Practical Points to Note about Foreign Direct Investment after the amendment to Foreign Exchange and Foreign Trade Act

Practical Points to Note about Foreign Direct Investment after the amendment to Foreign Exchange and Foreign Trade Act

Fumiaki Makino (Attorney)

Tang Honghai (Chinese Lawyer (Not admitted in Japan))

 

The Foreign Exchange and Foreign Trade Act was enacted in a short period of time. One reason behind this is that there was a regulatory tightening of inward investment in Europe and America. In particular, Foreign Investment Risk Review Modernization Act (FIRRMA) was enacted on August 2018 to expand the authority of Committee on Foreign Investment in the United States (CIFUS) and the European Council has approved and adopted a regulation setting up a framework for the screening of investments from non-EU countries. In this article, we would like to define Inward Direct Investment, to outline prior notification and Post-Investment Report schemes for Foreign Direct Investment, and to explain the Designated Business Sectors and procedures for prior notification as well as the practical points to note about Foreign Direct Investment after the amendment to Foreign Exchange and Foreign Trade Act. It should be noted that any opinions expressed in this article are personal opinions of authors.

 

I. Introduction

 The Foreign Exchange and Foreign Trade Act (hereinafter referred to as “the Foreign Exchange Act”) was enacted in 1949. The Foreign Exchange Act applies to foreign trade involving the movement of funds, goods, or services between Japan and foreign countries and also foreign currency transactions between residents. According to the Article 1 of the Foreign Exchange Act, the purpose of this act is “ on the basis of the freedom of foreign exchange, foreign trade and other foreign transactions, to enable proper expansion of foreign transactions and the maintenance of peace and security in Japan and in the international community through the minimum necessary control or coordination of foreign transactions, and thereby to ensure the equilibrium of the international balance of trade and stability of currency as well as to contribute to the sound development of the Japanese economy.”
 The Foreign Exchange Act was amended four times in 2002, 2004, 2017, and 2019. In 2017, the following amendment was made to the Foreign Exchange Act.

 

(1) Additional industries that required to file a prior notification for specified acquisition. Foreign investor became required to file a prior-notification when they acquire stocks of unlisted companies from other foreign investor if the company conducts business in certain Designated Business Sectors that may impact Japan’s national security.

(2) Introduction of Order for Follow Up Measures
New schemes have been introduced as to giving ordering measures for stock sales for foreign investor who makes Foreign Direct Investment, etc. without filing a notification or by giving the false notification, if such Foreign Direct Investment, etc. may impact Japan’s national security.

 

Also, the following amendment was made in 2019. In this article, we would like to explain the amended Foreign Exchange Act

 

(1) Introduction of exemption scheme for prior notification for stock purchases.
Introduced an exemption scheme for prior notification for stock purchases on the conditions that foreign investor comply with certain conditions.

(2) Reviewing the scope of prior notification.
The threshold for prior notification for stock purchases has been lowered from 10% to 1% for listed companies. Prior notification became required for certain actions such as the nomination of board members of the investee company and propose transfer or disposition of investee company’s business activities in Designated Business Sectors.

(3) Enhancing information exchange among relative domestic authorities with foreign counterparties.

 

 

II. Definition of Foreign Direct Investment

1. Foreign Direct Investment, etc.

 According to Article 26, Paragraph 2 of the Foreign Exchange Act and Article 2, Paragraph 16, Item 1-7 of Cabinet Order on Foreign Direct Investment, Foreign Direct Investment, etc. is defined as transactions or actions to be made by foreign investor as follows (Summarized based on the document on “Q&A for the Foreign Exchange Act” provided by Bank of Japan).

(1) Investment ratio or voting rights percentage is 1% or more respectively when acquiring stocks or voting rights for listed companies in Japan (including over-the-counter, hereinafter collectively referred to as “Listed companies, etc.”). In this case, investment ratio and voting rights percentage includes those held by foreign investor who has a close relationship with the person who has acquired stocks or voting rights for Listed companies, etc.

(2) Acquire stocks or equity of unlisted companies in Japan, except in the case of the acquisition of outstanding stocks or equity through the transfer from other foreign investor.

(3) Transfer the stocks or equity of unlisted companies in Japan, which was obtained when an individual was a resident, to foreign investor after the individual becomes a non-resident.

