Under the current administration, an accommodating monetary policy has bolstered financial institutions’ lending appetite. Competitive market dynamics have also put downward pressure on interest rates and lending fees.
Borrowers are therefore benefiting from easy access to debt financing. Japanese companies have been increasing capital expenditure for these years. M&A, infrastructure projects and the real estate market have also been active. The value of outstanding loans held by Japanese banks exceeded JPY534 trillion at the end of 2020, compared to JPY507 trillion at the end of 2019.
The COVID-19 pandemic is heavily impacting the lending market in August 2021 as this article is being written. In response to a request of the Japanese Financial Services Agency, banks are striving to provide liquidity to support borrowers to ensure the survival of their businesses. Some banks are extending commitment lines to various sectors, including airlines and travel agencies, while others are responding flexibly to requests for amendments of existing loan terms (including extension of loan repayments).
Given the relatively wide availability of senior facilities provided by banks, the role played by high-yield facilities has been somewhat limited. However, high-yield and mezzanine debt remain popular for borrowers seeking to stretch debt capacity in structured transactions such as leveraged buyouts and real estate acquisitions. Mezzanine debt is typically provided in the form of subordinated loans or preferred shares.
Banks and other conventional financial institutions continue to play a central role in the Japanese loan market, with the most sizeable being three mega banks (Mizuho, MUFG, SMBC), which, together with Resona and Resona Saitama, account for 39.7% of the outstanding loan balance as of the end of 2020. Other players include non-bank money lenders, private investment funds and government-related financial institutions.
The fintech movement is gathering pace in the Japanese market, with start-up firms and conventional financial institutions seeking to make fundamental changes to almost all aspects of finance. In the context of lending and investment, crowd-funding, social lending and transaction lending are prime examples, all of which seek to match investors with borrowers who have not previously had access to conventional finance.
The amendment to the Civil Act (contract law) took effect in April 2020 which made it easier to grant security over the receivables with a transfer restriction.
In addition, a study group supported by the Ministry of Justice released a report about a proposed framework of new legislation for security over movable properties and receivables, and another study group organised by the Financial Services Agency is discussing an introduction of a new legal system for a blanket collateral. These developments may promote lending practices that do not rely on real estate collateral or individual guarantees provided by management members.
The Ministry of the Environment of Japan (MOE) developed the "Green Loan and Sustainability-Linked Loan Guidelines 2020" (the "MOE Guidelines") in March 2020, which were prepared based on the globally-accepted principles published by international loan market associations. The MOE Guidelines provide the basic framework for engaging in green loans and sustainability-linked loans in practice. Through the continuous updating of the guidelines to reflect precedents and dialogue with market participants, the foundation for the promotion and growth of green loans and sustainability-linked loans is developing in Japan.
While there are still some areas that require further discussion and improvement (including the establishment of the setting and evaluation methods of the SPTs, expansion and implementation of information disclosure standards and systems, as well as tackling "green wash" or "sustainability wash", it is expected that ESG and sustainability lending will make significant progress, backed by the large-scale financial resources available in the indirect finance market in Japan.
A lender who makes a loan in Japan must have a licence under Japanese regulation if that loan is made as part of its money-lending business, subject to certain exemptions (such as intra-group lending). The licence requirement will be satisfied if the lender is licensed as a bank or a Japanese branch of a foreign bank, or if it is registered as a money lender.
Provided that foreign lenders abide by the licence requirement described in 2.1 Authorisation to Provide Financing to a Company, there are no further material restrictions applicable only to foreign lenders. If a foreign lender cannot abide by the licence requirement, it may consider subscribing bonds rather than making loans.
There are no material restrictions on granting security or making guarantees that apply only to foreign lenders. For further information on the enforcement of security interests by foreign lenders, see 6.4 A Foreign Lender's Ability to Enforce Its Rights.
The Foreign Exchange and Foreign Trade Act sets out the Japanese policy regarding foreign currency exchange. As far as normal international lending is concerned, there are certain post facto reporting requirements.
There are no general regulations that restrict the use of loan proceeds. However, financial institutions are regulated under the Criminal Proceeds Transfer Prevention Act, which aims to prevent money laundering and financial support for terrorism activities. To that end, the Act requires financial institutions to:
Under the recent amendment of the Act, if the borrower is a corporation, financial institutions are required to identify the individuals who have substantial control over that borrower.
