Investing in Japanese data centres: a guide

Data centres – and in turn investments relating to them – are increasing worldwide. Japan is home to the third largest number of data centres, after the US and China. The regulatory settings in Japan may make it a more attractive destination for data centre investments in the future.

In this insight, we look at laws and regulations relating to data centres in Japan, as well as:

-     Why it might become a favoured investment destination

-     Customer contracting considerations

-     Investment structuring

-     ESG considerations (in particular, renewable energy), and

-     Considerations when selecting the location of a DC.

Our experts are closely watching this space, both in Japan and across Asia.

What is the current status of data centres in Japan?

(1) Increase in data centres in Japan

A data centre (DC) is a facility that specialises in installing and operating servers and networking equipment. In some cases, a DC is a provider of cloud services. In many cases, however, it is entrusted by cloud service providers and companies to house servers and networking equipment and perform maintenance and operations on their behalf.

In recent years, as digitisation progresses, important information such as personal details and big data held by government agencies and companies is stored at DCs. The roles of DCs are expected to grow significantly with the popularisation of 5G, automated driving and AI.

(2) International environment in Japan's favour

Investment in DCs is increasing internationally as the volume of data increases. In 2019, there were more large-scale DCs operated in Japan than in any other country, except the United States (where 40% are operated) and China (where 10% are operated).[1]

Given the increasing importance of data, some other governments are increasingly moving toward data localisation.

The Japanese Government has adopted a policy position of promoting the free flow of data and does not provide data localisation regulations or require government access. Therefore, it is possible that investing in politically independent Japanese DCs will be more attractive to overseas customers as well.

What Laws and Regulations is a DC subject to in Japan?

(1) Data Protection Regulations

With the exception of the regulations under the Personal Information Protection Act (PIPA) set out below, the Japanese government has not established its own data protection regulations. From the perspective of economic security, it is possible that the government will introduce business regulations to protect essential data and infrastructure in the future, but no legislation is currently proposed .

(2) Personal Information Protection Act

The regulations of the PIPA apply to data stored by a DC that is "Personal data"[2] under the PIPA. In such cases, the DC is entrusted with the storage of Personal data pursuant to the PIPA.

Therefore, security control measures to appropriately manage Personal data must be taken. Specifically, this requires the establishment of:

• an organisational control system
• a personnel control system
• a physical control system, and
• a technical control system.

In addition, it is necessary to comply with the regulations relating to the supervision of employees and restrictions on the provision of data to third parties and certain others.

(3) Telecommunications Business Act

Where a DC intends to engage in a "Telecommunications Business" under the Telecommunications Business Act (TBA) that uses telecommunications facilities to mediate the communications of others, or otherwise uses telecommunications facilities for the communications of others, it must, in principle, register with the Minister for Internal Affairs and Communications or submit a report to the Minister [3].

In many cases, however, a DC will simply provide server space to major cloud service providers and telecommunications carriers. In this case, the DC is not deemed a Telecommunications Business and is not regulated by the TBA.

If a DC provides a service that mediates the communication of other persons, such as internet access and mail service, to the users, it may be deemed a Telecommunications Business. In such cases, the DC will be required to register or report to the Minister, appoint chief telecommunications engineers and comply with technical standards for telecommunications facilities [4].

(4) Government Access

In Japan, there are no regulations that provide for data localisation and government access.

This may be relatively advantageous for foreign operators using a Japanese DC.

How to contract with a DC?

(1) When DC provides server installation space

In many cases, the provision of server space by a DC will be considered a “Lease Contract”, with customers as tenants.

This raises the question of whether the Act on Land and Building Leases (ALBL), which strongly protects tenants, applies. When the ALBL applies, the lessor is subject to onerous restrictions such as a prohibition on terminating the lease contract without justifiable reason.

In this regard, the Supreme Court determines whether or not the service falls under the category of "Building" under the ALBL, in accordance with whether or not there is a "structure/size that is partitioned from other parts by barriers, etc. and can be occupied exclusively"[5].

Therefore, whether the ALBL applies depends on the specific circumstances of the individual services provided by the DC, and the manner in which services are provided should be considered upfront in light of this.

(2) When a DC provides cloud services

When a DC provides cloud services directly to customers, it is likely that such services are typically quasi-delegated contracts. In this case, the ALBL will not apply to the contract, so the DC has more flexibility in the terms that can be agreed with the customer.

What Should You Consider When Investing From Overseas?

(1) Investment scheme

i. TK-GK – THE ‘SILENT’ PARTNERSHIP

When investing in projects such as the establishment of a Japanese DC from abroad, there are many cases in which the silent partnership (Tokumei Kumiai, “TK”) agreement is used. In such cases, foreign investors are often silent partners.

