In Japan, there has been strong support for sustainable finance from across the private sector as well as from policy makers and regulators. Institutional investors are now widely encouraged to consider environmental, social and governance (ESG) factors – provided they are financially material. 

However, it is not well understood whether investment institutions in Japan are permitted to invest for sustainability impact – that is, to use their powers and resources to intentionally pursue sustainability outcomes.

Drawing on findings from the 2021 report, A Legal Framework for Impact, this Report aims to clarify the extent to which institutional investors in Japan are currently permitted or required to invest for sustainability impact.[1] It then makes recommendations for Japanese policy makers that would empower and support investors to better integrate the consideration of sustainability impacts into their decision-making.

The above report also introduced the concept of investing for sustainability impact (IFSI). This is used in the report’s legal analysis as a concept to catch, broadly, any activities that involve an investor intentionally attempting (through investment decisions, stewardship or policy engagement) to bring about assessable behaviour changes among investee companies, policy makers or other third parties to achieve positive sustainability outcomes. 

The case for investing for sustainability impact

Investors recognise that global crises like climate change and poverty pose significant risks to economic growth and financial returns over the long term. Accordingly, leading institutional investors are increasingly seeking to mitigate these risks by setting sustainability impact goals across their portfolios. Investing for sustainability impact requires an element of intentionality not necessarily considered by traditional forms of ESG integration. It entails setting explicit sustainability impact goals, taking action to achieve them, and assessing changes in real-world outcomes.

Such practices are also being driven by market demand and government policy. Institutional investors are facing growing pressure from clients and beneficiaries on these issues. In Japan, awareness of initiatives like the UN Sustainable Development Goals is high; however, consumers are not always sure how to contribute through their investments.

The Japanese government has set out strong support for green growth and responsible investment through a number of high-profile policy initiatives in recent years, and the country’s financial regulators are increasingly developing policy to align financial markets with sustainability goals. However, further policy measures are needed to guide and support investors.

The need for policy reform in Japan

Japanese authorities have made clear that investors are permitted to consider ESG factors, where relevant to financial returns. But they have not given the same clarity with regard to approaches that align with investing for sustainability impact. The findings of A Legal Framework for Impact indicate that investors’ understanding of their legal duties regarding sustainability goals is discouraging them from taking such action.

Market infrastructure to support and guide investors continues to improve and the Japanese government has set out strong support for green growth and responsible investment through a number of high-profile policy initiatives. New corporate reporting rules, for example, will improve sustainability disclosures for investors. However, important gaps remain, limiting investors’ ability to integrate sustainability impacts into their decision-making.

Guidance on stewardship could be improved to help support investors to address system-level risks and better hold companies accountable for causing externalities that may affect their broader portfolios. Market regulations can be clarified to avoid discouraging collaborative engagement that can help them to do so efficiently.

ESG disclosures by investment managers and investment funds are largely voluntary and not subject to regulation, raising the risk that clients and beneficiaries may struggle to identify appropriate products, or may even be subject to misleading claims.

Policy recommendations

  • Clarify the extent to which investors’ duties permit or require them to consider pursuing sustainability impact goals;
  • Ensure better investor access to corporate sustainability-related information by updating existing rules, standards and guidance;
  • Clarify when and how investors can use stewardship activities to pursue sustainability impacts, by updating the stewardship code, and through relevant implementation support programmes;
  • Enhance transparency and market discipline on responsible investment claims by introducing rules and guidance on disclosures, labelling and classification;
  • Ensure better communication between investment managers and their clients and beneficiaries on sustainability objectives and preferences by introducing relevant guidance.