Session Summaries

Introduction

“From savings to asset formation”- action and challenges

○　To promote stable asset formation instead of just saving money, the Financial Services Agency (FSA) has introduced tax incentives for households. In 2014 the “NISA” scheme was launched, and this is set to be followed by the “Dollar-Cost Averaging NISA” scheme in 2018. Having in mind that households to assume a certain degree of risk, in March 2017 the FSA formulated “Principles for Customer-Oriented Business Conduct”, which requires financial institutions to conduct customer-oriented business and thus play a role in realizing the shift from savings to asset formation.

○　The U.S. also faces the similar challenge of encouraging households to invest to meet their future needs. Giving investors choices, for example the introduction of defined contribution plan (i.e. 401(k) plan), has encouraged greater household participation in the markets.

○　It is important to get investors to understand the relationship between investment risk and return.  It also is critical to have the appropriate regulatory regime in place to ensure that markets are fair and transparent so that investors can make appropriate investment decisions.  This is an ongoing concern for all regulators including in the U.S.

○　Before NISA was introduced, a tax incentive system was designed from the standpoint of investors, offering tax advantages on profits earned from trading; however by the introduction of NISA, the system has been designed from the consumer perspective, with the aim of encouraging more people to accumulate assets.

○　There are two important challenges to be dealt with for promoting this shift from “investors” to “consumers.” The first is how to narrow the information gap between financial business workers and consumers. It can be addressed through financial education and the creation of systems for supporting it. In the U.K., for example, financial advisors, who provide advice to consumers from the customer standpoint, play a significant role in this regard. They could serve as useful reference for Japan. The other challenge is how to respond to the diverse consumers. As more consumers start investment, variation in terms of financial literacy will increase among the people in the market, so a flexible system design will be vital.

○　The GPIF has to conduct ultra-long-term investment planning as it is handling government pensions for 100 years. The GPIF believes that companies formulating their business strategies from a long-term perspective will lead to stable dividends, so we have adopted an ESG approach to invest.

○　What we emphasize in particular in the ESG investment is engagement by asset managers with the companies they invest in. We ask the asset managers to actively engage in dialog with the companies in matters of E (Environment), S (Social), and G (Governance).

○　Comparing data on corporate investment behavior reveals that recently capital expenditure has begun to rise and that money has been allocated to M&A as well. Similarly comparing data on household behavior finds that the younger generation is stepping up its investment in financial assets, despite decreasing real disposable income.

○　The key to translating this small change into a major trend of “from savings to asset formation” is to change the behavior of households. The first important task is to ensure that financial products and markets, which are the tools for asset formation, are fair and transparent. The second is to increase the level of financial literacy among the public. To enhance financial literacy, bolder measures than have been adopted in the past will be essential.

The key to achieve the shift “from savings to asset formation”

Focus in ESG investment

○　What we pay most attention to in terms of ESG investment is whether such investment approach will be able to produce sustainable profits. We conduct investigations and provide explanations concerning this in our annual disclosures.

○　We are discussing ESG with pension investors around the world, and they are of view that companies emphasizing ESG have low downside risk.

Promoting the shift “from savings to asset formation”

○　Two-thirds of personal financial assets are held by elderly people, i.e. the generation decumulating their assets. The challenge for them is that their life planning is substantially changing rather than how to invest their money.

○　As the aging population develops, the time period during which they decumulate their wealth in is becoming longer than expected, so I feel that the system needs to incorporate measures to enable assets to be cashed in efficiently.

○　If we recommend that households adopt more balanced portfolios, I want financial institutions to play a role in achieving that. In addition to the prerequisite in which the compliance must be ensured and legal violations must be prevented, I even hope that financial institutions will conduct business in such a way as to pursue best practices.

Recommendations for Japan’s future investment market

○　Legal enforcement is crucial for creating a market that is trusted by investors. There needs to be a belief that improper conduct in the market will be detected and addressed.

○　It is important for regulators to invest in IT to enable the analysis of vast quantities of transaction.  In order to be effective regulators of fast moving and IT-intensive markets and participants, regulators need to have the right people and tools to keep pace with market innovations. A market that investors do not trust, is unlikely to funds the needs of the real economy or of investors no matter how much diverse financial products are offered or what tax incentives are provided.

