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Article13 Oct 2022

The state of debate on ESG in Japan

A new report by Citi Research’s Ryota Sakagami examines the growth of sustainable investing in Japan, and prospects for the future.

Sustainable investment is growing globally, but growth in Japan has been particularly notable in recent years.   

Indeed growth in sustainable investment has been accelerating, according to a survey by the Japan Sustainable Investment Forum (JSIF). Domestic sustainable investment in Japan grew from ¥56.3trn in 2016 to ¥514.1trn in FY2021, a CAGR of 56%, and the weighting within the total assets under management by the institutional investors that replied to the questionnaire rose from 16.8% in 2016 to 61.5% in 2021.  

Leading global and Japanese ESG indices outperformed in 2018-2020 but since 2021 performance has been in line with the benchmark.  

However, in a recent ESG report (Japanese only), the Government Pension Investment Fund (GPIF) points out that over the past five years, investments in equity ESG indices have overall generated excess returns while the Sharpe ratio has been higher than TOPIX, and the GPIF has said it intends to grow investments in equity ESG funds, including active funds.  

The GPIF and other pension funds are determined to expand ESG investment, and the government has a range of policies to promote ESG investment, so Citi analysts say they expect ongoing growth in ESG investment in the Japanese equity market.


ESG Indices: Relative Performance 

7. ESG indices: Relative performance
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Japanese government’s ESG policies 

The Japanese government also has multiple policies aimed at promoting the uptake of ESG investment. In the area of governance, 2021 amendments to the Corporate Governance Code include rules that companies listed on the JPX Prime Market should make disclosures of the quality and quantity outlined by the Task Force on Climate-related Financial Disclosures (TCFD) or an equivalent framework.  

Companies with March year-ends will be required to disclose climate-change related information in the corporate governance reports that they submit after June 2022 shareholders’ meetings. If they do not make the disclosures, they will have to explain the reasons. 

Thanks to past TCFD Consortium activities, Japan has for some time had the largest number of organizations that support the TCFD in the world (800 as of April 2022), and we expect the amendments to the corporate governance code to drive further progress. The number of companies listed on the Prime Market was 1,839 as of April 2022. 

In addition, the Financial Services Agency (FSA) is considering whether to make it mandatory for general companies that are required to submit annual securities filings to disclose climate change risk, and it could apply new rules from as soon as FY3/24. 

The FSA considerations center around making it mandatory for disclosures related to governance and risk management, which are two of the four pillars of the TCFD, but for disclosures related to strategy and indicators/targets to be discretionary. 

More than 4,000 companies are required to submit securities filings. The CDP (formerly known as the Carbon Disclosure Project), sends questionnaires to companies to evaluate their environmental activities based on requests from institutional investors and companies that make ESG investments. It has broadened the scope of its activity in Japan. 

More than 13,000 companies worldwide have responded to the CDP, and they account for more than 64% of world market cap. Of these companies, Japanese ones account for some 900. The questionnaires comply with TCFD guidance for disclosure categories, and given the trend towards mandatory TCFD disclosures, expect the number of Japanese companies that respond to the CDP questionnaire will also grow. 


Green Growth Strategy: Definition of growth areas to achieve net zero by 2050 

In environment-related regulation, the Ministry of Economy, Trade and Industry’s (METI) Green Growth Strategy (Japanese only), published in June 2021, identifies 14 growth areas in the push for decarbonization The overall framework calls for an expansion in renewable energy in the electric power sector, and electrification, hydrogenation, energy saving and CO2 recovery in sectors other than electric power. 

The METI is drafting a concrete process agenda through 2050, which will form the fundamental strategy for the consideration of support in terms of taxation and finance. Many factors remain unknown, including investments in the power transmission network and power storage systems, improvements in the cost competitiveness of renewable energy, and the restarting, replacement and construction of new nuclear power generation capacity. 

In October 2020, the Japanese government established the ¥2trn Green Innovation Fund (Figure 11), aimed at accelerating the structural transformation and innovation needed in the energy and industrial sectors to achieve carbon neutrality by 2050. 

The Green Innovation Fund aims at having the public and private sectors share similarly ambitious and concrete goals, and to provide ongoing support to the efforts of companies etc. in R&D, testing and social installation as specific business issues. 

Around ¥1.6trn of the funds have already been allocated to selected projects, with the biggest being ¥300bn for a large-scale hydrogen supply chain, ¥194bn for the use of hydrogen in steelmaking, ¥151bn for next-generation batteries and next-generation motors, and a substantial ¥141bn for next-generation digital infrastructure, but there have also been allocations to a broad range of other projects. 

The full note goes into greater depth on Japan’s decarbonisation strategy and looks at ESG investment strategies for Japanese equities. For more information on this subject and if you are a Citi Velocity subscriber, please see Japan Equity Strategy - State of and debate on ESG investment in Japan’s equity market 

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here. 


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