Japan’s problems are well documented: Years of deflation, an ageing population, a strong yen, the March 2011 earthquake, tsunami and nuclear meltdown, a record trade deficit of $54 billion, and a net debt GDP ratio that “places it in a slightly better position than Greece, but worse than Italy” says Professor Mitsuhiro Fukao, Professor of Economics, Faculty of Business and Commerce, Keio University. However, there is an increasing sense of cautious optimism about the world’s third-largest economy. “Around 2 percent of Japan’s GDP was disrupted by the earthquake, tsunami and nuclear disaster,” says Fukao. “The direct impact of the earthquake was much smaller than the global financial crisis in 2008 and 2009. The economy is rebounding.”
“The March 2012 Bank of Japan Tankan survey on market sentiment shows a definite improvement over December 2011 and the GDP seems to be on the up, albeit slowly,” says Junzaburo Kiuchi, corporate partner at Freshfields Bruckhaus Deringer’s Tokyo office.
“We see 2012 being a better year than 2011,” says Stephen Bohrer, counsel at Nishimura & Asahi. “Things began to look brighter by the end of 2011, and that momentum has continued. Overall the business climate, which translates into legal work, has improved.”
Growth trends
“Outbound M&A is a very hot topic, and the current boom looks to continue for the rest of the year and beyond,” adds Kiuchi. “In 2011, Japanese companies made around 800 cross border acquisitions valued at over $89 billion. This was the largest number of cross border M&A deals on record since 2000. We would expect this trend to continue and surpass 2011.”
”Japanese companies are very active (in) looking at overseas acquisitions,” agrees Kenneth Siegel, managing partner of Morrison & Foerster’s Tokyo office. “In addition to the traditionally active companies, you also see trading companies that, for many years, were unsure how they would deploy funds and expand globally, figuring out how to be important global players. These companies are now very active in outbound transactions, particularly in minerals and commodity-related transactions, which have historically not been a focus for Japanese companies.”
“The main factor driving outbound M&A is demographic issues in Japan combined with a stagnant market. If Japanese companies want to expand, the obvious choice is to go overseas,” says Kiuchi. “Japanese businesses also tend to have greater cash resources and good access to debt funding as Japanese banks tend to have strong relationships with buyers.”
Other factors, says Kiuchi, are the lack of private equity bidders which has led to less pressure in competitive bids - which many Japanese strategic investors tended to struggle with - and strong government support. “The Japan Bank for International Cooperation (JBIC) apparently has $130 billion of credit available to lend for strategic overseas M&As and in 2009, the government established the Innovation Network Corp of Japan, which has $25 billion available with a stated aim of strategic investment in areas of environment and energy, electronics and IT, biotech and infrastructure such as water supply, railway service, and nuclear power supply.”
This outbound trend appears to extend across all sectors, “but particularly food and beverages, pharmaceuticals, and energy and resources appear to be active areas,” says Yuko Tamai, a corporate partner at Nagashima Ohno & Tsunematsu. “Japanese financial institutions are very active in expanding overseas at the moment,” adds Yoshiaki Muto, managing partner of Baker & McKenzie’s Tokyo office, “taking advantage of the strong yen, the weakened European financial state, and growing Asia-Pacific markets.”
Tamai lists India, Indonesia and other Southeast Asian countries as particular outbound “hot spots.” “The Latin American, eastern European and Asia-Pacific regions are keeping our corporate lawyers busy,” says Muto. Nishimura & Asahi, meanwhile, has opened offices in Beijing, Singapore and Vietnam over the past 18 months which primarily cater to this outbound demand.
So what about inbound? “Inbound M&A opportunities are limited by the strong yen, weak domestic growth, and structural and legal barriers. For example, in the public M&A space, hostile takeovers are not allowed in practice; cross shareholdings by Japanese corporate act as ‘de facto’ takeover defence mechanisms,” says Kiuchi. “However, there are definitely ‘hot’ pockets in Japan, especially for the sophisticated investor. Japanese technology is likely to be an attractive area for Asian companies, in particular Chinese and Korean companies, looking to buy know-how. The recent interest in Elpida is a good example of this,” he says, referring to the Japanese chipmaker which is in acquisition talks with U.S. multinational Micron Technology, having also had interest from U.S. private equity firm TPG Capital LP, China’s Hony Capital and South Korea’s SK Hynix.
