Japan’s regulator: Domestic LPs unlikely to follow western approach to ESG

Japanese LPs will continue to favour corporate engagement over exclusionary screening of controversial sectors, according to Satoshi Ikeda, chief sustainable finance officer at the country's financial watchdog.

Japanese approaches to environmental, social and governance investments are unlikely to converge with those of western institutions, according to Japan’s financial regulator.

Speaking in a virtual Q&A session for sister publication Private Equity International’s Responsible Investment Forum: Tokyo on 7 October, Satoshi Ikeda, chief sustainable finance officer at the country’s Financial Services Agency, said domestic institutions prefer to engage with portfolio companies on ESG rather than exclude problematic assets or sectors.

Satoshi Ikeda FSA
Ikeda: Japanese LPs take a collaborative approach to ESG

“Institutional investors in Japan take a relationship-based view of their investment, even if in the end it can be sold at their discretion,” Ikeda said.

“The exclusionary approach may give an impression that institutional investors are just protecting themselves. In Japan, the more collaborative approach with investee companies is very much welcome, because that gives a certain impression of commitment to that investee company and also it has a very great foundation of constructive dialogue.”

Sustainable investment assets under management totalled $30.1 trillion as of 2018,  according to a report from the Global Sustainable Investment Alliance. Of this, $19.8 trillion was held in negative or exclusionary screening strategies, against $9.8 trillion for corporate engagement and shareholder action.

Japan accounts for just 7 percent of sustainable investment AUM and represents 13 percent of all capital dedicated to corporate engagement and shareholder action. The US, which holds 39 percent of sustainable AUM globally, accounts for just 18 percent of the strategy.

Japan, the world’s third-largest economy, represents only 1 percent of negative or exclusionary screening AUM globally, versus 40 percent for the US and 55 percent for Europe.

“There may be some expansion of the exclusionary approach due to the fact that there’s going to be a certain consensus among the investors’ community that certain types of businesses [are] immoral and that [they] should not be the target for investment,” Ikeda said.

“Except that I think the Japanese institutional investors will take a collaborative approach with the investee companies, so I think the proportion of their investment strategy will not converge with the so-called western strategy of ESG investment.”

Active engagement with portfolio companies could prove more effective in promoting sustainability than outright exclusion. Last month, Mark Machin, president and chief executive of CPP Investments, said companies that are heavily reliant on carbon-based fuels and want to transition would need capital to do so.

“If you starve the industry completely of capital, they’re not going to be able to transition as quickly and as effectively,” Machin said. “I think investing in some of these companies, if they are committed to transition, it makes sense.”

Japanese institutions have embraced ESG wholesale. The country’s sustainable investing AUM rose from ¥840 billion ($7.9 billion; €6.7 billion) in 2014 to ¥232 trillion as of 2018, representing a 308 percent compound annual growth rate, according to GSIA.

Government Pension Investment Fund of Japan, the world’s largest pension fund, is a vocal proponent. It released a joint statement with the California State Teachers’ Retirement Scheme and USS Investment Management in March warning managers that focusing solely on short-term returns without considering other stakeholders would be to ignore “potentially catastrophic systemic risks”.

Japan’s FSA has also been active in promoting the domestic ESG agenda. Its 2014 Stewardship Code, requiring institutional investors to pursue sustainable growth of portfolio companies, was expanded earlier this year to include asset classes beyond listed equities and redefined to explicitly mention ESG and sustainability considerations.