Foreign Direct Investment Regulations and the Practice thereof – Given the Recent Economic Security Environment – Part02

FDI Screening Practice (1): Investor’s Filing – Government’s Screening

Hamaguchi

In my impression, with a series of related revisions, the legal regime for FDI screening has become quite complicated. From here on, we will discuss the process of FDI screening from foreign investors’ notification filing to the Government’s screening.

Roku

One of the practical issues that I often worry about is whether foreign investors and their attorneys should have preliminary consultation with the government authorities before formally filing notification. The parties have an option to formally file notification without such preliminary consultation; however, in that case, it is difficult to foresee how long the Government’s screening will take and predict from when the investors can conduct their FDIs. For this reason, foreign investors would like to know a rough estimate of when they can conduct their FDIs before formal filing through preliminary consultation.

Osawa

The Ministry of Economy, Trade, and Industry (METI), for which I worked until last month, is a competent ministry in charge of a wide range of the Designated Business Sectors. METI, which scrutinizes roughly 90% of all FDIs for which prior notification is submitted, accepts foreign investors’ request for preliminary consultation in response to their needs. When a foreign investor formally files prior notification after the investor obtains METI’s “informal approval” through preliminary consultation, in most cases, the investor will be allowed to conduct the FDI six to eight business days after the date of formal filing, if METI is in charge of all the Designated Business Sectors that the investee Japanese company is involved in.

Hamaguchi

How about cases where the investee Japanese company is involved in the Designated Business Sectors that other competent ministries are in charge of?

Osawa

As far as I know, some competent ministries do not accept investors’ request for preliminary consultation. As for an FDI related to the Designated Business Sectors that such ministries are in charge of, a foreign investor would be unlikely to conduct the FDI along the above schedule as the ministries would not start screening before formal filing.

Roku

What sort of communications will be held with the government authorities in preliminary consultation?

Osawa

During preliminary consultation, METI scrutinizes an FDI in the same manner as in the case of formal filing. Looking at a draft notification document that the investor submits along with the request for preliminary consultation, public information, and information that METI separately collected, etc., METI closely scrutinizes the FDI. Additionally, METI sometimes sends a questionnaire to the foreign investor, or conducts an interview with the investee Japanese company after obtaining the investor’s consent if applicable, to acquire information necessary for screening.

Roku

At what stage does METI accept request for preliminary consultation? Foreign investors are eager to know the government authorities’ preliminary view on FDIs in the early stages of their transaction projects, because it would be a serious problem if investors are ordered by the Government to discontinue FDIs under FEFTA after investors have spent a lot of time and resources. Will METI accept request for preliminary consultation at such early stages?

Osawa

Generally speaking, METI cannot form its view on FDIs if the specific transaction scheme and the policy of management involvement after investment have not been established. Even if a foreign investor asks for preliminary consultation at such early stages, METI may decline the investor’s request. Even if METI accepts the investor’s request, the investor would usually be able to hear METI’s germinal impression only. Therefore, generally, it would be a better choice for a foreign investor to request preliminary consultation after the contents of the notification document and the transaction scheme have been roughly determined.

Roku

Thank you.
As for the screening process without undertaking preliminary consultation, the government authorities sometimes send a questionnaire to a foreign investor. In that case, in my impression, the screening period (including the period necessary for the investor to prepare the answer) tends to be much longer. Are there any criteria for the government authorities to decide whether to send a questionnaire on each case?

Osawa

Given that a questionnaire aims to gather information necessary for the screening, the government authorities would decide on a case-by-case basis. Generally, where an investee Japanese company is an unlisted company, the government authorities would be more likely to send a questionnaire compared to a case of a listed investee, because public information related to an unlisted company is relatively limited.

Hamaguchi

Is it possible to avoid receiving a questionnaire by detailing in the notification document the matters that would be questioned by the government authorities?

Osawa

If supplementary information is included in the notification document, the government authorities would consider the information during the screening. For this reason, there would be cases where the government authorities finish screening without sending a questionnaire thanks to the supplementary information, whereas the government authorities would have done so if the supplementary information was not included.
The supplementary information is meaningless unless it captures the concerns of the governmental authorities which scrutinize FDIs from the viewpoint of national security. Ideally, it would be better to involve those with knowledge of economic security (e.g., those who engaged in FDI screening in competent ministries) in preparation of notification documents, etc. and accurately describe the information that the government authorities consider important.

Roku

Recently, there has been an increase in investments by activist funds in Japanese companies. Some activist funds make drastic proposals such as acquisitions or sales of business, while others only request more returns to shareholders, improvement of capital efficiency, and strengthening corporate governance. Therefore, it would be difficult to say generally, but from what viewpoint do the government authorities scrutinize FDIs planned by activist funds that fall under the category of foreign investors?

Osawa

FDI Regulations do not aim at blocking activist funds’ investments, therefore, activist funds would not be treated unfavorably solely because of their attributes. However, the government authorities would see the risk very seriously, if any, of businesses important to national security may be negatively impacted by activist funds’ proposing or encouraging transfer or abolition of such business or requesting excessive returns to shareholders, looking at the activist funds’ past management involvement and investment behavior, etc.

