Structuring an ESG Mutual Fund in Japan – Finance and Banking

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At the time of its inception, Japan’s first ESG-focused venture capital fund, the MPower Partners Fund, founded by former Goldman Sachs Vice Chair Kathy Matsui and with a volume of $ 150 million, was attracting a lot of attention in the fund industry.

The MPower Partners Fund is a rarity in Japan due to its female leadership, as noted by Bloomberg and other media outlets. In addition, while the venture capital investment market in Japan has grown rapidly in recent years, it remains small compared to its counterparts in the US and China. The launch of the fund marks a significant milestone in the Japanese mutual fund industry.

Despite the relative novelty of ESG funds in Japan, structuring an ESG strategy-based mutual fund is similar to structuring any other type of mutual fund. This article highlights practical knowledge and advice that fund managers can refer to when setting up an ESG mutual fund in Japan.

Think through

In Japan’s mutual fund industry, certain fund structures have become widely accepted among certain investor groups. Despite this familiarity, fund managers are encouraged to evaluate the extent to which the considerations discussed below may apply to their proposed fund.

There is no guarantee that a fund structure that worked in the past will work again in the future. Furthermore, given the constant changes in the laws regulating investment funds, it would be precarious to launch a fund without carefully weighing its risks and potential returns.

The structure of a mutual fund is one of, if not the most important, characteristic. Although it is easy to fall back on “proven” fund structures, we recommend fund managers carefully examine the structure of the fund before launching it.

Structuring considerations

When structuring a venture capital fund, taxation is one of the most important considerations. Ultimately, the performance of the fund strategy is insignificant, unless both the investment of the fund assets and their distribution to investors are tax-efficient. Several factors can potentially affect tax efficiency, including the type and location of the target assets, the shape of the mutual fund itself, the management of double taxation treaties, and the legal system of fund investors.

In addition, it is equally important for fund managers to thoroughly understand any regulatory considerations that may apply to the operation of the fund, as each jurisdiction has its own laws and regulations that govern different aspects of their operations. The laws and regulations of any jurisdiction in which the fund has a connection (e.g. where the investments are made, where the fund is managed, where the fund units are offered, etc.) should be carefully examined to ensure that the fund can work in full compliance with applicable laws. In addition, given the inherent cross-border nature of mutual funds, various licenses, registrations or notifications may be required from regulators.

Finally, it should be noted that the attractiveness of a fund does not necessarily come with tax concerns and regulations. Even if a mutual fund is established in a tax efficient manner and in full compliance with applicable regulations, there is no guarantee that the fund will successfully raise capital. Investors in certain jurisdictions may have strong preferences for certain types of mutual funds due to their structure and location. As a result, some investors will only invest in structures that they have invested in the past.

The ESG component

While the structuring process of an ESG fund is not that different from that of other venture capital funds, the selection strategy of the portfolio companies plays a bigger role in ESG funds. ESG fund managers must strictly adhere to a variety of self-imposed investment guidelines that restrict the industries they can invest in and the ways in which investments are made.
Due to the recent popularity of ESG strategies with allocators, some fund managers may seek to “green wash” their funds by adding an isolated ESG component to their strategies. This practice has become more common due to the discrepancies in the interpretations of “ESG”.

However, “greenwashing” is not without its risks. First, various regulatory agencies are taking steps to prevent this practice. For example, the US Securities and Exchange Commission published a “Risk Alert” in April after recent investigations into ESG investing and the discovery of problematic ESG investment practices.

In addition, investors themselves are becoming increasingly complex in understanding and monitoring their investments in ESG funds. We have observed that more and more key investors in Side Letters are documenting additional ESG investment restrictions and monitoring obligations with fund managers.

Given the latest trends, we anticipate that “real” ESG themed mutual funds will continue to grow in popularity. As regulations for ESG funds evolve and investors gain more experience with such investments, we believe that ESG fund managers who are genuinely social and environmental can enjoy more opportunities and successes in this area.

The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.

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