Japan’s FSA steps on the gas

The financial services regulator has put down a marker for a more ambitious suite of CG reforms in Japan in coming years. ACGA’s Secretary General Jamie Allen offers initial reactions.

Loyal readers of CG Watch will know that certain issues have been a deadweight on Japan’s score for many years. Cross-shareholdings remain entrenched in many companies, while others still hoard cash, driving down ROE. Uncertainty lingers over collective engagement by investors thanks to burdensome restrictions in the large-shareholding reporting rule. Most nomination and remuneration committees remain advisory in nature and lack any legal foundation in company law. And despite improvements in non-financial reporting rules in 2019, company disclosure on what boards discuss and how well they perform is patchy. So it was refreshing to see the Financial Services Agency (FSA) announce a new “opinion statement” on 26 April that could usher in a more ambitious action plan to address some of the most intractable problems in corporate governance in Japan.

While the statement will be the subject of much discussion in the coming months, and hopefully formal public consultation, this first draft proposes three main action areas: encouraging management teams to focus more on such things as cost of capital and investment in human capital to improve overall corporate value in a sustained way; improving board and director effectiveness; and deepening dialogue between companies and investors through various measures, including legal obstacles to collective engagement, better corporate disclosure of this dialogue, and strengthening shareholder rights.

The first policy bucket aligns nicely with the recent notification of the Tokyo Stock Exchange (TSE) to request all companies in the TSE Prime and Standard markets to disclose how they intend to raise ROE and ROIC above their weighted average cost of capital on a sustained basis. For its part, the FSA wants companies to think harder about capital efficiency and growth through a review of their business portfolios, the level of investment in human capital and intellectual property, and how they could take advantage of new ideas around sustainability to develop their businesses. Notably, this part of the statement also emphasises the goal of greater diversity in boards and “core human resources”, such as “increasing the percentage of female executives (target of 30% or more by 2030)” (underlining added), an idea given impetus by Prime Minister Fumio Kishida in late April.

The second area hones in on board effectiveness and touches on more substantive disclosure of CG information in the annual securities report and expanded skills training for directors, especially for independent directors.

The third and biggest bucket looks at the broad topic of company-investor dialogue and relationships. It starts by encouraging investors to strengthen their internal governance structures and practices, including allocating sufficient resources to stewardship. It states that companies need to enhance disclosure of both the “status” and “content’ of their dialogue with investors. There is a reference to the duplication of financial and non-financial information in the annual securities report (Yuho) and the separate pre-AGM business report (required under company law). There is a welcome statement on promoting awareness of companies which have responded to the governance expectations of global investors, as well as an emphasis on the need for more English-language disclosure. The FSA then raises a series of legal issues that can adversely affect the company-investor relationship, namely concert-party regulation, beneficial ownership opacity, and greater protection of minority shareholders in partial takeovers. And lastly it says there is a need to look more into quasi-controlled listed companies (the parent-child issue) and reduction of cross-shareholdings.

The suggested implementation dates for these policy actions range from 2023 to 2025.

ACGA’s initial analysis

Formally called the “Action Program for Accelerating Corporate Governance Reform: From Form to Substance”, the statement emanates from the FSA’s Council of Experts formed to oversee the ongoing development of the Japanese Stewardship and CG Codes. While the Council has produced forward-looking statements listing priority areas for reform before, it would be fair to say that the proposed Action Program is both more ambitious (since it addresses controversial issues routinely kicked down the road) and strategic (it seeks to find solutions to some of the biggest obstacles to good corporate governance in Japan). Much previous policy reform has felt piecemeal and reactive. This statement appears, on the whole, to be more systematic and proactive.

Sensibly, it also reflects a desire on the part of the FSA to be more pragmatic in CG reform and move away from the routine three-yearly revisions of the Stewardship Code, which has already been revised twice (in 2017 and 2020) and many assumed would undergo a further rewrite this year. In ACGA’s view, the regulator will get more bang for its buck from this Action Program than a fourth edition of the Stewardship Code.

One area of disappointment: there is no mention of reforming the advisory nomination and remuneration committee system and giving it a proper legal basis. While this is, strictly speaking, the purview of the Ministry of Justice (MOJ), not the FSA, some other elements of the Program will require support from the MOJ—mostly notably reducing duplication between the Yuho and business reports. The door will therefore need to remain open to cross-agency collaboration.

To what extent the Program succeeds will depend in large part on the final details of any new regulation, especially in legal areas such as concert parties (“joint holders”), safe-harbour protections for “making important suggestions” to companies, reduction of cross-shareholdings, and takeover protections. There will undoubtedly be a high level of resistance from the usual suspects in the business community. This is why investors and progressive companies need to nail their colours to the mast and get behind it!