Just when we thought Japan was on the right track toward global best-in-class capital stewardship and pro-free markets rule making, we get a rude wake-up call suggesting Japan’s national interest and free capital flows may be on a collision course.
In late October, Prime Minister Shinzo Abe’s Cabinet approved legislation, which is now before the Diet, that proposes to bring down from 10 percent to 1 percent the criteria for mandatory pre-reporting for foreign investment in Japanese listed companies with businesses deemed important for national security. Unfortunately, making it more difficult for foreign investors to buy Japan will not make it easier for the Japanese to buy Japan.
Of course, there is nothing surprising in politicians seeking to protect national interests; and in fact Japan is merely following the United States in legislating greater political veto power over (supposedly) unwelcome foreign influence. Politics trying to bully itself into the way of free market capitalism is one of the new mega-trends unleashed by the backlash against globalization.
In fact, a possible silver lining is that Japan’s foreign investment rules may end up becoming more transparent and accountable. For example, the old rules left so much ambiguity that when a U.S.-based fund tried to take over the maker of a popular tonkatsu (pork cutlet) sauce in 2007, some politicians called for the company to be protected from foreign “black ships” in the name of protecting the “national interest.”
Having clearly defined rules and administrative guidance on what exactly constitutes national security interests in a company’s business should be welcomed by all investors; although it does raise risks of creative corporate leaders setting up noncore business units that are designated as worthy of national security protection so that now the entire company is technically a national security asset. Designing rules to prevent “national security poison pills” must be considered carefully.
Of course, foreign investors and financial firms have started an impressive lobbying effort to help soften the blow. And yes, Japan’s politicians and technocrats are playing with fire. Given that almost one-third of Japanese equities are owned by global investors, and foreign capital funds almost 70 percent of average daily stock market turnover, building walls to keep foreign money out of Japan may not only drain liquidity but could actually force a significant structural sakoku — closed country — discount on much of Japan Inc.
There is plenty of empirical evidence that pressure on management for better governance, better capital stewardship and more focused operational efficiency has been highly dependent on global investor activism and engagement.
Practically speaking, the new rule will raise administrative walls and costs for non-Japanese investors to make shareholder proposals in general, and proposals for board members and spin-offs in particular (the exact ordinances and guidelines are still under review before going into effect, likely from next April). Global activists and foreign investor leadership engaging with management with proposals for higher investment returns are poised to become less of a force. So the real question is whether domestic Japanese investors can and will now follow up and take over from foreign investors as catalysts for change.
I am very bullish on Japan’s ability and willingness to engender positive change from within. Japanese markets for the Japanese and by the Japanese is poised to become the next big mega-trend in Tokyo financial markets. Why? Because Japan’s asset owners — individual household savers and pensioners — are increasingly desperate for real change and higher returns for their financial assets.
To wit: Japan’s public pension fund, the Government Pension Investment Fund (GPIF), has reformed itself and is now a global leader in putting pressure on managers for best-in-class capital stewardship. Spinning off noncore corporate assets, reducing nonessential cross-shareholding, raising dividends and share buybacks, investing in a more diverse workforce — Japan’s very own national pension fund is leading the charge for corporate change. If, as I suspect, private pension managers begin to follow the GPIF’s lead, corporate managers will have no choice but to deliver real change, i.e., real returns on investments.
Why now? Simply put, because global prospects are such that there is no place to hide anymore. In past decades, in spite of domestic rates stuck at zero, global diversification made sense as it offered positive carry cover for domestic liabilities. Now, with almost one-third of global bonds yields negative and many forecasting a global recession, Japanese pensions are poised to focus on the assets they know best: Japanese companies. Importantly, they know they can actually influence domestic corporate management to unlock value and much needed returns. Domestic pension asset-led capital stewardship activism is coming to Japan.
At the same time, I expect Japanese individual investors to become more assertive and influential in their demands for better corporate management and higher investment returns. Investor eduction and pooling of retail investment assets to put pressure on management and corporate strategies are poised to gain momentum before long.
In fact, the good returns and outperformance of foreign activist fund strategies has already begun to attract attention. Domestic financial advisers and fund managers are already in the process of setting up new funds to mobilize retail investor power. Importantly, Japan’s regulators and politicians have identified an urgent need for a more vibrant and high-performing home-grown asset management ecosystem.
All said, I expect a fundamental turning point in Japanese asset markets in general, the equity market in particular. Leadership will begin to shift away from “tourist” non-Japan money and toward homegrown domestic asset owners, i.e., individual investors and their pension managers.
Of course, the ultimate proof will be whether the new domestic activists will actually be catalysts for better corporate leadership. If history is any guide, homegrown forces for change take time to evolve, but once they get unleashed change comes faster and deeper than anything foreign “black ships” could have imagined.
Jesper Koll is WisdomTree’s head of Japan. Researching and investing in Japan since 1986, he is a top Japan strategist/economist. He blogs at www.wisdomtree.com/blog .