Explanation] What is sustainable finance?
~Explanation from the Fourth Report of the Expert Group on Sustainable Finance of the Financial Services Agency~.

Oct 3,2024

As companies are called upon to work towards the realisation of a sustainable society, the concept and approach of 'sustainable finance', which aims to solve various social problems by investing in and financing companies, is gaining ground. How are governments moving towards a new financial system, and how are companies expected to respond?

This report introduces the latest developments in sustainable finance from the Fourth Report of the Expert Group on Sustainable Finance, published by the Financial Services Agency in July 2024.

Table of Contents
What is sustainable finance?
Explanation of the main points of the fourth report.
　Development of market institutions
　Importance of increasing stakeholders' interest in sustainable finance.
　Promoting transition finance
　Initiatives related to decarbonisation and diversifying sustainability issues.
Major changes since the Third Report.
Response required of companies.

What is sustainable finance?

What exactly does sustainable finance mean in the first place? The FSA explains that it is 'finance for a sustainable society'. *1

The ISO Technical Committee on Sustainable Finance (ISO/TC 322) also defines sustainable finance as 'the integration of sustainability considerations, including environmental, social and governance practices, into the financing and procurement of economic activities'. *2

In other words, approaches to solving environmental and social problems using financial methods are collectively referred to as sustainable finance; ESG investment and sustainable loans are specific examples of sustainable finance initiatives.

Figure 1: Bureau of Policy Planning, Tokyo Metropolitan Government, 'What is Sustainable Finance (above)'Adapted from *3

As the transition to a sustainable society has become more important in recent years, the presence of sustainable finance has increased rapidly. For example, the share of sustainable investment in total investment by domestic institutional investors has increased by more than 40% over the past few years (Figure 2), and the use of sustainable finance is becoming essential to secure funds for corporate growth and to grow the Japanese economy.

Figure 2: Salary and Mutual Aid Division, Principal Accounts Department, Ministry of Finance, 'ESG investment'.Adapted from *4

The Sustainable Finance Expert Group has been convening at the Financial Services Agency since December 2020 in order to attract sustainable investment funds, which are estimated to total approximately USD 30 trillion worldwide*5, to Japan and to promote the growth of Japanese companies and the economy by expanding sustainable finance.

To find out more about sustainable finance, click here.

[Commentary] Sustainable Finance - Sustainable Response in the Financial Industry.

Explanation of the main points of the fourth report.

The fourth report, the latest report of the Expert Group on Sustainable Finance, was published on 9 July 2024. The original report can be found at the following link.

FSA:Fourth Report of the Expert Group on Sustainable Finance.

This section explains particularly important aspects of the sustainable finance initiatives and issues covered in the fourth report in four areas: development of market institutions, promotion to stakeholders, development of a sector-specific investment environment and initiatives related to decarbonisation.

Figure 3: Fourth Report of the Expert Group on Sustainable FinanceAdapted from *6

(1) Market system development.

In order to expand the scale of sustainable finance, it is necessary to develop an environment in which investors and others can obtain accurate data to compare and judge each investment product. In the fourth report, the three key issues are that companies should voluntarily disclose sustainability information, that a data base should be developed to consolidate and provide sustainability information on companies, etc., and that ESG assessment bodies should function appropriately.

There have been moves to enhance corporate disclosure, for example, the Sustainability Standards Board (SSBJ) released draft corporate disclosure standards in March 2024. In addition, the Financial Services Agency (FSA) provides systems such as EDINET that allow the public to view the disclosure content of securities reports on computers. *7 *8

On the other hand, the report points out that non-financial information used to assess a company's sustainability efforts is often non-quantitative and difficult to standardise and improve in quality. Although initiatives such as establishing a code of conduct for ESG assessment bodies are already in place, the report states that it is important to consider further concrete measures to ensure the practicality and reliability of sustainability information. *9

(⑵ Importance of increasing interest in sustainable finance among stakeholders.

If investors become interested in and knowledgeable about sustainable finance and actively invest in sustainable investments, companies and the economy as a whole will grow in the long term and in a stable manner. Therefore, the policy was that a wide range of investment opportunities should be expanded to attract investors.

