Amendments to Japan Foreign Exchange and Foreign Trade Act Now in Effect

The amendments aim to promote foreign direct investments for sound economic growth, while still ensuring sufficient review of foreign direct investment activities that could pose risks to national security in Japan.

Promulgated on November 29, 2019, the amendments to the Japan Foreign Exchange and Exchange Trade Act (FEFTA), Act No. 228 of 1949, provide a new framework of foreign direct investments. In connection with such promulgation, the amendments to the subordinate rules and regulations were issued on April 30, 2020, following the closure of the period in which public comments were submitted to the government. Subject to a 30-day transition period as discussed below, these amendments to the FEFTA and the subordinate rules and regulations (the Amendments) became effective on May 8, 2020.

General Rules

Under the FEFTA, when a foreign investor (as further explained below, a Foreign Investor) acquires shares in a Japanese company and such acquisition is considered as a foreign direct investment (FDI),[1] it is required to file a notification with the Japanese government via the Bank of Japan.[2] If a target Japanese publicly listed company (Target Company) conducts business in certain “Designated Business Sectors” that may impact Japan’s national security or public welfare, the Foreign Investor is required to file a prior notification of stock purchases (PN-SP) prior to the acquisition of shares. If the Target Company does not conduct any business in any Designated Business Sector, it is sufficient to file a post-facto investment report (Post-Facto Investment Report) after the acquisition of shares.

The Amendments aim to promote FDIs for sound economic growth, while still ensuring sufficient review of FDI activities that could pose risks to national security. This LawFlash briefly reviews key features of the Amendments and provides an overview of new rules and regulations concerning FDIs, with particular a focus on investments in Target Companies.[3]

Lowering the Threshold for PN-SP

Prior to the Amendments, the acquisition of shares in a Target Company was considered an FDI only if the shareholding ratio (on either share volume or voting rights basis, whichever higher, the Shareholding Ratio) reached 10% or more after the acquisition. Accordingly, a Foreign Investor acquiring shares in a Target Company conducting business in a Designated Business Sector was required to file a PN-SP only if the Shareholding Ratio reached 10% or more after the acquisition.

The Amendments reorganized Designated Business Sectors and lowered this 10% threshold to 1% in order to protect Japan’s national security. This change greatly increased the possible filings as many foreign shareholders hold directly and indirectly more than 1% of Target Companies, causing considerable concern in the international investment community in Japan.

Introduction of Exemption Scheme for PN-SP

However, while lowering the threshold for filing of PN-SP from 10% to 1%, the Amendments fortunately also introduced a new exemption scheme for PN-SP concerning share acquisition of a Target Company in order to avoid imposing an undue burden on Foreign Investors. Following the Amendments, two categories of exemptions (i.e., Blanket Exemption and Regular Exemption) became available depending on the nature of the Foreign Investor.

Blanket Exemption

The Blanket Exemption is available for the following foreign financial institutions (FFIs) that are licensed or registered in a manner where they are subject to regulation and/or supervision under financial regulatory laws in Japan and other jurisdictions:

• Securities firms
• Banks
• Insurance companies
• Asset management companies
• Trust companies (excluding those solely engaged in custody businesses)
• Registered investment companies (including mutual funds and exchange-traded funds)
• High-frequency traders (limited to those registered in Japan)

The Blanket Exemption provides a comprehensive exemption from the filing requirement of PN-SP related to the acquisition of shares in a Target Company for FFIs, as long as the following conditions (Exemption Conditions) are satisfied:

• Foreign Investors and their closely related persons (e.g., parent companies and subsidiaries) will not become directors or corporate auditors of the Target Company
• Foreign Investors will not make any of the following proposals to general shareholders meetings of the Target Company concerning Designated Business Sectors:
  • A transfer of all or part of the Target Company’s business
  • A transfer of all or part of shares or interests in a subsidiary of the Target Company
  • A merger or company split of the Target Company
  • A distribution of a business of the Target Company or its subsidiary or shares in a subsidiary of the Target Company, as dividend of surplus
  • The discontinuance of a business of the Target Company
  • The dissolution of the Target Company
• Foreign Investors will not access nonpublic information about the Target Company’s technologies in relation to business in Designated Business Sectors

Accordingly, even if an FFI acquires shares in a Target Company conducting business in a Designated Business Sector, it is not necessary that the FFI file a PN-SP regardless of its Shareholding Ratio, as long as the Exempted Conditions are satisfied; provided, however, that a Post-Facto Investment Report will need to be filed in cases where the Shareholding Ratio reaches 10% or more.