(4) Foreign investor agree to any of the following.
1. The substantial change in the business purpose of the company in Japan. (only when the company is Listed companies, etc. and foreign investor holds1/3 or more of the total number of voting rights)
2. Proposal concerning the nomination of director or company auditor
3. Proposal concerning the transfer of the whole of business (For 2,3, this applies only when such company is Listed companies, etc. and foreign investor holds 1/3 or more of the total number of voting rights for such company)

(5) Non-residents or foreign corporation, which is considered as foreign investor, establish its branch office, factory and/or business facility (excluding representative office) in Japan or practically change the type and/or business purpose thereof.

(6) Money loan to domestic corporation of which loan period exceeds one year (excluding loan of money in Japanese currency from foreign investor who is a resident. Hereinafter referred to as “Money-Loan”) and fall under any of the following.

a)The outstanding loan after domestic corporation get Money-Loan from such foreign investor exceeds the amount equivalent to hundred million yen.
b)The total amount of outstanding loan after domestic corporation gets a loan from such foreign investor and the remaining amount of equity issued by such domestic corporation and held by such foreign investor exceeds the amount equivalent to 50% of the amount being specified as liabilities of such domestic corporation after Money-Loan.

(7) Business transfer from residents (only from corporations) and/or business transfer due to absorption-type company split and merger. (Excluding cases (1), (2), (3) above).

(8) The corporate bonds issued by domestic corporation and its amortization period after acquisition date remains one year or over, and its acquisition is based on the corporate bonds offered to the designated foreign investor. (Excluding a case where a resident foreign investor acquires the corporate bonds indicated in Japanese currency. Hereinafter referred to as “Acquisition of corporate bonds”) and falls under any of the following.

a)The remaining amount of corporate bonds of the domestic corporation held by foreign investor after Acquisition of corporate bonds exceeds the amount equivalent to a hundred million yen.
b)The total amount of outstanding corporate bonds of the domestic corporation held by foreign investor after Acquisition of corporate bonds and the outstanding loan after the domestic corporation gets a loan from the foreign investor exceeds 50% of the amount being specified as liabilities of the domestic corporation after Acquisition of corporate bonds.

(9) Acquisition of investment securities issued by a corporation established under special Acts such as the Bank of Japan etc.

(10) Discretionary investment in shares of a listed company, investment ratio based on ownership ratio of stocks or voting rights percentage based on ownership ration of voting rights is 1% or more. In this case, the investment ratio and voting rights percentage include those held by foreign investor who has a close relationship with such discretionary investment managers.

(11) Accept the authority to act on behalf of such other persons for exercising voting rights of domestic corporation held directly by others (hereinafter referred to as “Proxy for Exercising the Voting Right”) and it refers to those that fall under any of the following. However, it is limited to those that fall under any of the following (1) to (3) of b.

a)It is Proxy for Exercising the Voting Right pertaining to voting rights for Listed companies, etc. and also voting rights percentage based on mandatory’s ownership ratio of voting rights after accepting the right to exercise of such Proxy for Exercising the Voting Right is 10% or more. In this case, the ratio of such voting rights includes voting rights held by foreign investor who has a close relationship with such mandatory.
b)It is Proxy for Exercising the Voting Right pertaining to voting rights for unlisted companies, and which is accepted from other investors than foreign investor.
(1)Mandatary is not a person from such company or executive officers of the company.
(2)If a proposal for exercising voting rights using authority obtained by appointment falls any of the following.
 a. Nomination or removal of a director
 b. Shortening the terms of director
 c. Changes to articles of incorporation (concerning the change in the purpose)
 d. Changes to articles of incorporation (concerning the issuance of stock with veto rights)
 e. Business transfer etc.
 f. Dissolution of the company
 g. The Absorption-type Merger Agreement etc.
 h. The consolidation-type merger agreement etc.
(3)Mandatary solicits Exercising Voting Rights of Listed Share by Proxy.

(12) Acquisition of authority to exercise voting rights etc. and that voting rights percentage based on holder’s ownership of the voting rights is 1 % or more. The ratio includes voting rights held by foreign investor who has a close relationship with such holder.

(13) After an individual become non-resident, the individual delegates the authority of representation that foreign investor may exercise the voting rights for the unlisted company in Japan obtained when the individual was a resident. However, this applies to a case where the foreign investor falls under the category of (1) and (2) of b of (11) above.

