The Cabinet Office approved a draft Bill (the Bill) on 18 October 2019 that will be presented to the Diet for review during its current session (4 October to 9 December 2019). The aim of the Bill is to tighten the regulations concerning foreign investment in Japan. Tightening the regulations is a two-step process: (1) the draft Bill amends the framework for the regulations on foreign investment into Japan; and (2) a Cabinet Order, which will be published within the next six months, that will set out further detail on how the new regime will operate in practice. The draft Bill is scheduled to receive approval by 9 December 2019. This client alert summarizes the key points contained in the draft Bill, as well as an assessment of what might be expected in the anticipated Cabinet Order.
New 1 percent threshold
Once enacted into law, the government's Bill will amend the Foreign Exchange and Foreign Trade Act (FEFTA) to lower the threshold (from 10 percent to 1 percent) above which prior-notification is needed for foreign investors to hold an equity stake in Japanese listed companies in certain key industries.
Under the draft Bill, foreign investors include:
- Non-resident individuals;
- Corporations, partnerships, associations or other entities established under foreign jurisdictions or having their principal offices in foreign countries;
- Corporations established under Japanese law of which the ratio of the sum of the voting rights directly or indirectly held by those listed in (1) and/or (2) is 50 per cent or more;
- 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; and
- Corporations, partnerships, associations or other entities in which the majority of either the officers (i.e., directors or similar) or the representative officers are non-resident individuals.
It remains to be seen in the Cabinet Order which industries will be caught by the new 1 percent threshold regime. That said, the existing 10 percent threshold regime applies to foreign investment in key industries which might be vulnerable to concerns of national security. There is a high possibility that the new 1 percent threshold notification regime will apply to the same key industries caught by the current 10 percent threshold notification regime, which includes:
- Companies whose business relates to national security (e.g., manufacturing weapons, satellites and nuclear power plants);
- Companies whose business relates to public infrastructure (e.g., electricity, gas, and telecommunications);
- Companies whose business relates to public order and safety (e.g., pharmaceutical manufacturing and private security services) ; and
- Companies facilitating the smooth management of the Japanese economy (e.g., agriculture, forestry, fisheries, oil, air and marine transport).
Additionally, in August 2019 the government expanded the scope of foreign investment in 'key industries' for which prior approval is required to include software, technology manufacturing, and communication industries. In addition to what was already covered by FEFTA (including the other aforementioned industries), since August 'key industries' now include:
1. Businesses that manufacture devices and components related to information processing, namely:a. Integrated circuits
b. Semiconductor memory media
c. Optical discs, magnetic tapes and discs
d. Electronic circuit implementation boards
e. Cable communication equipment
f. Mobile phones and PHS
g. Radio communication equipment
h. Electronic calculators
i. Computers (e.g., personal computer, laptop, and tablet)
j. External storage device
2. Businesses that produce information processing-related software, namely:a. Custom software development services
b. Embedded software services
c. Packaged software services
3. Telecommunications services:
a. Regional telecommunications (except wired broadcast telephone services)
b. Long-distance telecommunications
c. Cable broadcast telephone services
d. Miscellaneous fixed telecommunications
e. Mobile telecommunications
f. Data processing services
g. Internet user support services
New provisions introduced by the draft Bill
The draft Bill adds a new requirement whereby any foreign investor that gives 'consent to matters which could have a significant effect on the management of the business of that company' (details of which will be specified by the Cabinet Order) will have to notify the Ministry of Finance (the MOF). Unfortunately, little clarity has been given by the government as to the meaning of 'matters' which could have a 'significant effect on the management of the business of that company'. Investors will therefore need to wait for the anticipated Cabinet Order to be published to gain greater insight into how the new provision will operate in practice. Additionally, the draft Bill creates a new notification requirement for any foreign investor that transfers a business, implements a merger or absorption-type company split with a Japanese company.
It remains to be seen how these new provisions will impact foreign investors and whether the new provisions introduced by the draft Bill will apply only to foreign investment in certain key industries already covered by FEFTA, as discussed above, or potentially widen the scope of industries caught.
New exemption system
Whilst the draft Bill has not offered a great level of detail into how the new provisions will operate, it has put in place a new exemption system for foreign investors that could help mitigate onerous effects arising from the new provisions. The scope of the new exemption system will be clarified in the upcoming Cabinet Order. However, according to a paper published on 18 October 2019 by the MOF1, stock transactions by foreign banks, foreign securities firms (when using their own proprietary accounts), insurance companies, and asset management companies will be exempted from the prior-notification requirement, irrespective of the business sectors of the stocks. As readers will appreciate, 'asset management companies' is a very broad category and this category will be further defined by the Cabinet Order. Further, larger financial institutions as well as smaller brokerage firms will likely be included in the definition of 'foreign securities firms'.
The notification process
Currently, under FEFTA, written notification must be given to the MOF and the minister with jurisdiction over the target company's area of business e.g., minister of agriculture, transportation, etc. The MOF and relevant minister will then review and consider if the proposed investment is likely to impair national security, impede public order, compromise public safety, or have a significant adverse effect on the smooth management of the Japanese economy. Under normal circumstances, the application process takes between 5 to 10 days from the date of filing, but can potentially take up to 30 days. Notification (which is submitted manually) is submitted via the Bank of Japan- no filing fee is required and the relevant form(s) can be found on the website for Bank of Japan.