Desired role of the SESC in promoting the shift “from savings to asset formation”

○　As the venues for asset formation, capital markets need to be fair and transparent. The SESC views “a market trusted by everyone” as the market to be aimed at.

○　The SESC regards constructive dialog with relevant parties as a key tool for achieving that. I believe that through the dialog, it will be possible to identify root causes and structural issues and to address issues before becoming actual problems.

Following the above discussion, Commissioner Indo described the initiatives being carried out by each SESC department.

Conclusion

Finally, the moderator summed up the discussion by stating the following three important points to promote the shift “from savings to asset formation:”

・　It is important to provide financial education, including education on risk;

・　Diversified investment not only in terms of asset type but also in terms of timeframes and currencies is important; and

・　Investors, asset managers, and sellers should establish systems for commissions and compensation with facing in the same direction.

Introduction

Group governance and M&A at global companies

○　For the purpose of better group management, if internal structures and rules are standardized throughout the corporate group as much as possible,  internal audits become easier to perform and it also becomes easier to view the group as a whole. In this sense, a positive spiral of group governance can be established. It is also important for senior management at head office and at the frontline departments to communicate closely with each other.

○　As a means of evaluating ourselves, our company is increasingly seeking to improve the ratings and to win awards given by external organizations. The goal of these challenges are not necessarily to win good ratings or awards, but rather identify and address points that cannot be answered through the challenges, or in other words, points that have not been addressed. Doing this can contribute to the development of the company.

○　Recent incidences of wrongdoing at overseas subsidiaries seem to indicate that parent companies’ governance functions are ineffective, and that wrongdoing seems to happen in the shadows which parent companies did not govern well. Companies acquired through M&A and subsidiaries of regional headquarters are examples of entities operating in the shadows. Given this situation, although it is difficult for auditors to audit global companies with a very high level of quality, the key is to ensure that Japanese auditors can effectively govern local auditors. It is especially important to maintain a mindset of communicating with local auditors with appropriate frequency.

○　In addition to bolstering corporate group governance, it is also necessary to enhance group governance of local auditors by Japanese auditors. Both approaches are vital for making financial information more reliable.

○　Compared with the U.S., labor productivity in Japan is fairly low, which points to the inefficiency of Japan’s management model. This gap has emerged over 30 years as U.S. legislation such as ERISA has made managers fearful and forced them to improve investment performance.

○　There are also big gaps between the U.S. and Japan in terms of stock market capitalization and sales per share. These gaps have meant that a cycle of portfolio management that employs a management strategy of “getting rid of ‘pets’ with low market share and little growth potential in favor of pouring money into startups, growing these startups into cash cows, and using the money generated from them to make new investments in startups” has not emerged in Japan. I think the opinions of shareholders can be effective for changing this situation.

Enhancing international competitiveness, group governance, and the perception of Japanese companies among overseas investors

○　There are huge differences between CG in the U.K. and in Japan. In Japan, differences in CG arise depending on factors such as corporate culture, the personality of the CEO, and shareholder composition. Regarding resource allocation and decision-making, in the U.K. (1) shareholder orientation is high (in Japan it is low), (2) more than half of board members are independent directors (in Japan only two or three are), (3) the chairman maintains independence (in Japan the chairman is often the former president), and (4) the CEO’s successor is selected by a nominating committee (in Japan the current CEO designates a male successor). So there are differences between the U.K. and Japan.

○　Although independent directors in Japan are becoming more diverse, there are only 320 foreign directors out of a total of 40,000. This is a relatively low figure compared with the U.K., France, Germany and the U.S. In these countries the CEO and other directors expect foreign outside directors to point out different things from the other directors during the decision-making process.

○　Overseas investors expect the boards of Japanese companies to not only include foreign directors, but also to be a reflection of global business. For example, they need to understand markets, domestic and overseas regulations, and local companies. They also place importance on a basic system of CG being in place, sound financial reporting, an internal culture of accountability, consistency and self-discipline in management. As an ideal for governance, it is important that management look at it not only from the perspective of compliance, but also as a tool for bringing change to the company on a continuous basis.

○　Regarding M&A governance, despite advances in the technical aspects of M&A, the success rate is still around 30% which is the same level it was 20 years ago. This is because boards are not engaging in adequate discussion before deciding to proceed with M&A deals.

