PLC Global Finance update for January 2011: Japan

Practical Law UK Articles 0-504-5507 (Approx. 6 pages)

PLC Global Finance update for January 2011: Japan

by Atsumi & Sakai

Review of 2010/What to expect in 2011

The financial markets in Japan 2010 and outlook for 2011

The Hatoyama cabinet resigned en masse on 4 June 2010 with the Kan cabinet being formed shortly after on 8 June 2010. The Kan cabinet succeeded the policies of the Hatoyama cabinet and is continuing to make genuine efforts to implement them as follows:

Japan's Financial Services Agency provides detailed rules on centralised clearance of OTC derivatives, consolidated-basis supervision of securities companies and other rules and published the results of public comment on 21 December 2010. These rules will come into effect on 1 April 2011.
On 10 November 2010, Tokyo AIM, Inc., a subsidiary of Tokyo Stock Exchange Group,Inc. announced that it will establish the "TOKYO PRO-BOND Market" (a bond market for professional investors). The new market will enable issuers to benefit from a speed and flexibility of issuance equivalent to using Euro MTN programmes, by means of simplified disclosure documents and procedures.
In order to deal with high levels of personal debt in Japan, the Amended Money Lending Business Act came into force in stages over a three and a half year period, and was completely in force by 18 June 2010. This amended Act provides for a reduction of the maximum interest rate and introduction of total quantity regulations to prevent excess borrowing and excess lending.
The "Cabinet Office Ordinance on Partial Amendment of the Cabinet Office Ordinance on Disclosure of Corporate Information, etc. (2010 Cabinet Office Ordinance No.12)" which sets out rules regarding full disclosure of corporate governance of listed companies, was proclaimed and came into effect on 31 March 2010.

Expected major reforms in financial sector in 2011

Six months have passed since the Kan cabinet came into office on 8 June 2010, Since then, its major advance in the reform of the financial sector was its adoption of the "New Growth Strategy" at a Cabinet meeting held on 18 June 2010.

As the next step for carrying out the strategy, the Financial Services Agency of Japan (FSAJ) published the "Action Plan for the New Growth Strategy" (the Action Plan) on 24 December 2010, which has the predominant aims of:

Enabling appropriate finances for corporations in accordance with their scale.
Enabling Japan's market to be a financial centre for Asia.
Enactment and amendment of financial regulations to enable investors to invest their assets efficiently and effectively.

The key financial measures which the FSA proposed to be taken in its Action Plan are as follows:

Permitting banks and insurance companies to engage in finance lease business (which only subsidiaries thereof were permitted to engage in under the Banking Act and Insurance Business Act).
Establishing the "TOKYO PRO-BOND Market" during 2011.
Simplifying the disclosure process and the contents of quarterly reports.
Permitting foreign companies to make disclosure via offering documents written in English when they issue bonds by public offering.
Amending the Financial Instruments and Exchange Act and some related regulations to make the process of rights issues smoother.
Introducing tax initiatives to permit companies to issue Islamic bonds within Japan.
Making the Japanese Bond Income Tax Exemption Scheme which treats interest and profit from redemption of corporate bonds in book-entry form received by non-residents exempt from tax, a permanent tax system.

Commercial and Corporate sector

Legislative initiatives

Amendments to the Copyright Act facilitate the circulation of digital contents and access to and use of copyright works within Japan by permitting exploitation of copyright materials on the Internet, prohibiting the downloading of illegal audio or visual recordings of copyright materials through the Internet for private use if the person downloading the material knows that the material was created without a license and providing physically disabled persons with the opportunity to access copyright materials.

Amendments to the Cabinet Office Ordinance on Disclosure of Corporate Information, etc. came into effect on March 2010 and require that security reports of listed companies contain, amongst other items:

An outline of the governance system adopted by the relevant company and an explanation of why such system was adopted.
Disclosure regarding the names of and amounts of remuneration paid to directors and statutory auditors where such person's remuneration for the relevant fiscal year is JPY100 million or more.
The total amount of shares for the current and previous fiscal year which the company holds solely for the purpose of realising direct investment gains.

Case law

In 2010, the courts made the following important rulings:

The imposition of:
- inheritance tax on the lump sum paid under a life insurance policy;
- income tax on the annual payments made to the relevant beneficiary under the policy constituted double taxation and therefore in breach of Japanese tax laws.
In a case involving the purchase of shares by a company in its subsidiary (as part of a restructuring) for a price much higher than their alleged true value, the directors of the purchaser were sued by the company's shareholders for damages in an amount equal to the difference between the price paid and the true value of the shares. The Supreme Court held that the director's were not liable and applied the business judgment rule under which it acknowledged a broad discretion of directors in the restructuring of group companies.

Expected major reforms in Corporate sector in 2011

It was expected at the beginning of 2010 that the proposed enactment of the Public Company Act (an Act regulating of Public Company) would be the subject of much discussion and consideration by the ruling Democratic Party of Japan, but this has, in fact, not been the case. Instead, insofar as corporate law is concerned, the DPJ’s focus has been on amending the regulations affecting the parent-subsidiary and this has resulted in the Justice Ministry’s Legislative Council Corporate Law Subcommittee which has as its agenda: (1) protection of parent company’s shareholders, (2) protection of subsidiary company’s shareholders and creditors and (3) regulation of the procedures applicable to the formation of business combinations. However, it is not certain that these amendments will come into effect.