According to the MOF, to date there has only been one instance of the government stopping a proposed investment. In 2008, the Children’s Investment Fund, a UK-based activist fund, notified the authorities of its intention to purchase up to a 20 percent stake in J-Power, an electric power wholesaler owning core infrastructures in the Japanese electricity supply. After their review, the relevant ministers stopped the proposed investment, citing concerns that the "notification impacted and could interfere with Japan's policies on the stable supply of electricity, nuclear and nuclear fuel cycle and the maintenance of public order."
Implications for foreign investment in Japan
The government's Bill could have a chilling effect on foreign investment into Japan as the 1 percent threshold might deter outside investors due to increased scrutiny and delays to the transaction schedule. At present, under Japanese company law shareholders holding at least 1 percent of a company's voting rights can present resolutions at a general meeting, and shareholders holding at least 3 percent or more of a company's voting rights can demand a shareholders' meeting.
Some commentators have defended the draft Bill as an attempt to align Japan with similar U.S. and European regulations, i.e. the aim is to protect sensitive/confidential information and advanced technologies from being appropriated by other countries. However, some market participants have expressed concern that the proposed amendments will undermine Japan's Stewardship Code, which encourages foreign investors to participate in the management of Japanese companies in order to facilitate business operations and maximise shareholder value. Lowering the threshold to 1 percent, along with the introduction of several new requirements, exceeds similar restrictions imposed by other countries. By way of comparison:
- In the United States, the Committee on Foreign Investment in the United States ("CFIUS") has the power to review foreign investments in US businesses on national security grounds. As a result of the recently passed Foreign Investment Risk Review Modernization Act 2018 ("FIRRMA"), certain critical technology investments require a submission of a mandatory declaration with CFIUS as of November 2018, and certain additional categories of foreign investments will become subject to mandatory filing requirements on or before February 13, 2020. While historically CFIUS's jurisdiction was triggered in the context of transactions that could result in control of a US business by a foreign investor, FIRRMA expanded CFIUS's jurisdiction to certain noncontrolling investments involving US businesses dealing in critical technology, sensitive personal data, and critical infrastructure as well as certain real estate transactions that were outside CFIUS's jurisdiction in the past. Baker McKenzie has been assisting clients with comments on the proposed rules that are expected to come into force in 2020.
- In the E.U., the E.U.'s Framework Regulation (the "Regulation") created a common basis for screening foreign investment into Member States on grounds of public security and public order. However, the Regulation does not set out mandatory screening requirements at EU-level, and it is up to the specific Member State to decide how to screen foreign investment. In Germany, for example, notification is required when foreign investors acquire (either directly or indirectly) 10 percent or more of voting rights in a company operating in 'critical infrastructures', and 25 percent of voting rights in companies operating outside of 'critical infrastructures.'
- In the U.K., there is currently no standalone foreign investment screening regime. However, the U.K. government can intervene under U.K. merger control rules where any transaction meeting the relevant thresholds gives rise to public interest concerns (currently limited to national security, financial stability and media plurality). On 24 July 2018, the U.K. Government published a White Paper setting out its proposals for screening of investments that pose a threat to national security. The proposals capture investments or activities involving the acquisition of more than 25% of an entity's shares or votes, or 50% of an asset, or significant influence or control over an entity or asset. Whilst notification is voluntary, if parties choose not to notify then the government will be able to call in the deal for national security review. The government will be able review deals that relate to any sector of the economy, though has stated that certain 'core areas' are more likely to raise national security issues- for example, parts of national infrastructure sectors, some advanced technologies, critical direct suppliers to government and emergency services sectors, and military and dual use technologies.
There are instances of the Japanese government watering down proposals for legislative amendments after pressure from foreign investors. For example, in 2018 the Japanese Ministry of Economy, Trade and Industry (METI) attempted to push through a number of proposals to introduce strict new deadlines and other measures on solar project developments in Japan. The initial proposals would have retracted some important features of the existing regulations, which were originally designed to promote solar project development. However, METI eventually relaxed its position after a period of public consultation. Baker McKenzie was active and took a leading role in that public consultation process. In particular, Baker McKenzie worked closely with key stakeholders in the solar industry and engaged in consultation with the government on the possibility of investor-state dispute proceedings against Japan if the government chose to go ahead with its original proposals. The threat of initiating proceedings mirrored a similar scenario that had already occurred in Spain with its foreign investors when it attempted to amend, amongst other matters, certain regulatory measures originally designed to incentivize foreign investment in renewable energy.
We will continue to monitor the situation closely, in particular regarding the possibility of the Japanese government opening up the draft Bill to a period of public consultation. In the coming months it will be important for interested parties potentially affected by these reforms to remain aware on how the new notification requirements might negatively impact foreign investment. There are structures which foreign investors may be able to employ to avoid the applicability of mitigating structures and also the potential for engagement in any governmental consultation processes.