Climate change has been recognised as a material issue affecting the sustainability of almost all companies. Japan’s Climate Change Adaptation Act and its Act on Promotion of Global Warming Countermeasures, read together, create regulatory expectations that all sectors of Japanese society must make efforts to control climate change through mitigation and adaptation.1
Climate change risks are increasingly being acknowledged by Japanese regulators. The Bank of Japan (BoJ), as Japan’s primary prudential regulator, has acknowledged that climate change poses a systemic risk to the Japanese financial system.2 The BoJ’s Strategy on Climate Change includes the launch of a fund-provisioning measure, which requires financial institutions to disclose information on their efforts to address climate change to receive support from the BoJ; encouraging financial institutions to enhance their Task Force on Climate-related Financial Disclosure (TCFD)-aligned disclosures and to promote investments in climate-related financial products.3 In 2022, the Bank of Japan announced active support for financial institutions in identifying and managing their climate-related financial risks, with a view to maintaining the stability of the financial system and the smooth functioning of financial intermediation.4 The Bank, in cooperation with the Financial Services Agency (FSA), has been carrying out pilot exercises of the scenario analysis based on common scenarios.5
Japan’s Ministry of the Environment Climate Change Policy Division has reported that climate-related risks can result from reassessment of the value of a large range of assets with a large volume of GHG emissions during the process of adjustment towards a lower-carbon economy, and has advised companies to engage in scenario analysis to assess the resilience of their business in the face of global warming.6
Directors’ Duties and Climate Change
Japan is a civil law jurisdiction, and the legal basis for the scope of directors’ and officers’ duties is set out in statute under the Companies Act of Japan and the Civil Code. Directors in Japan have three primary duties:
- a duty of loyalty,7 including a requirement to act in the company’s best interests, which a growing number of lawyers and regulators believe includes its long-term sustainability;
- a duty to comply with all laws, regulations, ordinances, resolutions of shareholders’ meeting and the company articles.8 For directors of large companies,9 it includes a requirement to develop systems related to management of the risk of loss to the company and any of its subsidiaries10 and to establish a proper internal control system to ensure that the execution of their duties complies with the relevant laws, regulations and articles of association.11 In such companies, a director’s duty of care will not be effectively performed without a proper internal control system;12 and
- a duty of care, to the standard of a prudent manager,13 which informs the duty of loyalty and the duty to comply with all applicable laws and regulations. If a director has met this standard, it may be a defence to personal liability for an alleged breach of the duty of care.14 Likewise, if there are no “significantly unreasonable aspects” involved in the decision (known as the ‘business judgment rule’), directors will not have breached their duty of care.15
Directors who neglect their duties are jointly and severally liable to the company for any resulting damages; and where directors are grossly negligent or knowingly fail to perform their duties, such directors are also liable to third parties or shareholders for the resulting damages.16
Directors could breach their duty to ensure the company is obeying laws and regulations by failing to consider the Climate Change Adaptation Act. This duty requires that businesses endeavour to adapt to climate change in accordance with the content of their business activities, and to cooperate with governments at all levels. It therefore follows that directors have a duty to endeavour to ensure their companies take robust action to adapt to climate change. In the future, any strengthening of statutes that would require companies to set targets towards decarbonization or that require companies to disclose governance, strategy, risk management, and metrics in line with an international framework would add those duties to other duties of directors.
A failure to monitor climate change risks and climate change-related regulations could give rise to a breach of the directors’ duty of care in their oversight and management of the company if a board were to fail to set up an appropriate risk management system.17 In order to comply with their duty of care in relation to the duty of oversight, directors need to ensure that such a risk management system is proper and sufficiently capable of fulfilling the responsibilities to monitor and manage the company’s business, given the likelihood and magnitude of climate risks to the company. Since the financial risks of climate change are so broadly acknowledged by governments, scientists, financial institutions, companies, investors, and civil society, it is no longer a defence for directors to say that they were unaware of the risks.
As well as potentially breaching their duty of care in respect of the duty of oversight of risks and compliance, directors could potentially breach their general duty to act with due care in the best interests of the company in failing to address climate-related risks and opportunities.18 Examples of breach of the duty of care could include failure to make relevant enquiries to management regarding physical and transition risks to the business due to climate change; or failure to seek outside expertise where the directors do not possess the knowledge or expertise to devise a strategy to address climate risk. Other examples might include failure to robustly assess the assumptions underlying revenue/cost projections for climate-related disruption, and failure to ensure assets and supply chains are resilient to foreseeable physical climate risks.
Additionally, regulators are now requiring the disclosure of climate-related risks (see below). The responsibility that corporate directors therefore have to ensure adequate disclosure, combined with the expectations contained in the Climate Change Adaptation Act and the Act on Promotion of Global Warming Countermeasures, put directors in the position of having to stand by the quality of the practices that these disclosures reveal, in effect creating a clear obligation to address climate-related risks and opportunities to an adequate standard. Heightened disclosure creates a de facto expectation of a higher standard of care.
