Like the nation’s famous cherry blossom trees, business in Japan is opening up after a bleak covid winter. But this time things seem different. John Church reports
Slowdown and lockdown are two words with which we are all too familiar in terms of influence over the past few years, and Japan has been affected by both, but it’s there that the similarity with many other nations ends.
Few nations’ business activities have been so dominated by cultural influences in past decades, and few seem to have evolved so quickly since those two lynchpin words have impacted the global economy.
It would be foolhardy to suggest any radical about-face or restructuring of ideology in a country so well-known for its closed cultural identity and resistance to outside influences that permeates all walks of life, from personal to business practice and even politics.
Yet there is a sense that Japan is at a crossroads, and to progress it has quickly endorsed necessary changes and the mindset to accomplish future growth. A compendium of factors has global investors in unprecedented numbers knocking on Japan’s door – and perhaps for the first time the door is being earnestly left ajar.
“These observations are reasonable,” says Masakazu Iwakura, senior partner at TMI Associates and professor of law at Hitotsubashi University in Tokyo. “Japan is internationalising its development,” he says. “Businesspeople, particularly, are obliged to change due to the impact of the outbound effect. They must internationalise and they must change – they must not be as they were pre-pandemic.”
Recent trends have seen large companies recruiting and professionalising their teams to international norms, and talent sent abroad for international experience returning to Tokyo boardrooms. Domestic law firms, once poor cousins to the international outfits, are now holding their own on cross-border deals.
Activity inbound and outbound is pulsing as the nation accepts that conditions predetermining future growth have changed in a post-pandemic world that in some ways has reshaped Japan’s business and legal psyche. Laws governing employment fairness and inclusivity continue to evolve apace. So, what is driving Japan on?
“We have recently seen more and more inbound investment into Japan by non-Japanese companies,” notes Nishimura and Asahi’s managing partner, Ryutaro Nakayama.
“One rationale behind this investment should be linked with the weak yen against other currencies, especially the US dollar; the exchange rate makes acquisitions by non-Japanese companies easier and cheaper. However, it also stems from the increased divestment of business by Japanese companies, mainly due to a change in mindset of Japanese companies into businesses portfolios.”
While recognising a shift, Nakayama also countenances caution with foreign investors keen on entering Japan. “In general, Japan has a fair legal system and business environments [for] foreign investment, although there are ordinary courses of regulations with respect to foreign direct investment (FDI) rules, as with other countries,” he says. “The hurdles lie more in cultural perspectives like a language barrier. Business partners in Japan, or advisers, should assist you on clearing these hurdles.”
And there is plenty of assistance needed as international companies show a major interest in the nation and inbound investment surges forward, although in terms of investment interest some of the sources are surprising.
“Japanese technology companies have long attracted overseas investors and this trend shows no sign of abating,” notes Takeshi Iitani, a founding member of southgate, a law firm established in 2016 that gives Japanese and international lawyers an equal say in how the firm is managed and projects are run.
“Foreign investors have traditionally valued Japanese engineering and continue to be on the lookout for manufacturers of machinery and technical components but, more recently, we have also seen an interest in software and IT companies, especially by overseas VC investors.”
Iitani says investors from the US and Europe continue to be active in Japan, spurred in part, of course, by the weakening yen against the greenback. But he notes that Chinese companies, too, have been acquiring assets in Japan, especially in the technology space, and more recently Indian and Southeast Asian companies are starting to explore opportunities.
“Inbound M&A activity appears to be relatively stable, but inbound VC activity has increased significantly in the past couple of years,” says Iitani. “The Japanese VC market is very small and quiet compared to China and India, to say nothing of the US, and for this reason had been overlooked by international VC investors for many years.
“But the overheating of VC markets and perceived excessive startup valuations around the world between 2018 and 2021 have led investors to search for undervalued assets, and many investors set their sights on Japan – a market with strong fundamentals but lacking the glitter of some of its neighbours.”
