Japan’s TSE changes must go further on corporate governance
The Tokyo Stock Exchange revamp will be of little use without fundamental changes to allegiant holdings and independent director training, suggest sources
While the Japan Exchange Group (JPX) made improvements to the corporate governance aspects of the Tokyo Stock Exchange (TSE) in April 2022, sources have told IFLR that a lot still needs to be done.
“The JPX and TSE are still far from where they should be,” said Nicolas Benes, representative director at The Board Director Training Institute of Japan, commenting in a personal capacity. “Because JPX apparently wanted to allow famous-name companies to be listed on the Prime market, despite relatively small market capitalisations, the TSE set the bar at a very low level,”.
A company only needs to have ¥10 billion of tradeable shares and a tradeable share ratio of 35% to be listed on the Prime market. “This means a company with a market cap of only $250 million can be on the Prime market. In the US, this would be a very small company.”
Ken Hokugo, director of corporate governance at Japan’s Pension Fund Association, agreed. “I had high hopes for the restructuring because the number of listed companies in Section 1 of the TSE was just too many, in addition to the TSE Section 2, Jasdaq, and Mothers companies,” he said. “In total, there are about 3800 public companies. This is a huge number in an economy of Japan's size, which means that many of them are rather small.”
Companies in the Prime market need to adhere to rules in the Corporate Governance Code, which was revised in June 2021 to incorporate stricter rules around diversity, sustainability and the board of directors.
Chie Mitsui, senior researcher at Nomura Research Institute, said that while the restructuring is a largely positive development, what matters is how JPX approaches corporate governance. “The 1800 companies listed on Prime have a big discrepancy between the best and worst companies on corporate governance performance,” she said. “It is unrealistic to expect the same level of preparation, so quality matters, such as disclosure of climate change and human rights.”
In the past, TSE did not monitor the quality of disclosure, rather, quantitative criteria had been the focus, such as market capital or floating stock ratio. “TSE’s approach has been to say that they’ve prepared the infrastructure, so it is the investor's turn to engage with companies,” said Mitsui. “But there are too many companies in the Prime market, so it is difficult to only rely on investors.”
The expectation for Prime listed companies to effectively communicate governance strategies is going to increase. “For some companies, it is their first time to start disclosing newly set requirements, such as skills matrix or metrics related to the Taskforce on Climate-related Financial Disclosures,” said Ema Shingai, associate at Brunswick Group.
Companies are supposed to ‘comply or explain’ how they are aligning with the updated Corporate Governance code, and it is expected that companies will explain how they are working towards complying to the code. “For example, in the beginning a skill matrix could be a box-ticking exercise due to lack of expertise and resources for some companies,” said Shingai. “However, as the matrix will allow investors to see the areas of strength and weakness of the management skills more clearly, it will likely lead to more questions from the investors.”
As a result, companies will have to elaborate on why their management is structured in a certain way, and if they admit an area of vulnerability how they plan to work on improving. “There may be instances where the interests of Japanese companies do not necessarily fit with the revised governance code, but have very good reasons for this,” said Shingai. The key will be communicating more actively around their approach.
According to Hokugo, there are many important things to do before implementing these changes at TSE, or at the very least, to do at the same time. This includes installing stricter rules to force the reduction of allegiant holdings and dealing with the governance issues and conflicts of interest in cases where both a parent company and its subsidiaries are listed companies.
“These two are the most troubling and inscrutable or unfathomable issues for foreign investors, and they have, do, and will, turn off a lot of potential foreign interest in Japan's stock markets – interest that would surge if, conversely, it were addressed in time,” said Hokugo.
Companies that are moving in the right direction have continued to incrementally do so, but that has occurred because they are high quality companies, not because of corporate governance policy changes, let alone the effect of the Corporate Governance Code and its revisions, said Hokugo.
Hukugo observed companies that have more independent directors to have slightly lower allegiant holdings, with some companies adopting the ‘three committee’ structure – one with a remuneration committee, audit committee, and nomination committee, where each committee has a majority of outside directors. “If changes like these constituted significant improvement, one would expect that Toshiba and many other scandals would not have occurred,” said Hokugo, adding that they did.
Voluntary nature of corporate governance
To list on the Prime market, at least one-third of the directors on a company’s board need to be independent. “To some, this might sound like a significant change, but when one considers that about 70% of TSE1 companies already had that many independent directors, it is clear that in reality it is only a minor change,” said Benes. “Then again, companies are allowed to set their own definition of ‘independence’.”
Even though the Corporate Governance Code is already a ‘comply-or-explain’ code, a company does not have to explain anything. Even if the company has a large market capitalisation, it can simply choose to be listed on the Standard market instead of the Prime, and therefore have only two independent directors. The company does not have to explain that choice.
“JPX and TSE have succeeded in making a governance code that is already largely voluntary, even more voluntary,” said Benes.
The criteria for the Prime market should go further in increasing the required number of independent directors. “Boards don’t change as much as they should until half or more of their directors are independent,” said Benes. “That is the point at which internal executives stop assuming they can usually channel the board in the direction they want, because if things are brought to vote, they might just lose. In contrast, if a board only has two out of 12 independent directors, those two persons will usually not even bring certain topics up in the first place, because they know it is pointless.”
Another aspect that is problematic with the new market structure is that even if companies cannot fulfil the requirements for listing on Prime, the TSE has put in place transitional measures to allow time to comply. “While for some criteria this makes sense, if the TSE was going to give companies more time to make the transition, they should have set the bar higher on other matters as well,” said Benes. “For instance, CEOs shouldn’t be allowed to sit on nomination committees, let alone chair them, and they should have put in more detailed requirements about the role and procedures for those committees.”
Benes thinks that even though the concept of ESG has very rapidly gained support in Japan, the “G” in ESG – the board as driver of the entire ESG bus – is the area that needs the most attention in order for ESG management to amount to much more than “disguised PR”.
Japan needs more attention to substance rather than just appearance, said Hokugo. “This requires more truly independent directors who act out of a real sense of duty as independent directors, without any bias in favour of agreeing with the management who picked them and pay them,” he said. “We believe that independent directors are there to represent us, the minority shareholders, and we want them to act like that. With governance that is sincerely implemented from this perspective, the governance part of ESG will certainly improve. E and S improvement would definitely follow, not the other way around.”
With many things changing quickly, director training is an area that needs to be improved. “Many boards claim to have a policy about director training, but the so-called ‘policy’ is merely to train people who need training or to provide orientation about the company for new outside directors,” said Benes.
The new Corporate Governance Code should have required companies to disclose details about the governance-related training actually conducted in the prior year, including how many persons, at what level, for how many hours, and about what subjects, said Benes.
“Moreover, the investor community should be demanding disclosure of such details,” said Benes. “This would force companies to do what is necessary, while giving investors grounds for not approving nominees who are not qualified.”
For Hokugo, two things are foremost for real change. “First, we need many more truly talented, right-minded independent directors who have had real and appropriate trainings which are global-standard level, and keep shareholders in mind all the time, not people who consider Japan an easy market for earning post-retirement income without doing much work or dealing with much stress,” he said. “Second, we need more asset managers who are willing to vote against the election of director candidates who do not have these characteristics.”