Free discussion

Japan’s CG Code

○　During the past few years the regulatory framework for CG at Japanese companies has changed substantially. Although I think the hard aspects such as the regulations are not much different from those in the U.K. and are in good shape, there are problems with the soft aspects such as the side of achieving the required corporate culture and CG.

○　Sufficient time can be given to reforming CG policy. A concern is, with each company in the midst of transformation, whether the next revisions of CG Code should actually happen? CG is a problem that needs to be digested at the level of top management, so it needs time. Isn’t there the concern of a misunderstanding arising whereby people incorrectly assume that by revising CG, the revised points are the only points that require attention?

Japanese companies’ “cross shareholdings”

○　Even though CG has been introduced, the situation regarding cross shareholdings of Japanese companies has not really changed. In the next CG a philosophical framework could be included.

○　There should be tough rules that force companies to explain to investors why they are holding these shares. Depending on the reason, there are also cases that are not problematic, such as cases where principal investors become shareholders jointly.

Who should monitor governance at listed companies

○　With monitoring of companies by their main banks getting weaker, the stakeholders that surround companies comprise consumers, customers, employees, suppliers, local communities, and shareholders/investors. If the feedback obtained from communication with these stakeholders is humbly accepted by companies, it can be an effective way of monitoring CG.

○　Even among activist investors, investors have recently emerged who make ESG their theme or think about what sorts of things should constitute management objectives for companies. So equity holders also have a role to play as monitors of governance.

○　Ultimately, it is the directors who should make the decisions, but if there has been a problem, there should be communication between investors who are actively investing funds and members of the board of directors.

○　Even though investors are mentioned as playing a role in governance, in Asia it is extremely rare for investors to talk to corporate boards.

Governance for enhancing corporate value after M&A

○　It is important for statutory auditors, the internal audit function, and external auditors to each carry out checks from their own standpoints.

○　It is important to strengthen internal audit departments.

○　It is important for there to be a vibrant and globally minded accounting profession in Japan. This means continuing to recruit and train high quality accountants with good communications ability. The status of the profession also needs to rise. At companies I have observed, the status of internal audit also needs to be raised. As firms expand internationally, both quantity and quality of internal audit teams need to be strengthened. There are still too few people with English speaking ability in this area.

○　The board of directors should control the M&A process. Independent directors should look at how specific M&A deals will add value to the company. Furthermore, independent directors do not just need to check that M&A add value. They have to understand how each acquisition or merger fits in with the company's overall strategy. In order to do this, it is even more important that companies have regular comprehensive discussions of big picture, long term strategy at the board.

How many years will it take for the concept of shareholder accountability to take root in Japan?

○　There are no doubt differences among companies, but I think it takes about five years to go from recognizing the importance of accountability to actually propagating it within the company.

○　About ten years.

○　Accountability for CG is already taking shape.

○　It will take decades to get it up to the levels in the U.K. and U.S.

○　It will not be achieved in my lifetime to get it up to the levels in the U.K. and U.S. It is not necessarily meant to be a pessimistic statement. Japan needs to decide what kind of governance framework it wants to end up with. Not necessarily to aim for the US and/or UK model.

 Expectations for the SESC

○　I would like the SESC to push companies to adopt a more proactive approach to disclosure that goes beyond legal requirements.

○　It is important to “identify root causes” and “expand the release of information.” There can be a myriad of root causes, but if any of them relate to group governance, you should perform an in-depth analysis of them, and further broaden information channels to give market participants a deep level of understanding.

○　To focus on transparency and accountability. Both when the SESC has taken action as a regulator and when it has not, the SESC should provide an explanation. It should be able to tell markets why it did not take action even though it had suspicions.

Conclusion

The following was recognized through this session.
Out of the U.S., Europe, and Japan, it was the U.S. that recovered fastest from the 2008 financial crisis. It is said that the difference was that compared with other countries, capital markets in the U.S. were far larger than anywhere else, and that is why they were able to bounce back quickly.
From now on the hope is that in Japan, too, capital markets develop and become stronger, that the investment chain functions properly, and that national wealth is created for Japan. During that process, the job of the SESC is set to become even more important.

