Japan has given itself the chance to establish a joint venture arrangement between local and foreign firms that could be the envy of the region. But will it be taken? Stephen Mulrenan reports from Tokyo
Alarming fact
Bengoshi Suzuki Hitoshi recently published the novel Judicial Occupation. Masahisa Ikeda, managing partner of Shearman & Sterling, says: "The book treats the international firms as evil and, in the past few months, has been attracting quite a lot of attention."
Japan's biggest firms (stats taken from the ALB50 survey, February 2002)
Rank Firm Total Partners Others
- Nagashima Ohno & Tsunematsu 170 41 129
- Mori Hamada & Matsumoto 163 55 108
- Nishimura & Partners 135 31 104
- Mitsui Yasuda Wani & Maeda 84 14 70
- Anderson Mori 80 30 50
1 March 2003
Bills drafted by the Office for Promotion of Justice System Reform to be submitted to ordinary Diet session
Amendment to the Special Measures Law concerning the Handling of Legal Business by Foreign Lawyers
This amendment is intended to abolish the provision prohibiting the employment of bengoshi by registered foreign lawyers (gaikokuho-jimu-bengoshi (GJB)) and liberalise joint legal business between GJBs and bengoshi by abolishing the current specific joint enterprise.
Legal reform
It is more than 50 years since the establishment of the constitution of Japan. The troubled nation's experiences during the past decade have forced it to reflect on its history and re-evaluate its strategy. Symbolic of such reform is the proposed transformation of the country's legal system.
An efficient and fair legal system and competent legal services are vital when attracting foreign investment. So it should come as little surprise that a reformist prime minister should champion a cause to establish just such a system.
Prime minister Junichiro Koizumi, with his cabinet ministers, is heading a special commission overseeing the judicial reform initiative, or, in the words of the Judicial Reform Council, ensuring the legal system "penetrates the entire state and all of society and becomes alive in the people's daily life".
Central to achieving such an outcome is the need to develop a much larger pool of lawyers and judges with the necessary knowledge and experience. Practitioners confirm that Tokyo is awash with legal work but the shortage of lawyers is handicapping the economy.
Eric Sedlak, a partner at Squire Sanders & Dempsey, says: "There has been pressure on the larger firms with the smaller ones complaining that they are sucking up all the law graduates who pass the national bar examination each year."
The Judicial Reform Council, an advisory body to the justice minister, was established in July 1999 to review the country's century-old legal system and consider ways of making it user-friendly. In June 2001, the council issued its final report in which it stipulated a number of recommendations.
Among these was a proposal to triple the number of Japanese lawyers who pass the national bar examination to 3000 a year by 2010, with the aim of expanding the number of practising judges, prosecutors and lawyers to 50,000 by 2018.
To do this, and in an effort not to flood the market with under-qualified bengoshi, the council proposed setting up US-style postgraduate law schools, offering specialised education. This law school system will be introduced in 2004, with a new bar exam likely to be in place by the following year.
The Japanese government has committed itself to implementing these reforms within three years. But achieving such reforms requires the full support of the legal community as well as political will. With one foreign lawyer describing efforts to triple the number of successful applicants to the bar per year to 3000 as "pretty insignificant", this is by no means guaranteed.
What is a synthetic securitisation?
Synthetic securitisations combine two key capital market tools: the credit derivative and the conventional asset securitisation. Unlike a conventional securitisation where the originator sells the securitised assets usually to an offshore company designated exclusively for such a purpose (a special purpose vehicle or SPV), a synthetic securitisation does not involve the transfer of assets. Instead, it involves the purchase of credit-default protection to protect the owner of the assets (the bank) from the risk of loss on the assets. Such protection is achieved by the bank entering into a credit-default swap agreement with a credit-default protection provider.
Source: Balbir Bindra, Sidley Austin Brown & Wood, Hong Kong
Leader of the pack
Much anticipated legislation, passed by the Diet in July 2003, lifted restrictions on international firms operating in Japan and provided the country with an opportunity to lead the region's legal development. Reporting from Tokyo, Stephen Mulrenan finds out if it will be taken
On 26 November, a trade war between the US and other steel-producing countries escalated that little bit further when Japan followed the European Union in notifying the World Trade Organisation (WTO) that it would impose retaliatory tariffs on its high-profile trading partner.
