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 financial instruments business and financial transactions, including securities offerings and distributions, for the purpose of maintaining the fairness of the 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, these 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 The role of regulatory and supervisory agencies and 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, developing the financial industry, 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 (METI) 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 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 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.
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 procedure, 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 the 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.i).
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 investor 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.
Money-lending activities from overseas to residents in Japan are restricted mainly under the Money Lending Business Act12 and the Usury Act.13 In brief, direct lending from overseas to residents in Japan is prohibited except when a foreign bank uses a licensed branch or a licensed agent under the Banking Act, or when 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.
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, financial instruments business operators (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.
Recent developments in regulations
Amendments to the disclosure rules
On 31 January 2019, the FSA amended the Cabinet Office Ordinance on Disclosure of Corporate Affairs to rectify shortcomings that many annual and other periodic securities reports have, with a formulaic presentation of general financial information that lacks specific descriptions on corporate strategy. It intends to enhance annual securities reports to include narrative and non-financial descriptions. In the securities report under the amended rule:
- with respect to the section about management policies and strategies, the inclusion of, inter alia, the management's perceptions of market conditions, competitive advantages, major products and services and customer base is now required;
- regarding the section about the risks of the business, a description of the degree and timing about the likelihood of a risk materialising, the potential impact of that risk on the business and countermeasures against risks is required;
- with regard to accounting estimates and assumptions, a description of the management's perceptions regarding the uncertainty of the estimates, and of the assumptions used in such estimates, and the potential impact of possible changes on business results arising from such uncertainty, is required;
- regarding the section about executive compensation, a description of compensation programmes and policies (including information on performance-linked compensation) and the outcome of such programmes is required;
- regarding stocks held by the company for political, cross-holding or other reasons, a description of the method of reviewing whether there is a rational reason for such holdings is required; and
- regarding the section about audits, details on the activities of the board of corporate auditors, the tenure of the auditing firm and any fee paid to an auditing firm belonging to a network (network firm) need to be disclosed.
In addition, the FSA published the Principles for the Disclosure of Narrative Information and the Reference Casebook of Good Practices on the Disclosure of Narrative Information on 19 March 2019. The FSA is encouraging corporations to enhance their disclosure beyond mere compliance with regulatory formalities so that it should be useful for investment decisions and for constructive dialogue between investors and corporations.
Further to the above, by an amendment to the Cabinet Office Ordinance on Disclosure of Corporate Affairs on 21 June 2019, a description of an auditor's opinion in unusual situations will be upgraded and improved. More specifically, in the event that an accounting auditor is replaced by a newly appointed accounting auditor, corporations would be required to describe the opinions of the corporate auditors and of the accounting auditor to be replaced, and also the substantive reasons for the change of accounting auditors, in the extraordinary report. Incidentally, the disclosure requirements for an issuance of certain stock compensation have also been revised. Under the revised rules, the obligation to file securities registration statements under the FIEA is exempted if shares with a restriction on transfer for a certain period are solicited from or offered to the directors, officers or employees of the issuing company or a wholly owned subsidiary. Instead of filing a securities registration statement, an extraordinary report is required to be submitted in the same way as per stock options. According to the FSA, these amendments are part of a strategy for strengthening corporate governance, making it easier for companies to introduce stock-based compensation such as restricted shares or performance shares referred to in the Guidebook for Introducing Incentive Plans for Sustainable Corporate Growth as Board Members' Compensation to Encourage Companies to Promote Proactive Business Management published by the METI.
New exemption from takeover bid rules
Under Japanese law, in principle, a tender offer is not required in the case of securities transactions on the Japanese financial instruments exchange market. On the contrary, to secure transparency and fairness of securities trading, the FIEA makes it obligatory to follow the takeover bid (TOB) regulations in the case of certain transactions made outside of the Japanese financial instruments exchange market, and it was considered that securities transactions conducted on foreign financial instruments exchange markets fell under those cases.
