Japan is amending its
law on foreign investment to better protect domestic
companies and improve corporate governance. For foreign
investors, the change in rules will mean more due diligence,
but also a change in how they approach activism more
IFLR’s latest primer looks at how Japan,
following changes in similar rules in the US and EU, is
changing its law to protect domestic enterprises from
increasing foreign ownership.
What does the investment law cover?
Japan has passed a bill that will cut the threshold
requiring foreign investors to notify regulators before their
share purchases in sensitive companies from 10 to one percent.
Changes will be made to the Foreign Exchange and Foreign Trade
Act, and are expected to be effective from May 2020.
Sensitive companies are those related to weapons, nuclear
energy, semiconductors and railroads.
Japanese businesses will be allocated to one of three
categories to differentiate between those that will be subject
to the one percent threshold, those that may be exempt, and
those that are not subject to the requirement.
See also: US-China trade war part one:
tariffs’ impact on deal flow is
How will foreign investment be affected?
There will be increased regulatory requirements for equity
investors operating at scale, explains Martin King, managing
partner at Tyton Capital Advisors. For example, if a hedge fund
wishes to take a short-term position in a small or micro-listed
Japanese company, it will need to notify the Ministry of
Finance when it breaches the one percent threshold. The
investor's use of capital may change to avoid the added expense
of the newly mandated reporting. This will have significant
changes on the investment direction of foreign investors, and a
drastic impact on the attractiveness of Japanese companies to
"Foreign investors are working hard to quantify the cost of
meeting the new requirements to inform their investment process
moving forward," said King. "Increased costs mean decreased
profitability, so certain practices may come to an end. Those
activities affected but still profitable will likely continue,
but will create a compression in profitability."
In terms of sectors affected, the focus will be on
technology and telecommunications, such as semiconductor,
integrated circuits, data processing services, and software
Hiroko Jimbo, partner at Nishimura & Asahi added that in
addition to the changes being implemented, the Ministry of
Finance changed its ministerial notification earlier in 2019 to
expand the designated business category for ownership
notifications to include all software development and service
businesses. "Combined with this business category change, the
burden of pre-notification will increase dramatically," she
Not only will investors need to notify the government of
their investment plans, but these plans could be stopped should
the government find them risky to national security. With the
threshold dropping drastically from 10 to one percent,
investments could easily be caught be the notification
China’s new foreign investment law
How will the law impact activist shareholders?
According to Nicholas Smith, equity strategist at CLSA,
hedge funds will be most affected by the change in law as
it’s likely to limit their ability to influence
company management and raise their costs of doing business.
There will be an increase in administration and compliance
costs to comply with the notification requirement as more due
diligence will be necessary when investing in Japanese
businesses. When it comes to activism, filing at one percent
will hurt investors most related to activism and these tend to
be hedge funds. In the long term, the stocks of companies
targeted by the law will suffer.
Japan has seen a growing
trend towards shareholder activism in recent years as Prime
Minister Abe continues to improve corporate governance. For
instance, changes have been made to the
Stewardship Code for businesses to increase engagement with
investors and better manage conflicts of interest.
Shareholders, including foreign institutional investors, are
increasingly asking questions about their long-term
investments, such as disclosure of voting activities and the
inclusion of company policies on potential and actual conflicts
of interest. Yuki Kimura, director at Japan Stewardship Forum,
an industry organisation with more than 80 members in the asset
management industry, said: "The one percent threshold is simply
too low and will discourage foreign investor involvement in
Japanese companies. This is contradictory to the
government’s ongoing efforts to increase corporate
See also: PRIMER: China’s new foreign
What areas of the law lack clarity?
While the law will certainly be lowering the notification
requirement to one percent, there remain a number of areas that
lack clarity. "Definitions are still missing – for
instance, the law doesn’t define what foreigner or
investor means, and who will be given exclusions," said
It’s also unclear whether the duration of
ownership makes a difference, and whether there is a difference
in the treatment of public versus non-public companies.
While the Ministry of Finance has announced that a number of
companies will be exempt from the notification requirement, it
is unclear what these will be until the Cabinet Order and
Ordinance are released in May 2020.
How does it compare with similar laws in other
The change is in line with the efforts of other countries
– such as the US and Germany – to increase
investment controls amid concerns that sensitive technologies
and businesses are being taken over by foreign countries, such
For instance, in the US, in 2018, the Committee on Foreign
Investment in the US (Cfius) was given expanded jurisdiction to
review foreign investments in the US, especially in sectors
such as technology and critical infrastructure.
Smith believes that while Cfius reviews in the US are
stricter, what is not expressly prohibited is still permitted.
However, Japan will likely be taking a strong approach on the
law’s implementation and the law will be
interpreted more broadly.
King added: "I think the legislation will likely expand in
the future using the US as a blueprint. Japan is a fiercely
protectionist country, and such rules are necessary to maintain
National security investment clearances: what
dealmakers need to know