Japan's traditional restrictions on ownership tended to make dealing with its businesses relatively difficult for foreign investors and even for its own domestic players. Now that the market is opening up after decades of sluggish growth, it is more dynamic. 

A new set of corporate governance rules to make Japan’s equity market more efficient and liquid will galvanize the Asian country’s stock market, Naoya Oshikubo, senior economist at SuMi TRUST, said.

New rules for the Tokyo Stock Exchange, slated to take effect from 4 April, will streamline the market and help eliminate “cross-shareholdings,” which in the past have stymied boardroom shakeups and improvements for firms' performance, Oshikubo said in a note. 

“The changes to the Tokyo Stock Exchange (TES) structure, coupled with the revision of the corporate governance code in Japan, are set to make significant improvements to the governance of Japanese companies, which were in a need of a boost to attract more foreign investors. Stricter governance standards and their impact on stock indices will hopefully revitalise the markets and, as a result, we should see more foreign investors invest in Japanese companies,” the economist said.

Corporate governance reform has been a bone of contention in Japan for years. Its traditional restrictions on ownership tended to make the country’s businesses relatively difficult for foreign investors. Opening up the market is seen as way in which the country, emerging from decades of sluggish growth, can become more dynamic. 

“By categorising companies into three divisions - Prime Market, Standard Market and Growth Market - the new TES structure aims to create a more attractive market for investors,” Oshikubo said. “Many large companies will choose to go public on the Prime Market which will have a higher market capitalisation (10 billion yen or more and a tradable stock ratio of 35 per cent or more) and liquidity, and global institutional investors will be allowed to invest. From a liquidity perspective, we expect the reduction of strategically held shares to continue.”

“Also, given that companies in this division will be required to have a higher level of governance – with more than one-third of the board of directors being external directors as well as setting voluntary goals for the promotion of women and foreigners - this move will lead to the diversification of companies’ management teams,” Oshikubo continued. 

“Alongside the restructuring of the Japanese market, a standard for the elimination of ‘cross-shareholding’, will be introduced and will hopefully finally put an end to this widely criticised practice. The new standard is expected to set stricter rules on the definition of a tradable stock with companies holding numerous cross-shareholdings being forced to decrease them to maintain their listing on the Prime Market. As a result, we will likely see a rush by large corporations to sell their cross-shareholdings,” the economist added. 

The note added that more changes will affect the country’s TOPIX equity market. From October 2022, companies with a market capitalisation of JPY10 billion or less will begin to be excluded from TOPIX. The process will work through phases, ending in January 2025. Stocks with a small market capitalisation will also be excluded from the index, and the weighting of companies with less liquidity will be reduced in the TOPIX.