Global Investor Sentiment on Japan Stewardship and ...

Information Classification: Confidential

Global Investor Sentiment on Japan Stewardship and Corporate Governance Codes

October 2015

Presented by: Michael S. O’Brien, Vice President BNY Mellon Depositary Receipts ESG Advisory Team

Information Classification: Confidential 2

I. Methodology II. Japan Stewardship Code (February 2014)

1. U.S. and European Signatories 2. View of the Code 3. Impact on Engagement with Japanese Issuers 4. Effect on Investment in Japanese Equities

III. Japan Corporate Governance Code (June 2015) 1. View of the Code 2. Expectations for Impact of the Code 3. Effect on Investment in Japanese Equities

IV. Sentiment on Corporate Governance Progress in Japan V. Summary APPENDIX: Questionnaire

AGENDA

3 Information Classification: Confidential

Methodology


Key Objectives: • Assess investor sentiment on Japan Stewardship and Corporate Governance Codes1

• Gauge how the Codes may impact investment in Japanese equities • Understand how the Stewardship Code may influence engagement between investors and issuers • Gain insight into investor expectations for the Corporate Governance Code’s effect on 1) shareholder

returns; 2) capital policy; 3) cross-ownership; 4) board structure; 5) disclosure and transparency; and 6) corporate growth

Telephone Interviews: Between August 25 - September 16, 2015 Study Population: 20 institutional investment professionals – portfolio managers and equity analysts representing $768.8 billion in equity assets, including $54.4 billion in Japan2

Methodology

Equity Assets Under Mgmt.

$769B

Total Equity Value Held in Japan

$54B

Of Overall Japanese Equities Held in EUR & N.A.

11%

Average % of Firms’ EAUM held in Japan

14%

Average # Japanese Securities Held

155

1 The means for assessing investor sentiment was accomplished through a perception study conducted by Ipreo on behalf of BNY Mellon. All data, information, statistics and analysis is based on the responses obtained from that survey.

2 Ownership information from Ipreo public ownership data sourced as of September 2015.


Methodology – Participant Attributes

Participant Breakdown By Annual Turnover

Participant Breakdown By Geographic Region Participant Breakdown By Investment Style

60%

40%

Europe

North America

5% 5%

45%

5% 40%

Aggressive GrowthGARPGrowthHedgeValue

40%

45%

10% 5%

Low

Medium

High

Very High


Japan Stewardship Code (February 2014)


Stewardship Code U.S. and European Signatories

Breakdown by Signatory Status

20% 5%

75%

Yes

Yes - Japan Affiliate

No

Primary reasons for participants becoming Code signatory:

• They believe in the Code’s principles • Seek to improve corporate culture in Japan and believe it takes

commitment from both institutional investors and issuers • It is required by their Japanese clients

Stewardship principles pose no problems

• Respondents already proactively engage in principles through U.K. Stewardship Code and/or UNPRI

Primary reasons for participants not becoming Code signatory*:

• Most believe it is solely for domestic institutions • They have no plans to become signatories because they do

not invest on behalf of Japanese clients or they already adhere to the U.K. Code

• Signatory status is under consideration but specific requirements need further review and internal discussion before their firms become official signatories

* Six participants were not aware of their firms’ status and they are categorized as non-signatories based on the September 2015 list of signatories compiled by the Financial Services Agency. This list is available at: http://www.fsa.go.jp/en/refer/councils/stewardship/20150911/02.pdf

Presenter

Presentation Notes

25% are code signatories

http://www.fsa.go.jp/en/refer/councils/stewardship/20150911/02.pdf


Code viewed positively by 90% of respondents because it:

• Formalizes and legitimizes the practice of constructive engagement, a welcome change to the perceived passive equity culture in Japan

• Is expected to push shareholder value creation to the forefront of dialogue between investors and issuers

• Advocates voting disclosure as a fiduciary responsibility, should promote better checks and balances on management teams, and should improve market efficiency

Stewardship Code: View of the Code

View of the Japan Stewardship Code

The sole respondent with a neutral opinion appreciated the introduction of the Code, but held low expectations under the belief that the Code was merely a set of written principles, which did not guarantee action or execution. Other opinions expressed:

• Any major systemic overhaul will depend on how prominent, domestic investment firms adopt the Code and conform to the ‘spirit’ of its principles in practice

• The ‘comply or explain’ approach leaves room for interpretation and flexibility, but may lead to ‘box-ticking’ behavior

• The corporate culture in Japan is deep-rooted, and thus the effects of the Stewardship Code (which is viewed as a first step in the right direction) are likely long term in nature

90% 5% 5%

Positive

Neutral

No Opinion


Since the Code’s enactment, 30% of respondents have increased their engagement with Japanese issuers. Remainder cite no change in their engagement primarily because their firms have historically maintained high levels of interaction with Japanese companies. Nearly all investors point out that the quality and content of their discussions have improved:

