The new era of equity governance in Japan

Author: | Published: 18 Mar 2015
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Yoshihiro Tanaka of Asuka Corporate Advisory and Yosuke Mitsusada of Asuka Asset Management outline the symptoms of equity governance changes taking place in Japan

The Japanese finance industry is now entering into an era of equity governance. We believe a good cycle of corporate governance movement in Japan, boosted by a series of governmental stimulus packages, will change the mindset of Japanese companies and investment community. Japan's Stewardship Code (JSSC), adopted in 2014, and the Corporate Governance Code (JCGC), scheduled in 2015, will promote dialogues between the companies and investors and improve the quality of the Japanese business community. The positive cycle of engagement investment and the improvement of equity performance are about to be set in motion.

"The implementation speed of these programmes has been exceptional"

The relationship between Japanese investors and listed corporations is facing changes, due to increasing interest in corporate governance movements. The Japanese business community is at the cusp of an equity governance era, which the Japanese equity market will benefit from.

The Japanese equity market has been in a downward trend for over 20 years. Aside from the influence of prolonged deflation and appreciation of the yen, this can be attributed to several factors, such as cross-shareholdings, low capital efficiency of listed corporations (from the corporations' point of view), a bias on index-linked equity investment styles, and the so-called short-termism (from investors' point of view). On the other hand, the enhancement of investment returns for pension assets is seen as an urgent issue for Japanese society, which has an ageing population. The reform of the equity market is therefore high on Japan's agenda.

Chart I: good cycle of engagement investments

As Chart I demonstrates, a good cycle of corporate governance movement in Japan is brought about by changing the asset owners of pension assets, asset managers and corporations. This will encourage the improvement of equity performance and lead to a continuous improvement in the quality of the Japanese business community.

There have been a series of stimulus packages, which include reforms in corporate law, the tax system and a revitalisation programme for the equity market since the announcement of the Japan Revitalisation Strategy (JRS) by the Japanese Government in June 2013. The JRS has given birth to the Japan's Stewardship Code (JSSC) in 2014 on the investor side and the Corporate Governance Code (JCGC) scheduled in 2015 on the listed side. Considering that government policy generally takes time to be implemented in real business, the implementation speed of these programmes has been exceptional. The Japanese business community, which has a strong culture of obedience to governmental regulation in general, has taken this seriously.

Asset owner changes

The Government Pension Investment Fund (GPIF), the world's largest public pension fund, with approximately $1.27 trillion in assets under management and an opinion leader among Japanese asset owners, has shown signs of change.

The social pressure to improve the investment return of Japanese public pension funds, which is relatively low compared to the world standard, is growing. Consequently, the GPIF decided to increase exposure of Japanese equity in their assets up to 25% from 12% in October 2014. In reforming from a bureaucratic organisation, the GPIF is discussing further organisational changes, including the investment decision process and the recruitment of investment professionals outside of government.

The GPIF accepted the JSSC before other pension funds, and introduced an engagement funds category as an independent asset class. The transition toward proactive risk taking and creative manager selection is becoming more distinctive. Such attitudes are expected to spread over other mid- to small-sized pension funds, including public and private ones.

Asset manager changes

As Chart II shows, 109 asset managers, including investment trust managers and investment management advisory companies, accepted the JSSC at the end of August 2014. The number seems small compared to 735, the total number of asset managers who are registered with the Japan Investment Advisers Association. However, considering that the registered number of investment advisors for the first year of the UK Stewardship Code (UKSSC) was only 48, which quadrupled in three years, this number has the potential for future increase and can be assessed as penetrating ahead of schedule.

Chart II: the number of insitutions accepted ukssc

October, 2010 March, 2013 March, 2014
Asset Managers 48 101 205
Asset Owners 12 60 74
Service Providers 8 14 14
Others 6 10 10
Total 74 185 303
(Source: UEDA(2013), FRC and Asuka Corporate Advisory)

The number of institutions accepted jssc (August, 2014)

# accepted JSCC Change in # (May, 2014) Change in %
Trust Banks 6 0 0.0%
Investment Trust & Investment Management Advisory 109 23 26.70%
Pension Funds 17 5 41.70%
Insurance Companies 21 2 10.50%
Others 7 3 75.00%
Total 160 33 26%
(Source: FSA and Asuka Corporate Advisory)

Chart III: the differences in purposes of setting ssc/cgc by countries

Compared with the UKSSC, which was introduced due to an increase in investment risks triggered by a series of corporate scandals, the JSSC can be seen as a component of the stimulus package to accelerate growth of the Japanese economy by enhancing the capital efficiency of Japanese corporations. Therefore, the concept of 'improving and fostering the investee corporations' corporate value and sustainable growth' is imposed on Japanese financial institutions in the JSSC, in addition to the 'improvement of long-term risk-adjusted returns to shareholders', as per the UKSSC.

The acceptance of the code by life and property and casualty insurance corporations will also have a positive effect on the market. Despite criticism that they are so-called silent major shareholders, 21 out of 77 insurance corporations accepted the codes. They have started not only to disclose the results of their voting, but have announced that they will start dialogues with investee corporations.

Listed corporation changes

As of November 2014, the Financial Services Authority (FSA) and the Tokyo Stock Exchange (TSE) are in the final drawing-up process of the JCGC. This targets the implementation of the Code into the shareholders' meeting of listed corporations effective in June 2015. The introduction of core concepts in the JCGC, such as independent outside directors, improvement of capital efficiency, liquidation of cross share holdings and constructive dialogue with shareholders under the JSSC, are expected from the market participants.

