Oversight and Accountability in Corporate Governance --- what we are expected to do globally, and what we do in Japan Toshio Oya Assistant Commissioner For International Affairs Financial Services Agency (FSA), Japan * This presentation is prepared under the sole responsibility of the presenter. All remarks represent the presenter’s own views, and not those of the FSA.

2 I.The Importance and Implications of Oversight and Accountability of Corporate Governance (CG) (1) What can good CG achieve? (2) Is good CG the only way to achieve growth? II.The Ways to Enhance Oversight and Accountability of CG (1) Mechanism for Good Oversight (at the Board and Shareholders’ Meeting) (2) Mechanism for Accountability --- Enhanced Disclosure (3) Strict Enforcement III. Overview of Japan’s CG (1) Board Structure and Nomination (2) Oversight by Shareholders Outline FINANCIAL SERVICES AGENCY Government of Japan

3 (1) What Can Good CG Achieve? ● Ensuring good and sound corporate decisions for better resource allocation leading to more innovation and profitability ● Gaining investors’ confidence, and enhancing investment in and growth of the company ● Attracting capital inflows into the market and enhancing growth of the country I. The Importance and Implications of Oversight and Accountability of Corporate Governance (CG) FINANCIAL SERVICES AGENCY Government of Japan

4 (1) What Can Good CG Achieve? ● The Corporate Governance Committee of the OECD Has started discussion on “Value Creation and Growth.” ● The relevant reference in the OECD Principles of CG: “The corporate governance framework should be developed with a view to its impact on overall economic performance, market integrity and the incentives it creates for market participants and the promotion of transparent and efficient markets.” I. The Importance and Implications of Oversight and Accountability of Corporate Governance (CG) FINANCIAL SERVICES AGENCY Government of Japan

5 (2) Is good CG the only way to achieve growth? ● Which is better for growth ： 1) quick decision-making by controlling shareholders, or 2) better CG with good oversight and accountability in place ? ● Can we envisage the “best CG mechanism & measures” to achieve quick and sound corporate decisions with results (earnings)? I. The Importance and Implications of Oversight and Accountability of Corporate Governance (CG) FINANCIAL SERVICES AGENCY Government of Japan

6 The elements of “better CG requirements ” include: ● More independent/outside directors ● Reduced role of controlling shareholders ● More protection of minority shareholders ● disclosure of the voting results by institutional investors ⇒ The question is: 1) Should all of the above be regulated by law, or 2) should we take a more “market-based” approach, which regulates less and leaves evaluation of the company to the market? II.The Ways to Enhance Oversight and Accountability of CG (1) Mechanism for Good Oversight FINANCIAL SERVICES AGENCY Government of Japan

7 ● Enhanced Disclosure is the core CG element. ● Without full disclosure, the market cannot make judgment of the real competitiveness (sustainable profitability) of a company (and the degree of the edge over its competitors) and would not invest in the whole industry in the country. ● Fair value accounting rules and implementation of them play an important role. II.The Ways to Enhance Oversight and Accountability of CG (2) Mechanism for Accountability FINANCIAL SERVICES AGENCY Government of Japan

8 ● Any rules must be strictly enforced, because fair and consistent application of the rules is crucial to gain market confidence. ● Good CG regulations mean nothing without strict enforcement and could not attract investments. ● Sufficient resources need to be ensured for enforcement. II.The Ways to Enhance Oversight and Accountability of CG (3) Strict Enforcement FINANCIAL SERVICES AGENCY Government of Japan

9 ●What aspects are unique to Japan? ・ Very few controlling shareholders (*) ⇒ Only 3.3% of the companies listed in TSE 1 st section have controlling shareholders (*) defined as shareholders that own more than 50% of the outstanding shares, parent companies excluded ・ Disclosure and strict enforcement are the core elements of Japan’s CG. ・ Any unique elements in Japan’s oversight framework, i.e. 1) board structure and nomination, and 2) oversight by shareholders? III Overview of Japan’s CG FINANCIAL SERVICES AGENCY Government of Japan

10 ● The Companies Act provides for 2 options: 1)“Company with Committees” model （ added in 2003 ） ; 2) “Company with Audit & Supervisory Board” model 1) “Company with Committees” model Three committees: each shall have at least three members. a nominating committee a compensation committee an audit committee More than half of the members of each committee shall be outside directors (“ODs”). The share of this model is only 2.2 %. (1) Board Structure and Nomination III. Overview of Japan’s CG FINANCIAL SERVICES AGENCY Government of Japan

