Identifier
Created
Classification
Origin
08TOKYO408
2008-02-14 17:54:00
CONFIDENTIAL
Embassy Tokyo
Cable title:  

FOREIGN INVESTMENT IN JAPAN -- OBSTACLES REMAIN

Tags:  EINV ECON PREL PGOV OECD JA 
pdf how-to read a cable
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P 141754Z FEB 08
FM AMEMBASSY TOKYO
TO RUEHC/SECSTATE WASHDC PRIORITY 1764
INFO RUEHBJ/AMEMBASSY BEIJING 1683
RUEHRL/AMEMBASSY BERLIN 1342
RUEHFR/AMEMBASSY PARIS 5990
RUEHUL/AMEMBASSY SEOUL 7753
RUEHFT/AMCONSUL FRANKFURT 0464
RUEHFK/AMCONSUL FUKUOKA 6109
RUEHHK/AMCONSUL HONG KONG 6448
RUEHKSO/AMCONSUL SAPPORO 6712
RUEHGH/AMCONSUL SHANGHAI 0335
RUEHBS/USEU BRUSSELS
RHEHAAA/NSC WASHDC
RUEHIN/AIT TAIPEI 6898
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/TREASURY DEPT WASHDC
RUEAWJA/JUSTICE DEPT WASHDC
RUEHGV/USMISSION GENEVA 3249
C O N F I D E N T I A L SECTION 01 OF 04 TOKYO 000408 

SIPDIS

SIPDIS

DEPT FOR EAP
ALSO FOR EEB/IFD: DIBBLE, BYERLY, AND KAMBARA
NSC FOR TONG
DEPT PASS USTR FOR CUTLER AND BEEMAN
USDOC FOR 4410/ITA/MAC/OJ/NMELCHER
JUSTICE FOR ANTITRUST DIVISION - CHEMTOB
TREASURY DEPT FOR IA/CARNES AND POGGI
GENEVA FOR USTR

E.O. 12958: DECL: 02/12/2012
TAGS: EINV ECON PREL PGOV OECD JA
SUBJECT: FOREIGN INVESTMENT IN JAPAN -- OBSTACLES REMAIN
DESPITE GOVERNMENT POLICIES

REF: A. TOKYO 317

B. TOKYO 324

C. 07 TOKYO 3689

D. 07 TOKYO 454

Classified By: Ambassador J. Thomas Schieffer. Reason 1.4 (b)(d)

C O N F I D E N T I A L SECTION 01 OF 04 TOKYO 000408

SIPDIS

SIPDIS

DEPT FOR EAP
ALSO FOR EEB/IFD: DIBBLE, BYERLY, AND KAMBARA
NSC FOR TONG
DEPT PASS USTR FOR CUTLER AND BEEMAN
USDOC FOR 4410/ITA/MAC/OJ/NMELCHER
JUSTICE FOR ANTITRUST DIVISION - CHEMTOB
TREASURY DEPT FOR IA/CARNES AND POGGI
GENEVA FOR USTR

E.O. 12958: DECL: 02/12/2012
TAGS: EINV ECON PREL PGOV OECD JA
SUBJECT: FOREIGN INVESTMENT IN JAPAN -- OBSTACLES REMAIN
DESPITE GOVERNMENT POLICIES

REF: A. TOKYO 317

B. TOKYO 324

C. 07 TOKYO 3689

D. 07 TOKYO 454

Classified By: Ambassador J. Thomas Schieffer. Reason 1.4 (b)(d)


1. (C) Summary: The GOJ maintains its policy of boosting
foreign direct investment and the sharp rise in FDI inflows
in 2007 show foreign investors are not "fleeing Japan".
Recent high-profile debates over particular investment cases,
public warnings by a cabinet member that Japan's investment
climate has lost its attractiveness, and a METI Vice
Minister's off-the-reservation remarks, however, show that
problems persist and need to be addressed. Pessimism among
many investors over the continued slow pace of reform in
Japan and sharply eroding market sentiment have added further
negative factors to a mix that includes on-going cultural and
regulatory obstacles to investment, many of which the GOJ
identified in a December 2007 FSA report. Whether the Fukuda
government has the political will to follow through on its
explicit investment agenda as it looks to consolidate the
ruling party's support base in advance of elections later
this year is an open question. End Summary.

No Change of Policy, Just Lack of Leadership
--------------


2. (SBU) A series of unconnected policy initiatives and
statements by Japanese officials since the New Year raised
doubts about the GOJ's commitment to promoting inward FDI.
Most prominent among these events have been a Ministry of
Land, Infrastructure, Transportation and Tourism (MLIT) draft
bill that would limit foreign ownership in privatized
Japanese airport operators to 33 percent (septel),METI
statements that it opposed a UK-based investment fund's (TCI)

application to raise its stake in electricity wholesaler
Electric Power Development Co. (known as "J-Power"),and
public comments by METI Vice Minister Takao Kitabata
denigrating shareholders's role in corporate governance (Ref
A).


