Social contract: The future of ESG finance in Japan
Japanese issuers have embraced green, social and sustainability bonds, offering domestic and international investors a range of deals designed to tackle climate change, gender equality and other problems. But the local investor base is still small — and some issuers have lingering questions about funding costs. GlobalCapital talked to a group of leading market participants about the potential for Japan’s ESG bond market.
Participants in the roundtable were:
Kazuyuki Aihara, head of ESG products, Nomura
Satoshi Ikeda, chief sustainable finance officer, Financial Services Agency (FSA)
Natsuko Kuroda, director of finance, finance department, Japan Finance Organization for Municipalities (JFM)
Shinya Momose, vice-president, finance office, finance and accounting department, Nippon Telegraph and Telephone Corporation (NTT)
Jason Mortimer, head of sustainable investment, fixed income, Nomura Asset Management (NAM)
Naoki Shinada, director, treasury department, Development Bank of Japan (DBJ)
Hiromi Yoshiura, director, bond section, budget division, bureau of finance, Met Tokyo
Moderator: Matthew Thomas, GlobalCapital
GlobalCapital: How has Covid-19 changed your approach to ESG?
Kazuyuki Aihara, Nomura: Covid-19 had a major impact on the bond market. Covid-19 response bonds were issued in large numbers and, as a result of that, the social bond market got bigger. That is one major impact of the pandemic on the sustainable financing market. The pandemic also changed how issuers view the markets, particularly by encouraging them to consider shorter-term funding.
The major impact we have seen, however, is that the vulnerability of the world became clear — and that threw questions of sustainability into sharp relief. That was not necessarily reflected in rising issuance. Of course, we saw some Covid-19 bonds but green bond issuance did not really increase. Still, the market started to pay more attention to sustainability and what it means in practice. That is going to help this market grow in the long term.
Satoshi Ikeda, FSA: I believe that Covid-19 triggered a renewed focus on sustainability among Japanese companies. Japanese executives tend to talk about the long term; it is common here for companies to boast about how many years they have been operating. But it is clear that rather than just looking back at their history, companies need to think about their resilience and robustness for the future — and a lot of that comes down to how they will adapt to challenges around sustainability. Covid-19 is a very extreme example of those challenges.
Against that backdrop, there is a very vocal call for the Japan FSA to lay out certain social bond criteria tailored to the Japanese context. We recently established a study group on social bond standards. It aims to issue guidelines aligned with the ICMA social bond principles, but with a lot of weighting on the Japanese specific context in issuing social bonds. It should be said that sustainability includes many issues other than Covid. The wider market is clearly going to be helped by Prime Minister Suga’s declaration that Japan has committed to carbon neutrality by 2050. That has broadened the perspective among Japanese companies on sustainability and they are now very much rushing to address that challenge as well. Right now, it’s kind of a sustainability bubble in Japan.
Naoki Shinada, DBJ: The characteristics or impact of Covid-19 on the Japanese economy are four-fold. First, of course, is the public health impact. Second, the restrictions imposed on specific industries or specific sectors as Japan adjusts to the pandemic. Third is the impact on small and medium-sized corporations, or very small corporations suffering from undercapitalisation — they suffered from a huge negative economic impact. Fourth is the impact on employment, not just on part-time workers but even in the case of full-time employees, where we have seen a rather sudden reduction in demand brought about by the loss of employment.
These are the four main factors to consider when you look at the impact of Covid-19 on Japan. How have issuers adapted to these challenges? Some issuers, including those on this roundtable, have acted in a way that is akin to public service — and they emphasise very much the public benefit of their issuance of social bonds.
DBJ is certainly among those issuers. Even before Covid-19, we have been extending loans and investment to support corporations — our day-to-day activity already has a social aspect. In October last year, the existing sustainability bond framework was renewed and improved.
Social bonds are really starting to be understood by investors now. Green bonds are easier to understand, since they attempt to tackle climate change. But we have added social bonds because disaster recovery, healthcare and social well-being are all important issues that need to be tackled alongside climate change. We are seeing very high demand for this type of issuance at the moment. Covid-19 bonds have only brought more attention to the market.
Natsuko Kuroda, JFM: JFM deals with local municipalities only. They are responsible for the development of water works, sewage treatment and the building of hospitals, as well as dealing with natural disasters, disaster prevention and risk management for Covid-19. These local municipalities were greatly impacted by the pandemic, and our loans extended to the local municipalities were expected to increase in value, but we still had big questions going into this year. What specific types of project would need funding? In what sorts of sectors? How much more would we need to lend this year?