Southgate represented the Softbank Vision Fund in its first investment in Japan, in 2021 and 2022. And Iitani adds that legal AI startup LegalForce’s 2022 JPY13.7 billion (USD105.6 million) series D financing in the third quarter of last year was representative of this trend in inbound investment.
The investment syndicate was led by some of the most prominent VC investors outside Japan (Softbank Vision Fund 2, Sequoia China and Goldman Sachs) and inside Japan (Mizuho Capital, Mitsubishi UFJ Capital and WiL [World Innovation Lab]).
“In addition, several Asia-based hedge funds and PE funds, perhaps finding private company valuations too high, turned their attention to late-stage startups in Japan,” says Iitani.
Yasuyuki Kuribayashi, a partner at City-Yuwa Partners, also acknowledges the trend. “There has been a large upturn in startup activity in Japan in recent years, partially due to new government incentives, although traditional barriers still limit the development of startups as a whole, especially when compared to the US,” he says. “The key growing industry is the tech sector, with TMT especially attracting attention.”
Atsumi & Sakai senior partner Ryuichi Nozaki says the firm has assisted startup activity in various sectors including online marketing, advertisement technology, asset-based finance, insurance brokerage, fund management platform services, online remote medical services, platforms for matching specialist services, sharing economy services, customer profiling with AI technologies, and software as a service (SaaS) for property management.
“Startups in Japan are everywhere,” he says. “There are possibilities of technologies enhancing the efficiency of services, or connecting service providers and customers.”
Nozaki’s firm is assisting startups with combined teams zeroing in on: (1) lawyers who focus on startups in general, with the understanding of their goals, needs and expectations from lawyers, their ecosystems and mindsets; and (2) lawyers with expertise in particular legal practice areas that differ depending on the startups (for example, financial service regulations, medical service regulations, IP law, etc.)
“We also offer services in assisting clients with their preparation for IPOs, as our team of lawyers have the practical understanding and insights of requirements from stock exchanges’ listing reviewers, as well as experience in startup companies’ establishing accounting/tax management systems and compliance systems.”
Nakayama, from Nishimura & Asahi, notes that Europe is a hot-button destination for Japan’s international players, even as older distribution lines to China dry up due to the covid lockdown and geopolitical uncertainties, although he does not draw parallels between the two.
“We are certainly witnessing more and more investment by Japanese companies in Europe, and in Eastern Europe in particular,” he says. “We also have seen certain divestments by Japanese companies of their business from China. However, we do not think that this uptick in Japanese investment activity in Europe is directly related to the supply chain divestments from China.
“Instead, it would seem that Japanese companies are equally reacting to changes in the supply chains, but [are] product driven. Take the manufacturing of batteries for electric cars for the European market as an example: because the batteries and their components are so bulky and heavy, they are best manufactured within Europe, close to the carmakers’ plants.
“Hungary, due to low wages, an attractive taxation system and generous government support, is transforming itself into a manufacturing hub for electric car batteries. The respective tier 1 and 2 suppliers are practically forced to set up their facilities in the immediate vicinity of those huge battery plants. Unsurprisingly, many of those suppliers are Japanese companies.”
Yohei Koyama, a partner at Mori Hamada & Matsumoto, says Japanese companies have traditionally been hesitant to enter into transactions without first holding face-to-face meetings or conducting on-site due diligence. He believes many Japanese companies have spent the pandemic period stockpiling cash and restructuring their operations in order to be ready now that restrictions are lifting and travel is more freely permitted.
“We believe Japanese businesspeople will resume business travel to seek business and investment opportunities now that the covid-19 restrictions have been lifted and more Japanese executives can physically travel to meet promoters and companies,” he says.
“Furthermore, as a result of supply chain disruptions caused by covid-19, the US-China trade war and the Ukraine-Russia war … Japanese companies may consider expanding their manufacturing to other South Asian countries such as India, Vietnam and other Southeast Asian countries.
“India and Japan have a good and strong relationship, both politically and economically. We anticipate that Japanese companies will have more business and investment opportunities in India in the future.”