“There isn’t strong growth for new investment,’” says Muto. “However, foreign investors and companies have already built up a significant presence in Japan and there is a lot of restructuring taking place at the moment.”
“Integration of large companies as part of industry consolidation should be expected, given the current state of the Japanese economy,” says Tamai, while Bohrer adds, “I have seen a continued demand for joint venture, licensing and strategic alliance work, as they generally have a lower upfront capital requirement.“
“Distressed assets are also likely to be an area that attracts attention. There are also some niche inbound plays, particularly for ‘contrarian’ investors who are willing to bet against the pack, in, for instance, the real estate, TMT and pharmaceutical sectors,“ says Kiuchi.
“Real estate is another growth area,” says Muto. “There is still concern regarding the impact of the earthquake, followed by the tsunami and nuclear disaster. But it is starting nonetheless. It seems that money is coming in from those looking for an alternative to the Chinese real estate market.”
“We are seeing a number of the private equity funds coming back in to town,” says Siegel. “Also, some interesting project finance and development work, particularly in alternative energy.”
Energy concerns
On May 5 this year, Japan shut its last operational nuclear power station. With 30 percent of its power having previously come from nuclear energy, and strong opposition to the stations reopening, Japan has a serious energy shortfall, which has led to a record high fiscal trade deficit attributed to increased natural gas and oil imports.
“Japan is set to adopt a feed-in tariff, which requires the utilities to take power that is generated from independent power producers, and pay a set tariff,” says Siegel. “If so, it will probably be the only major country to retain this system to encourage alternative energy development. So U.S. solar companies and other alternative energy providers are now getting very interested in Japan as a potential investment opportunity.”
While alternative sources develop, imports must continue. Fukao, however sees a positive in this, saying: “What I expect is (that) the bigger demand for foreign fuel will weaken the yen somewhat, which will stimulate Japanese exports.”
But is Japan facing another summer of power shortages? A government- backed panel’s preliminary findings, based on all nuclear reactors staying offline, suggest Japan could have a power surplus of 0.1 percent in August. However, Osaka and the surrounding region are expected to see a significant shortage. “(However), unlike last year, the Japanese manufacturing sector has enough time to respond,” says Fukao. “Some are changing their production patterns, producing more in spring when there is enough power, and less in summer.”
”Demand for energy continues to be a focus for the trading houses,” says Kiuchi, examples being Mitsubishi and Mitsui’s recent deals with Australian oil and gas producer Woodside, their partnership with Shell and OAO Gazprom on the Sakhalin-2 project in Russia’s Far East, and their commercial development agreements with Sempre Energy to develop a natural gas export facility in Louisiana.
Another concern has been the stability of struggling power company TEPCO. However, these fears have been allayed thanks to the Japanese government approving a restructuring plan that will see it acquire a controlling share in the company in return for a capital injection of one trillion yen.
Recovery and reconstruction
The Noda administration has also agreed to a massive post-disaster recovery and reconstruction budget. “The implementation of the budget is delayed. However, it will boost the public works sector of the Japanese economy in this fiscal year,” says Takahira Ogawa, Singapore-based sovereign analyst and director at Standard & Poor’s.
Another key industry that is reviving post 2011 is Japanese car manufacturing which was hit badly by not only the earthquake and tsunami, but also by the floods in Thailand. “If there is no disaster this year, the production level of cars will recover,” says Ogawa, evidenced by recent results from Honda, reporting a 60.7 percent increase in consolidated net income for the quarter ended March 31 in addition to Toyota posting net profits of 121 billion yen for the first three months of 2012 and predicting net profits of 760 billion yen by March 31, 2013.
