Until recently, Japan had very lenient foreign investment control which allowed Foreign Investors (as defined in FEFTA (defined below) and set forth below) to invest in almost any industry. However, this has been changing over the past several years as Japan follows the global trend of controlling investments in assets or industries that may give Foreign Investors access to sensitive technologies or information.
This article is intended to provide an up-to-date overview of the key features of Japan’s foreign investment control regulations and discuss some common issues Foreign Investors frequently encounter.
With very limited exceptions, the Foreign Exchange and Foreign Trade Act of Japan (“FEFTA“) is the only foreign investment control legislation in Japan. The primary method of control under FEFTA is the requirement that a filing be made before Foreign Investors make an investment into companies in certain business sectors, with such notice triggering a 30-day waiting period and government review.
Japan has experienced a recent surge in the number of prior notifications filed under FEFTA in connection with foreign direct investment (“FDI“). For example, 594 prior notifications were filed in 2018, and that number soared to 2171 in 2020 and 2859 in 2021. The number has slightly declined since 2022 and 2,426 prior notifications were filed, which still remain high.[1] One notable reason for this increase in prior notifications is due to an amendment to FEFTA in 2019 which expanded the industries that are now captured under its prior notification filing requirements. In addition, several other significant amendments to the FEFTA and its regulations were made effective in June 2020. One of the key changes was that the threshold for the obligation to file a prior notification was lowered in connection with share acquisitions of a Japanese listed company, as well as the introduction of new exemption regimes.
In light of these recent changes, it is crucial for Foreign Investors acquiring or holding shares of Japanese companies to understand when and what proceedings are required in connection with the acquisition of a Japanese company’s shares or engaging in shareholder activities. Failure to comply with FEFTA regulations may potentially result in such Foreign Investor being ordered to dispose their acquired shares and may subject the Foreign Investor to imprisonment or a fine.
Below are some commonly asked questions regarding foreign investment controls in Japan and the application of FEFTA to non-Japanese investors.
Q1 – What is the definition of a “Foreign Investor”?
It is important to note that the requirement to file a prior notification (or, if applicable, submit a post-facto report) when engaging in FDI may be applicable to any individual or entity that is deemed as a Foreign Investor under the FEFTA.
The FEFTA defines “Foreign Investor” as any of the following:
- non-Japan resident individuals;
- companies or other organizations formed under the laws of a jurisdiction other than Japan (foreign organizations);
- Japanese companies, of which 50% or more voting rights are, directly or indirectly, held by non-Japan resident individuals or foreign companies;
- partnerships, if either of the following is met: (a) 50% or more contributions to the partnership were made by Foreign Investors; or (b) majority of general partners are Foreign Investors; or
- companies of which majority of directors or other officers, or majority of directors or other officers with representative authority, are non-Japan resident individuals.
Thus, as a first step, when engaging in FDI, investors should determine if they fall under the definition of a Foreign Investor.
Q2 – Does a limited partnership formed under the laws of a jurisdiction other than Japan fall into the definition of “Foreign Investor”?
A limited partnership, or other partnership, formed under the laws of a jurisdiction other than Japan falls into the scope of Foreign Investors, either as a foreign organization as described in Q1 (1) above or as a partnership as described in Q1 (4) above, depending on, among other things, the identity of the owner(s) of the funds’ assets and what rights each limited partner holds.
If it is considered that the limited partners jointly hold the funds’ assets, the limited partnership will be categorized as a partnership that is a Foreign Investor. In this case, the limited partnership, but not each limited partner, has to file a prior notification or, as applicable, post-facto report if other requirements are met.
Otherwise, the limited partnership would be categorized as a foreign organization that is a Foreign Investor. In such case, the general partner may make a filing or a post-facto report on behalf of the limited partnership if the applicable governing law stipulates that the general partner holds the funds’ assets on behalf of the limited partners.[2]
Q3 – When and what proceeding is required in connection with “Foreign Direct Investments”?
Share acquisition is the most typical type of FDI. However, FEFTA defines other shareholder activities as FDIs, including, but not limited to, consent to substantial change in businesses of the company of which shares a Foreign Investor holds; voting for the appointment of a related party as a director or corporate auditor of the subject company; and business succession by a Foreign Investor from a Japanese company as a result of a merger.
It should be noted that a separate prior notification may be required by the Foreign Investor if the shareholder activity involves voting for the appointment of a related party as a director of the subject company, even if a prior notification has already been filed by the Foreign Investor when acquiring shares of such a company.