(14) For jointly exercising the voting rights for Listed companies, etc. held by both individual and foreign investor, it is required to gain the consensus of non-resident individuals or corporates enjoying the voting rights for Listed companies, etc., and that the voting rights percentage is 10% or more. This voting right percentage is the sum of voting rights held by holders and other party who have agreed to exercise the voting rights for the listed company. Also, this voting right percentage includes voting rights held by foreign investor who has close relationship with the assentient and voting rights held by foreign investor who has a close relationship with the other party’s assentient.

 As described in (2) above, we would like to insist that transferring the outstanding stocks or equity of the unlisted company in Japan from other foreign investor to foreign investor is considered as specified acquisition and is not subjected to Foreign Direct Investments, etc. This article leaves out the explanation of specified acquisition to mainly discuss Foreign Direct Investment. It should be noted that prior notification is still required even if such transfer falls under the category of specified acquisition.

 

 As you can see from the definition of Foreign Direct Investment, etc., the scope of the Foreign Direct Investment is wide and includes not only general investment but also the establishment of branch offices, factories, and other offices, a loan which meets the certain requirements and acquisition of corporate bond. For this reason, it is understandable that the term “etc.” was added after the Foreign Direct Investment. To understand the meaning of Foreign Direct Investment, etc. it is required to identify the Foreign Investor who will be the subject.

 

2. Foreign Investor

 According to the Article 26, Paragraph 1, of the Foreign Exchange Act, foreign investors fall under the category as follows (Summarized based on the document, “Q&A the Foreign Exchange Act” provided by Bank of Japan).

(1) Individual who is a non-resident.

(2) Corporate or other organization established based on foreign laws and regulations or corporate or other organization having its main office in foreign countries (including its corporate and other branch offices in Japan) (excluding corporate or another organization fall under (4) below)

(3) Company of which voting rights directly or indirectly held by a person specified above (1) or (2) accounts 50% or more in total.

(4) An investment partnership or investment limited partnership. Investment ratio calculated based on investment from non-resident occupies 50% or more of the amount invested by all union members, or the majority of an operating partner is non-residents.

(5) A legal entity or other organization in Japan in which a majority of officers are non-residents or majority of offices are with representation authority.

(6) Even if none of the above applies to a person, the person is still considered a foreign investor in the case where a person makes Foreign Direct Investment, etc. or a specific acquisition for foreign investor not under the name of the foreign investor.

 The definition of foreign investor seems very abstract, and it is difficult to understand its extensional meaning. A document “Rules and Regulations of the Foreign Exchange and Foreign Trade Act” published by the Ministry of Finance on April 24, 2020 (“Document provided by the Ministry of Finance”) provides a clear explanation for the definition of foreign investor. Please refer to the diagram below.

 

[Diagram 1] Scope of Foreign Investor

 

 There are at least 2 points to note as follows when determining whether the company falls under the category of foreign investor.
 First of all, even if foreign corporation establishes its subsidiary in Japan and makes an investment via such subsidiary, such subsidiary will also be considered as foreign investor as long as foreign company holds 50% or more of stocks of such subsidiary or of which majority of officers are non-resident. To determine whether the company falls under the category of foreign investor, it is necessary to pay attention to not only the location of the company but also whether non-resident or foreign company takes control of deciding the vehicle.
 Second, there is a case where foreign company invests through LP in a fund that was formed in Japan. If the amount invested by such foreign corporation is less than 50% of the fund, it should not be a problem. Even so, it is assumed that the investment amount exceeds 50% of the threshold value if a foreign corporation responds to the capital call by collecting funds after the foreign corporation makes an investment. In such case, the fund is considered as foreign investor so that it would interfere with the business of such foreign corporation thereafter when they make an investment. Therefore, a person, who conducts business as an operating partner in fund management, needs to pay attention to the setting of investment amount committed by foreign corporations.

 

 

Ⅲ. Prior notification and Post-Investment Report scheme for Foreign Direct Investment

 When foreign investor makes Foreign Direct Investment, etc. the foreign investor must (1) file a prior notification before transaction or investment (“prior notification”) or (2) file a Post-Investment Report after transaction or investment (“Post-Investment Report) to the Minister of Finance and the competent minister for the business via Bank of Japan, except for those procedures are not required.
 It must be noted that foreign investor shall file a prior notification or Post-Investment Report for Foreign Direct Investment, etc. If the foreign investor is a non-resident, notification or report shall be filed by a representative. In this case, a power of attorney is not necessary to be attached to the notification or report.

