Looking past the Kabuki (pun-intended) of Japan’s recent corporate governance awakening you will find an uncomfortable reality: not all shareholders get to vote. One would naturally assume that beneficial owners of common shares are entitled to vote at the annual shareholders meeting or whenever shareholder votes are called for. However, technically speaking, owning common stock in Japanese corporations entitles the shareholder of record to vote, not the beneficial owner. Often the shareholder of record is a third party such as a custodian or prime broker, which might not vote in the best interests of the ultimate beneficial owner. Sadly, if the beneficial shareholder wants absolute control of their vote, the process can be daunting if the shareholder is not domiciled in Japan.

1. The Dirty Little Secret
Stopping Foreign
Shareholders from
Exercising Their
Voting Rights in
Japan

2. Looking past the Kabuki (pun-intended) of Japan’s
recent corporate governance awakening you will
find an uncomfortable reality: not all shareholders
get to vote. One would naturally assume that
beneficial owners of common shares are entitled to
vote at the annual shareholders meeting or
whenever shareholder votes are called for.
However, technically speaking, owning common
stock in Japanese corporations entitles the
shareholder of record to vote, not the beneficial
owner. Often the shareholder of record is a third
party such as a custodian or prime broker, which
might not vote in the best interests of the ultimate
beneficial owner. Sadly, if the beneficial shareholder
wants absolute control of their vote, the process can
be daunting if the shareholder is not domiciled in
Japan.

3. Are you a Japan domiciled shareholder or not? The answer to this simple question is in fact
extremely important when considering exercising the rights of shareholders in Japanese-listed
companies, especially as it applies to the principles of shareholder equality. In other words, the
boundary creates the difference between direct ownership and indirect ownership. As a result,
a complicated, often opaque deeply layered ownership structure occurs. The complication is
further obfuscated when coupled with the current time-honored hierarchical custodian system
that causes shareholder equity to suffer by producing a variety of different voting status among
similar shareholders. The beneficial shareholder might be known only by the sub-custodian’s
name or the sub-custodian and the beneficial owner may both be listed as owners, but the
voting rights of such a combination are open to interpretation by corporate counsel, not
regulatory or shareholder law. There are several more combinations of custodial accounts,
omnibus accounts, etc. but the important take away here is that shareholder equality suffers.
Without delving deeply into the mechanics Japanese equity trading, it is instructive to have an
overview of the process to understand how certain types of shareholders might lose their
voting power. Figure 1 illustrates the process by which a foreign fund (XYZ) buys shares of a
Japanese listed company (ABC co.).

5. XYZ Fund sends their broker a buy order for 1,000 shares of ABC co.
which is executed on the Tokyo Stock Exchange. The broker returns a
trade confirmation to XYZ, which acknowledges the trade and sends
settlement instructions to their custodian bank, State Street. State Street
then instructs their local custodian, Mizuho Bank, to receive the shares. On
the settlement date, the instructions from either side of the transaction are
matched resulting in 1000 ABC shares being delivered to “Mizuho Bank -
a/c State Street”. The 1000 shares of ABC Co. (with voting rights) are held
in Mizuho Bank’s JASDEC account (the Japanese equivalent of DTCC*).
The net effect? Mizuho Bank is the proxy for State Street, not XYZ. The
name on the share register is not XYZ but the custodian, “State Street
Bank and Trust Company, standing proxy for Mizuho Bank”.
The beneficial shareholder will generally use electronic proxy services to
instruct the shareholder of record, in this case the onshore custodian or
prime broker, as to how they wish to vote. And this is where the process
gets disturbingly opaque.
*Depository Trust and Clearing Corporation

6. Similar but Different
In theory, electronic proxy service providers such as ADP and ISS enable foreign investors to vote on
annual general meeting (AGM) agendas through custodian or prime broker’s websites. But are they
actually voting? Here is where nuances in the legal structure become critically important, because the
direct link between the beneficial owner and the company owned are still not recognized by those systems.
A foreign investor can instruct the custodian/prime broker to vote FOR, AGAINST or ABSTAIN on each
agenda item through these portals. However, exercising a right and instructing a third party are two entirely
different things. Figure 2 shows how the process actually works.
Because ABC’s dividend is not paid by the issuer directly but by the custodian, we have clear proof that the
issuer does not recognize XYZ as a shareholder. And it follows that if a foreign investor is not a nominee
shareholder, it means they don’t have requirements for shareholder assertion against ABC – precluding
XYZ from exercising basic shareholder rights, such as attending the AGM as a shareholder or submitting
shareholder proposals in the AGM.