In this regard, the FSA amended the Cabinet Order of the FIEA on 29 April 2019. By this amendment, transactions that are traded on foreign financial instruments exchange markets, and considered non-detrimental to investor protections, are not subject to TOB regulations under the FIEA even if securities obtained therein are not purchased by means of tender offers.
Margin trading on proprietary trading systems
Margin transactions were assumed to be conducted only on financial instruments exchanges, and the FSA held the view that margin transactions on proprietary trading systems (PTSs) were not allowed. However, on 1 April 2019, the FSA lifted the ban on margin trading on PTSs by amending the Cabinet Office Ordinance of the FIEA and the Comprehensive Guidelines for Supervision of Financial Instruments Business Operators (Supervisory Guidelines). With these amendments, a financial instruments business operator (FIO) that operates PTSs is required to take preventive measures regarding conflicts of interest and appropriate measures equivalent to the self-regulatory functions of stock exchanges by which, for example, a PTS operator needs to publish data regarding transaction balances of margin trading and to investigate trading participants on the status of their compliance with the trading rules.
Curtailing settlement risks
For some years, the JSDA has been actively advancing efforts to shorten settlement cycles for Japanese government bonds (JGBs) and stock trades to facilitate and strengthen the functioning of the capital markets. As a result, the settlement cycle of JGBs has been shortened from T+2 to T+1 since 1 May 2018, and the new stock settlement cycle T+2 has been implemented since 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 (financial benchmark administrators) that set financial benchmarks, such as the Tokyo Interbank Offered Rate (TIBOR). Under the 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 inspections. 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 conflicts of interest) 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.
In July 2017, JBATA implemented a JBA TIBOR reform in line with the principle of IOSCO, expecting that financial indices would 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' in 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. Although TIBOR+ currently consists of Japanese Yen TIBOR and Euroyen TIBOR, the consolidation of those rates to Japanese Yen TIBOR is now under consideration.
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.
Apart from the above, a study group under the Bank of Japan is discussing preparations for the discontinuation of LIBOR. It is expected that the discontinuation of LIBOR may have a significant impact on the financial markets in Japan as well as other major countries. The study group issued a Public Consultation on the Appropriate Choice and Usage of Japanese Yen Interest Rate Benchmarks on 2 July 2019 and will continue discussions after soliciting comments from a wider range of relevant parties. In addition, the FSA has created a new webpage to disseminate information relevant to the discontinuation of LIBOR, and has expressed its stance of supporting the financial market during the transitional period.
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 regarding 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 amendments (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
Margin requirements on derivatives
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. For more about 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 counterparties on a bilateral basis, with some exceptions. For both IM and VM, there 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 2019 to 31 August 2020, IM obligations are applied to entities with an initial de minimis threshold of ¥105 trillion. Thereafter, IM obligations will be applied to entities with an initial de minimis threshold of ¥7 trillion from 1 September 2020 to 31 August 2021, which will be lowered to ¥1.1 trillion on 1 September 2021, which will be the first day of the final portion of the IM phase-in period. After the IM phase-in period ends on 1 September 2021, 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 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 Supervisory Guidelines to establish internal systems reasonably designed for the appropriate posting and collection of VM in line with BCBS-IOSCO's final report.
On 25 April 2019, the FSA updated the regulatory notice designating foreign margin rules for non-centrally cleared OTC derivatives pertaining to the adoption of substituted compliance based on equivalence assessments. This regulatory notice intends to avoid the duplicative application of Japanese and foreign margin requirements. Based on dialogue between the FSA and foreign authorities, the regulatory notice newly designates margin rules applicable to the countries under the European Economic Area Agreement as rules deemed equivalent to the corresponding margin rules of Japan. Prior to this update, foreign margin rules that are under jurisdiction of the US Commodity Futures Trading Commission (CFTC), the Office of the Superintendent of Financial Institutions (Canada), the Australian Prudential Regulation Authority, the Hong Kong Monetary Authority and the Monetary Authority of Singapore have been respectively designated.