If the loan proceeds are used for money laundering, terrorism or other anti-social activities, it may expose lenders to reputational risks at the very least. To mitigate this risk, the use of proceeds of a bank loan is usually specified in the loan agreement, and misuse thereof would be an event of default. Under standard syndicated loan documentation, the unanimous vote of the lenders is required in order for the borrower to change the use of proceeds.
In general terms, Japanese law recognises the concepts of agent and trust. In practice, administrative agents and security agents are commonly appointed in syndicated loan transactions governed by Japanese law. However, the agents’ roles are limited to administrative functions in most cases, and parallel debt structures (whereby the parallel debts belong to the agent who holds security interests on behalf of the lenders) are rarely adopted, although such structures are not impossible under Japanese law.
The use of security trust structures – whereby the security trustee holds security interests on behalf of the lenders – is also limited, although they are explicitly permitted under Japanese law. In many cases, each of the syndicated lenders holds its security interest on its own behalf and an inter-creditor agreement sets out the restrictions on its exercise, such as the enforcement being prohibited in the absence of majority lenders’ consent.
The most common transfer mechanism in the secondary loan market is the outright transfer of loan receivables. A loan receivable can be transferred without the borrower’s consent, unless the relevant loan document provides otherwise. The benefit of the associated security package can be transferred, with or without the consent of the security provider and other lenders, depending on the nature of the security interests, such as whether the security interest is a fixed security or a blanket security. Many loan documents oblige the security providers to co-operate with the secondary transaction by giving consent to the transfer of the security interest, subject to certain conditions.
Another secondary mechanism is loan participation. Under a participation arrangement, the loan receivable and security package does not legally transfer to the participant. As such, the participant benefits indirectly from the security package via the lender’s enforcement.
Japanese law does not prohibit a borrower or sponsor from agreeing with the lenders to buy back its debt. If the borrower buys back its own debt, the debt automatically disappears, unless it is provided as collateral in favour of a third party. If a sponsor buys back the debt, the debt obligation remains outstanding, which creates an issue regarding how to treat the sponsor’s share of the debt in the context of syndicate voting. Some syndicate loan agreements address this situation, but many others do not.
Under the Japanese tender offer bid (TOB) regulation, the offeror must be able to demonstrate its ability to fund its tender offer at the launch date. The offeror may satisfy this requirement by submitting a commitment letter provided by a financial institution. The Japanese Financial Services Agency has stated that the commitment letter provided for this purpose must evidence the certainty of funding to a fairly reliable degree. However, no further details of this requirement have been officially announced. In practice, the relevant financial bureau may provide comments on the draft commitment letter before the launch date of the tender offer. Once the final commitment letter has been filed, it becomes available to the public.
Borrowers generally negotiate with the lenders over the conditions precedent to eliminate the uncertainty of funding as much as possible. Lenders and borrowers sometimes agree on so-called “certain funds” terms, although the details may differ on a case-by-case basis. One of the most typical categories of transaction where these types of terms are negotiated is the leveraged public acquisition deal, although such negotiations also occur in the course of private acquisition finance transactions.
A cross-border payment of loan interest by a Japanese borrower to a foreign lender is subject to Japanese withholding tax, subject to certain exemptions. The tax rate is 20.42%, unless an applicable tax treaty provides otherwise.
A written loan agreement is subject to stamp duty, the amount of which differs depending on the amount loaned and the nature of the loan transaction, such as whether the loan is a term loan or a line of credit. The maximum duty amount is JPY600,000 per loan document.
Corporate taxation differs depending on the status of each party. International lenders should note that their Japanese tax treatment changes depending on whether or not the profit relating to the loan arises through their perpetual equipment in Japan.
Other taxes and charges that may become relevant to a loan transaction include registration fees and notary fees for the perfection of security interests, and court fees for the commencement of the judicial enforcement of security interests.
There are usury laws in Japan. Although multiple Acts address this issue in a complex manner, the most notable law is that the maximum interest rate for loan transactions is 15% where the amount loaned is JPY1 million or more.
The usury laws provide that fees or other monies paid to a lender in respect of a loan are deemed to be interest for the purpose of the interest-rate cap. In this context, the scope of “deemed interest” often becomes a practical issue. Firstly, under the Commitment Line Act, commitment fees are statutorily exempted from the scope of deemed interest, provided that the borrower falls within the prescribed categories, such as a stock corporation with share capital of JPY300 million or more. Secondly, whether other fees such as the arrangement and agent fees fall within the scope of deemed interest has, at times, been a critical issue. The practitioners’ approach to this issue is that, put simply, if the independent and substantial services (such as arrangement services) are provided and the amount of fees are within a reasonable range for such services, the fees should not fall within the scope of deemed interest.
