On October 8, 2019, the Ministry of Finance (MOF) in Japan unveiled amendments to the Foreign Exchange and Foreign Trade Act (FETFA). The amendments were subsequently voted into law by the Japanese government in November. Now, in February, foreign asset managers and other stakeholders have a chance to provide feedback to the MOF by way of a public consultation period. If the initial reactions from market participants are any indication, it is likely that it will be a very active consultation period.
The FEFTA amendments were made primarily to enhance national security and protect sovereign and strategically important Japanese assets from undue foreign influence. Similar rules exist in other countries, however, there are unique elements to the FEFTA amendments which have made global asset managers sit up and take notice. And since FETFA governs foreign ownership of Japanese securities, the FEFTA amendments should be of interest to any global asset management firm who invest into Japan.
For Japan, balancing the benefits of foreign investment with the protection of national security interests is neither new nor unusual. Many countries including the US, Germany, Australia, and the UK (among others) generally maintain free markets but also conduct market surveillance measures to protect strategically sensitive sectors of their economy from undue foreign influence. At its core, the FETFA aims to do just that: protect sensitive and confidential information (e.g. advanced technology) from being acquired by other countries.
FEFTA new requirements: What’s Changed?
FEFTA requires in-scope foreign investors (those holding more than 1% of securities) who have the intention of buying stocks companies of designated business sectors to file prior-notification for such stock purchases (PN-SP) to the Japanese authorities. Upon receipt, the authorities conduct a screening process for the filed PN-SP and then inform the foreign investor whether the purchase is acceptable and can be transacted. Under the amended law, the MOF state that the notification, screening, and clearance process will take a maximum of five days to complete.
Non-Japanese asset managers and asset owners argue that the Ministry of Finance should strike a more even balance between its stated policy goals and fostering foreign investment. After all, the increased scrutiny, transaction delays, and additional costs of compliance could have a negative impact on foreign investments into the country.
It’s important to note, existing FEFTA requirements already have foreign ownership threshold rules, albeit with a much higher 10% ownership threshold. Over the past 20 years – which is the time period the 10% threshold has been in effect — the Japanese authorities received 7,500 PN-SPs and have only rejected one, that instance being a case in 2008, where regulators refused an activist funds’ investment into an electricity company.
Areas of focus
There are several distinct areas of the amended FEFTA which are likely to draw most attention within the February public consultation period. The main ones include:
The reduction of the foreign ownership threshold from 10% to 1% is by far the most impactful proposal for global asset managers. The reduction brings many more foreign owners of Japanese securities into the scope of the requirements. At a recent industry session to discuss the changes, it was suggested that more than 2,500 foreign mutual funds hold 1% or more of in scope Japanese companies and as such foreign mutual funds might be heavily impacted by the amendments. While there have been dissenting industry voices about the chosen threshold, the logic behind it is tied explicitly to Japanese company law and is most unlikely to be changed. The Japanese Corporate Code conveys additional shareholder rights on holders of 1% of outstanding shares (e.g.: can make a submission at shareholder general assembly meetings and therefore the 1% carries over to this FETFA regulation.)
In-scope investors – exemption provision
Uniquely, FEFTA contains an exemption regime for entities who by their nature pose no national security risk to Japan. The exemption applies to banks, insurers, and asset management companies each of which will be exempted from the notification requirement. What remains unclear, however, is whether regulated mutual funds will be able to benefit from the financial institutions’ exemption.
Recent dialogue between asset management industry bodies and the Japanese Ministry of Finance suggests that regulated mutual funds such as European UCITS and US ‘40 Act funds might be exempt from PN-SP reporting regime since they are highly regulated and supervised by independent regulators. For now, it’s unclear whether the Ministry of Finance views other vehicles, such as AIFMD funds or private funds domiciled in the Caribbean, as being eligible for the financial institution exemption. This will be an area of critical importance within the consultation period.
If regulated funds remain in scope, there would be significant impacts to regulatory reporting, index tracking, best execution, stewardship, and voting requirements to ensure compliance. The MOF have stated that all 3,800 Japanese listed companies will be broken into three distinct categories based largely on their strategic importance to national security before FEFTA implementation. It goes without saying that it will be an important issue for any asset managers with Japanese holdings.
The FETFA amendments also expand the number of industries included in the threshold regime. Given the focus of the law centers on protection of national security, some thought the original “key industries” definition was too broad. Some industries — think nuclear facilities and cybersecurity — are intuitively linked to national security whereas a number seem less relevant (e.g: fisheries and leather manufacturing). While the final list and definitions of what constitutes a “key industry” is likely to be refined after the consultation period, it is not expected that the broad scope will be reduced to a great degree
Corporate governance and stewardship
Another area of debate is whether the amendments impede on foreign investors’ ability to affect their voting and engagement rights with the investable company. Some commentators have suggested that FETFA’s screening process undermines Japan’s Stewardship Code (as well as other global stewardship requirements applying to foreign asset owners and managers) as it seeks to reduces attempts to “influence management.” FEFTA amendments require foreign directors to seek MOF pre-approval before taking up their seat on the board of a Japanese company. The rules also impose certain restrictions on investor engagement with companies they are invested, but only as it relates to national security matters. Foreign investors who use the exemption from PN-SP are required to express in a post-investment report their intention to comply with the following three conditions:
- Investors or their closely-related persons will not become board members of the company.
- Investors will not propose transfer or disposition of important business activities of the invested company to the general shareholders meeting.
- Investors will not access non-public information about the invested company’s technology that can impact national security.
No other conditions are attached to shareholders rights. FEFTA imposes no other restrictions on engagement with invested companies by foreign investors.
The public consultation on the FEFTA amendments remains open with the Ministry of Finance welcoming of submissions and have been very transparent in their engagement since the initial publication of the amendments.
The timeline on the process is outlined below. The Japanese government and MOF have expressed a desire for the amendments to take effect in May 2020, ahead of Japan’s “high season” of company annual general meetings (typically in June). Now is the time for industry to get its questions and queries in so that the foreign asset management voice is heard.