Japan: Transformed FDI Ecosystem Emerges in the Wake of New Regulations and Restrictions
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Overview of regime
Outline of applicable legislation and relevant authorities
The Foreign Direct Investment (FDI) control regime in Japan is mainly governed by the Foreign Exchange and Foreign Trade Act (FEFTA). The FEFTA is supplemented by various cabinet orders and ministerial ordinances (collectively, the FDI Regulations).
The purpose of the FEFTA is to prevent national security-related technology outflows while continuing to promote FDI for sound development of the Japanese economy. Under the FEFTA, foreign investors will need to submit prior notifications and post-investment reports to the government authorities when making certain types of investments (inward direct investment) in Japanese companies. The government authorities in charge of the relevant business sector will review the notifications and reports and determine whether the investment will undermine national security, public order, public health and safety, or the smooth functioning of the national economy.
In addition to the restrictions on foreign investment imposed by the FEFTA, there are also certain restrictions on investments by foreign investors and the appointment of foreign directors in specific business sectors such as telecommunications, broadcasting, and transportation, as provided under the relevant Japanese laws (e.g., the Broadcasting Act, the Radio Act, the Civil Aeronautics Act, the Consigned Freight Forwarding Business Act, and the Security of Ships and of Port Facilities Act).
Scope of regime
In response to growing concerns over Japan’s security and the outflow of critical technologies and in light of the trend toward stricter FDI Regulations in the interest of global security, since October 2017, the Japanese government has introduced several significant amendments to the FDI Regulations, including expanding the scope of inward direct investment caught by the regime, revising the scope of prior notifications and introducing an exemption system for prior notifications. The current inward direct investment regulations under the FEFTA, which reflect these amendments, are detailed below.
Foreign investors making inward direct investments are generally required to provide prior notification if the investment target company, including its subsidiary, is engaged in a business in a designated business sector. If the investment target company is not engaged in a business in a designated business sector, the foreign investor will only need to submit a post-investment report after the investment has been made. In addition, a foreign investor who acquires shares of a Japanese non-listed company from another foreign investor (defined as ‘specified acquisition’ under the FEFTA) will need to submit a prior notification if the investment target company, including its subsidiary, is engaged in a business in a designated business sector.
‘Foreign investor’ as defined in the FDI Regulations includes the following:
- individuals who are not domiciled or resident in Japan;
- companies or other entities that are organised under the laws of foreign countries or whose principal places of business are located outside Japan (excluding partnerships falling under 4 below);
- companies in which 50 per cent or more of the total voting rights are held, directly or indirectly, by individuals and/or companies falling under 1 and/or 2 above;
- general partnerships (nin-i kumiai) established for the purpose of investing in companies, limited partnerships for investment (toshi jigyo yugen sekinin kumiai), or any other similar partnerships, where either:
- 50 per cent or more of the total contributions are made by non-residents as defined in the FDI Regulations or certain other foreign investors; or
- a majority of the general partners who are delegated to execute the business of the partnerships are non-residents as defined in the FDI Regulations or certain other foreign investors; or
- companies or other entities in which a majority of the following are individuals who are not domiciled or resident in Japan:
- directors or other officers; or
- directors or other officers with power of representation.
Inward direct investment
Under the FDI Regulations, the definition of ‘inward direct investment’ mainly includes the following transactions:
- Acquisition of shares or voting rights in a Japanese listed company, where the investment ratio is 1 per cent or more in the aggregate with any party who has a special relationship with those foreign investors.
- Acquisition of any share or equity in a Japanese non-listed company from persons other than foreign investors.
- Succession of all or part of the business from a Japanese company by a business transfer, demerger, or merger.
- Agreeing with a substantial change in business purpose of a Japanese company. In the case of a Japanese listed company, this is applicable only when a foreign investor holds one-third or more of the total voting rights.
- Agreeing with any of the matters below, which are designated as matters that would materially affect the management of a Japanese company. In the case of a Japanese listed company, this is applicable only when a foreign investor holds 1 per cent or more of the total voting rights:
- appointment of directors or statutory auditors who are the foreign investors or a party who has a special relationship with such foreign investors;
- sale of the entire business or part of the business;
- sale of all or part of the shares or equities of a subsidiary;
- distribution of the business or the shares of a subsidiary as dividend;
- dissolution; and
- abolition of business.
