Japan is to tighten rules about foreign ownership stakes in domestic firms, prompting worries that this is a blow to corporate supply-side reforms.

Newly enacted rules tightening Japanese oversight of foreign investment in domestic firms should not prove a significant barrier to inflows, fund managers at RWC argue.

Last Friday, Japan's prime minister, Shinzo Abe, approved proposed revisions to the Foreign Exchange and Foreign Trade Act which will increas the regulatory requirements for foreign direct investment in Japan. A bill will now be passed to the Japanese Diet and, if passed, could come into effect by March 2021.

The new rules cut the ownership threshold at which foreign investors have to notify regulators from 10 per cent to 1 per cent of a “potentially sensitive” company’s shares.

Some organisations and commentators, such as the Financial Times - now Japanese-owned - fear that this will blunt the recent trend of greater shareholder activism in Japanese firms which has shaken up how they are run and have unlocked shareholder value. The supply-side reforms of Japanese corporate governance are among the reasons why some investors, such as the firm Comgest, have been more upbeat about their stock market over the long term. Historically, Japan has been relatively tough for foreign investors to penetrate (see an analysis here.)

Nicola Takada Wood and Michael Connors, portfolio advisors at RWC Japan Active Engagement team, are sanguine about the change, and don't see it as a major problem for foreign investors. They have argued that the FT has "taken a very negative and rather sensationalist stance on the bill, calling it the `anti-activism' law".

"The apparent potential for the definition of the term `strategic' to be all-encompassing (the FT cites, for example, the inclusion of leather goods in the definition) has rung alarm bells among foreign investors who see this as a rolling back of some of the progress in corporate governance made under Abenomics, becoming, in effect, a one-size-fits-all poison pill," the fund managers said.

"The main point we would emphasise is that we don’t expect the law to directly impact our strategy, as there are numerous exemptions in place and we rarely go above a 1 per cent holding in a company," they continued.

"In this light, our ability to engage without taking large stakes, and our relationship with Nissay may make us look more attractive than other foreign activist funds," they said.

"Our relationship with Nissay Asset Management, the investment arm of Japan’s largest insurance company, means that we can engage and influence corporate managers from a position of mutual respect without forcing discussions through ownership," they said.

The managers said that recent moves will certainly prompt investors to ask how deeply the government is committed to reforming the supply side of the economy.

"While we are aware that constant vigilance is the price of liberty, we believe that this legislation is all about geopolitical concerns surrounding China and our answer to the opening question is: `No; we should not be too worried'."