Despite what seemed to be a growing momentum in activist investing and corporate governance reforms in Japan, a new government proposal could put a stop to it all.

A record 55 Japanese companies were subjected to activist demands by November 19 this year, compared to 51 in the same period last year and 35 in 2017, according to Activist Insight Online. Most common demands were for board changes, with more than half of the firms targeted receiving such requests, a 27% increase when compared to the same period last year. Balance sheet demands, which have been in the top for many years including 2019, stayed the same at 24 this year when compared to last year.

Many notable campaigns came from those 28 companies targeted with board-related demands, including ValueAct Capital Partners at Olympus, Kinya Seto and Keiichiro Ina at Lixil Group, and King Street Capital Management and Effissimo Capital Management at Toshiba.

All activists in the mentioned campaigns came out victorious, no mean feat in a country where activist success in getting board seats has been rare at best. In May, technology giant Toshiba refreshed a majority of its board following discussions with a host of shareholders, including Effissimo and King Street. The company appointed seven new directors to an enlarged 12-member board, including three foreigners for the first time in nearly 80 years. Earlier in the year, ValueAct won a seat on the board of Olympus, while Seto won a proxy fight for the entire Lixil board and was reinstated as CEO.

A growing acceptance

The successful campaigns of 2019 have marked a change in Japan’s usual tight-knit corporate governance toward more openness to advice from outside shareholders. GO Investment Partners’ CEO Paola Perotti, puts the improvements down to the introduction of the Stewardship Code in 2014 and the corporate governance code in 2015, which requires a minimum of two independent directors and recommends that boards be at least one-third independent.

According to Perotti, these have led to an increasing proportion of independent board members, surging cash returns to shareholders and capital efficiency improvements. “These welcome changes have some way to go to match global standards but activists may well perceive them as symptoms of a gradual opening up of corporate Japan.” She warned, however, that while board-related activism may be a straightforward argument for foreign activists, it is unlikely to be acceptable to Japanese companies and investors.

Indeed, many activists are aware of that caveat but launch proxy contests anyway, often as a way to raise awareness among shareholders of issues like capital allocation, board independence, and operational matters. Dalton Investments lost a proxy contest for one board seat at Japanese financial institution Shinsei Bank at the company’s June 19 annual meeting, although the activist’s founder told Activist Insight Online in June that he was satisfied with the results of his campaign. Shortly after Dalton launched its campaign, the company launched a share buyback worth 23.5 billion yen ($220 million).

Alicia Ogawa, director of the project on Japanese corporate governance and stewardship at Columbia Business School, told Activist Insight Online that the governance code opened a whole new door for shareholders to have an influence, giving foreign investors a hook to push for changes. She explained that the last wave of activism in Japan in the 1990s focused on asset stripping which created a heavy backlash toward foreign investors in particular. “Most realized they’re not welcome as long as they pursue that kind of strategy and in the long run it’s better to achieve that outcome through governance improvements.”

Halting the change

Despite the progress made in the country, recent proposed amendments to the Foreign Exchange and Foreign Trade Act could reverse the trend towards more activism. Citing national security, the new proposals call for significant changes to the current regime, including the reduction of the threshold for a foreign investor to file a “pre-acquisition notification” from 10% to 1%. Foreign investors would also have to file a prenotification of their intentions when planning to influence management on governance or business issues, increasing administrative and legal costs.

According to Ogawa, there is not enough understanding of activism in Japan and she fears that the ruling will take so long to figure out that foreign investors will lose confidence in the government and leave. “I can’t overstate how much upset this announcement has caused in the foreign investor community. It’s created an entire meltdown,” Ogawa told Activist Insight Online. “I believe that national security is a legitimate issue and they will do their best to figure it out but from a PR perspective, it’s been handled very poorly.”

The slow acceptance is continuing, however, and there is a greater understanding and higher tolerance of activism in Japan among the media, according to Ogawa. There are some activist names that domestic investors still disapprove of though, she warned. “They hate the activists that come in after something has happened and take advantage of a problem, but there’s appreciation when there’s a nobler purpose than asset stripping.”

Perotti noted that “activist investing in Japan so far has had mixed results.” According to the investor, “there is a possibility that a constructive and culturally sensitive ‘Japanese way’ of engaging may be more acceptable and thus more effective over the long term but it is too early to judge.”