Although such retaliatory action was eventually not required, with the US retreating on a policy that violated global trading rules, the incident is indicative of the somewhat uneasy relationship Japan enjoys with the world's only superpower. "Japan's decision [to retaliate] was significant," says Eric Sedlak of Squire Sanders & Dempsey, "because the Japanese are very considered over the US relationship."
And this has been at the forefront of the minds of the populace in recent weeks following the killing of two Japanese diplomats in Iraq. The deaths have placed prime minister Junichiro Koizumi in an increasingly difficult position, as they follow his pledge to deploy noncombat troops to help rebuild the stricken Middle Eastern nation.
The loudest voice of disapproval has come from Koizumi's political foes in the Democratic Party, which gained a significant number of seats during the country's recent national elections. They argue that such a pledge inevitably makes Japan more vulnerable to terrorist attack, and cite the killings as evidence of this. And recent preparations by the City of Tokyo for a possible biological attack illustrate that such concerns go well beyond mere political gamesmanship.
Writing in one of Japan's leading national dailies, The Asahi Shimbun, associate professor of political science at the University of California Steven Vogel recently voiced the opinion that Japan should not feel obligated to help with postwar peacekeeping in Iraq, because the US did not receive approval for its actions from the UN. But he emphasised that Japan still had an important role to play: "Japan can still serve as an example to the world - as an economic power that is not a military power. It can do so by committing itself to peaceful diplomacy: expanding aid to poor countries, taking the lead on global problems, strengthening international institutions, and negotiating peaceful solutions to international conflicts."
Japan's 'moment of truth'
And it is not only in the political arena that Japan has the opportunity to lead the way: it is the contention of Michael Hancock of Lovells that the Japanese legal system now has the opportunity to serve as an example to, if not the world, certainly the region.
Upon assuming the position of president of the Federation of Japanese Bar Associations (Nichibenren) on 1 April 2002, Tohru Motobayash described 2003 as "our moment of truth". And in some senses it was: in July last year the Diet passed progressive legislation that, when implemented, will lift restrictions on the form of association through which Japanese lawyers (bengoshi) and foreign (gaiben) lawyers may choose to operate. Masahisa Ikeda, managing partner of Shearman & Sterling, says of the development: "This legislation is very welcome and about time. Although associations are in practice very hard to put together, we will look into this as a possible business model."
Under the changes, the country's joint venture structure has been replaced, with registered foreign lawyers free to forge local partnerships with bengoshi under certain conditions. Stipulations include the use of 'gaikokuho kyodo jigyo' or 'Legal Professional Corporation' in the partnership title, and the sharing of office premises. The new law will be phased in over a two-year period, with practitioners citing early 2005 as the likely target. European commissioner Frits Bolkenstein has asked Japan's minister of justice, Mayumi Moriyama, to request that foreign lawyers be involved in its implementation.
One of the most outspoken critics of Japan's restrictive legal system has been Robert Grondine at White & Case. He says of the new legislation: "It's very shortsighted to say, hoorah ... we've won. I don't look at it that way. It's not a 'we win-they lose' situation. It's a rapidly evolving global market." He adds: "Even Japan recognises it is not very healthy. Every component of Japan's judicial system has had under-investment for many years and the weakness of the Japanese judicial system was creating a distinct disadvantage for Japanese businesses. But very, very quickly for Japan - three to four years - they had a consensus that rapid change was needed."
As chair of the European Business Council's legal services committee, which has lobbied hard for reform and which issued a white paper on developments on 13 November, Hancock is excited by the new law and believes it could set a precedent for neighbours such as China, Korea, Malaysia and Singapore. "This is going to be revolutionary for Japan and it's going to be revolutionary for Asia," he says. "It is going to rip open the market across Asia and, unusually, Japan is going to lead the trend. Singapore has something similar to what Japan is about to get rid of and Singapore is very anxious to be at the cutting edge of legal technology."
