Japan's Ministry of Finance (MOF) and its ministries with jurisdiction over the target entity's business review foreign direct investments under the Foreign Exchange and Foreign Trade Act (FEFTA).
Japan enacted an amendment to the FEFTA on November 29, 2019. When the amendment came into force on June 7, 2020, it expanded the scope of foreign direct investment review, lowered the threshold for screening the purchase of listed companies' shares to acquisitions at 1 percent or more, and introduced a new prior notification exemption scheme for share acquisitions.
Sometimes filers receive questions regarding their own business, intended transactions with the issuer and similar questions from the ministries
Depending on the type of business in which the target entity is engaged or the nationality of the foreign investor, FEFTA requires a "foreign investor" to submit a prior notification and/or a post-transaction filing through the Bank of Japan to the MOF and relevant ministries. Foreign investors include:
- Individuals who do not reside in Japan, termed "non-residents"
- Entities or other groups established under laws or regulations of, or having their principal offices in, foreign countries
- Entities in which an individual or entity described above holds 50 percent or more of the total voting rights
- Partnerships operating in the investment business of which 50 percent or more of the total capital has been contributed by foreign entities, foreign groups or non-residents, or the majority of general partners are non-residents
- Entities in which the majority of directors or representative directors are non-residents
TYPES OF DEALS AND ACTS REVIEWED
The MOF and Japan's ministries with jurisdiction over the target entity's business review two types of transactions: designated acquisitions and inward direct investments.
A designated acquisition is a transaction wherein a foreign investor acquires shares of a non-listed company from other foreign investors.
An inward direct investment occurs when a foreign investor:
- Acquires a listed target entity's shares, after which the foreign investor "beneficially owns" 1 percent or more of the listed target entity's outstanding shares. (The 2020 FEFTA Amendment reduced the threshold from 10 percent to 1 percent.) "Beneficial ownership" means the possession of voting rights by the foreign investor, collectively with its "special related persons," through shares held directly by any such persons, shares that any such person has been granted authority to manage on a discretionary basis and shares with respect to which any such person has been granted a voting proxy. "Special related persons" means that certain direct and indirect subsidiaries and certain direct and indirect parent companies of the foreign investor, the officers and directors of the foreign investor and those direct and indirect subsidiary and parent entities to which this definition applies, entities of which the officers and directors of clause constitute a majority of the officers and directors where the foreign investor is an individual, the foreign investor's spouse and direct blood relatives; where the foreign investor is a government, administrative body, public body or the like, governments, administrative bodies and public bodies and the like of the same country or region as the foreign investor; and where other non-residents who have agreed to exercise voting rights together with the foreign investor and the "special related persons" of such other non-residents. The direct and indirect subsidiary and parent entities to which this applies are defined as entities in which the foreign investor directly holds 50 percent or more of the voting rights, entities that the entities of (1) directly hold 50 percent or more of the voting rights in; (2) entities that directly hold 50 percent or more of the voting rights in the foreign investor; (3) entities that directly hold less than 50 percent of the voting rights in the foreign investor individually but, in the aggregate with the direct holdings of entities that such entity directly holds 50 percent or more of the voting rights in, directly hold 50 percent or more of the voting rights in the foreign investor; (4) entities that directly hold 50 percent or more of the voting rights of entities described in (2) or (3); (5) entities that the entities described in (5) directly hold 50 percent or more of the voting rights of; (6) entities that the entities of (5) or (6) directly hold 50 percent or more of the voting rights of; (7) entities that the entities of (3) directly hold 50 percent or more of the voting rights of; and (8) entities that the entities of (3) or (8) directly hold 50 percent or more of the voting rights of.
- Acquires voting rights of a listed target entity, after which the foreign investor beneficially owns 1 percent or more of the listed target entity's total voting rights. (This threshold will be less than 1 percent of outstanding shares to the extent that there are shareholders holding odd lots.)
- Acquires shares of an unlisted target entity, including at incorporation, from resident shareholders.
- Consents to material changes to the business purposes of an unlisted target company at any beneficial ownership level, or a listed target company where the foreign investor's beneficial ownership accounts for one-third or more of the target company's total voting rights.
- Consents to shareholder meeting proposals that are defined to have a material impact on the target Japanese company's business in the regulations, specifically including (among other things) the appointment of a foreign investor or a foreign investor's "closely related person" as a director or an audit & supervisory board member; the transfer or disposal of the entirety of the business; a merger in which the target Japanese company is not the surviving company; or dissolution of the company for an unlisted target company at any beneficial ownership level, or for a listed target entity, where the foreign investor's beneficial ownership accounts for 1 percent or more of the total voting rights of the target company.
