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PRIMER: Japan’s revised Corporate Governance Code

IFLR’s latest explainer looks at how companies are preparing for the revised code and areas where it still falls short, such as gender diversity and board independence

Japan revised its Corporate Governance Code in June to incorporate new measures spanning gender diversity, independent directors on boards and climate risk disclosure. Corporate governance experts have told IFLR that the measures are positive but need to go further to set a higher bar for Japanese companies.

What are the revised changes about?

One of the changes made to enhance board independence and diluting power from any single individual is to increase the number of independent directors from at least two to at least one-third of the board for Prime market listed companies, the top segment of the Topix (Tokyo Stock Price Index). Additionally, companies should establish nomination and remuneration committees.

In the area of diversity, companies should disclose a policy and voluntary measurable targets in promoting diversity by appointing females, mid-career and non-Japanese professionals. Businesses should also disclose human resource development policies to ensure diversity and include the status of implementation.

For sustainability and environmental, social and governance (ESG), companies should develop a basic policy and disclose sustainability initiatives. The quality and quantity of climate-related disclosure should also be improved based on the Task Force on Climate-related Disclosures’ recommendations.

It is important to emphasise that the code is only voluntary and companies only need to adhere to it on a “comply or explain” basis. However, for companies that want to be listed on the Prime segment of the Topix, meeting the requirements set out in the code is the minimum standard.

What are the most challenging aspects for businesses?

A challenge for companies in all market segments is putting policies into practice and ensuring these policies are aligned with company purpose and long-term strategies, said Kerrie Waring, CEO at International Corporate Governance Network. “The revised code has gone further than ever before with stricter governance requirements and innovations around sustainability, particularly around climate-related disclosure and human capital management,” she said.

With the requirement for companies to disclose the duties and membership of remuneration and nomination committees, it shines a spotlight on the need for independent decision-making and helps to dilute power from any single individual. “It could be challenging for this shift to take place in Japan expeditiously as well as ensuring that such committees are independent and diverse,” said Waring.

Additional requirements and qualifications regarding independence, experiences of management and diversity for board directs would make it difficult companies to find appropriate candidates. “I believe this should be a tentative challenge as these requirements would create bigger needs of such qualification, leading to the future growth in the relevant labour market,” said Yoshiyuki Kizu, partner at Nishimura & Asahi.

See also: ESG a catalyst for shareholder activism in Japan

With higher requirements for companies that want to stay in the Prime segment of the Topix, would this take away from the motivations of the code or is the connection between the two positive?

As most companies wish to remain in the Prime segment to retain a competitive edge leveraged on higher standards of the corporate governance code as required for this segment, Waring believed that this is hugely important for this brand positioning and credibility.

“Companies will strive to retain this position, particularly if they are currently listed on the top segment at the moment,” she said. “Most will step up to meet the new code standards-overlayed by continued investor pressure who will hold their feet to the fire to ensure no corporate governance washing is occurring.”

However, some sources said that the connection between the ability to be listed on the Prime segment and the code takes away from the purpose of the revision. Chie Mitsui, senior researcher at the Nomura Research Institute, said that the underlying motivations for the code lacks discussion on what is good governance. “We’re still stuck in an obsolete discussion on numbers, rather than what is important and why we need good governance,” she said.

The tie-up between achieving the standards set out in the code and the ability to be in the Prime did not improve things, said Mitsui. “Companies that are on the border of being included in the Prime have been rushing to find new board members and changing disclosure practices, but whether things have really improved as a result is uncertain.”

She added that with over 1000 companies, the Prime segment is overpopulated, setting a low bar for companies that may not necessarily be of good quality.

See also: Japan mulls diversity targets in corporate governance code

What areas does the revised code still fall short?

While changes in the Corporate Governance Code are generally welcomed, corporate governance experts said that there are areas where it can do better.

One area that the code can do better is to set higher standards for disclosure. “Without better disclosure, we can’t know what companies are doing,” said Mitsui. As only companies in the Prime segment of Topix are required to disclose information in English, there is a lack of transparency for non-Japanese speakers. Looking at examples in other countries where English is not the primary language, Taiwan is a good example of where listed companies have to disclose information in English.

Corporate governance, or the lack of it, in Japan, has been put in the spotlight in recent months with the ousting of Toshiba’s chairman, after it was found that overseas investors were pressured to vote in line with the management board’s nominees at the 2020 AGM. “Management responsibility, transparency of AGMs and auditing practices are still not clear for many companies,” said Mitsui.

While many of the changes to the code require companies to disclose information, such as climate-related disclosures, diversity policies, approaches to human capital and committee mandates, the code does not specify where this information should be disclosed.

“This information is material to long-term corporate value creation and should be disclosed in the annual securities report, in English and prior to the AGM,” said Waring.

Improvements concerning human rights in company supply chains and climate change risks also need to go further in the code, said Mitsui.

Tracy Gopal, founder and CEO at Third Arrow Strategies, which aims to create a network of female executives in Japan, said that the “comply or explain” approach of the code is not going far enough in accelerating gender board diversity.

“Japan has failed to achieve female director percentage targets set in 2015, so the soft approach isn’t working,” she said. “Companies have had sufficient time to identify qualified candidates and if none has been identified, I would like to understand the process for candidate identification and the definition used by the company for what constitutes ‘qualified’.

Further improvements could also be made to add reference to a period over which goals around diversity policies are achieved, along with a requirement for annual reporting. “We also encourage reference to the importance of equity and inclusion, alongside diversity, to address social inequalities, particularly in relation to racial discrimination and fair representation,” said Waring.

As for independent directors, while the improvement to at least one-third of the board is required for Prime segment companies, Waring said that this needs to move to at least a majority. Furthermore, the previous requirement of just two independent directors is retained for companies that are not listed in the Prime segment.

“To facilitate the appointment of independent directors in the future, the code should reference the importance of there being a transparent and rigorous appointment process for independent directors under the responsibility of a nomination committee,” said Waring.

In order to ensure clearer delineation between the role of the chair and the CEO, the board should be chaired by an independent director who should be independent on the date of appointment.

“Should the role of the chair and CEO be combined, the board should explain the reasons why this is in the best interests of the company in the annual report and keep the structure under review,” said Waring.

See also: PRIMER: Japan’s new foreign investment law

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