James Lawden of Freshfields agrees: "Japan may lead the way with this and Korea is keeping an eye on developments in Japan. It could be a useful precedent." But others are not so sure. A partner at an international law firm says: "Certainly the Korean Bar Association will be aware of and consider the changes to be made in Japan, but whether they will follow suit is uncertain. For the liberalisation of the Korean legal market to take place, the existing laws will need to be amended through the National Assembly. Next year being an election year for the National Assembly members makes it even more difficult to predict."
And in China, where Ministry of Justice (MOJ) rules expressly prohibit foreign firms from providing PRC law advice or from entering into any kind of relationship with PRC lawyers or law firms, practitioners remain unconvinced. Robert Lewis of Lovells in Beijing says: "I think the MOJ is not likely to be influenced immediately by the pending developments in Japan. Chinese officials with whom I have spoken in the past have uniformly taken the position that China will move much more slowly than other jurisdictions in this regard because the Chinese bar is at a much less mature stage of development."
He adds: "The MOJ is unlikely to consider permitting foreign firms to hire local lawyers for fear that this would undermine the development of local firms as the top practitioners move to the foreign firms. I do not anticipate any significant changes for at least five years, and then the logical step would be to permit some joint ventures."
John Jiang, a partner at EastBright Law Firm, agrees. He says: "I don't think the latest development in Japan will have any significant influence on the development of China's regulatory regime governing foreign lawyers. The Chinese bar associations at both the national and local levels are currently focusing their effort on bringing up the professional standards and competency of their members, so that they will be in a better position to compete with multinational law firms in the PRC legal services market."
Ongoing problems
But if Japan is to lead by example in the region, it will have to iron out some ongoing problems with its latest legislative development, A point recognised in the EBC white paper: "Inexplicably ... and contrary to the forward looking spirit of the new law, certain Nichibenren regulations will have to be satisfied for bengoshi and gaiben to share the same business name." These regulations include:
· A bengoshi employed by a gaiben would not be able to give advice in the name of the foreign firm unless there is a bengoshi partner in such firm
· The potential benefits of fairly recent legislation enabling bengoshi to incorporate their law offices remain limited only to bengoshi
· Only one year of experience gained as a foreign-admitted lawyer working in Japan may be credited towards the three-year pre-requisite for qualification as a gaiben.
There is concern that these regulations could limit the effectiveness of the new legislation. Squire Sanders' Sedlak says: "The new legislation went 75-80% the way we wanted, but our concern is that the regulations could take it backwards." And some of the other long-standing residents of Tokyo have also only cautiously welcomed the legislation. Steve Lewis, managing partner of Herbert Smith's Tokyo office, described the development as positive but warned of a potential "sting in the tail". He says: "The implementation will be down to the Nichibenren, which is generally against liberalisation, so who knows what the sting in the tail will be. My guess is that it will be something financial - such as partnerships in Japan must be ring-fenced from their headquarters in, for example, London and New York, on a financial basis to ensure independence. And that would be unworkable for most international law firms."
White & Case's Grondine is even more forthright, claiming that as ever with Japan, it could be a case of two steps forward, one step back. "They want a lot of praise in Japan for taking baby steps when the rest of the world is sprinting ahead," he says. "[The Nichibenren] doesn't accept the march of reality. They love the word 'ultimately', and I ask them, does that mean when you're dead?"
Keeping a look out
Despite the reservations about the new legislation, it has forced firms to look over their shoulders at what their rivals are doing. Freshfields Law Office is said to be one of the better joint ventures, but partner James Lawden says his firm cannot afford to stand still. "There are others around that have good operations and it's going to be very difficult if someone does something big," he says. "One would then have to review one's own strategy."
If market rumours are to be believed, there is a good deal of dialogue at the moment between the UK magic circle firms in particular and the preeminent Japanese firms on the prospect of linking together. Fumitaka Eshima, managing director and head of legal at UBS, says he is sure some of the UK firms are seriously considering this. "If one [a tie-up] were to happen, I suspect it will be with one of them," he says. "There must be a sense of competition among the major international firms in Tokyo. If one were to do a groundbreaking deal, I'm sure that would put great pressure on the others to do something similar."