The required proceedings would depend on what business the subject company conducts. If the relevant company engages in any “Designated Business“(further discussed in Q6 below), such Foreign Investor shall be required to file a prior notification in connection with an FDI, unless an exemption is applicable. Once the FDI is concluded, the Foreign Investor that has filed the prior notification must also submit a post-closing report within 45 days from the closing.
On the other hand, if the subject company only conducts “Non-Designated Business“, the Foreign Investor may only need to submit a post-facto report.
Q4 – How long after the filing of a prior notification can a Foreign Investor conclude a transaction?
When a Foreign Investor has filed a prior notification, there is generally a 30-day waiting period from when the regulatory authority has accepted the prior notification. However, in practice, the waiting period may be as short as two weeks but may also be extended to a maximum of four months (if a hearing is necessary, a maximum of five months) if the regulatory authority considers that a careful review is necessary from the viewpoint of national security or public welfare.
Once clearance has been obtained, the Foreign Investor may conclude the transaction at any time within 6 months from the date the prior notification was accepted.
Q5 – What procedures are required when acquiring shares of a Japanese company?
DEFAULT OBLIGATIONS
As a default rule, if a Foreign Investor desires to acquire shares of a target company, the Foreign Investor is required to file a prior notification if:
(i) the target company (including its Japanese subsidiaries and joint ventures with 50% or more voting rights) engages in any Designated Business[3], and
(ii) (a) the target company is a non-listed company (regardless of the number of shares of such company owned by the Foreign Investor after acquisition); or
(b) the target company is a listed company and the Foreign Investor will own 1% or more of the shares of the listed company after acquisition.[4]
The Foreign Investor is also required to file a post-closing report within 45 days from the closing of the share acquisition in either case.
EXEMPTIONS
Notwithstanding the foregoing, there are a number of exemptions[5] from the above default obligations that Foreign Investors may rely on.
A. Non-Listed Company
If the target company is a non-listed company not conducting any “Core Business” (further described in Q6 below), a Foreign Investor may rely on this exemption if such Foreign Investor complies with the following exemption requirements (“Exemption Requirements“):
Exemption Requirements
- the Foreign Investor, including its related parties, shall not assume the role of director or any other officer of the target company;
- the Foreign Investor shall not make, or have someone make, a proposal regarding the transfer or termination of the target company’s business that falls into the category of a Designated Business during any shareholders meeting; and
- the Foreign Investor shall not access any non-public technical information relating to the business falling into the category of a Designated Business.
Please note, however, that a Foreign Investor relying on the foregoing exemption from filing a prior notification shall still be required to submit a post-facto report within 45 days from the acquisition of shares in the target company.
B. Listed Company
If the target company is a listed company, then it is important to determine whether the Foreign Investor is a foreign financial institution (“FFI“)[6] under FEFTA since there is a “blanket” exemption applicable to FFIs. For an FFI that complies with the requirements for this exemption, such an FFI may acquire shares of a listed company that conducts a Designated Businesses – either a Core Business or Non-Core Business – without filing a prior notification. However, if an FFI acquires shares of a listed company relying on the blanket exemption and, as a result, holds 10% or more of the shares of such listed company, the FFI will still be required to file a post-facto report within 45 days from the acquisition.
For Foreign Investors that are not FFIs, there are other exemptions available for acquiring shares of a listed company. If the target company conducts a Designated Business but a Non-Core Business only, the same exemption regime for cases where the target company is a non-listed company will apply. However, if the target company conducts any Core Business, a non-FFI Foreign Investor may be exempted from filing a prior notification if it holds less than 10% of the shares of the target company after acquisition and the non-FFI Foreign Investor complies with the Exemption Requirements above, as well as the following:
- the Foreign Investor shall not attend, or have a designated person attend, a meeting of the board of directors or other committee with authority to make material decisions on Core Business related matters; and
- the Foreign Investor shall not make a proposal requesting to respond or take action to a board of directors or other committees with authority to make material decisions on Core Business related matters.
Non-FFI Foreign Investors who have acquired shares of a listed company conducting a Designated Business without filing prior notification relying on an exemption must file a post-facto report within 45 days from such share acquisition if:
(i) after such acquisition, its shareholding in such target company will become or exceed 1% of the shares of the target company;
(ii) after such acquisition, its shareholding in such target company will become or exceed 3% of the shares of the target company, and
(iii) after such acquisition, its shareholding in such target company equals or exceeds 10% of the shares of the target company.
Q6 – What is a Designated Business and a Core Business?
