i Structure of financial laws and regulations in Japan
The Financial Instruments and Exchange Act (FIEA)2 and the Cabinet Order and Cabinet Office Ordinances thereunder are the most basic and important direct regulations on capital markets in Japan. The FIEA regulates the financial instruments business and financial transactions, including securities offerings and distributions, for the purpose of maintaining the fairness of capital markets, protecting investors and developing the economy. There are no overarching laws that regulate all financial institutions, which means that each type of institution is regulated separately. For example, banks are regulated by the Banking Act,3 securities firms are regulated by the FIEA and insurance companies are regulated by the Insurance Business Act.4 The FIEA is still important, however, even for financial institutions that are regulated by laws other than the FIEA because those laws may refer to provisions of the FIEA that are then applied to such institutions mutatis mutandis. As a result, such institutions are in effect also regulated by the principles of the FIEA in many respects, for example when conducting securities and derivatives transactions.
There are several other laws and regulations that specifically govern certain types of financial transactions, including derivatives transactions, securitisations, structured products, investment funds, trusts and partnerships, including the Commodity Derivatives Act,5 the Act on Investment Trusts and Investment Corporations,6 the Limited Partnership Act for Investment,7 the Act on Securitisation of Assets,8 the Trust Act9 and the Companies Act.10
ii Roles of regulatory and supervisory agencies and of the central bank in the Japanese capital markets
The Financial Services Agency (FSA) is responsible for, inter alia, ensuring the stability of the Japanese financial system, protecting investors and carrying out surveillance over securities transactions. The FSA delegates powers relating to securities registration to local finance bureaus (LFBs) and to daily market surveillance, inspections of financial instruments firms, inspections of disclosure documents and related activities to the Securities and Exchange Surveillance Commission (SESC).
The commodity derivatives business is regulated by either the Ministry of Economy, Trade and Industry or the Ministry of Agriculture, Forestry and Fisheries (or both), depending on the type of underlying commodity.
The Bank of Japan, which is the country's central bank, is independent of the Japanese government, including the FSA, as is the case with central banks in many other jurisdictions. Its mission mainly focuses on the implementation of monetary policy, treasury and government securities-related operations.
Additionally, there are several self-regulatory organisations (SROs) whose membership consists of financial institutions. Among them, the Japan Securities Dealers Association (JSDA) is the most representative and important organisation in the Japanese capital markets. It promotes sound business development and protects investors by ensuring that securities transactions by its members are conducted fairly and smoothly.
There is also an electronic system called Compliance WAN, which can be accessed by the SESC, LFBs, securities companies, SROs (including the JSDA) and stock exchanges. This system enables the SESC and LFBs to use transaction data sent, for example, from securities companies for the purpose of market surveillance.
iii Financial dispute resolution
Several options exist for resolving financial disputes in Japan: judiciary proceedings in court, arbitration procedures at an arbitral tribunal and alternative dispute resolution (financial ADR) procedures.
Usually, a party to a financial transaction is able to sue the counterparty in court, and, once a court procedure is chosen, the parties will be entitled to a decision by a district court and two instances of appeal to the High Court and the Supreme Court.
Alternatively, a party may elect arbitral institutions, including the Japan Commercial Arbitration Association or the International Chamber of Commerce, for arbitral awards that are deemed to be final and binding by the courts. Japan is a member of both the ICSID Convention and the New York Convention, and Japan's Arbitration Act11 is based on the UNCITRAL Model Law.
In addition to court and arbitral procedures, an investor may seek settlement of a financial dispute by choosing the financial ADR procedures, which is a simplified and expeditious resolution system.
iv Scope of jurisdiction
In general, it is believed that Japanese laws and regulations do not apply to activities by foreign companies outside Japan as the scope of jurisdiction should be limited to Japanese territory. With respect to cross-border cases, however, there is no provision that specifies the extent of the application of financial laws and regulations, and the scope of the powers of regulatory authorities is still open to interpretation. Even so, it is almost always the case that Japanese laws and regulations apply when a foreign company solicits an investor who resides in Japan, even from outside Japan (see Section II.v).
In practice, the FSA maintains close and constant contact with the regulators of foreign countries. Financial institutions should pay careful attention to the relevant overseas regulations as well as the Japanese regulations.