However, if the silent partner is deemed to be jointly investing in real estate directly, this will be a real estate specified joint enterprise under the Real Estate Specified Joint Enterprise Act (RESA) and the approval of the Ministry of Land, Infrastructure, Transport and Tourism is required.

Accordingly, in the structuring of a scheme, it may be necessary to hold real estate as a beneficial interest in a trust or combine it with a loan.

 It is also essential to confirm the tax treatment of overseas investment, such as the treatment of withholding tax on dividends from the silent partnership under the double tax treaty between the country where the foreign investor is located and Japan.

The high-level process of establishment of TK-GK scheme is as follows:

I. Incorporate GK (Godo Kaisha) as a business operator

II. Select the land

III. Find a lender

IV. Draft agreements (TK agreement; land (or beneficial interest) purchase agreement; construction agreement; loan agreement, etc), and

V. Sign and Close.

ii. TMK – SPECIFIED PURPOSE COMPANIES

When investing in real estate in Japan directly from abroad, investment is often made using specified purpose companies (Tokutei Mokuteki Kaisha, “TMK”) under the Asset Liquidation Act. A TMK must conduct its business based on the Asset Liquidation Plan (ALP) that it submits to the Local Finance Bureau [6], and must comply with other strict restrictions; for example, the contractor of the business related to the leasing of real estate must be a licensed residential land building business operator[7].

Therefore, careful consideration should be given to the appropriateness of a TMK structure.

The high-level process of establishment of TMK is as follows:

I. Incorporate TMK and file opening of business

II. Select the land

III. Find investors

IV. Draft ALP; land purchase agreement; construction agreement; specified bond purchase agreement, etc;

V. Sign and Close

(2) What Should You Consider in relation to Environmental, Social and Governance (ESG) concerns?

i. Power Saving

A DC is a facility that consumes a large amount of electricity. It is likely that the amount of energy consumed will increase drastically due to the increasing amount of data processing in the future.

The benchmarking system based on the Act on Rationalizing Energy Use may apply to the DC, with the purpose of reducing power consumption.

The purpose of this benchmark system is to promote mid- and long-term energy conservation efforts across industries. Target companies are required to report the benchmark indices in their periodic reports every year if their annual energy consumption exceeds the crude oil equivalent of 1,500kL by setting the level of energy conservation (benchmark target) that should be targeted for each industry.

In 2022, data centre businesses (for this purpose, defined as “businesses that operate or utilise data centres for the purpose of data processing and provide some of the facilities or functions related to information processing”) also became subject to the benchmarking system. These businesses are required to report on their energy-use amounts for the 2022 fiscal year (and for the fiscal years that follow) from July 2023.

ii. Power Supply by Renewable Energy

Given the large consumption of electricity, it is essential to promote the use of renewable energy as much as possible from the viewpoint of decarbonisation. Therefore, in selecting a location for a DC, it is often necessary to consider whether there is a renewable energy generation facility nearby that can receive electricity.

In addition, if a DC is powered by natural fluctuating sources such as sunlight, the introduction of battery storage can facilitate a more stable supply of power.

(3) What to Consider When Selecting a Location

i. Resilience

Since Japan has a large number of natural disasters such as earthquakes and tsunamis, it is necessary to take into account the possibility of these disasters and the resilience of the site (such as the reliability of communications during disasters).

It is also necessary to investigate geographical data such as geotechnical features and the distance from the submarine cable.

ii. Submarine Cable

When using a Japanese DC, it is important to consider that Japan is surrounded by the sea. Therefore, when deciding the location of a DC, the availability submarine cabling should also be considered. The landing bases of submarine cables in Japan are concentrated in the areas from Minami-boso to Kita-ibaraki and Shima, but new submarine cables may be laid in the future.

The Internet Exchange (IX), which is the interconnection point for internet service providers, also functions together with submarine cabling and is integrated with DCs. The IX was originally concentrated in the Tokyo area, but since the Great East Japan Earthquake in 2011, it has been expanded to Osaka and other areas. Future IX expansion is another consideration when selecting a location for a DC.

Conclusion

As mentioned above, a number of factors make Japan an attractive destination for data centre investment, including:

・Japanese DCs are not strictly regulated compared to other countries; and

・Japan has a lot of flexibility for DC investment and development.

Any investment decision must pay careful consideration in relation to:

・provision of electric power

・selection of locations, and

・appropriate investment structures.

Want to know more about investing in data centres across Asia? Check out our related insights:

-     KWM South & Southeast Asia Data Centre Briefing

-     Vietnam: Opportunities in the Data Centre Market