- Establishing a branch, factory, or other business office (excluding a representative office) in Japan, or substantially changing in type or business purpose.
- Granting a loan with a term of more than one year to a Japanese company, with the result that (1) the total outstanding amount of loans exceeds the amount equivalent to ¥100 million and (2) the total outstanding amount of the Japanese company’s loans and bonds (if any) held by the foreign investor and any party who has a special relationship with the foreign investor exceeds 50 per cent of the total debt of the Japanese company.
- Acquisition of bonds with a term of more than one year between the acquisition date and the maturity date issued by a Japanese company, with the result that (1) the outstanding amount of the Japanese company’s bonds held by the foreign investor exceeds the amount equivalent to ¥100 million and (2) the total outstanding amount of the Japanese company’s loans and bonds held by the foreign investor and any party who has a special relationship with the foreign investor exceeds 50 per cent of the total debt of the Japanese company, except where the acquisition of bonds denominated by Japanese yen by a foreign investor who is domiciled or resident in Japan.
Designated business sectors
Under the FDI Regulations, certain business sectors requiring prior notification of inward direct investment are defined as ‘designated business sectors’, including business sectors that could significantly undermine national security, which are classified as ‘core business sectors’. Examples of core and other designated business sectors are discussed below. Whether an investment target company falls under a designated or core business sector is determined not only based on the business purposes of its or its subsidiaries’ articles of incorporation but also based on their actual business operations.
Designated business sectors (core business sectors)
- Manufacturing of weapons, aircrafts, nuclear facilities, space products, semiconductors and dual-use technologies;
- pharmaceutical and special medical device manufacturing businesses;
- metal mining related to significant mineral resources;
- certain cybersecurity-related business (e.g., network security monitoring, service providers of the programmes designed for critical infrastructures); and
- certain infrastructure-related business (e.g., electricity, gas, telecommunications, water supply, railway and oil).
Designated business sectors (non-core business sectors)
- Other software business, data processing service business, and internet-use support business;
- other infrastructure-related business; and
- heat supply, broadcasting, public transportation, biological chemicals, security services, agriculture forestry and fisheries, air transportation and maritime transportation.
Exemption from prior notification
Foreign investors making inward direct investments, such as the acquisition of shares or voting rights, are exempted from submitting prior notifications if they meet certain requirements listed below. However, if a certain percentage of shares or voting rights is acquired under the prior notification exemption, a post-investment report will be required.
Inward direct investment to designated business sectors (non-core business sectors)
Foreign investors are exempted from submitting prior notification if a target company is engaged in a business in a designated business sector that is not a core business sector, as long as they comply with the conditions below:
- foreign investors or a party who has a special relationship with such foreign investors cannot be appointed as directors or statutory auditors of the target company or certain of its related companies;
- foreign investors cannot, by themselves or through other shareholders, propose to the general meeting of shareholders of the target company certain matters such as the transfer or disposition of the target company’s business in the designated business sectors; and
- foreign investors cannot access non-public information about the target company’s or certain of its related companies’ technology in relation to business in the designated business sectors.
Inward direct investment to core business sectors
Foreign investors who acquire less than 10 per cent of the shares or voting rights of Japanese listed companies are exempted from submitting prior notification if the target company engages in business in a core business sector and is in compliance with the following additional conditions as well as the general conditions above:
- for business in core business sectors, foreign investors cannot attend meetings of the target company’s board of directors or other committees that make important decisions on such business; and
- for business in core business sectors, foreign investors cannot, by themselves or through their designated person, make proposals in writing and require responses or actions by certain deadlines to the target company’s board of directors or other committees that make important decisions or the members of such board or committees.
Review process – procedure and substantive assessment
Outline of notification and review process
If a foreign investor makes an inward direct investment or a specified acquisition, it is required to submit prior notification in the prescribed form to the Bank of Japan (BOJ) within six months prior to the date of the contemplated transaction. The prior notification is submitted via the BOJ to the Minister of Finance and the ministers in charge of the relevant designated business sectors, such as the Minister of Economy, Trade and Industry (METI), the Minister of Land, Infrastructure, Transport and Tourism, the Minister of Health, Labour and Welfare, among others, at the designated BOJ counter, by mail or online (however, an application is required to use the online service).