The typical forms of security interest and perfection requirements corresponding to each type of asset are set out below. If the security is not perfected, the lender cannot assert its preferred position vis-à-vis third parties. Such third parties include perfected secured creditors, perfected acquirers of the target’s properties, and the bankruptcy trustee of the security-provider.
A mortgage is the most typical form of security for real estate. The secured obligation can be specified (ordinary mortgage; futsu-teito) or designated as a certain group of unspecified obligations (blanket mortgage; ne-teito).
Lenders register the mortgage at the relevant legal affairs bureau in order to perfect the mortgage. The registration fee is 0.4% of the amount of secured obligation. To reduce the upfront cost, some lenders permit the borrower to make a provisional registration only, which costs JPY1,000 per property. Once the mortgage is provisionally registered, the mortgagee reserves priority over other mortgagees who register their mortgages after the provisional registration. However, provisional registration is of little use unless formal registration is completed, so lenders need to ensure that they are always in possession of all documents necessary to allow them to register the mortgage formally.
Pledges and security assignments (ie, security by way of assignment or assignment for the purpose of security) are the most typical forms of security for movable properties. The secured obligation can be specified or designated as a certain group of unspecified obligations.
To effectuate a pledge over movable properties, actual delivery of the subject properties is required. For this reason, security assignment is more often adopted, since actual delivery is not required.
To perfect a security assignment of movable properties, actual delivery or constructive delivery (such as the occupant’s manifestation of its intent to occupy the subject assets on behalf of the lenders) of the target properties is required. Registration of the transfer will also perfect the security assignment.
Movable properties can be collateralised as individual properties or as a pool of properties. The pool needs to be sufficiently identified by specifying the type of asset, the location and other necessary criteria. This method enables the lenders to capture after-acquired movable properties as security.
Pledges and security assignments are the most typical forms of security for receivables. The secured obligation can be specified or designated as a certain group of unspecified obligations.
Lenders can perfect the pledge or security assignment by giving notice to, or obtaining consent from, the obligor in written form, together with a notarised date certificate. Registration of the pledge or transfer will also perfect the pledge or security assignment.
Future receivables can be subject to the pledge or security assignment if the target receivables are sufficiently identified and follow the other requirements.
Receivables may be collateralised without having to obtain the obligor’s consent even if the underlying contract has a transfer restriction clause. However, if receivables are collateralised in breach of a contractual restriction, the obligor may refuse to pay the secured party upon the enforcement of the security if the secured party was aware, or due to gross negligence unaware, of the restriction at the time of collateralisation. One exception to the foregoing general rule relates to bank deposits, which cannot be collateralised without the bank's consent. Banks are generally reluctant to give consent unless they are a secured party.
A pledge is the most typical form of security for shares. The secured obligation can be specified or designated as a certain group of unspecified obligations.
Even if the articles of association of the issuer contain transfer restrictions, a share pledge can be effectuated by an agreement between the pledgor and the pledgee. However, lenders sometimes request that the target company amend its articles of association so as not to hinder the enforcement of the pledge, or otherwise to ensure the smooth enforcement of the share pledge.
The perfection method differs depending on the type of shares. If the shares are dematerialised, the pledge is perfected by means of electronic book-entry. If not, the share pledge is perfected by delivery of the share certificate representing the pledged shares. If the shares are not dematerialised and the issuing company does not issue share certificates pursuant to its articles of association, the share pledge is perfected by requesting that the issuing company record the pledge on its shareholder ledger.
Other types of assets – such as debt securities, IP and trust beneficial interests – are taken as security and perfected in accordance with the steps applicable to each type of asset.
The concept of a universal security interest (whereby the lender is granted security interest over all the debtor’s property, whether present or after-acquired, to secure its secured obligation) is not available to secure loan obligations under Japanese law. Therefore, lenders need to follow the creation and perfection procedure for each type of collateral asset. As mentioned in 5.1 Assets and Forms of Security, future (after-acquired) movable property and receivables can be collateralised to the extent that doing so is permitted under the applicable requirements.
There are no specific statutory limitations or restrictions on downstream, upstream and cross-stream guarantees. However, there are often issues in relation to upstream guarantees, due to the general fiduciary duty owed by the guarantor’s directors. If a subsidiary provides an upstream guarantee solely for the benefit of a majority shareholder (owning less than 100% of the shares in the guarantor) in the absence of the subsidiary’s corporate benefit, the directors of the subsidiary will be exposed to the risk of breaching their fiduciary duties. To avoid this risk, in practice, upstream guarantees are often made subject to the consent of any minority shareholders.
