Have there been any recent changes to the Foreign Investment rules in Japan?
The Japanese government has announced several key amendments to the Foreign Exchange and Foreign Trace Act (FEFTA Amendments) and their related regulations, which tighten the regulatory requirements for foreign direct investment (FDI) in Japan.
The last of the FEFTA Amendments was implemented on June 7, 2020.
If yes, please provide a brief summary of the changes
In summary, the changes to FEFTA have:
- expanded the scope of the Designated Business Sectors (DBS) required to comply with prior notification and waiting period requirements;
- reduced the threshold of what would qualify as foreign investment-related activities; and
- introduced an exemption scheme for prior notification for investment in public company; and
- expanded the definition of foreign investors to include companies where 50% or more of the voting shares are held by the Japanese resident foreign investor and / or their subsidiaries, and partnerships that intend to engage in investment businesses where the total amount of contribution by non-resident partners is more than 50% of the total amount, or where a majority of executing partners are non-residents.
Further detail relating to each of these changes is included below.
Extended scope of DBS
The FEFTA amendments expanded the scope of the DBS, by adding the following sectors relating to information and communication technology:
(a) Manufacture of devices and components related to information processing, including:
- Manufacture of integrated circuits;
- Manufacture of semiconductor memory media;
- Manufacture of optical discs and magnetic tapes and discs;
- Manufacture of electronic circuit mounting boards;
- Manufacture of wired communication equipment;
- Manufacture of mobile phones and personal handy-phone system phones;
- Manufacture of radio communication equipment;
- Manufacture of computers (other than personal computers);
- Manufacture of personal computers;
- Manufacture of external storage
(b) Production of software related to information processing, including:
- Custom development of software;
- Embedded software;
- Packaged software;
(c) Telecommunications services, including:
- Regional telecommunications;*
- Long distance telecommunications;*
- Wired broadcasting and telephony;
- Other fixed telecommunications;*
- Mobile telecommunications;*
- Information processing; and
- Internet use support.*
*The FEFTA amendments broadened the scope of these restrictions.
The FEFTA amendments also divided the DBS into two categories, the Core Sectors and the Non-Core DBS. Tighter exemptions apply for foreign investment in companies conducting business in the Core Sectors.
The Japanese Ministry of Finance (MOF) published a list that classifies each listed company into one of the following categories:
Companies subject to post-investment report only (i.e. Non-Designated Business Sectors)
Companies conducting business activities only in the designated business sectors other than core sectors (i.e. Non-Core Designated Business Sectors)
Companies conducting business activities in the core sectors (i.e. Core Sectors)
*The list can be downloaded here:
Lowered threshold for foreign investment-related activities
Previously, the FDI regime applied to any acquisition of 10% or more of the equity in a listed Japanese company by a foreign investor, or any vote that constituted a material change of the business scope of the target company by a foreign investor who enjoys at least one third of the voting rights of the target company.
The FEFTA Amendments have lowered the threshold so that the actions falling under FDI now include:
- the acquisition of 1% of the equity ownership or voting rights of a listed Japanese company by a foreign investor along with its Closely-related Persons either by ownership or by proxy, or a circle of foreign investors;
- any vote on the nomination of the foreign investor itself or its closely related person as a board member of the target company;
- any vote for a proposal, made by those foreign investors, to transfer or dispose of the target company's business in the DBS; and
- the transferral or inheritance of a resident company by a foreign investor via merger or split.
Exemption scheme introduced for prior notification of investment in public company
The FEFTA Amendments provide 'Blanket Exemptions' from the prior notification requirement for foreign institutional investors – including banks, securities firms, insurance companies, asset managers, trust companies and high-frequency traders. The Blanket Exemption is applicable to all DBS including the Core Sectors.
Exemptions can be obtained only if foreign institutional investors and their Closely-related Persons do not plan to become board members, propose to transfer or dispose of the business under DBS, or access non-public information about target companies' technology.
The FEFTA Amendments also provide a 'Regular Exemption', which is available for sovereign wealth funds and those classified as 'General Investors' to apply for via a screening process. Once the screening process is complete, the foreign investor will need to enter into a MoU with the Japanese government before being eligible for Regular Exemption from the prior notification requirement.
The Regular Exemption is not available to investments in Core Sectors (such as weapons production, nuclear power, certain kind of electrical power and communication) reaching a 10% threshold or where the foreign investor is a state-owned company, unless they have been accredited by the Japanese government.
