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Japan in the Capital Markets Sept 2021

Japan’s ESG market receives policies and products fillip

Japan’s environmental, social and governance (ESG) bond market is set to have another record year, buoyed by a change in sentiment and the launch of new products, writes Pan Yue.

The ESG debt market in Japan appears to be on the cusp of change, thanks to a new initiative from the central bank.

The Bank of Japan unveiled its inaugural climate change strategy in July, a move that is widely expected to support the growth of the country’s green bond sector.

There are different elements to the BOJ policy. First is simply encouraging Japan’s largest banks to enhance their ESG disclosures and conduct a climate scenario analysis of their operations. Second is to kick off a new funding plan later this year, which will allow select financial institutions to borrow money at a 0% interest rate for up to 10 years — effectively allowing them to lower their cost of holding excess reserves with the central bank. The funds borrowed under this scheme must only be used for green, sustainability, climate change or transition financing efforts.

The third pillar of BOJ’s framework is buying more green debt. Foreign currency green bonds from non-Japanese borrowers will become eligible for purchase as part of the central bank’s foreign exchange reserves.

The strategy follows similar approaches from the European Central Bank and Bank of England, although BOJ’s measure is being viewed as not quite as aggressive, says Koji Shimamoto, president of Société Générale Securities Japan.

“I feel the new policy is solid and concrete, but the direct impact on the market seems limited because BOJ’s action [will not provide] direct exposure in the secondary market,” says Shimamoto. “It’s not as aggressive as some European central banks.”

For example, the European Central Bank can make direct purchases of green bonds in the secondary market, while also using part of its funds to invest in green bond funds. The ECB has a sustainable and responsible investment strategy that aims to increase the share of green securities in its funds portfolio. It also announced an action plan to include climate change considerations in its monetary policy strategy in July.

Shimamoto is not alone in predicting a limited direct impact from the new measures.

But the consensus is that the move will have a strong effect on market sentiment, as the BOJ has long been perceived as having a reluctant attitude towards ESG issues. The BOJ has previously implied that climate change issues do not fall into its mandate of maintaining stability in the capital markets.

“[BOJ’s new policy] provides lenders and investors financial support,” says Reiko Hayashi, director and deputy president of Bank of America’s Japanese subsidiary. “The size of the funding plan is not big, but the attitude from BOJ is a big change. It’s a symbolic change, and I think it’s quite meaningful that the BOJ raises its voice in this market.”

While the BOJ’s new policy is focused on green, or climate-related financing, broadly, many believe the uplift in sentiment will spill into the broader ESG market.

“BOJ’s climate change-related measure will trigger interest from investors who have never been interested in ESG before,” reckons Suzaki Kazuhiro, director of the fund management division of Japan Student Services Organization, which has been selling social bonds on a quarterly basis for the past two years. “We would also pay attention to the increased demand from investors who already invested in ESG, which will lead to further development of the entire ESG market.”

Strong deal volume

Japan had a strong year of green bond issuance in 2020. Last year, the country’s issuers sold $10.6bn of green bonds, according to the Climate Bonds Initiative

That allowed the country to rank seventh of all countries for green issuance in 2020, and second in Asia, falling only behind China, shows Climate Bonds Initiative. That is a jump from Japan’s eighth place globally in 2019.

As of the end of August, 72 green, social and sustainability (GSS) bonds worth $17.2bn had been sold by Japanese issuers, a jump compared with the 51 GSS bonds worth $11.5bn raised during the same period in 2020, according to Dealogic. The numbers do not include sustainability-linked or transition bonds.

The market has been helped by Japanese issuers’ willingness to sell new products.

For instance, Japan produced its first transition finance deals this year.

In March, Kawasaki Kisen Kaisha, a transportation firm also known as K Line, raised a ¥5.9bn($53m) climate transition loan from Mizuho and Sumitomo Mitsui Trust Bank. Nippon Yusen Kabushiki Kaisha, a liner and logistics company, quickly followed suit, issuing a ¥20bn transition bond in July.

Transition bonds are not considered traditional green notes as they allow companies that do not meet the usual green standards to raise money to transition their infrastructure and practices to comply with the Paris Agreement.

More transition bonds and loans are expected to follow — especially as various government bodies are increasingly focusing on developing the transition finance market.

For starters, the Japan government has committed to reducing greenhouse gas emissions in the country to net-zero and achieving carbon neutrality by 2050. It has also said it will promote policies that contribute to growth focused on decarbonization, including carbon pricing.

In May, Japan’s Financial Services Agency (FSA) and the Ministry of Economy, Trade and Industry (Meti) jointly published guidelines on climate transition finance.