Regular Exemption

The Regular Exemption is available for other non-FFI investors, except for (1) investors with a record of sanction due to a violation of the FEFTA, and (2) foreign state-owned entities (SOE) except those who have been accredited by the Japanese government, as explained below. The scope of the Regular Exemption differs depending on whether a target Japanese company engages in business in “Core Business Sectors.”[4]

If a Target Company conducts a business in Designated Business Sectors but such business is not categorized as any of the Core Business Sectors, a Foreign Investor will be exempted from filing a PN-SP regardless of the Shareholding Ratio, as long as the Exempted Conditions are satisfied; provided, however, that a Post-Facto Investment Report will need to be filed in cases where the Shareholding Ratio reaches 1% or more.

If a Target Company conducts business in a Core Business Sector, Foreign Investors will be exempted from filing a PN-SP if the Shareholding Ratio is under 10%, as long as the Exemption Conditions, and the following additional conditions, are satisfied (provided, however, that a Post-Facto Investment Report will need to be filed in cases where the shareholding ratio reaches 1%):

• Concerning business activities in Core Business Sectors, Foreign Investors will not attend and will not have their designated persons attend the Target Company’s executive board or committee meetings that make important decisions in these activities.
• Concerning business activities in Core Business Sectors, Foreign Investors will not make proposals and will not have their designated persons make proposals in writing to the board of directors or the executive board of the Target Company or to individual board members requiring their responses and/or actions by certain deadlines.

In order to facilitate the understanding of Foreign Investors as to whether a PN-SP needs to be filed in connection with the contemplated share acquisition, on May 8, 2020, the Japanese government published a list of all listed companies categorizing them as follows:

• Companies not conducting business in Designated Business Sectors
• Companies conducting business in Designated Business Sectors other than Core Business Sectors
• Companies conducting business in Core Business Sectors

No Exemption

As noted above, (1) investors with a record of sanctions due to violation(s) of the FEFTA and (2) SOEs may not rely on either the Blanket Exemption or the Regular Exemption. Accordingly, when these investors acquire shares in a Target Company conducting business in a Designated Business Sector and the Shareholding Ratio reaches 1% or more after the acquisition, it is necessary for the SOE to file a PN-SP.

However, sovereign wealth funds and public pension funds (collectively, SWFs) that are considered to pose no risk to Japan’s national security are eligible for the Regular Exemption if they are specifically authorized and accredited by the Japanese government under a procedure to be specified. In connection with obtaining such exemption, the Japanese government intends to execute a memorandum of understanding with each SWF providing accreditation where the Japanese government believes both of the following conditions will be satisfied:

• The investment activities of the relevant SWF seek only economic returns
• The investment decisions by the SWFs are made independently of the relevant sovereign government

Discretionary Investment Management

Where a foreign investment manager (Foreign Manager) acquires shares in a Target Company on behalf of a Foreign Investor under a discretionary investment management mandate, it is necessary to consider both (1) the filing obligation with respect to the Foreign Manager, and (2) the filing obligation with respect to the relevant Foreign Investor.

Filing Obligations of Foreign Managers

A Foreign Manager’s acquisition of shares in a Target Company under a discretionary investment management mandate on behalf of relevant Foreign Investors is considered an FDI if (1) the Foreign Investors’ rights as shareholders (including voting rights) have been delegated to the Foreign Manager and (2) the Foreign Manager’s Shareholding Ratio (aggregated Shareholding Ratio held on behalf of all investors in all funds managed by the Foreign Manager) reaches or exceeds the specified threshold (i.e., 1%) that also has been changed from 10% to 1% pursuant to the Amendments.

Accordingly, if a Foreign Manager acquires 1% or more of the shares in a Target Company on behalf of investors and such investors’ rights as shareholders (including voting rights) have been fully delegated to the Foreign Manager, the Foreign Manager will be required to file a PN-SP, even though the Foreign Manager is not the legal owner of such shares. However, as noted above, if the Foreign Manager qualifies as an FFI, the Blanket Exemption may be available to prevent the need for a filing.

Filing Obligations with Respect to Foreign Investors

Prior to the Amendments, a Foreign Investor was also required to file a PN-SP concerning the acquisition of shares in a Target Company, even where the acquisition was made by a Foreign Manager under a discretionary investment management agreement and the Foreign Manager was required to file a PN-SP concerning the acquisition.

Following the Amendments, a Foreign Investor is not required to file a PN-SP concerning the acquisition of shares in a Target Company if its investment authority and shareholder’s rights (including voting rights) have been fully delegated to the Foreign Manager. On the other hand, if a Foreign Investor reserves any of its investment authority or voting rights, it is necessary to file a PN-SP upon reaching or exceeding the 1% threshold even if a Foreign Manager files a PN-SP, unless, as noted above, the Regular Exemption applies.

Expansion of the Scope of Foreign Investors

Indirect Subsidiaries

Prior to the Amendments, a Foreign Investor included (1) non-Japan-resident individuals, (2) foreign companies, (3) Japanese companies whose 50% or more of shares are held by non-Japan-resident individuals or foreign companies, and (4) direct subsidiaries of Japanese companies set forth in (3).