For institutional investors, such as asset owners, the organisation encourages them to manage and invest in assets in a sustainable manner by, for example, announcing the Asset Owner Principles (draft). *10 For individual investors, the Government has also created a system to make it easier for individuals to invest in sustainability by, for example, announcing supervisory guidelines for ESG investment trusts. *11

However, it is pointed out in the fourth periodic report that "while progress has been made in sustainable finance initiatives and measures, there are aspects of the basic significance of sustainable finance that have not necessarily been widely understood". In particular, it is difficult for individual investors to grasp the significance and effects of sustainable investment, and it is difficult for them to feel that they are helping to solve social issues. In order to increase investors' interest in sustainable finance, it is important to provide investment opportunities and information that enable them to concretely realise the basic significance and effects of sustainable investment. Specifically, the report points out that products that have a clear use of funds and make it easy to imagine and realise the investment effects, such as bonds that invest in projects that contribute to environmental improvements in the region, are likely to attract interest.

The lack of sustainability personnel has also presented a challenge in that the supra-regional and overarching knowledge of sustainable investment has not been sufficiently disseminated to all levels of management and other stakeholders. In order to develop sustainability personnel, we are considering widely communicating the needs of sustainability personnel and specific images of career building, and increasing the number of personnel who are interested in sustainable finance through open discussions with a variety of personnel and stakeholders.

(iii) Promoting transition finance.

Of the four investments listed in the 'Investment climate development by sector' section of Figure 3, this section provides an overview of the efforts to date and future prospects for 'transition finance', which was a particular focus within the fourth report.

Transition finance refers to "a new financing approach that aims to support companies that are making steady GHG reduction efforts in accordance with a long-term strategy to achieve a decarbonised society". *12 GX is also an abbreviation for 'green transformation', which refers to a shift in the economic and industrial structure towards a clean energy-centred society by reducing the use of fossil energy. For example, if a company takes steps towards GX, it is eligible for transition finance, which enables it to raise funds smoothly.

To find out more about GX, click here.

[Commentary] Overview of Japan's GX Strategy - Towards Accelerating Green Transformation.

In recent years, Japan has been very active in the field of transition finance, as represented by the promotion of GX investment, with the Basic Policy on Transition Finance being formulated in 2021 and follow-up guidance in 2023, and the world's first state-issued transition bond, the Climate Transition Interest Bond, being issued in February 2024. The Climate Transition Interest Bond, the world's first government-issued transition bond, was issued in February 2024, and this is an area in which the Japanese Government is making a notable effort. *13 *14 *15 The Fourth Report positioned the Climate Transition Interest Bonds as "aiming to serve as a catalyst for further expansion of transition finance in Japan and abroad", and transition finance initiatives are expected to expand even further in the future.

⑷ Initiatives related to decarbonisation and diversifying sustainability issues.

In terms of decarbonisation initiatives related to transition finance, the fourth report covers 'risk management and customer support in financial institutions', 'promoting international and regional decarbonisation and GX' and 'carbon credit markets'.

In July 2022, the Financial Services Agency published its 'Basic Approach to Addressing Climate Change in Financial Institutions'. *16 It also states that "it is important for financial institutions to contribute to the growth and sustainability of the economy and society (among others) by identifying risks and opportunities associated with their customers' businesses, and by reducing risks and promoting opportunities" (Fourth Report, p. 20), and that financial institutions should help their customers manage their risks to climate change. The report also states that financial institutions should help their customers manage their climate change risks.

With regard to the development and penetration of international decarbonisation and GX, the government states that it will continue to promote and disseminate GX, showing its achievements such as the Asian GX Consortium and the AZEC Leaders' Summit. On the other hand, the report also states that although GX for SMEs*17 , which account for 20% of GHG emissions as businesses, is an important issue, it is not always easy for SMEs facing various management challenges to tackle GX. In order to support SMEs in their efforts towards GX, the report explains that it will be important to communicate that decarbonisation initiatives will not only reduce risks for companies, but also improve management and create business opportunities.

As for carbon credits, the GX League's emissions trading system is scheduled to be fully operational in 2026*18 , as an example, and the assumption that trading will be further expanded and diversified in the future was made, and the group indicated that it would promote research and discussion to ensure the transparency and soundness of trading in carbon credits. The government has indicated that it intends to promote research and discussion to ensure the transparency and soundness of transactions related to carbon credits.

On the other hand, the report also points out that modern environmental and social issues are becoming increasingly diverse, such as the protection of biodiversity and human rights issues associated with labour in the supply chain, and that various sustainability issues interact with each other in such a way that the conservation of natural capital can also lead to improvements in climate change. The Fourth Report points out that, in order to solve sustainability issues, it is necessary to comprehensively consider various environmental and social issues from a broad perspective that is not limited to decarbonisation and GX. (From the Fourth Report, p. 5: Core issue (3))

Major changes since the Third Report.

