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Commentary – Japan’s foreign exchange law: New curbs on global investors won’t serve Japan’s broader national interests

  • January 6, 2020
  • , The Japan Times
  • English Press



The Japanese government deserves to be congratulated for having elevated national security to a priority, with a review of financial rules and regulations an important part of the debate. There can be no doubt that policymakers must, and can, do more to ensure Japan will continue to be a top-tier nation, admired for her sovereignty, prosperity and global competitiveness.


Unfortunately, making it more difficult and cumbersome for global investors to buy Japanese companies is not going to do much to achieve the goal of securing greater national security.


If at all, to achieve this noble goal, the coming changes to the foreign exchange law are too blunt a tool, rather like using a sledgehammer to fix a thumbtack. The risks of unintended consequences cannot be underestimated, and where the sledgehammer risks breaking down the wall, the legal changes will almost certainly undermine the smooth and efficient functioning of Japan’s financial markets. More importantly, it could actually accelerate a new trend of insularity and ossification in corporate Japan.


The fundamental issue at stake is not so much the technical changes coming to the foreign exchange law. In fact, it is easy to understand why Japanese leaders feel pressured to follow the U.S. lead in seeking to raise bureaucratic and political oversight over global investment flows.


However, the fact that all this happens in the name of supposedly protecting national security is, in my personal view, the real red flag. Why? Because the best way to protect security is to ensure your nation’s corporate sector is strong, innovative and globally competitive.


If corporate Japan is to have a bright future, it absolutely needs more active debate with the stewards of global finance. And yes, sometimes the investors’ threat to challenge board members and existing corporate structures is absolutely key to the mid- and long-term competitiveness and sustainability of all stakeholders.


In fact, the empirical reality of Japan’s market verifies this point in great clarity. Almost all successful corporate turnarounds in past decades originated in either substantial foreign direct investment or global investors’ active lobbying for change — Nissan, Sharp, Sony, Fanuc, Shiseido, just to name the highlights.


Make no mistake — for global relevance and future competitiveness, the more interaction with global investors, the better it will be for Japan’s national competitiveness, and thus her national security.


Leveraging global investor knowledge and insights is essential for listed companies. Already, about 63 percent of listed companies’ profits come from global sales, up from approximately 49 percent seven years ago. Yes, Japan’s domestic economy is poised to be lower-growth than other global markets, so the need for a more global and open perspective and challenges to the status quo are poised to grow ever more important.


Unfortunately, the upcoming changes in the law are poised to be used, by some Japanese leaders, to shut out global challengers and justify business as usual behind the excuse of “national security.”


Clear speak: The upcoming changes in the foreign exchange law run could easily become a kind of “poison pill” preventing necessary corporate renewal and innovation. Corporate Japan has a natural tendency to prefer no action and no change, and the new legal rules risk fortifying this trait.


Corporate ossification and retreat from globalization is my real worry; and unfortunately, the revised foreign exchange law could easily become a creeping liability for the future dynamism and global competitiveness of corporate Japan.


Specifically, the new and tighter rules are poised to, in effect, shut out Japanese firms from the forces of the global competition for risk capital and, under the mantle of national security, feed complacency and stagnation. Already, Japanese conglomerates have fallen behind in many new leading-edge technologies, such as cybersecurity, quantum computing, drone technology and more.


Whether we like it or not, global finance is the most efficient and effective tool to force senior management to stay on top of their game. Therefore the risks are high that the new rules will end up merely protecting already outdated technologies, feeding a new breed of “zombie companies” in Japan. This is particularly true since, unlike America, where the move toward tighter restrictions began, Japanese companies do not have a natural competitive strength in cutting-edge technology any more.


What about global investors? Technically, the coming changes to the law will raise both the cost of investing here as well as the risks. Internal compliance and controls will have to be tightened to ensure the new potential criminal liabilities are minimized.


We will need to see the exact administrative procedures that will be required, which is still under debate (Japanese technocrats have done an excellent job at proactively seeking input from foreign investors).


However, no matter how smooth the procedures may get, the net result is a higher compliance-cost base for investing in Japan. For large, established players this should not be a problem. But smaller startup asset managers are poised to suffer disproportionately from the new, higher compliance and legal costs forced by the new rules. Tokyo’s reputation as the global finance compliance center will grow.


From a Japan equity strategist’s perspective, much of the bull-case for Japan depends on unlocking the deep value offered by Japanese companies that is well documented in listed firms’ historically low valuation metrics and historically high cash balances.


We need a catalyst to unlock this value. Unfortunately, making it more difficult for foreigners to buy Japan does not make it easier for Japanese to buy Japan.


To truly strengthen security, the government should step up public incentives for technology companies to stretch and sweat their engineers harder; raise R&D spending for both university and corporate researchers, and stimulate commercialization of new technologies deemed to be in the national interest by offering tax breaks to researchers, start-up entrepreneurs or in-house development.


Protection is typically backward-looking, and what Japan needs is forward-looking incentives to unlock next-generation innovation and commercialization. To get there, Japan needs more, not less, pressure from global financial investors.


What Japan really needs is more active and engaged domestic investors and fund managers who aren’t afraid to engage and challenge senior corporate leaders. Policies designed to help domestic asset owners unlock corporate value are not just welcome, but essential to allowing a new catalyst for corporate revival.


This is where policy action is needed, to promote Japan for the Japanese. National security is based on homegrown strength and policies to unlock domestic aspirations, not on restricting global capital from becoming partners in this process.


Jesper Koll is senior advisor at WisdomTree Investments Inc. Researching and investing in Japan since 1986, he is a top Japan strategist/economist. 

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