In response to known challenges concerning ESG evaluation and data provision, including transparency and fairness of evaluation, and the expanding  role of organizations which provide these services, Japan has compiled a draft Code of Conduct for ESG Evaluation and Data Providers. The draft Code was published in July 2022 and can be read here.

Japan is currently seeking public comments regarding the draft Code. The comment period will end on September 5, 2022. 

Background

Japan’s Financial Services Agency (FSA) decided to make headway with the draft Code, which is the first of its kind in the world to be issued by a national regulator.  It follows discussions by the FSA’s Technical Committee for ESG Evaluation and Data Providers and the FSA’s “Report by the Expert Panel on Sustainable Finance” which recommended the FSA to promote discussions on expected codes of conduct for ESG evaluation and data providers.

The draft Code also responds to a report published in 2021 by the International Organization of Securities Commissions (IOSCO) which called for greater attention on the use of ESG ratings and data products.

Framework & Application

The aim of the draft Code is to ensure that ESG evaluation and data is used reliably throughout the investment chain.   It is intended to encourage “…further improvements in ESG evaluation and data provision services based on their own initiatives and ensuring flexibility in response to future business model changes.” As such, the draft Code of Conduct is principles-based and designed to be a voluntary code that applies on a ‘comply or explain’ basis.  Japanese financial market participants can decide appropriate ways to implement the “Principles” and “Guidelines” with due consideration to the “Concepts” according to their own situation.

Currently, there are no specific statutory regulations or definitions for ESG evaluation and data providers in Japan. However, the draft Code sheds some light on the coverage of these terms. Specialist institutions that do not provide data directly to investors as part of their business are not covered by the draft Code. However, organizations that provide ESG data may be covered by the draft Code if, for example, their service adds information to corporate data.

The draft Code outlines 6 principles with associated guidelines and concepts for application.  The 6 principles are:

  • securing quality: ensure the quality of ESG evaluation and data provided with basic procedures are established;
  • human resources development: secure necessary human resources to ensure the quality of the evaluation and data provision services provided;
  • ensuring independence and managing conflicts of interest: including identifying activities and situations that could undermine the independence or neutrality of the ESG evaluation and data provider’s business;
  • ensuring transparency: publicly clarify the philosophy and methodology for evaluations;
  • confidentiality: establish policies and procedures to protect non-public information; and
  • communication with companies: including responding to important or reasonable issues related to information source raised by companies subject to evaluation.

The draft Code provides an integrated description of the roles expected of the two types of ESG evaluation and data providers, namely the subscriber pay model and the issuer pay model.

Finally, the draft Code annexes excerpts from the Technical Committee’s report on recommendations to institutional investors that use ESG evaluation and data for their investment decisions  and companies that are subject to ESG evaluation and data collection. However, it is unclear how the investor recommendations would be implemented or enforced.

It is noted that there is no specific statutory or regulatory authorities which directly mandate such investor recommendations, which appears to be inconsistent with the FSA’s general approach to regulate asset managers.

Global Context

While Japan is the first country to make headway with a Code of Conduct, measures to improve the quality of ESG data and evaluations, including introducing regulations, are actively being discussed in other regions. For example, as noted in our blog article here, the European Securities and Markets Authority published a letter to the European Commission in June 2022 providing findings from the call for evidence to gather information on the market structure for ESG rating providers in the EU.  Proposals to regulate the quality of ESG ratings or other data products will continue to emerge in response to the increase in ESG products and focus on ESG investment.

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