The agendas focus on the following:

Protection of parent company’s shareholders.

Allowing shareholders to bring derivative actions against the company's subsidiaries.
Improving shareholder access to information generated by subsidiary companies.
Providing for shareholders to be involved in subsidiaries’ decision-making processes.

Protection of subsidiary company's shareholders and creditors

Imposing liability on a parent company where it inappropriately exercises voting rights at meetings of a subsidiary's shareholders and causes damage to the subsidiary company's business.
Providing subsidiary company's shareholders an appraisal right in the event that a new controlling shareholder emerges.
Imposing liability on a company for the salaries payable to employees of a subsidiary where the parent company acts in its own interest to the detriment of the subsidiary company.

Regulation of the procedures applicable to the Formation of Business Combinations

Amendments in relation to the regulation of cash out and incorporation of new institution to execute cash out.
Revision of appraisal rights.
Revision of right of minority shareholders to injunctive relief.

Financial markets regulation

Japan moves to expand the scope of disclosures that may be made in English

In response to Japan's decline as a centre for foreign investment in Asia, the Financial Services Agency established a Disclosure System Working Group ( DSWG) is to consider expanding the scope of disclosures that may be made in English by foreign companies whose securities are transacted in Japan's market. The DSWG's report was published on 17 December 2010 and strongly urges an increase in the scope of disclosures that may be made in English.

At present, only continuous disclosure documents (for example, annual assets securities reports, semi-annual securities reports) are permitted to be filed in English under Japanese law. However, the report suggests that not only continuous disclosure but also disclosure related to the issuance of securities should be permitted to be made in English. With respect to issuance disclosure documents, the report argues for allowing the company information in such documents to be written in English if securities issued by the relevant foreign company have been listed or publicly offered in a foreign market, and if the company information has been disclosed in English in such foreign market. However, the report draws the line at information regarding the securities themselves and suggests that such information be written in Japanese due to its significance to the decision to invest and may be material in the context of any issue regarding the manner of solicitation of the securities.

In response to the report, Japan's FSA has indicated that a bill of amendment to the relevant securities laws will be submitted to the Parliament within fiscal year 2011.

Corporate loans and security

Short sales and Japan's moves to promote transparency and fairness in public share offers

In 2010, the volumes of short selling in shares in Tokyo Electric Power Co. (TEPCO), Nippon Sheet Glass Co. and INPEX Corp., an oil development company (all listed on the Tokyo Stock Exchange), increased and share prices of those companies dropped just before they announced their respective capital increase plans. These cases and other similar cases have given rise to speculation both within Japan and overseas that the holders of non-public information relating to fundraising activities and expected falls in share price consequential to such fundraising may be misusing such information.

It has been customary practice in Japan for security firms underwriting share issues to conduct demand surveys by contacting investors and providing them with non-public information about the issuer companies. It has been suggested that such practice facilitates the use of short sale trades to profit from the non-public information, even though the Japan Securities Dealers Association (JSDA), a self-regulatory body comprised of securities firms in Japan, has provided rules for such surveys including requirements to obtain agreement from participants regarding confidentiality and trading restrictions. On 24 December 2010, the Financial Services Agency of Japan (FSAJ) announced its "Action Plan to Vitalise the Financial and Capital Markets and Financial Industry", in which it demanded JSDA to consider stricter controls on the use of non-public information relating to companies issuing new shares.

Even short sales that are made after the announcement regarding the issue of new shares is made can distort the pricing mechanism for the new shares and may harm investors' confidence in the fairness and transparency of the market. As such, the FSAJ also announced in the abovementioned Action Plan that they will implement new rules similar to the US SEC Regulation M in the first half of 2011 , which will prohibit the acquisition of new shares where the purchaser has, during the period between the date on which the announcement regarding the issue of the new shares is made and the date on which the price of the new shares is fixed, sold shares in the issuing company.

Project finance

The Japanese government seeks to attract foreign investment

The ratio of the residuary amount of foreign direct investment against GDP in Japan is 3.6%, which is quite low compared to Korea (10.5%) and the US (15.8%). Moreover, some surveys reveal that Japan is becoming less competitive as an Asian business centre due to the high cost of doing business in Japan (for example; high corporate taxes, strict regulation and burdensome administrative procedures). However, recent measures proposed by the Ministry of Economy, Trade and Industry (METI) may lead to Japan attracting more foreign investment. Those measures include the following:

Reducing the tax rate to 28.5% for five years for eligible foreign firms. This proposal is in addition to the general reduction of the effective corporate tax rate by 5% (to 35.64%) during fiscal 2011.
Making it faster to screen residency permits for foreign workers at eligible foreign firms, with the process to be completed in around 10 days, instead of the current one month.
Permitting eligible firm's executives to defer payment of personal income tax for share warrants issued by foreign parent firms.
Reducing fees payable to register patent rights in Japan by half for certified R&D sections established by eligible foreign firms.
Providing initial investment subsidies for eligible foreign firms with large potential for economic benefits (METI has stated that JPY2.5 billion is secured as the 2010 supplementary budget for this policy).

As to what constitutes an eligible company, it is envisaged that this will encompass internationally operating global companies, especially companies that establish regional headquarters in Japan, gather human resources excelling in management, engineering, etc., and R&D centres with the potential to leverage Japan's manufacturing capacity.

PLC Global Finance update for January 2011: Japan | Practical Law