A plan by the government to impose stricter rules on foreign investment in local equities will be “detrimental” to the market, impede the ability to raise funds and undermine seven years of market reforms, according to Goldman Sachs Group Inc.
The Finance Ministry last week proposed a measure that would require foreign investors to report in advance when they plan to buy more than 1 percent of shares in companies related to national security, compared with the current threshold of 10 percent. The bill — which has been approved by the ruling Liberal Democratic Party — must now be greenlighted by the Cabinet and then by both houses of the Diet before becoming law. The changes are expected to be implemented in the fiscal year starting in April, Goldman said.
“The implementation of the new regulation as currently proposed could have a substantial negative impact on the Japanese stock market,” Goldman strategists including Kathy Matsui, vice chair of Goldman Sachs Japan and a renowned voice in the nation’s markets, wrote in an Oct. 16 note. “There is a risk that the new regulations could deter foreign investor participation, causing a decline in market liquidity.”
Under the new rule, foreign investors — who account for about 70 percent of the local stock-trading volumes — will face the “additional burden of time, expenses and legal risks,” the Goldman strategists said. This, in turn, will raise the risk premium of investing in Japan, they said.
The draft of the bill is aimed at strengthening the monitoring of investments in national security-related industries, while also promoting foreign direct investment. The new rules apply to industries such as weapons manufacturing, power generation and communications, while exceptions will apply for purchases of assets for investment portfolios.
“The most critical issue in our view will be what exemptions are ultimately made,” according to Goldman. While portfolio investments will not be subject to the stricter rules, the exact definition of what would fall into that category “remains unclear,” the analysts said.
The Nikkei Asian Review reported Thursday that the government plans to exclude asset-management companies, including hedge funds, from the rule. The newspaper didn’t cite any sourcing. Among Goldman’s questions are whether block trades — which could be larger than 1 percent of a company’s shares — would be regarded as portfolio investing.
The U.S. bank isn’t alone in warning that the move could undermine Prime Minister Shinzo Abe’s efforts to promote investment from abroad and shareholder engagement. Abe’s administration introduced the stewardship code in 2014 followed by the corporate governance code in 2015.
“There is a significant risk that Japan’s inward FDI (foreign direct investment) could decline,” the Goldman team wrote. “Not only would this impede firms’ ability to raise capital, but this could also undermine seven years of positive momentum in market reforms.”
Matsui is famous for her work on “Womenomics,” which has been cited by Abe himself.