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 Private Equity International’s inaugural Responsible Investment Forum: Tokyo, 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.

“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.”

Ikeda’s comments came amid calls by the head of private equity and infrastructure at Japan’s Government Pension Investment Fund for Japanese and international investors to use the pandemic to return to a ‘better normal’.

Yoshitaka Todoroki, who oversees PE and infra at the ¥162 trillion ($1.5 trillion; €1.3 trillion) Japanese pension giant told the Tokyo forum that ESG issues are even more important than they were prior to covid-19.

“If we’re going to go back to normal, let’s go back to much better than before. Rather than stepping back from the covid-19 pandemic issues, we continue to pursue how we can materialise these ESG-related ideas. It is becoming far more important to drive ESG issues across GPIF’s portfolio.”

Wholesale acceptance

Globally, 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.

But 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.”

Japanese institutions have embraced ESG wholesale. The country’s sustainable investing AUM rose from ¥840 billion in 2014 to ¥232 trillion as of 2018, 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 2020 warning managers that focusing solely on short-term returns without considering other stakeholders would be to ignore “potentially catastrophic systemic risks”.

Since issuing that statement, GPIF has attracted “far more investors who agree on that concept”, Todoroki said.

“In the public space, we have selected some indices to drive ESG related investments. We continue to develop such new activities regarding ESG, maybe firstly in the public space, but also the private space. We want to discuss with market participants how we can pursue ESG-related goals or objectives in this market,” Todoroki told the Tokyo forum.

While all three ESG issues are equally important, GPIF may try to effect environmental and social change in its portfolio and fund managers via governance methods first, Todoroki added.

“If G is a quicker way to support E and S, we may look at G issues [first],” he said.

Japan’s FSA has also been active in promoting domestic ESG. Its 2014 Stewardship Code, requiring institutional investors to pursue sustainable growth of portfolio companies, was expanded in 2020 to include asset classes beyond listed equities and redefined to explicitly mention ESG and sustainability considerations.

Sayaka Takatsuka

Four ‘unknowns’ for Japanese LPs considering impact

Sayaka Takatsuka, senior director at impact firm Shinsei, says domestic LPs are still getting to grips with the strategy

Japanese limited partners have four priorities to address before fully embracing impact investing, according to Sayaka Takatsuka, senior director at Japanese impact manager Shinsei Corporate Investment.

Speaking in a teaser session for Private Equity International’s Responsible Investment Forum: Tokyo, Takatsuka said the Tokyo-headquartered firm’s LPs are looking to define impact and environmental, social and governance internally, as well as how to source deals that fit these briefs. Other steps include ascertaining how to measure impact in their investee companies and how to disclose these results to the public.

“All these processes are unknown for the LPs yet,” she added. “[The] GP has to have high literacy in order to, not educate, but share the cases with the LPs so that the level of impact investment will be higher.”

Shinsei is deploying its second impact fund, the 2019-vintage Japan Impact Investment II, which held a first close on ¥2.2 billion in June last year and targets childcare and nursing care, among other businesses. It includes commitments from Mizuho Bank, Bank of Yokohama and Sumitomo Mitsui Trust Bank, according to PEI data.

ESG and impact investing are climbing the agenda in Japanese financial services. Takatsuka is an advisor to both the Global Steering Group’s Japan Impact Investment Task Force and an impact investing study group run by Japan’s Financial Services Agency.

“FSA has gathered all financial institutions, including mega-banks and local banks and insurance companies, etc, and they’re starting to share the knowledge and the process of impact investment,” Takatsuka added. “The FSA is more interested in this area so that the financial institutions can incorporate that idea into their daily financial businesses.”

Development Bank of Japan is among those planning to embrace impact funds, PEI reported last year. Its decision was partly influenced by the Japanese government and a desire to promote the strategy among domestic financial institutions.