Recent inbound investments into Japan, both in the public and private spheres, have been strongly buoyed by a broad range of foreign investors, from private equity to the industrial investors. Even Japanese startups are attracting the attention of industrial and strategic investors across the globe. This positive development is generally the result of the initiatives of the Japanese government, since 2013, to promote foreign investments in Japan, with the aim of increasing such investments to JPY 35 trillion by 2020. As part of these efforts, the Japanese government has amended the Foreign Exchange and Foreign Trade Act (the "FEFTA"), which governs foreign investments in Japan, to deregulate such investments and other cross-border transactions involving Japan.
Given the global trend toward closer scrutiny of inward foreign investments, particularly for national security reasons, the Japanese government is also gradually tightening its inbound foreign investment regulations. In line with this, additional business sectors, such as cybersecurity, have been added to those requiring pre-closing governmental review for foreign investments (the "Designated Business Sectors"). In July 2020, following the outbreak of Covid-19, the Japanese government added the pharmaceuticals and medical equipment sector to the list of Designated Business Sectors to ensure a stable domestic supply of such medical products. Nevertheless, the Japanese government is still actively promoting and opening the door to the foreign investors to promote economic growth in Japan.
Key Points about Foreign Direct Investment Regulations in Japan
Scope of the FEFTA
The FEFTA is the principal legislation regulating inward foreign investments into Japan. Foreign investments in certain business sectors, such as broadcasting and telecommunications, civil aeronautics, mining, and marine transportation, are governed by sector-specific laws and regulations.
The FEFTA regulates inward direct foreign investments by the Foreign Investors1 (the "FDI"). Such FDI include, among others:
- acquisition of 1% or more of the shares in a listed company in Japan;
- acquiring share(s) in unlisted companies in Japan from persons who are not Foreign Investors;
- voting affirmatively on certain matters in respect of a Japanese company under certain circumstances, such as (i) a substantial change in the company's scope of business; (ii) the company's appointment of a director or corporate auditor, and (iii) the transfer of the whole of the company's business or a fundamental reorganization of the company;
- providing loans to Japanese companies that exceed statutory thresholds; and
- establishing a branch, factory or other business office (excluding a representative office) in Japan.
Prior-notification requirement under the FEFTA
Under the FEFTA, in general, a foreign entity investing into Japan must submit an ex post facto report to the relevant governmental authorities via the Bank of Japan. The primary purpose of this requirement is to enable the government to keep statistical records of the number of ex post facto reports it has received.
The FEFTA, however, requires prior notification to be made in cases where the target company (or any of its subsidiaries) of the contemplated FDI is in the Designated Business Sector. This is not an issue only in respect of traditional national security business sectors like broadcasting and telecommunications, where foreign investments are generally understood to require prior notification. However, the scope of Designated Business Sectors has been broadened with recent updates to the FEFTA, and now include the following sub-sectors (among others) within the broadcasting and telecommunication as well as cybersecurity industries:
- software manufacturing;
- information processing; and
- services ancillary to internet services (with certain exceptions).
With the above said, the FEFTA has lately introduced the following new categories of exemption from the prior-notification requirement:
- the "Blanket Exemption", which enables limited categories of foreign financial institutions, under certain circumstances, to acquire shares, with no upper limit, in publicly traded companies in Designated Business Sectors without prior-notification; and
- the "Regular Exemption", which enables certain foreign financial institutions, without prior-notification, to: (a) acquire shares in publicly traded companies in Designated Business Sectors under certain circumstances (with the exception of investments of 10% or more in companies in Core Business Sectors2); and (b) acquire shares in private companies in Non-Core Business Sectors under certain circumstances.
Application of these exemptions from the prior-notification requirement involves very complex and technical analysis and procedures. It is also noteworthy that there is in practice more difficult to circumvent the prior notification requirement when investing in privately-held Japanese entities in Designated Business Sectors. Consultation with experienced local counsel in this area is therefore crucial to avoid unintentional contravention of the prior-notification requirement.
Another point to note is that prior notification under the FEFTA is also required when foreign investors seek to acquire shares of an unlisted Japanese company from another foreign investor, if the company engages in any business that affects national security.
Governmental review of prior-notifications
Where prior notification is required, a proposed investment cannot be completed until the elapse of a 30-day statutory waiting period from the date on which the notification is accepted. During such period, the relevant governmental authorities will request for additional information from the notifying party. The waiting period may be extended by up to five (5) months if the authorities need more time to complete their review. Based on their review, the authorities may request a suspension of the investment or amendment of the proposed investment terms that are deemed problematic from the viewpoint of national security or public order and safety, or if the investment will have a significant adverse effect on the Japanese economy.
Although there have been cases where regulatory review has taken considerably longer than the statutory waiting period, the authorities have rarely exercised its discretion to suspend a proposed FDI. Indeed, to our knowledge, there has been only one case where a suspension order was issued. In 2008, the Children's Investment Master Fund ("TCI Fund"), a UK-based fund, contemplated acquisition of up to 20% in J-Power, a Japanese electricity supplier. Based on their review, the authorities issued a recommendation that TCI Fund should not purchase more than a 10% stake in J-Power. This was followed by further regulatory review and a series of interviews with the relevant stakeholders, after which the authorities decided to suspended the proposed investment, citing concerns that the investment could potentially threaten the provision of affordable electricity, affect the implementation of the nuclear policy of Japan, and obstruct the construction and maintenance of J-Power's nuclear fuel recycling plant.
Although the scope of Designated Business Sectors subject to the prior notification requirement has been considerably expanded, it can reasonably be expected in practice for a straightforward case of FDI for clearance to be issued before the expiration of the 30-day waiting period (e.g., two weeks or less). In complex cases, however, the entire review period could take up to a few month or more to complete. In some instances, the relevant authorities may also make their clearance subject to certain post-investment undertakings by the foreign investors. A cautious foreign investor might consider initiating prior consultations with the relevant authorities before filing a prior notification (the "pre-filing consultation") to resolve issues that the authorities may find problematic. In fact, pre-filing consultations would be advisable in practice.
FDI regulations can significantly affect the structure and timeline of a transaction. It is therefore essential for the foreign investors, as a matter of prudence, to conduct careful checks in advance as to the necessity of prior notification for a contemplated inward direct investment into Japan. In particular, a foreign investor should obtain sufficient information from the target company to determine whether it falls within any Designated Business Sector in the course of due diligence. Given the complexity of such analysis, a foreign investor could inadvertently violate the prior notification requirement if it fails to conduct appropriate legal investigations. It should also be noted that even after completion of the FDI, the exercise of voting rights in the investee company can in certain situations be subject to the prior notification requirement.
Accordingly, it is strongly advisable for foreign investors to engage experienced local counsel from the early stages of a proposed direct investment and, if prior notification is necessary, consult with local counsel on its potential impact on the proposed investment and on the strategy for securing clearance.
1. "Foreign Investor" generally means: (i) an individual not resident in Japan; (ii) an entity (corporation, partnership, association, etc.) not resident in Japan; (iii) (a) a Japanese-organized company or (b) partnership organized for investment purposes (including those established outside of Japan), for which 50% or more of voting rights or controlling interests are directly or indirectly owned or controlled by an individual or entity not resident in Japan; and (iv) a corporation or other entity in which the majority of either its officers or representative officers are not individuals resident in Japan.
2. "Core Business Sectors" are sub-categories of Designated Business Sectors that the Japanese government considers of substantial significance to national security. Accordingly, such sectors require higher levels of governmental scrutiny.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.