On June 11, 2021, the Tokyo Stock Exchange, Inc. (TSE) published amendments to Japan’s Corporate Governance Code (the Code). In relation to the revision of the Code, the Japan Financial Services Agency (FSA) published the revised Guidelines for Investor and Company Engagement (the Guidelines) on the same day. The Guidelines are a supplemental document intended to encourage institutional investors and companies to implement both Japan’s Corporate Governance Code and Japan’s Stewardship Code effectively on a “comply or explain” basis.
The amendments to the Code are characterized by the fact that the scope of application of the Code will differ depending on which market segment a company is listed following the Market Structure Review of TSE, which is scheduled to become effective in April 2022, or whether a company has a controlling shareholder. The new market structure is comprised of three market segments, “Prime”, “Standard” and “Growth”.
The main revisions of the Code can be broadly classified into the following four categories:
- Attention to sustainability and ESG;
- Diversity policy disclosure;
- Board functions and board independence; and
- Other major points including promoting the use of electronic voting platforms and disclosure in English.
Attention to Sustainability and ESG
In light of the adoption of the Sustainable Development Goals (SDGs) at the United Nations Summit, and the increased support from a number of organizations for the recommendations of the TCFD, the Code stipulates the importance of further promotion of positive and proactive responses to sustainability-related issues.
In particular, for companies listed on the Prime Market, the Code states that they should collect and analyze the necessary data on the impact of climate-related risks and earning opportunities on their business activities and profits, and enhance the quality and quantity of disclosure based on the TCFD recommendations (Supplementary Principle 3.1.3).
Diversity Policy Disclosure
The Code states that companies should present their policies and measurable goals for ensuring diversity as well as disclosing their status. Companies are also requested to present their policies on development of human resource and internal environment to ensure diversity, as well as disclosure of their implementation status (Supplementary Principle 2.4.1).
Board Independence and Board Functions
The Code requires that, for companies listed on the Prime Market, independent directors must make up at least one-third of the board, while a minimum of two independent directors will be required for companies listed on other markets (Principle 4.8)
However, for companies that have a controlling shareholder, the Code requires at least one-third of directors be independent (a majority if listed on the Prime Market), or for a special committee composed of independent persons to be established to deliberate and review material transactions or actions that conflict with the interests of the controlling shareholders and minority shareholders (Supplementary Principle 4.8.3). The Code also provides for companies to establish policies and procedures for nominating directors and disclose them along with the combination of skills, etc. that each director possesses in an appropriate form according to the business environment and business characteristics, etc., such as what is known as a “skills matrix”. When doing so, independent directors with management experience at other companies should be included (Supplementary Principle 4.11.1).
Other Major Points
- Electronic Voting Platforms – The Code stipulates that companies should take steps for the creation of infrastructure which allows electronic voting. Companies listed on the Prime Market should, at minimum, make the Electronic Voting Platform available to institutional investors (Supplementary Principle 1.2.4).
- Disclosure in English – The Code outlines that companies should, to the extent reasonable, take steps for providing English language disclosure. Companies listed on the Prime Market should disclose and provide necessary information in their disclosure documents in English (Supplementary Principle 3.1.2).
- Utilizing the Internal Audit Department – The Code states that the board should appropriately establish effective internal controls (Principle 4.3.4), and ensure coordination between the internal audit department, directors, and statutory auditors (as known as kansayaku in Japanese) by establishing a system in which the internal audit department appropriately reports directly to the board of directors and the board of statutory auditors in order for them to fulfill their functions (Supplementary Principle 4.13.3).
Glass Lewis’ Views
Glass Lewis generally agree with the main points of the direction of the revised Code which strengthens alignment with global governance trends and developments, and investors’ expectations. Here are Glass Lewis’ views on some specific revisions:
Promoting Electronic Voting Platforms and Disclosure in English (Supplementary Principles 1.2.4 and 3.1.2):
Glass Lewis strongly supports efforts to facilitate proxy voting by electronic means, a common method of transmitting votes in many countries.