The duty of care for publicly-listed companies is reinforced by the Japanese Corporate Governance Code. The Corporate Governance Code recommends that publicly-listed companies address ESG and other sustainability issues proactively to create value for all stakeholders over the mid- to long-term. It was revised in June 2021 to include a recommendation for Japanese companies to further promote positive and proactive responses to sustainability issues in light of the increasing number of organisations supporting the TCFD recommendations, and to require boards to develop a basic policy for the company’s sustainability initiatives to increase corporate value over the mid- to long-term.19 The Code, while non-binding, therefore offers strong normative guidance for directors to effectively manage material climate-related financial risks and opportunities. The impact of soft law such as the Corporate Governance Code has the potential to be instrumental in shifting climate governance, as the principles adopted by companies form part of their fundamental rules of operation. Companies listed on the Prime Market of the Tokyo Stock Exchange will be required, on a ‘comply or explain’ basis, to collect and analyze data on the impact of climate change-related risks and earning opportunities on their business activities and profits, and to enhance the quality and quantity of disclosure in accordance with the TCFD recommendations or an equivalent framework.20 The prime market includes 68 banks.21 In 2023, the Japan Exchange Group (JPX) reported survey results of 400 surveyed companies that make up 76% of the total market capitalization of all companies listed on Tokyo Stock Exchange.22 It found that of TCFD’s 11 recommended disclosures, more than 65% of companies are now disclosing governance, and risks and opportunities, and Scope 1 and Scope 2 emissions. 48% are now disclosing Scope 3 emissions, and only 47% are integrating climate into their overall risk management strategies or assessing the resilience of their strategies based on scenario analysis.
Directors’ Disclosure Obligations and Climate Change
The duty to disclose is contained in the Financial Instruments and Exchange Act (FIEA).23 The FIEA requires disclosure (on a continuous and periodic basis)24 of material business risks. These risks are often reported as ‘non-financial information’ in annual reports.
Effective 31 January 2023, amendments to the Cabinet Office Order on Disclosure of Corporate Affair now require companies to include a new section in the Securities Registration Statement and Annual Securities Report (collectively, disclosure statements) to report on sustainability-related initiative.25 Disclosure is to be aligned with the four pillars of the TCFD framework, specifically:
- Governance – governance processes, controls, and procedures to monitor and manage sustainability-related risks and opportunities.
- Risk management – processes for identifying, assessing, and managing sustainability-related risks and opportunities.
- Strategy – where material, disclose initiatives to address sustainability-related risks and opportunities that may affect management policies and strategies of the submitting company and its consolidated subsidiaries in the short, medium, and long term; and where a submitting company decides not to disclose after assessing them to be immaterial, the company should disclose the assessment process and reasons for determining immateriality.26
- Indicators and targets – where material, disclose information to assess, manage, and monitor performance with respect to sustainability-related risks and opportunities of the submitting company and its consolidated subsidiaries on a long-term basis; and where a submitting company decides not to disclose indicators and targets”, it should disclose the assessment process and reasons for the determination of immateriality.27 The Disclosure Principles imply that it is not mandatory but recommend that the submitting company actively disclose information on greenhouse effect gas emissions falling into Scope 1 (direct emissions by the company itself) and Scope 2 (indirect emissions from the use of electricity, heat and steam supplied by other companies).28
The Amendment applies to Disclosure Statements for fiscal years ending on or after 31 March 2023. While the Amendment doesn’t define the term sustainability, according to the attachment Document ofPrinciples Regarding the Disclosure of Narrative Information, the subtitle of that is “Concerning Disclosure of Sustainability Information” released together with the Amendment “Disclosure Principles“,29 sustainability information includes matters related to the environment, society, employees, respect for human rights, anticorruption, governance, cybersecurity, and data security.30
The amended Disclosure Guidelines confirm that a submitting company will not be held immediately liable for false statements on account of forward-looking information to the extent that specific, generally reasonable explanations are provided, for example, it was appropriately reviewed internally on a reasonable basis, and where a summary of the review is disclosed with the forward-looking information stating the facts, assumptions and reasoning process on which it was based.31 The Disclosure Guidelines also clarify that the management of a submitting company may be held liable if it fails to disclose material forward-looking information that could affect investors’ investment decisions where said management was aware of said information as of the filing date and withheld said information, and also where the management was not aware of the materiality of the information without reasonable grounds.32
These new requirements build on the FSA’s Cabinet Office Ordinance on Disclosure of Corporate Affairs, which expanded the FIEA requirement to include material ‘forward-looking’ risk. Insofar as climate change is now universally regarded as posing a material business risk, it follows that the FIEA requires disclosure of risks and forward-looking risks arising from climate change. This requirement is particularly compelling given the guidance and regulatory developments relating to climate-related disclosures discussed below. Finally, if directors detect any fact likely to cause substantial detriment to the stock company, they must immediately report such fact to the shareholders or to the company auditors.33