“Tourism is coming back, particularly an increase in the number of Chinese tourists. However, the tourism industry is very small in Japan,” says Ogawa. It may be small, making up only around 7 percent of Japan’s GDP, but it is receiving a major government push with Prime Minister Noda calling it “a frontier” for Japan at the 12th World Travel and Tourism Council Global Summit in Tokyo. The Prime Minister is also encouraging “aggressive tourism promotion measures” forming part of the Ministry of Land, Infrastructure, Transport and Tourism’s Recovery and Rehabilitation Plan as part of this push. Linked to this is a recent extension of the low-cost carrier market in Japan with Peach Aviation having taken to the skies in March, Jetstar Japan and AirAsia Japan due in July and August respectively thanks to increased landing slots, the new low-cost carrier (LCC) terminals, and the promise of lowered landing fees.
Consumption tax
The consumer market is also an emerging growth trend with compa- nies targeting “customers who have money, but will not spend it,” says Muto, particularly in the fields of high-level health care, life sciences and technology.
However, the consumer market stands to be impacted when the proposed increase to the consumption tax comes into force.
Japan’s consumption tax currently stands at around 5 percent, much lower than most European countries which have a value added tax of around 20 percent. It is this percentage of consumption tax that the Noda administration wants to raise to 10 percent to cut the budget deficit. However, it seems this may not be enough. “It is far too small (an increase) to cut the budget deficit,” says Fukao. “In order to balance, you would have to raise it by 20 points, to at least 25 percent.” One can imagine the opposition to such a hike; however, while it is not easy politically, the budget deficit is also unsustainable.
An increase is ”inevitable,” says Ogawa. “But it depends on the timing, and (the increase) alone will not solve the fundamental problem, which is the social security and pension system,” he says.
“If consumption tax is increased, consumer spending will change,” explains Bohrer. However, he does not see this impacting the demand for legal work (though domestic clients will be subject to this higher consumption tax), save that perhaps there could be a rush on large purchases, for example real estate, ahead of it being phased in.
At the same time, there is a corresponding suggestion that the corporate tax rate will go down, adds Bohrer. It is hard to know if or when this will happen. That said, it is also true that the government is very concerned about the competitiveness of Japanese companies, which would certainly be assisted by a drop in the corporate tax rate.
Legislative developments
So what about other legislative changes that would impact the Japanese corporate and legal world?
“There have been recent amendments to tender offer rules that allow exchange offers to be made,” says Bohrer. “There are still some technical difficulties that have prevented this taking off, and there will have to be some further modifications. But I see this as a potential area for growth.”
Another area that has been subject to recent change is the Japanese anti-monopoly law, which has been reformed regarding companies prefiling notifications to the Japanese Fair Trade Commission. The prenotification consultation system essentially has been abolished, and instead, these consultations should be made in connection with an actual filing, making the merger filing procedure more efficient and transparent, says Bohrer, adding that Japanese regulators are also taking a more proactive approach on regulation and anti-monopoly activities. As a result, compliance and dealing with the agency will be an area that companies will need to be focused on.
A potential area of change is corporate governance, following in the wake of the recent Olympus and AIJ scandals, and a continuing demand that corporate governance become more robust, says Bohrer. “We anticipate legislative action to change requirements for independent directors on boards and how disclosures are made, and potentially what kind of securities law liabilities companies will have. We suspect issues about corporate governance will follow through amendments to the Company Law.”
Japan’s Company Law, which had its last major overhaul in 2006, is currently subject to significant revision with various proposals being discussed but nothing agreed upon yet. “Whilst nothing on the magnitude of the 2006 amendments, we are expecting there to be significant changes requiring further legal work on how to implement these changes and what it means for companies operating in Japan,” says Bohrer.
How quickly these amendments will come in to play remains to be seen. In fact, they may not impact this year at all, but will be ones to watch for in 2013.
Something else to watch is the possible enacting of what is being called a Japanese version of a consumer class action system. “The impact of this possible new system is still unknown,’’ says Tamai, “but this may increase consumer-related litigation in the future. The proposal has not been submitted to parliament, but is expected to be in the current session.”