None of this was very clear to us, which was part of the reason we didn’t issue any coronavirus bonds. Another reason was that in February 2020, we issued euro-denominated green bonds for the first time, allocating the proceeds to sewage works implemented by the local municipalities, and we wanted to concentrate on our first impact reporting. In February 2021, we issued our second green bond. The total amount of funding we are extending to local municipalities is expected to increase, which resulted in revising our funding plan. In July 2020, there was an increase of ¥300bn ($2.74bn) and in December there was an additional ¥200bn, for a total of ¥500bn.
In fiscal year 2021, we are planning to issue a total of ¥2.24tn.
Shinya Momose, NTT: Japanese corporations are now really interested in ESG. In May 2020, NTT disclosed our energy and environment vision to reach zero emissions. We issued a green bond worth ¥40bn to accompany this vision.
People started to work from home during the pandemic, so remote meetings became crucial. And as one of the largest IT companies in Japan, we had to be involved in the implementation and dissemination of these technology changes. We felt that this had to be further accelerated.
We have funded through a mix of offshore and domestic bonds. In December 2020, we raised ¥1tr in the domestic market. In February, we turned to the dollar and euro markets, raising $8bn and €2bn, respectively. These were not ESG bonds; they were common bonds. But we carried out IR activities to 120 foreign investors — and they were all interested in ESG. As a result, we now give full disclosure of our ESG activity throughout the year. That information disclosure is increasingly important for investors.
Hiromi Yoshiura, Met Tokyo: In December 2020, we issued domestic bonds for which the use of proceeds was limited to Covid-19 countermeasure-related projects. In issuing this bond, we chose the non-labelled format, which does not involve the set-up of a framework or external review, to achieve speedy execution. At the time of issuance, we have successfully attracted attention from a wide range of investors, including some from overseas.
Jason Mortimer, NAM: The biggest takeaway from the Covid period has been expansion of the ESG investment universe from being largely focused on green to increasingly including social. That opens up a lot of new possibilities. It’s almost like finding the other half of the map.
When you add all these various social kinds of investment categories to what we already had on the environmental side, it does really seem to be well suited to Japan. Green bonds sold by Japanese issuers account for only about 5% of the global total. The share rises to about 16% on the social side. This is a market that obviously took off quite a lot last year.
It was quite interesting to hear what the FSA representative said. The question of resilience is crucial and the pandemic has really opened people’s eyes to it. It’s not just a question of resilience in relation to the pandemic but also supply chains, telecommunications, cyber security and other national critical functions such as the power supply.
That seems to be a very interesting area for impact investment — how can we make sure we are investing in assets that have a sort of in-built resilience to these risks?
Social investment has a strong ethical base. Whereas green is a very global issue, with social factors you have to look a bit more at the local context. In Japan, we are looking especially at rebuilding supply chains, looking at medical supply chain resilience, disaster resilience, infrastructure. Those are the kinds of things investors like us want to see more.
GlobalCapital: Let’s turn to issuers on this point. What’s your view of the social bond market?
Shinya Momose, NTT: At the moment, the green bond market is bigger and deeper, but we see good potential for sustainability or social bonds. From our perspective, digital inclusion is one area that could be well funded through social bonds. There are certain remote areas in Japan — so remote they should be seen as a serious problem. To revitalise those remote areas, digitalisation is very important — and this is one clear area in which technology companies like us can contribute to social gains.
The current framework we have is only a green bond issuance framework, but when we look at social aspects, the ESG bond issuance potential is quite large for us.
Naoki Shinada, DBJ: I just talked about four characteristics of the impact stemming from Covid-19. Those are the consequences of Covid-19, but there are many other factors we need to consider when it comes to social bonds — disaster response, the disparity between regions, income disparities. There is plenty of room for social bonds to expand further.
Hiromi Yoshiura, Met Tokyo: Although it will be domestic bonds, we are also planning to issue social bonds in FY2021, in addition to the domestic green bonds we have been issuing regularly. Further development of ESG bonds, which are of great interest to investors nowadays, in a way that allows issuers to utilise proceeds for various projects, is desirable as it will lead to a virtuous cycle of activating ESG investment.
Natsuko Kuroda, JFM: We may consider social bond issuance in the future. All the projects we lend to do have a social component, so the expansion of the social bond market is a tailwind for us, I guess. But when we will issue social bonds, which projects we will use, what sort of reporting we will need — these are all open questions at this point. This is something we are studying internally.
At the same time, we have to consider investors — how hungry are they for social bonds? There is no clear definition of social bonds, so there is still a bit of ambiguity in the market. Looking at the growth of investors in this market, and looking at what conclusions are reached by the FSA study group, should help us make a better decision about issuing social bonds.
