On 30 June 2023, the Working Group on Impact Investment (“Working Group”), which was established under the Expert Panel on Sustainable Finance of the Financial Services Agency of Japan (“FSA”), published a report (“Report”) (in English and Japanese) setting out domestic and international trends in impact investment and draft basic guidelines consisting of four key principles as discussed below (“Guidelines”). The Report seeks to fill a gap in the lack of standards regulating “impact investment”, one of several sustainable finance investment methods, and noted “impact investment” market practices are still developing. In contrast, other ESG investment methods such as “integration” and “positive or negative screening” appear to be more commonly used in the market.
The Guidelines seek to encourage dialogue and align understanding on basic concepts and processes for “impact investment” between investors, financial institutions and companies in Japan and globally, and develop knowledge and experience in this area. The Guidelines further aim to create an environment in which investors and financial institutions can invest more confidently without concerns of greenwashing, and to help companies in obtaining financing and support.
What are impact investments?
The Report describes “impact investment” as an investment “having core characteristics of proactively identifying specific social or environmental ‘impact’ that should be realised through an individual investment, and committing to strategies to actually realise those ‘impact’, as well as generating a certain level of ‘financial return’ as in the same manner as regular investments”.
The Guidelines are applicable to a wide array of investments and are not limited to certain investment targets, investment entities (e.g. listed companies or start-ups) or asset classes. However, investments that do not aim to generate financial return (e.g. donations), and investments whose intended impact is not clarified, are out of scope.
Overview of the Guidelines
In summary, the Guidelines lay out four main principles as follows.
Clarify the social or environmental impact and financial return intended to be realised through the investment. Specify how the investment will develop and cultivate the market and create both social or environment impact and financial returns. If impact and returns will be realised in the long term, demonstrate how they would be realized during such period.
Clearly explain the social or environment impact and financial return that would not have been realized but for the investment. It is important to demonstrate how the investment target is developing its business in the market and present a nexus between the business and the social or environmental effect. As with Intentionality, if impact and returns will be realised in the long term, demonstrate how they will be realized during such period.
3) Identification, measurement and management of impact
Identify, measure and manage the impact and profitability of investments in quantitative or qualitative terms. Identify the characteristics, size and potential of the market that will have a social or environmental impact and generate financial returns and continue to measure and manage such factors post-investment. Utilise internationally recognised frameworks to identify, manage and measure the indications.
4) Innovation, transformation and acceleration
Identify the novelty or advantages of the investment target that will accelerate changes in the market, creating a social or environmental impact and generating financial returns.
The FSA noted from past roundtable events and industry developments in Japan that interest in “impact investment” is growing. The Guidelines provide a “foundation” for discussions among Japanese and foreign stakeholders which will help to further improve and expand the Guidelines as the market develops. The invitation for public comments on the Report closes on 10 October 2023.