Japan’s unrealised ESG potential

Reactions to COP28 continue to roll in.

Yesterday, climate activist Bill McKibben spoke to Boston’s public radio station. Unsurprisingly, he was roundly sceptical about the UN climate negotiations. But the fact that “fossil fuels” were mentioned for the first time in the final communique was positive, McKibben said.

That fossil fuels breakthrough “will only be a significant victory if we make it one”, McKibben said.

For today, I have a report on the ESG potential that has yet to be realised in Japan’s stock market. As part of its effort to reach carbon neutrality by 2050, Japan’s government is providing green stimulus funds. Below, I dive into which companies are poised to benefit from these government subsidies. — Patrick Temple-West

Amid stock market boom, can Japan lure ESG investors?

Japan’s stock market has been on a tear this year. But for sustainability-focused investors there are still under-appreciated opportunities in Japan’s top companies.

In 2020, Japan said it aimed to be carbon neutral by 2050 — a big shift for the country, which relied on fossil fuels for 87 per cent of its energy in 2017 after the country closed nuclear reactors following the Fukushima disaster. Renewable energy (excluding nuclear power) comprised just 11 per cent of Japan’s energy, and Japan has continued to build coal power stations. Only this month, at the UN climate conference, did Prime Minister Fumio Kishida say Japan would stop building new coal power plants.

So, Japan has some catching up to do. As part of its shift away from fossil fuels, Japan’s Ministry of Economy, Trade and Industry (METI) proposed ¥2tn ($14bn) of subsidies for companies doing research and development into clean energy.

The government’s spending has not been allocated evenly. About a quarter of the government’s green funding has been allocated for hydrogen and another ¥500bn has been reserved for developing unconventional materials that could replace concrete or plastic. 

Carbon removal projects, ranging from technology-based sequestration to natural removal processes, will receive 3 per cent of the funds. Auto businesses will enjoy up to 11 per cent of the funds for green transportation.

Those government funds could prove lucrative for big Japanese companies making green investments, according to a December 11 report from Morgan Stanley. Up to 45 companies could take advantage of the government’s green funds. These include well-known Japanese companies such as Sumitomo Chemical — which is involved in green transportation, new materials to cut carbon and carbon removal — the bank said. Another example is Nippon Steel, which is involved in green industrial processes and carbon removal projects.

Japan’s big-name car companies are likely to receive funds for green transportation: Toyota, Honda, Nissan and Mazda.

Perhaps because of the country’s reliance on coal, environmental, social and governance (ESG) investors have overlooked Japan. Only two Japanese companies in Asia-Pacific ESG funds are included in the top holdings: Toyota and equipment maker Shimano, Morgan Stanley said. More than 20 other companies are under appreciated by top sustainability funds around the world, including Nippon Steel, Sumitomo Chemical and other auto companies, according to the bank.

“We believe mainstream ESG investors have not yet fully looked into this space,” Morgan Stanley said. “From a market perspective, global investors are still underweight in Japan,” adding that the bank expects foreign investors will close the gap and divert cash to their underweight Japanese holdings.

As Japan finally starts to distance itself from coal, sustainability investors should take notice of the country’s corporate leaders in green technologies. Japan’s 2023 stock market returns should further invite international investors to take another look at the country’s investment potential.

Warren Buffett in 2020 placed a $6bn bet on Japan’s general trading houses. And Berkshire Hathaway issued yen-denominated corporate bonds this year.

As we have seen in the US with the $369bn Inflation Reduction Act, federal funding to cut carbon emissions can help attract investment dollars and stimulate a green ecosystem. (Patrick Temple-West)

EU officials leave financial sector out of CSDDD deal

Seemingly inspired by the late-night COP28 talks earlier this week in Dubai, politicians and officials worked into the small hours in Brussels yesterday morning, to hammer out a deal on the key points of the EU’s contentious Corporate Sustainability Due Diligence Directive.

This awkwardly named law is aimed at forcing large companies based or operating in the EU to reduce their negative impacts on human rights and the environment, and to improve dramatically their disclosures on this front.

In the words of Lara Wolters, a Dutch European parliament member who was at the forefront of these negotiations, it’s aimed at making sure “honest businesses” aren’t fighting an unfair contest with “cowboy companies”. To many observers, however, this week’s late-night deal is only a partial success.

The agreement follows tough discussions between representatives of the European parliament and the European Council, which represents national governments of the 27 member states.

Several technical details of the directive still need to be agreed. The final text will then need to be approved formally by EU institutions, and then passed into law by national parliaments.

The provisional agreement states that EU-based companies with more than 500 employees and global revenue exceeding €150mn will need to “identify, assess, prevent, mitigate, bring to an end to and remedy” their negative social and environmental impacts, and also those of their “upstream and downstream partners”.

This requirement will also apply to smaller companies — with at least 250 staff and revenue over €40mn — if they have significant operations in potentially higher-risk sectors such as textiles and agriculture.

And the directive will require affected companies to create and adopt a plan for aligning their operations with the climate goals of the 2015 Paris agreement.

Significantly, these rules apply to companies anywhere in the world, if they generate the aforementioned levels of revenue within the EU — about 4,000 of them, on top of 13,000 companies in the EU, according to an estimate by S&P Global. This has drawn a wary reaction from foreign officials including US Treasury secretary Janet Yellen, who has said she is concerned about “the directive’s extraterritorial scope”.

Companies could be fined up to 5 per cent of their revenue if they fail to comply with the new rule, which will also make it easier for affected individuals and communities to sue them.

But according to critics of the deal, it has a crucial missing piece: the financial sector, which has been given a carve-out from due diligence requirements under the directive. This was a key bone of contention in these talks. Some members of the European Council, reportedly led by the French government, argued against forcing financial companies to vet every loan and investment for social and environmental impacts.

“The deal is an insult to people and communities suffering from the severe harms that EU financiers are contributing to globally,” said Uku Lilleväli, sustainable finance policy officer at WWF.

The European Council’s official announcement stressed, however, that the financial sector has only been “temporarily excluded” from the scope of this directive, which will include a “review clause for a possible future inclusion”.

With European parliament members and civil society bodies set to keep pushing for that change to happen, EU financial companies would be wise to start getting their houses in order. (Simon Mundy)

Smart read

Eighteen California children are suing the US Environmental Protection Agency, The Los Angeles Times reports. The lawsuit alleges that the EPA violated their constitutional rights by allowing pollution from burning fossil fuels to continue despite knowing the harm it poses to kids.