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Japan-UK free trade agreement and Japan Inc M&A

23 November 2020. Published by Nigel Collins, Partner, Head of Japan Desk

Japan and the UK signed a post-Brexit bilateral free trade agreement on 23 October 2020 with an implementation date of 1 January 2021. This ensures continuity in trade and investment beyond the end of the UK's transition period.

British International Trade Secretary, Liz Truss said that the U.K. expects to secure "£15 billion pounds of additional trade" with Japan.

Politically and commercially this is an important deal for the UK and strengthens our relationship with the world's third-largest economy. The agreement goes beyond the benefits of the existing Japan-EU trade agreement in areas like digital and data. It is also a crucial step towards the UK joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), one of the world's largest free trade areas covering 11 Pacific nations, including Japan and Australia and accounting for circa 13% of the global economy. Initial discussions have begun for the UK's accession to the CPTPP.

The new deal has been largely welcomed by Japanese companies, although concern remains whether the UK will reach a free trade agreement with the EU by the end of the transition period. Historically, many Japanese companies expanded into Europe using the UK as its base, and without such a deal, Japanese-owned European businesses will be disrupted. 

Japan's Foreign Minister, Toshimitsu Motegi, said, "It is of paramount importance that the supply chain between the United Kingdom and the European Union is maintained even after the UK's withdrawal from the EU…Japan has high hopes that an agreement is reached soon on the negotiations between the UK and the EU on their future partnership".

The new deal removes tariffs on Japanese cars in stages to zero in 2026, which is the same as in the existing Japan-EU agreement, while the UK will immediately scrap tariffs on railway cars and auto parts. Japanese tariffs on British farm products are kept at the same level as under the agreement with the EU. Interestingly, rules on e-commerce and financial services are more ambitious than the Japan-EU agreement, including the prohibition on governments requesting businesses to disclose algorithms used in artificial intelligence technology and encryption data.

However, there was a missed opportunity by not agreeing a policy around investment. This may simply have been down to each side being in a hurry to get this agreement in place prior to the end of the transition period. The UK has been a key place of investment by many Japanese corporates and a European gateway since the 1980s and this is expected to continue (see below). 

As noted in Morita-Jaeger (2020), the UK Government could have shown a strong commitment to Japanese investment by including a comprehensive investment chapter encompassing investment protection and dispute settlement. Further investment liberalisation is no longer a contentious issue for the Japan-UK investment relationship since investment policy environments in both Japan and the UK are already quite liberal, and Japan and the EU agreed to negotiate a bilateral investment treaty but have not yet reached agreement. The UK could have taken a lead in this respect. 

Japan has also just signed the massive Regional Comprehensive Economic Partnership (RECP) trading agreement with China and the 10 members of ASEAN on 15 November covering nearly a third of the global economy, closing out eight years of tough negotiations. 

Japan is well placed with its new trading arrangements, and RCEP is being seen by some commentators as a driving force for a greater focus on relationships and opportunities across Asia. So, will this put a dampener on the role of Japan/Europe M&A as we move out of the pandemic? 

Is Japan Inc ready?

Japanese businesses are well placed to come out of the current Covid-19 crisis in good shape and with cash to spend on their much-needed expansion. It is well-known these days that Japan Inc has a declining birth rate, ageing population, flat domestic growth, low interest rates and a need to expand beyond its borders to offset the tough challenge of growing organically. It has also experienced a lower level of shareholder pressure over the years and these conditions have contributed to a swelling of cash reserves. US$4.8tn according to corporate filings. The need, appetite and cash are available. 

In addition, there is, and has been for many years, a push by the Japanese Government and major banks to continue the expansion of Japanese business abroad. Europe, with its abundance of businesses, historic brands, new technology and a sophisticated M&A market is very likely to remain an attractive hunting ground for acquisition hungry Japanese companies. On the whole, Japan Inc is seen as a good acquirer in that there is little or no stripping of assets or repatriation of profits, rather an investment in building an ecosystem or industry. This will stand them in good stead as FDI restrictions are only going to become increasingly restrictive over time. 

Investment opportunities in Europe?

During the pandemic many European businesses have taken on more debt to survive the terrible impact this disease has had on their businesses. For some, this will create a need for investment, partnering or sale of businesses. Others may fall into insolvency, although Japan Inc is generally not keen on acquiring a failing business and turning it around. Japan Inc will be looking for businesses that have weathered the pandemic well, even if they are now more highly leveraged. The weakness in the pound makes them an even more attractive target. 
In the coming years we will also see more disposals by Japan Inc. This is a relatively new trend as they become more comfortable with disposing of non-core or underperforming businesses. Historically, they would hold on to businesses and prop them up with intra-group loans rather than closing them down or selling them off. This is an aspect of Japanese corporate culture that is changing, and we have advised on an increasing number of disposals over the last couple of years. The pandemic will have sharpened the focus and scrutiny on some of these businesses, and I understand from banking and legal contacts in Japan that the number of inquiries by Japan Inc thinking about disposing of businesses is on the increase. 

Which sectors will be hot?

Japan Inc's business interests are so wide that all sectors will experience activity from the manufacturing of bespoke widgets through the acquisition of heritage brands and investment in cutting edge new technology.

Industrials still account for most of the current activity along with Healthcare, IT & Software and Consumer sectors. The need to decarbonise industry is another sector that is going to see a tremendous amount of activity by Japan Inc over the coming years. Japan is looking to position itself as a leader in the decarbonisation of industry. We can expect a flow of investment into green hydrogen, carbon capture, battery storage, fuel cells and other clean energy related projects across Europe. Both at the large-scale power plant level and investment into early stage new technology. 

Japan Inc is very much set to play an important role in driving post Covid-19 M&A and Europe remains a very attractive location.