Then in June, Meti said it will set up a taskforce to come up with a sector-specific roadmap for the transition to decarbonization, with the aim of promoting climate transition finance. It listed steel, chemicals, electric power, gas, petroleum, cement, and paper and pulp as target sectors for the 2021 fiscal year.

Meti is also asking the market for examples for a transition finance model with a deadline of January 14, 2022.

“After [Meti publishes the roadmap], issuers from those industries can make their transition plans and strategies based on the roadmap, and they’re very keen to tap the market,” says Sachie Ii, head of the sustainable strategy development office at Mizuho. “I think we’ll see more issuers come to the market, maybe by the end of the year or next year.”

Next up could also be sustainability-linked bonds, which many liken to transition bonds. Sustainability-linked bonds are relatively new in the market, but they have been gradually gaining traction as they offer companies with limited green assets access to the ESG market.

These bonds do not rely on a sustainable use of proceeds. Instead, borrowers tie the pricing of their notes to their own efforts to meet sustainable goals, such as reduced carbon emissions.

“In the case of sustainability-linked bonds, we’ve seen a couple of SLB bond issuances with coupon step up structure and some other structures, such as ESG-related donation structure,” says Bank of America’s Hayashi. “Basically, these SLB issuances were well received by investors, but for coupon step-up structure, some investors are not used to such structures and might not be able to participate at this moment.”

Taiga Nagao, vice president of debt strategy and issuance at Sumitomo Mitsui Banking Corp, adds that it also takes time for issuers to get ready for SLBs, as they must evaluate the bank’s portfolio, like loans provided by SMBC to companies, and set up appropriate ESG targets.

“First, we need to understand how much [carbon dioxide] emissions are generated through our loan/investment portfolio… by engaging with our customers and then set up some targets regarding those emissions,” he says.

Social bonds gain traction

Despite the hurdles, Japan’s ESG market is heading in the right direction.

The country has also seen a shift in focus to social bonds since last year, when more social funding was required to support communities during the Covid-19 pandemic. Bankers say the market is likely to keep expanding as Japan is developing its own social bond guidelines.

The new guidelines, which are being developed by the FSA, will clarify what is considered social.

Hayashi, a member of the working group on social bonds, says the new guidelines will be in line with the international principles established by the International Capital Market Association, but they will provide more detail in terms of what kind of target corporations or social issues can be included — something Hayashi thinks is unique.

For instance, the draft version of the guidelines lists examples of categories and target populations that can benefit from social bond proceeds.

Some of the examples include welfare for an ageing population, companies and residents in geographically and socio-economically disadvantaged areas and the promotion of diversity.

The FSA sought public comments on the draft between July and August. The final guidelines were yet to be published at the time of going to press.

There are challenges, however, in satisfying investors about the real impact of social bonds from corporations.

“For green bonds, you can quantify the impact, like the reduction of CO2 emissions,” says SMBC’s Nagao. “For social bonds, the impact is a bit harder to be quantified. From our conversations with investors, some of them prefer to see the impact in numbers.”

Yasunobu Katsuki, sustainable development goals primary analyst at Mizuho, says the purpose of Japan’s guidelines on social bonds is to facilitate such issuance from private companies. As of March 2021, around 81% of social bonds in Japan had been issued by government agencies, according to FSA data. Corporations only accounted for 6% of social bond sales. The remaining 13% were issued by foreign institutions.

The numbers for green bonds were 20% and 74%, respectively, for government agencies and corporations.

There are some creative implementations of social bonds on the horizon, however. Japan International Cooperation Agency is planning to sell a gender bond in September. The government agency, which provides aid for economic and social growth in developing countries, will use the proceeds to enhance gender equality and increase women’s access to schools. The deal will be the first of its kind from the country.

JICA’s transaction, to be led by Barclays Securities Japan, Mitsubishi UFJ Morgan Stanley Securities, Mizuho Securities, Tokai Tokyo Securities and SMBC Nikko, will consist of a 10 year tranche and a 20 year portion.

Although the product is considered niche and will not be able to fit many other issuers’ ESG framework, experts believe the deal will demonstrate the diversification potential of the market.

“Japanese investors and companies are focusing on carbon dioxide emissions, and more on the green and transition side,” says Ii. “The next topic will be diversification and women’s issues.”

That can bring about some much-needed change to Japanese culture, where women representation in company boards still lags its developed market peers. There’s still a long way to go for large-scale growth and change in Japan’s ESG market — but the foundation is getting stronger by the day. s

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