• Management is willing to have two-way dialogue about capital allocation, ROE targets, balance sheet management, shareholder returns, and governance

• Senior executives exhibit candidness, transparency, and genuine interest when speaking with investors

Stewardship Code: Impact on Engagement with Issuers

Impact on Engagement

When probed, 80% of participants agree that Japanese issuers have become more receptive to investor outreach citing:

• An increasing internal focus on the Investor Relations function at many companies (as evidenced by the addition of IR personnel)

• Greater IR efforts in scheduling meetings, traveling on global roadshows, and providing senior-level access

• More global visibility by presidents and top management executives of Japanese companies

30%

80%

70%

20%

0%

20%

40%

60%

80%

100%

Firms' Engagement Japanese Issuers'Receptiveness

Increased No Effect


Despite the overwhelmingly positive sentiment, 70% of participants state that the Stewardship Code will not have a direct impact on their investment in Japanese equities because they:

• Expect that meaningful changes will be gradual, rather than immediate

• Question if the Code on a stand-alone basis is enough to spur any major changes

• Believe engagement is not a driver of their investment decisions

Stewardship Code: Effect on Investment in Japan

Effect on Investment in Japanese Equities

The smaller portion of participants who plan to add to their Japan ownership state that:

• Introduction of the Stewardship Code is a catalyst that allows their firms to pitch a stronger ‘Japan story’ to potential and existing clients, who may have disregarded or avoided the country before

• They expect that heightened investor scrutiny under the Code will incite broader governance improvements and increase the number of Japanese companies that pass their investment screens

30%

70%

Increase

No Effect


Japan Corporate Governance Code (June 2015)


Most survey respondents are familiar with the Corporate Governance (CG) Code’s objectives and principles and a few of them have thoroughly reviewed the Code in its entirety. A vast majority of participants hold positive views of the Corporate Governance Code because:

• It largely mirrors the UK CG Code • It logically goes hand-in-hand with the Stewardship Code • The ‘comply or explain’ approach is appropriate within a

Japanese context from a cultural perspective • Issuers are expected to place greater emphasis on

shareholders (vs. historical focus on other stakeholders) • As companies with best-in-class corporate governance

emerge, others will be pressured to show improvements

Concerns about the Code include: • Whether it will be truly embraced in spirit rather than viewed

as a minimum threshold • It lacks focus on minority shareholder rights in takeovers • It has the potential for companies to adhere to principles

superficially (e.g. by encouraging numerous independent but ineffective board directors)

Corporate Governance Code: View of the Code

Familiarity with the Japan Corporate Governance Code*

(Average Rating: 3.35)

View of the Corporate Governance Code

*0=Not At All Familiar, 5=Very Familiar

10% 5%

40%

30%

15%

0

1

2

3

4

5

90% 10%

Positive

Neutral


Corporate Governance Code : Potential Impact

How do you expect the Corporate Governance Code to impact the following areas?*

*0=No Impact, 5=Very High Impact

5% 5% 5% 5% 5% 10% 5% 5% 5% 10% 15% 10%

15% 20% 25%

40% 35% 60%

50% 35% 25%

35% 40%

25% 25% 25%

35%

10% 5% 10%

0%

20%

40%

60%

80%

100%

Board Structure ShareholderReturns

Cross-ownership

0 1 2 3 4 5 No Opinion

3.30 3.11 3.00 2.85 2.78 2.70


Board Structure A majority of survey participants are confident that Japanese issuers will appoint at least

two independent directors (if they have not done so already), as progress in the area has already been demonstrated and this is one of the most clear-cut guidelines of the Code

× However, the qualifications of appointees (i.e. expertise, diversity, independence) as well as the magnitude and extent of their influence are areas of uncertainty for the investment community

Capital Policy Most participants foresee that the Code will place greater attention on capital efficiency and

drive more Japanese issuers to outline clear policies for allocating capital and targets for profitability and returns

× Participants with muted expectations in this area assert that the practice of setting ROE targets has been a mainstay in corporate Japan and these participants lack conviction that the Code will materially alter these companies’ ability to hit their goals

Shareholder Returns Given the expected focus on efficiency, respondents hope to see companies prune their

balance sheets and return cash to shareholders via dividends and buybacks × On the other hand, respondents are concerned that some companies will deploy any excess

capital toward CapEx and M&A instead, which limits the Code’s impact on shareholder returns



Disclosure and Transparency Disclosure and transparency have steadily progressed in recent years and participants expect that

the Code will further drive improvements in financial reporting, strategic articulation, and presentation materials

× However, some worry that a subset of Japanese companies will remain opaque and evasive in their communications, especially since the Code does not explicitly address guidelines for transparency

