A $3.4 Billion Hedge Fund Is Let Down by Japan on Foreign Buying Rules

(Bloomberg) -- The Japanese government’s attempt at imposing stricter monitoring rules on foreign investment in local equities is a “disappointing” step, according to California-based Dalton Investments LLC.

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% of shares in companies related to national security, compared with the current threshold of 10%. The ruling Liberal Democratic Party on Tuesday approved the bill, which must be greenlit by the cabinet and then by both houses of parliament before becoming law.

After a rising chorus of opposition from market participants, including the operator of the Tokyo Stock Exchange, ruling party officials on Friday had temporarily delayed the plan saying that there needs to be more study behind the proposal.

“The news was completely out of the blue for us,” said Shiro Hayashi, who heads the Japanese advisory arm of Dalton, which has about $3.4 billion under management. “Tightening a requirement for the filing is a disappointing development, although we understand this as a national security issue. A 1% threshold is too strict. It has a restraining effect for stealth buying.”

The draft of the bill says the attempt 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.

Yet the proposal could also undermine Prime Minister Shinzo Abe’s efforts to promote investment from abroad. Abe’s administration has been encouraging companies to become more responsive to shareholders’ concerns. Foreign investors have offloaded a net 3 trillion yen ($27.6 billion) of Japanese equities so far this year as an ongoing trade dispute between the U.S. and China dimmed the earnings outlook for export-reliant Japan Inc. The Topix is up 6.8% this year.

Part of the criticism from investors is the lack of clarity on how, if enforced, the new rules will be implemented and which investments will be subject to exemptions.

“There is a potential this just becomes another kind of barrier, or inefficiency, for capital to move across borders,” Matthew Chan, executive director of Asia Securities Industry & Financial Markets Association, said on the sidelines of a conference in Tokyo. “There should be a dialogue and transparency and an open thinking. The concern is the industry is not clear about what it looks like in the implementation.”

The Liberal Democratic Party said Friday it decided to delay the plan to enforce the new rules. More study is needed to determine whether they are in line with those of other countries, LDP lawmaker Masahiko Shibayama said in an interview.

The operator of the Tokyo Stock Exchange also weighed in against the measure. Japan would lose the trust of the rest of the world if it is adopted, Japan Exchange Group Inc. Chief Executive Officer Akira Kiyota said in an interview with the Financial Times.

Dalton, for its part, said it has no immediate plans to change its strategy and that the new rules will be manageable for the hedge fund. Should there be a change, “we hope the government can ease the threshold to at least 5%,” Hayashi wrote in an emailed interview. “We have to monitor cautiously if there is a sign of a reversal trend against the corporate-governance reform,” he added.

To John Vail of Nikko Asset Management, the proposal isn’t a complete surprise given the global trend in governments restricting foreign investments on national security concerns. He doesn’t expect a huge impact on Nikko Asset’s investments.

“It’s at least a trial balloon,” Vail, the Tokyo-based chief global strategist at the Japanese investor, said in an interview. “These things don’t happen by mistake.”

--With assistance from Isabel Reynolds and Emi Urabe.

To contact the reporter on this story: Min Jeong Lee in Tokyo at mlee754@bloomberg.net

To contact the editors responsible for this story: Lianting Tu at ltu4@bloomberg.net, Teo Chian Wei, Cecile Vannucci

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