While we note that the proposed revisions require companies listed on the Prime Market to use electronic voting platforms and disclose necessary information in English, we believe that this principle should be required for all listed companies regardless of the market segment.
Further, we believe that the Japanese market, where the percentage of foreign shareholding is rising, has an increasing need for timely disclosure in both Japanese and English.
Promoting Attention to Sustainability (Principle 2, Supplementary Principle 2.3.1):
In recent years, an increased focus on sustainability-related issues has caused mainstream investors to question whether companies are effectively addressing the potential risks posed by their operational impact on the environment and society.
In our views, investors need comparable and comprehensive reporting, including a basic policy and the company’s initiatives on sustainability-related issues, in order to effectively assess the risks facing their portfolio companies. As such, we support standardized disclosure frameworks such as TCFD.
While the proposed revisions require internationally recommended disclosures frameworks such as TCFD, the Code does not include a provision to establish a board-level management and oversight function responsible for sustainability-related issues, which, we believe, should be included in the proposed revisions.
Promoting Diversity (Supplementary Principle 2.4.1):
Glass Lewis believes that diversity, in general, is a positive force for driving corporate performance, as qualified and committed executives and directors with different gender, backgrounds, experiences, and knowledge will likely enhance corporate governance. In our views, boards should therefore routinely examine whether its members and company personnel possess the appropriate mix of skills and experience to promote and protect shareholder value and, in particular, should explore steps to ensure the participation of more women at the company.
While we note that the revised Code requires companies to disclose policies, measures and goals for ensuring diversity, we also note that in the United States, Europe, and other Asian markets, a quota system for female directors has been introduced.
Outside Japan, policies on gender diversity and the board of directors tend to be formulated by reference to the activities of the 30% Club.
In Japan, the 30% Club appears to have been actively engaged in activities in order to achieve corporate diversity, however, only a few companies, such as Ajinomoto Co.,Inc. (TSE: 2802), have set and disclosed targets for the percentage of women on their board of directors and other executives.
As such, we suggest that a quota system could help promote women to core human resources and executive posts.
It is said that Japanese society is lagging behind other countries in improving the ratio of female executives and promoting women’s activities. However, we expect the revised Code will encourage Japanese companies to increase the ratio of female executives by promoting the development of women who will be candidates for future executives.
Enhancing Board Independence (Principle 4.8):
Glass Lewis believes that a board will most effectively provide the strategic advice and oversight necessary to protect the interests of shareholders if it has a sufficient level of independence. In this regard, we commend the revision for enhancing board independence levels at companies listed on the Prime Market by requesting one-third of their directors (two directors in the previous Code) as independent directors.
However, one-third independence of the board is the minimum requirement in the global market, not a best practice. In addition, we note that number of public comments on enhancing board independence recommend the Code to require a majority of directors be independent at companies listed on the Prime Market, and at least one third of directors at companies listed on other markets.
Considering international market standards and higher expectation of governance for companies listed on the Prime Market, we recommend that the Code require that, for companies listed on the Prime Market, independent directors make up a majority of the board, and for companies listed on other markets, independent directors make up at least one-third of the board.
Promoting Voluntary Committees’ Independence (Supplementary Principle 4.10.1):
We note that the additional provision regarding voluntarily-established nominating and remuneration committees at companies listed on the Prime Market states that such committees should be majority independent.
However, we note that this revision does not include a provision on the chairmanship of each committee. Given that a designated committee chair maintains primary responsibility for the actions of their respective committee, we believe that the committee chair should be an independent director. We strongly recommend that the Code be changed to require an independent chair for each committee.
As discussed above, while there is still room for Japanese companies to improve their corporate governance, Glass Lewis expects the revised Code will encourage Japanese companies to further improve their corporate governance practices and more closely align with global best practices going forward.
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For Glass Lewis’ current policy guidelines for Japan and other markets, see here (the Japan policy guidelines will be updated to reflect the revised Code in due course). For more on Sustainability Reporting and Board Gender Diversity, see our In-Depth reports.
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