Directors have overall responsibility for ensuring that a company’s financial disclosures are accurate, and so may be primarily liable for misleading disclosures made to the market.34Both companies and directors may be subject to sanctions under financial services legislation for failure to comply with disclosure requirements. Unlike general directors’ duties, disclosure pursuant to financial services law is not subject to the business judgment rule; therefore, a court will not consider whether a decision to make or omit a disclosure was “significantly unreasonable” but will focus on whether the disclosure was required by law
Earlier regulatory and guidance developments was aimed at enhancing the disclosure of climate-related risks, including:
- In 2019, a TCFD Consortium was launched to encourage effective TCFD disclosures, supported by the Ministry of the Environment and the Ministry of Economy, Trade and Industry.35
- In March 2020, the Ministry of the Environment issued practical guidance on scenario analysis in line with TCFD recommendations.36The TCFD Consortium released ‘Guidance on Climate-related Financial Disclosures 3.0’ on 5 October 2022.37
- The Japan Exchange Group, Inc and Tokyo Stock Exchange Inc strongly endorsed ESG disclosure, including disclosure of climate-related risks, with the publication of a ‘Practical Handbook for ESG Disclosure’ in March 2020.38
- In 2021, the FSA indicated a movement towards mandating climate-related financial disclosures for companies listed on the Prime Market in its Strategy on Sustainable Finance.39
- On June 25, 2021, the Minister for Financial Services, Taro Aso, consulted the Financial System Council at the FSA with respect to making the disclosure system enhance constructive dialogue between investors and companies.40 The Financial System Council set up the FSA Disclosure Working Group, and the recent amendments are based on its findings that companies that submit securities reports should appropriately disclose their sustainability-related initiatives to make Japanese capital markets more attractive in the global context. Japan’s Ministry of Economy, Trade and Industry (METI) and the FSA announced that TCFD-aligned disclosures would become mandatory in the Prime Market of the Tokyo Stock Exchange effective April 2022. Companies listed on the Prime Market segment are to enhance the quality and quantity of disclosure based on the TCFD or an equivalent framework.41
- In its Strategy on Climate Change, the Bank of Japan announced that it will require financial institutions to make disclosures on results and targets on green loans and investments alongside the steps they are taking to meet the TCFD disclosure requirements.42
- The Ministry of the Environment announced in October 2021 that the Cabinet has approved the Climate Change Adaptation Plan, based on the Climate Change Adaptation Act, which describes measures to be taken for climate change adaptation, including science-based goals, target periods, strategy and the management and evaluation of the progress, including specific sector-based guidance.43
- The Japan TCFD Consortium has issued the Green Investment Guidance 2.0, with amendments that include transition finance, carbon neutrality, carbon pricing, and climate risk management for investors and other stakeholders.44
- In July 2022, the Expert Panel on Sustainable Finance of the FSA published its second report on the direction of policy measures for sustainable finance. The report emphasises that institutional investors must deepen their knowledge of the sustainability practices of their investee companies in order to increase the growth and sustainability of assets under management and expand the benefits for the ultimate beneficiaries over the long term.45
In December 2022, the FSA finalised the Code of Conduct for ESG Evaluation and Data Providers. This is a voluntary code of conduct which provides for ESG Evaluation and Data Providers to endorse it on a ‘comply or explain’ basis. The Code sets principles on matters such as quality of the service of ESG evaluation, managing independence and conflicts of interest, and ensuring transparency of methodologies and processes for the evaluation.46
- Finally, disclosing information beyond that which is required by law is encouraged by the Japanese Corporate Governance Code.47 In particular, the Corporate Governance Code requires companies listed on the Japanese Prime Market to disclose their initiatives on sustainability, to collect and analyse necessary data on climate-related risks, and to enhance the quality and quantity of their disclosures based on the TCFD recommendations.48
Practical Implications for Directors
Given that Japan’s government and regulators have become increasingly emphatic regarding the need for companies and their directors to adopt climate resilience measures in business practices and disclosure, well-counselled boards will:
- delegate climate risk identification and evaluation to a clearly-identified team in management that reports directly to the CEO and board;
- ensure that the board has effective oversight of management in terms of identifying, managing, and disclosing climate-related risks and opportunities;
- put on the agenda for the board, within 3 or 6 months, a process to start developing a climate transition roadmap to 2050 with transparent carbon neutrality or reduction targets, with clear interim targets to 2040, 2030, and within the current rolling multi-year strategic plan, and periodically thereafter report back to the board;
- delegate to the appropriate committee(s) of the board, such as risk, audit, legal and governance, scenarios/strategy, nominations/ remuneration, or sustainability/corporate responsibility, the task of translating the long-term strategy into a clear decision-making process for each aspect that is relevant to each committee; and
- discuss with disclosure counsel the most effective means of developing an external engagement and communications plan and how best to engage in effective oversight of rigorous disclosure and accounting.
- Dr. Masafumi Nakahigashi, Professor of Law, Nagoya University
- Dr. Yoshihiro Yamada, Professor of Law, Ritsumeikan University
- Dr. Janis Sarra, Professor of Law, University of British Columbia, Canada Climate Law Initiative