The relatively high exposure to Japanese companies in our portfolios, and the fact that ESG in Japan is still in the maturing phase in comparison to the Americas and Europe, were a good reason to discuss a wide range of ESG topics.
Checking ESG progress
We met with 16 companies, some of which are included in our fund portfolios or our investment universe. The discussion topics ranged from climate change, animal testing, and plastic packaging to sustainable procurement, labour rights, and corporate governance. These meetings allowed us to check Japanese companies’ progress in ESG, and define the areas where they are doing well, and the areas that need improvement. They also gave us the opportunity to identify best practices for other (Japanese) companies to follow. Three of the topics discussed are highlighted below.
Since the Japanese government introduced ’Net Zero Emission by 2050‘ in October 2020, many companies have adopted the targets set by the Taskforce on Climate-related Financial Disclosures (TCFD). While this is an important first step, we have been encouraging companies to set targets approved by the Science Based Target initiative (SBTi), as part of our climate change engagement program. Discussing this topic, we have learned that setting science-based targets can be challenging, especially for those who have difficulty monitoring and estimating CO₂ emissions in the first place. A notable example is Kyoritsu Maintenance.
The company acknowledges the difficulty of measuring the CO₂ emissions of their student housing business given that students have individual contracts with electricity and gas companies. Sekisui House, on the other hand, has been pioneering CO₂ emission reduction in Japan through its net Zero Energy Houses (ZEH). With advanced heat insulation and electricity generation systems, ZEH can reduce household energy consumption by no less than 60% to 80%. Beyond CO₂ emission reduction, Sekisui House has long been making afforestation efforts. Over the past 20 years, the company has planted more than 17 million trees. Such efforts have led tree species in urban residential areas to increase almost tenfold in Japan.
Several of the companies we engaged with are also working rigorously to reduce the lifecycle impact of plastic and waste in response to the new Act on Promotion of Resource Circulation for Plastic, which was approved in April 2022. Fancl, for example, targets a 30% plant-based or recycled plastic packaging of its products by 2030.
The company also takes such environmental initiatives to create social benefits. Subsidiary Fancl Smile employs people with disability to clean and dry plastic packaging collected at direct sales points. These plastics are turned into flowerpots, which are donated to Yokohama city, where the company is headquartered and where it has production facilities.
Palm oil, or plant oil as it is called in Japan, is an indispensable ingredient for food, feed and fuel or non-food products, such as soap, cosmetics. Given that palm oil production, and wood production in general, continue to be a major driver of deforestation, it is essential that we ensure these raw materials are procured sustainably.
One of the ways we verify sustainable procurement practices is by monitoring the percentage of certified raw materials. Company engagement has revealed that demand for FSC and PEFC-certified wood is increasing in Japan.
Lack of consumer awareness about palm oil is leading to low levels of sustainably sourced palm oil. Despite the low public awareness, Fancl and Lion are among the few companies that have either achieved or are very close to achieving 100% RSPO-certified palm oil. The latest reports show that Lion has achieved 93% certification for domestic palm and kernel oil derivatives, while Fancl has achieved 100% RSPO-certified palm oil through the book & claim method. We will continue to encourage companies to source palm oil from an identity-preserved supply chain because it offers complete traceability. Currently only 19% of palm oil produced globally is RSPO-certified, meaning the vast majority is at risk of being connected to deforestation, human rights abuses, and other environmental and land-use issues. Therefore, we are constantly engaging with companies to support local mills and smallholder farmers to produce palm oil according to the NDPE standards of no deforestation, no development on peat, and no exploitation of people and communities.
Over the past 30 years, a worldwide movement to end animal testing in cosmetic and non-cosmetic products has been gaining momentum. With the rise of ethical consumerism, businesses are becoming more conscious of the consumer preferences for cruelty-free products. Japan is one of the few remaining countries that allow animal testing even on cosmetic products. The lack of a clear legal framework on animal testing has resulted in Japanese companies having a blurred stance on this issue.
Although many Japanese companies subscribe to minimising animal testing, they maintain the possibility of conducting animal tests “if legally required.” The main issue emerges from the ambiguity associated with the definition of “legally required animal tests”, as the law in Japan does not specify when to conduct animal testing or refrain from it. Even the most comprehensive legal framework on animal testing “The Act on Welfare and Management of Animals” (1973) does not contain specific metrics to determine legally required animal tests. This legal ambiguity has disincentivised many companies from abolishing animal testing. Some companies still view animal testing as a simple and effective means to ensure safety and efficacy of products. Others may never conduct animal testing, but they maintain a leeway in their company policy in case of future legal amendments that may necessitate testing products on animals. A case in point is personal care company Lion, which stated to us that no animal testing has occurred in the last four years, but its policy leaves room for animal testing in case there are significant safety concerns about their products, or in case the authorities require them to do so.
Yet, there is hope for change. Lion has been actively developing alternative methods for testing safety of products for oral use (including toothpaste and gargle products). Traditionally, hamsters, rats, guinea pigs, dogs, and rabbits have been used for the so-called ’oral mucosal irritation testing’*. Lion is currently developing a testing method using a human 3D model of cultured oral mucosa, which achieved 87.5% accuracy in distinguishing between 32 “irritants” and “non-irritants”**. Although scientific verifications for many alternative methods are underway, we are hopeful that Japanese companies will follow the path of Lion. Generally, companies appreciate our feedback and will consider disclosing animal testing policies when updating their ESG disclosure. Some companies have also noted the possibility of abolishing animal testing when not required by law, provided that alternative testing methods are established. We will keep raising awareness of the availability of alternatives and will keep encouraging active replacement of animal tests.
Having spoken to companies that are viewed as having good ESG practices in Japan, we were able to not only assess which companies are leaders in this space, but also to gain knowledge on different topics, including regulations in Japan. By sharing our questions in advance, we were able to have a constructive dialogue with members of the Corporate Social Responsibility and Investor Relations teams and clarify our Minimum Standards and our way of thinking in terms of sustainability practices. Furthermore, these questions were also shared with their executive officers to be discussed during board meetings. Overall, companies highly valued the discussions on ESG-related topics and expressed a willingness to continue them on a regular basis. Engagement is something of the long haul and it usually takes some time before concrete results can be achieved. We will thus continue our engagement with the companies in our fund portfolios and investment universe on a yearly basis and monitor progress.
Special thanks to Mari Izumikawa and Yuri Izumikawa, who helped to overcome the cultural differences and language barriers.
*A simple method for oral mucosal irritation test by intraoral instillation in rats, The Journal of Texicological Sciences, Vol.41, No.2, 233-239, 2016, available at: https://www.jstage.jst.go.jp/article/jts/41/2/41_233/_pdf.
**Alternative Approaches to Animal Testing, Lion, available at: https://www.lion.co.jp/en/rd/basic/safety/case01.php.