Nicholas Benes: Public Comment on Revision of the Stewardship Code

1) Pension Funds
2) Other Types of Investors
3) “ESG Factors”
4) Debt Instruments

1) Pension Funds

The proposed revisions to the Stewardship Code do not make it clear enough exactly how corporate pension funds, or smaller pension funds of any type, can sign the Code and comply with it without bearing excessive cost, work, or confusion.  Because this is not sufficiently clear at present, to date only an extremely small number of the defined-benefit pension funds at listed non-financial companies in Japan have signed the Code (only about 10, out of a total of 700 or more such funds). As a result, a rather odd situation exists in that most Japanese companies claim to care for their employees deeply, but judging from their actions, do not seem to care much about employees’ investments or post-retirement quality of life – or even, to care about preserving shareholder value by reducing the cash infusions needed to keep their pension plan fully funded. This makes a mockery of the language in the Corporate Governance Code about stewardship (Principle 2.6 企業年金のアセットオーナーとしての機能発揮), and of the Stewardship Code itself.

Another reason for the extremely small number of signatories from non-financial corporate pension funds is that the Ministry of Health, Labour and Welfare (MHLW, which is in charge regulating pension funds) has done nothing at all to move towards “comply or explain” disclosure of “stewardship policy” as one sub-part of the ”investment policies “(運用方針) that pension funds are required to set forth pursuant to the enabling regulations of the Company Pension Law (企業年金施行規則). ( I suggested this in 2016 to MHLW, but no action a was taken.  See: スチュワードシップ コードが実効的に機能するために、年金ガバナンス強化の具体策を提言する, at https://bdti.or.jp/2016/08/20/pengovrprop/ )

The FSA should request that MHLW take such the simple, obvious and non-mandatory measures that I proposed, even if only by way of administrative rules such as tsutatsu (通 達). The MHLW’S failure to do so (even though six years have passed since the Stewardship Code was created) flies in the face of the government’s policy to improve economic productivity by means of simultaneously improving governance and investment practices, using the “two wheels of a cart” that I referred to in 2013 and 2014 when I first proposed the concept of a corporate governance code to leaders of the LDP.  It is surprising that the opposition parties do not criticize this strange contradiction in Japan’s “growth policy”.

While it is excellent that the proposed revisions (Sections 1-3, 1-4, and 1-5) contain words such as “Asset owners, corresponding to their size and capacity, etc..” (アセットオーナーは、自らの規模や能力等に応じ), this language is far too vague, and therefore insufficient. The well-known reality is that corporate pension funds in Japan are thinly staffed and for historical reasons, usually do not have many (or any) staff with deep knowledge of asset management, proxy voting, engagement–or the experience and abilities to monitor any of those activities.

To clarify exactly how corporate pension funds can realistically comply with the Stewardship Code without taking on undue burdens, the Code should make it clear that asset owners can choose from specific, feasible activities in order to comply, and that the compliance standard depends not only on size and capacity, but also on the quality and experience of existing staff. In particular, the Code should make it clear that in the case of corporate pension funds: (1) a pension fund may hire an outside qualified (independent) consultant to help it to put in place stewardship policies and criteria, and to evaluate asset-managers’ activities each year (perhaps using a version of the “Smart Format” http://smart.stewardship.or.jp/ reporting system); and that (2) in cases where “capacity” and staffing pose impediments, as long as the signatory pension fund makes public on its website a detailed report prepared by the consultant (in its own name) and formally approved by the board of the pension fund, it will have complied with the Stewardship Code. At the same time, the Code should strongly encourage pension funds to learn from such activities and move towards hiring (or training) staff to diligently perform those stewardship activities in the future, albeit still with the support of outside independent consultant experts as necessary.

Unless the Stewardship Code specifically refers to example actions such as these and makes it clear that they would suffice for compliance with the Stewardship Code by corporate pension funds for the time being, there will continue to be an embarrassing gap in the Stewardship Code, which will not be based on market reality. Asset managers (which are regulated by FSA) have all obediently signed the Stewardship Code, but the private pension funds that channel significant money to them have not. In the area of corporate pension money, no one is “watching the watchers” of companies, and as a result, the Stewardship Code is not functioning.  In this sense, corporations themselves are undermining both the Corporate Governance Code and the Stewardship Code.

2) Other Types of Investors

Japan’s capital market for listed companies has a unique shareholder composition. Banks, corporations and insurance firms hold a very significant percent of the listed company market. It is not clear to this writer whether the Stewardship Code is being diligently applied by all insurance companies to their main account (どんぶり勘定)equity holdings. If not, this needs to be considered, and the FSA as regulator should take account of it. However, more importantly, currently the Stewardship Code does not apply at all to similar “direct” holdings of stock by banks (as opposed to the equity holdings of their asset management affiliates). At present there is no expectation or social pressure for banks to sign and comply with the Stewardship Code with respect to such direct holdings, even though (as banks, an essential institution in society) they hold those stocks on behalf of deposit holders on a basis which is tantamount to an indirect fiduciary role. As the agency that regulates banks, the FSA should bring bank equity holdings in listed companies into the scope of the Stewardship Code, and require banks to either: (a) sign the Stewardship Code with respect to those holdings or (c) at the very least, publish how they have voted with respect to each resolution at each investee company’s AGM.  (I proposed this in a memo submitted to the FSA as a member of its “Corporate Governance Liaison Committee in 2010, but my proposal was ignored. )

3) “ESG Factors”

Japanese institutions need to first improve governance at their portfolio companies, and thus are not ready for a direct reference to “ESG” in the Stewardship Code. References that institutions should consider “sustainability” are a natural and feasible step forward, but at this early stage direct requirements to consider “ESG factors” and “SDGs” will confuse Japan’s market by distracting attention from the inescapable fact that Japanese companies must first improve their governance, and only then can boards be realistically expected to more responsibly identify and consider those ESG factors that have a material impact on their sustainable profitability and financial condition. This is because to many companies in Japan at the present time, creating IR materials that refer to “ESG factors” and “SDG’s” has become a sort of PR game to show that they have good intentions and are good corporate citizens, while distracting from the fact that their governance structures and practices are still sub-standard when viewed in a global context. It is also because globally and not just in Japan, the world of ESG-based investment is still in its very early stages, and there is little agreement about what precise ESG factors in any particular industry are most important for sustainable growth and profitability, and what ESG-related statistics and facts should be disclosed by companies. As a result, there is also very little basis or ability anywhere in the world to make worthwhile comparisons between companies, because there are no standard disclosure criteria and consensus about what they should be.

Said another way, allowing Japanese institutions to claim that they “comply” with the Stewardship Code because their investment policies have taken an ESG perspective that claims to analyze and “integrate” what is often self-serving, spotty, and non-comparable ESG and SDG data which may have dubious relation to each company’s actual sustainable growth and profit, will have the effect of: (a) distracting institutional investor focus from the most important issue in Japan at this time, which is improving governance first, (b) enabling corporations to maintain momentum for such distraction; and (c) putting undue burdens (or the perception of them) on corporate pension funds and other smaller potential signatories.

4) Debt Instruments

Similarly to the above comment, I believe it is too early to include pure debt instruments in the scope of the Sustainability Code, because debt is a non-voting security and therefore holders of it have little ability to improve governance, the most important thing to improve in Japan. Inclusion of debt in the scope of the Stewardship Code at this stage will also have the effect of putting undue burdens (or the perception of such) on corporate pension funds and other smaller potential signatories.

Nicholas Benes

NOTE: The above comment is my individual opinion, and NOT the opinion of any organization or company with which I am affiliated.

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