Japan expanded the scope of industries subject to prior notification for Inward Direct Investment in 2019

Under the Foreign Exchange and Foreign Trade Act (FEFTA), the Ministry of Finance (MOF) and the relevant ministries with jurisdiction over the transaction matter review foreign investments, including acquisitions of Japanese businesses by foreign persons or businesses. The Ministry of Economy, Trade and Industry (METI) also enforces FEFTA.

WHO FILES

FEFTA requires a "Foreign Investor" to submit an advance notice or a post-transaction filing depending on the type of business in which the target entity is engaged or the nationality of the Foreign Investor, through the Bank of Japan to MOF and relevant ministries. Foreign Investors include:

• Any individual who is a nonresident of Japan
• Any entity established pursuant to foreign laws, or other entities having their principal office in a foreign country
• Any entity in which 50 percent or more of the voting rights are held by an individual or entity described above
• Any entity in which the majority of directors or the representative directors are individuals who are non-residents of Japan

TYPES OF DEALS REVIEWED

The MOF and the relevant ministries review two types of transactions: Inward Direct Investments and Designated Acquisitions.

Inward Direct Investments

An Inward Direct Investment includes, among others, where a Foreign Investor acquires shares of (i) a Japanese unlisted company (including initial incorporation) from resident shareholders, or (ii) a Japanese listed company, resulting in the Foreign Investor's holding of 10 percent or more of the listed company's outstanding shares.

An Inward Direct Investment also includes a Foreign Investor's lending to, or purchase of company bonds of, a Japanese company if and so long as the amount and duration thereof exceeds a certain threshold. In addition to the above, there are a few other types of transactions that constitute Inward Direct Investments.

Expansion of coverage of Inward Direct Investments

On October 26, 2019, the Cabinet Order on Inward Direct Investment, etc. and Order on Inward Direct Investment, etc. was amended to expand the scope of Inward Direct Investments. The following significant amendments were made:

• Acquires shares that result in such Foreign Investor's "Beneficially Owning"(*1) 10 percent or more of the voting rights outstanding

• Receives proxies to vote shares (*3) where: (i) the subject company is publicly listed and, with the shares subject to proxy included, the recipient Foreign Investor's total voting rights Beneficially Owned equal or exceed 10 percent of the total outstanding voting rights; or (ii) the subject company is not publicly listed
• Receives consents from another Foreign Investor that, together with those otherwise Beneficially Owned by the Foreign Investor, total 10 percent or more of the total voting rights of a publicly listed company

*1: "Beneficial Ownership" for this purpose means that the Foreign Investor, collectively with its "Special Related Persons," (*2) "holds" a number of voting rights on an aggregated basis that counts the votes for shares that the Foreign Investor holds directly, shares the Foreign Investor has been granted authority to manage on a discretionary basis, and shares with respect to which the Foreign Investor has been granted a voting proxy.

*2: "Special Related Persons" historically was limited to (i) the acquiring party's parent company; (ii) the acquiring party's officers and directors; (iii) the acquiring party's spouse and direct blood relatives (where the acquiring party is an individual); and (iv) other Foreign Investors who have agreed to exercise voting rights together, etc. Now, however, this amendment adds a new group (v) that includes the "Special Related Persons" of those Foreign Investors who have agreed to exercise voting rights, etc. (category (iv) above) to these preexisting categories (i) – (iv).

*3: "Proxies to vote shares" are limited to those agenda items with respect to which the proxy holder has a possibility of materially influencing management or exerting effective control over management of the subject company specified under the regulations.

A Designated Acquisition

A "Designated Acquisition" is a transaction where a Foreign Investor acquires shares of a non-listed company from other Foreign Investors.

Almost all Inward Direct Investments (with some statutory exceptions) require post-transaction filings, unless advance notice is required. Transactions requiring advance notice are subject to review and approval by the MOF and the relevant ministries. Investment from certain countries or in certain designated industries (e.g., airplanes, weapons, nuclear power, agriculture, forestry and fisheries, and the oil industry) are designated as transactions that may affect national security, public order or public safety of Japan, or may have a significant adverse effect on the Japanese economy, and consequently require advance notice filings. A Foreign Investor is required to submit advance notice for Designated Acquisitions if the target company is engaged in business related to Japan's national security (i.e., the target company falls in a designated industry such as airplanes, weapons and nuclear power). Post-transaction filings are not required for a Designated Acquisition.

SCOPE OF THE REVIEW

On May 27, 2019, METI expanded the scope of the industries for which Inward Direct Investments require advance notice filings through its public notice revising relevant Cabinet orders pursuant to Articles 27.1 and 28.1 of FEFTA.

