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By Naoko Konishi

Since ancient times, the social significance of business has been highly valued in Japan. The well-known phrase “Sanpo yoshi” (i.e. “good for the seller, good for the buyer and good for the society”), was the management philosophy of the Omi merchants, one of the three Japanese great merchants’ segments, active from the Middle Ages to the Early Modern Period, which is still the basis for the management philosophy of many Japanese companies and a spirit that is very familiar to the Japanese people.

The Japan Business Federation (so-called “Keidanren”) states that what Japan’s business community should do is to practice “Sustainable Capitalism” in line with the “New Capitalism” advocated by Japan’s Government. It also places priority on improving wellbeing, realizing ”Society 5.0 for SDGs”, creating a virtuous circle of growth and distribution through strengthening industrial competitiveness, and conserving the global environment.

With regard to sustainability measures for Japanese companies, the Tokyo Stock Exchange, Inc. (“JPX”) determined Japan’s Corporate Governance Code (“GC”); which was revised, with effect, on 11 June 2021.

Unlike the European’s approach, which embodies in the text of corporate laws response to the ESG, Japan has adopted, as its soft law, the form of a corporate governance code.

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GC sets out a practical framework to support precise decision-making by management for the sustainable growth and medium- to long-term enhancement of the corporate value of listed companies and plays the role of a common basis in constructive dialogue with investors.

GC was first formulated in 2015 and subsequently revised for the second time in 2021 in the wake of the revision related to JPX’s market segmentation reform as the reorganization of the existing market segmentation into three market segments, in descending order of size, so-called “Prime market”, “Standard market“ and “Growth market”. This revised GC has effect from 4 April 2022, addressing various governance issues, including tackling issues around the ESG factors.

The Prime market is for companies with a market capitalization of a size that makes them suitable for investment by many institutional investors, with higher standards of governance and a commitment to sustainable growth and medium- to long-term corporate value with a focus on constructive dialogue with investors.

The Standard market is for companies with a certain market capitalization as investment targets in a public market, with basic governance standards as listed companies, and a commitment to sustainable growth and medium- to long-term increase in corporate value.

The Growth market is for companies with relatively high risk in terms of business performance, while a timely and appropriate disclosure of business plans and progress is forecasted in order to realize high growth potential and a certain market valuation.

Depending on the concept of each market segment, quantitative and qualitative listing criteria relating to liquidity, corporate governance, etc., are established as follows.

The GC consists of a three-tier structure of five Basic Principles, and 31 Principles and 47 Supplementary Principles linked to the five basic principles. Growth market listed companies are to apply the Basic Principles, while Standard and Prime market listed companies are to apply the Basic Principles, Principles and Supplementary Principles. The latest amendments raise the level of governance for listed companies as a whole and include provisions requiring prime market companies to have a higher level of governance than in other markets.

The basic nature of the GC is that it adopts a “principles-based approach” and a “comply-or-explain approach”.

As to principles-based approach, it sets out only principles and leaves the details to individual companies. By defining abstract expressions and content, the principles are open to a wide range of interpretations, and each company shares the purpose of the principles, interprets and applies them substantively based on its own situation.

As to the comply-or-explain approach, companies subject to CG shall fully explain the reasons for not implementing the principles and convince shareholders and others. If in light of the company’s own circumstances, it is not appropriate to comply with the principles, it is permissible not to comply being, however, obliged to disclose information; corporate governance practices of each listed company are published on the website of JPX.

In this regard, the approaches to ESG are set out in the GC as follows:

– “Listed companies should take appropriate action on social, environmental and other sustainability issues” (Principle 2-3)

– “The Board of Directors, recognizing that addressing sustainability issues is an important part of risk management, shall take appropriate action to ensure that it is addressed; in addition, it shall consider proactively and proactively addressing these issues, taking into account that the demand for and interest in these issues has increased significantly in recent years”(Supplementary Principle 2-3 (i))

– “Listed companies should appropriately disclose their own sustainability initiatives when disclosing their management strategies. They should also disclose and provide clear and specific information on investments in human capital and intellectual property while being aware of the consistency with their own management strategy and management issues. In particular, prime market listed companies should collect and analyze the necessary data on the impact of climate change-related risks and profit opportunities on their business activities, as well as the earnings and disclose information based either on the internationally established disclosure framework Task Force on Climate-Related Financial Disclosures (“TCFD”) or on an equivalent framework promoted to enhance the quality and quantity of disclosures” (Supplementary Principles 3-1 (iii))

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As mentioned above, Japan has adopted corporate response to the ESG, as its soft law, in the form of the GC. Keidanren notes that the GC is principles-based and that compliance and careful explaining, based on the company’s strategy, have the same degree of value. In particular, Japanese companies have a tendency to aim for compliance based on the principles of the GC, and Keidanren points out the need to share a renewed awareness of the fact that the GC does not formally encourage compliance, and to work towards improving corporate communications and promoting investor understanding, including the sharing of good practices in the explanation. Therefore, what is ultimately important is how to ensure effectiven