Nishimura & Asahi set up shop in Europe via two offices in Germany, ahead of the investment curve. “Before deciding to invest in Eastern Europe, or anywhere in Europe really, our clients typically require local guidance to navigate the complex permit, foreign investment, tax and government grant regulations,” says Nakayama.
“When we opened our offices in Europe in 2020, we did so mainly because our research showed the upcoming increase in demand from Japanese companies considering investment in Europe. Now, as the tide of Japanese investment is starting to actually come in, we feel fortunate to be able to provide Japanese companies with focused and effective advice as well as efficient communication throughout Europe.”
Iwakura, from TMI, notes that since the pandemic, China has been closed, and Japan has had to consider alternatives. “We had relied overly on China, but when it closed borders due to covid, and when US strategies against China became stronger, Japan had to consider: should we be so reliant on China?
“Still, I expect Japanese companies to look to a reopening China with their business and consider how to do business there under the current geopolitical climate,” he says. “Others have now left, and this trend began in the pandemic and has dramatically changed Japanese businesses. Europe and other parts of Asia and the US market (including mid and South America) are attractive now.”
Eric Roose, managing partner of the Tokyo office at Withers, says the depreciated yen has made real estate very attractive to foreign investors. “However, the large funds and institutional investors were already highly active in the market well before the yen began to decline,” he points out.
“High net-worth investors from Asia [notably Singaporeans, Thais and Hong Kongers] and the family offices in Singapore and Hong Kong have been attracted to the market due to the weaker yen, making real estate investment in Japan relatively cheap for them,” he says, adding, “many of these parties do not require financing in Japan to acquire assets.”
Roose says that, despite recession concerns worldwide, Japan’s property market is and will continue to be active due to the weak yen, low interest rates and a stable political environment. He identifies the following real estate sector trends on land and space:
- Commercial office space is slow;
- Residential is in high demand;
- Logistics and data centres are booming, with many large market entrants;
- Hospitality is picking up. (“We are seeing more deals there as tourists from around the world will inevitably flock to Japan as covid restrictions relax.”);
- Senior care facilities are strong; and
- Renewable energy facilities remain active, and the push for ESG investment by institutional investors from around the world will continue to drive demand.
Roose also points to US-based fund interest, with heavy investment from American investors, pensions and institutional investors. “The funds are also increasingly attracting investment money from Canada, Europe and the Middle East,” he says.
“Japan real estate continues to provide strong low-risk returns, making it a highly attractive investment. Singapore sovereign funds are active investors in both sponsored APAC funds who invest in the Japan real estate sector, as well as directly investing in real estate projects on their own. Now that China has dropped its covid restrictions, China high net-worth investors will surely be attracted to the market as well.”
Withers’ strategy is specifically tailored to service foreign investment funds, foreign institutional investors, and family offices targeting Japan real estate. Roose points to strong expertise and deep benches in real estate law (four partners), real estate financing (three partners), funds regulatory (two partners), and international and Japan taxation (two partners).
“We also have full corporate law capability (one partner) to service clients who do acquisitions of large portfolios of real estate in the form of corporate M&A transactions. Our teams are comprised of both Japanese-qualified and foreign-qualified legal and tax professionals.
One of the most significant legislative changes impacting the operations of employers in Japan is due to the recent overhaul of employment legislation, following the enactment of the Work Style Reform Act.
A report prepared by Tatsuo Yamashima, a senior partner at Atsumi & Sakai, notes that the reform act has had a substantial impact on employees due to the following notable changes: (1) amendments to the working hours system; (2) ensuring the use of annual paid leave; (3) tracking of working hours; and (4) equal work, equal pay.
Measures to combat discriminatory practices and sexual harassment are in particular notable for a nation that has in the past remained conservative on progressive and inclusive culture. The legal sector is a prime example as it is remarkable for its skewed domination by men.
Atsumi’s Nozaki adds: “An employer’s obligation for ‘equal work, equal pay’ and to prevent harassment in the workplace have become applicable to companies that are not categorised as a “large company” from April 2022. “Compensation for overtime work that exceeds 60 hours per month shall be increased from 25% or more to 50% or more for the companies that are not categorised as a ‘large company’ from April 2023 as well.”