In general, a subsidiary is restricted from acquiring its parent’s shares. This restriction is interpreted to be applicable not only where the subsidiary legally acquires its parent’s shares, but also to a transaction that results in the economically equivalent result. Theoretically, it is not totally clear whether a target providing financial assistance for the acquisition of its own shares conflicts with such a restriction. However, it is common practice for the acquired target company to grant security or provide a guarantee to secure the acquisition facilities borrowed by the parent vehicle and partially funded by the sponsor.
If an acquisition vehicle does not acquire 100% of the shares in a target and the target grants security or provides a guarantee in respect of the acquisition, this may give rise to an issue regarding the target director’s fiduciary duties. See 5.3 Downstream, Upstream and Cross-Stream Guarantees.
In addition to the general rules explained above, there are some special statutory restrictions in relation to granting security or providing guarantees. For example, granting security over insurance claims arising under a liability insurance policy is prohibited. Also, an individual cannot guarantee unspecified obligations without specifying the maximum amount of the guarantee. Guarantee by an individual is restricted in some other respects.
If the secured obligation of a security interest is specified, the security interest disappears upon full payment of the secured obligation by operation of law. If the secured obligations are designated as a certain group of unspecified obligations, the lenders usually need to release the security interest in order for that security interest to disappear.
The general rule is that the priority among several security interests over an asset is determined by reference to the time at which each security interest is perfected, or the first perfected security is given first priority. Therefore, as a matter of ranking the security interests, subordination can be created in many cases by perfecting the subordinated lender’s security after the senior lender perfects its own security.
There are technical difficulties in creating several security interests with different rankings over some types of assets. For example, theoretically, it is not clear whether there can be several security assignments over one property. Moreover, the book-entry system does not accept multiple pledges over dematerialised shares. In these cases, senior lenders and subordinated lenders agree to contractual subordination or other arrangements to accomplish a similar outcome.
Among unsecured obligations, several methods of subordination are used. Aside from structural subordination (which involves borrowing entities at different levels, where the subsidiary borrows senior debt and the parent borrows subordinated debt), there are two types of contractual subordination structure: absolute subordination and relative subordination.
Absolute subordination arrangement
Under an absolute subordination arrangement, in an insolvency situation, the payment of subordinated debt is conditional on the full payment of the senior debt. Senior lenders thus ensure that the subordinated lender does not receive payment in priority to, or at the same ranking with, the senior lender.
Relative subordination arrangement
The essence of a relative subordination arrangement is an inter-creditor agreement between the senior and subordinated lenders. Typically, the subordinated lenders agree to hand over any payment they receive from the borrower to the senior lenders until the senior debt is paid in full, subject to certain exceptions. This type of arrangement is not intended to be effective vis-à-vis an insolvent borrower.
The central requirement for a lender to be able to enforce its security interest is that the secured obligation remains unpaid when due and payable. The lender typically declares an acceleration of the entire secured obligation pursuant to the loan agreement if it enforces its security interest before final maturity.
Under standard security documentation, a lender may choose to enforce a security interest created in a commercial transaction by a judicial (in-court) procedure or private (out-of-court) process.
Using judicial enforcement, a lender may enforce a mortgage over real estate by submitting the real estate registration certificate on which the mortgage is registered. Typically, that real estate is then sold to a third party through a judicial auction process, and the sale proceeds are applied to the repayment of the secured obligation.
One of the problems with judicial enforcement is that the sale proceeds are likely to be substantially lower than would be realised through a private auction. A lender should therefore consider selling the subject property out of court, or acquiring the subject property itself at fair value and discharging the secured obligation by the same amount.
Japanese courts generally recognise the validity of the choice of a foreign law as the governing law of a contract, but the governing law of security interests cannot be chosen by the parties. For example, security interests over real estate and movable properties are governed by the law of the location of the subject properties.
Japanese courts also generally recognise the validity of a submission to a foreign jurisdiction.
A waiver of sovereign immunity is upheld, provided that it is made in compliance with the requirements of the Act on the Civil Jurisdiction of Japan with respect to a Foreign State.
