In 2020, investment into Islamic financial products by Japanese investors progressed to an actual implementation stage from the examination stage. New Sukuk investment by a Japanese investor was successfully completed earlier in 2020 by virtue of the precedent deal in 2019 that clarified the Japanese law/tax position on the treatment of Sukuk issued outside Japan. In other areas of Islamic finance, it is expected that the growing importance of environmental, social and governance (ESG) considerations for investment decisions would encourage the growth of Islamic finance in light of the ESG financing by financial institutions that include Japanese banks in the years to come.
Review of 2020
In April 2020, Japan’s AEON Financial Service directly invested in Sukuk issued in Malaysia by its local subsidiary, AEON Credit Service. This was a significant step forward after the precedent transaction in 2019 whereby Japan’s MUFG directly acquired Sukuk issued by Malaysian issuers. The 2019 transaction involved certain Sukuk Wakalah issued outside Japan. However, the legal and tax treatment of offshore Sukuk had not been clarified in Japan before the transaction.
In Japan, the tax treatment of profits distributed to the holders of financial products is primarily determined by the legal characteristics of such financial products. As such, it was essential to identify the legal characteristics of such Sukuk and to ascertain the tax position of the Japanese investors before actual deals are implemented in practice. During the course of the aforementioned transaction in 2019, we worked closely with the relevant parties including Japanese tax and other authorities to examine the Japanese law/tax position of different types of offshore Sukuk under the relevant pieces of Japanese legislation.
As a result, the 2019 transaction paved the way for Japanese investors to acquire and hold Sukuk issued outside Japan. The new investment by AEON Financial Service in 2020 is living testimony that Japanese investors are looking to offshore Sukuk as one of their alternative investments to be included in their investment portfolio.
Another development we saw in 2020 was an expansion of the investor base for Islamic finance. A leasing company in Japan invested in a Shariah compliant lease transaction for a major hospital chain operator in Indonesia to install medical equipment to treat patients who contracted COVID-19. We assisted the investor with structuring the overall transaction by clarifying the implication of Indonesian Shariah law on the investment structure. It was the first Shariah compliant lease transaction in Indonesia for Japanese investors and we hope it will open the gateway for a wider scope of Japanese financial institutions, not just banks, to provide financing to their overseas clients in a way that will better meet their demands.
Preview of 2021
In Japan, the growing awareness of sustainability and decarbonization, as well as the quality of corporate governance, is enhancing the integration of ESG issues into investment behavior. This is represented by the recent expansion of the green bond market from JPY500 billion (US$4.79 billion) in 2018 to JPY800 billion (US$7.67 billion) in 2019. Legal frameworks for green bonds as well as other types of impact finance have been developed by a series of non-binding principles and guidelines following the publication of the Principles of Responsible Institutional Investors (the Principles) by Japan’s Financial Services Agency.
By August 2020, 286 institutional investors, including Japan’s Government Pension Investment Fund, singed up to the Principles which are widely recognized and implemented in Japan. The most recent version of the Principles was published in March 2020, which recognizes “consideration of sustainability” as one of the core components of “stewardship responsibility” that institutional investors are encouraged to perform for their investment.
ESG finance is also supported by other guidelines such as the Guidelines for Green Bond and the Guidelines for Green Loan and Sustainability Linked Loan, both published by Japan’s Ministry of Environment. These principles are largely based on the international guidelines such as the Green Bond Principles established by the International Capital Market Association or the Green Loan Principles established by the Loan Market Association.
These domestic guidelines in Japan are further developed by the Ministry of the Environment in its report titled ‘General Idea for Impact Finance’ published in July 2020 with a view to advancing ESG finance/investment as a part of the core business of Japanese financial institutions.
Against the backdrop of the foregoing, we have seen new efforts among Japanese financial institutions to embark on expanding their financial services to include Islamic sustainability-linked loans in the overseas jurisdictions. Islamic finance intrinsically involves social and ethical values and has operated to address these issues in various forms. As such, it is expected that ESG Islamic finance transactions will contribute to the further growth of the ESG finance market globally.
Conclusion
For Japanese investors, Sukuk investment has been tested and has become one of the feasible options in order to diversify their investment portfolio. ESG finance, which is intrinsically compatible with Islamic finance, is also expected to add momentum in expanding the variety of Islamic finance products provided by financial institutions including Japanese banks.
Naoki Ishikawa is a partner at Mori Hamada & Matsumoto. He can be contacted at [email protected].