The Amendments expanded the scope of the definition of a Foreign Investor by excluding the limitation of the direct holdings in (4) above. As a result, both direct and indirect subsidiaries of Japanese companies in which 50% or more of the outstanding shares are held by a Foreign Investor will be considered as Foreign Investors.

Partnerships

In Japan a partnership is not considered as an independent legal entity. Accordingly, prior to the Amendments, if a partnership acquired shares that would otherwise trigger the necessity of a PN-SP filing, all partners (both general partners and limited partners) that fall under the definition of a Foreign Investor were required to file a PN-SP, regardless of their investment ratio in the partnership.

Importantly, following the Amendments, a partnership is deemed as a Foreign Investor only if (1) 50% or more of the relevant investment was made by Foreign Investors, or (2) a general partner of the partnership (if more than one general partner in the partnership exists, a majority of such general partners) is a Foreign Investor. As a result, only partnerships deemed as Foreign Investors are subject to the obligation to file a PN-SP. In that case, the general partner must file a PN-SP in the name of the partnership.

Expansion of the Scope of an FDI

Although share acquisitions are the key features of FDIs, the FEFTA also defines other shareholder’s activities as FDIs, such as a consent to substantial change in the corporate objectives of the Target Company (but only where the Foreign Investor has one-third or more of the voting rights).

Moreover, the Amendments added the following shareholder activities as FDIs (but only where a shareholder has 1% or more of the voting rights):

• Voting at the Target Company’s shareholders’ meeting for appointment of the Foreign Investor itself or its closely related person (e.g., officer) as a director or corporate auditor of the Target Company
• Proposing, and voting at a shareholders’ meeting for, any of the following to the Target Company concerning its business in a Designated Business Sector:
  • A transfer of all or part of the Target Company’s business
  • A transfer of all or part of the shares or interests in a subsidiary of the Target Company
  • A merger or company split of the Target Company
  • The distribution of a business of the Target Company or its subsidiary or shares in a subsidiary of the Target Company, as a dividend of surplus
  • The discontinuance of a business of the Target Company
  • The dissolution of the Target Company

Accordingly, if a Foreign Investor holding shares of a Target Company plans to conduct any of the above activities, a PN-SP must be filed in advance.

Post-Facto Investment Reports

As noted above, where a Foreign Investor acquires shares in a Target Company that does not conduct any business in a Designated Business Sector, it is sufficient to file a Post-Facto Investment Report. In that case, the Foreign Investor is required to file the Post-Facto Investment Report (1) upon reaching the Shareholding Ratio of 10% or more, and (2) in connection with each share acquisition after exceeding the 10% threshold. Contrary to a PN-SP, the Amendments did not change this 10% threshold for Post-Facto Investment Reports.

In addition, when a Foreign Investor relies on the exemption for a PN-SP newly introduced by the Amendments, the filing of a Post-Facto Investment Report is sufficient even where the acquisition of shares in the Target Company is conducting a business in a Designated Business Sector. In that case, the Foreign Investor is required to file a Post-Facto Investment Report in each of the following circumstances:

• The first time that the 1% threshold has been reached or exceeded (where the Foreign Investor relies on the Regular Exemption)
• The first time that the 3% threshold has been reached or exceeded (where the Foreign Investor relies on the Regular Exemption)
• Each time the 10% threshold has been reached or exceeded, and each time a share acquisition occurs after the Shareholding Ratio becomes 10% or more

The Amendments also changed the deadline for the filing of this Post-Facto Investment Report. Prior to the Amendments, the filing deadline for Post-Facto Investment Reports was the 15th day of the month following the month in which the relevant share acquisition was concluded. However, following the Amendments, the Post-Facto Investment Report needs to be filed within 45 days of the relevant share acquisition.

Transition Period

Although the amended rules and regulations became effective on May 8, 2020, the Amendments provide for a 30-day transition period for implementation of the new rules for filing a PN-SP and the application of the exemption scheme.

Accordingly, the new rules for filing a PN-SP will apply to share acquisitions, and other FDI activities, conducted on or after June 7, 2020. If a Foreign Investor plans to acquire shares, or conduct other FDI activities, on or after June 7, 2020, it is expected that a PN-SP will be filed during this 30-day transition period.

In addition, in response to public comments, the Japanese government made it clear that no obligation to file a PN-SP under the new rules and regulations will be imposed unless there is any share acquisition or other FDI activity after the full implementation of the new rules and regulations. In other words, even if a Foreign Investor holds more than 1% of the shares in a Target Company as of June 7, 2020, it will not be required to file a PN-SP unless the Foreign Investor acquires additional shares in that company thereafter. Thus, existing shareholdings in Target Companies are “grandfathered,” provided the Shareholding Ratio is not increased.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Tokyo
Tomoko Fuminaga
Narumi Ito

CFIUS Contacts

Washington, DC
Kenneth Nunnenkamp
Giovanna Cinelli
Ulises Pin

Boston
Carl Valenstein