Japanese law adopts the principle of reciprocity regarding the recognition of foreign judgments. As such, Japanese courts will recognise final and conclusive civil judgments rendered by a foreign court, provided that:
Japan is a party to the New York Convention (1958) and the Geneva Conventions (1927), so the recognition of a foreign jurisdiction is determined in accordance with these conventions, to the extent they are applicable. Otherwise, the recognition of a foreign arbitral award is determined based on the same requirements as apply to a domestic arbitral award under the Arbitration Act, which are as follows:
Regarding the enforcement of share pledges, foreign lenders are restricted from acquiring pledged shares over companies that conduct certain limited categories of business related to national security, including telecommunications, broadcasting and aviation.
In addition to judicial insolvency proceedings, private restructuring processes are very important. They are initiated by the borrower’s lawyer and sometimes involve a third-party organisation specialising in private turnaround situations.
This type of process is chosen by a financially distressed debtor who would like to avoid the damage that would be caused by the public announcement of the commencement of statutory insolvency proceedings.
Given the private nature of this process, creditors' rights are not involuntarily impaired and unanimous agreement among major creditors is required in order for the debtor to implement its restructuring plan.
There are three major statutory insolvency proceedings: bankruptcy (hasan), civil rehabilitation (minji saisei) and corporate reorganisation (kaisha kousei). Bankruptcy results in the liquidation of the borrower’s business, while the other two proceedings allow the debtor’s business to continue once substantial changes have been made to its assets, liabilities and equity, pursuant to a rehabilitation or reorganisation plan.
Statuary Insolvency Proceedings
Under statutory insolvency proceedings, creditors of unsecured claims are generally prohibited from enforcing their loans once judicial insolvency proceedings have commenced (and, in most cases, immediately after the insolvency application has been filed with the court) with respect to the borrower. Unsecured creditors must instead recover their claims in accordance with the insolvency procedure, in terms of both the timing and the amount of the recovery. The same applies to the enforcement of a guarantee in the insolvency of the guarantor.
The general rules applicable to secured creditors depend on which of the three insolvency proceedings is chosen.
Corporate Reorganisation Proceedings
Under corporate reorganisation proceedings, secured creditors are prohibited from enforcing their security interests outside the reorganisation proceedings, and can receive repayment only in accordance with the reorganisation plan approved in the reorganisation proceedings, in terms of both the timing and the amount of the recovery. More than two thirds of the voting rights held by all secured creditors need to be voted in favour of a reorganisation plan if the plan provides for a rescheduling of the secured claims, and more than three quarters of the voting rights are needed if the plan provides for other restrictions on the security interests (for example, a haircut of the secured portion of the claims held by the secured creditors).
The Corporate Reorganisation Act recognises the concept of a "cram-down", whereby the court may approve a plan without the consent of certain classes of creditors; for example, the secured class of creditors (Article 200-1). However, in order for the court to approve a plan pursuant to a cram-down provision, the court is required to grant fair protection to the objecting class of creditors, for example by distributing the fair value of the security interest to the secured claim holders.
Bankruptcy and Civil Rehabilitation
Under bankruptcy proceedings and civil rehabilitation proceedings, the enforcement of a security interest is, in principle, not affected by the insolvency of the borrower. However, there are notable exceptions to this general rule with regard to civil rehabilitation. First, the court may issue an injunctive order to stop the enforcement of a security interest by a creditor, to the extent that the injunctive relief would be in the general interest of creditors and the relevant secured creditor would not suffer unjustifiable damage as a result. Second, the court may approve the extinguishment of security interests where the collateral is essential for the continuance of the debtor’s business.
However, in order for the extinguishment to be utilised, the debtor is required to pay off the fair value of the collateral to the security-holder. The fair value will be determined by the court, and the secured creditor may request an expert appraisal if it is not satisfied with the value proposed by the court.
Unsecured loans, including any unsecured portions of partially secured loans, are usually treated as general claims in Japanese insolvency proceedings.
General claims are subordinated to common benefit claims, such as fees to the bankruptcy trustee, and preferred general claims, such as wages for employees and certain tax claims.
However, general claims have priority over certain subordinated claims, such as accrued interest arising after the commencement of insolvency proceedings.
Regarding secured claims, see 7.2 Impact of Insolvency Processes.
Japanese insolvency legislation does not have a general principle that allows an insolvency court to lower the priority of a claim on the grounds that the claim is held by a controlling shareholder.