Close-out netting upon an event of default of insolvency
In relation to IM requirements, the bill to amend the Close-out Netting Act14 has passed at the Diet and will be enforced before 1 September 2020; that was expected to be the first day of the final portion of the IM phase-in period for non-centrally cleared derivatives. Under the current Close-out Netting Act, collaterals in the form of borrowing or lending assets are validly netted out even if the counterparty goes insolvent, but the Act does not provide for the validity and enforceability of the close-out netting arrangement of collaterals in a form of a pledge. Therefore, especially under the Japanese corporate reorganisation proceedings, there had been a concern that collateral taking the form of a pledge is subject to the restriction under the corporate reorganisation procedure and is not fully enforceable. By this amendment, however, the Close-out Netting Act will clearly stipulate that a close-out netting arrangement of collateral taking the form of a pledge would be enforceable under any Japanese insolvency proceedings, including corporate reorganisation proceedings. It should be noted that the applicable scope of collateral taking the form of a pledge would be expected to be limited to those posted as IM, considering that this amendment is to be made in order to satisfy requirements under the non-cleared margin rules issued by BCBS-IOSCO that IM must be immediately available to the collecting party in the event of the counterparty's default, regardless of any form of IM collateral. The enforcement order and the Cabinet Office ordinances of the Close-out Netting Act relating to this amendment are still under discussion.
Regulation of shadow banking
Based on an FSB report entitled Strengthening Oversight and Regulation of Shadow Banking, published in 2013, the FSA has made some amendments to the regulation of shadow banking. In addition to those amendments, on 1 July 2019, the Cabinet Office Ordinances on the FIEA were amended to reflect the Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos of the FSB's report, which mainly regulates the reinvestment of cash collateral provided under securities lending or repos with maturity or liquidity transformation or leverage risks in order to follow FSB policy. Typically, under the amendment, FIOs engaging in investment management business are required to upgrade the content of the reinvestment reports for their customers by adding certain elements to the statutory limits pertaining to the reinvestment of cash collaterals and setting certain requirements regarding the assessment or management of the value of collaterals.
Real estate funds and real estate investment trusts
In the investment management business, transactions between two funds, where one fund investing in the other fund has the same FIO acting as investment manager, have been basically prohibited for the purpose of preventing conflicts of interest, with some exceptions. In the case of real estate funds or real estate investment trusts (REITs), such transactions had been allowed when all investors gave their consent. This restriction was relaxed through an amendment of the Cabinet Office Ordinance on the FIEA on 5 June 2019 in view of the increasing number of investors investing in real estate funds or REITs. Under this amendment, transactions between two real estate funds or REITs investing in other funds have become allowed if all rights holders of the funds are composed only of QIIs, the transaction price is calculated by appraisal or other reasonable method, and more than two-thirds of all right holders has given their consent.
Japan–China exchange-traded fund connectivity scheme
Japan Exchange Group, Inc (JPX), a holding company of Tokyo Stock Exchange, Inc (TSE) and Shanghai Stock Exchange, have agreed to collaborate on a scheme for linking the exchange-traded fund (ETF) markets of both exchanges. The Japan–China ETF Connectivity scheme aims to create more opportunities for cross-border securities investment between Japan and China, and feeder ETFs of ETFs investing in Japanese or Chinese assets are able to be listed on the market in the other country. The trading under this scheme is based on qualified foreign institutional investor (QFII) and qualified domestic institutional investor (QDII) quotas especially created for the scheme. A Japanese investment management company to which a QFII or QDII quota has been allocated by the Chinese regulator is allowed to set up cross-border funds to invest in ETF products in China. Eligible target ETFs will initially be limited to those ETFs that track stock indices, and they must satisfy liquidity requirements and have been listed for more than one year. Similarly, feeder ETFs of TSE-listed ETFs in Shanghai will allow Chinese investors to indirectly invest in Japan.
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 vary depending on whether a 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 on a case-by-case basis, and it did not refer to any other foreign limited partnership.
