The latest revision to Japan’s Corporate Governance Code was released on June 11. The Code, a set of principles and guidelines meant to steer corporate governance of listed companies, is considered a companion piece to Japan’s Stewardship Code. Enacted in 2015 and first revised in 2018, the latest version takes into account the new market classifications on the Tokyo Stock Exchange (TSE) which are scheduled to take effect on April 4, 2022. What has changed in the Code and how should companies prepare?
Translated from an article originally published in AL-IN, vol.60, June, 2021

TSE, a subsidiary of Japan Exchange Group, Inc. (JPX), will reorganize next April into three new market segments: Prime Market, Standard Market, and Growth Market.  Companies wishing to be listed on the Prime Market will need to strengthen their governance or explain their policies to shareholders and investors. 

How TSE will be restructured?











Source: TSE

JPX, which resulted from the January 2013 merger between TSE and Osaka Securities Exchange (OSE), currently is divided into 5 market segments: 1st Section, 2nd Section, Mothers, JASDAQ Standard, and JASDAQ Growth.  The 1st and 2nd Sections were reorganized into a single entity of the merged TSE and OSE.  However, Mothers and JASDAQ, both emerging markets, have existed independently without being reorganized even after the merger into JPX due to their distinct characteristics and longstanding rivalry.  Exchanges outside Japan, including NASDAQ and the London Stock Exchange, sort companies into two or three categories.  Only Japan assigns five groups.

According to Kentaro Hayashi, Head of Listing at TSE, “After a series of discussions on how to reorganize the market in a way that would contribute to the enhancement of corporate value and sustainable growth of listed companies, not just a number crunching exercise, we came up with a proposal to reorganize the market into 3 distinct segments: Prime, Standard, and Growth Market.”  TSE conducted a series of interviews on the restructure with institutional investors in Japan and abroad.  “The Prime Market is designed with investment criteria of institutional investors in mind, including a listing threshold of at least JPY 10 billion in market capitalization of tradable shares, and adherence to certain standards of corporate governance and sustainability,” said Hayashi.

The Corporate Governance Code was revised, in part, to set a higher standard for companies listed on the Prime Market, one that meets the demands of institutional investors.

Kentato Hayashi
Head of Listing
Tokyo Stock Exchange

How will the revised Code affect Japanese companies?

“It won’t be easy for each of more than 3,700 listed companies in Japan to comply with the entirety of the Code.  Therefore, the basic stance is a principles-based approach: Comply where you can, and where you cannot, explain why you can’t or don’t need to comply,” explained Kazutaka Kuroda, Senior ESG Strategist at Mitsubishi UFJ Morgan Stanley Securities.  Kuroda summed up how companies have responded to the Code to date.  “Some companies gave a cursory explanation saying, ‘Let's just say we are implementing all the basic principles.  If a shareholder asks for a detailed explanation, say I'm sorry.’  The latest revision makes it difficult to be vague about one’s compliance.”  Companies will now be forced either to comply or explain why they don’t.

What is the focus of the revision?  According to TSE’s Hayashi, who is a secretariat member of the Council of Experts Concerning the Follow-up of Japan’s Stewardship Code and Japan’s Corporate Governance Code (Follow-up Council), the latest revision focuses on three concepts: 1) sustainability, 2) diversity, and 3) fulfilling the function of a board of directors.  Discussions of the Follow-up Council centered around the importance of “responding to changes”. 

When the Corporate Governance Code was enacted in 2015, the focus was on so-called “offensive governance” to retain global competitiveness of Japanese companies.  Since then, a series of corporate accounting scandals has made “defensive governance” important as well.  While the Council considered how to adapt the Code to these concerns, the COVID-19 pandemic forced another reckoning.  “Coronavirus has drastically altered how people move and communicate.  Companies who fail to adapt to these changes will be unable to achieve mid- to long-term sustainability of continuous growth and increased corporate value.  Recognition grew among the Follow-up Council that management decision-making is even more important, and that it is essential to strengthen the functions of the board of directors to support this decision-making,” said Hayashi.


The 3 key considerations incorporated in the latest revision to the Code are:

1) Advancing Sustainability

As the COVID-19 pandemic has brought increased attention to the importance of ESG, environmental and social factors are included in this revision.  Kuroda of Mitsubishi UFJ Morgan Stanley Securities points out that “Sustainability was referenced in the original Corporate Governance Code of 2015 in Section 2: Appropriate Cooperation with Stakeholders Other Than Shareholders (General Principle 2).  The latest revision elaborates on the definition of sustainability.  A big step forward.”  Supplementary Principle 2.3.1 specifically states, “The board should recognize that dealing with sustainability issues such as dealing with climate change and other global environmental issues, respect for human rights, fair and appropriate treatment in the workforce, including employee health and the work environment, fair and reasonable transactions with suppliers, and crisis management for natural disasters, are all important management issues that can lead to earning opportunities as well as risk mitigation…”  Sustainability has tended to focus on environmental issues, specifically climate change, but it also needs to address sustainability issues that are rapidly gaining attention due to the Corona disaster.

The revised Code requires a higher level of response to environmental concerns and includes a new description of the Taskforce for Climate-related Financial Disclosures (TCFD).  For example, as clearly stated in Section 3: Ensuring Appropriate Information Disclosure and Transparency (General Principle 3), “In particular, companies listed on the Prime Market should…… enhance the quality and quantity of disclosure based on the TCFD recommendations…”

2) Promoting Diversity

Supplementary Principle 2.4.1 states, “Companies should present their policies and voluntary and measurable goals for ensuring diversity in the promotion to core human resources, such as the promotion of women, foreign nationals, and midcareer hires to middle managerial positions, as well as disclosing their status.”  Hayashi said, “The period of high economic growth during the post-WWII Showa era as well as the lost 30 years of the Heisei era were led by Japanese companies populated and led mainly by Japanese men.  It has been noted that a different kind of organization is required in the Reiwa era, and the question is how to integrate the diversity of human resources -- not just Japanese men -- into the organization.”

3) Fulfilling the Function of a Board of Directors

In order to effectively promote sustainability and diversity, a board of directors must be able to fulfill its functions.  As Kuroda observed, “Personally, I think the most important thing in this revision is that the roles and responsibilities of the board of directors are also specifically stated in Supplementary Principle 4.2.2 ‘The board should develop a basic policy for the company's sustainability initiatives…’  In short, members of the board of directors are now required to possess a baseline understanding of sustainability.”

Kuroda also applauds the revisions requiring the addition and disclosure of a board member skills matrix.  The idea is to identify the knowledge, experience, and abilities that directors should possess, and to disclose how each director stacks up.  “What are the requirements for directors and do those serving on the board meet them?  Particularly, when the number of outside directors increases, the skills of individual directors will be diligently scrutinized.  The skills matrix will make it easy to see if the requirements are being met,” Kuroda said.  Some media reports on the revision have emphasized the new requirement that outside independent directors comprise at least one-third of the board at Prime Market companies.  What’s important, however, is that both the quality and quantity of directors is now being examined.

Kazutaka Kuroda
Senior ESG Strategist
Mitsubishi UFJ Morgan Stanley Securities

How will listed companies respond to the revised Code as they prepare for TSE’s new market segmentation next year?  At the end of this year, TSE listed companies will be asked to choose the market segment on which they intend to be listed.  The new market segmentation will have a significant impact on the portfolios of investors in Japanese stocks, as it will necessitate a review of the constituents of the market benchmark TOPIX.  Investors should keep a close watch on this and other upcoming changes.


< Masayoshi Koike >


Japan’s Corporate Governance Code (Revised June 2021):