Japan removed South Korea from its trade whitelist on August 2 after it decided on July 4 to ask for individual licenses for the exports of three materials (EUV photoresist, hydrogen fluoride, fluorinated polyimides). As a result, the export items classified as strategic items will be required to obtain individual permits (takes up to 90 days, renewed every six months, three or more application documents are required) instead of comprehensive permits (takes one week, renewed every three years, two application documents). Non-strategic materials that can be used for military purposes will be subject to a “catch-all” system. This will likely increase the inventory costs of affected companies and raise uncertainties that a production line could come to a stop if permits are not allowed within three months. However, we note that Korea was the only country in Asia that was on the whitelist. Not even those heavy producers of semiconductors and electronic devices in the region, such as China, Taiwan, and Singapore, enjoyed the whitelist status, not to mention Thailand, Malaysia, and the Philippines where Japan has many production facilities. However, none of these countries have had their production interrupted because of delayed imports from Japan. Why? Because Japanese companies that have established a Compliance Program (CP, or ICT, short for Internal Compliance Program) are granted special comprehensive permits, meaning they can export their products through a swift approval process which is practically the same as the benefits enjoyed by the whitelist countries.
Currently, 632 Japanese companies have established the CP, according to Japan’s Ministry of Economy, Trade and Industry; when including the other CP firms that are undisclosed for a variety of reasons, the number of CP companies totals around 1,300. Shin-Etsu Chemical (OTCPK:SHECF) and SUMCO (OTCPK:SUOPY), the oligopolistic players in the silicon wafer market, are believed to be among the undisclosed CP companies. Most of the key players in the global supply chain are also assumed to be CP companies. As such, if Korean IT H/W companies make the most of the CP, they are unlikely to face production problems in the short term, in our view.
Of course, difficulties may escalate for Korean SMEs that do not work with Japanese CP companies. For this reason, Samsung Electronics (OTCPK:SSNLF) ordered its suppliers to secure three months’ worth of inventory, according to news reports. In the near term, replenished inventories and CP companies will help prevent production problems.
However, in the mid to long term, Korean companies need to: 1) localize the production of affected materials; 2) diversify import sources; and 3) increase the production output from plants based in whitelist countries. Meanwhile, we maintain Overweight on the semiconductor sector as the removal from the whitelist has negligible impacts on production while being sentimentally positive for memory semiconductor price negotiations. We also keep a positive view of the electronic materials/parts/equipment sectors for increasing regulatory support for localization as well as the prospect of an increased market share within Korean clients.
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