Under the FEFTA, in principle, foreign investors submitting prior notifications have to wait until 30 days have passed from the date of the prior notification before making the inward direct investment or specified acquisition (waiting period). However, the waiting period may be shortened if the inward direct investment or specified acquisition is deemed unlikely to undermine national security. Conversely, the waiting period may be extended for up to five months if a review is deemed necessary from the perspective of national security.
If any questions arise in preparing the prior notification, the foreign investor may consult with the BOJ or the relevant ministries by emailing a draft of the prior notification before submitting it. Since, in such prior consultation, the authorities conduct an examination substantially equivalent to the review of the prior notification, the review process of a notification submitted after the prior consultation will be likely to proceed smoothly.
Submitted prior notifications are reviewed by the Ministry of Finance (MOF) and the competent authorities from the perspective of national security. During the review process, the ministries in charge of the relevant business sector may send written questions to the foreign investor. The questions will vary from case to case but typically include questions about the background and purpose of the investment in question (i.e., whether and to what extent the foreign investor intends to be involved in the management of the target company, whether and to what extent the foreign investor intends to access material technology and information held by the target company), the details of the business, and the attributes of the foreign investor, among other matters.
Key considerations for authorities’ review
During the waiting period, the ministries in charge of the relevant business sector will review the proposed investment to determine whether it undermines national security. With respect to the considerations in reviewing inward direct investments by such authorities, the MOF and other relevant ministries have published 12 factors including:
- the degree of impact on maintaining the basis of production and technologies in the business sectors that relate to safeguarding national security, maintaining public order, or safeguarding public safety;
- the possibility of leakage of technologies or information that relate to safeguarding national security, maintaining public order, and safeguarding public safety;
- the attributes of the foreign investor, including its capital structure, beneficial ownership and business relationships, and the foreign investor’s plan and track record of activities relating to investment; and
- the track record of the foreign investor’s compliance with the FEFTA and other jurisdictions’ equivalent or similar legislation.
If the BOJ and the competent authorities find that an inward direct investment or specified acquisition stated in the notification may affect national security, public order, public health and safety, or the smooth functioning of the national economy, they may issue a recommendation that such inward direct investment or specified acquisition be changed or not implemented. If the foreign investor gives notice of rejection or fails to give any notice, the authorities may order the investor to modify or discontinue the contemplated transaction. If the foreign investor fails to follow the order, the authorities may order the investor to take necessary measures such as disposal of the acquired shares.
Foreign investors who have submitted a prior notification are required to report the completion of the transaction pertaining to such prior notification to the MOF and the ministers in charge of the relevant business sector via the BOJ in the prescribed form within 45 days after the date of the completion.
If the foreign investor makes inward direct investments into a company conducting business activities only in non-designated business sectors and its shareholding ratio or voting rights ratio in such target company becomes 10 per cent or more (the number of shares and voting rights held by persons with certain relationships to the foreign investor is also taken into account in the calculation), a post-investment report is, in principle, required to be submitted within 45 days of completion of the transaction. Inward direct investments subject to post-closing notification do not require further approval or action from the ministries. There is no post-investment reporting system for specified acquisitions.
Penalty for non-compliance
Foreign investors who make inward direct investments or specified acquisitions without submitting the prior notification required under the FEFTA face penalties of up to three years’ imprisonment or a fine of up to ¥1 million or a combination of both (however, if three times the amount of the investment exceeds ¥1 million, the fine will be less than three times the amount of the investment).
Foreign investors who discover that a prior notification for inward direct investments or specified acquisitions required under the FEFTA has not been submitted will need to promptly prepare a case questionnaire and email it to the MOF. The case questionnaire form is available on the MOF’s website, and it requires summaries of violations including how the violations are revealed and the cause of the violations. The MOF and the ministers in charge of the relevant business sector may take necessary measures, depending on the nature and manner of the violations specified in the submitted case questionnaire.
Foreign investors who fail to submit post-investment reports face penalties of up to ¥500,000 or imprisonment for up to six months.
Foreign investors who fail to submit post-investment reports by the prescribed deadline will need to promptly submit the report with a note in the ‘Other Matters’ column, explaining the reason for the delay and indicating that it was submitted late.