One of the notable risk areas for lenders in statutory insolvency proceedings is the risk of avoidance. The creation of a security interest by a financially distressed borrower may be invalidated (by the insolvency trustee or the debtor-in-possession) if the security interest was created to secure existing debt:
The perfection of a security interest may also be avoided even where the creation of a security interest itself may not be avoided pursuant to the criteria above. This is to prevent the holder of a security interest that has been hidden for a long time from obtaining priority over general creditors after the borrower becomes financially distressed. The requirements of such avoidance include the perfection:
Obtaining a guarantee or receiving a payment may become subject to the risk of avoidance under certain circumstances.
Following the nuclear power crisis caused by the Great East Japan earthquake in 2011, the electricity industry has changed drastically. Renewable energy has drawn increasing attention as an alternative energy source. The Japanese government has accelerated this movement by introducing the feed-in tariff in 2012. Although the focus is shifting from photovoltaic to other power sources (such as wind, geothermal and biomass), renewables projects remain one of the highlights of the Japanese project finance market. However, the suspension of operation of nuclear reactors has made the country more dependent on fossil fuels. Thermal power projects are another recent highlight in this field, although the Ministry of Environment has concerns about carbon emission control.
A substantial portion of existing Japanese social infrastructure was constructed during the 1960s and 1970s. To meet the need to renovate and replace these facilities in the coming decades, the Japanese government is facilitating the use of PPP/PFI structures, another trend that market participants are focusing on.
The most notable recent area of Japanese PPP transactions is airport concessions. Concession rights have been granted for some major airports, including Kansai airport, Osaka airport, Fukuoka airport and Shin-chitose (Sapporo) airport.
The PFI Act and the Airport Concession Act are the most relevant pieces of legislation to airport concessions. Under these Acts, a public authority that administers public facilities confers the right to operate the airport facilities on a concessionaire, who is then allowed to charge users fees for using the airport facilities. The ownership of the airport facilities and land is retained by the government.
Since concessions are new in the market, the negotiation and documentation is less standardised. Private parties, together with government authorities, are working to establish new market practice.
Airports are not the only type of facility that can be privatised by the concession method. Tollways and water and sewage systems are hopeful areas, some of which have already been privatised by way of concession.
In general, there are no material regulatory approvals or taxes that are unique to project finance transactions, although specific projects may trigger such requirements (see 8.7 The Acquisition and Export of Natural Resources).
In general, the transaction documents are governed by Japanese law and do not need to be registered or filed with a governmental body.
The Agency for Natural Resources and Energy is the principal government body responsible for the Japanese policy regarding natural resources and energy. In addition to the Basic Act on Energy Policy, several laws and regulations are implemented for each sector of the energy industry.
The most common legal forms of a project company are stock corporations (kabushiki kaisha) and limited liability companies (godo kaisha). A stock corporation is the most general form of corporation, and a limited liability company is a more summary form.
If the lender provides the project company with a commitment line and would like to rely on the exemption under the Commitment Line Act (see 4.3 Usury Laws), the project company cannot be a limited liability company.
There are no material restrictions on foreign investment in a stock corporation or a limited liability company, other than notification under the Foreign Exchange and Foreign Trade Act.
Bank facilities are the major sources of financing for domestic projects.
Mining natural resources such as oil, natural gas and minerals may be subject to a licence requirement under the Mining Act and other relevant regulations. The export of natural resources is not subject to any special restrictions under the Foreign Exchange and Foreign Trade Act.
Under the Foreign Exchange and Foreign Trade Act, a prior notification to the government should be filed with respect to any foreign investment in a Japanese company that is engaged in the operation of certain types of infrastructure, such as electricity generation. There is a 30-day waiting period from the date of the receipt of the notification, which may be shortened to two weeks in the absence of any substantial issues. During this period, the government will review the proposed investment, taking national security, public order and public safety into consideration.
The basic environmental policy of Japan is set out under the Basic Environment Act. There are also various additional environmental, health and safety laws, such as the Air Pollution Control Act, the Water Pollution Control Act, the Soil Contamination Countermeasures Act, the Noise Regulation Act, the Vibration Regulation Act, the Industrial Water Act, the Offensive Odour Control Act, the Waste Management and Public Cleaning Act, and the Environment Impact Assessment Act.
Most of these Acts are administered by the Ministry of Health, Labour and Welfare, and the Ministry of Land, Infrastructure, Transport and Tourism.