8. Diverse exercise
Compounding the problem faced
by non-voting beneficial owners is
the comingling of shares held by
global custodians in “omnibus
accounts”. While custodians and
sub-custodians keep books and
records for millions of individual
accounts, as long as there are no
specific indications, the custodian
usually holds securities in a
disaggregated pool (Figure 3).

10. Voting instructions from unrelated shareholders are aggregated by the proxy service providers and are
collected by the global custodian. When the votes are split, say in an extreme case 60% is FOR and 40% is
AGAINST, the global custodian instructs the sub-custodian accordingly.
However, the Japanese Company Act allows diverse exercise for “persons who hold the shares on behalf of
others” and the sub-custodian is interpreted as such a person. Since the sub-custodian has only one
omnibus account, it’s easy to imagine them being overwhelmed by the sheer number of diverse exercises for
each agenda for thousands of companies during the highly concentrated Japanese AGM season at the end
of June.
While the facts are murky and dependant on each sub-custodian / prime broker’s policy and capability, but
there must be some (or many) providers who cannot handle diverse exercise and opt for using a simple
majority vote. If that is the case, a minority vote may not even be registered at the company’s AGM.
Global custodians may not disclose how aggregated results contribute their actual way of exercise, leaving
investors to see only the final result of the vote in the AGM. There is at least a significant possibility that the
40% against vote would not be reflected in the above case at all. If negative votes were known and
considered, over time more agendas might fail and that there is probably a chance that greater numbers of
agendas would be voted down in the Japanese AGM process. The bottom line is, the voice of a foreign
investor might not be heard at all or only in the nuance of a statistic.

11. Are there practical solutions?

12. It seems like a lot of bureaucratic tape needs to be cut here. But there is hope, particularly for
foreign activist investors where having a voice is crucial to their strategy. If these investors want to
be a “shareholder of record”, they need to proactively ask the Japanese sub-custodian or prime
broker to be a direct standing proxy for them. This is outside the standard custodian service
agreement and may cost extra, since the service is extremely time intensive. For example, before
each record date, foreign investors will have to instruct share transfer from the normal custody
account to the standing proxy’s account to be entitled to the right – all done manually.
There might be another solution. At a recent meeting Symphony moderated between Broadridge
Financial Solutions and senior stock exchange representatives’ discussions centered around the
implementation of a digital proxy voting system. Broadridge confirmed that they could solve many of
these problems using the Investor Communications Japan (ICJ) technology backbone that ICJ has
developed with Broadridge. One potential impediment however, is that the local Japanese bank
owned Transfer Agents all use different systems for tracking share ownership. In any switch to a
newer system, both the bank’s records would have to run in duplicate with the new ICJ system for
some period of time risking confusion and extra costs. Even if the ultimate outcome was one where
massive savings could be achieved by the banks, the current employees at the Transfer Agents
would need to be repurposed. This is just one example of the hidden issues in the reality of
shareholder equality and corporate governance in Japan.

13. One significant and common principle of the stewardship framework often found in other
countries requires institutional investors to be responsible for proxy voting decisions and
the proper exercise of shareholder rights. In particular, Japan’s recently introduced
Stewardship Code is designed to empower shareholders to vote their shares, prodding
management to act differently, shake up company boards, stimulate growth by improving
profitability and capital efficiency, and ultimately increase total shareholder returns.
The sense of increased corporate accountability introduced by recent governance reforms
in Japan under Abenomics is subverted by this flaw in foreign shareholder accountability
due to the out-of-date proxy infrastructure, which has yet to catch up. If our collective hope
is that introverted and conservative management may be improved by shareholder
activism, a more simple and straightforward voting system is required. That could be the
largest value-added service and lead to the achievement of the shareholder equality
principle. Advances in fintech could pave the way for foreign owners of Japanese
companies to seamlessly call on management for reforms. Until then, the current process
may look acceptable on the surface, but it is a crucial disadvantage for investors,
regardless of your domicile, and an impediment to the hope for accelerated economic
growth in Japan.

14. THANK YOU!