II THE YEAR IN REVIEW
i Developments affecting debt and equity offerings
Framework for legislation or regulation on debt and equity offerings
To conduct a debt or equity offering (whether primary or secondary), a securities registration statement (SRS), mainly consisting of information about the securities being offered and about the issuer, must be filed with the director-general of the relevant LFB, unless the offering constitutes a 'private placement' that is exempt from disclosure obligations (private placement exemption).
Two major private placement exemptions are the small-number exemption (which may be available when solicitations are made to no more than 49 investors in Japan) and the professional investors exemption (which may be available when solicitations are made only to qualified institutional investors (QIIs) or specified investors defined in the FIEA). Detailed conditions for each exemption differ depending on the type of security being offered.
Once a company has filed an SRS with the LFB as described above, it becomes subject to continuous disclosure obligations and must file annual securities reports, semi-annual or quarterly reports and extraordinary reports with the LFB, as all listed companies in Japan must do.
Recent developments in regulations
Fair disclosure rules
By the amendment to the FIEA enacted in May 2017, the Fair Disclosure Rules have been introduced since 1 April 2018. Similar to that of Asian or European countries, the enactment of the Fair Disclosure Rules of Japan means that if a listed company or its directors, among others (the information provider), disclose non-public material information to any investor or broker-dealer (the information recipient), that information shall be announced publicly so that it can be accessed by other investors as well. More specifically, if the disclosure to information recipients is to be made intentionally, the material information shall be publicly disclosed simultaneously. If the disclosure to information recipients was made unintentionally, the material information shall be publicly disclosed promptly after the disclosure. Details about the scope of information providers, information recipients and material information are described in the amended FIEA and the Enforcement Order and Cabinet Office Ordinances related thereto.
Additionally, the FSA has published guidelines for the Fair Disclosure Rules, and the Japan Investor Relations Association has published guidelines in action regarding best practice for disclosure and dialogue. These documents provide listed companies with guidance on the management of information subject to the Fair Disclosure Rules and set out a classification of information in three groups: (1) information that should be disclosed to the public; (2) a non-material piece of information that may be disclosed to analysts or investors, even if it helps them to complete a 'mosaic' of information that, taken together, is material; and (3) information that should not be disclosed to anyone outside the company. The aim of these documents is to promote fair disclosure and to activate dialogue between financial institutions and investors for the purpose of encouraging investment in the capital market of Japan.
Mandatory disclosure system
On 26 January 2018, the Cabinet Office Ordinance on Disclosure of Corporate Information, etc., the Ordinance for Enforcement of the Companies Act and the Rules of Corporate Accounting were amended based on a proposal described in the 'Report – Promoting Constructive Dialogue', published in April 2016 by the Working Group on Corporate Disclosure of the FSA. The aim of these amendments is that the duplicative disclosure system requiring mandatory disclosure of business reports and annual securities reports should be streamlined and improved by unifying the requirement under the Companies Act to disclose business reports with the requirement under the FIEA to disclose annual securities reports.
As a result, the description of the status of major shareholders and share options can be the same whether it is required in a business report or an annual securities report. On the other hand, there is a new requirement, due to which an annual securities report must include descriptions of non-financial information such as business policies, strategies and management's discussion and analysis of financial condition.
Since 1 April 2018, the amended FIEA has also introduced a new regulation of high-frequency trading in response to increasing concerns about the effect of high-frequency algorithmic trading (HFT) on market stability, efficiency, fairness and system vulnerabilities. The new regulation requires high-frequency traders, including institutional investors and HFT firms, to register with the Prime Minister. A financial instruments business operator (FIO) that is already registered with the Prime Minister is not required to apply for the registration, but it needs to file a notification concerning its engagement in high-frequency trading. This type of high-frequency trader is required to establish an internal operational control system so that it can engage in high-frequency trading in an appropriate manner. It is prohibited from having another person engage in high-frequency trading under the name of the high-frequency trader. It also needs to maintain legal ledgers and submit an annual business report.