Insights into recent enforcement practice
With the 2019 amendment to FEFTA, which fully came into effect in June 2020, the threshold for prior notification of the acquisition of an interest in a listed company was lowered from 10 per cent to 1 per cent, and (1) the appointment of a director of a target company and (2) the transfer or discontinuance of a target company’s business operations in a designated business sector now requires prior notification. As a result of the amendment, the number of prior notifications increased sharply in 2019 and has remained high since 2020. By business sector, in FY2022, 61 per cent of all prior notifications for acquisitions involved information processing services, software, integrated circuit manufacturing and semiconductor memory media manufacturing, which were added to the designated business sectors in August 2019 to ensure cybersecurity.
If, after reviewing the submitted prior notifications, the authorities find that the transaction will not undermine national security, the review process is concluded and the waiting period is often shortened. It is notable, however, that the review process may take longer than before as the number of prior notifications has been increasing. In some cases where the foreign investor commits to comply with certain matters in the prior notification, which can resolve national security concerns, the review process may conclude without any recommendation to change or not proceed with the inward direct investment. While it is difficult to generalise about such matters to be complied with, they sometimes cover matters such as restrictions on access to material information and policies on voting rights. In addition, there has been only one case (in 2008) in which the authorities issued a recommendation or an actual order not to make the proposed investment.
Practical insights and strategic guidance for investors
Determination of whether the target company’s business falls under a designated business sector
Foreign investors who make inward direct investments or specified acquisitions will need to confirm whether the target company (including its subsidiaries) engages in business activities in designated business sectors. However, simply confirming the business purpose provided for in the articles of incorporation of the target company does not suffice; the actual business activities of the target company will need to be reviewed. In other words, even if the business purpose in the articles of incorporation does not involve a designated business sector, prior notification is required if the target company actually engages in a business that falls under a designated business sector. Therefore, the nature of the business actually operated by the target company should be identified through the due diligence or by other measures. In particular, a detailed business analysis of the target company may be required when determining whether the target company engages in designated business sectors such as software business, information processing business, or internet support business. In the analysis of the target company’s business, the Japan Standard Industrial Classification can be used as a reference as it is used to determine whether a particular business falls under a designated business sector, or inquiries to the MOF or the other ministries in charge of the relevant business sector may be necessary.
In addition, for inward direct investments into Japanese listed companies, foreign investors can refer to the List of Classifications of Listed Companies regarding the Prior-notification Requirements on Inward Direct Investment, which was prepared and updated on 19 May 2023 by the MOF. The list provides classifications of Japanese companies listed on the Japanese stock exchanges into the following categories:
- companies engaging in business activities only in non-designated business sectors;
- companies engaging in business activities in designated business sectors other than core sectors; and
- companies conducting business activities in core business sectors.
Indirect transfer of shares
Generally, acquiring a foreign company that has a Japanese subsidiary will not be considered an inward direct investment, considering that the acquisition of shares in the Japanese subsidiary by the parent entity must already have been treated as an inward direct investment. Therefore, a change of control at the parent level would not generally trigger a separate reporting obligation unless the transaction is viewed as a circumvention of the FDI Regulations.
Transaction schedule and terms and conditions of contract
As explained above, inward direct investment requiring prior notification may not be implemented until 30 days have passed from the date of notification (i.e., the waiting period). Therefore, in preparing the schedule for such a transaction, the parties will need to take into account the waiting period and the time required to prepare the prior notification. In addition, in their investment-related agreements, parties should at least consider making FDI clearance and expiry of the waiting period a condition precedent to closing, and require mutual cooperation on the prior notification process.
In the case of start-up investments, the investment quota of the individual investors is often not fixed until shortly before the investment, as negotiations on the investment tend to proceed in parallel with several investors. In such case, if the finalised investment ratio exceeds the figure indicated in the prior notification, it will have to be re-submitted. To avoid this, a practical approach would be to give the maximum investment ratio in the prior notification.
Triggering events often overlooked
- Foreign investors who have invested in a Japanese company and have submitted a prior notification or a post-investment report required under the FEFTA are still required to submit another prior notification or a post-investment report for additional investments, even if the additional investments are made in the same company.
- Prior notification of inward direct investment may be required even for investments at the subsidiary level, since all Japanese subsidiaries directly owned by a foreign investor or companies in which the foreign investor indirectly owns more than 50 per cent through its subsidiaries are considered foreign investors under the FEFTA.