Expanded definition of foreign investors
Under the previous FDI regime, foreign investors included:
- companies located in Japan that were 50% or more owned by foreign investors, as well as direct subsidiaries of such companies; and
- corporations, partnerships, associations or other entities in which the majority of either the officers (i.e. directors or similar) or the representative officers were non-resident individuals.
- The FEFTA Amendments expanded the criteria to include:
- companies established under Japanese law of which the ratio of the sum of the voting rights held by the Japanese resident foreign investor (companies located in Japan with 50% or more ownership of foreign investors) and / or their subsidiaries is 50 per cent or more; and
- a partnership that intends to engage in investment business where the total amount of contribution by a non-resident to the total amount of contribution by all partners is equivalent to 50/100 or more, or a majority of executing partners are non-resident.
What was the rationale for the changes?
According to the outline of the FEFTA Amendments published by the MOF, the main reason for modifying the FEFTA is to further promote FDI to help drive economic growth and to bring Japan in line with other jurisdictions such as the USA and UK, which have strengthened FDI screening measures to protect national security.
Are these changes temporary and if yes, when are they likely to be reviewed again? If not, are they part of a bigger reform (ie have there been any other recent developments, and are you expecting any further changes)?
At this stage we do not expect any further changes and there is no evidence to show that the changes are part of a bigger reform. The changes in the foreign investment regulations in Japan are not temporary and they are mainly a response to growing global concerns about national security and the leakage of critical technology.
In response to the COVID-19 pandemic, Japan has also designated the manufacture of pharmaceuticals for infectious diseases, and the manufacture of highly controlled medical devices as Core Sectors, to ensure the stable supply of necessary drugs and equipment for domestic use.
Are there any particular sectors that are affected the most?
Hedge funds and venture capital firms, along with their target companies (especially start-ups) will be most affected by the changes as they are likely to limit their capacity to influence company management.
There will also be an increase in administration and compliance expenses in order to comply with the notification requirements as more due diligence will be necessary when investing in Japanese businesses.
Additionally, foreign shareholder activism, which has been on the rise in recent years in Japan, will likely be affected by the FEFTA Amendments. The FEFTA Amendments will make it more challenging for foreign activist investors to target listed Japanese companies, some of which have struggled when dealing with activist investor campaigns.
For many financial institutions, the adverse impact of the FEFTA Amendments may not be as critical as expected. Provided these institutions can avoid being involved in the management of the Japanese companies that they invest in, they will likely be exempt from the prior notification requirements.
What is the outlook for foreign investment in Japan?
The FEFTA Amendments will likely delay the speed of closing deals and result in higher due diligence costs for foreign investors considering investment in Japanese companies, particularly those operating in DBS.
This added cost of doing business may dampen the mood for FDI in Japan. However, the FEFTA Amendments have only recently come into effect and so it is still too early to predict the outlook for FDI in Japan.
What it is your advice to foreign investors in Japan?
The FEFTA Amendments add restrictions to investments in more than half the listed companies in Japan, though a series of blanket exemptions will apply for particular investors, including most financial and asset management firms. Investors will need to consult with their advisors at an early stage to determine whether a target company's operations fall within one of the DBS.
The revised FDI regime will ultimately see a number of foreign investors not previously subject to MOF notification requirements or approval required to comply with these requirements. These investors and their advisors will need to become familiar with the foreign investment framework and obtain guidance on how to notify and engage with the MOF.
Does the MOF coordinate with other government agencies, including the antitrust regulator?
Foreign investors required to file a prior notification must file with the MOF and other relevant ministries via the Bank of Japan. The MOF and the ministries related to the DBS that the target company engages in will review and assess the proposed investment to prevent national security threats. Apart from the DBS-related ministries, the MOF does not coordinate with Japan's antitrust regulator, the Japan Fair Trade Commission (JFTC), or any other government agency for that matter, to assist with its review.
Foreign investors are required to file with the JFTC for concentration screening under the Anti-Monopoly Act if the transaction meets the relevant antitrust thresholds. JFTC's review is independent from the MOF's review under FEFTA.
 See the JFTC's explanatory document for thresholds of mandatory notification here: https://www.jftc.go.jp/en/policy_enforcement/mergers/index_files/ThresholdforNotification.pdf