Japan has long presented a challenging environment for international investors despite having had very lenient foreign investment control. The challenges arise out of certain invisible barriers for non-Japanese investors to come into the Japanese market, including unique business and market cultures, limited transparency, and limited human resources with business-level English capabilities. However, things have changed drastically over the past decade. Foreign investors have streamed into the Japan market as a result of noteworthy changes in the investment environment in Japan, and significant and continuous efforts by the Japanese government to attract foreign investors.
Enhanced market discipline in the Japanese capital markets
Historically, shareholders of Japanese listed companies did not exert much, if any, pressure on the management of such companies. Shares in Japanese listed companies were cross-held by their business partners and banks, who acted as management-friendly shareholders. Large domestic institutional investors, including pension funds and life insurance companies, were silent, passive investors, who almost always voted in favour of the management’s proposals.
With the increasing awareness of the need for rules of conduct for management and institutional investors, Japan’s Stewardship Code was published in 2014 (as amended, the “Stewardship Code“), and the Tokyo Stock Exchange (“TSE“) adopted Japan’s Corporate Governance Code in 2015 (as amended, the “Corporate Governance Code“).
The Stewardship Code emphasises accountability of institutional investors and encourages them to disclose policies on proxy voting and their voting activities, to monitor their investments, and to engage in constructive dialogue with the companies in which they invest.
The Corporate Governance Code has significantly enhanced the corporate governance of Japanese listed companies to bring it up to par with the global standard. For example, in 2022, 92.1% of the listed companies in the TSE Prime Market have appointed 1/3 or more independent directors to their board of directors. This is a significant jump from 6.4% in 2014. The Corporate Governance Code has also increasingly evoked awareness of a director’s responsibility and accountability to shareholders. About 70% of the companies in the TSE Prime Market now provide their earnings reports and notices of annual general shareholders meetings in English to international investors. The Corporate Governance Code requires listed companies to review and disclose the risks and benefits of cross-shareholdings, which caused a constant trend of unwinding of cross-shareholdings.
As a consequence of these changes, Japan’s capital markets now impose significantly more discipline on listed companies and institutional investors, and offer substantially increased accessibility and transparency to international investors.
Such transparency has resulted in, more possibilities for activist funds to participate in the governance, particularly by making shareholder proposals. Increasingly, shareholder proposals have become more widespread among Japanese listed companies. 50 of the listed companies in the TSE Prime Market received 224 shareholder proposals in total for the shareholder meetings held in June 2022. This represents a sharp rise from 28 companies and 119 shareholder proposals in total in 2018. Not only has the number of shareholder proposals increased, so has the support from shareholders in general for such proposals. In the past, shareholder proposals were almost never successful. However, this is beginning to change as, in 2022, there were a few proposals which were supported by other shareholders and were approved at the shareholders meetings. Even in cases where there was not sufficient support to approve proposals, such proposals still received wide support from other shareholders; thus, demonstrating that shareholders are becoming more active participants in the governance process and willing to exert more pressure on the boards of directors and hold them accountable for their decisions.
M&A and start-up investment opportunities on the rise
M&A
The number of M&A transactions in which Japanese companies are involved has been increasing year by year. Previously, Japanese companies were reluctant to sell their businesses, since it was perceived as a failure of the management and abandonment of their employees. More recently, however, this perception has changed and now M&A is widely recognized as a positive business strategy. One driver of this change has been the increase in global competition faced by Japanese companies which has been exacerbated by a domestic market that is shrinking due to aging population. The shrinking domestic market drives not only conglomerates but also small to mid-sized companies to expand their businesses outside of Japan. Japanese companies are now actively selling their non-core businesses and acquiring businesses both within and outside of Japan which they expect to have strong synergy with their core business. Another recent trend giving rise to M&A transactions is utilizing M&A for business succession. In such cases, older entrepreneurs sell their businesses because they cannot find adequate successors within their companies. With all these changes and the continued aging of Japan’s population, it is very likely that the number of M&A transactions involving Japanese companies will continue to grow over the mid to long term.
Start-up investments
Start-up investments in Japan have also been steadily expanding due to a significant increase in appetite for equity financing by Japanese start-up companies. The result of this has been a steady increase in the number of investments made by non-Japanese investors, and a spike in such numbers in 2021. In Japan, IPO is the main exit path for investors, accounting for about 2/3 of the exit transactions in 2021, but exits through M&A transactions (such as the acquisition of Paidy by PayPal Holdings) are becoming increasingly more common.
Improved investment environment for international investors
Changes in attitude towards non-Japanese investors
With the progress of global expansion of their businesses, many Japanese companies are now welcoming investments and employees (and even managers) from international investors. This is especially true for companies run by younger generation managers and start-up companies. Human resources with sufficient English capabilities remain an issue for international investors, but is gradually improving, as many Japanese companies and people become increasingly aware of the importance of English skills in a global market.
FDI regulations remain limited
Although the Foreign Exchange and Foreign Trade Act (as amended, the “FEFTA“) was amended in 2019 and 2020 to tighten the foreign investment regulations, Japan still has very limited foreign investment control. The FEFTA requires non-Japanese resident investors to make a filing before or after making an equity investment into Japanese companies or businesses, depending on the type of business conducted by the relevant target company. Such filings, however, are routine and are almost never rejected. In fact, there is only one known case in which the government did not approve the transaction. Except for the FEFTA, there are no general restrictions on investments or the appointment of non-Japanese directors by foreign investors, other than with respect very few industries such as aviation, broadcasting and freight forwarding businesses.
Government policies promoting foreign direct investments
Over the years, the Japanese government has been actively implementing a variety of measures to make the investment environment in Japan more foreign investor friendly. In 2020, the government set a target to double the amount of the foreign direct investment to 80 trillion yen (12% of the GDP) in 2030. In particular, the government aims to (i) promote investment into human resources through the foreign direct investment; (ii) promote digital transformation (DX), green transformation (GX) and foster start-ups through foreign direct investments; and (iii) improve the living environment for non-Japanese people to promote foreign direct investments.
A key ongoing project regarding foreign direct investment promotion released last year (the actual action plans under this project will be finalized this year) includes preparation of model contracts to meet global standards, standard investment contracts, enhancing support to international companies entering into Japanese market, and establishing and expanding a wide array of subsidies and foundation grants to promote investments, including investments by non-Japanese enterprises into strategic focus areas (such as semiconductors, data centres, next-generation telecommunication technologies, and green innovations).
How we can support
Japan’s markets are now more open, accessible and transparent to foreign investors than ever before. Japanese companies are eagerly expanding their businesses outside of Japan and are taking steps to welcome people from overseas. Nevertheless, there are still some unique cultures and aspects to doing business in Japan or with Japanese companies. Language also still remains somewhat of a barrier to accessing Japan’s markets. In addition, understanding legal rights and obligations affecting the operations of Japanese companies, such as employment law or laws regarding intellectual property, remain an integral part of successfully investments.
With the aim to support international investors and people doing business and investing into Japan or with Japanese business partners, Withers launched a Japan desk in Singapore led by a Japan-qualified lawyer, and, at the same time, brought in a new corporate / M&A team in Tokyo in 2022. With our new team on the ground in Japan and around the region, we are eager and well placed to support our clients to understand the Japanese market, laws and practices in making investments in Japanese companies – and, of course, bridging any language gap that might exist. We look forward to sharing our knowledge and experience with you and helping you to succeed in the Japan market.