Japanese companies have also lagged behind systems elsewhere with regard to whistleblowing, and although legislation is catching up, there are caveats that may concern foreign investors, notes Kengo Nishigaki, the founder of GI&T Law Office.
“Under the Whistleblower Protection Act of Japan, a company with more than 300 employees must have a whistleblowing system, thus I would say almost all major Japanese companies have a whistleblowing system inside Japan,” says Nishigaki.
“However, the law does not make it clear that the company shall implement the system throughout its group companies, including foreign subsidiaries. Thus, statistically, a majority of major Japanese companies do not have a global whistleblowing system that covers foreign subsidiaries.
“As foreign operations tend to be more vulnerable to risks such as accounting fraud, tax evasion and embezzlement, amendments to the law or stock exchange rules are necessary so that at least listed companies with a certain size of foreign operations must implement a global hotline system.”
From 11 October 2022, the ban on short-term visas was lifted for foreign travellers entering Japan, including for business travel, signalling the dissipation of covid-19 from the horizon.
The preceding years were tough, and law firms as elsewhere adapted by necessity and capitalised on hot spots to stay afloat, but, in many cases, improved best practice.
“Covid had a braking effect on cross-border transactions in many M&A markets, and Japan was no exception,” says Eric Marcks, a co-founder of southgate. “In fact, the effects of covid on outbound M&A work in Japan were perhaps more pronounced than in many other markets because Japanese buyers attach a lot of importance to on-site due diligence – they like to ‘kick the tyres’. Such due diligence was impossible during the early stages of covid, which brought outbound work nearly to a standstill.”
Covid did not change the fact, however, that Japanese companies had a lot of cash that they had allocated to acquisitions. “When they were no longer able to spend that cash outside Japan, they repurposed it to domestic targets, which led to a boon in domestic work,” says Marcks.
“While international firms in Tokyo struggled on account of the dearth of cross-border work, domestic firms had one of the busiest years on record thanks to a flood of domestic transactions. Although we were known primarily as a cross-border firm, because we had a strong domestic practice for our inbound deals, we started getting many inbound deals from our clients that had until that point worked with us primarily on outbound deals.”
Marcks says Japanese clients quickly learned to work remotely. “Like many international firms, we had already been working remotely on a limited basis before covid, so when covid hit we had no problem going fully remote,” he says. “As a result, we were able to hit the ground running under the new work rules brought on by covid and served our clients seamlessly from the start.
“Before covid, most of our M&A work was cross border, split evenly between inbound and outbound, and after covid about 30-40% of our transactional work is domestic, which makes for a healthier allocation of work, improves training opportunities for our Japan-qualified attorneys, and further strengthens our inbound deal capability.”
Kuribayashi, at City-Yuwa, says his firm fared well, comparatively, during covid. “We quickly adopted infection control using the avoidance of the three Cs (closed spaces, crowded places and close-contact settings), and reporting of covid infections and quarantining of those infected,” he says.
“We were also able to quickly adopt a hybrid system of remote and in-person work. Unlike many other large firms in Japan, we don’t have satellite offices, so we were able to continue to effectively utilise our office in Tokyo and avoided the problem of underused or unused spaces. Given our strength in employment practice, we were able to advise our clients on the employment issues related to covid.”
Kuribayashi says the firm’s M&A and real estate finance practices did well, likely due to the low yen with resulting incoming investments and overall expectations of a long-term recovery. “Our domestic and international dispute resolution [business] has seen significant demand, which is seemingly due to the pay-off of our efforts to develop and promote our arbitration practice, a recognition of the depth and experience of our litigation practice, and an increase in disputes due to the current overall instability,” he says.
Akiko Yamakawa, a partner at Vanguard Lawyers Tokyo, says that during the pandemic, there was the initial burst of questions on employers’ obligations to protect employees’ health and privacy (for example, what to do if an employee tested positive, whether firms could require employees to report to work) as well as questions relating to furloughs and available government support as businesses very suddenly contracted.