A&O has, for some time, been the subject of market rumours linking it with Big Four firm Anderson Mori - although that might have more to do with being housed under the same roof, at Tokyo's relatively new and exclusive Izumi Garden Tower building. Leading newspaper The Nikkei even published an article on this in which one lawyer interviewed described Anderson Mori as the "potentially vulnerable" one out of Japan's Big Four firms, while another said the firm was "struggling to keep its position in the Japanese legal market".
But A&O's Paul Cluley does not believe that tie-ups will be inevitable following implementation of the new regulations. "We'd be surprised if, the moment it's through, there's a glut of unions. Dialogue is a long-term game. Just because it's possible doesn't mean it's right." He adds: "If we're going to have a Japanese tie-up and generate synergies, you have to be looking at a firm with the right resources. The market has evolved and you now need a much broader scope to your venture."
Perhaps more likely is the rumour linking Linklaters with leading finance firm Mitsui Yasuda Wani & Maeda. Howard Goldwasser, partner in Orrick's Tokyo office, says: "The larger Japanese firms are far more reluctant to give up their independence. But this is a logical pairing and Mitsui might be more willing to sacrifice autonomy."
Linklaters' David Deck says he believes a relaxation in the regulations will bring about a change in the legal landscape, but declined to reveal his own firm's plans. "We're always looking at Japanese lawyers and certainly have 2005 in mind," he says. "We're committed to doing something with Japanese lawyers and have very ambitious plans. But I really can't give you any specifics at this time." He adds: "We're all aware of the rumours that have come up from time to time and have taken the position not to comment on them."
With everybody watching everybody, Lovells' Tim Lester says it is not surprising firms are being coy. "People are going to be keeping their cards pretty close to their chest on this because there are seriously limited opportunities," he says. "But within a two to three year period after the legislation is in place - possibly less - if you do not have local law capability, you're out of this market."
Orrick's Goldwasser agrees. "There is a real sense that things are going to change dramatically and people are really now positioning themselves for this. The key to staying successful as a foreign firm in Tokyo is to practice Japanese law. It's only a matter of time before the client moves towards the one-stop-shop model."
However, Philip Quirk, managing director and head of the law division at Morgan Stanley, is more moderate. "If you get excellent people combining together, that's always going to be very powerful. But would I walk away from a firm that didn't have local law capability at this moment in Japan? No, I wouldn't. Is it convenient to have it? Yes it is."
Getting on with business
While the legal market waits in anticipation for the implementation of the regulations, most practitioners agree that clients are becoming far more sophisticated in the way they outsource work and it is also for this reason that both the domestic and international firms are considering unions. Bill Bruinooge, partner and head of Denton Wilde Sapte's Tokyo office, says: "Ten years ago, it was much more relationship driven. Now, for example, banks are very conscious of using the best firm for what they need to get done."
And, while the current joint law enterprise system is cumbersome compared with other jurisdictions, practices cannot afford to let it prevent them from getting on with business. Morgan Stanley's Quirk says: "I believe in free, unfettered, but regulated markets. People should be able to combine together. Japanese lawyers should be able to go into partnership with Western lawyers. The association goes part of the way but not far enough. The position in Japan is just not acceptable but we just cannot allow that to stop us doing business."
But Quirk isn't ruling out the possibility that the new legislation will revolutionise the way Morgan Stanley does business. He says it would be unusual if the firm made a decision to depart from a usual preferred counsel on the basis that another firm has local law capacity, "but that may change if the local capacity is first class."
You can bank on it
The banking sector holds the key to Japan's economic revival. And although the Takenaka Plan, the country's initiative to revive its financial sector, has just claimed its latest scalp, practitioners say it provides little indication of prospects for the coming year
Based in Tochigi prefecture north of Tokyo, Ashikaga Bank - Japan's 10th largest - is responsible for 45% of all lending in the prefecture, holding 40% of local residents' deposits. But its size and close ties to the community could not detract from the awful state of its finances: despite owning assets worth ¥5.3tn (US$48bn), a special inspection by the country's financial watchdog, the Financial Services Agency (FSA), recently revealed that the bank had far more problem loans than had previously been declared.
