Recent Change of Regulations and Practice in Construction and Energy in Japan

Introduction – Tightness in the Construction Industry

Recently, a number of events have kept the construction industry very busy in Japan, including the clean-up and rebuilding after a number of large scale earthquakes and various construction activity in the build up to the 2020 Tokyo Olympics.  The Olympics have spurred not only the construction of public facilities and infrastructure, but also many private projects planned for completion by 2020 on the expectation of an influx of foreign visitors.  Rehabilitation and reconstruction after the 2011 East Japan Earthquake and tsunami is still ongoing, but in April this year, half of the island of Kyushu, Japan’s fourth biggest island was also hit by series of large earthquakes.  This has put pressure on an already tight construction industry with serious shortages of workers and materials.  Industry insiders appear concerned about uncertainties related to the forecasting of construction cost.  In these circumstances, some local governments are beginning to defer less urgent public works projects until after 2020, in order to avoid unexpected cost increases.

The Japanese government has also taken measures to help relieve the shortage of construction workers, including by deregulation of foreign construction workers.  Until one year ago, it was not allowed to use foreign workers at construction sites except for training purposes and the training period was limited to three years at most.  However, as of April 1, 2015, the foreign workers who have completed training to work at a construction site are now allowed to continue working for several years beyond the three year limit.  This deregulation is, however, effective only until March 31, 2021, which means that such foreign workers will presently be allowed to work on construction sites only until shortly after the Tokyo Olympics.

Aside from construction related to the Olympics and reconstruction following earthquakes, there has also been a gradual increase in PPP/PFI projects in Japan, a number of changes in the regulation of the renewable energy market, and a new infrastructure fund market.

Increase of PPP/PFI

The Japanese government has been promoting PPP (Public Private Partnership) and PFI (Private Finance Initiative) projects since the PFI Act was enacted in 1999, with limited success.  In 2011, the government introduced a concession scheme, under which a private project company may be granted with the right to operate publicly owned facility and to gain income from the operation.  The first concession project was the project to operate two airports in the Osaka area for 44 years. Operation by the private project company has commenced in April this year.  Since the concession fee of this project was quite high (about 2.2 trillion yen) the winning consortium included 30 large companies in the Osaka area in addition to Orix Corporation Group, a leading Japanese financial services group, and VINCI Airports, a French airport concession company.  An interesting aspect of this tender project was that it was truly opened up to foreign bidders, with efforts made to accommodate and attract such bidders, something that has not been the case to-date for infrastructure projects in Japan.  Following this airport concession tender project, we expect there will be more PPP/PFI projects that are opened up for foreign companies to more easily participate.

The Japanese government has been taking many other measures to stimulate the use of PPP/PFI projects in addition to concessions.  One effective measure was the request issued by the Cabinet Office in December of 2015, addressed to the government authorities and the major local governments.  It requested them to put a priority on PPP/PFI schemes when planning public projects and also for each authority and large local government to prepare and issue guidelines stipulating the procedure for utilizing PFI/PPP schemes.  Under a PPP/PFI process, a private company or consortium conducting PFI/PPP projects is chosen through a bid process in which proposals from bidders are evaluated for factors other than simply price, including design, construction plan, operation plan, financial plan and risk mitigation measures.  As a result of these measures, it is highly likely that we will see more public projects taking this kind of bidding process.

Following the first concession project for the airports in Osaka, a number of other airport concession projects are currently in the process of bidding or preparation for tender.  The Cabinet Office also plans to expand the concession projects to other types of infrastructure.  The most likely candidates are water supply facilities, waste water treatment facilities, toll roads and sports facilities.  Concession tender projects have already commenced for a toll road in Aichi Prefecture and a waste water treatment facility in Hamamatsu City.

PFI projects are typically financed using project finance, under which the project company procures finance from banks under limited recourse loans.  The banks obtain security on every asset and right owned by the project company.  One of the characteristics of Japanese PFI finance schemes is that bankruptcy remoteness is not strongly emphasized.  In PFI project, a project company is usually formed as a stock company (kabushiki kaisha) and the major consortium members are required to hold its shares throughout the project period.  Mezzanine finance is rarely used in PFI projects.  However, the PFI Fund, which was established under the revised PFI Act tends to actively provide mezzanine finance to PFI projects.  This fund was established in 2013 by both government and private companies, for the aim of procuring finance for concession projects and other PFI projects in which the project company is to be run independently.  So far, the fund has provided or decided to fund a total of 15 PFI projects.

Renewable Energy

In Japan, the Feed-in Tariff (FIT) Act came into force in July 2012.  Since then, the number of renewable energy projects, especially solar power projects, has increased tremendously.  The key concept of the Act is that the local electric utility companies are obliged to purchase renewable energy at a certain fixed procurement price.  The types of renewable energy covered by the Act include solar power, wind power, water power, geothermal power and biomass energy.  The Act and this system are supervised by the Agency of Natural Resources and Energy, an agency of the Ministry of Economy, Trade and Industry (“METI”).  The fixed purchase price and fixed period, which are determined and announced by the Minister of METI every fiscal year based on the opinion of the committee specially established for calculation of purchase price.  The fixed purchase price tends to decrease gradually over time.  As an example, the purchase price for mega-solar electricity rapidly decreased from JPY 40/kWh in 2012 to JPY 24/kWh in 2016.

Project finance is regularly used to finance renewable energy projects.  The project company is usually formed as godo kaisha, which offers an advantage over a kabushiki kaisha in terms of bankruptcy remoteness.  Investors commonly invest in the project company under a silent partnership (tokumei kumiai).  For this reason, renewable energy project financing is similar to real estate finance rather than other PFI project financing schemes.

