32 ASIAN LEGAL BUSINESS – JULY 2023 WWW.LEGALBUSINESSONLINE.COM ESG people who benefited from their investments or the amount of greenhouse gas emissions reduced, aiming to prevent misleading fundraising and help investors make informed decisions. In October 2022, the FSA established the “Working Group on Impact Investment” under the Expert Panel on Sustainable Finance. The group is expected to explore ways to expand impact investment that contributes to solving social and environmental issues and creating new businesses, including startups, while referring to trends and examples of impact investment in Japan and overseas. According to an FTSE Russell report, ESG investment in Japan is expected to further increase the need and demand for passive investment using quantitative ESG scores that are based on transparent methodologies. DATA, EVALUATION IN FOCUS Given this need for more comprehensive ESG ratings and scores, Japan has also stepped up efforts to improve the transparency of ratings and the methodologies that data providers use. The value of ESG assets are set to reach $53 trillion by 2025 and concerns are growing over the substantial influence that unregulated ESG data providers could have over the industry. The International Organization of Securities Commissions (IOSCO) said in a 2021 report that a lack of standards could lead to a series of risks, including greenwashing and the misallocation of assets. Following the calls included in the report for tighter oversight of ESG ratings and data providers, Japan’s FSA finalised a new code of conduct for ESG ratings and data providers in December 2022 and opened it up for endorsement for six months. The draft code aims to ensure that ESG evaluations and data are used reliably throughout the investment chain. It is intended to encourage “… further improvements in ESG evaluation and data provision services based on their initiatives and ensuring flexibility in response to future business model changes.” Satoshi Ikeda, Chief Sustainable Officer at the FSA, said the code opened a dialogue between data providers and regulators, even if it is just in its initial implementation stages. Hideki Takada, Director for Strategy Development at the FSA, said in an interview that the FSA hopes the code of conduct will improve the transparency and fairness of ESG data and assessment services, as well as the development of the ESG market. Japan’s approach “emphasises flexibility rather than obligation,” Takada said. Therefore, the code of conduct is designed to be voluntary on a “comply or explain” basis. With the recent finalisation of the code, ESG data providers operating in Japan will be requested to adhere to the six principles that the code outlines. These six principles relate to the quality of ESG ratings and data, the establishment of basic procedures, the availability of professional human resources to ensure the quality of ratings and data provision services, the development of professional skills, policies to ensure independent decision-making, and how to handle conflicts of interest appropriately. “While not perfect, the FSA’s approach takes Japan one step closer to improving the transparency and function of ESG ratings. However, the effectiveness of a voluntary code has yet to be tested in this nascent sector. The regulator’s permissive stance over the possibility of diverse rating results is also questionable,” Hazel Ilango, an energy finance analyst with the Institute for Energy Economics and Financial Analysis, said in a February commentary. FTSE Russell, MSCI, Sustainalytics, Refinitiv, Moody’s ESG, and ISS ESG have all made public statements in support of the code of conduct. And Japan is not alone in stepping efforts to develop standards for ESG ratings and data providers. Both the U.K. and Singapore are also in the process of developing their respective codes of conduct. COMBATING GREENWASHING Japan’s FSA has also put forward a series of guidelines to promote ESG investments while combating greenwashing by investment trust managers (ITMs). Greenwashing refers to efforts by companies to give false impressions or information that may be misleading about whether their products or services are environmentally sound. The proposed guidelines define the scope of ESG Public Funds and include checkpoints for disclosures and management of ESG Public Funds, noted Tomoko Fuminaga, a partner at Morgan, Lewis & Bockius, and Kyoko Nagano, of counsel of the firm in a note. ESG Public Funds are defined as public investment trust funds that use ESG factors as primary factors to make investment selections and which hold themselves out as such in their summary prospectus. The guidelines require ITMs to disclose specific ESG factors used in investment selection, how such factors are considered, limitations and risks in the investment process, and any ESG-related stewardship code policies. They also require ongoing disclosures related to the actual proportion of investments, performance results, and actions taken under ESG-related stewardship code policies. If an ITM delegates its investment authority, it must conduct due diligence on the delegated manager and disclose any relevant matters. In terms of management, the guidelines require ITMs to ensure it has appropriate resources, such as data and information technology infrastructure and human resources, to monitor investment management following the investment strategies of ESG public funds. If investment management activities are delegated, the ITM should have an appropriate system for due diligence on matters related to strategies, portfolios, reference benchmarks, and ongoing disclosures. The guidelines also require ITMs to conduct due diligence on the internal controls of ESG evaluations and data providers, including their objects, methodology, limitations, and purpose.