"The transition toward proactive risk taking and creative manager selection is becoming more distinctive"

Ahead of the implementation of the JCGC, some symbolic changes have already been observed among listed corporations. The penetration of outside directors among TSE I listed corporations reached 74.3% in 2014 compared to 62.3% in 2013. As for TOPIX100 corporations' cases, which represent the attitudes of the largest Japanese corporations, the number was even higher, reaching 92% compared to 89% last year. This trend is expected to further accelerate, as the Institutional Shareholders Service has announced a new policy on director elections in Japan that targets top executives of corporations that have failed to achieve an average return on equity (ROE) of at least five percent over the previous five years.

Corporate governance movements under the influence of shareholders seems to have been spreading among large, conservative mainstream corporations. Such corporations, for instance members of the Federation of Economic Organisations, used to be more passive in accepting changes. For example, Canon, Nippon Steel & Sumitomo Metal and Toray Industries, have adopted outside directors. Further, business consolidation undertaken between Mitsubishi Heavy Industries and Hitachi, and the rejection of anti-takeover measures in the shareholders' meeting of Capcom are symbolic cases showing the penetration of corporate governance consciousness in the Japanese business community. We have been involved in dialogues with the investee corporations since 2005, as an investment manager and an advisor for engagement fund specializing in the investment of small to mid-sized corporations there is a definitive change in the mentality of those managing these corporations: the winds of change are beginning to blow on Japan.

Chart IV: distribution of companies under roe 8.0% by market cap (n=2009)

Chart V: Japan's stewardship code: distribution of acceptance

Chart VI: PBR breakdown (5 year average)

MSCI Japan 1.2 6.9% 16.8
MSCI Japan Small 0.9 5.60% 15.9
MSCI US 2.4 14.60% 16.2
MSCI Asia ex Japan 1.6 13.90% 11.3
MSCI Europe 1.6 10.90% 14.9
(Source: Bloomberg, Asuka Corporate Advisory)

Japanese Stock Market changes

Despite expectations from changes to asset owners, asset managers and listed corporations, the performance of the Japanese Equity market has been less attractive in 2014, compared to the US and other Asian markets, though slightly more positive than European markets. However, the Japanese governance reforms are still in their infancy; the coming year will no doubt see changes in the Japanese corporate community affecting the performance of the equity market in the long run.

Though small, the changes mark significant steps for Japanese asset owners, asset managers and listed corporations. It is important that the early adopters of these changes are the leading institutions or corporations in their industries, so that the changes will spread down to the bottom.

The number of corporations whose ROE fails to reach eight percent accounts for 53% (3,767) of all the listed corporations in Japan. Eight percent is the figure that the Ito Review, a project backed by the Ministry of Economy, Trade and Industry, set as a tentative target for listed corporations. The small- to mid-sized corporations whose market capitalisation is less than $500 million account for 75.9%. Those small- to mid-sized corporations are sitting on world quality products and local or outdated management; from a corporate governance and modern corporate management point of view, they are dormant Japanese corporations that tend to prefer homogeneity and are based on a so-called culture of shame compared with western corporations, will be affected by the changes occurring in large corporations. In other words, the sweet spots in corporate governance reform are those small- to mid-sized corporations that are lying dormant. A change is on the horizon.

"Ahead of the implementation of the JCGC, some symbolic changes have already been observed among listed corporations"

In order to clarify the effect of dialogues between financial institutions and corporations on the equity market, Chart V shows an analysis on the engagement styles of financial institutions who accepted Japan's Stewardship Code. As of the end of August 2014, 160 institutions who accepted the JSSC have been categorised based on the scope of acceptance and the concreteness of engagement activities.

Chart V shows that, although large numbers of financial institutions accepted the full range of the JSSC, the concreteness of their activities is generally vague. Consequently, the main focus of the dialogue between institutional investors and listed corporations for the time being is expected to be the improvement of capital efficiency through voting.


Yoshihiro Tanaka
Representative Director, COO
T: +81 3 3500 9888
F: +81 3 3500 9892

Asuka Corporate Advisory

Yosuke Mitsusada
Chief Fund Manager
T: +81 3 3500 9800
F: +81 3 3500 9840

Asuka Asset Management

Though these engagement approaches may seems to be entry-level, they are a fit for the majority of financial institutions who are still seeking the best engagement methods for themselves, and a fit for the majority of dormant Japanese corporations, as they are simple and clear targets. It will urge them to take business risks actively. The combination of ROE targets and voting works powerfully to improve the lower end of the Japanese equity market.

It is well known that the Japanese corporations' price-to-book-value ratio (PBR) are relatively low compared to their global peers. However, as is clear from the breakdown analysis of PBR, the low evaluation of Japanese corporations' assets does not come from the price-to-earnings ratio (PER), but from low capital efficiency (ROE). If Japanese corporations and investors could improve ROE successfully to 10 to 15% (which is the global average) the potential of the Japanese market is huge.

Welcoming in a new era

Having gone through the era of debt governance before the 1990s, the Japanese finance industry is now entering into an era of equity governance; the management agenda will change into capital efficiency and profitability from sales driven management. The positive cycle of engagement investment, as shown in Chart I, is about to be set in motion.