Recently, there has been increased scrutiny and restrictions implemented on foreign direct investment ("FDI") in the world's main economies. This has been a reverse of countries' attitudes of favouring liberalization of cross border transactions. We have seen the most protectionist measures imposed on the technology sector as countries try to shield sensitive information and technologies. Notably, both in the U.S and in the U.K, the government strengthened its ability to review FDI in technology sectors in 2018.
COVID-19 accelerated this global U-turn of approaches towards FDI. The same protective attitude towards technology is now being felt in the medical sector. In line with this trend, the Japanese government has added the sectors of medicine and medical equipment to the list of protected businesses under the Foreign Exchange and Foreign Trade Act ("Forex Act").
While significant, this most recent amendment seems only an afterthought to the lengthy and complex series of amendments made to the Forex Act over the past 2 years. The fundamental stance of the Japanese government has been to increase FDI into Japan, with an ambitious target to increase FDI by 35 trillion yen by 2020. However, these amendments further restrict FDI by expanding protected sectors, increasing thresholds for prior notifications, and widening the definitions of 'FDI'.
Because of the complexity of the series of amendments to the Forex Act, it is useful to first unpack some important terms and requirements.
"Foreign Investor" means (1) non-residents of Japan; (2) foreign companies; (3) Japanese companies that have 50% or more of their shares held by a person or entity who qualifies under (1) and/or (2); and (4) Japanese companies in which the majority of either officers or the representative officers are non-resident individuals of Japan.
"Foreign Direct Investment": Investments not only though share acquisition or subscription to new shares in Japanese companies, but also other activities of foreign shareholders: including exercising their vote at shareholder meetings, appointing or removing a director, making proposals having a material impact on the management of the company.
"Prior notification": A filing to the Bank of Japan required prior to an investment in a Japanese company by a Foreign Investor. For example, required for Foreign Investors that purport to own or control 1% or more of either shares or voting rights in a Japanese company in the Designated Business Sector and Core Business Sector. Companies that need to make prior notifications essentially require clearance and approval from the Ministry of Finance to invest in Japanese companies.
"Core Business Sector" are those sectors in the Designated Business Sector that the government designates as crucial to national security. Includes oil, railways, utilities, arms, space, nuclear power, aviation, telecommunication and cybersecurity sectors. As of June 2020, 558 companies were listed in this category, and make up 40% of the market capitalization of all listed companies.
"Designated Business Sector" is made up of the Core Business Sector and other non-core business sectors. The non-core sectors include broadcasting, public transportation, agriculture, forestry and fisheries, air and maritime transportation, etc. As of June 5 2020, there are 1,553 companies in the non-core sector.
2._Recent amendments to the Forex Act in relation to acquisitions of listed company shares
In 2019, the industries requiring prior notification if foreign shareholding exceeded 10% of shares in listed companies was expanded. Then, the 10% threshold shifted focus from the percentage of equity, to the total number of voting rights. In May 2020, the threshold was lowered from 10% to 1% for the Designated Business Sectors: with some different exemptions for (i) non-core business sector of the Designated Business Sector and (ii) Core Business Sector, respectively. As a result, of the 3800 companies listed on the Tokyo Stock Exchange, 2111 will require prior notification and effectively Ministry of Finance approval. Of the 2111 companies that require prior notification, investments in the 558 in the Core Business Sectors will require rigorous reviewing.
The amendments lead to confusion, as it is not always clear cut what industry the investee company is doing business in. For instance, handbag businesses may be deemed as operating in the arms sector, since the use of leather has traditionally been prominent in creating weapons. In response to this, the government published a schedule of all listed companies and classified them into 3 categories, which it plans to continuously update: a) companies in the Core Business Sector; b) non-core companies in the Designated Business Sector; and c) Companies that are in neither of the above Sectors.
3._Addition of the medicine and medical equipment sector
In April, the government announced that, effective from July 15, 2020, it will add medicines and medical equipment to the Core Business Sectors. This move is to ensure a stable domestic supply of medicines and medical equipment amid the COVID-19 pandemic and potential future outbreaks. These include manufacturers of vaccines, heart and lung machines, ventilators, pharmaceuticals, etc.
While in theory it should be easy to determine what companies might come under the scope of the new regulation, as with the previous amendments, there will be surprising consequences for some. An updated list of companies added to the Core Business Sector is yet to be announced. Thus, the scope of the application is yet to be understood.
4._Impact of these amendments
Foreign investors looking to invest in Japanese listed or unlisted companies should conduct due diligence to ascertain all the business activities and possible future business activities of the investee company: especially those looking to invest in Japanese companies that may have a smaller medical subsidiary or manufacturers of parts or equipment that could be used in the medical industry. If there is a possibility that the investee company could enter a restricted sector, the Foreign Investor's voting powers and proposals at shareholder meetings will require a prior notification, as it would fall within the scope of FDI under the Forex Act.
Further, in a previous article, we discussed the growth of shareholder activism in Japan. The definition of FDI that captures shareholder actions in appointing directors or suggesting agenda items at shareholder meetings could curb this trend, especially for notable U.S based activist funds that have become known.
The amendments empower the government to suspend, modify and rescind FDI. Yet it should be emphasized that for most investors, the main effect is procedural nuisance, not having FDI blocked outright. Since the government implemented prior notification requirements, as far as public knowledge goes, only one FDI has been blocked by the government. There are also exemptions for investors who meet certain requirements. In any event, foreign investors will need to carefully structure their investment and engage an experienced Japanese law firm when investing in a Japanese listed or private company.
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