General Overview of the Effects of COVID-19 on Japan
The outbreak of COVID-19, which the World Health Organization declared a pandemic on 11 March 2020, has significantly affected the Japanese economy, including its financial markets. The first case of COVID-19 infection in Japan was confirmed on 15 January 2020. Since then, the disease has spread across the country. Despite the countermeasures put in place by the national and local governments of Japan, including the declaration of states of emergency, restrictions on the number of people entering Japan and entreaties for self-isolation, pandemic containment in Japan has only met with limited success as of 31 August 2021.
Monetary Easing Policy of the Bank of Japan
The Bank of Japan (BOJ), the central bank of Japan, has adopted a policy of dramatic monetary easing in recent years to stimulate the economy. This has continued in light of the significant disruptions to the Japanese and global economy as a result of COVID-19. According to the Statement of Monetary Policy published by the BOJ on 16 July 2021, the BOJ has opted to continue with monetary easing. As part of this policy, the following, among other measures, have been adopted:
Recent Trends and Developments in Financial Markets
Real estate finance
Market trend overview
Before the onset of COVID-19, there had been expectations of increased demand in the Japanese real estate market due to anticipated improvements in tourist arrivals in the period leading up to the 2020 Tokyo Olympic Games. In line with these expectations, a large number of offshore investors demonstrated robust appetite for inbound investments in hotels and retail properties across Japan. As a result of the pandemic, however, the Olympic Games had to be postponed and were ultimately held in the absence of spectators. The uncertainty surrounding tourism recovery, in addition to the government’s policy of self-isolation, has adversely affected the cash flow of hotels and retail properties. Office properties have also been affected, as teleworking and decentralization emerged as solutions to cope with the spread of COVID-19. However, there have been recent signs of a robust recovery in the property market, indicated by the greater demand among both onshore and offshore investors with surplus funds, who are looking beyond the pandemic curve. Additionally, continuing demand for logistics properties and data center facilities is expected, driven by the growth in e-commerce and cloud services.
Sale-and-leaseback of owned properties
To secure working capital and improve their financial outlook amid the economic uncertainties ahead, some companies are exploring the “sale-and-leaseback” of the properties they own, such as buildings housing their headquarters. Notably, in September 2021, Dentsu Group Inc announced its execution of an agreement for a sale and leaseback of its headquarters. This transaction, if completed, is expected to mark one of the largest property sales in Japan.
Real estate security tokens
Security token offering (STO), an alternative form of fundraising under which security tokens representing certain rights are offered, have been in the spotlight in Japan.
In July 2021, a securities registration statement (SRS) was filed for the issuance of tokenised beneficiary interests in a trust pursuant to the Financial Instruments and Exchange Act of Japan. According to the SRS, the underlying asset of the relevant trust is a residential property in Tokyo. The tokenised beneficiary interests were underwritten by securities houses and distributed to investors. According to press releases, the offering is the first public offering of security tokens in Japan involving a trust with beneficial interest certificate backed by assets, made possible by co-operation between the relevant real estate company, trust bank and two securities houses, which came together to formulate a viable transaction structure.
Market trend overview
2020 saw the ravaging of several borrowers and their group companies because of the pandemic, as a result of which they had to request for waivers of breach of financial covenants or emergency credit from lenders. In the case of new transactions, the terms of lending (including the financial covenants required by lenders) have temporarily increased in stringency, on top of a rise in interest margin by around 50-100bps as compared to rates in the pre-COVID market. Despite these developments, both domestic and overseas private equity (PE) funds have shown strong continued interest in the investment opportunities in Japan. As a result, the market has largely returned to normal levels.
Latest trends in leveraged buyout transactions
The Ministry of Economy, Trade and Industry of Japan (METI) published a paper entitled “Practical Guidelines for Business Transformations - Toward Changes to Business Portfolios and Organizations” in July 2020. This paper, intended to encourage businesses to embrace business restructuring to achieve sustainable growth, has resulted in an increasing number of divestitures by Japanese conglomerates of their assets or non-core businesses (including divestment of shares in their subsidiaries, both private and public, that operate such non-core businesses) to third parties, such as PE funds. In some of these transactions, Japanese sellers have committed to substantial reinvestments into divested businesses and continuing involvement in the management of those businesses.
From the financing perspective, co-investment structures of this kind present some practical hurdles, such as how certain values can be ascertained in the event of dead-lock situations. However, lenders have recently shown more flexibility when appropriate arrangements can be made to secure their interests, such as ensuring that share pledges and other security interests can be enforced.