 

 

IV. Designated Business Sectors and procedures

 Prior notification for Foreign Direct Investment, etc. is required if the investee company conducts business activities that fall under any of the following.

(1) Nationality or country (including region) of the Foreign Investor is not listed in Appendix 1 of Order on Foreign Direct Investment (“Order on Foreign Direct Investment”).

(2) Business activities conducted by Investee company are included in Designated Business Sectors (except in the case where prior notification scheme is used)

(3) Following actions are taken by Iranian or its related people
a)Acquisition of stocks or equity of the company in which business activities include investment by Iranian with the prior approval of the United Nations Security Council
b)Discretionary investment in Listed companies, etc. in which business activities include investment by Iranian with the prior approval of the United Nations Security Council.
c)Transferring stocks or equity of unlisted companies (limited only to companies in which business activity is an investment by Iranians with the prior approval of United Nations Security Council), which have been held by non-resident before the individual becomes non-resident, to other Iranian or its related people.

 

1. Designated Business Sectors

 The most important thing people need to keep in mind is a case (2) above when determining the necessity of filing a prior notification. Therefore, it is very important that we need to understand the Designated Business Sectors below when we consider whether prior notification is required for what scenarios.

 

 Designated Business Sectors is specified by the Minister of Finance and the competent minister for the business under the provision of Article 3, Paragraph 3, of Cabinet Order on Foreign Direct Investment (“Provisions concerning Designated Business Sectors”) and it is published in the form of Diagram 1 to 3. Among those Designated Business Sectors, sectors handling weapons or nuclear weapons must be treated carefully from the viewpoint of national security, and they are considered as core sectors. If foreign investor would like to invest in investee companies of which business activities are in core sectors, they are likely are subjected to Exemption Conditions on Core Sector’s Business Activities. To understand the amended Foreign Exchange and Foreign Trade Act, it is important to understand the concept of core sectors and an exemption scheme for prior notification; however, we would like to leave out the explanation of them in this article.

 

 Since the Designated Business Sectors covers 155 types of industries in total, we cannot explain each type of business in this Article. Please refer to documents provided by the Ministry of Finance for the outline of the Designated Business Sectors.

 

[Diagram 2] Designated Business Sectors

 

 As you can see from the diagram above, Designated Business Sectors covers a wide range of industries; thus, foreign investor need to consider whether they invest in Investee Company that conducts business activities in the Designated Business Sectors before they invest. It is recommended for foreign investor to refer to the list of listed companies with Designated Business Sectors published by the Ministry of Finance so that they can use the list to determine whether they will be required to file a prior notification for the investment; however, they must note that the list is not created under provisions of laws and regulations. Therefore, it is likely that some of those listed companies may already have engaged in Designated Business Sectors that they have not yet announced to the public, but it is not certain whether the foreign investor will be held responsible for the failure of filing a prior notification if it is found that foreign investor invested in the investee company which conducts business activities in the Designated Business Sectors after they make an investment.
 On the other hand, foreign investor is required to determine whether unlisted companies conduct business activities in Designated Business Sectors on their own when investing in unlisted companies. In that regard, they can refer to the matrix of goods and techniques as listed in the website of Security trade control which is published by the Ministry of Economy, Trade and Industry, or “Japan Standard Industrial Classification” provided by the Ministry of Internal Affairs and Communications.
 Foreign investor is required to collect information from the investee company properly through due diligence, as they, at their own discretion, need to determine whether the investee company is conducting business activities in Designated Business Sectors. If it is difficult for them to determine whether the investee company conducts business activities in Designated Business Sectors based on the information that they collected from the investee company, it is recommended that they will ask the governmental body having jurisdiction for more information by phone as it may be useful to them.
 The scope of designated business sectors has been expanded for cybersecurity-related businesses following by the amendment of the Foreign Exchange and Foreign Trade Act. It is recommended for foreign investor to refer to Document provided by the Ministry of Finance.

 

[Diagram 3] Scope of specific cybersecurity-related businesses in Designated Business Sectors.

 

 Especially, many unlisted companies so-called start-up companies conduct cyber-security related business as listed in diagram 3 above. Therefore, it should be noted that, in many cases, foreign investor needs to file a prior notification when making an investment in start-up companies in Japan.
 If their businesses fall under the category of any of the following, their businesses are not considered as Designated Business Sectors.

