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Third Point leads criticism of Japan’s foreign investment law

Lack of details on enforcement sparks trepidation among investors

TOKYO -- Continued uncertainty surrounding details of a new law on foreign investment is likely to dent appetite toward Japan, experts warned.

Japan's parliament last November revised the Foreign Exchange and Foreign Trade Act, which requires foreign investors to submit prior application to buy shares above a certain threshold in companies deemed crucial to national security. The revision lowers the threshold to 1% of the shares from the previous 10%.

About 400-500 listed companies are expected to be subject to the new rules, Nikkei reported on Friday, which is more than a tenth of all listed companies. An official list of companies will be released in April, ahead of the revised law's implementation in May.

With a large number of companies potentially affected, the focus has turned to a scheme that exempts investors who meet certain conditions. But details of the conditions -- a gauge of how strictly Tokyo intends to limit the ability of investors to propose changes in areas like governance -- remain uncertain, experts said.

"We were surprised" by the passing of the act, activist investor Daniel Loeb, CEO of the New York-based hedge fund Third Point, wrote in a letter to investors on Jan. 30.

Saying that the company had cheered Prime Minister Shinzo Abe's corporate governance reforms since 2012, Loeb said the 2019 changes "could undermine these positive reforms," by adding scrutiny to foreign investment. "One effect the bill clearly could have is to make it more difficult for engaged shareholders to build positions," Loeb wrote.

The activist investor questioned the rationale of the law revision. "The bill’s stated justification was to prohibit creeping foreign ownership of nationally strategic assets but, as in the U.S., there was little evidence presented that such a threat exists or could not have been addressed under existing regulations."

Third Point, a shareholder in Sony, has proposed to the company that it spin off its cash-cow image sensor business to unlock value for shareholders. Sony has refused to do so.

In the letter, Loeb pinned hopes on the "application of the rule," which is currently under preparation by various ministries, to "do less to chill corporate governance reform in practice than it seems to do on principle."

Hidenori Yoshikawa, a consultant at Daiwa Institute of Research, said, "What kind of key proposals will meet the conditions for exemption is still a gray area."

The move comes at a time when shareholder activism is on the rise in Japan, in what many view is the result of the government's own efforts to attract foreign investment. Its governance code and stewardship code has prompted companies to hire independent board members, for example.

U.S. activist hedge fund Elliott Management recently called for changes in governance at SoftBank Group, which owns a stake in a mobile network operator.

Japanese activist investor Yoshiaki Murakami has taken more dramatic steps, experts say, such as launching a hostile takeover bid for Toshiba Machine. Toshiba Machine has fought back by claiming that Murakami, who lives in Singapore, is a foreign investor and is violating foreign investment rules.

"In an ideal world, all investors should have the freedom to exercise any rights to which they are legally entitled in order to maintain healthy corporate governance," said Yutaka Kimura, a partner at Baker McKenzie's Tokyo office.

"The market continues to follow the recent trend of valuing open dialogue between listed companies and their shareholders. Overseas investors may be concerned that the new rules, once implemented, may reverse of this trend."

Havard Chi, director of Singapore-based activist fund Quarz Capital Asia said, "We are concerned that the new legislation could be used to prevent sound measures to create shareholder value and enhance corporate governance from being put into place."

The proposed 1% rule "is pretty restrictive and seems unreasonably low and arbitrary," he added.

Parts of the revised law, at this point, still hold ambiguity for investors like Quarz, which has called for more transparency regarding criteria for companies that will be blocked based on national security concerns.

"Without clarity and rules-based regulation, we can assume that a number of companies, particularly those which require corporate governance attention would lobby," said Chi.

Extra paperwork, time and cost could also hinder foreign investors from coming into the market, as it is "in contrary to the government's policy of promoting an efficient and vibrant financial market in Japan," Chi said.

"The worrying thing for us as investors is that we are already substantial minority investors in some listed Japanese companies and have been actively engaging with them in capital allocation. What if management decides to purchase sensitive assets resulting in the company to be put in this bucket? Are we forced to sell our stake to under 1%? The proposed amendment is definitely creating uncertainty to investing in Japan to foreign investors," Chi said.

Masahiko Ishida, partner at DLA Piper in Tokyo, said, "There is no surprise to the number of companies that will reportedly be affected. The question is which companies will fall under the category of information technology."

He said one reference point is the Committee on Foreign Investment in the United States, or CFIUS, which targets foreign investment into businesses that rely on technology, infrastructure and data.

"There are investment funds that are not currently an 'activist' but want to have the option of communicating with management. These types of investors are increasing because they believe such measures are becoming more effective than in the past. But if exercising this option is limited to below a 1% stake, they may reconsider making investments."

Additional reporting by Ken Moriyasu in New York.

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