Guide on ESG-related Risk Management - for Coordinated Efforts and Dialogue among Companies, Investors, and Financial Institutions
August 23, 2018
Japan Federation of Bar Associations
On the ground that Japanese companies, as well as the investors and financial institutions which provide investment or finance them, are expected to address the risks arising from ESG (environmental, social, governance) issues such as human rights violations and environmental destruction, the Japan Federation of Bar Associations (“JFBA”) has published the “Guide on ESG-related Risk Management” (“Guide”) for Japanese companies, investors, and financial institutions to talk and work together on managing risk related to ESG issues.
Background and Purpose of the Guide
Triggered by the UN Principles for Responsible Investment (PRI) launched in 2006 that set forth behaviors investors should take which advocate for investments that give due consideration to ESG aspects, stakeholders including companies, investors, and financial institutions are more interested in how companies address ESG issues.
In recent years, in the context of a growing awareness of the negative effects of corporate activities, such as human rights violations and environmental destruction, which are occurring as risks related to ESG aspects in corporate activities, national and international rulemaking has been accelerated following the adoption of the UN Guiding Principles on Business and Human Rights, the Paris Agreement on climate change, and the Sustainable Development Goals (SDGs). Corporate management is thereby required to recognize and deal with ESG issues as an important part of their risk management. In addition, investors and financial institutions are also expected to know how their investee and borrower companies manage ESG related risks, and are required to engage in a dialogue with them.
To cope with such ESG related risks, the JFBA has published the Guide for companies, investors, and financial institutions, in addition to lawyers who provide legal advice to them, to suggest to them how they talk and work together on managing risks related to ESG issues.
Composition of the Guide
The Guide is composed of three chapters which provide guidance for companies (Chapter 1), institutional investors (Chapter 2), and financial institutions (Chapter 3), respectively. Since it is vital for the three parties to work and engage together, the three chapters are closely related.
① Chapter 1: Disclosure of non-financial information of companies
Mainly for listed companies, this chapter provides practical guidance on (i) how to establish systems to deal with ESG related risks, (ii) examples of non-financial information to be disclosed, and (iii) how to disclose non-financial information, including what media to use, in a manner to complement Japan’s Corporate Governance Code and the Guidance for Integrated Corporate Disclosure and Company –Investor Dialogue for Collaborative Value Creation by the Ministry of Economy, Trade and Industry.
② Chapter 2: Engagement (dialogue) in ESG investment by institutional investors
Especially for institutional investors who conduct passive investment in mid- to long-term shareholding, this chapter provides practical guidance on how to engage in dialogue in the case of corporate scandals arising from ESG related risks, as well as during normal times to prevent such events, in a manner to complement the Japan’s Stewardship Code and the Guidance for Integrated Corporate Disclosure and Company -Investor Dialogue for Collaborative Value Creation.
In light of the Japan Exchange Regulation’s (JPX-R) issuance of the Principles for Responding to Corporate Scandals and the Principles for Preventing Corporate Scandals for the listed companies, this chapter clarifies the common understanding on what engagement (dialogue) institutional investors should have with their investee companies for preventing and responding to corporate scandals. Further, it offers some options on how to have such dialogue.
③ Chapter 3: Inspections by financial institutions for ESG investment - including ESG model provisions
With an understanding of the purpose of the Equator Principles and the Principles for Financial Action towards a Sustainable Society (Principles for Financial Action for the 21st Century), this chapter provides guidance for financial institutions which extend loans on how to have loan inspections and a dialogue with, and support for, borrower companies, while giving due consideration to ESG issues, in a manner to further develop the supervision guidelines published by the Financial Services Agency regarding eliminating the involvement of antisocial groups from investment deals.
In addition, model ESG provisions to be included in loan agreements are provided with explanations for consideration as well as the points to be noted at the time of implementation. And, the points to be noted when financial institutions enter into financial agreements with small and medium-sized companies are also included.
Nature of the Guide
The Guide is a collection of good practices at this time on how to handle ESG related risks, which is not supposed to give any binding requirements on companies. Rather, the Guide is intended to help companies which do not have adequate resources (human, capital, or information) to conduct an effective response.
Since how ESG issues are addressed differs depending on various elements such as company size, business types, conditions of investments or loans, etc., it is more appropriate to take a principles-based approach. If companies do not take any measures according to the Guide, a “comply or explain” approach (an approach that requires compliance, otherwise, an explanation of why there was no compliance) would be a useful method in the sense that any reasonable reason would be explained.
It should be noted in the Guide that “should” is used for recommended measures that should be implemented to address ESG related risks, and “may” is used for those measures that preferably may be implemented depending on physical, human, or economical environments.