11 III. Overview of Japan’s CG 2) “Company with Audit & Supervisory Board” model This model has been commonly seen in Japan. No ODs are required. Large and public companies opting for this model shall have at least three members (Corporate auditors). At least half of them shall be outside members. Pro: Members, away from business decisions, can concentrate on checking directors. Con: Members can raise their voice but cannot vote. (1) Board Structure and Nomination FINANCIAL SERVICES AGENCY Government of Japan

12 (1) Board Structure and Nomination ●Issues for discussion: A “mandatory” OD system may contribute to better CG, but does it alone make a difference? Legal clarity: What is “outside?” Is it clearly defined? The quality of ODs: Investors need to check whether oversight by ODs actually works effectively. Japan’s approach: “non-mandatory” ODs, with 1) enhanced legal clarity and 2) full and specific disclosure on Board structure FINANCIAL SERVICES AGENCY Government of Japan

13 FINANCIAL SERVICES AGENCY Government of Japan (1) Board Structure and Nomination 1) Legal Clarity ● Tokyo Stock Exchange Securities Listing Regulations requires an listed issuer to secure at least one independent director or auditor (Audit & Supervisory Board member). “Independent” director/auditor is defined as outside director/auditor having no specific conflicts of interests with general shareholders. ● The draft amendment to the Companies Act provides: “ODs” exclude spouses and second degree relatives or closer of directors, executive officers, etc. of the company, its parent company, and “brother” companies sharing the same parent company.

14 (1) Board Structure and Nomination 2) Full and specific disclosure for investors ● Government Ordinance requires that Annual Securities Reports stipulate: the roles and functions of ODs in CG; and in case of not appointing ODs, the alternative governance structure and rationale for adopting it. ● The draft amendment to the Companies Act requires certain public companies without ODs disclose reasons why appointing ODs is not appropriate for them. FINANCIAL SERVICES AGENCY Government of Japan

15 (1) Board Structure and Nomination ●This disclosure rule is not just a “Comply or Explain.” ・ “What to explain” is specifically stipulated. ・ The disclosures shall be included in the annual reports, which are scrutinized by Audit & Supervisory Board Members. ・ Any violation of these disclosure rules shall be subject to penalties: fines or administrative sanctions, etc. ●The full disclosure requirement could result in more ODs; it may be extremely difficult to explain the reasons for not appointing ODs that can convince investors. FINANCIAL SERVICES AGENCY Government of Japan

16 (1) Board Structure and Nomination The rationale for the “non-mandatory” approach ● This approach could be friendly to both business and investors, because: 1) Companies can make the best choice tailored to their circumstances ； and 2) Investors need to, and can, rely on their own judgment rather than formalistic tick-the-box method. ● The “Official” rationale behind the “non-mandatory” approach ---- Report by the Financial System Council ‘s Study Group on the Internationalization of Japanese Financial and Capital Markets ： “With respect to persons from the company’s major corporate shareholder or major business affiliate, whilst it is possible that these persons could hardly qualify as being “independent,” it has also been pointed out that excluding all such persons indiscriminately using formulaic standards may not necessarily be appropriate when considering the effectiveness, specialization and other requirements of a supervising body. ” FINANCIAL SERVICES AGENCY Government of Japan

17 (2) Oversight by Shareholders ● Disclosure of voting results Government Ordinance provides that listed companies shall disclose the number of votes cast for/against or withheld in additional reports (i.e. extraordinary reports) ● Enhanced disclosure by institutional investors (being discussed) Institutional investors, with fiduciary duties for their clients, are held accountable for exercise of their voting rights and disclosure of the action. *In 2012, top 10 asset management companies opposed to 17.5% of companies’ proposals in average (though in 2010 they opposed 13.9%) FINANCIAL SERVICES AGENCY Government of Japan

18 (2) Oversight by Shareholders ● The options being discussed (*) include the following: - Institutional investors prepare and disclose guidelines on the exercise of their voting rights; - Institutional investors disclose the voting results. (*) discussed at the Financial System Council ‘s Study Group on the Internationalization of Japanese Financial and Capital Markets ● More and more Institutional investors have made guidelines on the exercise of their voting rights and disclose both the guidelines and the voting results. FINANCIAL SERVICES AGENCY Government of Japan

19 Thank you for your attention. FINANCIAL SERVICES AGENCY Government of Japan