Post By: Ty Francis, Chief Advisory Officer, LRN
The Olympic Games always reflect the world as it exists at the time.
So can be said for changes in the regulatory landscape that represent a microcosm of world and economic events, sentiments, and risks and opportunities on the horizon.
As the world was turning as much of its attention to ethics, compliance, risk, inclusion, accessibility as to the sporting excellence displayed in Tokyo this past summer, the Tokyo Stock Exchange (TSE) and Financial Services Agency revised its Corporate Governance Code, creating higher standards for companies and aligned to meet global standards for corporate governance.
Japan’s Corporate Governance Code sets forth established principles for effective corporate governance. It is designed – when appropriately complied with and implemented – to contribute to the development and success of companies, investors and the Japanese economy as a whole.
In the Code, corporate governance is defined as the structure for transparent, fair, timely and decisive decision-making by companies, with due attention to the needs and perspectives of shareholders and also customers, employees and local communities.
This latest revision follows its introduction in 2015 and an update in 2018, and is connected to the Japan Revitalization Strategy, which outlined several initiatives to accelerate corporate governance systems and stewardship.
The Code established five fundamental principles for companies and provided a framework for achieving stronger performance over the long term and becoming more competitive globally.
- Securing the rights and equal treatment of shareholders, which includes developing an environment in which shareholders can exercise their rights appropriately and effectively.
- Appropriate cooperation with stakeholders other than shareholders, which includes the board and management establishing a corporate culture where the rights and positions of stakeholders are respected and sound business ethics are ensured;
- Ensuring appropriate information disclosure and transparency;
- Responsibilities of the board, which includes oversight of the corporate environment, internal controls and “defensive functions,” while also setting business principles and ensuring proper board training; and
- Dialogue with shareholders.
This latest revision is intended to deliver more such benefits to organizations, and it is timed to TSE’s restructuring of Japan’s market segments in April 2022, which includes the creation of a “prime” segment for the biggest and best-governed stocks.
Among the revisions in the Code:
- Enhancing Board Independence
- to align with global best practices for independent directors and ensure a fair distribution of power – including requiring prime market-listed companies have at least one-third of the board be independent and establishing new committees and practices on board nomination, remuneration and diversity of skills.
- Promoting Diversity
- to provide greater operational efficiencies and to align with global expectations, including new disclosure requirements on the appointments of women, non-Japanese and mid-career professionals; and transparency into human resources policies and their effectiveness.
- Attention to Sustainability and Environmental, Social and Governance (ESG)
- To create policy and disclosure initiatives on the company’s sustainability and enhance the quality and quantity of climate-related disclosure aligned with international frameworks.
The revisions reinforce previous guidance that includes the need to establish business principles as the foundation of corporate value creation and the availability and effectiveness of Codes of Conduct for employees to express their values and carry out sound and ethical business practices. This includes a focus on the substantive assessment of whether the company’s corporate culture truly embraces the intent and spirit of the code of conduct, and not solely on the form of implementation and compliance. It also includes an appropriate framework for whistleblowing and objective assessments of and responses to reported issues. The board should be responsible for both establishing the framework and ensuring and monitoring its enforcement, according to the Code.
The Code adopts a principles based approach to corporate governance and a ‘comply or explain’ method of enforcement, meaning a company must disclose its compliance or explain why it is not in compliance. Though voluntary, companies are now scrambling to comply with the Code revisions, as compliance is a requirement for organizations to be listed in TSE’s prime market segment.
The revisions in the Code are groundbreaking for Japan and have gone further than ever in establishing new requirements for operating effectively, sustainably and with the full landscape of stakeholders needs at the center. However, critics have said the revisions don’t go far enough to have real impact nor do they meet global standards of good governance.
Fears include the Code revisions forcing a “check the box” mentality that has plagued other organizations. Others worry requirements may mask deep and lasting change with such an intensive focus on quantity – how many board members or disclosures – versus the quality of operations and mindsets of management that ultimate direct and oversee decision making and strategies for value creation.
While some companies are working hard to achieve alignment with the revisions to the Code, others may choose to delist rather than meet more stringent and specific requirements. Regardless of individual company actions, Japan’s move is aligned with a growing recognition globally that corporate governance is key to sustainability and growth and must be rethought amid a global pandemic and seismic changes in business, society and geopolitically.
About the Author: Ty Francis MBE is the Chief Advisory Officer at LRN where he leads LRN’s worldwide ethics & compliance and board advisory consulting business. He helps companies reinvent and rewrite codes of conduct, deliver policy simplification, provide strategic E&C program evaluations, and conducts ethics and culture assessments.