“We also advised on how to implement remote work policies,” says Yamakawa, an employment law specialist. “Over time, clients’ needs shifted to advising on return-to-work policies, as well as balancing employers respecting individual employees’ rights versus employers’ obligations to protect employees’ health (e.g., whether firms could mandate vaccination when they return to work). We, of course, also had to advise on redundancy exercises.”
Marcks, of southgate, remarks that in the recent past of covid, and perhaps just prior, Japanese law firms have rapidly evolved their competitive edge. “Japanese firms are aggressively recruiting experienced international lawyers in Tokyo, taking advantage of a decrease in hiring and the thinning of ranks of international lawyers by international firms,” he says.
“The perception used to be that Japanese firms hired international lawyers to act primarily as copy editors and international attorneys faced a glass ceiling at Japanese firms, but this is no longer the case, as the quality and quantity of international lawyers at these firms has improved significantly, and some Japanese firms are now credible competitors to international firms in certain cross-border areas.
“The widening gulf in legal fees between international firms and Japanese firms – international firm rates in Tokyo continue to increase, whereas those of Japanese firms remain stable – also makes Japanese firms more appealing for small-cap and mid-cap cross-border matters.”
Yamakawa, at Vanguard, says Japan will still be recovering from covid, but the spring back will be quick. “There already seems to be an increase in interest in inbound investment in Japan, especially in the areas of technology and green energy,” she says.
“With the continued growth in technology and green energy, there is likely to be an increase in companies being established and expanding, as well as an increase in regulatory oversight, which likely means that there will be a steady demand for legal services.
Within the legal industry itself, during the pandemic, law firms, like other companies, began embracing remote work. However, while there are undoubtedly benefits from working remotely, they will not replace the advantages of being able to collaborate within offices.
“I would expect to see law firms using remote work to enable more flexible work options, but I wouldn’t expect firms to be predominantly remote work-based going forward,” she says. “Also, a reform is underway in the Japanese court system that will allow for electronic filings and increased usage of remote hearings, which will hopefully contribute in improving efficiency.”
Iwakura, at TMI, says an important topic this year for Japan will be dealing with national security regulation, especially in the context of the US and China.
“For example, with sensitive technology industries, we can’t easily export to China or other sensitive places, because of US restrictions,” he says. “And exports from businesses in China to the US will encounter compliance issues. The Japanese government has also strongly regulated trade via the Ministry of Economy, Trade and Industry.”
Roose, at Withers, says real estate and corporate acquisitions of real estate companies will continue to be a robust legal sector. “Strong interest in renewable energy sector projects and development of data centres will pick up even more steam in 2023,” he adds. “Japanese companies will continue to make strategic investments outside of Japan, despite the weaker yen, and global firms who can capture that work will benefit.”
Kuribayashi, at City-Yuwa Partners, acknowledges optimism for a recovery in sectors such as real estate, technology and green energy, with increased inbound investment as well as an uptick in hotel business. “Japanese businesses are continuing to emphasise ESG [environmental, social and governance] and SDGs [sustainable development goals] as policy goals,” he says.
“Amendments to employment laws related to childcare and employment of the elderly, and the Act on the Protection of Personal Information and the Telecommunications Business Act took effect in 2022, and these amendments will require responses from companies in many sectors.
“For these reasons our outlook is very positive, although some traditionally strong practices might see some stagnation depending on overall domestic economic growth.”
Koyama, at Mori Hamada, believes Japanese companies will continue to engage in M&A activity, both domestically and globally. “Global factors such as recession and the US Federal Reserve increasing its benchmark interest rate may have an impact on volume and deal size, but we believe 2023 will be an active year for deal making,” he says.
“Furthermore, we believe that other practice groups such as insolvency and restructuring (due to the impact of covid-19 on businesses and a rise in prices/inflation), compliance advisory, sustainability and ESG advisory practice, business and human rights diligence and advisory, will continue to see interest from Japanese and foreign clients.”