FIOs are allowed to accept an order that involves high-frequency trading only from high-frequency traders that have registered with or notified to the Prime Minister. A financial instruments exchange will be able to conduct investigations to look into high-frequency traders' compliance with applicable laws, regulations and administrative orders. More details are provided in the Enforcement Order, the Cabinet Office Ordinance on Financial Instruments Business, etc. and the FSA's Supervisory Guidelines. As well as Japanese traders, non-resident traders should note these regulations and guidelines, because non-resident traders are also required to make a registration. Legal ledgers and annual reports can be made in English.
Management of corporate bonds without bond administrators
Under the current Companies Act, if a company issues bonds, it is necessary for the company to appoint a bond administrator and entrust the receipt of payments, the preservation of rights of claim and other bond administration to that bond administrator. However, in cases where it can reasonably be expected that the bondholders can manage bond administration by themselves, the company does not need to appoint a bond administrator. In fact, a bond administrator has not been appointed in many cases in which this exception rule has been relied on. On of the reasons is that it can be difficult to find a candidate for bond administrator, because the role has very strong power, broad discretion and heavy responsibility, and qualification requirements for the position are very strict. Given this situation, the Companies Act Working Group of the Legislative Council of the Ministry of Justice is currently discussing the possibility that the Companies Act would admit a new position of 'bond administrative assistant', who would handle only simple administration having limited power and liability with less discretion, which would enable bondholders to outsource bond administration more easily.
Curtailing settlement risks
For some years, the JSDA has been actively advancing efforts for shortening settlement cycles for Japanese government bonds (JGBs) and stock trades to facilitate and strengthen the functioning of the capital markets. For example, the settlement cycle of JGBs has been shortened from T+2 to T+1 since 1 May 2018. If they can confirm stable operation of the JGB T+1 settlement system, the new stock settlement cycle T+2 will be implemented on 16 July 2019.
To implement recommendations by the Financial Stability Board (FSB), the FIEA was amended in May 2015 to introduce a new regulatory framework for organisations that set financial benchmarks, such as the Tokyo Interbank Offered Rate (TIBOR) (financial benchmark administrators). Under the amended FIEA, the FSA may designate an entity as a financial benchmark administrator that is then required to establish and observe operational rules consistent with the principles for financial benchmarks of the International Organization of Securities Commissions (IOSCO) regarding its systems of governance, the quality of its benchmarks, the quality of methodology and accountability. A financial benchmark administrator is subject to supervision by the FSA (not the SESC), including on-site inspection. Each reference bank or financial institution that submits rate data is subject to and monitored for compliance with the code of conduct (including the avoidance of conflict of interests) agreed upon with the financial benchmark administrator. Manipulative activities by FIOs or registered financial institutions (RFIs) are prohibited and sanctioned. The FSA has designated the JBA TIBOR Administration (JBATA), a subsidiary of the Japanese Bankers Association, as a financial benchmark administrator. JBATA engages in the calculation, publication and administration of JBA TIBOR.
On 24 July 2017, JBATA implemented a JBA TIBOR reform in line with the principle of IOSCO, expecting that financial indices will be based on 'actual' transactions rather than 'virtual' ones. With the implementation of this reform, a new financial index (TIBOR+) has been introduced that is defined as the average of interest rates that reference banks or financial institutions deem as prevailing actual market rates 'assuming transactions between prime banks' on the Japan unsecured call market. All reference banks need to calculate their reference rates following the integrated and clarified calculation or determination process prescribed in the rules determined by JBATA. From these facts, TIBOR+ can be interpreted to reflect the 'actual' funding cost of the reference banks or financial institutions.
In addition to the above, the Bank of Japan is preparing for the adoption of a risk free rate (RFR), namely the Tokyo Overnight Average Rate (TONA), which is an uncollateralised overnight call rate. Although some other countries are considering a transition from interbank offered rates, such as LIBOR to RFRs, Japan pursues the multiple rate approach recommended in the FSB Report – TIBOR+ and TONA – which means that TONA will not replace TIBOR. The RFR is intended to be used as an alternative to TIBOR+ as it is stable, easy to understand and already widely used in the wholesale derivative markets. The Bank of Japan will continue the discussion of planning for the best practice of TONA to be established by the end of 2021.
ii Developments affecting derivatives, securitisations and other structured products
Framework for legislation or regulation
The FIEA is the most basic and fundamental instrument of regulation applicable across the spectrum of derivatives, securitisations and other structured products. There are also other laws governing these products, such as the Act on Investment Trusts and Investment Corporations, the Limited Partnership Act for Investment, the Act on Securitisation of Assets, the Trust Act and the Companies Act. Other related laws and regulations may apply depending on the type of product.
