Japan's strategic reforms have sparked record foreign investment and a Nikkei 225 surge, as cost-conscious management and market-friendly policies transform the country into an attractive global investment hub.

Foreign ownership of Japanese stocks climbed to a record last year after significant reforms in the country’s capital markets that has led to record foreign investment and a surge in the Nikkei 225 index.

The reforms were widespread and touched on various aspects of the country’s financial landscape, including changes to the Tokyo Stock Exchange (TSE) to promote cost-conscious management, revisions to tender offers and shareholding reporting systems, efforts to eliminate cross-shareholdings, and government support for foreign fund managers, all aimed at making Japanese capital markets more appealing to investors.

These have all been part of a concerted push to make Japan a leading asset management centre, say Akio Kawamura and Yukihito Machida, partners at Atsumi & Sakai. The push has largely been successful, with 31.8 percent of total stock exchange value owned by foreign investors in the fiscal year that ended in March 2024, the highest since 1970.

One of the most impactful of the many reforms came from the TSE on March 31 last year, when the exchange moved to require that all listed companies on the Prime and Standard markets take “action to implement management that is conscious of cost of capital and stock price.” This initiative encouraged companies to disclose a variety of information, including their policies, targets and any specific initiatives for improvement.

“The trend to implement management that is conscious of cost of capital is becoming more prevalent,” say Kawamura and Machida.

This push for transparency has been complemented by other regulators. For instance, Japan’s Ministry of Economy, Trade and Industry (METI)’s “Guidelines for Corporate Takeovers, published in August 2023. The guidelines set out a code of conduct for M&As, stressing that acquisition of a corporation that enhances corporate value and secures shareholders’ interest would still be desirable, even if target companies do not approve. The guidelines also encouraged directors to seriously consider what would be the best approach to enhance corporate value, opening the door to dynamic market activity.

“Such momentum encourages companies to reform by their own initiative,” added Kawamura and Machida.

The combined effects of all these initiatives have been complex, drawing strong interest from global investors, many of whom have been frustrated with tactics aimed at blocking takeovers and entrenching management.

The shift in corporate culture, coupled with factors like the weak yen and low interest rates, have made the Japanese market increasingly attractive to foreign investors, with many entering the market in anticipation of positive effects arising from the new Nippon Individual Savings Accounts (NISA) program.

The program, which offers an unlimited tax-saving period and allows Japanese retail investors to shift money into foreign equities, was designed to encourage Japanese households to move cash and savings into stocks and mutual funds.

“An increased number of foreign investors are coming to the Japanese market in anticipation of (NISA’s) positive effects,” the partners says.

About 12 trillion yen (US$74.3 billion) will flow into foreign equity investments through the new NISA in 2024, according to a new Barclays Securities estimate, bringing knock-on impacts on foreign investment.

Other regulatory changes have also played a crucial role. In May this year, Japan’s National Diet passed amendments to the Financial Instruments and Exchange Act, revising both its Tender Offer System and the Large Shareholding Reporting System.

The changes were driven by "the growing importance of constructive dialogue between companies and investors in Japan's capital markets,” say Kawamura and Machida. “This is a part of efforts to promote constructive dialogue between companies and investors to enhance corporate value over the medium to long term.”

Changes to the Financial Instruments and Exchange Act has also allowed companies to outsource their middle and back-office operations, which have not been common in the country. Regulators have also instituted a system to support foreign fund managers in obtaining necessary permits and licenses to do business in Japan.

“Specific measures to implement these policies are expected to be further discussed in the future,” say Kawamura and Machida.