The net-zero opportunity emerging in Japan

By the end of April 2021, nearly 40% of all firms listed on the Nikkei 225 had already committed to net-zero goals — a doubling of the number of companies with such pledges from the end of 2020. As well as wider trends pointing towards ESG and net-zero considerations holding greater sway in Japan, specific areas of investment have presented international appeal.

Taking an overall look at the market, Teppei Yamaga, a senior ESG specialist at Nomura Asset Management, does believe that Japan is an attractive market for sustainable investment. He points to the nation as being a worldwide leader in patent applications for carbon dioxide emissions reduction technologies.

"The enterprise value of Japanese companies should appropriately reflect the value of their sustainability initiatives and could help them return to fair value, making the Japanese market even more attractive for sustainable investment,” he says.

As an example, Drew Edwards, head of Japan value equities at investment manager GMO, is investing in a Japanese company that produces ultra-low friction paints for ship hulls that reduce resistance in the water, in turn leading to increased efficiencies and reduced carbon emissions from the industry.

“These steps to reduce energy usage are a component of the move to net zero, and investors looking at sustainable portfolios should be alive to nuances that exist within sectors,” adds Edwards.

Elsewhere FSSA Investment Managers, part of First Sentier, is invested in S-Pool, a special needs employment service that also provides a carbon-credit trading and consulting business, which looks to educate Japanese companies and help them meet the requirements of ESG disclosure (and how they can meet net-zero targets).

“For manufacturing companies, we focus on their supply chain management system and check whether they engage with their suppliers or impose certain ESG standards when selecting potential suppliers. We would also ask about their long-term plans on carbon neutrality,” says Sophia Li, a portfolio manager focused on Japan at FSSA.

How Japan is hospitable to net zero

There is an interesting backdrop for Japan’s emerging net-zero investment opportunities. Culturally, the country is already aligned with a sustainability mindset.

Figures from the Global Sustainable Investment Alliance show the country’s ESG-linked investments in 2020 were ¥320trn ($2.9trn), a 32% increase from 2018. While these figures may seem impressive, the nation’s total ESG investment was dwarfed in size for the year by Europe ($12trn) and the US ($16.5trn), even when accounting for population differences.

Regardless of comparison, ESG investing in Japan is undoubtedly growing, and international investors are playing a part in this. Edwards points to an amenable national culture: “While ‘net zero’ is relatively new in Japan, the concepts behind it are consistent with Japan’s long-held culture of ‘Sanpo Yoshi’ which predates European and North American views on sustainability. Sanpo Yoshi is a cultural norm in which transactions must be good for the business, the consumer, and good for the wider community.”

As evidence of this culture, Edwards points to commendable attitudes towards recycling in Japan, with the nation’s single-use plastic recycling rate sitting at 85% as of 2019.

Craig Mercer, head of ESG at Dalton Investments, also sees the wider opportunities for the region: “Japan is an attractive market for sustainable investment. The market offers a wide range of leading companies across a variety of different sectors. Market participants have led in areas of green technologies, responsible packaging, and responsible technology hardware manufacturing.”

However, Mercer also points to an issue within Japan that is felt worldwide: data scarcity. Specifically, he notes that many Japanese companies do not report findings in English. Without a team based within the country, it can be hard for investors to determine which names are leading in areas of sustainability.

Is Japan’s sustainability reflected in its regulation?

Japan’s Financial Services Agency (FSA) recently published its second panel report on sustainable finance, in which the regulator identified climate-based opportunities and risks, including comment on climate-related risk management for financial institutions and examples of potential approaches to client engagement.

While this guidance is non-binding, it acts as a standard for dialogue between the FSA and financial institutions and shows serious intent from the Japanese state toward sustainability in its economy.

There can be little doubt that Japan’s overall attitude to sustainable finance is developing positively. In April 2022, the Tokyo Stock Exchange restructured the market into three new segments: the Prime Market, the Standard Market, and the Growth Market. To be classified as ‘Prime’, companies must adhere to minimum standards relating to areas such as English language disclosure, and climate-related disclosure in line with the Taskforce on Climate-Related Financial Disclosures.

In this spirit, several major Japanese corporations have also set carbon-reduction targets, such as the Mitsubishi conglomerate pledging to halve its greenhouse gas emissions by 2030, from a 2020 baseline.

However, Japan still lags in other areas, such as formalising its own sustainable investment taxonomy like that of the EU.

“The EU is five to ten years ahead of all the major global markets in areas of ESG regulation, with the rest of the world playing catch-up. That said, the leading companies in Japan are already implementing clear objectives to move towards a net-zero economy, and, in all likelihood, the companies that are more advanced in this area will be the long-term winners,” says Mercer.