Japanese Law Update #5: The Corporate Governance Code of Japan 2021 Emphasizes the Importance of Diversity and the Commitment to ESG
The year 2021 has witnessed a significant change in the landscape of corporate governance in Japan. In March, the reform of the Companies Act of Japan came into force, making it a requirement for listed companies to appoint at least one outside director to their boards. In June, following this reform, the Corporate Governance Code of Japan (“CGC”) was revised and came into force (“CGC2021”). The CGC is a soft law instrument introduced by the Tokyo Stock Exchange (“TSE”). TSE listed companies are required to comply with the CGC, or to explain the reasons for failing to do so.
The revision of the CGC is part of the preparation for the reorganization of the TSE that is scheduled to take place in the next year, which will reorganize its market segments. The TSE currently consists of five segments: First Section, Second Section, Mothers, JASDAQ Standard, and JASDAQ Growth. After April 2022, the number of segments will be reduced to three: Prime Market, Standard Market, and Growth Market. Large international companies, which are currently listed in the First Section, expect themselves to be listed in the Prime Market next year. However, companies which aim to be listed in the Prime Market are required to meet the higher standard of corporate governance under the CGC2021.
In July 2021, TSE notified its listed companies of the provisional results of the evaluation of which companies met the requirements to be listed in either the Prime Market, the Standard Market, or the Growth Market. According to media reports, around 30% of the current First Section listed companies have not met the requirements to be listed in the Prime Market.
Diversity and ESG are the major focus of the CGC2021. This revision drew attention from the market, and more than 100 public comments were submitted to the TSE. Global proxy advisory services including Glass Lewis and ISS have shown their appreciation of the revision in their public comments. The main changes in CGC2021 are as follows;
1. Improving Diversity
The CGC2021 emphasizes that TSE listed companies should improve diversity in the workplace. A newly drafted section in the CGC2021 states that TSE listed companies are required to set measurable goals for ensuring diversity. For example, Supplementary Principle 2.4.1 of the CGC2021 states that the companies should promote women, foreign nationals, and midcareer hires to management positions. While some public comments, including comments by Glass Lewis, proposed the implementation of quotas for female directors, that TSE did not go that far in this round of revisions.
2. Commitment to Sustainability
The CGC2021 requires corporate boards to deal with sustainability issues. Supplementary Principle 2.3.1 of the CGC2021 defines sustainability as issues including “climate change and other global environmental issues, respect for human rights, fair and appropriate treatment in the workforce, including employee health and the work environment, fair and reasonable transactions with suppliers, and crisis management for natural disasters,” and states that these are all important management issues that can lead to profit opportunities as well as risk mitigation.
Further, companies to be listed in the Prime Market are required to meet a higher standard of disclosure. Supplemental Principle 3.1.3 of the CGC2021 states that those companies should enhance the quality and quantity of their disclosure in relation to sustainability based on the recommendation of the TCFD (Task Force on Climate-related Financial Disclosures) or its equivalent.
3. Enhancing the function of the Board of Directors
The CGC2021 elevates the requirements regarding board members, especially for companies to be listed in the Prime Market. For example, these companies are required to appoint outside independent directors to make up at least one-third of their boards. In addition, these companies shall establish a nomination committee and a remuneration committee under the board, and consult with these committees for their perspectives on gender, diversity, and other related issues when making decisions on the nomination and remuneration of its directors.
According to media reports, potential nominees for independent outside directors are relatively few and far between. Therefore, companies aiming to be listed in the Prime Market next year are going to face a tough competition over a limited number of eligible nominees for their directors.
Yoshie Midorikawa, Partner
Yoshie Midorikawa has extensive experience in complex disputes and arbitration under the rules of the ICC, SIAC, UNCITRAL, LCIA, and ICSID. Having worked with leading law firms in Japan and Singapore, she has handled parallel proceedings across multiple jurisdictions as well as domestic disputes before Japanese courts. Through learning in the United States, practicing in Singapore, and serving on an international law firm’s arbitration team, among other accomplishments, she has developed expertise operating in diverse international environments. She has also served as a board member of listed companies in Japan, improving their corporate governance. Her deep understanding of the civil law system, her working experience in international environments, including common law jurisdictions, and her knowledge of business, enable her to bring practical and nuanced legal solutions to international commercial disputes. She is listed among “Best Lawyers in Japan 2022(Litigation)”, “Best Lawyers in Japan 2021(Litigation)” by Best Lawyers.