Japan: landmark corporate governance reforms

Japan: landmark corporate governance reforms

Freshfields – Japan has seen landmark reforms in corporate governance during 2014 and 2015. In February 2014, Japan’s Financial Services Agency (FSA) released the final version of the Stewardship Code, the first of its kind for Japan. In March 2015, the FSA released the final version of the Corporate Governance Code, based on the OECD Principles of Corporate Governance and reflecting elements of the UK Corporate Governance Code.


Japan has seen landmark reforms in corporate governance during 2014 and 2015. On 26 February 2014, Japan’s Financial Services Agency (FSA) released the final version of the Stewardship Code, the first of its kind for Japan. On 5 March 2015, the FSA released the final version of the Corporate Governance Code (Governance Code), based on the OECD Principles of Corporate Governance and reflecting elements of the UK Corporate Governance Code (notably the ‘comply or explain’ principle).

The Stewardship Code is already in force. On 13 May 2015, the Tokyo Stock Exchange (TSE) announced that it had finished revising its listing and related regulations to implement the Governance Code and that it would come into force on 1 June 2015. This leaves limited time for listed companies to implement any necessary measures to comply with the Governance Code before Japan’s traditional AGM season in June, although the TSE has put in place transitional arrangements for companies that cannot immediately comply.

This briefing provides an overview of the reforms the Governance Code and the Stewardship Code (together, the Codes) implement, including the background to and objectives of the reforms, and to whom and how they apply.

Background to the reforms

One of the higher profile elements of the structural reform piece (the ‘third arrow’) of Abenomics (Prime Minister Shinzo Abe’s economic revitalisation programme) has been the improvement of corporate governance. These reforms have been driven in large part by pressure from the foreign business community to address what it perceives as a weak corporate governance regime in Japan. This is illustrated by, for example, inefficient use of capital by Japanese companies (some large companies are sitting on considerable cash reserves) and a series of corporate governance scandals over several years (most infamously the Olympus scandal).

Japan has made progress on corporate governance in the past, even relatively recently, but efforts to reform corporate governance in Japan have traditionally been met with strong opposition from the business community, particularly the country’s most powerful business lobby keidanren (Japan Business Federation). As such, none of the previous reforms have been as significant as the introduction of the Codes. In 2002, for example, the Japanese Companies Act was amended to allow companies to optionally adopt a ‘committee system’ corporate governance structure. While there were some high-profile adopters (eg Sony), this structure remains underused, most likely due to the requirement to appoint outside directors (which, until now, has not applied to the traditional ‘statutory auditor’ (kansayaku) corporate governance structure used by most companies). Similarly, in 2004 the TSE introduced the ‘Principles of Corporate Governance for Listed Companies’ and then revised them in 2009. However, these are not binding. Listed companies only need to ‘respect’ the Principles, and ‘make efforts to enhance their corporate governance’. The Principles have not been wholeheartedly embraced.

In contrast, the Governance Code has a broad scope and will be binding on listed companies on a comply or explain basis, as discussed below. The Stewardship Code applies on a voluntary basis but has already seen significant take-up. While it remains to be seen what impact the Codes will have working together in practice, on paper they represent a considerable step forward for Japanese corporate governance.

Principle objectives of the Codes

The Governance Code is stated to establish fundamental principles for effective corporate governance in listed companies in Japan. It defines ‘corporate governance’ as a structure for transparent, fair, timely and decisive decision-making by companies, with due attention to the needs and perspectives of shareholders as well as customers, employees and local communities. The Governance Code seeks ‘growth-oriented governance’, and its primary purpose is ‘to stimulate healthy corporate entrepreneurship, support sustainable corporate growth and increase corporate value over the mid- to long-term’.

The Stewardship Code sets out principles considered helpful for institutional investors in fulfilling their stewardship responsibilities with due regard to both their clients and their beneficiaries as well as to investee companies. The Stewardship Code defines stewardship responsibilities as the responsibilities of institutional investors to enhance the medium- to long-term investment return for their clients and beneficiaries by improving and fostering investee companies’ corporate value and sustainable growth through constructive engagement, or purposeful dialogue, based on in-depth knowledge of the companies and their business environment.

The Codes are expressed to be ‘two wheels of a cart’ with the combined goal of achieving effective corporate governance in Japan. The Governance Code asks companies to examine their corporate governance, in light of the aim and spirit of the Governance Code, and to act to address any identified issues, supported by purposeful dialogue with institutional investors based on the Stewardship Code.

To whom do the Codes apply?

The Governance Code will apply to all companies listed on securities exchanges in Japan, other than foreign companies. Companies listed on the first and second sections of the TSE will need to explain any non-compliance with the Governance Code in its entirety. Companies listed on the Mothers market (TSE’s market for high-growth and emerging companies) and JASDAQ will only need to explain any non-compliance with the General Principles of the Governance Code.

Compliance with the Stewardship Code is voluntary, but institutional investors that support the Stewardship Code and are prepared to accept it are expected to publicly disclose their intention to do so. Despite being voluntary, as of 12 March 2015, 184 institutional investors had disclosed their intention to accept the Stewardship Code. Nearly every major Japanese institutional investor is on this list, including the Government Pension Investment Fund, as well as a number of large foreign institutional investors.

How do the Codes apply?

Both Codes adopt a ‘principles-based’ approach and a comply or explain approach in their application. Both approaches are relatively novel in the Japanese market.

A principles-based approach, rather than a rules-based approach, is intended to allow flexibility for listed companies (in the case of the Governance Code) and institutional investors (in the case of the Stewardship Code) to implement the Codes focusing on substance, rather than black letter rules, and in a manner suited to the specific conditions and situations that they face. Implementation could depend, for example, (in the case of the Governance Code) on the company’s industry, size, business characteristics, company organisation and surrounding environment, or (in the case of the Stewardship Code) on the institutional investor’s investment policies.

The comply or explain approach in the Governance Code mirrors the approach in the UK Corporate Governance Code and is binding on listed companies. In other words, if a listed company finds, in view of its individual circumstances, that it is inappropriate to comply with specific principles of the Governance Code, it does not need to comply with those specific principles, but it must explain in its corporate governance report its reasons for not complying. Notably, the preamble to the Governance Code states explicitly that ‘offering a superficial explanation using boilerplate expressions would be inconsistent with the concept of “comply or explain”’.

While the Stewardship Code only applies on a voluntary basis, those institutional investors that have accepted the Stewardship Code are expected to comply or explain in the same way as described above on the Governance Code. An institutional investor’s explanation for any non-compliance should be included in its periodic report on how it fulfils its stewardship responsibilities.

Future review and revision of the Codes

The FSA is expected to review the Stewardship Code ‘periodically, about once every three years’.

The Governance Code is expected to be reviewed ‘periodically’ to ensure that it ‘continues to achieve its objectives … under rapidly changing economic and social circumstances’. In practice, it is reasonable to expect that the Governance Code will also be reviewed on a three-year cycle.

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