Earlier this year, we flagged certain pending amendments relating to the Japanese Foreign Exchange and Foreign Trade Act (FETFA). After several months of deliberation, the final rules were recently published and they grant some respite to managers of ‘40 Act Funds, UCITS, and AIFMD from the most onerous parts of the rules. This is a welcome comfort blanket for managers at a time of need.
The final FEFTA rules were published to the Ministry of Finance, Japan (MOF) website on May 7 and go into full effect on June 7. The timing is important since mid- to- late June represents Japan’s “high season” for company annual general meetings. There had previously been some uncertainty and a degree of anxiety among foreign asset managers about the impending amendments. But the shape of the final rules will likely receive a warm welcome by foreign asset managers given many now fall under a blanket exemption granted by the Ministry of Finance (MOF).
As a reminder, the enhancements to FEFTA aims to bolster Japan’s national security and protect strategically important Japanese assets from undue foreign influence. The Foreign Exchange and Foreign Trade Act (FEFTA) revisions require overseas investors to submit a prior notification of certain stock purchases to the government via the Bank of Japan if they plan to acquire a stake of 1% or higher in listed Japanese companies in 12 sectors ranging from utilities, arms, space, nuclear power, aviation, telecoms, and cybersecurity (among others).
Company Categorization List
FEFTA divides listed companies into three distinct categories across 12 business sectors. The three categories are based on the strategic importance of a company to Japan’s national security. Each designation is attached with different levels of compliance obligations attached to inward direct investment ranging from those requiring prior notification, those not requiring prior notification, and those with exemptions.
The numbers breakdown of the published list is:
- Non-designated Sectors: 1,698 companies (44% of total)
- Designated Sectors (Non-Core): 1,584 companies (42%)
- Core Sectors: 518 companies (14%) – prior notification protocols apply to all trades on core sector companies
It’s no surprise that the COVID-19 pandemic has impacted almost every area of policymaking. Japan is no different. To that end, it has been widely reported that Japan is considering designation of the advanced medical industry as a highly sensitive sector under FEFTA to ensure the stable supply of necessary drugs and equipment for domestic use in managing the pandemic.
Foreign Financial Institutions
The FEFTA rules have always contained certain exemptions for Foreign Financial Institutions (FFIs). These exemptions have existed because the MOF believe that for the most part foreign financial institutions are subject to a high degree of regulation and supervision. It is extremely unlikely that transactions made by FFIs are intended as a stepping stone to the misappropriation or transfer of technology information likely to represent a risk to Japan’s national security. Such exemption may be obtained by the FFI so long as they adhere to certain board governance requirements, do not propose to transfer or dispose of certain business activities, or seek to access non-public information about investee companies’ technology.
Who was and wasn’t considered a FFI however was open to debate within the consultation. In what was generally received as positive news in the industry, the MOF have now confirmed that the definition explicitly grants the blanket exemption to asset managers and regulated mutual fund vehicles ranging from US ‘40 Act registered investment advisers and ’40 Act investment companies, Alternative Investment Fund Managers (AIFM) supervised by the UK Financial Conduct Authority (FCA), Type 9 (Asset Management) license holders in Hong Kong supervised by the Securities and Futures Commission, Investment companies, common funds, and unit trusts managed by a management company licensed under the UCITS Directives.
Although now largely exempt from the pre-notification of trade requirements, foreign asset managers still need to be aware that there remain obligations relating to post-investment reports that are still required under the FEFTA amendments.
Such reports are necessary when a FFI’s total shareholding reaches:
- 1% for the first time
- 3% for the first time
- 10% or more for each transaction (as has been the case before the amendment)
Such reports must be submitted within 45 days from the transaction settlement date. For the following transactions, investors are not required to specify ministers responsible for business sectors in the post-investment report:
- stock purchases (under 10%) with exemption in designated business sectors
- stock purchases in non-designated business sectors
Intermediated Filing Obligations
There has also been much scrutiny of who is obliged to file the required reports. Normally, there is a chain of intermediation inherent in the investment process, where the asset owner often delegates decision making and trade execution to another party or such ownership is collectively pooled as in the case of mutual funds. Under FEFTA, the responsible party to file a BOJ notification depends on which party exercises the voting rights and not on the identity of the party that has nominal ownership. We previously explored this phenomenon when discussing the EU’s Shareholder Rights Directive.
Such intermediation, however, is often complicated. The final rules legislate for some of the more usual intermediated relationships. The notification and reporting obligation are largely dependent on the entity who retains primary investment and voting authority. Firms will need to be clear about who will report in each instance.
The amended FEFTA is effective since May 8, but the 30 day-transition period runs until June 7. During this interim period, foreign investors will be expected to submit a prior notification if they plan to purchase 1% or more of the designated companies. Also, the company classifications are not permanent and remain subject to change at the discretion of the MOF if there are material changes in a company’s business activities. While the new rules provided foreign asset managers with a comfort blanket there remains some analysis and work to do on reporting for all foreign asset managers who trade Japanese listed securities.