Japan’s Economic Security Measures Are Immense But Ineffective – Analysis

By Ayaka Hiraki

On 19 August 2024, major Japanese retailer Seven & i Holdings announced that it had received a buyout proposal from Alimentation Couche-Tard, a leading Canadian retail chain. If approved, this acquisition would create the largest convenience store operator in the world.

Then in September 2024, Japan’s Ministry of Finance declared that Seven & i Holdings operates in a ‘core sector’ under the Foreign Exchange and Foreign Trade Act. This designation requires foreign acquirers to submit prior notification for any acquisition and undergo a national security screening to identify risks and vulnerabilities, which could result in the termination of the deal or further requirements posed toward the foreign investor.

While these regulatory measures may complicate acquisitions, they also highlight Japan’s growing focus on economic security and the evolution of its regulatory framework.

Japan’s foreign investment regulations have undergone significant changes. Under the revised Act, implemented in May 2020, foreign investors acquiring over one per cent of the shares in listed companies in designated sectors must submit prior notification and undergo the screening process. 

In December 2022, as part of the Economic Security Promotion Act, Japan introduced the concept of ‘critical products’, which are seen as essential for public welfare and the domestic economy, such as machine tools, industrial robots and semiconductors. Industries related to these products are subject to investment screening. 

These developments show that the government has expanded its conceptualisation of the economic security challenges related to incoming foreign direct investment. While previously it focused on direct risks, such as the erosion of defence industrial bases or military applications of technology, it has begun to include indirect risks, such as data leaks and economic vulnerabilities, in its screening process.

But while the targets of inward direct investment screening have expanded to include a diverse array of firms, such as retailers and technology companies, the methods of investment screening have not been modernised to suit the new reality.

Japan’s approach emphasises strict entry regulations through prior notification requirements. These case-by-case reviews often introduce uncertainties for foreign investors, potentially discouraging direct investments that are aimed at global expansion through the Japanese market.

At the same time, Japan’s efforts to monitor the evolving risks of foreign ownership are very limited once investments are completed. For example, when Tencent, a major Chinese technology company, invested in Rakuten, a Japanese e-commerce and financial platform, the Japanese government imposed conditions to prevent Tencent from accessing confidential data. While Japan, in coordination with the United States, monitored this investment due to concerns over potential data leaks to China, the effectiveness of this monitoring and its ability to prevent unauthorised data access remain unclear.

A further challenge arises from the fact that in complex shareholding structures, a privately-owned company headquartered in a jurisdiction that is not a noted economic security risk to Japan may be influenced through ownership stakes. These could be held by sovereign wealth funds and strategic partnerships with third country State Owned Enterprises, or have significant business interests in jurisdictions where such risks may be present. 

Future changes in ownership and exposure to third party influence may alter the economic security implications of foreign acquisitions deemed acceptable at the time of their completion. This highlights the need for robust post-transaction risk management.

Both the United States and the European Union have adopted measures to enhance the effectiveness of investment regulations. In the United States, authorities have the power to mandate divestitures if national security risks are identified post-investment. Similarly, the European Union introduced foreign subsidy regulations in 2023, requiring transparency in subsidies and funding sources for transactions involving state-owned enterprises to ensure fairness and competitive integrity.

These measures aim to address economic and security concerns and protect domestic markets more effectively by balancing pre- and post-transaction security considerations. But Japan’s implementation of screening and its monitoring activities have often been limited to ad hoc responses. While all of these screening approaches present significant hurdles and unpredictability to foreign investors, Japan’s current system is less effective in facing the changing nature of economic security challenges.

Japan would benefit from improving the effectiveness and transparency of its investment regulations. Clearer screening criteria, along with more accessible guidance and examples, may comfort foreign investors. There would also be benefits to revisiting post-transaction monitoring and enforcement mechanisms.

A ‘narrow scope, high walls’ approach could be effective. This strategy would focus on military–civilian dual-use technologies and competitive sectors critical to Japan’s economic growth, ensuring stringent monitoring of these areas while encouraging investment in less critical sectors. In addition to robust entry screening, continuous monitoring could deter investments with improper motives and enable timely interventions when necessary. Such measures would minimise economic security risks while fostering a healthy investment environment that supports Japan’s global competitiveness.

• About the author: Ayaka Hiraki is a Research Fellow at Deloitte and a PhD student at Keio University, Tokyo.
• Source: This article was published by East Asia Forum