Will Japan’s Economic Security Push Trigger a Paradigm Shift in Its Due Diligence Mindset?

Amid growing concerns about Chinese espionage and threats to Japan’s supply chains laid bare by geopolitical tensions and the COVID-19 pandemic, Japanese Prime Minister Fumio Kishida has made economic security a signature policy item ahead of upper house parliamentary elections in July.

In a move that is likely to appeal to voters in a country where distrust of historical rival China has reached new heights, the Kishida administration has announced that it will submit a bill to the Diet, Japan’s parliament, before the end of its current session in June.

Both the government and Japan’s servile mainstream media have refrained from naming China as the target of the legislation, but it is clearly designed to reduce dependence on imports from the world’s second-largest economy and secure Japanese infrastructure assets and technology.

In late January, Akira Amari, a former secretary-general of Kishida’s governing Liberal Democratic Party (LDP) and one of the most vocal proponents of the bill, left few in doubt that China was its principal focus: “The COVID-19 pandemic revealed Japan’s heavy reliance on Chinese-made masks. Without having to fire a single missile, China could bring Japan to its knees just by blocking exports of these and other medical supplies,” he said.

The bill aims to safeguard Japan’s supply chains to ensure that flows of critical goods such as semiconductors, medical supplies, and rare earths are not held hostage to geopolitical tensions. Companies involved in critical infrastructure, such as electricity, gas, logistics, communications, and finance, must disclose their suppliers for screening. The proposed legislation also prohibits the disclosure of sensitive technology, particularly that pertaining to the country’s nuclear and defense industries, and seeks to promote public-private cooperation on advanced technologies.

According to government sources, enforcement will be the remit of a new unit within the Cabinet Office, akin to the Committee on Foreign Investment in the United States — the inter-agency body that reviews the national security implications of foreign investment in the US.

Fearful of recriminations against Japan’s extensive investments in China and the competitive disadvantages that Japanese companies could face, business groups have publicly voiced their concerns and sought to water down the proposed penalties for non-compliance; which are, at present, a relatively anemic fine of up to JPY 1 million — approximately USD 870,000 — and a maximum prison sentence of two years. Behind the scenes, the pro-China lobby within the LDP also appears to have mounted its own offensive. One of the principal architects of the bill, Toshihiko Fujii, a councilor in the Cabinet Office, was forced out of his post on February 8 after a weekly tabloid magazine claimed that he had engaged in extramarital affairs. It had all the hallmarks of political hit job.

Regardless of attempts to stymie or dilute the bill’s provisions, political observers believe it is likely to come into force next year. Ahead of time, Japanese multinationals are scrambling to draw up policies to ensure compliance with the reporting obligations and assemble in-house ‘economic security’ teams.

If experience is any indicator, prescriptive policies alone will be insufficient without a change to Japan Inc.’s current mindset. In a relatively recent nod to the long-but-distant arm of Washington’s FCPA enforcers, many Japanese companies now mandate anti-corruption due diligence ahead of a potential overseas investment or on-boarding of a new supplier, distributor, or agent. But all too often this is treated as an administrative tick-the-box exercise rather than an opportunity to properly evaluate the reputational, political, legal, or other risks associated with the transaction or business relationship. Whether the proposed economic security legislation results in a paradigm shift in perceptions towards the value of conducting meaningful investigative due diligence remains to be seen. Japanese companies have been warned, however. This time the enforcers are closer to home and the reputational fallout of compromising national security will be far greater than that arising from corruption or price-fixing charges in some far-off land.