expressed ongoing, strong encouragement for the adoption of the TCFD recommendations. For example, at the RI Asia Japan 2019 conference, Satoshi Ikeda from the Financial Services Agency expressed support and encouragement for TCFD. Hiroshi Komori of the Japan Government Pension Investment Fund (GPIF) also expressed support for the TCFD recommendations, in alignment with GPIF’s stated views. GPIF has been a strong voice for the implementation of ESG more broadly as well; the fund’s principles include specific attention to “including the consideration of ESG factors.”
Inspired by such voices, Japanese investors and companies are stepping up. A total of 76 Japanese companies/organizations have committed publicly to the TCFD. Out of those 76 entities, 27, or more than one-third, represent the financial services sector.
To gain the full benefit of TCFD analysis, it will also be essential for investors and companies to look beyond a narrow focus on the quantitative analysis of physical and transition risk. To achieve this, they should use foresight and scenario analysis on a broad range of climate resilience factors, such as related changes in mass migration, human health, labor markets, technologies, etc. In addition, they should address the TCFD guidance regarding a company’s governance, strategy, risk management, and metrics and targets. Doing so may in turn improve the structure for broader ESG efforts as well.
Japanese banks have an opportunity to apply leading global practices on environmental and social risk management to address risks beyond climate.
As Japanese banks are eagerly pursuing growth domestically and overseas, they are pursuing investment and financing activities across industries. Sessions at RI Asia Japan 2019 addressed topics such as ESG in supply chains, natural capital, and life below water, yet it seemed that financial services companies had less-developed approaches in these areas compared to climate. While many banks have adopted sector policies on their activities regarding coal, it is imperative to manage a broader range of risks.
Many European and American banks have adopted robust environmental and social risk management (ESRM) approaches and sectors policies covering industries such as mining, forestry, and hydropower, and topics such as human rights and water. Japanese banks should develop similar approaches starting with overall ESRM policies and governance, adding specific guidance through sector policies and promoting implementation through practical tools.
Based on the presentations and conversations at the conference, it seems that there are some areas where Japanese financial institutions are pursuing leading approaches to ESG management and where there are opportunities to do more. BSR looks forward to continuing to serve our members based in Japan and doing business in the country and checking back in with RI Asia Japan 2020.