A factor that could have a major impact on Japan’s legislation would be Japan joining the Trans-Pacific Strategic Economic Partnership (TPP), a move which “(would involve) a significant ‘opening up’ and review of Japan’s legislation and regulatory framework,” according to Muto. However, the government and parties are divided on TPP, and whilst President Obama has supported Japan joining the TPP, no decision has been made. “There is no strong momentum for TPP, at least for this year,” says Ogawa.
Gaiben Law
There is another potential legislative change aimed directly at lawyers – a proposed revision of the Act on Special Measures concerning the Handling of Legal Services by Foreign Lawyers or Gaiben Law which governs foreign lawyers operating in Japan. The amendment relates to the ability of gaiben (foreign lawyers) to operate through hojins, or legal entities. Being able to operate through a hojin would enable foreign firms to open more than one office in Japan, something that is currently forbidden. However, the present position is far from clear.
“The new amendment to the law proposed by the Ministry of Justice was going to permit hojins comprising gaiben, and also hojins comprising both bengoshi (Japanese attorneys-at-law) and gaiben,” explains James Lawden, Japan managing partner at Freshfields Bruckhaus Deringer and a co-chairman of the Gaiben Kyokai, the association of registered foreign lawyers in Japan. “However, a bill filed recently purports to amend the Ministry’s proposal so that only hojins comprised entirely of gaiben should be permitted,” he adds.
“It is very strange because the current law already allows GJB (registered foreign lawyers) and bengoshi (local lawyers) to form a single partnership called a joint enterprise,” says Muto. “The proposed revision is making good progress on deregulating the Japanese legal service industry, but is not a satisfactory change for international law firms already practicing in Japan,” he says.
“I do not think the change in the law is going to significantly affect how international firms practise in Japan going forward. It has levelled the playing field between international and domestic firms for the purposes of opening additional offices in Japan. But in a way, that failed to clarify the tax implications of expanding. To take advantage of the law probably requires a change of entity that might have adverse tax consequences. So until it is clear that firms can pursue this in a tax efficient way, it is probably not going to make a material difference,” says Siegel.
An area not being addressed by the current amendments is the current requirement that before being admitted as a gaiben, lawyers must spend at least two years practising outside Japan. “This is the most significant issue for us,” says Siegel. “We would like to be able to hire young attorneys and potentially have them spend their entire careers in our Tokyo office. Having to transfer attorneys who are busy to another office to meet this requirement is artificial, costly and adversely affects both attorney development and client service. This we would love to see changed.”
“We are not sure when the recent proposed amendment will be implemented or in what form,” says Lawden.
“We are meeting with the Ministry shortly, so hope to have an update after that.”
2012 and beyond
“Japan can change the course of its own future,” says Ogawa, “but time is getting shorter to do so.” There are undoubtedly many issues to address: the Bank of Japan is struggling to meet its price stability goal of an annual growth rate of consumer price index at 1 percent, “revolving door” prime ministers have made meaningful change difficult and now, according to a recently unveiled population clock, the nation is facing extinction in 1000 years if the birth rate does not increase.
However, lawyers working in Japan have no doubt the country can, and will, overcome its problems.
“This is still a robust market where foreign and domestic law firms can thrive,” says Bohrer.
“There is all that gloom and doom out there, but it is not nearly as bad as it is portrayed,” says Siegel. “From a lawyer’s point of view, there are a lot of areas where we see positive trends.”
“Japan’s economy is not growing rapidly but it is growing steadily. It is gaining its confidence back and spending again. It is healthy,” says Muto.
The Research Institute of Economy, Trade and Industry (RIETI) agrees and, barring another natural disaster or a European crash, is forecasting a 2 percent growth rate for Japan in 2012. So whilst Japan may not currently have the dynamism of China or the flare of India, it does have a quiet stoic strength that should not be underestimated. It perhaps pays to recall the tale of the tortoise and the hare - that sometimes it is not always about being the fastest.
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