Variation in mezzanine financing methods
In Japan, multiple tranche senior loans (with both of amortization features and bullet repayment) are the most typical method by which to finance leveraged acquisitions. Mezzanine financing is also a valid option for sponsors wishing to limit equity contribution amounts. Typically, mezzanine financing is made in the form of subordinated loans or preferred shares (whether convertible or otherwise). Recently, with more sponsors seeking higher leverage, mezzanine loans to the holding companies of borrowers in senior loans have been gaining in popularity. Such holdco mezzanine loans are structurally subordinated to the senior loans, as a result of which no intercreditor agreement is generally required between the senior lenders and the holdco mezzanine lenders.
Market trend overview
The impact of COVID-19 on financing for renewable energy projects has been limited, compared to other types of financing. This is mainly because the pandemic has not had an adverse effect on electricity prices under the Feed-in Tariff system in Japan.
Promotion of offshore wind power projects
The Japanese government intends to expand domestic electricity supply from offshore wind power generation facilities. According to the Vision for Offshore Wind Power Industry (1st) published on 15 December 2020, the Japanese government set the following targets for enhancement of the offshore wind power industry:
To promote offshore wind power projects, the Act on Promoting Utilization of Sea Areas for the Development of Marine Renewable Energy Generation Facilities of Japan (the “Marine Renewable Energy Act”) was passed and came into effect as of 1 April 2019. A summary of the procedures for development of offshore wind power projects in Japan under the Marine Renewable Energy Act is as follows:
As of 31 August 2021, the following sea areas have been designated as Promotion Zones:
As of 31 August 2021, the tender period for each of the above sea areas has expired, and a business operator for the sea area off the shore of Goto City, Nagasaki Prefecture, has been selected. Business operators for the other sea areas indicated above have yet to be selected as of 31 August 2021.
The amount of project financing for offshore wind power projects is expected to increase as the Japanese government continues to encourage the development and expansion of the offshore wind power business and projects in Japan.
In anticipation of the permanent cessation of the JPY-LIBOR benchmark rate after 31 December 2021 (as announced by the UK’s Financial Conduct Authority in 2017 and subsequently confirmed on 5 March 2021), market participants are expected to take certain countermeasures.
In particular, market participants are expected to put in place either a “transition” or “fallback” mechanism for legacy contracts prior to the discontinuation of the LIBOR. “Transition” mechanisms are intended to replace LIBOR with an alternative benchmark rate for the reference rate prior to the permanent discontinuation of LIBOR, and “fallback” mechanisms will involve agreement between contracting parties in advance on the use of a replacement rate following the permanent discontinuation of LIBOR, for existing contracts referencing LIBOR.
For purposes of “fallback” mechanisms, sample fallback provisions have been published to facilitate the introduction of fallback language in contracts for the loan market as follows (both available in Japanese only). In particular:
Additionally, the ISDA’s IBOR Fallbacks Supplement amending the 2006 ISDA Definitions and IBOR Fallbacks Protocol for legacy non-cleared derivative contracts referencing LIBOR and other interbank offered rates (IBORs) took effect on 25 January 2021.
For alternative benchmark rates, three options are available in the JPY market. One is the TIBOR, calculated and published by the JBA TIBOR Administration. Another is the overnight (O/N) risk-free reference rate (RFR) Compounding (Fixing in Arrears) (hereafter "compounding in arrears"), which uses the uncollateralised overnight call rate (TONA). The last option is a term risk-free rate, referred to as TORF (Tokyo Term Risk Free Rate) in Japan. TORF is an interest rate benchmark based on the overnight index swap (OIS) rate, a fixed interest rate exchanged in interest rate swaps (IRS) based on a floating rate calculated using compounding in arrears over the relevant coupon period.
Based on the discussions and deliberations of the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks, TORF is the most preferred option among market participants. TIBOR, for loan products, and compounding in arrears, for bond transactions, also have the support of market participants to some extent although concerns have been raised (eg, with regard to operations, systems and accounting) because the amount of a payment based on compounding in arrears would only be known right before the payment has to be made.
Because of the economic differences between LIBOR and alternative benchmark rates (particularly in the case of TIBOR), market participants have to agree on adjustments to the spread for purposes of reflecting such economic differences.
As of August 2021, discussions are still ongoing amongst market participants on the measures to be taken in response to the discontinuation of LIBOR. In some project financing transactions where the borrower’s payment of LIBOR-based interest have been fixed under interest swap arrangements, lenders have shown preference for a transition to the TIBOR as the alternative benchmark rate (subject to negotiations with the borrower and the swap counterparty on the spread to fill the economic gap between the TIBOR and LIBOR).