Cross-ownership Some respondents are optimistic that several Japanese banks already have articulated a

commitment to reduce cross-ownership, but a few point out these efforts may be in response to impending international banking regulations rather than as a result of the the CG Code

× Other participants find that Japanese companies still show resistance to the topic of cross-shareholdings, and they worry that issuers will maintain irrational explanations for their cross-ownership

Mid- to Long-term Corporate Growth Participants seek long-term sustainable growth as the ultimate by-product of the CG Code

(along with the Stewardship Code), as companies de-emphasize short-term performance, allocate capital toward high-return projects, and better align interests with shareholders

× On the opposite end, many respondents do not view improving corporate governance as a direct function of growth, but rather believe the Code can drive a better ‘returns story’ in Japan



85% of respondents include corporate governance as a material consideration when making investment decisions, noting that:

• A strong fundamental investment case is predicated on managerial oversight, shareholder value creation and transparency

• It can sometimes serve as a negative screen or restrictive factor, even if the investment opportunities based on financial measures are attractive

As such, a majority of survey participants expect to increase their investment in Japanese equities in light of the CG Code because:

• As companies show tangible improvements, the pool of investable Japanese companies will expand

• Japan-specific funds will be able to attract more client AUM based on a compelling case for improving corporate governance

• Investors hold high expectations for the Code’s effects (as outlined earlier)

Corporate Governance Code: Effect on Investment

Effect on Investment in Japanese Equities

Is corporate governance a material consideration in your investment decision-

making process?

85% 10% 5%

Yes

No

Mixed Opinion

65%

25%

10%

Increase

No Effect

Not Applicable


Sentiment on Corporate Governance Progress in Japan


Collective sentiment shows that most respondents believe in a combination of the three aforementioned initiatives as the most powerful tool to propel corporate governance in Japan When asked to choose among initiatives, the Corporate Governance Code is widely viewed as the biggest driver of long-term positive impact because:

• It places the onus on Japanese issuers • It specifically outlines a set of principles that directly influence investment attractiveness • The ‘comply or explain’ approach allows for an evolving interpretation as the equity culture develops

A few participants are more optimistic about the new TSE listing regulations that require more robust corporate governance standards penalizes transgression with a more severe threat because TSE is a rules-based approach

Sentiment on Corporate Governance Progress

Which of the following do you believe will have the most long-term positive impact on corporate governance in Japan?

5%

68%

16%

11%

Stewardship Code

Corporate Governance Code

New TSE Listing Requirements

None of the Above


Summary


Stewardship Code: • Good News

o Viewed positively by respondents o Positive engagement practices reported since the Code’s introduction

• Bad News o Majority of participants indicate no material impact on investment in Japan o Just 25% of participants are signatories to the code

Governance Code: • Survey participants are reasonably familiar • 90% have a favorable view of it • Board Structure and Capital Policy are areas where respondents believe the Code will have the most

impact Sentiment on Progress:

• Corporate Governance Code cited as the most influential driver of good governance in Japan

Summary


Appendix


Appendix: Questionnaire

Stewardship Code 1. Is your firm a signatory to the Japan Stewardship Code? If yes, what prompted your decision to be a signatory? If no, why not? Are there particular requirements that your firm believed to be difficult to adhere to (bearing in mind that the Code is not mandatory, and firms can explain non-compliance)? 2. What is your view on the Japan Stewardship Code (Positive, Negative, Neutral)? 3. In what ways has it impacted your firm’s engagement with Japanese companies (Increased, No Effect, Decreased)? If no change or increased, have Japanese issuers been receptive to your requests for engagement? 4. How will the Stewardship Code impact your investment in Japanese equities (Increase, No Effect, Decrease)? Corporate Governance Code 5. How familiar are you with the requirements of the Japan Corporate Governance Code? Please rate using a scale where 0=Not at all familiar, 3=Vaguely familiar, 5=Very familiar. 6. What is your view on the Japan Corporate Governance Code (Positive, Negative, Neutral)?


Appendix: Questionnaire (continued)

7. How do you expect the Corporate Governance Code to impact the following areas? Please rate using a scale where 0=No Impact and 5=Very High Impact.

• Shareholder returns • Capital policy (e.g. ROE targets) • Cross-ownership • Board structure • Disclosure and transparency • Mid- to long-term corporate growth

8. Is corporate governance a material consideration in your investment decision-making process?

• If yes, how will the implementation of the Corporate Governance Code impact your investment in Japanese equities? (Increase, No Effect, Decrease)

9. Which of the following do you believe will have the most long-term positive impact on improved corporate governance in Japan?

• The Japan Stewardship Code • The Japan Corporate Governance Code • New listing rules on the TSE requiring comply or explain to more robust governance requirements • None of the above - I do not believe that any of these initiatives will have a material impact on

improving corporate governance in Japan.

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