It should also be noted that the government emphasises the OECD/G20 BEPS 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) for the past few years. Under the 2019 Tax Reform Act, in line with the recommendations in BEPS Actions 4 and 8, restrictions on interest deductions (earning stripping rules) and the transfer pricing legislation will be revised. Further, the controlled foreign company income taxation regime that had been amended in the 2017 and 2018 Tax Reform Act was further amended by the 2019 Tax Reform Act to make necessary adjustments in terms of foreign tax laws or practices.
Apart from the above, the following reforms on domestic taxation that may affect foreign or domestic investors have recently been implemented.
First, a period of tax exemptions for interest income arising from repo transactions of book-entry JGBs or certain foreign bonds having high liquidity between specified financial institutions and specified foreign companies has been extended for another two years to 31 March 2021. The purpose of these tax exemptions is to encourage foreign investors to participate in Japanese repo markets.
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 can make investments of up to ¥400,000 per year tax-free, and can hold an ISA for a maximum of 20 years for the period running from 2018 to 2037. The government continues to proactively promote the use of NISAs, because these accounts steadily increase individuals' participation in the stock market and have attracted the interest of retail investors.
Third, with regard to cryptocurrencies defined in the Payment Services Act (PSA),15 the valuation of cryptocurrencies for individuals at fiscal year end, and the valuation method and recognition methods of capital gains or losses and other matters concerning cryptocurrencies for companies, have been or will be clarified under the 2019 Tax Reform Act and any relevant rules to be issued.
With respect to consumption tax, the tax rate was raised from 8 to 10 per cent on 1 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,16 the Civil Rehabilitation Act,17 the Corporate Reorganisation Act,18 the Companies Act and the Act Concerning the Special Provisions for the Reorganisation of Financial Institutions.19 In addition, in line with the international agreement reached at the FSB and G20 Cannes Summit on 4 November 2011, the Deposit Insurance Act20 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 of time that 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. Regarding the revision of Close-out Netting Act setting forth the enforceability of close-out netting of financial transactions under the insolvency proceedings, see Section II.ii.
With regard to the Principles on Loss Absorbing and Recapitalisation Capacity of G-SIBs (Global Systemically Important Banks), under a resolution published by the FSB, the FSA has published a draft of a new pronouncement designating entities subject to the total loss absorbing capacity (TLAC) requirements among FIOs that are subsidiaries of foreign companies. The draft of the new pronouncement also stipulates that the required standards for internal TLAC and qualification requirements that should be satisfied by those FIOs. The final pronouncement is scheduled to be enforced on 31 March 2020.
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.
The JPX is the largest company operating financial instruments exchange markets to provide market users with venues for cash equity trading through its subsidiary, TSE, and for derivatives trading through Osaka Exchange, Inc (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. Finally, the JPX is scheduled to commence commodity trading operations in the first half of fiscal 2020 after making Tokyo Commodity Exchange Inc (TOCOM), a wholly owned subsidiary.
Other than above, there are four financial instruments exchanges (Nagoya Stock Exchange, Sapporo Securities Exchange, Fukuoka Stock Exchange and Tokyo Financial Exchange (TFX)) and one commodity exchange (Osaka Dojima Commodity Exchange.)
There have been no material amendments to regulations for financial instruments exchanges under the FIEA or for commodity exchanges under the CDA recently.
On a practical level, the government has been pushing for the creation of an integrated exchange to make the JPX become more competitive among global financial hubs for a long time, while the TOCOM was reluctant to become a subsidiary of the JPX and was seeking alternative survival strategies amid Japan's shrinking commodities market. After long talks, the JPX and the TOCOM agreed in March 2019 that they will merge their businesses by transferring most of the futures listed on the TOCOM – precious metals, rubber, agricultural products and sugar – to the OSE. At the same time, as the METI plans to launch an energy market, the JPX and the TOCOM have agreed that oil futures currently listed on the TOCOM will not be transferred to the OSE, and that they will continue considering listing electricity and liquefied natural gas futures on the TOCOM. In the first half of fiscal year 2020, the merger and transferring proceedings will be completed and the new operation will be started under the consolidated exchanges.