Designated Business are those that have been designated as important for national security and public welfare. Traditionally, these have included, among other things:
(i) manufacture or repair of weapons, aircraft, satellites, and nuclear power plants;
(ii) software service for the industries listed in (i) above;
(iii) metal mining;
(iv) manufacture of certain hazardous materials;
(v) manufacture of certain medical products and medical devices;
(vi) agriculture, forestry industry, and fishery industry;
(vii) certain Japan traditional industries; and
(viii) utility-related industries.
In 2019, the scope of a Designated Business was expanded by adding certain industries such as:
(i) manufacture of information processing related equipment, including, but not limited to, integrated circuits, semiconductor memory media, wired communication equipment, mobile phones, and personal computers;
(ii) manufacture of software-related information processing; and
(iii) information and communication related service businesses.
Further, in 2023, the scope of a Designated Business was expanded again by adding certain industries, such as:
(i) manufacture of machine tools and industrial robots;
(ii) manufacture of storage batteries;
(iii) manufacture of metal 3D printers;
(iv) manufacture of manufacturing equipment for semiconductors; and
(v) engine manufacture of marine equipment.
Core Businesses are a subset of Designated Businesses and are those industries that are considered highly important to protect national security. Popular business industries for start-up companies, such as manufacture of integrated circuits or semiconductor memory media, manufacture of software, or information processing services, often fall into the scope of a Core Business. In addition, all business industries added to the scope of Designated Business in 2023 as mentioned above, also fall under Core Businesses. As noted above, if a Foreign Investor is acquiring shares of a Japanese company conducting any Core Business, the Foreign Investor may not be allowed to rely on an exemption from prior notification filing or may be subject to stricter requirements to use the exemption.
Q7 – Is any proceeding required when acquiring the business of a Japanese company?
With respect to the acquisition of a business by way of business transfer, demerger (i.e., spin-off), or merger (other than in the form of a share purchase of a Japanese company) by a Foreign Investor, a prior notification is required if the business falls under the definition of Designated Business, and a post-facto report is required if it is not a Designated Business.
Q8 – Is any proceeding required when acquiring options or convertible bonds?
With respect to the acquisition of options, neither a prior notification nor a post-facto report is required. However, when acquiring convertible bonds, a prior notification or post-facto report may be required if certain requirements are met, such as the redemption period exceeding 1 year and the balance of the bond after the acquisition exceeds JPY 100 million.
Q9 – Is any proceeding required when converting options or convertible bonds to ordinary shares?
In cases where options or bonds are converted to ordinary shares, a Foreign Investor may be required to file a prior notification or submit a post-facto report. It should be noted that neither prior notification nor a post-facto report is required if the subject company exercises a call option attached to such option or convertible bond and the Foreign Investor acquires ordinary shares as consideration.
Q10 – Is any proceeding required when appointing a director?
If the target company conducts a Designated Business, a Foreign Investor has to file a prior notification when voting for the appointment of a person in close relationship with the Foreign Investor (defined in detail under the FDI regulations, which includes directors, family members, or a person or entity who agrees to vote in consortium with the Foreign Investor) as a director of the target company. This will be the case even if the Foreign Investor has filed prior notification when acquiring shares of the target company.
However, no prior notification needs to be filed in connection with a director appointment, if:
(i) the Foreign Investor has filed a prior notification when acquiring shares of the target company; and
(ii) the Foreign Investor holds 50% or more of the voting rights of the target company.
Q11 – If a Foreign Investor, through its fully owned subsidiary (“Buyer SPC”) acquires a Japanese company (“Target Company”), and after the completion of the acquisition, the Foreign Investor plans to merge the Target Company and Buyer SPC, what procedures may be required under FEFTA?
For the purposes of this analysis, the assumption is that (i) the business purpose of the Buyer SPC is to control business activities by holding shares; and (ii) after the acquisition, the Target Company will be a wholly owned subsidiary of Buyer SPC.
A. When Buyer SPC as a surviving company merges with Target Company as a merged company
Both Buyer SPC and Target Company are Foreign Investors because more than 50% of the voting rights are, directly or indirectly, held by the Foreign Investor. Therefore, the following analysis is necessary:
(i) whether a prior notification or post-facto report by Buyer SPC is required in connection with the succession of business from Target Company as a result of the merger; and
(ii) whether a prior notification or post-facto report by the Foreign Investor is required in connection with a substantial change in business purpose of Buyer SPC (this would be on the assumption that Buyer SPC will have to change its business purpose in order to accept and engage in the business succeeded from Target Company).