- If a foreign investor makes a minority investment in a target company engaged in a business in designated business sectors, a separate prior notification of inward direct investment is required if the foreign investor or a person affiliated with the foreign investor is appointed as a director or statutory auditor of the target company.
Recent reforms and reform proposals
In response to the introduction of the designation ‘specially designated critical commodities’ to secure stable supplies under the Economic Security Act on 5 May 2022, the following business sectors related to the nine specially designated critical commodities were added to the list of core business sectors in order to secure stable supply chains and address the risk of technology leakage and diversion of commercial technologies into military use:
- importing fertilisers (potassium chloride, etc.);
- manufacturing machine tools and industrial robots;
- manufacturing storage batteries (and related materials);
- refining metals and mineral products;
- manufacturing metal 3D printers and metal powder;
- manufacturing permanent magnets (and related materials);
- manufacturing semiconductors manufacturing equipment;
- wholesaling natural gas; and
- manufacturing marine engines.
In addition, it was clarified that drones are included within ‘aircraft manufacturing’, which is a core business sector, and other activities, including manufacturing antibacterial products and refining petroleum, were added to the scope of specified acquisition. As a result of this reform, specially designated critical commodities under the Economic Security Promotion Act will be fully covered as core business sectors. In response to this reform, ‘List of classifications of listed companies regarding the prior notification requirements on inward direct investment under the FEFTA’ mentioned above was updated in May 2023.
The scope of designated business sectors may be reviewed and further expanded to strengthen economic security.
1 Masaki Mizukoshi is a partner and Yuka Hirano is an associate at Nagashima Ohno & Tsunematsu.
2 English translation of the FEFTA is provided at https://www.japaneselawtranslation.go.jp/en/laws/view/4412.
3 There are other transactions that could fall under the scope of the ‘inward direct investments’ to which the FDI Regulations apply, such as obtaining consent from another foreign investor regarding the joint exercise of voting rights, or accepting a proxy enabling the foreign investor to exercise voting rights.
4 A party who has a special relationship with a foreign investor is defined as a party who has permanent economic relationship, kinship, or other special relationship equivalent thereto under the FDI Regulations, for example, (1) an entity in the foreign investor’s group (subsidiary, parent company, sister company, etc.), (2) a director or officer of the foreign investor, (3) an entity that the directors or officers of the foreign investor control, or (4) an entity that agrees to act in concert with the foreign investor in respect of the voting rights of the targeted listed company.
5 Acquiring any share or equity in a Japanese non-listed company from foreign investors is regulated as a specified acquisition under the FDI Regulations.
6 Foreign investors who have been sanctioned due to violations of the FEFTA or state-owned enterprises (except those accredited by the authorities) are not eligible for the exemption.
7 If certain foreign financial institutions invest in a Japanese listed company engaged in core business sectors, subject to compliance with the conditions described in ‘Inward direct investment to designated business sectors (non-core business sectors)’, they are exemption from prior notification regardless of the number of shares or voting rights to be acquired.
8 Generally, questions are emailed to the administrative staff email address listed on the notification form.
9 MOF, press release, ‘Factors to be considered in authorities’ screening of prior-notification for Inward Direct Investment and Specified Acquisition under the Foreign Exchange and Foreign Trade Act’ (8 May 2020) available at https://www.mof.go.jp/english/policy/international_policy/fdi/gaitamehou_20200508.htm.
10 MOF, ‘Regarding cases where non-notification is revealed’ available (in Japanese only) at https://www.mof.go.jp/policy/international_policy/gaitame_kawase/fdi/monitoring_2.html.
11 In 2008, the Children’s Investment Fund (TCI), a British hedge fund, submitted a prior notification for the acquisition of shares in a Japanese listed company, Electric Power Development Co, Ltd. The MOF and the METI determined that the acquisition might affect the stability of electricity supply and nuclear energy policy and disrupt the maintenance of public order and recommended that the acquisition not proceed. When TCI did not comply, the Ministries issued a cease-and-desist order in May of the same year.
12 Please note that under the Companies Act of Japan, subsidiaries include any entity in a direct capital relationship and any entity in a control relationship (e.g., a sub-subsidiary or a third-generation subsidiary), but do not include companies or other entities incorporated under the laws of a foreign country.
13 Ministry of Internal Affairs and Communications, Japan Standard Industrial Classification available at https://www.soumu.go.jp/english/dgpp_ss/seido/sangyo/index.htm.