In the year between the release of the Third Report in June 2023 and the publication of the Fourth Report, how have the circumstances surrounding sustainable finances, and the FSA and the government's approach and approach to sustainable finance, changed? This section explains the changes since the Third Report, comparing the word clouds and word counts of the Third and Fourth Reports.

Figure 4: Word cloud of the third report(Prepared by the author)

Figure 5: Word cloud of the fourth report(Prepared by the author)

Table 1 Table comparing the number of occurrences of characteristic words(Prepared by the author)

The word cloud in Figures 4 and 5 shows that words related to transition finance, such as 'transition' and 'transition interest-bearing bonds', are more prominent in the fourth periodic report than in the third periodic report. Table 1 extracts words that appear in the third and fourth periodic reports that are characteristic of the third and fourth periodic reports. Words such as 'financed emissions' and 'GX League' have increased in number of occurrences in the fourth periodic report. Instead, the number of occurrences of words such as climate change and ESG has decreased in the fourth periodic report compared to the third periodic report, indicating a move towards more specific support for companies.

The terms 'green finance' and 'green bonds' have also become more frequent since the Fourth Report. Green finance refers to "bonds or borrowings*19 to raise funds specifically for initiatives in environmental fields such as global warming countermeasures and renewable energy", of which green bonds are bonds.

The fourth periodic report notes that "international principles for financial instruments with green characteristics have been updated from time to time, and it is important to continuously discuss them in Japan and (omitted) reflect them in our framework in a timely manner". In fact, the Green Bond Guidelines*20 established in 2017 have been revised twice so far, and the systems and rules related to green finance are expected to continue to change.

Response required of companies.

Due to active government initiatives, future investments and loans are expected to be even more influenced by sustainable finance. What measures are companies required to take to ensure smooth access to financial assistance?

Promote and publicise initiatives for a decarbonised society.
The drive for transition finance has become very active in recent years, and in the future, companies actively engaged in GX and other initiatives for a decarbonised society will be highly valued by investors and financial institutions.

Improved disclosure of sustainability information.
By quantifying and disclosing sustainable social initiatives, investors interested in sustainable finance will find it easier to invest and finance. A subsidy programme to subsidise the costs of receiving third-party assessments from ESG assessment bodies and other institutions when raising funds through transition finance will also begin in June 2024*21, and it is expected that many companies will disclose sustainability information and improve their information.

aiESG offers ESG analysis services on the supply chain of manufactured goods. If you have any interest or questions about corporate disclosure, please do not hesitate to contact us.

Enquiry:https://aiesg.co.jp/contact/

References.
*1 https://www.fsa.go.jp/policy/sustainable-finance/index.html
*2 https://webdesk.jsa.or.jp/common/W10K0500/index/dev/isotc_322/
*3 https://2021.tsfw.tokyo/what_is_sustainable_01
*4 https://www.mof.go.jp/about_mof/councils/fiscal_system_council/sub-of_kkr/proceedings/material/kyosai20221125-3-2.pdf
*5 https://www.gsi-alliance.org/members-resources/gsir2022/
*6 https://www.fsa.go.jp/singi/sustainable_finance/siryou/20240709/01.pdf
*7 https://www.ssb-j.jp/jp/domestic_standards/exposure_draft/y2024/2024-0329.html
*8 https://www.fsa.go.jp/search/20231211.html
*9 https://www.fsa.go.jp/news/r4/singi/20221215/20221215.html
*10 https://www.cas.go.jp/jp/seisaku/atarashii_sihonsyugi/bunkakai/asset_dai4/siryou1.pdf
*11 https://www.fsa.go.jp/common/law/guide/kinyushohin/
*12 https://www.meti.go.jp/policy/energy_environment/global_warming/transition_finance.html
*13 https://www.fsa.go.jp/news/r2/singi/20210507_2/03.pdf
*14 https://www.fsa.go.jp/news/r4/singi/20230616.html
*15 https://www.mof.go.jp/jgbs/topics/JapanClimateTransitionBonds/index.html
*16 https://www.teitanso.or.jp/cif3/
*17 https://www.env.go.jp/content/000123580.pdf
*18 https://www.env.go.jp/earth/ondanka/page_01417.html
*19 https://www.resonabank.co.jp/hojin/service/kigyoseicho/sien/sei_c0410.html
*20 https://greenfinanceportal.env.go.jp/bond/guideline/guideline.html
*21 https://www.teitanso.or.jp/cif3/

Return to Report list

Report

Explanation] What is sustainable finance? ~Explanation from the Fourth Report of the Expert Group on Sustainable Finance of the Financial Services Agency~.