In 2006, the FIEA underwent radical amendment (it was formerly the Securities and Exchange Act), as did the Commodity Derivatives Act (formerly the Commodity Exchange Act) in 2011. The main purpose of these amendments was to provide more complete protection for investors and to improve and enhance the convenience of participating in the Japanese market. While these amendments introduced strict and rigid regulations for investor protection, there are exceptions for rules and regulations that are applicable to financial instruments businesses targeting only professional investors, QIIs or commodity derivatives professionals. In other words, the rules and regulations applicable to the financial instruments business can differ depending on the type of investor. The FSA has also promoted a considerable number of further amendments to the FIEA in recent years to implement agreements reached at the G20 summits, which aim to strengthen the global financial system by fortifying prudential oversight, improving risk management, promoting transparency and continuously reinforcing international cooperation.
Recent developments in regulations
In light of statements made by leaders at G20 summits calling for improvements in over-the-counter (OTC) derivatives markets, there have been several legislative and regulatory developments intended to implement new policies regarding central clearing, trade reporting, margin requirements and trading platforms since 2012. The following reforms on OTC derivatives markets have been implemented in more recent times (with respect to central clearing and trade reporting, see Section II.iv).
On 1 September 2016, non-cleared margin rules under the Cabinet Office Ordinance of the FIEA became effective, by which the margin requirements for non-centrally cleared derivatives stipulated by the Basel Committee on Banking Supervision and IOSCO (BCBS-IOSCO) have been implemented. These rules require that FIOs engaged in Type I financial instruments business (Type I FIOs) and RFIs post and collect Initial Margin (IM) and Variation Margin (VM) to and from the counterparty on a bilateral basis, with some exceptions. For both IM and VM, there were and have been phase-in periods, during which margin obligations apply to a given entity only if certain de minimis thresholds are met by the average during the preceding three months of the month-end aggregate notional amounts of the entity's non-cleared OTC derivatives, OTC commodity derivatives and physically settled foreign exchange forwards and swaps (determined on a consolidated group basis). From 1 September 2018 to 31 August 2019, IM obligations are applied to entities with an initial de minimis threshold of ¥210 trillion. Thereafter, IM obligations will be phased in for the last portion of the phase-in period from 1 September 2019 to 1 September 2020, with an initial de minimis threshold of ¥105 trillion that will be lowered to ¥1.1 trillion. After the IM phase-in period ends on 1 September 2020, IM will be required if:
- the average during the preceding year of the month-end aggregate notional amounts of the entity's OTC derivatives (on an unconsolidated basis) is ¥300 billion or more; and
- the average during the preceding year of the month-end aggregate notional amounts of the entity's non-cleared OTC derivatives, OTC commodity derivatives and physically settled foreign exchange forwards and swaps (determined on a consolidated group basis) is ¥1.1 trillion or more.
The VM phase-in period has already ended – on 1 March 2017. Currently, VM is required if the average during the preceding year of the month-end aggregate notional amounts of the entity's OTC derivatives (on an unconsolidated basis) is ¥300 billion or more.
Parties may agree bilaterally to introduce a minimum transfer amount as long as it does not exceed ¥70 million for the sum of IM and VM.
Even if Type I FIOs and RFIs are below the de minimis threshold for VM, they are still required by the FSA's comprehensive guidelines to establish internal systems reasonably designed for the appropriate posting and collection of VM in line with BCBS-IOSCO's final report.