Jason Mortimer, NAM: My take from the buy side is that it just opens up a whole new whole new side of the market. Social bond issuers tend to be quite a bit different from what you get in the green bond market. For example, some of the largest issuers in Japan are motor expressway operators.
They would not necessarily work as green bond issuers but they have figured out a way to make it work on the social side. We see about 10% of issuance being allocated to health. Last year we saw quite a bit of SME financing related to the crisis, which is another interesting area, especially when it has a regional component.
I would certainly invite more issuers to consider social bonds. Even when green is not the right fit for an issuer, there are still things they can do in the ESG market.
GlobalCapital: How is Nomura advising issuers right now when it comes to preparing, or even simply considering, social bonds?
Kazuyuki Aihara, Nomura: The vulnerability of society was brought to the forefront by Covid-19 and we recognised that there was a major change taking place. That change was particularly clear in terms of behavioural patterns, such as remote working and working from home. Issuers have adjusted to that. For instance, we worked as lead manager for Tokyu Corporation’s sustainability bond. Tokyu Corporation is providing rail transportation services in Tokyo metropolitan area. The proceeds of that deal were used for the construction of a membership-based shared satellite office for workers in its railway area. The shared satellite office will reduce the need for the company’s workers to expose themselves to the virus, so there is a clear social benefit there.
This is just one example, but the pattern can be seen across many different industries. As companies have adjusted to the pandemic, they have realised they need funding for projects they were not considering a year or two ago — and many of those projects can be seen as social projects. There’s a clear need among a lot of issuers to fund these projects but there is also a desire among investors to find strong ‘impact investments’. This is a good time for the market to develop.
GlobalCapital: What’s the role of the FSA in developing this market? How much of a priority is sustainable finance for the FSA at the moment — and what’s the end-goal?
Satoshi Ikeda, FSA: The FSA wants to upgrade the role of the Japanese market in the global context. Sustainability, social finance and ESG more broadly are an integral part of that. But I think it’s important to note that developing sustainable finance is not just the job of the regulator.
Sustainable finance has been embraced by the Ministry of the Environment, as well as the Ministry of Economy, Trade and Industry. In a sense, the whole government is trying to address this challenge at the moment. Why this co-ordinated effort? The reason is that some people see this as another kind of industrial revolution.
Businesses need to transform themselves to fit the sustainability-related agendas. That means developing this market is not simply about expanding the investor base or improving the efficient functioning of the financial market. It is about making sustainability a crucial component of enhancing enterprise value.
Late last year, we established an expert panel on sustainable finance. The group is looking at how the market itself can be improved, but at the same time there is a lot of focus on how financial institutions and corporations can transform themselves. If we are going to move to a point where sustainability becomes central to enterprise value, we need to stop thinking of this simply as a bond market question. Equity investors need to be involved, as well as other market players.
GlobalCapital: A key question when it comes to developing these markets, everywhere in the world, is the development of the investor base. How far has the sustainable and social investor base developed already — and what needs to be done to give it that next push?
Jason Mortimer, NAM: The investor base is still quite limited for these deals in Japan and the questions we see from people in the market are often pretty foundational. What is ESG? What does it mean? Are the deals too tight? Are they too small? Do they trade? It’s a growing market but a lot of people are still getting over those early-stage hurdles.
There are actually a lot of corporate issuers. It’s not necessarily just policy banks or supranational-type issuers any more. But certainly when you compare us with Europe, we don’t get the same diversity of issuers in this market. We want to grow to that level. We want to get to the point when there are dedicated investors and a great variety of issuers. But now is the time to shape how the market is going to develop. Social bonds are going to help this market grow. When you add social bonds alongside green bonds, it makes this market a more comprehensive, full package offering. That’s going to really open the door for us — not necessarily through the kind of dedicated green bond funds you have seen in Europe, but through existing investors who realise they need to become more flexible and make more effort to understand these markets. Once people start to see the impact sectors, and how that will affect the real economy, they will start to get excited.
Kazuyuki Aihara, Nomura: Japanese issuers can get the best of both worlds when it comes to growing their own domestic investor base but also appealing to those dedicated funds outside Japan. DBJ and JFM have already turned to the European market, because the investor base there really is so sophisticated in terms of how they evaluate sustainability. That offshore issuance is going to continue to grow and it will actually help the Japanese market, because it makes issuers more comfortable with answering the hard questions. Of course, over time Japanese investors will become much experienced in this market, too.
Hiromi Yoshiura, Met Tokyo: We have been issuing domestic green bonds targeting institutional investors since FY2017. The subscription rate, which was 4.1 times in FY2017, increased to eight times in FY2020, while the number of investments is also increasing year by year. We believe that the number of investors interested in ESG bonds is steadily growing in Japan as well, and that trend is likely to continue in the future.