- Obtains proxy voting authority wherein the target company is publicly listed and the aggregate voting rights beneficially owned by the foreign investor after obtaining such proxies equals or exceeds 10 percent of the total voting rights, or the target company is not publicly listed. This applies only where the proxy is not held by the target company or any of its officers or directors; the agenda items with respect to which proxy voting authority is granted may grant the proxy holder control over the management of the target company or material influence over the management of the target company; and the proxyholder solicited the proxy.
- Acquires the right to cause voting rights to be exercised with respect to listed companies, after which acquisition such foreign investor's total voting rights beneficially owned equals or exceeds 1 percent of the total voting rights.
- Obtains the agreement of other foreign investors to jointly exercise their respective beneficially owned voting rights of a publicly listed company, where the aggregate beneficially owned voting rights across all relevant foreign investors account for 10 percent or more of the total voting rights of the publicly listed company.
- Lends to a Japanese company where both the amount owed to the foreign investor exceeds JPY 100 million and the aggregate amounts owed including corporate bonds held by the foreign investor exceed 50 percent of the target company's debt.
- Purchases corporate bonds that meet all of the following criteria: The bonds are issued to the specific foreign investor; the redemption date is more than one year in the future; the balance due on the bonds exceeds JPY 100 million; and the aggregate of the balance due on the bonds and under other loans made by the foreign investor accounts for more than 50 percent of the target company's debt.
The introduction of the exemptions for prior notification of share acquisitions will reduce the burden on foreign investors
VOTES IN FAVOR OF AGENDA ITEMS
"Designated industries" are those for which transactions may affect national security, public order or the public safety of Japan, or may have a significant adverse effect on the Japanese economy, such as airplanes, weapons, nuclear power, agriculture, forestry and fisheries, and the oil industry.
When the target company is in a designated industry, foreign investors who intend to take the following actions require advance approval in response to pre-action notice filings:
- Vote in favor of a shareholders' meeting proposal for the appointment of the relevant foreign investor or its closely related persons as a director or an audit & supervisory board member of the target entity. This requirement applies not to third-party foreign investors, but only to the foreign investor who is or whose closely related person is nominated. In this case, a prior notification is required regardless of whether the appointment is proposed by the foreign investor itself or a third party (including the target entity)
- Vote in favor of a shareholders' meeting proposal submitted by the foreign investor to transfer or dispose of the target entity's businesses in designated industries
If the resolution is proposed by a third party (not directly or indirectly proposed by the foreign investor), closely related persons include:
- The directors and officers (regardless of title, those with the power to execute business, and including the Japan representative) of the foreign investor and certain of its direct and indirect parent and subsidiary entities
- Members of the governing body with authority to make investment decisions, whether termed an investment committee, management committee or otherwise, for the foreign investor or certain of its direct or indirect parent or subsidiary entities
- The foreign investor's spouse and direct blood relatives, if the foreign investor is an individual
- The directors, officers, agents and employees of the individual, entity or other organization that have agreed with the foreign investor to jointly exercise their voting rights, and such individual, entity or other organization's closely related persons
If the resolution is proposed directly or indirectly by the foreign investor, however, closely related persons include:
- Employees, agents, directors and officers of the foreign investor and certain of its direct and indirect parent and subsidiary entities
- Employees, agents, directors and officers of individuals or entities for whom the foreign investor is a major customer or supplier, or that are major customers or suppliers of the foreign investor
- Persons who have received large amounts of money or other assets from the foreign investor
- The foreign investor's spouse and direct blood relatives, if the foreign investor is an individual
- Individuals or entities who agreed with the foreign investor to jointly exercise their voting rights, and such individuals' or entities' closely related persons
- Persons who fell within any of the categories described in this list within the past year
FILING AND REVIEW PROCESS
A foreign investor is required to make a prior notification and/or a post-transaction filing through the Bank of Japan to the MOF and relevant ministries with respect to certain inward direct investments. Prior notification filings may be required depending on whether the target entity is engaged in designated industries or the characteristics—including nationality or location (including region) and whether the foreign investor qualifies for exemptive relief—of the foreign investor.
Transactions requiring prior notification filings are subject to review and approval by the MOF and the relevant ministries. Where required, foreign investors must make their prior notification filings within six months prior to the act of inward direct investment.
By default, transactions subject to a prior notification filing cannot be closed until the expiration of a 30-calendar-day waiting period from the date on which MOF and the ministry having jurisdiction over the transaction received the prior notification filing. However, the waiting period is usually shortened to two weeks. Nevertheless, 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 over the transaction find the transaction under review 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 relevant ministry 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 a modification of the content of the transaction or its discontinuance before the expiration date of the waiting period.
A foreign investor who obtained a prior notification filing approval for certain inward direct investments is required to make a post-transaction filing of the completion of the inward direct investment within 45 days of the completion of the transaction or the act. Inward direct investments for which such a post-transaction filing is required include the acquisition or disposal of shares or voting rights, lending money or receipt of repayment, or the purchase of corporate bonds or redemption of the same. However, voting in favor of proposals at shareholders' meetings does not require a post-transaction filing.