In November 2017, the FSA clarified its interpretation of the International Swaps and Derivatives Association with respect to structured trust products that are subject to the FSA's Supervisory Guidelines. If (1) the underlying assets are safe assets with zero-risk weight, such as JGBs or loans credited to local governments, (2) the underlying assets perform the same function as the VM in the event of a default by the trust fund (which means that the counterparty is entitled to receive the underlying assets preferentially) and (3) the fund has set up the facility and system especially to calculate the fair market value of financial instruments, the VM does not need to be collected from trust accounts as long as the exposure from derivative financial instruments does not exceed the market value of the underlying assets. In cases where the exposure from derivative financial instruments exceeds the market value of the underlying assets, the VM needs to be collected from the trust fund account to make up for a lack of assets in the event of default by the trust fund. Incidentally, the VM is always required from a counterparty of derivative transactions regardless of whether the exposure from derivative financial instruments exceeds the market value of underlying assets.
Securitisations and other structured products
There have been no material amendments to the regulations regarding securitisations and other structured products since the amendment to the FIEA of 2016 regarding investment funds.
However, to strengthen the international competitiveness of financial markets and the funds industry in the region, it is intended to establish an Asia Region Funds Passport (ARFP) as a regional market for collective investment schemes facilitating cross-border offerings across Japan, Australia, the Republic of Korea, New Zealand and Thailand. The ARFP aims to reduce regulatory duplication by establishing a standardised set of requirements for fund operators and to benefit investors through broader and more diverse fund offerings while maintaining investor protection. Japan has completed its preparation to implement this ARFP and is waiting for other countries to do the same. The formal commencement of the ARFP is expected to occur on 1 February 2019. The ARFP considered further initiatives to extend the passport across the region and noted continuing discussions in a number of economies in the region who have the potential to join as participants, including Singapore, the Philippines and Hong Kong.
iii Relevant tax and insolvency law
In general, all corporations in Japan are subject to treatment as taxable entities. Foreign corporations are liable to pay certain types of corporate tax and income tax on domestic-sourced income, which varies depending on whether the foreign corporation has a permanent establishment in Japan. Non-corporate forms that are sometimes used as a vehicle for financial transactions, such as general partnerships, limited liability partnerships or trusts, are, in principle, fiscally transparent for Japanese tax purposes. However, in a tax dispute regarding whether a limited partnership established under the laws of the state of Delaware (Delaware LP) is a corporation for Japanese taxation purposes, the Supreme Court ruled on 17 July 2015 that a Delaware LP constitutes a corporation under Japanese tax law. This ruling stated that whether a foreign limited partnership is regarded as a corporation under Japanese tax law shall be determined case by case, and it did not refer to any other foreign limited partnership.
It should also be noted that the Japanese anti-tax haven rules were amended by the 2017 Tax Reform Act, which has been effective for fiscal years beginning on or after 1 April 2018. By this amendment, Japanese controlled foreign company (CFC) regimes will shift to more of an 'income approach', although it is still based on an 'entity approach', which will be consistent with the final report issued by the OECD/G20 project aiming to tackle and prevent base erosion and profit shifting (i.e., tax avoidance strategies exploiting gaps and mismatches in tax rules to artificially shift profits to low-tax or no-tax locations). Under the current rule, if a foreign subsidiary's tax rate is less than 20 per cent, it is treated as a tax haven subsidiary and the Japanese shareholder must include the CFC income unless the active business exception tests are satisfied. Under the new rule, however, if (1) a foreign company does not meet the 'economic activity test' consisting of elements such as business, substance, administration and control criteria, and (2) the foreign tax rate is less than 20 per cent, income earned by the foreign subsidiary must be aggregated and included within Japanese tax income. Also, if (1) a foreign company falls into the categories of a 'paper company' or 'cash box' or a company located in the 'black-list' countries defined therein, and (2) the foreign tax rate is less than 30 per cent, income earned by the foreign subsidiary must be aggregated and included within Japanese tax income. In addition, even when a foreign company (including foreign financial institutions defined under tax law) satisfies the 'economic activity test' stated above, if the foreign tax rate is less than 20 per cent, certain passive income still must be aggregated under certain conditions.
Incidentally, the definition of a permanent establishment will be amended in line with the final report issued in respect of the above-mentioned OECD/G20 project. Also, to attract overseas funds through venture companies and rehabilitating companies, foreign partners of an investment limited partnership will be exempted from Japanese taxation on certain income created by the business of the investment limited partnerships from a fiscal year commencing on or after 1 January 2019.
Apart from the above, the following reforms on domestic taxation that may affect investors have recently been implemented.
