Japan has launched significant new corporate governance reform by revising its Stewardship Code, which requires institutional investors to disclose voting records for investments and establish governance structures to prevent conflicts of interest. The challenges will be in how the changes are implemented ahead, including how existing legislation might conflict with the controversial subject of collective engagement between investors and the companies they invest in.

Features of the amendment

As part of prime minister Shinzo Abe’s “Three Arrows” of “Abenomics”, the Stewardship Code was created in 2014 to revitalise Japan’s economy by improving corporate governance to boost the corporate value of listed companies. While it is not legally binding, it adopts a “comply or explain” approach to engage asset managers and institutional investor to be signatories.

The amended Code has two highlights:

  • the individual disclosure mandate requires institutional investors to disclose voting records for each investee company for each individual agenda item. Previously, they were only required to do so for each major agenda; and
  • asset managers are required to establish appropriate governance structures designed to better prevent conflicts of interest, such as third-party committees to oversee decision-making or the exercise of voting rights.

“The revisions overall are designed to push institutional investors to give more care and consideration to the exercise of their voting rights, and to require enough transparency and disclosure so that it will no longer be enough to simply affect the pretense of compliance,” says Tatsuya Taniguchi, partner at TMI Associates. “A large number of major institutional investors in Japan were already seriously considering how they exercised their voting rights even before the revisions. For these investors it might seem as if the reforms only increase their procedural burdens, but overall I think the increased transparency is important to ensure that such considerations are actually given and given consistently.”

“The disclosure of voting records may lead to investors voting more mechanically,” says Hiroaki Takagi, partner at Nishimura & Asahi. “This could impact voting results for companies and restrict the freedom of asset managers to vote freely and may lead to secret discussions with companies.”

“Some don’t necessarily have the freedom anyways,” says Jamie Allen, secretary general, Asian Corporate Governance Association (ACGA). “The transparency of voting records is a good move. After all, sunlight is the best disinfectant.”

“While the added focus on managing conflicts of interest is welcome, it may be more sensible to allow greater latitude for asset managers to develop their own system,” adds Allen. “The guidance states that such structures could include an independent board of directors or third-party committees, but there needs to be more flexibility so that asset managers actually think through their system and not just do a tick-the-box exercise.”

Gradual adoption of the Stewardship Code

While adoption of the Code is voluntary and signatories are under no legal obligation to comply, lawyers have seen a gradual interest from their institutional investor clients to adopt the Code. Taniguchi says that when the revisions were first being discussed, some institutional investors opposed them but a large number of them in Japan have now announced or begun the implementation of individual disclosure procedures, and many have established third-party committees to oversee their decision-making and voting. In contrast, some overseas institutional investors have continued to oppose the new individual disclosure rules and are not taking steps to comply.

"Institutional investor engagement with companies has become deeper and more regular over the past decade. Regulators are encouraging the change with guidance and codes for investors to follow, and investors are increasingly seeing good stewardship as part of their fiduciary duties,” says Nathan Fabian, Director of Policy and Research at PRI. “At the core of stewardship is the responsibility of asset owners and investment managers to be effective stewards of the assets they hold for their beneficiaries.” The organisation, in its report on fiduciary duty in Japan, recommends enhanced oversight of reporting against the Stewardship Code, mandatory disclosure of proxy voting records and that corporate pension plans sign the Code.

“The aim of the “comply or explain” approach is that over time, more will disclose and those who are will be able to differentiate themselves by gaining more market credibility,” says Allen. “While Japan is not the top leader in the region in corporate governance, it was the first to have a stewardship Code back in 2014 and continues to have the most signatories to the Code.”

More clarity needed on collective engagement

As well as these revisions, the new Code’s reference to collective engagement has been controversial. The Code states that “in addition to institutional investors engaging with investee companies independently, it would be beneficial for them to engage with investee companies in collaboration with other institutional investors (collective engagement) as necessary”. The Japanese Financial Services Agency (FSA) indicates that this provision does not necessarily encourage or require collective engagement, but simply presenting it as an option available to investors. “Previously, however, collective engagement was sometimes misunderstood to be illegal under Japanese law, so these revisions will essentially signal the commencement of collective engagement in Japan,” explains Taniguchi. “But Japanese investors have almost no experience in collective engagement and there are still numerous remaining legal issues to collective engagement and will have to seriously consider how best to implement it.”

“Japan’s joint holder rules are concerned with investors working together and influencing the company,” says Allen. “There is the danger that investors may be prosecuted for acting in concert, so there needs to be safe harbour provisions, similar to those of the UK and Australia. However, there is the grey area that while investors cannot make suggestions, they can ask questions.”

The changes to Japan’s Stewardship Code to strengthen corporate governance of institutional investors and asset managers is welcomed especially by lobby groups such as the PRI which are calling for more measures on proxy voting disclosure and more participation in the Code. However, more clarity will be needed on aspects such as guidelines on implementing collective engagement.