If Target Company conducts any Designated Business:
(i) Buyer SPC must file a prior notification in connection with the succession of business from Target Company as a result of the merger; and
(ii) the Foreign Investor shall file a prior notification in connection with consent for the substantial change in the business purpose of Buyer SPC.[7]
If Target Company only conducts a Non-Designated Business:
(i) Buyer SPC must submit a post-facto report in connection with the succession of business from Target Company; and
(ii) with respect to the consent for the substantial change in business purpose of Buyer SPC, neither prior notification nor post-facto report is required because the change of business purpose does not relate to a Designated Business.
B. When Target Company as the surviving company merges with Buyer SPC as the merged company
As Buyer SPC conducts a Non-Designated Business only, a post-facto report by Target Company would suffice in connection with the succession of business from Buyer SPC. Also, an amendment to the articles of incorporation of Target Company would not be necessary.
It should be noted that, in cases where Target Company is the surviving company, the Foreign Investor may acquire shares of Target Company as a merger consideration, which may require the Foreign Investor to file a prior notification or submit a post-facto report depending on what business the Target Company engages in and whether any exemption is available.
Q12 – What penalty may be imposed for failing to file a prior notification?
A Foreign Investor engaged in any FDI in violation of its prior notification obligations or consummating any FDI during the waiting period before obtaining clearance after filing the prior notification, may be ordered to dispose of all or part of the acquired shares or otherwise take the required measures. Furthermore, the Foreign Investor may be subject to imprisonment for a maximum of 3 years and/or a fine of up to JPY 1 million.
Q13 – Is there any other proceeding under FEFTA that a Foreign Investor should be aware of?
When a Foreign Investor acquires real estate in Japan or rights pertaining to real estate (leasehold rights, for example) for investment purposes, the Foreign Investor needs to submit a post-facto report within 20 days of the acquisition.
If an acquisition is not for investment purposes, no reporting is required. For example, no reporting is required in any of the following cases:
(i) acquisition for the purpose of residence by the Foreign Investor himself/herself or by his/her relatives, employees or other workers (provided however, acquisition of villas or second home does not qualify for residential purposes, and thus reporting is required);
(ii) acquisition by a Foreign Investor engaging in non-profit businesses for the purpose of performing such businesses;
(iii) acquisition for the purpose to use as his/her own office; or
(iv) acquisition from another Foreign Investor.
Conclusion
The foregoing is an overview of the key features of FEFTA and its regulations. However, as described above, the requirements for each FDI activity, as well as different types of exemptions in connection with such activities, can be complex. Therefore, it is vital for Foreign Investors who plan to acquire shares of Japanese companies, or intend to engage in any shareholder activities, to consult with their legal advisors well in advance of conducting such activity to determine if such activity is regulated by FEFTA and if the Foreign Investor is subject to any notification or reporting requirements thereunder.
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Footnotes
[1] “Number of Prior-notification under Foreign Exchange and Foreign Trade Act (FY 2022)” June 2023, Foreign Investment Policy & Review Office, Ministry of Finance
https://www.mof.go.jp/english/policy/international_policy/fdi/Data/20230623.pdf
[2] See No. 13 of the Public Comments on proposed amendments to Cabinet Order on FDI and Orders on FDI published on April 30, 2020.
https://public-comment.e-gov.go.jp/servlet/PcmFileDownload?seqNo=0000201775
[3] In addition, regardless of the business industries that the target company conducts, a prior notification is required if (i) the Foreign Investor is located in a country or area other than the 163 countries or areas listed in Table 1 of the Order concerning FDI; or (ii) an Iran-related party engages in FDI.
[4] Shares/voting rights held by closely related parties of the acquirer shall be added when calculating the holding ratio. The Same applies hereinafter.
[5] The exemptions are not available for (i) certain categories of Foreign Investors such as those that were sanctioned due to violations of FEFTA and 5 years have not passed since the completion of the punishment, foreign governments, and foreign-government-owned corporations; or (ii) for disqualified types of transactions.
[6] FFIs include, but are not limited to, brokerage firms and investment management firms that engage in such business under the registration under the laws of a foreign country. For example, Investment Advisers registered under the US Investment Advisers Act of 1940, Authorized Fund Manager and Alternative Investment Fund Manager licensed and regulated by the UK Financial Conduct Authority are included as FFIs.
[7] Shareholder resolution adopting merger agreement at the merged company is generally required as one of the merger processes. Thus, in cases where Buyer SPC consents to the merger agreement at the shareholders meeting of Target Company, Target Company shall file a prior notification for this, given that Target Company engages in a Designated Business. However, assuming Target Company is a wholly owned subsidiary of Buyer SPC, generally the short form merger process is used, under which the shareholder resolution at Target Company is not required.
