Overview
Cross-shareholdings are a relic of Japan Inc’s clubby bad old days, when large firms took strategic stakes in each other to fend off hostile takeovers and maximise control over corporate decisions, often to the detriment of small shareholders’ interest. While the scale of cross-ownership has been on the wane in recent years, they still account for more than 8 per cent of total equity in the Japanese market and remain a corporate governance headache.
An unlikely remedy for the problem has emerged from Japan’s push to enhance disclosure on carbon emissions. Under new standards being proposed, Japanese companies would be required to count the carbon footprints of their cross-held partners as well as their own, while also disclosing emissions throughout their value chains. An analysis by Fidelity International finds that reported emissions would surge under the new disclosure rules for those Japanese companies with large cross-shareholdings.
The plan to tighten emissions disclosure in line with global standards will put pressure on Japanese companies to reduce their cross-ownership further, potentially driving another nail in the coffin of this longstanding governance issue in Japan. Investors could seize on an opportunity to engage with companies to decarbonise and unwind cross-shareholdings at the same time.
In recent quarters Fidelity has been encouraging one automobile conglomerate to unwind its complex web of cross-ownership, as part of our engagement on sustainable practices. The group and its subsidiaries are pushing ahead with a plan to sell shares worth about US$4bn in one of their biggest suppliers.
Regulators tighten their grip
In June 2023, the International Sustainability Standards Board issued new guidelines on how to disclose climate-related risks and opportunities, making it mandatory to reveal Scope 3 emissions, which encompass greenhouse gases produced by a company’s suppliers or clients along its value chain. When calculating Scope 3, a company should include emissions attributable to its equity investees. The Japanese version of such guidelines is being drafted by the Sustainability Standards Board of Japan with similar requirements. It is expected that listed Japanese firms will be required to follow these rules as soon as the fiscal year ending March 2026.
The new rules would supersize carbon footprints for some companies, according to a Fidelity analysis of 30 firms whose cross-shareholdings are among the biggest in the Japanese stock market. For the five most affected companies, their emissions would more than double after being adjusted for cross-ownership. On a median basis, emissions would rise by a third for the 30 companies surveyed.
In one extreme case, an Osaka-based drugmaker would see the new rules bring a 16-fold increase in its annual emissions - from 80,000 to 1.3m tonnes, mainly due to the company’s interest in a producer of air conditioners which is among Japan’s biggest emitters. Cross-shareholdings account for about 15 per cent of the drugmaker’s total equity.
Japan Inc’s ESG push has gathered steam over the last two years, with significant progress in climate-related disclosure, as well as reform measures to boost governance. There are more signatories to the Task Force on Climate-related Financial Disclosures in Japan than in any other country. Regulators restructured the Japanese stock market into three segments in 2022, with higher governance standards for the so-called ‘prime’ segment. In addition, the Tokyo exchange has been encouraging constructive dialogue between listed companies and investors.
Japan’s Corporate Governance Code demands companies annually assess whether the purpose of their cross-shareholdings is appropriate. Listed firms are required to examine operational risks associated with such ownership structures, but we think climate-related risks should also be assessed in the process.
Accelerating change
Japan is catching up with other parts of the developed world where corporate ownership has already been reformed. Germany finished unravelling a complex web of crossholdings more than a decade ago, with Deutsche Bank, for example, selling its Daimler stake in 2009.
The E and G factors of sustainable investing are interwoven for Japan Inc, with the improvement of emissions disclosure partly depending on efforts to reduce cross-ownership. It presents an opportunity for investors to take an holistic approach to ESG engagement. With careful execution, Japan could kill two birds with one stone.
