There is much talk in Japan and elsewhere about SDGs (Sustainable Development Goals) and ESG (environment, social and governance) investment criteria. Is there more happening than just talk? We have some answers.

Japan's second wave of ESG investment

Japanese institutional investors have picked up the pace of investment in green bonds, sustainable bonds, and other ESG-focused bonds. Those bonds are likely to become a second pillar of ESG investment for Japanese institutions, along with equity portfolios into which they have gradually introduced ESG-aligned assets. Recently, Japan's massive government pension fund signaled its embrace of ESG. As a result, Japanese corporate pension funds, which have long been wary of ESG products, will now likely have to follow suit.

GPIF leads the second wave

The first advance toward ESG investment by Japanese asset owners was led by the Government Pension Investment Fund (GPIF), which officially adopted three ESG indexes for Japanese equities in 2017. A fourth index was added in September 2018. The move spurred asset managers to offer a host of ESG-related funds and products to other investors.

The second wave in ESG investment began with GPIF ‘s announcement in April that the giant pension management body, jointly with the World Bank, would take further steps to promote ESG integration into fixed income investment. That action provides the World Bank, as a large green bond issuer, an unrivaled opportunity to pitch its bonds to the world's largest pension funds, which hold JPY 29 trillion in non-Japanese fixed-income securities.

GPIF has since announced similar initiatives with regional development banks, such as the Asian Development Bank and the European Investment Bank. In September, it launched the "index posting system" to promote new indexes for green and sustainable bonds.

Some institutional investors in the private sector are already well ahead of GPIF in green or ESG bond investing. Insurance firms, such as Nippon Life Insurance Company and the Dai-ichi Life Insurance Company, have invested in ESG-focused bonds since 2014. In June, Dai-ichi Life bought JPY 10.8 billion in IBRD-issued green bonds. As recently as September, Nippon Life and its affiliate Taiju Life invested JPY 10 billion in European SDG corporate bonds.

The most recent investment data for Japan support rapid growth in green bond investments. "Sustainable investment" in fixed income by Japanese investors has reached JPY 28.8 trillion, up from 18.3 trillion a year earlier, according to a March survey by the Japan Sustainable Investment Forum, a body of asset managers and auditors.

GPIF has been the unchallenged leader in green bond investments, with a massive total assets under management of JPY 159 trillion. Without publicizing the fact, GPIF has for some time managed its entire AUM with an eye toward "integrating ESG factors based on our Investment Principles" (ESG Report 2018).

Corporate pensions are slow to come around

Corporate pension funds represent the next frontier for ESG bonds. Corporate pensions, whose first and practically sole focus has been to provide stable returns of about 2%, have not been keen on ESG investments. The modest appetite for ESG assets derives mostly from comparisons with broader Japanese equities; ESGs often underperformed even against a weak TOPIX and Nikkei 225 in 2018 and 2019. Even so, institutional investors can't be discounted as they represent AUM around JPY 60 trillion.

Recent data show the ESG investment space is growing. A June survey by JP Morgan Asset Management (Japan) said the percentage of corporate pension funds with ESG-related exposure in Japanese stocks increased from 1.6% a year ago to 7.0% now; the number of corporate pension signatories to the Stewardship Code reached 28 by the end of September, almost double from 13 last year.

But corporate pension managers aren't necessarily driving the advance. In September, one magazine¹ quoted a corporate pension CIO as saying he had not focused on ESG investment when structuring his portfolio, although about 70% of the equity strategies he eventually adopted were ESG-integrated products. Despite such indifference, ESG investment has advanced because asset managers have introduced more ESG-related product into the market. The same pattern will likely lead to a second wave of ESG investment in fixed income products as well.

The aforementioned CIO also said his office was preparing to sign the Stewardship Code. Still, 28 signatories out of 12,794 defined-benefit corporate pension plans is hardly worth celebrating.² Katsuyuki Tokushima, Head of Pension Research at NLI Research Institute, noted a structural change might be necessary to increase significantly the number of signatories among corporate pensions. "The average scale of corporate pension funds is too small in both AUM and management staff to implement full stewardship activities. Some type of integration of pension management offices may be needed even if their stewardship activities are limited to monitoring that of the asset managers whose fund products the pensions select and purchase," he said.

Increasing government pressure

Increased pressure from authorities demanding a focus on ESG investment will definitely come to bear on corporate pensions next year. The Financial Services Agency of Japan (FSA) opened the latest round of the Council of Experts for the Stewardship Code on October 1st, in preparation for the 3-year revision, due in 2020. The FSA agenda for the round includes promoting greater participation in the Code by corporate pensions, and guidelines involving asset managers, investment consultants, and proxy advisors.

Although the final revisions are far from set, FSA clearly signaled its reform agenda by introducing on opening day the draft revision of the UK's Stewardship Code, which demands that UK investors enhance ESG investment in bonds and other asset classes. Even absent the Code, corporate pensions in the UK are otherwise obliged to invest in ESG.

Japanese authorities are unlikely to adopt a similar obligation policy in the near future, but pressure has mounted on corporate pensions to step up their ESG investments. The Ministry of Health, Welfare and Labor, which oversees laws governing pension schemes is now considering measures to enhance pension governance, including ESG investment. Under such pressure, how much longer can corporate pensions avoid ESG investment?

1. ‘ESG 2019,' a special edition of SOKEN Inc.'s AL-IN magazine, included an interview with the CIO of Takeda Pharmaceutical's pension fund.

2. Of the 12,754 defined-benefit corporate pension plans, 759 are "fund-type", managed independently of the sponsor company and 12,035 are "contract-type", managed in-house by the sponsor. Most contract-type pensions belong to smaller organizations (up to several hundred employees), which are not technically excluded from being signatories to the Code.


< Ben Wada >