(1) Software services, Information processing services, Support services using the internet that are provided by the same company associating with the businesses as listed in Appendix 3 “Provisions concerning Designated Business Sectors”

(2) Software services, Information processing services, Support services using the internet that are provided for parents company and its subsidiary (only for those conduct business activities as listed in the separate chart 3) conducting business activities as listed in Chart 3 “Provisions concerning designated business sectors”

 Moreover, foreign investor is required to consider whether the business conducted by the relative company of the investee company falls under the category of Designated Business Sectors before filing a prior notification. If the joint venture, of which 50% or more of equity is held by a subsidiary of the investee company and/or the investee company, conducts business activities in Designated Business Sectors, it should be noted that prior notification is required.

 

2. Procedures for filing a prior notification

 The prior notification shall be filed to the Minister of Finance and the competent minister for the business via Bank of Japan in the format specified by the Order on Foreign Direct Investment six (6) months before transaction or investment.
 It is prohibited to make Foreign Direct Investment, etc. for transactions requiring a prior notification until it has passed 30 days from the day when the Minister of Finance and the competent minister for the business receives the prior notification (“Acceptance date of notification”) (Article 27, Paragraph 2, of the Foreign Exchange Act). However, the prohibition period will be shortened to 2 weeks after the acceptance date of notification. (Article 10, Paragraph 2, Item 1 of Order on Foreign Direct Investment)
 It should be noted that the foreign investor will be subjected to a criminal penalty if he or she fails to file a prior notification before making Foreign Direct Investments etc. even though he/she needed to file a prior notification before Foreign Direct Investments etc. According to Article 70, Paragraph 1, Item 22 of the Foreign Exchange Act, the Foreign Investor shall be punished with imprisonment with work for not more than three (3) years or a fine not exceeding one (1) million yen or fine may be imposed on the ground that he/she fails to file a prior notification.
 Please refer to the flow chart below in the document provided by the Ministry of Financial for the necessity of filing a prior notification when foreign investor acquires stocks of a listed company.

 

[Diagram 4] Prior notification for stock purchases for Listed Company

 

 Please refer to the flow chart below for the necessity of fling a prior notification when Foreign Investor purchases stocks of an unlisted company.

 

[Diagram 5] Prior notification for stock purchases for Unlisted Company

 

 As described in the flowchart above (Diagram 5), the criteria of investment ratio for Foreign Direct Investment includes investment made by foreign investor who is considered as “Closely related Persons”. However, the problem is what exactly “Closely Related Persons” is. The definition of Closely Related Persons is very difficult to understand. To summarize this, Closely Related Persons is defined as a person who has a permanent economic relationship with a person performing Foreign Direct Investment, etc., its relative, and/or a person who is equivalent to thereof (limited to a person who falls under the category of foreign investor)
 “Closely-related Persons” is defined in detail in Document provided by the Ministry of Finance as follows.

 

[Diagram 6] Definition of Closely related Person

 

 

V. Conclusions

 It is said that the amendment to the Foreign Exchange Act this time is to constrain activists but the Japanese government denies it. Regardless of the purpose of amendment to the Foreign Exchange Act, it is certain that the amendment had an impact on foreign investor. This also had an impact on the investee company. Usually, the listed companies have a constructive dialogue with their stakeholders but use different approaches to stakeholder engagement depending on the ratio of shareholding of shareholders. However, if they are requested for equal treatment of stakeholders who only hold 1% of their stocks and stakeholder who have 10% of their stocks, they will have to spend more time on stakeholder engagement and it will lead to a significant increase in their man-hours.
 If there is an impact of COVID-19 on global macroeconomic, foreign institutional investors are likely to consider geopolitical factors relating to COVID-19 and incorporate it into their investment strategy. In this case, it may bring a great change in the traditional form of investment. It is likely that investment destinations (core areas) like Silicon Valley, Israel, and Shenzhen can be replaced by other investment destinations. If Japan is considered as a safety area that is less affected by COVID-19, the number of venture investments from foreign investor would be increased significantly. Of course, we have our venture investment in Japan so that it may be wise to invest in Japanese venture capital through LP.
 In such cases, prior notification as stipulated by the Foreign Exchange Act should not hinder those who would like to make innovation happen. At least, we hope that the prohibition period after filing a prior notification for an unlisted company will be eliminated for Foreign Direct Investment.

 

 

Professional(s) in Charge