Apart from traditional financial instruments exchanges, cryptocurrency exchange services have been newly regulated by the amended PSA21 or the FIEA (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 transactions with a party that is not an FIO or RFI, transactions that are booked in a trust account or 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 when the monthly average outstanding notional amount of OTC derivatives is ¥300 billion or more, or when the monthly average outstanding notional amount of property booked in a trust account of an FIO or RFI is ¥300 billion or more.
On a practical level, the JSCC provides clearing services for many listed products, such as OTC derivatives (CDS and IRS) and OTC JGB transactions traded on any financial instruments exchange in Japan.
With respect to commodity derivatives transactions, the Japan Commodity Clearing House Co, Ltd (JCCH) provides clearing services for transactions conducted at any commodity exchange, and OTC commodity derivatives transactions. The TFX also provides clearing services for products listed on the TFX, and is planning to provide new clearing services for OTC FX transactions.
In line with the integration of the JPX and the TOCOM (see above), clearance functions of the JSCC and JCCH will also be integrated by the first half of fiscal year 2020.
Swap execution facilities
The FSA and the CFTC issued a joint statement regarding the comparability of certain derivatives trading venues in the US and Japan on 12 July 2019. The CFTC will exempt certain electronic derivatives trading facilities (electronic trading platforms (ETPs)) regulated by the FSA from the requirement to register with the CFTC as swap execution facilities (SEFs), and the FSA will also facilitate the authorisation process of foreign ETP and SEF operators for the derivative platforms authorised and supervised by the CFTC. The FSA and the CFTC aim to work cooperatively across borders to promote growth and innovation while supporting financial stability in the field of the cross-border swaps trading framework.
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
Fintech and cryptoassets
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 upon which sector the institution belongs to (see Section I.i). The FSA also published the Discussion Paper on Dialogues and Practices Regarding IT Governance at Financial Institutions on 14 March 2019. In light of the growing importance of optimising IT systems at financial institutions in carrying out their respective strategies to enhance corporate values, the Paper mainly outlines key discussion points when the FSA holds dialogues on IT governance with financial institutions.
Since April 2019, it has become necessary to be registered as a cryptocurrency exchange service provider, which has to be a stock company or a foreign cryptocurrency exchange service provider having at least one office in Japan, and to have a minimum capital amount of ¥10 million for a cryptocurrency exchange service 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 of cryptocurrencies, and (3) the management of users' money or cryptocurrencies in connection with (1) or (2). A registered cryptocurrency exchange service provider is under certain obligations, including:
- to keep customer information secure;
- to provide users with sufficient explanations so that they can make informed decisions;
- to segregate users' assets from its own assets;
- to maintain books and records; and
- to submit an annual business report, and be subject to the anti-money laundering and combating the financing of terrorism (AML/CFT) regulations, including the Act on Prevention of Transfer of Criminal Proceeds.
There have been incidents of customer cryptocurrencies leakages as well as inadequacies in the management systems of service providers. In addition, some cryptocurrencies have become targets for speculative investments as the price thereof has been fluctuating, and margin trading and fundraising transactions using cryptocurrencies such as initial coin offerings (ICOs) or security token offerings (STOs) are emerging. Meanwhile, the FSA considered the regulations on these businesses through a discussion at the study group on cryptocurrency exchanges, and they were also discussed with the Japan Virtual Currency Exchange Association (JVCEA), which is the national cryptocurrency industry group, to make it begin industry self-regulation, which was introduced in late 2018.
