Crucial change needed to improve corporate governance in Japan

Updates on Japanese business and finance

The writer is managing director of the Board of Directors of the Directors Education Institute of Japan

Since Japan introduced codes of conduct for companies and shareholders, three words have resonated in the corporate landscape – “commitment”, “taiwa ” (discussion) and “stewardship”.

Japan introduced its first management code for investors in 2014, and its first corporate governance code in 2015. At the time, I argued that a code for companies was necessary because both policies would function like “the two wheels of a cart”.

The corporate governance code would provide information so that investor engagement encouraged by the stewardship guidelines can be effective. Shareholders will receive the information they need to assess companies.

However, the fine print of Japan’s stewardship framework still leaves much to be desired, compared to the British model that the Japan Financial Services Agency originally sought to emulate.

When most foreign institutional investors think of “engagement”, they envision a two-way dialogue in which they can make suggestions on issues such as capital structure, dividend policy, governance practices, membership composition. advice, etc.

In the UK, investors are free to do this and keep their discussions confidential, which the issuing company may also wish.

If an investor buys more shares, so that he owns more than 3% of the company, he will have to file a simple “large stake” report. But he will not have to disclose his “goal”To own the stock unless he plans to take over the company.

Therefore, investors need not worry about ambiguous definitions of “purpose” which are subject to interpretation at the discretion of regulators. They can also easily lead a “collective commitment”, which is now becoming common on themes linked to environmental, social and governance issues.

But in Japan, if a large asset manager buys more than 5% of a company’s shares, he will have to ask himself, “Can we make any suggestions – or strong clues – on such issues?” Indeed, he must publicly declare to the FSA whether it is to “just make a pure investment”, or if he can also “make suggestions on important actions” by the company, a list which includes many topics that diligent fund managers want. to discuss.

Filing the report indicating the possibility of “making important suggestions” requires more frequent internal monitoring and reporting to the FSA. These should be done separately from internal reporting systems according to the practical regime that is used if one simply chooses to “shut up and not make suggestions”. In the case of collective commitment, the potential charges are again amplified.

These regulations pour cold water on the usual concept of “constructive engagement” of large investors, essentially labeling them as “likely activists.” They also throw sand into the cogs of the compliance systems of large institutions.

Japan created this onerous reporting regime in 2006, after a series of unsuccessful attempts by activists to scale Japan’s citadel walls. The management code later extolled the virtues of institutional investor engagement because historically they had been far too lazy and silent.

Unfortunately, however, Japan has done nothing to change its reporting rules for large holders. Concretely, the FSA retained with one hand the benefits of “engagement” that its stewardship policy had just promised with the other.

Over time, other ironies have surfaced. The companies hoped the 2006 rules would slow activist investors. However, many activists now just make public announcements, so the rules don’t put them off much. Mainly, the rules only burden large traditional institutional investors, especially passive funds.

The divergence between the UK and Japan is clearly reflected in their stewardship codes. In the UK, the code proactively requires “signatories, where appropriate, to engage in collaborative engagement to influence issuers”.

In contrast, the most recent version of the Japanese Stewardship Code weakly states that “as required, it’s possible this collective commitment may to be beneficial “. A footnote then reminds informed readers that the possibility of collaborative engagement was reduced in 2006.

It would be a shame if bureaucratic inertia prevented the FSA from aligning its regulations with the Japan of 2021. The “large holding reports” rules were intended to provide better disclosure for the benefit of investors. They were not intended to “protect” public enterprises from having to hear suggestions from their owners.

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