Satoshi Ikeda, FSA: In terms of the institutional investor base, the deficiency in Japan is the participation of asset owners in the ESG or sustainability-related market. That is hindered by the lack of capability among certain public pension funds, which gather a huge amount of money from beneficiaries but can sometimes be quite conservative. Right now, the Japanese government is trying to change that by encouraging the public pension funds to embrace the idea of sustainability or ESG into their investment strategy.
The reason we see this reluctance among asset owners is that there is a very firmly rooted concept that certain environmental or social agendas will undermine financial returns. It’s important to change that kind of mindset, but it is starting to happen. Last year, the Japanese government changed the investment mandate of public-sector pension funds for requiring them to embrace ESG-based investment strategies. It is encouraging that, with this instruction, KKR, which is not that famous private equity fund but the Japanese government employees pension fund, and others are moving in that direction.
Jason Mortimer, NAM: It’s interesting to look at this question of how returns are affected by an ESG component. I guess I’m going a little bit into advertising mode here but I recently published research looking at the performance of green bonds in euros and dollars during times of market stress. I looked at issuers that had both green and non-green bonds outstanding. Green bonds, in a very skewed distribution, outperformed the non-green bonds on the same issuer curve, in both dollars and euros.
So then we move on to the wider question: does ESG actually work to raise returns? We are telling our clients very emphatically it does — we have the data. We did a study using our own internally-determined ESG credit scores for euro corporate bonds going back 20 years. We broke it down by quartiles and the lowest quartiles had lower returns. It’s not just that the returns were worse, but also the volatility was higher, so it is clear the Sharpe ratios really do get improved when you systematically apply ESG to your risk and return analysis.
The idea that this is not a feasible area to invest in, or that it is a kind of charity market — that really has to go. It’s our job as investors to do the work, to show data with real results to clients, and to prove to them that ESG actually is something that you should care about. It’s a market of huge opportunities for investors.
GlobalCapital: What about issuers? What’s the main appeal of this market?
Natsuko Kuroda, JFM: When we talk to overseas investors, it is clear there is a large pool of dedicated investors who want to buy green bonds — that offered an opportunity to tap a new source of demand. But through these deals we can also fulfil a wider function for Japanese local governments. These local governments are contributing to sustainable development goals, whether through sewage projects or transportation projects, but since most local governments do not have a GMTN programme or green bond framework to access the international green bond market, it is important for us to get their story out there.
Shinya Momose, NTT: NTT has issued both green bonds and conventional bonds. It has become clear to us that even when we are selling a conventional bond, investors are still interested to hear about the ESG angles to our business. Investor awareness of this area is increasing.
In the future, we may look to issue an ESG bond in the European market, given the depth of the investor base there, but even in Japan this is no longer a market that can be ignored by bond issuers.
Naoki Shinada, DBJ: One factor that those of us working at DBJ need to bear in mind is that the full privatisation of DBJ remains as a target. It is important for us to use our credit strength to develop many diverse sources of funding in preparation for that. We issue bonds with and without government guarantees, but since we are thinking about that privatisation we have concentrated on our non-government guaranteed bonds when exploring green or ESG options. As a way of expanding our international businesses, we have now issued in both euros and dollars in this market and the investor interest was very large. I think this market has a lot of potential in the future.
GlobalCapital: One area of the ESG market that we haven’t touched on so far but that has real potential is the transition bond market. Do you think transition bonds will take off in Japan?
Kazuyuki Aihara, Nomura: This is definitely an interesting market for us. Around 85% of the energy demand in Japan is still dependent on fossil fuel. But prime minister Suga has now made a commitment for the country to become carbon net zero by 2050.
That is a major change in the direction of policy and although the government’s transition strategy for net zero by 2050 is still being formulated, transition finance will become a big part of this.
Jason Mortimer, NAM: Transition bonds are the missing part of the market in Europe. This may be an area where Japan can step in. Some investors are fundamentally opposed to this concept but in my view, an all-or-nothing approach is not going to work to help countries transition to where they want to be in terms of carbon emissions.
When you think about the potential size of the transition bond market, we are talking about orders of magnitude more than green bonds.
This could really become a very large part of the market almost overnight. There are big questions we have as investors. How do we price this risk? How do we compare different types of transition? Some people are talking degrees of warming — this is zero degree warming portfolio, this is a 1.5 degree warming portfolio, and so on. That might be the way we analyse transition bonds: fitting them into broad buckets based on the environmental impact. That is still something we need to think about, but I definitely believe transition bonds can fill a gap in the market.GC