3. (U) All this negative news coincided with a sharp drop in
the Tokyo Stock Exchange, exacerbating already bearish market
sentiment. It also drowned out more positive news on the
investment front including from PM Fukuda, whose January 18
Diet policy speech reiterated the government's goal of
doubling the country's FDI stock by 2010. The METI Director
of Industrial Organizations emphasized to Econoff Feb. 12
there is no change to government policy in promoting inward
FDI and pointed to a recent sharp rise in inward M&A, from
171 cases worth 630 billion yen in 2006 to 308 cases worth 3
trillion yen in 2007. At the same time, Japan's FDI stock as
of September 2007 (the latest figures available) was 15.4
trillion yen, up 20 percent over the year-end 2006 level,
according to official Ministry of Finance figures.


4. (C) Also on the positive side, Cabinet proponents of
economic reform, led by Financial Services Minister Watanabe
and Minister for Economic and Fiscal Policy Ota -- with the
help of some senior LDP Diet members -- have defeated, at
least for the moment, MLIT's proposal to cap foreign
ownership in Japan's airport operators. Meanwhile, METI
announced it will extend its examination of TCI's application
to increase its holdings in J-Power until mid-May while
actively attempting to clarify Kitabata's remarks, in

TOKYO 00000408 002 OF 004


response to strong press criticism and Embassy expressions of
concern. Kitabata apologized Feb. 7 for his "inappropriate"
comments and even METI Minister Akira Amari felt obliged to
tell reporters the next day that his deputy's comments were
"perhaps too radical" and "misleading."

Continuation of Long Existing Trends
--------------


5. (C) There was little new in any of these developments
although their cumulative impact was magnified by eroding
global investor sentiment. Kitabata's remarks, as shocking
as they were, echoed his previous criticisms. He has made no
secret of his antagonism to activist shareholders such as

SIPDIS
U.S.-based fund Steel Partners. In July 2007, he told
reporters, "companies should be run for the benefit of
stakeholders, not shareholders," and in November he
criticized Steel Partners as an example of shareholders that
"lack the experience needed to manage companies or enhance
corporate values."


6. (C) The TCI/J-Power case triggers a 1991 law requiring
foreign investors seeking to acquire over 10 percent of any
company operating in a sensitive sector, including
electricity generation and distribution, to obtain government
approval in advance (Ref D). Significantly the government
has never rejected a proposed investment under the 1991 law.
Nor are there overall limits on the aggregate amount of
foreign investment allowed in J-Power only on the size of
individual stakes. (According to a recent company report, as
of January 2008, 39.9 percent of J-Power's shares are held by
foreigners. Approval of TCI's application would raise the
level of foreign ownership to 49.9 percent.) In the same
way, the MLIT proposal on airport operators mirrors a
provision in the 1986 Law that privatized former state-owned
telephone company NTT.


7. (C) More worrisome, though, is the case of Sapporo
Holdings where the firm's nominally independent advisory
committee concluded that a takeover bid by Steel Partners was
not in the best interests of the company or its shareholders
(Ref B). Steel Partners consciously adopted a more
conciliatory approach to Sapporo's board after the courts
labeled it an "abusive acquirer" following Steel's failed
2007 effort to acquire the condiment maker Bull-Dog Sauce Co.
Despite Kitabata's occasional sniping of the fund, the GOJ
has taken no formal role in this case.

Some Reasons for Optimism
--------------


8. (C) In addition to the temporary derailment of MLIT's
airport proposal, there have been other positive, if less
reported, developments. Minister for Economic and Fiscal
Policy Ota raised her public pro-reform profile by moving
quickly to establish a new Experts Advisory Group on
Investment to replace the disbanded ministerial-level Japan
Investment Council, a body PM Koizumi had used to generate
policy recommendations and FDI targets. Professor Haruo
Shimada, chairman of the new group, told EMIN Ota wants to
"awaken the public to the need for continued reform" and has
instructed the working group to develop recommendations to
improve Japan's new M&A rules (including the associated tax
regulations for triangular mergers) and to examine other
areas of investment-related regulatory reform. The committee
expects to complete its draft report by mid-April to

TOKYO 00000408 003 OF 004


influence the GOJ annual broad-based economic policy White
Paper due out in June.

