By Masahiko Hosokawa, professor at Meisei University

Rakuten’s partnership with Chinese IT major

The leakage of private information at LINE and Rakuten’s partnership with Chinese IT giant Tencent have delivered a blow to confidence in the digital platform industry, which forms the infrastructure of the digital economy. In a recent capital increase, Rakuten accepted an investment of 65.7 billion yen from a subsidiary of Tencent. As a result, Tencent holds 3.65% of Rakuten’s shares. Rakuten has been showered with sharp criticism, stemming from economic security concerns.

The Sankei Shimbun editorial on the issue was on the mark with its basic questions about Japan’s posture toward China. In this column, I would like to offer a few additional points to consider.

To alleviate the concerns of those who take issue with its tie with China, Rakuten should provide a much more thorough explanation than it has to date. Rakuten says that Tencent’s funding is pure investment [with no conditions attached], but when it announced it would accept Tencent’s investment, it told the press that it plans to forge a strategic partnership with that investor.

So far, Tencent has expanded its customer base by forming partnerships with firms in which it made small initial investments. For Rakuten, the true test of its partnership with Tencent has just begun. Rakuten must clarify what business it will conduct in partnership with Tencent and convince the nation that Tencent will not have access to the private information that Rakuten possesses on individuals and customer firms.

“Exemption for enterprises that are not state-owned” has led to loophole

The Rakuten-Tencent partnership presents two tough challenges for the Japanese government. First, the government will have to revise regulations in the foreign exchange law. The legislation was revised in November 2019 and enacted in May 2020 with an eye to keeping in step with Western countries, which had already strengthened their investment-related regulations with an eye on China. The revision to the foreign exchange law lowered the minimum threshold of investment in sensitive sectors from 10% to 1%. This made advance government approval mandatory for a foreign investor to take a stake of 1% or more in any Japanese enterprise in a “core” strategic sector. At the same time, however, exemptions to the mandatory advance approval were introduced, and this is where the problem crept in.

An exemption was made for “private” corporations that are not state-owned. The recent investment by Tencent as well as many other security-sensitive investments take advantage of this exemption.

In the case of China, attempting to distinguish between state-owned and private companies is clearly meaningless. The Chinese government is intensifying its control over non-state-owned enterprises, resulting in an increase in national security risks for Japan. In the U.S., former President Donald Trump issued an executive order banning Tencent’s chat application out of concern that private data may be stolen by the Chinese government through this app.

A law that allows such a company to invest in Rakuten, whose operations have implications for national security, has too many loopholes to be effective. This kind of situation must not be allowed again. The law must be immediately revised.

Some in the government argue that the current law is sufficient because the following requirement must be fulfilled for the advance notification exemption to be applied: The investing company must pledge not access secret technological information held by the company accepting the investment. Such a provision may seem adequate at first glance, but actually, it is only a promise by the investor, in this case, Tencent. How will Japan be able to make sure that Tencent is fulfilling that requirement, when Japan, unlike the U.S., has no means of gathering intelligence? We must not just rely on a belief in the innate goodness of companies.

The second challenge the government faces is how to deal with a Rakuten that is partially owned by Tencent. Rakuten subsidiary Rakuten Mobile plays a key role in Japan’s digital infrastructure, including its 5G network. Japan has earmarked 200 billion yen to develop a post-5G communications system to boost national security, and Rakuten Mobile has been chosen as one of its operators.

Rakuten Mobile is also a member of the strategic council on semiconductors and the digital industry, which was launched by the government in March. To the extent that the council discusses Japan’s national security, Rakuten Mobile’s tie with China is all the more a cause for concern.

Risk that Rakuten will be subject to U.S. restrictions

The Rakuten-Tencent tie is a serious potential risk in Rakuten’s relations with the U.S.

Tencent’s investment in Rakuten risks violating U.S. regulations in addition to Japanese legislation.

Rakuten is active in the 5G and other businesses in the U.S. Investments in such companies are subject to the rules of the Committee on Financial Investment in the U.S. (CFIUS), which enjoys far greater authority than Japanese agencies. Any issue that comes to light through future intelligence could lead to the CFIUS’ banning or suspending the company’s business transactions. The CFIUS’s decisions can be applied retroactively, as well.

Rakuten is a member of an industry group of trusted companies in the communications business to promote “clean network initiatives” as well as a new group led by the U.S. to work on 5G. Will Rakuten still be regarded as a “clean player” after forging this tie with Tencent?

Depending on the nature of the two companies’ business partnership, Tencent’s investment may have a serious impact on Rakuten’s U.S. operations. Rakuten should disclose the risk to its investors. It has a bearing on Japan’s national interests.

Both Rakuten and LINE are Japanese players in the field of economic security. Their management boards should be aware of their responsibility. Meanwhile, the administration of Prime Minister Yoshihide Suga should move quickly to fix the loophole in the system and thereby alleviate concerns that Japan is overly conciliatory toward China.