Given these situations, the amendments to the PSA to be enforced in the first half of 2020 newly regulate that cryptoasset exchange or custody services (dealing with cryptoassets other than highly liquid tokens representing electronically transferrable rights (security tokens)) must be registered as a cryptoasset exchange servicer (replacing the current cryptocurrency exchange service provider) under the PSA, and a cryptoasset exchange servicer will be subject to self-regulation under the JVCEA. It is also required to maintain customers' cryptoassets in a safe and secure method like an offline wallet (cold storage), and hold its own cryptoassets of the same type and quality as those of customers that shall be segregated from other assets. Furthermore, new regulations on advertisements of or solicitations for cryptoasset transactions will be implemented, and new regulations on cryptoasset margin trading will be introduced that are similar to foreign exchange margin trading. Not only that, OTC derivative transactions referring to cryptoassets will be specifically regulated by the FIEA, because cryptoassets will be newly designated as financial instruments that are regulated by the FIEA.
With respect to security tokens, any electronically transferrable rights representing profits or losses arising from cryptoassets issued in the STO or other investment schemes will be regulated as Type I securities under the FIEA. This means that the offering or trading of such rights through the STO or other collective investment schemes defined under the FIEA will be subject to disclosure requirements applicable to securities transactions under the FIEA. As a result, a person engaged in a business relevant to derivative transactions or offering or trading relevant to security tokens will need to be registered as Type I FIO in principle. Additionally, the amended FIEA will prohibit unfair trading and price manipulation involving cryptoassets. The FSA also amended the section on virtual currency (cryptoasset) exchange services under the Guidelines for Administrative Processes in September 2019, which intends to ensure appropriate business management structures and appropriate responses in the event of fraudulent leakage of assets and to add some supervisory focal points pertaining to ICO or STO.
Alongside this, the FSA is considering a financial systemic reform relating to the payment and settlement intermediary services, and it is expected that a reform bill to be created based on the report published by the Financial System Council on 26 July 2019 will be submitted to the Diet in 2020.
Corporate governance reform
Overall, the government has been making efforts on corporate governance reform that is highlighted as one of the most important points in Prime Minister Abe's growth strategy. Typically, in 2014, the Companies Act was amended to enhance corporate governance and to establish a subsidiary governance framework. Thereafter, while the amended Companies Act has promoted corporate governance of Japanese corporations, such as increasing the number of outside directors at listed companies, the government continues to seek a desirable approach that can further substantively strengthen corporate governance. In this context, the METI revised the Practical Guidelines for Corporate Governance Systems in September 2018 and newly formulated the Practical Guidelines for Group Governance Systems in June 2019. Not only that, the Ministry of Justice is expected to submit a bill to the coming Diet session to amend the Companies Act for the purpose of rationalisation of the procedures for shareholders' meetings to make them more efficient and to improve on transparency in determining executive compensation. Concurrently, the FSA has held regular follow-up meetings about the Stewardship Code and Corporate Governance Code to review those codes and practice.
2019 will mark the fourth round of joint Financial Action Task Force–Asia/Pacific Group on Money Laundering mutual evaluations of Japan with an on-site visit scheduled from 28 October 2019, and the results will be discussed during the plenary session scheduled for June 2020. Given the 2008 report on the third mutual evaluation stating that Japan was still non-compliant with some of the 40 recommendations, the FSA and financial institutions have taken actions. Over the past year, in particular, the National Police Agency and the FSA have amended the Ordinance for Enforcement of the Act on Prevention of Transfer of Criminal Proceeds to add or amend methods of verification of customer identification data of natural persons to be completed online or conducted on a non-face-to-face transaction basis. The FSA also revised the Guidelines for Anti-Money Laundering and Combating the Financing of Terrorism on 10 April 2019, and encourages financial institutions to appropriately manage the risk of AML/CFT by, among other things, clarifying customer risk assessments as a required action for financial institutions under the customer due diligence section of the Guidelines. It should be noted that the risk-based approach is newly introduced in the Guidelines. Self-regulatory organisations like the JSDA and the Japanese Bankers Association have prepared and disseminated practical manuals or Q&As that describe points to be noted for financial institutions.
