This article is written by Swaranjali Yadav pursuing a Diploma in International Business Law.
This article has been published by Sneha Mahawar.
Table of Contents
Introduction
Recently, there has been an inclination towards nationalism in most countries, especially in the wake of the pandemic. This tendency has affected the phenomenon of globalization. There has been a trend, in recent years, to put limitations or restrictions on foreign direct investments in a country. For example, in Canada, the government has put out an order that it would scrutinize every foreign investment in companies working in the medical sector. Similarly, in India, the government has put restrictions on the FDI from neighboring countries through the requirement of a prior notice to be served to the authorities. Japan is one of the countries to join the bandwagon recently. In the years 2019 and 2020, Japan introduced some amendments to its Foreign Exchange and Foreign Trade Act (FEFTA) to impose some restrictions on investment in certain sectors. This article talks about the provisions relating to foreign investment before the amendments and some background on the Act, the amendments that have been introduced recently and some important provisions in FEFTA and the exemptions from such amendments.
Before the amendment
The Foreign Exchange and Foreign Trade Act was enacted to liberalize the economy. This was also evident in the amendments which followed after the enactment. At that time, foreign investors were only required to submit a post-acquisition report to the Ministry of Finance and the relevant authority governing the industry. The post-acquisition report was submitted whenever a foreign investor acquired a stake in a private company or 10% or more voting rights in a public company. It should be noted that the report was submitted only after the shares were acquired. The report only provided notice of the investment and did not require the consent of the ministries. However, when foreign investors acquired a stake in an industry that was deemed to be closely related to Japan’s national security or was considered to be a key industry protected by the Japanese government, they were required to obtain prior approval from the government. The list included weapons, nuclear power, aircraft, agriculture, petroleum, and leather.
After the amendment
Starting from 2018, there seems to be a shift in Japan’s policy toward foreign investors. In 2019, cybersecurity was added to the “Core Sector” list and then in 2020, pharmaceutical and medical equipment were also added, possibly to secure a stable supply of medical necessities during the pandemic. In the latter half of 2021, rare earth metals were also added to the list. Most of the important amendments have taken place in the year 2019. The “Designated Business Sector” list consists of businesses falling into the following categories- national security, public infrastructure, public safety, protected domestic industries, and also some geographical areas with respect to which there may be certain restrictions in doing business (example – Iran).
There is another list that forms part of the FEFTA and is a subset of the “Designated Business Sector”, called “Core Business Sector” which prescribes even more stringent restrictions. This list was mostly concerned with the national security in Japan which is why it is regulated more heavily. Some of the “Core Sectors” includes electricity, weapons, aircraft, space, nuclear facilities, dual-use technologies, cybersecurity, gas, telecommunications, water supply, railway services, oil, and medical-related sectors.
The Act also lays out the actions which qualify as FDI. Apart from acquiring 1% or more shares in a “designated business sector”; when the investor acquires shares of a privately owned company; when an NRI, who was a resident before, transfers his shares to the foreign investor; when a substantial change is proposed to the objects of the company; when a business is transferred from a Japanese company; giving loans beyond a certain limit to Japanese companies, and such other acts are all considered as FDI.
The ministries review the notice and then issue a suspension or amendment order if the investment by the foreign entity is likely to hamper the public order, the economy of the country, the safety of the public or security of the nation. The amendments lowered the threshold of obtaining voting rights or shares from 10% to 1% and mandated that foreign investors acquire 1% or more of voting rights or shares in any listed company present on the list of FEFTA, to obtain prior approval from the Japanese Government. In any other case, foreign investors can serve a post-acquisition notice to the government.
The amendments also expanded the scope of the definition of a “foreign investor” by including “indirect subsidiaries” in which the overseas investors hold 50% or more shares. Before the amendment, the definition of “Foreign investor” included any overseas entity whether a corporation or an individual, corporations in Japan in which such entities held more than 50% shares and direct subsidiaries of such corporations. Similarly, in the case of partnerships, if the general partner qualifies as a “foreign investor” or if they made 50% or more investment in a Japanese corporation, they will be considered as foreign investors under FEFTA.
FEFTA also regulates the shareholders’ rights and acts, where the shareholder has 1% or more shares in the company and is classified as FDI. These include major decisions that may be proposed at shareholder’ meetings such as the appointment of a director or auditor; transfer of shares, interests or the business of the company or its subsidiaries; a merger or split of the company; distribution of the business or shares of the company or its subsidiaries; discontinuance and dissolution of the company. To do any of these acts the prior notice has to be submitted.
When a foreign investment manager holds 1% or more shares in a company on behalf of the foreign investors and exercises the shareholders rights on their behalf the manager will have to submit a prior notice with the Japanese authorities. The foreign investor, on the other hand, will be relieved from such formalities if he gives up all of these rights to his manager. However, on retention of some of the rights, the foreign investor will also be required to file prior notice.
Apart from FEFTA, there are other enactments as well which regulate the FDI in Japan in certain sectors such as the Broadcast Act, Nippon Telegraph and Telephone Corporations Act, Ships Act, Radio Act, Mining Act, etc.
Exemptions
The Act also provides for exemption in some cases. These exemptions are classified into two- “Blanket Exemption” and “Regular Exemption”. The “Blanket Exemption” is available only for “foreign financial institutions” registered in Japan and are subject to their financial regulations, such as banks, insurance companies and securities firms. However, to be eligible for the exemption they have to guarantee that they (including persons closely related to them) will not become directors or auditors of the company; will not ask for transferring the business or shares or interests in its subsidiaries, merger or split of the company, distribution of the shares or the business of the company or its subsidiaries as a dividend, discontinuance of the business or its disposal; it will not try to obtain the company’s technology which has been kept from the public. The objective is to keep foreign investors out of major decisions concerning the company. This type of exemption allows foreign investors to purchase any number of shares in a Japanese company without having to serve a prior notice to the Japanese authorities. However, they will have to submit a post-acquisition report upon acquiring 10% or more shares in the company. This exemption does not extend to private companies.
The second exemption which is allowed for entities other than “foreign financial institutions” is “Regular Exemption”. The extent of the exemption depends upon the type of business the Japanese company is engaged in. If the company is engaged in a “Designated Business Sector” and not a “Core Sector” the investor will be relieved from submitting a prior notice but will have to submit a post-acquisition report if acquired shares are 1% or more. However, the conditions specified above have to be taken care of. If the company is engaged in the “Core Business Sector” the investor will be relieved from filing a prior notice if he has less than 10% shares in the company but will have to serve a post-acquisition report if he holds more than 1% shares. The investor will have to abide by the conditions mentioned above and certain other conditions also. The investors shall not be present at important board meetings such as executive meetings and committee meetings and shall not make any written proposals to the Board or the Executive Board requiring responses from them.
Conclusion
Going forward, before making any investments, the foreign investors will have to consider the restrictions that have been introduced through these slews of amendments in certain sectors in Japan, especially the “Designated Business Sectors”. Along with the general restrictions the foreign investors will also have to keep in mind the industry-specific restrictions that are levied. For example, there is a limitation on FDI beyond 20% in broadcasters and 33% in Nippon Telegraph and Telephone. There might be a need to obtain approvals from different industries involved in such cases.
However, the Japanese authorities usually do not take a hard stance against the FDI in such sectors. They often allow foreign investors to invest in the companies after receiving satisfactory notice from them before such investments. Till now, only one such proposal for investment has been rejected by the Japanese authorities. Foreign investors should make decisions based on their interests at present and in the future. The short-term and long-term effects of these amendments on the FDI and ultimately the economy of Japan will only be clear after some time has passed.
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