Financial results for the April-September 2003 period showed that its liabilities exceeded its assets by ¥102.3bn (US$953m) and that it had been hopelessly insolvent since March. On Saturday 29 November, Japanese prime minister Junichiro Koizumi prepared for his government to take control of Ashikaga Financial Group Inc, bailing it out with an injection of more than ¥1tn (US$9bn).
The government's decision to temporarily nationalise the bank - it will eventually sell its shares - under article 102 of the Deposit Insurance Law sparked fierce debate over whether this evidenced a step forward in the country's so-called Takenaka Plan (named after top financial regulator Heizo Takenaka), its initiative to revive its financial sector by pressuring major banks to clean up their bad loans and tidy up their balance sheets.
On one side there are those who say that the government's decision to temporarily nationalise Ashikaga say it is a shift from its move earlier in the year to bail out Resona Holdings to the tune of ¥2tn (US$18bn) of public money (shareholders will lose their investments in Ashikaga, unlike in Resona). The argument goes that despite Ashikaga being the recipient of public funds in the past - for example ¥135bn (US$1.26bn) in 1998/99 - the government has finally recognised the futility of continually propping up ailing banks. And the country's non-performing loan (NPL) epidemic in its banking system is finally headed for a resolution.
In the other camp, detractors argue that the government's involvement is yet another example of its inability to let banks fail. "There are still a lot of large companies that need to be liquidated," says Katsu Sengoku of Nishimura & Partners. Those on this side say the focus of regulators on the country's smaller banks is distracting attention away from the larger ones, giving them little incentive to clean bad loans off their balance sheets. And the electorate voiced its concerns in the country's general election in November, when it returned the Liberal Democratic Party (LDP) to power but with a reduced majority - due in no small part to its disappointment over the watering down of the proposed shake up of the banking industry.
A brighter future?
On Tuesday 2 December, Japan's major banks released their financial results for the first half of the fiscal year ending in September [see table]. Despite concerns over their NPLs, the results were better than expected. Four of the top banks - Mizuho Financial Group, Sumitomo Mitsui Financial Group, Mitsubishi Tokyo Financial Group and UFJ Group - together posted net profit of ¥880.6bn (US$8.19bn).
But, perhaps more significantly, the results revealed they had all tackled, to a greater or lesser extent, their respective NPL problems. Outstanding bad loans fell 13.5% from March, down to ¥18tn (US$168bn). Mitsubishi Tokyo Financial Group even managed to meet FSA requirements to halve its NPLs a year and a half ahead of schedule.
Key to their success, say commentators, has been their willingness to seek innovative ways to restore themselves to a position of financial well-being. Ashursts' managing partner John McClenahan says: "Japanese banks used to think it was shameful to sell loans." No longer. For example, banks are increasingly using synthetic securitisation to improve capital ratios and manage credit risk. In March 2003, UFJ Bank followed in the footsteps of Mizuho Corporate Bank with a jumbo synthetic collateralised loan obligation (CLO). The CLO transaction was in respect of loans of ¥1tn (US$9bn) and three of the four firms that acted on the Mizuho deal were also involved on the UFJ transaction: Allen & Overy, Nishimura & Partners and Maples and Calder.
To deal with the banks' newfound enthusiasm for new methods to improve their capital ratios, Allen & Overy expanded its international capital markets (ICM) practice in Tokyo in May 2003 by relocating newly promoted partner Paul Cluley from its London office. Cluley's structured finance practice covers, among other things, repackagings, collateral debt obligation (CDO) and CLO transactions, and retail offerings of structured finance instruments. Cluley says: "In the last 18 months there has been a big change in the importance of structured finance work. It will take time for people's appetite to grow, but long term you can see how it's going to go." Latham & Watkins' managing partner David Shapiro agrees. "There has been a change in where people are looking to raise the money," he says.
Cluley says the trend in 2003 has been towards more managed deals, and with CDOs and CLOs being mostly synthetic the Asia-Pacific region is now following Europe, which in turn followed the US. Evidence of this is the relocation of experience, principally by the UK 'magic circle' firms, to Tokyo from London. Howard Goldwasser, partner in Orrick's Tokyo office, says: "They are transferring the technology from London. Asia is very much in catch-up mode."