Sustainable development goals and environment, society and governance investments
In recent years, Japanese companies have been raising awareness about their sustainable development goals (SDGs) and facing trends of the expansion of international environment, society and governance (ESG) investments that would take into consideration not only financial information of target companies but also information on target companies' efforts for the environment, society and governance. In light of this trend, the government is promoting the incorporation of SDGs into the management strategies of corporations, and the SDGs Promotion Headquarters headed by the Prime Minister formulates an action plan every year. Under the government's policy, the METI launched an SDG management and ESG investment study group, which has issued its final report. The FSA has also conducted research regarding the corporate disclosure of ESG information.
With respect to personal information protection, the Act on the Protection of Personal Information22 was amended in 2017 to bring the level of protection of personal data up to global standards. Given that, in January 2019 Japan and the European Commission mutually recognised each other's personal data protection system as equivalent. Japan and EU enjoy solid protection of their personal data when transferred, while all their companies can benefit from free data transfers to each other's economies.
Furthermore, the Civil Code23 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. Financial institutions should be more careful about these changes to basic laws.
III OUTLOOK AND CONCLUSIONS
Although there exists a strong fear in the market that a crash is coming soon globally, caused by the US–China trade war, nothing has happened yet thanks to good economic conditions in the US. Having said that, it is rumoured that once the crash arrives, Japanese small and medium-sized regional banks will be heavily hit, because they already have been damaged by the lower (or negative) interest rate policy of the Bank of Japan to achieve quantitative and qualitative easing, and by the rapid depopulation of the regions that these banks have been serving. To strengthen their competitiveness, mergers or the stepping over of lower level business alliances among many regional banks are expected to accelerate under the leadership of the FSA. However, mergers of regional banks may trigger the deterioration of services for the people living in such areas. The concept of fiduciary duty is recommended by the FSA to be implemented at financial institutions such as banks and securities companies as soft law, but how to implement such duty in the problematic regional areas is a big challenge.
It should be also noted that the benchmark reform in or outside Japan may affect Japanese financial institutions in the near future. The benchmark reform in Japan in line with IOSCO's principles is mostly complete with regard to TIBOR, which consists of Japanese Yen TIBOR and Euroyen TIBOR (see Section II.i), and TIBOR has been operated in a quite stable and reliable way. On the other hand, the preparation of the RFR in Japan recommended by the FSB is still under construction. TONA will be the first RFR for the Tokyo markets, but the creation of TONA, with tenors such as six-month TONA, is a difficult task. We believe it will take some time for TONA to be ready to go as an RFR.
At the same time, the shutdown of LIBOR, scheduled for the end of 2021, will have a considerable impact on various types of financial products traded in or outside Japan. International Swaps and Derivatives Association (ISDA) is in the process of establishing fallback procedures for such cessation, but financial products not referring to ISDA are outside of such procedures. While the FSA has already given the market warnings about moving to other benchmarks or to adopt the fallback provisions, the reaction of the market is still slow, as it is in other areas of the world.
Finally, it must be mentioned that the Diet passed a bill in June 2019 to amend the PSA and the FIEA to cope with the development of the situation surrounding cryptoassets (see Section II.v.). These amendments indicate that Japan is one of the front-running countries in trying to regulate cryptoassets in a reasonable way, but there still seems to be many challenges. As one example, ICOs have become officially recognised in Japan by the amendment, but the requirements are so difficult to satisfy, and therefore ICOs will be very hard to achieve in practice.
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. 32 of 1983, as amended.
13 Act No. 195 of 1954, as amended.
14 Act No.108 of 2008, as amended.
15 Act No. 59 of 2009, as amended.
16 Act No. 75 of 2004, as amended.
17 Act No. 225 of 1999, as amended.
18 Act No. 154 of 2002, as amended.
19 Act No. 95 of 1996, as amended.
20 Act No. 34 of 1971, as amended.
21 Act No. 59 of 2009, as amended.
22 Act No. 57 of 2003, as amended.
23 Act No. 89 of 1896, as amended.