JAPAN: An Introduction to Banking & Finance: Domestic

Updates to the Regulations Concerning Sustainable Finance to be Imposed on Banks

Publication of “The Expert Panel on Sustainable Finance, FSA: The Third Report”

In June 2023, the expert panel on sustainable finance of Japan’s Financial Services Agency (FSA) published its third report on enhancing sustainable finance (the “Third Report”). This report identified three pillars for enhancing sustainable finance in Japan – the enhancement of:

• corporate disclosure;

• capital market functions; and

• the role of financial institutions. 

With regard to both corporate disclosure and to the role of financial institutions, new regulations imposed on banks are also referred to in the report.

Regulations concerning corporate disclosure

In January 2023, the FSA amended the Cabinet Office Order on Disclosure of Corporate Affairs (Ministry of Finance Order No 5 of 1973) and added a new section requiring companies to disclose their “views and initiatives on sustainability” as part of their annual securities report. The amendment applies to companies for accounting periods ending after 31 March 2023. Specifically, it is now mandatory for companies to provide information on “governance” and “risk management”, as well as key parts of “strategies” and “metrics and targets”.

In addition, the Tokyo Stock Exchange’s (TSE) Corporate Governance Code provides as a supplementary principle that “each company listed on the TSE Prime Market should collect and analyse necessary data on impacts of climate change-related risk and revenue opportunity on the company’s business activities and revenue, and then enhance the quality and volume of its disclosures based on the Taskforce on Climate-Related Financial Disclosures (TCFD) as an internationally established disclosure framework or any other framework equivalent thereto.”

In June 2023, the International Sustainability Standards Board (ISSB), established by the IFRS Foundation, issued its “General Requirements for Disclosure” (S1 Standard) and “Climate-Related Disclosures” (S2 Standard). In Japan, the Sustainability Standards Board of Japan (SSBJ) is working towards finalising the Japanese S1 Standard and S2 Standard by the end of March 2025. The Third Report suggests that the Japanese standards being developed by the SSBJ should be reflected in the statutory disclosure items.

Banks that are located in Japan and that need to file annual securities reports are required to make disclosures in accordance with the Cabinet Office Order, as stated above. Moreover, banks listed on the TSE Prime Market are also required to make certain disclosures in accordance with the TCFD.

Regulations on development of an internal control framework

In July 2022, the FSA published its “Supervisory Guidance on Climate-related Risk Management and Client Engagement” (the “Guidance”). As a discussion paper, the Guidance is not meant to impose new obligations on banks to address each issue stated therein, but rather is intended to show the FSA’s views on inspecting and supervising banks based on the existing regulatory system.

In the Guidance, the FSA expresses its perspectives on the internal control framework expected to be developed by financial institutions, including banks, for deciding their strategies, as well as its views on recognising, evaluating and addressing or handling risks and opportunities with respect to climate change. The FSA also discusses specific cases of financial institutions’ engagement with client companies in supporting their response to climate-related risks, and what should be noted.

With regard to risk management at financial institutions, the FSA and the Bank of Japan had conducted a pilot scenario analysis of three major banks and three major non-life insurance groups by using common scenarios published by The Network for Greening the Financial System, and released the results in August 2022 (https://www.fsa.go.jp/en/news/2022/20220826/03.pdf). The FSA considers that a scenario analysis is a technique that is deemed to be effective in quantitative assessment of climate change-related opportunity and risk.

As for the engagement with client companies in supporting their response to climate-related risks, in June 2023 the FSA published its “Report by the Working Group on Financial Institutions’ Efforts towards Decarbonisation of the Economy”. Among others, the report points out that enhancing financial institutions’ engagement with client companies is key to decarbonisation, and discusses a variety of matters to be considered by financial institutions for achieving this goal.

Sustainable Finance in Japan  

Guidelines on sustainable finance loans

Sustainable finance loans are categorised into green loans and sustainability-linked loans. There is also another category of loans referred to as “transition finance” for the purpose of supporting companies working on greenhouse gas reduction in line with a long-term strategy for decarbonised society. Loans of these types that are to be executed in Japan are governed by the Green Loan and Sustainability-Linked Loan Guidelines of the Ministry of the Environment of Japan (MOE) as well as by international self-regulatory guidelines (https://www.env.go.jp/content/000128193.pdf).

While the MOE guidelines have no legal binding force nor punitive clause, following these guidelines is a condition for the loans to be deemed of market acceptance. These MOE guidelines were drawn up in 2017 and were subsequently revised in July 2022 by taking into account international principles, including the Green Bond Principles and the Sustainability-Linked Loan Principles (SLLP), which are international self-regulatory guidelines.

Green loans overview 

The characteristics of green loans are as follows:

• the proceeds are allocated exclusively to green projects;

• the proceeds are tracked and managed in a reliable manner; and

• transparency is secured through post-financing reporting on these matters.

What are green projects? 

The Green Loan Guideline provides that the “proceeds of green loans should be used for eligible green projects that have clear environmental benefits. The borrowers should assess such environmental benefits and are recommended to quantify the benefits where feasible”. Green projects may have associated negative environmental and/or social impacts, in addition to their intended environmental benefits. The “eligible green projects that have clear environmental benefits” are projects for which the borrower considers that such negative impacts are not excessive in comparison to the environmental benefits. The Green Loan Guideline provides criteria by which to judge whether such negative impacts are excessive or not.

Green loans executed in Japan 

The first green loan in Japan was executed in 2017. In total, the issued loans amounted to approximately JPY776.4 billion in 2022 and JPY837.8 billion in 2023 (as of 6 November 2023). The major green loans that have been executed in Japan are available on the MOE’s website（Issuance List (domestic) | Issuance Data | Loans | Green Finance Portal (env.go.jp), which sets out the loan recipient’s name, the use of proceeds and loan amount, etc. The main uses of proceeds for these loans are for the construction of power generation facilities using renewable energy, such as solar power stations and wind power stations, and for the acquisition of green buildings.

Sustainability-linked loans overview 

The characteristics of sustainability-linked loans are as follows.

• The borrower takes action towards ambitious sustainability performance targets (SPTs), and the degree of improvement towards sustainability is linked to the terms of financing. While in many cases the applicable interest rate (ie, spread) is lowered depending on the achieved SPTs, there are some cases in which, if no SPTs are achieved, the applicable interest rate (spread) is raised.

• Unlike green loans, the use of proceeds of sustainability-linked loans is not limited to specific projects.

• Transparency is secured through post-financing reporting on these matters. 

Sustainability-linked loans core components

The Sustainability-Linked Loan Guideline sets forth approaches to be satisfied or that are desirable for the following core components:

• selection of KPIs;

• calibration of SPTs;

• loan characteristics;

• reporting; and

• verification.

The provisions for calibration and verification of key performance indicators (KPIs) and SPTs were amended to be stricter when the Sustainability-Linked Loan Guideline was revised in 2022. 

Sustainability-linked loans in Japan 

The first sustainability-linked loan in Japan was executed in 2019. The total issued loans amounted to approximately JPY657.3 billion in 2022 and JPY467.1 billion in 2023 (as of 6 November 2023). The main sustainability-linked loans that were executed in Japan are listed on the MOE’s website（Sustainability Linked Loan Issuance List (Domestic) | Issuance Data | Loans | Green Finance Portal (env.go.jp) where names of the loan’s recipient, main financial institution and independent evaluator, and loan amount, etc can be confirmed.