For the last three years, the number of solar power projects has dramatically increased mainly due to the ease with which photovoltaic plants can be constructed compared with other types of renewable energy plants.  The Japanese government appears to be attempting to now lead production of renewable energy away from solar power projects to other types of renewable energy projects, such as wind power, water power, geothermal power and biomass energy.  One of the major issues of practice under the FIT Act is that the authorizations of renewable energy were granted by METI to many more solar power projects than was originally anticipated, but many approved projects have failed to reach operation.  A change in the Act has been proposed to the Diet in order to more quickly eliminate projects that are delayed and promote other projects that are able to come online sooner.  If the proposed change passes the Diet, approvals already granted may be cancelled if the project company fails to execute a grid connection contract with the relevant utility company by April 1, 2018.  It is also planned to decrease the burden of environmental assessment for other types of renewable energy projects, such as wind power.  The dramatic fall in the purchase price of energy produced by mega-solar power plants, from JPY 40/kW in 2012 to JPY 24/kW in 2016, also reflects this change in government policy.  Nevertheless, many still view solar power projects as viable financially, despite the removal of such incentives.

Many solar power projects that were approved in the first three years after the beginning of the FIT system, are moving from the development and construction stage to an operation stage.  Some of these projects will be owned by infrastructure funds after commencement of operation, some of which will be listed.  When the FIT Act first came into force, there were many unclear points and it was difficult to evaluate the potential risks during the development period and the following 20 year operation period.  Now, however, the situation has become much clearer and more stable, making the solar power market less risky and more suitable for fund-based investment in many ways.

Infrastructure Fund Market

In order to introduce more private finance into infrastructure projects in Japan, in April 2015, Tokyo Stock Exchange, Inc. established a market specifically for infrastructure funds.  The projects to be listed with this market are in principle limited to projects that have been in operation for more than one year and are producing a stable income.  The system of this market is similar to the J-REIT (Japan Real Estate Investment Trust) system, a market that opened on the Tokyo Stock Exchange in 2001 specifically for real estate investment.  For both markets, investment corporations (toushi houjin) and investment trusts (toushi shintaku) established under Japanese law can be listed.  However, one important difference from the J-REIT market is that foreign infrastructure funds can also be listed on this infrastructure market.  Considering the important role of the operator, timely disclosures are required of the operator of the assets.  In the case of domestic funds, it is also required to disclose the criteria for selection of an operator.  Foreign infrastructure funds may be listed to the Tokyo Stock Exchange only in conjunction with listing to a foreign financial instruments exchange.

In the one year since the infrastructure market was opened, there has been no IPO yet. One of the major reasons for this is that tax incentives were afforded only for a period of 10 years to infrastructure funds, which invest more than 50% in renewable energy projects, while the life of solar power facilities under tax treatment is 17 years.  In April 2016, however, tax reforms came into effect that extended the tax incentive period from 10 years to 20 years.  After this, the first IPO of an infrastructure fund, Takara Reven Infra Investment Company, was approved by the Tokyo Stock Exchange and is scheduled to be listed on June 2, 2016.  It has been announced that the Takara Reven Fund will invest primarily in solar power projects.  It is also predicted that several other infrastructure funds dealing mostly with solar power projects, such as Ichigo Holdings and Sparks Group for example, are to be listed within this year.  It is anticipated that initially, at least, this infrastructure market will be utilized mostly by solar power project funds.  Over time, however, it is expected that domestic and foreign funds investing into various types of infrastructure, including PFI/PPP projects, will be listed before long.

Closing – Other trends

Recently, there were two pieces of news concerning defects of construction work that rocked the construction world in Japan.  One was that Toyo Tire & Rubber Co., Ltd., one of the world biggest tire and rubber companies, had used fraudulent data to obtain a certification of seismic isolation rubber from a government authority.  The other was the news of piling work on a large multistory residential building built by Sumitomo Mitsui Construction Co., Ltd., one of Japan’s largest general contractors, together with its subcontractors, causing the building to begin leaning.  This will undoubtedly result in greater scrutiny of supervision and compliance across the construction industry.

Environmental requirements are also becoming increasingly strict in Japan.  In July 2015, a new piece of legislation was promulgated that require certain type of buildings, such as new non-residential buildings larger than 2,000㎡, to meet specified standards for energy consumption, without which, construction will not be approved.

Miho Niunoya

Miho Niunoya

Partner at Atsumi & Sakai

Email: miho.niunoya@aplaw.jp
Tel: +81 3 5501 1163

Miho Niunoya’s practice focuses on domestic and overseas construction, PPP (Public Private Partnership), energy, project finance and resolution of construction disputes. Recent transactions include a large scale national hospital, MICE (Meeting, Incentive Travel, Convention and Exhibition), urban development projects, various water supply and waste water treatment facilities, waste disposal plants, development and M&A in relation to solar power plants, and dispute settlement regarding an overseas power plant project. She has been consistently recognized in the fields of construction and energy by Chambers, Legal 500, IFLR, The Best Lawyers, and Asialaw Profiles. She also has extensive experience acting a committee member for selection of winning bidders on PPP/PFI projects.

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About Miho Niunoya

Email: miho.niunoya@aplaw.jp
Tel: +81 3 5501 1163

Miho Niunoya’s practice focuses on domestic and overseas construction, PPP (Public Private Partnership), energy, project finance and resolution of construction disputes. Recent transactions include a large scale national hospital, MICE (Meeting, Incentive Travel, Convention and Exhibition), urban development projects, various water supply and waste water treatment facilities, waste disposal plants, development and M&A in relation to solar power plants, and dispute settlement regarding an overseas power plant project. She has been consistently recognized in the fields of construction and energy by Chambers, Legal 500, IFLR, The Best Lawyers, and Asialaw Profiles. She also has extensive experience acting a committee member for selection of winning bidders on PPP/PFI projects.