In March, Lovells advised on Japan's first managed synthetic CDO, acting for lead manager and key client BNP Paribas in Tokyo and London. Caymans company Full Moon Finance issued ¥16bn (US$149m) of secured notes, rated AAA to BBB by Japanese rating agency Rating and Investment Information Inc, selling ¥16bn of mezzanine credit protection to BNP Paribas on a ¥140bn (US$1.2bn) basket of 70 Japanese Reference Entities. The transaction was secured on Japanese Government Bonds. Capital markets partner Tim Lester led the Lovells team in Tokyo. He said: "The last 18 months have seen significant growth in the use of synthetic structures in the Japanese market. The deal has taken the market a substantial step forward, introducing a managed product for investors."
Revitalisation
The legal practice areas of bankruptcy and mergers and acquisitions have also experienced recent growth, as a result of the need to rationalise failed Japanese companies. "A substantial proportion of our practice is in these areas," says Fumio Koma, name partner at Asahi Koma Law Offices. And Andrew Thorson of Dorsey & Whitney says: "We've also tried to market ourselves in these areas. Bankruptcy work is a cash cow for Japanese firms. It's almost a factory." It certainly produces enough work to persuade Big Four firm Nishimura & Partners to tie up with bankruptcy boutique Tokiwa Sogo Law Offices.
Key to nurturing the revitalisation process is the injection of foreign funds. "There are companies in Tokyo that would be more profitable with increased investment," says Squire Sanders' Eric Sedlak. While the popular local press has done its best in recent times to stoke fears of foreign banking vultures circling over distressed Japanese assets, there is now renewed interest in Japan on the part of foreign investors. Latham & Watkins' Shapiro says: "Over the next few years, we will see an increase in inbound investment activity and that's where we're trying to position ourselves."
In addition to the Bank of Tokyo Mitsubishi, several foreign investment funds are considering bidding for Ashikaga Bank to gain control of its strong operational base. One of those is US investment fund Lone Star, which has a track record to speak of having purchased Tokyo Sowa Bank and renamed it Tokyo Star Bank. Another is US private equity fund Ripplewood Group, which bought the failed Long-Term Credit Bank of Japan in 2000. And it was Ripplewood that made the headlines in 2003 with its US$2.2bn purchase of Japan Telecom from the UK's Vodafone Group [see deal mechanics on page 10].
The purchase of Vodafone's fixed-line business in Japan was the largest-ever leveraged buyout in Japan and the country's largest-ever acquisition financing, with Ripplewood funding the deal with around 80% debt - ¥200bn (US$1.79bn) - through a consortium of 11 banks. Together with local firm Mitsui Yasuda Wani & Maeda, Clifford Chance advised the banks on the transaction. It completed a good year for the UK firm, which also acted on behalf of a 13-strong consortium of lenders on Japan's largest ever leveraged financing earlier in the year - Jupiter Telecommunications' ¥140bn (US$1.2bn) secured financing. "We're hopeful we've created a good position for ourselves," says CC managing partner Robert Burley.
The financing by Jupiter, Japan's largest broadband and cable service provider, was on a much larger scale than previous leveraged financings in Japan. And unlike previous domestic financings which had relied solely on Japanese financial institutions, the Jupiter deal saw a diverse group of Japanese and foreign financial institutions involved in the financing agreements. Latham & Watkins represented Jupiter. Shapiro says: "It was a domestic project financing that had never really been done before." It also proved to be a model for the Japan Telecom leveraged buyout.
Practitioners say they are also targeting an expected influx of privatisation-related work, with the state of government budget deficits forcing the government to sell off assets like the highways and tolls, railways and tobacco.
In a country where the banking system plays a far larger role than in the West - where the majority of corporate borrowing is bank sourced - the future of the Japanese economy is tied very closely with the fate of the country's major banks. With foreign investors rediscovering Japan and the country's leading banks seemingly heading in the right direction, practitioners are hoping for an upturn in fortunes. Latham & Watkins' Shapiro perhaps sums up the general mood: "I'm guardedly optimistic," he says.