First, the combined national and local effective corporate tax rate for large corporations was reduced to 29.74 per cent from 29.97 per cent for tax years beginning on or after 1 April 2018. This reduction rate is intended to strengthen Japan's attractiveness as a business location and enhance the competitiveness of Japanese companies.
Second, a Japanese version of an individual saving account (ISA) system, called NISA, was introduced in 2014, which makes investments of up to ¥1.2 million per year tax free if the investment was made through an ISA. An investor can hold an ISA as a tax-exempt account for a maximum of five years falling within the period from 2014 to 2023. In January 2018, a new type of ISA, called the instalment-type NISA, was introduced for individuals who hope to build up their assets through instalment-type investments. An investor in this type of ISA makes investments of up to ¥400,000 per year tax free and can hold an ISA for a maximum of 20 years, within the period from 2018 to 2037. The government continues to proactively promote the use of the NISA because the account steadily increases participation in the stock market by individuals and has attracted the interest of retail investors.
With respect to consumption tax, it is scheduled to rise from 8 per cent to 10 per cent in October 2019. Although this tax is not directly applicable to financial transactions, the rate increase may have broader implications for the Japanese economy, including the financial markets.
The insolvency laws in Japan consist of the Bankruptcy Act,12 the Civil Rehabilitation Act,13 the Corporate Reorganisation Act14 and the Act Concerning the Special Provisions for the Reorganisation of Financial Institutions.15 In addition, in line with the international agreement reached at the Financial Stability Board and G20 Cannes Summit on 4 November 2011, the Deposit Insurance Act16 was revised to provide for an orderly resolution and recovery regime covering banks, securities companies, insurance companies, financial holding companies and similar entities that are experiencing financial difficulties. This regime gives the Prime Minister the authority to suspend the application of any termination provisions of certain financial agreements and to close out netting provisions for a period the Prime Minster designates. The Prime Minister thus has the ability to implement a kind of temporary stay for a designated period to enable a troubled financial institution to transfer its assets to an acquiring financial institution or a bridge financial institution.
Since 2014, there have been no material amendments to the above-mentioned insolvency laws or the Companies Act.
With respect to recovery and resolution planning, given the Guidance on Identification of Critical Functions and Critical Shared Services published by the FSB, the FSA's Supervisory Guidelines have been amended since 13 July 2018. This amendment requires financial institutions to analyse and identify a firm's essential and systemically important functions (critical functions) and to plan a strategy for continuity of those critical functions, which will be helpful for continuing to provide resolutions or enabling an orderly winding down.
iv Role of the exchanges, central counterparties and rating agencies
In principle, the FIEA regulates financial instruments exchanges, financial instruments clearing organisations (central counterparties (CCPs)) and rating agencies. The Commodity Derivatives Act (CDA) regulates commodity exchanges.
Japan Exchange Group, Inc (JPX) is the largest company operating financial instruments exchange markets to provide market users with venues for cash equity trading through its subsidiary, Tokyo Stock Exchange Inc (TSE), and for derivatives trading through Osaka Exchange, Inc (the OSE, formerly known as the Osaka Securities Exchange). The TSE also offers companies an alternative listing framework to meet the needs of professional and other investors, which consists of Mothers, JASDAQ, the TOKYO PRO Market and the TOKYO PRO-BOND Market. In addition to providing market infrastructure, the JPX also provides clearing and settlement services through a CCP, the Japan Securities Clearing Corporation (JSCC), and conducts trading oversight to maintain the integrity of the markets. However, the JPX has not yet commenced commodity trading operations because the Tokyo Commodity Exchange Inc (TOCOM) has not decided to become a subsidiary of the JPX and is still considering alternative survival strategies amid Japan's shrinking commodities market.
There have been no material amendments to regulations for financial instruments exchanges under the FIEA or for commodity exchanges under the CDA recently.
Apart from traditional financial instruments exchanges, the cryptocurrency exchange services have been regulated by the amended Payment Services Act (PSA)17 and the relevant Cabinet Office Ordinance since 1 April 2017. Please see Section II.v.
Since November 2012, FIOs and RFIs have been required to clear certain types of OTC derivatives transactions via the mandatory use of central clearing under the FIEA.
