Could Japan be the next ESG investment hotspot?

New report highlights rise in Asia’s second biggest economy of sustainable investment strategies.

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Japanese insurers face interesting challenges ahead as ESG takes off in the market.

A new report from Fitch Ratings said that Japanese insurers were “treading the ESG Tightrope” amidst changes to how their investment strategies are shaped, as the rise of sustainable finance comes to the market. 

The report, “Japanese Insurers Tread the ESG Tightrope”, which was released this week, said that pressure from investors was needed to be balanced “against local approaches and policyholders' interests”. 

Fitch said that Japan’s insurers are taking a “well-balanced” approach in their view of ESG. “Responding to ESG considerations presents a complex challenge for Japanese insurers, because there is no universally accepted answer on what constitutes the most suitable ESG approach,” it said. 

“Japanese insurers are monitoring developments in Europe and North America and have joined the inner circles of key ESG initiatives to contribute to the process of formulating criteria of ESG activities.” 

In Europe, ESG is now seen as the norm, with huge regulatory frameworks being developed and implemented – such as the UK’s Sustainable Disclosure Regulations (SDR), which came into effect this month, as well as the EU’s Sustainable Financial Disclosure Regime (SFDR). 

"Japanese insurers will continue to integrate ESG into risk management and investment frameworks while managing stakeholder expectations."

Japan’s path to sustainability disclosure standards has been slower but, as of last year, the country's authorities were mandating disclosure standards in a multi-stage approach, which would affect nearly 4,000 public companies in Japan, said a report from EY. 

“However, EU and US rules and standards, as well as the adoption of standards developed by the International Sustainability Standards Board, will also impact Japanese multinationals,” it added. 

"Japanese insurers will continue to integrate ESG into risk management and investment frameworks while managing stakeholder expectations and investment yield,” said Teruki Morinaga, Director, Insurance Ratings, in Fitch’s report. “As a result, we expect Japanese insurers to purchase ESG-related assets only when their risk-return profile is attractive.” 

The report also warned that a potential backlash against ESG remained a possibility in the country largely down to highly visible renewable energy projects rather than at an ideological level such as in the US. 

What’s important? 

As legislation will differ country-to-country so will the focus on different parts of ESG. 

The report said that ESG issues have become increasingly important for Japanese insurers, led by environmental issues, particularly the government's goal to achieve net zero emissions of carbon dioxide (CO2) by 2050. 

“Japanese insurers started to disclose their target CO2 emission reductions in their medium-term business plans on their websites, highlighting their efforts and progress,” it added. 

“Insurers' investments in ESG-related assets have increased over the years."

Governance issues are the next most important for domestic insurers, such as implementing appropriate oversight via a board of directors and criteria for investing. 

“Insurers' investments in ESG-related assets have increased over the years, but we believe their investing decisions will remain driven by the need to ensure adequate returns to policyholders and other stakeholders.” 

Larger macro issues around governance could also prove difficult in the famously homogenous country. Issues with gender parity could also be prickly. According to the report the average proportion of women on the boards of Japanese companies is 23% below the generally accepted global goal of 33%. This could mean tough conversations with investments to bring them up to scratch to meet 'governance' benchmarks.

Japanese life insurers’ ESG activities are primarily investment-related, while Japanese non-life insurers’ ESG activities are both investment and insurance underwriting. 

The larger social environment was even cited as one of the “Ten imperatives for 2024” for Japanese insurers, according to PwC’s 27th Annual Global CEO Survey released in June. It said that Japan’s population dynamics, given the societal trends of ageing and declining birth-rates, are steadily changing. “As this trend cannot be expected to change over the short term, insurers need to transform their business processes while responding flexibly.” 

On the list of ten imperatives, addressing sustainability issues consistently were ranked number nine. 

What of the economy? 

However, despite progress, the key factor will be the bottom line for the companies. Japan escaped some of the inflation event over the past few years, which damaged the economies in other developed nations. As of April 2024, its inflation rate was 2.5%. 

Furthermore, Japan's GDP shrank 0.5% quarter-on-quarter in Q1 2024, matching flash data while reversing from an upwardly revised 0.1% growth in Q4 2023. 

“Private consumption, which accounts for more than half of the economy, fell for the fourth straight quarter (-0.7%, in line with the initial reading and market consensus, after a 0.4% drop in Q4), marking the steepest fall in three quarters as consumers continued to reduce their spending in the face of expensive costs of living and sluggish wages,” said Trading Economics. 

This is in the backdrop of Japan’s outlier interest rate. In March, the Bank of the Japan (BoJ) increased its key interest rate from -0.1% to a range of 0%-0.1%. “It comes as wages have jumped after consumer prices rose,” said reports.

“We do not expect Japanese insurers to purchase ESG-related assets if the risk-return profile is not attractive."

In 2016, the bank cut the rate below zero to stimulate the country's stagnating economy. The economic picture for the country remained uncertain. 

Fitch said that it observed that investment yields remained important to most Japanese insurers, in view of the benefits to their policyholders and shareholders, despite ESG strategies that could put pressure on fiduciary returns. “We do not expect Japanese insurers to purchase ESG-related assets if the risk-return profile is not attractive, even as they accumulate ESG investments as encouraged by investors, the media and governments,” it said. “This may limit insurers' investments to those where the risk-return metrics are sufficiently attractive.” 

Cumulative ESG-related investment in Japan totalled JPY537 trillion (£2.7 trillion) at end-2023, up from the JPY493 trillion (£2.45 trillion) a year ago. 

Some insurers have set volume targets for ESG-related investment, such as Sumitomo Life Insurance Company, which aims for cumulative investment of JPY700 billion (£3.5 billion) in its medium-term business plan for the 2024-2025 financial year. 

With this rise in investment, and changing economic and social priorities, it remains likely that ESG will continue to grow in importance in the country with investment opportunities to follow.