Japan’s green lending scheme presents opportunities and challenges

In December 2021, the Bank of Japan (BoJ) made a welcome step by initiating a climate change-related lending program, providing zero-interest finance to lenders supporting projects such as renewable energy.

The scheme is notable for providing incentives for investing in green initiatives, although the BoJ still faces the same challenges around taxonomy and disclosures that are issues for other central banks around the world.

How the green lending programme works

To participate in the programme, financial institutions must satisfy climate-related disclosure requirements outlined by the BoJ. The amount of loans available is linked to a number of factors, including financial institutions’ investment performance on green loans and bonds, sustainability-linked loans and bonds related to climate change, and transition finance. The interest rate charged on these financial institutions is 0% per annum. While maturity is one year in principle, loans can be renewed until March 2031.

This new programme constitutes one of several long-term lending programs adopted by the BoJ with duration ranging between one and four years, at interest rates of 0% or 0.1%. The BoJ has so far provided loans under this scheme twice, in December 2021 and again in July this year. The outstanding loans from this scheme total 3.6 trillion yen (2.1 trillion yen in the first round and 1.5 trillion yen in the second), accounting for only 2.7% of total outstanding loans provided by the BoJ. In terms of BoJ’s total assets, the new loans account for 0.5%.

Under the scheme, financial institutions are required to disclose information on governance, strategy, risk management, and metrics and targets as described in guidelines from the Taskforce on Climate-related Disclosures (TCFD), as well as targets and results of their investment or loans.

Related to this initiative, the BoJ – which monitors the financial system from a macroprudential perspective through onsite and offsite investigations of financial institutions – announced in July 2021 that it will encourage financial institutions to make TCFD guideline-based disclosures. Meanwhile, Japan’s Financial Services Agency (FSA) is responsible for microprudential policy and conducts climate stress tests on large banks.

This is in line with the Corporate Governance Code, revised in 2021 by the FSA and the Tokyo Stock Exchange (TSE), which states that companies listed on the TSE’s prime market should collect and analyse data on the impacts of climate change-related risks and earning opportunities on their business activities and profits. In addition, they should enhance the quality and quantity of disclosure based on the TCFD recommendations or an equivalent framework on a comply-or-explain basis.

Disclosure requirements do not cover all financial institutions

If the BoJ is to make the green lending scheme as effective as possible, there are still several key challenges it faces.

One issue is ensuring that disclosure requirements for financial institutions are sufficient. According to the revised code, the requirement applies only to those financial institutions listed on the prime market and does not cover financial institutions listed on the standard and growth markets or on other Japanese stock exchanges, as well as unlisted financial institutions. Detailed measures on how to assess the degree of compliance with the requirement are also not available on the BoJ website.

If the BoJ’s objective is to promote a greening of the financial system following the initiatives of the Network for Greening the Financial System, it may need to ask the FSA and the TSE to apply TCFD-based disclosure to all listed financial institutions as soon as possible. This should also be applied to companies, since financial institutions’ climate-related disclosure rely on their clients’ disclosure.

Furthermore, since the Corporate Governance Code applies to listed companies only, the BoJ and the FSA may also need to find ways to promote TCFD-based disclosure to unlisted financial institutions and companies over time. One related issue is whether the code should be transformed into mandatory regulation, as stressed in the UN’s Principles for Responsible Investment. This reflects that the current code is based on a soft law and thus not legally enforceable.

Another important consideration is that Japan may benefit from providing more detailed guidelines on corporate sustainability disclosure with quantified indicators and climate scenario analysis, following the standardisation procedures to be offered by the International Sustainability Standards Board or the broader ESG-related indicators promoted by the Singapore Stock Exchange.

Japan lacks a green taxonomy

Another issue relates to taxonomy. It is good to know that green, sustainability-linked, and transition bonds issued in Japan are mostly based on International Capital Market Association guidelines. However, external review and reporting are recommended but not compulsory. Meanwhile, an environmental taxonomy — such as those adopted by the European Union, Singapore and Malaysia — is not available in Japan so the degree of “greenness” is uncertain, as it is not clear how those financed activities contribute towards Japan’s legally-binding carbon neutrality target by 2050 and reducing its associated carbon emissions by 46% by 2030.

Instead of a taxonomic approach, Japan has taken a unique path in formulating basic guidelines on transition finance and developing associated technology-based roadmaps for hard-to-abate sectors such as steel, cement, electricity, and oil and gas, as well as placing an emphasis on transition finance.

This approach reflects Japan’s energy policy and emission reduction plans. In 2021, the government announced plans to increase the proportion of renewable energy (including solar, wind, biomass, hydrogen and geothermal) and nuclear power between 2020 and 2030 — from nearly 20% to 36-38% and nearly 4% to 20-22% respectively. In contrast, the shares of liquid natural gas and coal are projected to decline from 39% to 20% and 31% to 19%.

Japan plans to phase out inefficient coal power plants while maintaining highly efficient ones. The volume of greenhouse gas emissions arising from fossil fuels will be reduced by utilising ammonia, hydrogen, biomass, and carbon capture and storage, as described in the government’s energy roadmap. One challenge will be to make this approach and any associated bonds compatible with those of the rest of the world, and align with the views of global issuers and environmental, social and governance investors.

Market neutrality to be maintained for now

Finally, in July 2021 the BoJ announced its intention to maintain market neutrality with regard to monetary policy and to avoid direct involvement in micro-level resource allocation as much as possible. This approach differs from that of the European Central Bank which stressed a need to shift from market neutrality to carbon neutrality in terms of reinvesting corporate bond purchases.

This implies that the BoJ does not intend to introduce environmental standards for purchasing or reinvesting corporate bonds, commercial papers, and stock exchange-traded funds. This approach could be reversed in future once there is greater understanding about climate change risk among companies and the public, as well as more progress on disclosure requirements across the economy.

Despite these issues, the green lending programme is still a welcome development in Japan’s progress towards meeting the Paris Agreement targets, although it still represents a tiny fraction of the BoJ’s loan books. It also remains to be seen exactly how effective it has been in promoting sustainable investment and reducing carbon emissions, so the upcoming release of initial results are awaited with keen interest.