With the revision of the rules, (a) additional industries became subject to the prior notification requirement, and (b) the scope of the industries currently subject to the prior notification requirement was expanded to cover more business entities.

Additional industries subject to prior notification requirement

The following industries became subject to the prior notification requirement:

• Industries manufacturing information processing devices and parts thereof including: Industries manufacturing integrated circuits, semiconductor memory media, optical disks, magnetic discs and magnetic tapes, electronic circuit boards, wired communication devices, mobile phones, radio communication devices, electronic computers, personal computers and external memory devices
• Industries pertaining to software for information processing including: Industries pertaining to customized development of software, development of embedded software and development of packaged software
• Industries pertaining to information communication services including: Industries pertaining to wired broadcast and telephone services, and information processing services

Expanded industries subject to prior notification requirement

The scope of industries pertaining to the following businesses was expanded for the purpose of the prior notification requirement: regional telecommunication services; long-distance telecommunication services; other landline telecommunication services; mobile telecommunication services; and services supporting internet access.

With this scope expansion, the business entities that are not required to register as telecommunication carriers under Article 9 of the Telecommunications Business Act will become subject to the prior notification requirement. In particular, telecommunication service suppliers that do not have their own telecommunication facilities (e.g., servers and base stations)—for example, those that provide services through third parties' cloud servers and/or other companies' communication network—will be required to submit prior notifications.

Background and imprecation

Increasing cybersecurity risks and concerns of leakage of advanced technologies (including technologies for artificial intelligence or AI) were major factors behind this revision of rules. METI's intention appears to have been reflected in the fact that industries pertaining to hardware (e.g., integrated circuits) and embedded software, which are essential for the application of AI technologies, have been added to the scope of the requirement. It suggests that METI intends to have generally all industries pertaining to AI developments be subject to the prior notification requirement. Including various types of communication services in the scope of the requirement appears to be METI's attempt to enhance cybersecurity.

TRENDS IN THE REVIEW PROCESS

The ministries have approved almost all of the notified transactions in the past. The only known case where a transaction was blocked was in 2008 when a foreign investment fund planned to acquire 20 percent of the shares of a power company. In response to the advance notice made by the fund, the MOF and METI recommended that the acquisition not be allowed because of the perceived risk that the transaction might disturb the maintenance of the public order in Japan. However, the fund did not follow the recommendation, so the MOF and METI ordered the fund to discontinue the acquisition. The fund did not appeal the order.

HOW FOREIGN INVESTORS CAN PROTECT THEMSELVES

The recent revisions of foreign investment rules in Japan reflect METI's increasing attention to cybersecurity and leakage of emerging technologies and calls for Foreign Investors' careful review of their investments into Japan as to whether the subject industry falls within the expanded scope of the requirement and, thereby, submission of a prior notification is required.

Where a review is conducted, although there is no specific provision regarding the procedures for mitigation measures in FEFTA and related laws or orders, the MOF and the relevant ministries are allowed to require mitigation measures, which are assumed to be negotiated with the Foreign Investor. That said, Foreign Investors can proactively propose and negotiate mitigation measures with the ministries in charge.

REVIEW PROCESS TIMELINE

A Foreign Investor who has made an advance notice filing cannot close the transaction until the expiration of 30 calendar days from the date the MOF and the ministry having jurisdiction over the transaction received the notification. However, the waiting period is usually shortened to two weeks. The MOF and the relevant ministries can extend the waiting period up to five months if necessary for the review.

If the MOF and the ministry with jurisdiction find the reviewed transaction problematic in terms of national security, they can recommend that the Foreign Investor change the content of the transaction or discontinue the transaction after hearing opinions of the Council on Customs, Tariff, Foreign Exchange and other Transactions. The Foreign Investor must notify the MOF and the ministry with jurisdiction of whether it will accept the recommendation within ten days after receiving such recommendation.

If the Foreign Investor does not provide notice or refuses to accept the recommendation, the MOF and the relevant ministries may order the modification of the content of the transaction or its discontinuance before the expiration date of the waiting period.

AMENDMENT OF FEFTA WAS ENACTED IN NOVEMBER 2019

On November 29, 2019, an amendment to FEFTA was enacted. The amended FEFTA lowers the threshold for screening of purchases of listed companies' shares to 1 percent or more. In addition, a shareholder proposal that proposes the foreign shareholder or its "closely related persons" as a board member, or to sell a material business, also will be categorized as a Foreign Direct Investment. The regulations to implement the revisions have yet to be announced, but are hoped and expected to include exemptions for financial institutions that would lessen the impact on Foreign Investors. The amended FEFTA is expected to come into force in spring of 2020.

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Foreign direct investment reviews 2019: A global perspective

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