FSA Explains Second Revision of Japan's Stewardship Code (Part 1): What Was Revised?

IJ reported in April (https://investmentjapan.jp/esg/1134/) on the March 24th release of the Second Revision of the Stewardship Code (the Revised Code). Below is a translation of Part 1 of our interview with Hiroaki Yamada , who involved in revision as a secretariat member of the Council of Experts on the Japan’s Stewardship Code; Deputy Director of Corporate Accounting and Disclosure Division, Policy and Market Bureau, Financial Services Agency (FSA).
The interview appeared in AL-IN vol. 56, July 2020, a magazine for Japanese institutional investors.

Investment Japan(IJ):	First, remind us of the Stewardship Code (the Code)’s purpose.
Yamada:	The Code was published in February 2014 as part of corporate governance reform that is important agenda of the government growth strategy. It defines principles of behavior for institutional investors to enhance corporate value and achieve sustainable growth in investee companies through constructive engagement. The Code was revised in May 2017. On March 24, 2020, the Code’s Council of Experts (FY2019) released the second Revised Code¹. Japan’s Stewardship Code and Corporate Governance Code (effective on June 2015, revised June 2018), which defines principles of behavior for corporations, are expected to function as “two wheels of a car”. Both codes are complementary to each other and share the goal of fostering medium- to long-term corporate value and sustainable growth, through which ensuring medium- to long-term returns on investment to their clients and beneficiaries.

Investment
Japan(IJ):

First, remind us of the Stewardship Code (the Code)’s purpose.

Yamada:

The Code was published in February 2014 as part of corporate governance reform that is important agenda of the government growth strategy. It defines principles of behavior for institutional investors to enhance corporate value and achieve sustainable growth in investee companies through constructive engagement. The Code was revised in May 2017. On March 24, 2020, the Code’s Council of Experts (FY2019) released the second Revised Code¹.

Japan’s Stewardship Code and Corporate Governance Code (effective on June 2015, revised June 2018), which defines principles of behavior for corporations, are expected to function as “two wheels of a car”. Both codes are complementary to each other and share the goal of fostering medium- to long-term corporate value and sustainable growth, through which ensuring medium- to long-term returns on investment to their clients and beneficiaries.

IJ:	Why was the Code revised a 2^nd time? Was there a particular catalyst?
Yamada:	The previous versions of the Stewardship and Corporate Governance Codes have brought steady improvement to operations among institutional investors and corporations, e.g., constructive dialogues. On the other hand, it has been pointed out that there were ongoing issues for stewardship activities in some areas. For instance, dialogues between institutional investors and corporations remains formalistic , and does not sufficiently contribute to enhancement of medium- to long-term corporate values. Under these circumstances, FSA convened the Council in October 2019 for a series of discussions² that resulted in the 2^nd revision of the Code³.

IJ:

Why was the Code revised a 2^nd time? Was there a particular catalyst?

Yamada:

The previous versions of the Stewardship and Corporate Governance Codes have brought steady improvement to operations among institutional investors and corporations, e.g., constructive dialogues. On the other hand, it has been pointed out that there were ongoing issues for stewardship activities in some areas. For instance, dialogues between institutional investors and corporations remains formalistic , and does not sufficiently contribute to enhancement of medium- to long-term corporate values. Under these circumstances, FSA convened the Council in October 2019 for a series of discussions² that resulted in the 2^nd revision of the Code³.

IJ:	What issues did the Council focus on?
Yamada:	There were a lot of discussions on sustainability-related issues as it has recently attracted the attention of investors and companies. As a result, the Revised Code specifies in the definition of stewardship responsibilities that constructive engagement or purposeful dialogue should be based on “considerations of sustainability (medium- to long-term sustainability, including ESG factors) consistent with investment management strategies”. At the same time, the Code’s stated aim to enhance medium- to long-term returns on investment of clients and beneficiaries by “improving and fostering investee companies’ corporate value and sustainable growth” was unchanged. Many portions of the Code were revised with regard to sustainability. For example, in Guidance 1-2, we added a sentence: “Institutional investors should clearly specify how they take the issues of sustainability into consideration in their policy, consistent with their investment management strategies.” Asset owners such as corporate pensions are likewise expected to respond to these revisions, in accordance with their size and capabilities. Furthermore, the Code primarily targeted institutional investors investing in Japanese listed shares. While maintaining that focus, the Revised Code’s provisions “may also apply” to asset classes other than Japanese listed shares insofar as such application contributes to fulfilling the ‘stewardship responsibilities’ mentioned in the beginning of the Code (Preamble 10). Since the Code mainly refers to Japanese listed shares, application of its provisions to non-equity assets is expected only where possible. Institutional investors that do not apply the Code to their non-equity holdings are not required to explain why. In the Revised Code, we defined parties such as proxy advisors and investment consultants for pensions as “service providers for institutional investors”⁴ to now include them in the Code. Under Guidance 8-1, service providers for institutional investors are required to disclose its policy and organizational structure to manage conflicts of interest.

IJ:

What issues did the Council focus on?

Yamada:

There were a lot of discussions on sustainability-related issues as it has recently attracted the attention of investors and companies. As a result, the Revised Code specifies in the definition of stewardship responsibilities that constructive engagement or purposeful dialogue should be based on “considerations of sustainability (medium- to long-term sustainability, including ESG factors) consistent with investment management strategies”. At the same time, the Code’s stated aim to enhance medium- to long-term returns on investment of clients and beneficiaries by “improving and fostering investee companies’ corporate value and sustainable growth” was unchanged.

Many portions of the Code were revised with regard to sustainability. For example, in Guidance 1-2, we added a sentence: “Institutional investors should clearly specify how they take the issues of sustainability into consideration in their policy, consistent with their investment management strategies.” Asset owners such as corporate pensions are likewise expected to respond to these revisions, in accordance with their size and capabilities.

Furthermore, the Code primarily targeted institutional investors investing in Japanese listed shares. While maintaining that focus, the Revised Code’s provisions “may also apply” to asset classes other than Japanese listed shares insofar as such application contributes to fulfilling the ‘stewardship responsibilities’ mentioned in the beginning of the Code (Preamble 10).

Since the Code mainly refers to Japanese listed shares, application of its provisions to non-equity assets is expected only where possible. Institutional investors that do not apply the Code to their non-equity holdings are not required to explain why.

In the Revised Code, we defined parties such as proxy advisors and investment consultants for pensions as “service providers for institutional investors”⁴ to now include them in the Code. Under Guidance 8-1, service providers for institutional investors are required to disclose its policy and organizational structure to manage conflicts of interest.

1	https://www.fsa.go.jp/en/refer/councils/stewardship/20200324.html
2	Discussions at the Council were based on the opinion statement “Recommended Directions for Further Promotion of Corporate Governance Reform”, published April 24, 2019 by the Follow-up Council of Experts Concerning Japan’s Stewardship Code and Japan’s Corporate Governance Code with FSA and Tokyo Stock Exchange as secretariats, jointly.
3	Prior to the second revision, public comment was solicited from December 20, 2019 to January 31, Summary of the opinions and responses are available at FSA’s website: https://www.fsa.go.jp/en/refer/councils/stewardship/20200324.html
4	Preamble 9 defines parties such as proxy advisors and investment consultants for pensions that provide services at the request of institutional investors, etc. to contribute to the institutional investors’ effective execution of stewardship activities as service providers for institutional investors.