Introduction

In this session the panelists, who had been taking on the challenge of tackling new risks in this new era, gave presentations and then took part in a discussion.
The outline of opinions expressed during the session was as follows.

Current initiatives

○　Business platforms based on blockchain technology (permission-type) are offered, and the scheme could have more effective governance by involving a third party into the network. The authorities will be able to use this network effectively by getting involved properly, which should be a form of RegTech needed.

○　For market surveillance, a correct understanding of actual conditions in the market is a prerequisite. In addition, if incidents such as unfair transactions occur, they should be quickly discovered, remedied, and penalized/prosecuted. For that reason, it will be important to analyze current market conditions with a forward-looking approach that anticipates developments five or ten years ahead.

○　Although technology development is recognized as a positive thing on the whole, it also brings risks and challenges with it, and the following points in particular will need to be kept in mind: (1) divergence of laws and actual conditions, (2) larger volume and more complex data requiring surveillance, (3) effective use of technology (e.g. analysis of big data).

○　Technological development will provide both opportunities and challenges. The LEI (Legal Entity Identifier) system that was adopted internationally in the wake of the last global financial crisis would have been unimaginable in an era in which technology was not advanced. On the other hand, there are challenges such as how regulators should utilize the information obtained, and how the appropriateness and accountability of robo-advisors should be regarded. Regulators need to look at both the bright and dark sides of the development. As FinTech advances, regulators have been taking actions to promote the innovation and simultaneously to protect users and ensure fairness.

○　Advances in technology such as blockchain and cloud computing are already affecting the current surveillance activities in some areas. In order to properly respond to such technology development, an ecosystem for RegTech needs to be established.

○　RegTech, the theme of this session, the following three elements can be raised as the component: (1) automation of regulatory reporting, (2) adoption of digital IDs for KYC (Know Your Customer), and (3) real-time analysis of market trends (e.g. use of algorithms). With regard to (1) in particular, financial institutions currently incur huge costs in complying with regulations, and it seems that the success of RegTech will hinge on the extent to which it allows such costs to be reduced.

Solutions to challenges

Responding to open innovation

○　When various technologies are being used (AI, blockchain, etc.), it is important to adopt an issue-driven approach, not a technology-driven one. In the case of blockchain, for example, it will be important to make an approach with the idea that improvements can be made by sharing data.

○　Budgets should be requested with having short-, medium-, and long-term visions for a system gathering digitized data and analyzing and examining it in real time.

Actions toward surveillance responding to technology development

○　Recently we got a prospect of practical application of AI to surveillance for detecting market manipulation and are developing market surveillance system utilizing AI. We have researched a variety of technologies until now. Some of them did not go so well, but it is important to keep taking on challenges.

○　Unfair transactions involving the use of multiple names (e.g. borrowed names) are currently aggregated by carefully examining each transaction to infer that they were all made by the same party. There is a potential to employ technology here.

Regulation of new financial products and transaction formats as well as development of human resources required for that

○　Since regulatory authorities around the world have engaged in discussions through a trial-and-error approach, they have a shared view to some extent on how each case should be handled. However, the current trend may completely overturn that. Taking ICOs as an example, with the stances of each country differing considerably, what should be done about that? I believe that this is a point that needs to be addressed through deeper international discussions.

○　Regarding the human resource development, it will be necessary to develop experts needed or to hire them from outside after considering and defining what is going to be needed five or ten years from now. Nevertheless this will not be achieved by regulators on their own, so both the public and private sectors will need to work hard together within the ecosystem.

Expectations for the SESC

○　Blockchain is a revolutionary technology that is capable of building such trust in the Internet as it cannot be tampered with. I would therefore like the SESC to make effective use of that technology in order to build up the trust further.

○　As the actions and behaviors of the SESC may directly determine the quality of regulation in some ways, I would like the SESC to engage in surveillance activities that appropriately reflect conditions and changes in the markets.

○　Policy determination should become more empirically-based through, for example, the use of regulatory sandboxes. If the SESC wants to advance innovation, they will need to foster a relationship of trust with the SESC and the market participants that provides supports in the case of failure.

The above comments were responded as follows:

○　With international cooperation becoming increasingly important, the SESC would like to take solid actions including enhancement of international cooperation while tapping the capabilities and knowledge of the private sector.

Conclusion