A foreign investor is required to submit a prior notification filing with regard to a designated acquisition if the target company is engaged in designated industries. Post-transaction filings are not required for a designated acquisition unless the foreign investor claimed an exemption from prior notification filings for its stock acquisition.
EXEMPTION SCHEME FOR PRIOR NOTIFICATIONS
The 2020 FEFTA Amendment introduced exemptions from the prior notification filings otherwise required for stock purchases. Foreign investors are categorized into three types under the exemptions from the prior notification filings: foreign financial institutions; general investors; and non-qualified foreign investors.
All of the exemptions are subject to the requirement that the foreign investor comply with the following three exemption conditions:
- The foreign investor and its closely related persons will not serve on the board of the target company as directors or audit & supervisory board members
- The foreign investor will not make proposals at shareholders' meetings, whether directly or through third parties, to dispose of material businesses in designated industries
- The foreign investor will not access sensitive confidential technologies that are related to the target company's business in designated industries
The coverage of the exemption differs depending on the type of foreign investor involved. The chart below summarizes the exemptions from prior notification filing requirements for share acquisitions in listed companies. Foreign investors do not need to file to be eligible for the exemption.
For foreign financial institutions that comply with the exemption conditions, the applicability of the exemptions is simple: They are exempted from filing a prior notification without any cap on their investment so long as they comply with the exemption conditions.
For general investors, the scope of applicability of the exemptions depends on whether the target company's business listed under the designated industries is categorized as a "core" sector. The FEFTA classifies designated industries into "non-core sectors" and "core sectors."
Core sectors include weapons, airlines, space, nuclear facilities, dual-use technologies, cybersecurity, electricity, gas, telecommunications, water supply, railway services and oil. Where general investors acquire shares of a target company that conducts a core sector business, they will be exempted from making a prior notification until the investment reaches 10 percent, provided that they comply with not only the exemption conditions but also the additional conditions for core sector businesses, which require that foreign investors do not sit on the target company's executive board or committees that make important decisions in the core sector businesses, and that foreign investors do not make proposals, in written form, to the executive board or board members of the target company requiring their responses and/or actions by a specific deadline.
The MOF publishes a list of public companies showing the classification of their respective businesses to indicate whether such businesses fall within the categories of "non-core sectors," "core sectors," or "undesignated" sectors. The list is to be reviewed and updated periodically; the latest update as of this writing was in July 2021.
- Japan expanded the coverage of foreign investment review in line with global trends. At the same time, the introduction of the exemptions for prior notification of share acquisitions will reduce the burden on foreign investors who only have a passive, pure investment intention
- The 2020 FEFTA Amendment does not prevent foreign investors from engaging with target companies, but a foreign investor who may wish to nominate board members at the target company's shareholders' meeting with whom the foreign investor or its related parties has a connection or relationship should seek counsel early to evaluate whether the proposal—and share acquisitions in advance of the proposal—requires a prior notification filing to be made
- State-owned enterprises and sovereign wealth funds are non-qualified foreign investors, but if they receive accreditation from MOF, they can be treated in the same way as general investors
- Investors such as investment funds who wish to make flexible and speedy investments in response to market trends should consider making a prior notification filing every six months for possible investments in a target company. If foreign investors are unsure of the exact number of shares and voting rights they may acquire within the next six months, they can specify the maximum numbers in which they could imagine investing in a relatively short time period.
- Even though the MOF and other relevant ministries can extend the 30-day waiting period for prior notifications, when ministries need more time for review, they usually ask filers to withdraw the original filing before the expiration of the 30-day period and resubmit later, when approval is about to be granted. Sometimes filers receive questions regarding their own business, intended transactions with the issuer and similar questions from the ministries, and may even be asked to make covenants in a filing relating to possible transactions (e.g., to not propose to sell a particular business or to not acquire confidential technical information of the target company). There is room to negotiate the language of the proposed covenants and filers can suggest changes to the ministries. After these negotiations, when the relevant ministries regard the contents of the filing to be sufficient to grant approval, filers may refile the prior notification with the agreed-upon covenants, and usually obtain clearance in less than 30 days.
- In principle, the applicability of a designated industry is determined based on the issuer's actual business. In practice, a filer makes the classification judgment based on publicly available information, such as company websites and commercial registries, as well as input from the issuer, if possible. For investments in an issuer with certain licenses or registrations, prior notification may be required based on the type of license or registration, regardless of actual business activities. For example, if a company is a "broadcaster" that has registered under the Broadcasting Act, or is a "telecommunications carrier" that has registered under the Telecommunications Business Act, the company is considered to be engaged in those businesses and falls under the category of designated industries, even if the company does not actually conduct such business activities.