The Financial Services Agency of Japan (FSA) published its responses to public comments on the draft version of new guidelines on environmental, social, and governance (ESG) public funds on March 31. This LawFlash discusses major points of the FSA’s responses to the draft guidelines (FSA’s Responses).

The FSA’s Responses clarify (1) the scope of the ESG-related public funds whose disclosures are subject to the guidelines (ESG Public Funds), (2) analysis on certain investment structure, such as fund of funds (FoFs) or foreign funds, and (3) the rules that apply not only to ESG Public Funds, but also to other publicly offered domestic investment trust funds that take ESG into consideration.

The FSA made the guidelines effective on March 31, 2023 (the Guidelines).

SCOPE OF ESG PUBLIC FUND

Type of Fund Is Limited to Publicly Offered Domestic Investment Trust Funds

The FSA confirmed that the type of ESG Public Funds whose public disclosures are subject to the Guidelines are limited only to the publicly offered domestic investment trust funds formed under the Investment Trusts and Investment Corporations Act of Japan (ITICA). Other types of funds, such as any types of private funds (i.e., trust, corporate, or limited partnership private funds), public corporate type funds, [1] and foreign domiciled trust funds, are excluded from the scope of ESG Public Funds. [2]

ESG Factors Are “Key Factors” in the Selection of Investments

If an investment trust manager (ITM) of a public investment trust considers ESG factors as “key factors” in the process of selecting investments, such ITM can and should classify the public investment trust as an ESG Public Fund and disclose as such in the “Purpose and Characteristics of the Fund” section of the summary prospectus (kofu mokuromisho) (Summary Prospectus).

ESG factors should be treated as “key factors” when they are decisively important factors in the process of selecting investments (for example, an investment is not made unless the investment target meets the designated ESG criteria, or the investment ratio is determined in accordance with such ESG criteria). [3] Multiple key factors can be recognized, [4] including the consideration of ESG in the selection of the investment universe or actual investment ratio. [5] If the ESG factors are merely subsidiary factors, such fund will not be considered as a ESG Public Fund. [6]

On the other hand, the FSA does not establish, recommend, or suggest any specific quantitative threshold in connection with an ESG “key factor.” [7] The FSA defers to ITMs to determine its own specific ESG factors (such as ratio or target) which could be reasonably explained as key factors in the process of selecting investment [8] .

The FSA considers that the description of the “Purpose and Characteristics (of the Fund)” section of the Summary Prospectus should contain sufficient information to enable investors to understand that ESG is substantially the key factor in the process of selecting investments by such fund. It is not sufficient to simply state that ESG is the key factor. [9]

ANALYSIS ON CERTAIN INVESTMENT STRUCTURES

Fund of Funds

ESG Public Funds include domestic public investment trust funds which have an ESG key factor through delegation arrangements. The delegation arrangements include delegation to a foreign sub-manager or investment in foreign funds through a FoFs structure. [10] Even if not all of the investee funds in the FoFs select investments based on ESG as a key factor (ESG Investee Funds), such FoFs can be considered as an ESG Public Fund if it can be determined on the whole that investments in the FoFs are ESG Investee Funds.[11]

Foreign Funds Publicly Offered in Japan

Foreign investment trust funds may be publicly offered in Japan through securities firms. Even if such foreign investment trust funds are public funds which select investments based on ESG as a key factor, the Guidelines do not apply to such foreign funds. This is because the FSA expects that foreign investment trust funds will be disclosed in accordance with their home jurisdiction’s laws and regulations and does not intend to apply equivalent Japanese rules to such foreign investment trust funds; however, securities firms should avoid misleading explanations to investors in terms of ESG. [12]

RULES THAT ALSO APPLY TO THE ESG-RELATED PUBLIC FUNDS

The FSA Responses clarify that the sections “Organizational System” and “Use of ESG Evaluation and Data Providers” apply to publicly offered domestic investment trust funds that take ESG into consideration (ESG-Related Public Funds), including ESG Public Funds. [13]

Therefore, all ITMs that manage ESG-Related Public Funds should also secure resources (such as data or IT infrastructure and human resources related to ESG) to adequately implement asset management in accordance with their ESG-related investment strategies and to monitor the implementation status on an ongoing basis.

They should also conduct due diligence on ESG data and evaluation providers. When an ITM delegates its investment authority to a third party, such ITM can meet this requirement by confirming that such third party properly conducts due diligence on ESG data and evaluation providers. [14]

[1] The FSA may consider introducing regulations in the future on J-REITs, which are investment corporation funds publicly offered to retail investors under the ITICA (FSA’s Responses No. 62-63).

[2] FSA’s Responses No. 55-62

[3] FSA’s Responses No. 12-14, 18, 20, 23-25, 29, 36, 38-40

[4] FSA’s Response No. 15

[5] FSA’s Response No. 12

[6] FSA’s Response No. 19

[7] FSA’s Response No. 11

[8] FSA’s Responses 8-10, 29-32

[9] FSA’s Response No. 67

[10] FSA’s Responses No. 50-52

[11] FSA’s Responses No. 51, 52

[12] FSA’s Response No. 60

[13] FSA’s Response No. 209

[14] FSA’s Response No. 207

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