Under the current FIEA, the types of OTC derivatives transactions that are subject to mandatory clearing are credit default swaps (CDS) on Markit iTraxx Japan referencing the credit of no more than 50 Japanese corporations, and 'plain vanilla' yen-denominated interest rate swaps (IRS) referencing three-month or six-month JPY LIBOR or Euro JPY TIBOR, which are eligible for clearing services provided by a Japanese CCP (i.e., the JSCC). However, certain transactions, such as (1) transactions with a party that is not an FIO or RFI, (2) transactions that are booked in a trust account, or (3) transactions between affiliates, may be exempt from mandatory use of a CCP.
With respect to client clearing, CDS or IRS transactions with a party that is not a clearing participant of a CCP may be exempt from mandatory clearing. However, IRS transactions are subject to mandatory clearing (through client-clearing services) when one or both parties is an FIO or RFI that is registered with the FSA. Registration is required (1) when the monthly average outstanding notional amount of OTC derivatives is ¥300 billion or more or (2) when the monthly average outstanding notional amount of property booked in a trust account of an FIO or RFI is ¥300 billion or more.
The JSCC provides clearing services for listed products, OTC derivatives (CDS and IRS) and OTC Japanese Government Bond (JGB) transactions.
With respect to commodity derivatives transactions, the Japan Commodity Clearing House Co, Ltd (JCCH) provides clearing services for transactions conducted at the TOCOM or the Osaka Dojima Commodity Exchange, and OTC commodity derivatives transactions.
Transaction information and trade repositories
Since November 2012, certain financial institutions, CCPs and trade repositories have been required to report OTC derivatives transaction information to the FSA under the FIEA. The FSA uses this data to regularly publish information regarding the number of transactions and total amounts. The DTCC Data Repository Japan has provided trade depository services in Japan as a 'foreign trade repository' under the FIEA since March 2013.
v Other strategic considerations
The FIEA, which imposes restrictions on the solicitation of certain securities transactions directed at residents in Japan (including offerings, purchases and sales of securities, but excluding securities lending and repo transactions), applies regardless of whether the solicitation is domestic or from overseas. This means that direct solicitation for securities transactions is permitted without satisfying licensing requirements only when it is directed at QIIs such as banks, FIOs and insurance companies. All other direct solicitation for securities transactions directed at residents in Japan is strictly prohibited by the FIEA and requires agency or intermediary services by a licensed FIO. Similar but different standards apply to the solicitation of derivatives transactions from overseas (which are also controlled by the FIEA). In any event, careful legal due diligence is highly recommended before entering into securities transactions with residents in Japan.
Money-lending activities from overseas to residents in Japan are restricted mainly under the Money Lending Business Act18 and the Usury Act.19 In brief, direct lending from overseas to residents in Japan is prohibited except when a foreign bank uses a branch in Japan that is licensed as the foreign bank's branch under the Banking Act or a borrower is an affiliate company of the lender. This restriction does not apply if the borrowing is made in the form of a bond issuance.
Note that the FSA is promoting the development of fintech. To date, the FSA has made amendments to the Banking Act, the FIEA and the PSA to facilitate fintech-related business in financial sectors. The need for multiple amendments reflects the fact that financial institutions are subject to different regulations depending on which sector the institution belongs to (see Section I.i).
For example, in 2017, the Banking Act was amended to allow a bank to hold the ownership of a fintech company. An amendment to the PSA became effective in April 2017 for a 'cryptocurrency exchange service', which is defined as any business relating to (1) the sale and purchase or exchange of cryptocurrencies, (2) an intermediary, agency or delegation for a sale and purchase or exchange and (3) the management of users' money or cryptocurrencies in connection with points (1) or (2). Before conducting a cryptocurrency exchange service in Japan, it is necessary to register as a cryptocurrency exchange service provider, which needs to be a stock company20 or a foreign cryptocurrency exchange service provider having at least one office in Japan, and needs to have a minimum capital amount of ¥10 million. A registered cryptocurrency exchange service provider is under certain obligations, including:
- to keep customer information secure, to ensure the proper implementation of the services;
- to provide users with sufficient explanation;
- to segregate users' assets from its own assets;
- to maintain books and records; and
- to submit an annual business report.