FDI Screening Practice (2): Government’s Actions Based on Screening Results

Roku

Next, we would like to discuss the actions to be taken by the government authorities based on the results of the screening. Under FEFTA, the government authorities have the authority to issue a recommendation to discontinue or change the substance of the FDI, and if the investor chooses not to follow the recommendation, the authorities can further issue an order to that effect. Has there been such a case?

Osawa

The government authorities issued a recommendation and order to discontinue the share acquisition of Electric Power Development (J-POWER), for which The Children’s Investment Fund (TCI) filed notification in January 2008. In this case, the government authorities found that TCI’s planned acquisition would affect the stable supply of electricity and the national policies regarding nuclear power and the nuclear fuel cycle and could thereby impede the maintenance of public order. The Japanese Government issued a recommendation that TCI discontinue the share acquisition in April 2008, and, since TCI refused to comply, further ordered the discontinuation of the share acquisition in May 2008 (after which TCI announced that it would accept the order).
In recent years, there have been growing moves by foreign governments to intervene in FDIs, some of which Japanese companies have been involved in. Given this trend, we should note the possibility that FDI interventions will be more often seen in Japan as well. Please see my recent article in which I listed major FDI interventions in foreign countries.※1

Roku

Are there any cases where the government authorities will request that a foreign investor comply with certain investment conditions in the screening process in cases where the government authorities will not issue a recommendation or order to discontinue or change the substance of the FDI?

Osawa

In some cases, during the screening process, the FDI at issue will be found to involve risks related to the national security but the risks would be dispelled addressed if the foreign investor complies with certain “promises.” In those cases, if the foreign investor pledges to keep such promises in the notification document, the government authorities would decide not to proceed with the issuance of a recommendation or order to discontinue or change the substance of the FDI and end the screening. Typical promises by foreign investors include promises not to propose transferring, downsizing or abolishing the business related to the Designated Business Sectors and promises not to access important confidential information.

Enforcement

Hamaguchi

Since there were a series of revisions to the FDI Regulations in recent years, I believe that both foreign investors and investee Japanese companies are paying close attention not to violate FEFTA (e.g., taking care not to fail filing of mandatory prior notifications). What sorts of monitoring are the government authorities conducting with respect to violations of FEFTA?

Osawa

With respect to all FDIs conducted without prior notification on the grounds that they are related to investee Japanese companies that are not involved in any of the Designated Business Sectors, METI’s practice is to monitor such FDIs by checking the ex post facto reports that must be submitted after conducting the FDIs. Further, in the prior notification screening process, METI also checks a foreign investor’s past transactions, etc. and examines whether there were any violations, such as a failure to file a mandatory prior notification. In addition, METI carries out monitoring based on information provided to the information desk of the Ministry of Finance (the ministry with jurisdiction over the FDI Regulations) and information provided by investee Japanese companies.

Hamaguchi

What sorts of sanctions may the government authorities impose with respect to violations of FEFTA?

Osawa

Intentionally failing to file a mandatory prior notification would be subject to a criminal penalty. In addition, whether the failure is intentional or negligent, the government authorities may issue an order for measures if an FDI is problematic from the viewpoint of national security. In practice, a foreign investor who committed a violation of FEFTA would be required to submit a particular investigation report specifically describing the content of the violation, etc. The government authorities would investigate the violation given the contents of the investigation report and take measures as necessary. Additionally, if a foreign investor who violated FEFTA files a prior notification for another case in the future, the facts of the past violation may be considered in the screening process.

Hamaguchi

Foreign investors who violated the Foreign Exchange Act should formulate some sort of preventive measures. What preventative measures are required?

Osawa

It is necessary for a foreign investor to specifically identify the cause of the violations and formulate and implement effective and specific recurrence prevention measures in line with the identified causes of the violations. For example, if a foreign investor failed to file a prior notification because the investor did not recognize that the business sector related to an investee Japanese company was added to the Designated Business Sectors due to a revision, the investor should take recurrence prevention measures to gather information on revisions related to the FDI Regulations by regularly checking the website of the Bank of Japan and related ministries and to establish an internal system for timely dissemination of the revised information. The government authorities will review the recurrence prevention measures through questionnairesinvestigation reports, etc. and may request that the investor reconsider the measures if the government authorities have doubts about their effectiveness. Please refer to my a discussion in my recent article published in May 2022※2 for the major causes of past violations and examples of recurrence prevention measures related thereto.

Hamaguchi

Today, we discussed the FDI Regulations, which are becoming increasingly important mainly in the context of M&A and corporate matters, while also introducing the latest practices. In recent years, since this practice area has become increasingly complicated and more specialized knowledge is required, it is necessary for both foreign investors and investee Japanese companies to deal with the FDI Regulations with the advice of well-versed attorneys. We would like to continue to provideing everyone with updates on the latest information.