Foreign Investors Sell but Domestic Investors Won't Buy
-------------- --------------


9. (SBU) Ota's renewed interest in reform was triggered, in
part, by the sharp fall in Japan's equity markets since the
first of the year. As of Feb. 12, the blue-chip Nikkei 225
is down over 15 percent from its level of December 28, the
last trading day of 2007, and almost 27 percent below the
seven-year high set in Feb. 2007. Although, foreign
investors turned net sellers of Tokyo stocks in July 2007 for
the first time since 2002 in response to the growing
sub-prime problems in the U.S., the margin of net sales has
been generally less than 1 percent of total trading volumes.
The larger problem has been the lack of domestic buyers.
Since July 2007, the percentage of trading on the TSE's First
Section by foreign investors has risen from less than 50
percent to almost 70 percent. Foreign investor trading on
the Osaka Stock Exchange has experienced a similar increase.

Japan Wants Investment but Prefers Certain Types
-------------- ---


10. (C) Despite the growing bearish sentiment towards Tokyo
equities in recent months, investment bankers agree Japan's
current legal framework for M&A is adequate. The major
obstacles to increased foreign investment in Japan remain
largely cultural and institutional, not legal and regulatory.
Japanese business leaders continue to reject an increased
role for activist shareholders in their company's activities
and express mixed feelings toward the role of investment
funds. Even a committed reformer like Tokyo Stock Exchange
(TSE) President Atsushi Saito told Emboffs recently that
Japan prefers "physical, real investment" in manufacturing or
services over portfolio investment. Many businessmen
consider the activities of investment funds to be "a money
game" and not "real" investment, he concluded.


11. (C) The real worry of corporate Japan and senior
economic bureaucrats like Vice Minister Kitabata is not too
much foreign investment, but the loss of control of corporate
assets. At the company level, the system discourages risk
taking and rewards the status quo. As the head of Lazard
Freres, Japan told Econoff recently, "Japan has too many
salaryman CEOs." The professional and financial interests
of a Japanese executive are linked to the continued
independent existence of his company. In most cases, such an
executive has little or no equity stake in his firm and would
receive no personal benefit from a boost in the company's
share price or the premium price associated with a hostile
takeover bid. Likewise, his retirement package is usually a
lump sum payment and a relatively small pension program
dependent on the good will and continued existence of the
company. Finally, there is no explicit or implicit reward
for risking the company's assets, regardless of the potential
reward, unless the existence of the company is at stake.
Such was the case in Citigroup's recent acquisition of the
brokerage Nikko Cordial and the reason the deal was completed
relatively quickly. Such risk aversion also makes a Japanese
CEO more willing to prefer a deal, if no other options are
possible, with a "white knight" buyer with which, in most
cases, his company has a pre-existing relationship.

What Needs To Be Done

TOKYO 00000408 004 OF 004


--------------


12. (C) There is wide agreement among both fund managers and
investment bankers that the remaining obstacles to increased
FDI in Japan are cultural and institutional, not legal.
Several market participants with whom we spoke, including
both fund managers and Japan Business Federation (Keidanren)
officials, pointed to high corporate tax rates as a major
burden. One U.S. fund manager told us cutting the top
corporate rate of 41 percent is the single most important
step the GOJ could take to encourage new investment flows.
High rates, he said, discourage funds from setting up here
and, if they are not here, potential deals are missed. He
even added most foreign investors could live with elimination
of the temporary 10 percent rate on capital gains and a
return to the regular 20 percent rate in return for lower
overall corporate rates.


13. (C) Second, policies should encourage a shift of more of
the 1,500 trillion yen in personal financial assets held by
Japanese households out of savings accounts and into the
markets. This shift could be done by increasing the types of
financial products offered on Japanese markets, adjusting tax
rates to encourage savings over investment, and accelerating
broad structural reforms that would stimulate domestic
demand, increase the productivity of Japanese firms and
trigger more economic growth.


14. (C) Finally, better corporate governance, especially an
increase in the number and strengthening of the role of
independent directors, would make it easier for investors to
use M&A to unlock the hidden value in many Japanese listed
firms. Lazard's CEO admitted to us that many of his clients
see significant hidden value in Japanese companies which
continue to have low return on equity and use capital
inefficiently. However,given current attitudes of Japanese
corporate directors, it is just too difficult to try to
unlock that value.


15. (C) The FSA's December 2007 Report on Strengthening the
Competitiveness of Japan's Financial and Capital Markets,
addresses many of the policy reforms called for by market
players, including increasing the variety of financial
products offered on Tokyo's markets, strengthening
self-regulation of markets, review of the firewalls between
banks, brokerages and insurance providers, increased
transparency of financial regulations and better corporate
governance. If the GOJ implements many of the report's
recommendations, it could have a dramatic, positive impact on
Japan's investment climate. Unfortunately as the country
moves closer to the next general election, the incentive to
take on powerful corporate interests will wane. The major
question is whether the government has the political will and
the energy to follow through on its own explicit agenda.
SCHIEFFER