Furthermore, the amendment to the Banking Act that was implemented in June 2018 has newly regulated electronic payment intermediate services providers, which display users' bank account statements and provide payment-related services from or to users' bank accounts, as intermediaries between a bank and its customers through an application programming interface.
Having said that, the FSA recognises that it is important to see the larger picture so that it can ensure proper support for fintech-related new business that transcends conventional boundaries through technological development. In addition, the need for further protection of investors is being recognised given that cryptocurrency XEMs worth ¥58 billion were stolen as a result of a hack attack on Coincheck, one of Japan's largest cryptocurrency exchanges, in January 2018. From these perspectives, the FSA is considering the possibility of introducing further regulations or amendments to the current regulations through a discussion at the Study Group on Cryptocurrency Exchanges established in April 2018. Meanwhile, the Japan Cryptocurrency Business Association, which is the national cryptocurrency industry group, is having discussions with the FSA to establish industry self-regulation.
Overall, the government takes the lead in raising the status of Tokyo as a global financial centre. For its part in achieving this goal, the FSA aims to have its financial regulations and supervisions aligned with international trends with a view to changes in the domestic and foreign market environment. In this context, over the years, the FSA has diversified primary markets and products, established markets for professional investors, and published and accordingly revised the Corporate Governance Code, the Principles for Customer-Oriented Business Conduct (Principles of Fiduciary Duty), the Japan's Stewardship Code (Principles for Responsible Institutional Investors) and the Guidelines for Investor and Company Engagement.
Furthermore, the Civil Code21 has been amended and will be implemented on 1 April 2020. The Civil Code is the fundamental law that provides for rules regarding legal relationships between contract parties or acts of tort. Also, an amendment to the Act on the Protection of Personal Information22 came into effect on 30 May 2017, which has made clear the scope of personal information and companies' obligations as regards enhancing the protection of personal information, making the level of protection comparable to that provided by EU law (General Data Protection Regulation)23 and allowing companies to use personal information more effectively. Financial institutions should be more careful about these changes to basic laws.
III OUTLOOK AND CONCLUSIONS
Fortunately, or unfortunately, Japan is the only country that has legislation controlling cryptocurrency (formerly called virtual currency). The PSA provides regulations on cryptocurrency exchange brokers. At one time, cryptocurrency, or cryptoassets, together with blockchain or distributed ledger technology (DLT) was hailed as a new tool for changing banking and capital markets activities. It was once thought that the initial coin offering would replace the initial public offering and the DLT was said to render central banks useless. However, owing to the leakage of cryptoassets from brokers' proprietary or customer accounts (or both) by hacking and market manipulation activities by brokers, huge damage has been done to the cryptoasset industry. The government is planning to introduce further regulations and is trying to manage the current situation mainly through regulation of the self-regulatory organisation. However, how can they introduce new regulations on cryptoassets without a clear legal characterisation, which is surely a conundrum for any country?
1 Akihiro Wani is a senior counsellor and Reiko Omachi is an of counsel at Morrison & Foerster LLP / Ito & Mitomi.
2 Act No. 25 of 1948, as amended.
3 Act No. 59 of 1981, as amended.
4 Act No. 105 of 1995, as amended.
5 Act No. 239 of 1950, as amended.
6 Act No. 198 of 1951, as amended.
7 Act No. 90 of 1998, as amended.
8 Act No. 105 of 1998, as amended.
9 Act No. 108 of 2006, as amended.
10 Act No. 86 of 2005, as amended.
11 Act No. 138 of 2003, as amended.
12 Act No. 75 of 2004, as amended.
13 Act No. 225 of 1999, as amended.
14 Act No. 154 of 2002, as amended.
15 Act No. 95 of 1996, as amended.
16 Act No. 34 of 1971, as amended.
17 Act No. 59 of 2009, as amended.
18 Act No. 32 of 1983, as amended.
19 Act No. 195 of 1954, as amended.
20 This means a kabushiki kaisha, as defined under the Companies Act.
21 Act No. 89 of 1896, as amended.
22 Act No. 57 of 2003, as amended.
23 According to the European Commission's website, the adoption procedure of the adequacy decision concerning Japan was launched on 5 September 2018.