Japan's Ministry of Finance (MOF), together with industry sector ministries, review FDIs under the Foreign Exchange and Foreign Trade Act (FEFTA).

FEFTA requires FDI review for a broad scope of transactions, with a hair trigger filing threshold, subject to exemptions available in public markets transactions.

Summary of major changes in 2023

• The Economic Security Promotion Act was promulgated in May 2022. The act newly designates as Specified Critical Products those products whose supply, if disrupted, would significantly impact the survival of citizens, their daily lives or economic activity. The Japanese government designated certain business sectors thought to have an impact on Specified Critical Products as "core" sectors under FEFTA. Acquisitions in such business sectors will now require prior approval under Japan's FDI review regime
• Newly added core sectors include: fertilizers; machine tools/industrial robots; storage batteries; metals and mineral products; metal 3D printers; permanent magnets; semiconductors (including manufacturing of semiconductor manufacturing equipment); natural gas; and marine equipment

Who files?

Depending on the type of business in which the target entity is engaged, FEFTA requires a foreign investor to submit a prior notification—a request for permission to conduct the action that is "inward direct investment" or "designated acquisitions" —and/or a post-transaction filing through the Bank of Japan to the MOF and relevant ministries in relation to each action constituting inward direct investment or designated acquisitions.

Foreign investors include: individuals who do not reside in Japan, termed "non-residents"; entities or other groups established under laws or regulations of, or having their principal offices in, foreign countries; entities in which an individual or entity described above holds 50 percent or more of the total voting rights; partnerships operating in the investment business of which 50 percent or more of the total capital has been contributed by foreign entities, foreign groups or non-residents, or the majority of general partners are non-residents; and entities in which the majority of directors or representative directors are non-residents.

Types of deals reviewed

The MOF and Japan's ministries with jurisdiction over the target entity's business review two types of transactions: designated acquisitions and inward direct investments.

A designated acquisition is a transaction where a foreign investor acquires any shares—even just one share—of a non-listed company from another foreign investor.

Inward direct investments can cover many scenarios, for example where a foreign investor acquires 1 percent or more of a listed target entity's outstanding shares or total voting rights; or acquires any shares of an unlisted target entity from a resident shareholder.

Inward direct investments also include transactions where a foreign investor consents to material changes to the business purposes of an unlisted target company, regardless of ownership percentage, or a listed target company where the foreign investor owns one-third or more of the target company's total voting rights.

Transactions are also defined as inward direct investments where the foreign investor consents to shareholder meeting proposals to nominate that foreign investor or certain related parties to the board or certain other extraordinary transactions such as a sale of the company, regardless of ownership percentage for an unlisted target company or when holding 1 percent or more of the voting rights for a listed target company.

Other scenarios include where the foreign investor obtains proxy voting authority at an unlisted company, or such authority equivalent to 10 percent or more of the total voting rights of a listed company; or acquires the right to exercise 1 percent or more of a listed company's voting rights.

Also covered are situations where the foreign investor obtains the agreement of other foreign investors to jointly exercise their respective beneficially owned voting rights, where the aggregate beneficially owned voting rights across all relevant foreign investors account for 10 percent or more of the total voting rights of a listed company; lends to a Japanese company more than ¥100 million (US$693,000), where the company's debt to the foreign investor accounts for more than 50 percent of the company's debt; or purchases corporate bonds that meets certain criteria, including that they amount to more than ¥100 million and account for more than 50 percent of the company's debt.

Scope of the review

Foreign investors are required to make a prior notification and/or a post-transaction filing through the Bank of Japan to the MOF and relevant ministries with respect to certain inward direct investments.

Prior notification filings may be required depending on whether the target entity is engaged in designated industries or the characteristics of the foreign investor—including nationality and location, including region—and whether the investor qualifies for exemptive relief.

A foreign investor who has obtained a prior notification filing approval for any inward direct investments is also required to make a post-transaction filing within 45 days of the completion of the transaction.

A foreign investor is required to submit a prior notification filing with regards to a designated acquisition if the target company is engaged in designated industries. Post-transaction filings are not required for a designated acquisition unless the foreign investor claimed an exemption from prior notification filings for its stock acquisition.

Review process timeline

Foreign investors must have made their prior notification filings within the six-month period prior to the completion of the transaction. In other words, approvals are valid until six months from the date on which the filings were officially received by the BOJ.

By default, transactions subject to a prior notification filing cannot be closed until the expiration of a 30- calendar-day waiting period from the date on which MOF and the ministry having jurisdiction over the transaction received the filing. However, the waiting period may be shortened to two weeks. Nevertheless, the MOF and the relevant ministries can extend the waiting period up to five months if necessary for the review.

If the MOF and the relevant ministry find the transaction under review problematic in terms of national security, they may recommend that the foreign investor change the transaction or discontinue the transaction after consultation with the Council on Customs, Tariff, Foreign Exchange and other Transactions. The foreign investor must notify the MOF and the relevant ministry of whether it will accept the recommendation within ten days after receiving such recommendation. If the foreign investor does not provide notice or refuses to accept the recommendation, the MOF and the relevant ministries may order a modification of the content of the transaction or its termination before the expiration date of the waiting period.

How foreign investors can protect themselves

Foreign investors are categorized into three types under the exemptions from the prior notification filings: foreign financial institutions; general investors; and non-qualified foreign investors. The coverage of the exemption differs depending on the type of foreign investor involved.

All of the exemptions are subject to the requirement that the foreign investor comply with the following three exemption conditions: firstly, that the foreign investor and its closely related persons will not serve on the board of the target company as directors or audit & supervisory board members; secondly, that the foreign investor will not make proposals at shareholders' meetings to dispose of material businesses in designated industries; and finally, that the foreign investor will not access sensitive confidential technologies that are related to the target company's business in designated industries.

In principle, the applicability of a designated industry is determined based on the issuer's actual business. In practice, however, a filer makes the classification judgment based on publicly available information, such as company websites and commercial registries, as well as input from the issuer, if available.

To help this assessment, foreign investors may refer to (but cannot rely on) the MOF list of public companies discussed above, designating businesses as being involved in "non-core sectors," "core sectors" or "undesignated sectors."

For investors who wish to make flexible and speedy investments in response to market trends, such as investment funds, it is worth considering making a prior notification filing a bit more frequently than every six months for possible investments in a target company.

Sometimes, after making a prior notification, filers receive questions regarding their own business, intended transactions with the issuer and so on from the ministries, and may be asked to make covenants in a filing relating to possible transactions. There is, however, room to negotiate the language of the proposed covenants, and filers can suggest changes to the ministries.

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