The International Capital Markets Review: Japan
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 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 and investment managers 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 these 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 of 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 relevant 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 financial 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 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 when conducting cross-border transactions.
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, which are required from all listed companies in Japan.
Money-lending activities from overseas involving 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 (FIBOs) 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 FIBO. 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.
With respect to securities token offerings, see Section II.v.
Recent developments in regulations
Bond administrative assistant
Under the Companies Act, for the purpose of protecting bondholders, a company is in principle required to set up a bond manager when the company issues a corporate bond. However, if the face value of each corporate bond is ¥100 million or more, the company may be exempted from this requirement. As a result, a large number of corporate bonds are currently issued without a bond manager because fees for bond managers are expensive and it is often difficult to find an appropriate person to be a bond manager because of the strict obligations and responsibilities that attend this position. Consequently, in some cases, bondholders can suffer substantial losses and much confusion in the event of a bond default.
In response to this problem, the Companies Act was amended to allow companies to set up a 'bond administrative assistant', who would assist in administration of bonds on behalf of bondholders when the company issues a bond without a bond manager. Following this amendment, in the event that a company goes insolvent, the bond administrative assistant will have the authority to make a filing of claims on behalf of bondholders to participate in bankruptcy proceedings, rehabilitation proceedings or reorganisation proceedings and to receive payment of claims relating to the bonds.
In addition, the powers and obligations of the bond administrative assistant may be agreed in the contract between the company and the postholder. The powers and obligations of the bond administrative assistant, unlike those of bond managers, can be designed on a case-by-case basis. Notably, the person occupying the role of the bond administrative assistant is expected only to 'assist' bondholders and the important decisions on bond management need to be made by the bondholders themselves or at a bondholder meeting. This amendment will take effect by the end of June 2021.
Additionally, there are two revisions in the amended Companies Act that were made with respect to the bondholder meeting system. First, where previously the scope of matters to be resolved at bondholders' meetings had been unclear, the amended Companies Act clearly provides that a resolution of the bondholders' meeting will be necessary for a reduction in the amount of bond principal or interest. Second, a new written resolution system will be allowed at a bondholders' meeting. These amendments will also take effect by the end of June 2021.
Pre-contract documents delivered online
FIBOs are currently required to deliver certain documents describing critical information, including on risks and fees prior to the conclusion of contracts on securities products. With the amendment of the Cabinet Office Ordinance of the FIEA on 1 April 2020, such pre-contract documents for customers may now be delivered online (from the second delivery onwards). FIBOs are required to take necessary measures for their customers to be able to easily find and read those documents for five years after the transaction.
Regulations on dark pool trading
On 19 June 2020, the Cabinet Order of the FIEA and the Comprehensive Guidelines for Supervision of Financial Instruments Business Operators (the Supervisory Guidelines) were amended to improve transparency in dark pool trading. Given that several online securities companies have launched dark pool trading services for retail investors in the past few years, there are concerns that individual investors may not understand dark pool trading sufficiently. Thus, dark pool trading regulations were introduced in 2020 and FIBOs have been required to develop their capabilities and framework so that they are able to (1) monitor the operational status of dark pools, (2) clarify to the customers the terms and conditions of routing transaction orders to dark pools, as well as information on routing paths (including information on the dark pool operator and trading participants), (3) record and store information on price and time so that price improvement effectiveness of dark pool trading can be reviewed, and (4) explain the price improvement effect of each transaction to customers who have carried out transactions in the dark pools. The amendments at (1) and (2), requiring clarification, have been enforced since 1 September 2020, and the amendments at (3) and (4), regarding price improvements, will be enforced on 1 September 2021. Correspondingly, the Tokyo Stock Exchange, Inc (TSE) has amended its trading rules for a dark pool venue (the ToSTNeT Market) to introduce a flag to identify orders matched in dark pools that are routed to the ToSTNeT Market. Also, the TSE has prohibited all margin transactions in the ToSTNeT Market, with limited exceptions.
Listing and disclosure rules
Based on the Japanese government's Action Plan dated 21 June 2019, the TSE made revisions to its listing and disclosure rules for the purpose of enhancing competitiveness and obtaining investors' trust in Japanese companies.
First, a listed company with a listed subsidiary will be required to disclose in its corporate governance report (1) a policy on the corporate group's management and (2) measures taken to ensure effectiveness of the governance over the listed subsidiary. In addition, the listed company is prohibited from appointing any person who has worked for the parent or an affiliated company within the past 10 years as an 'independent' director or auditor.
Second, delisting criteria for listed companies has been relaxed, so companies that have insufficient sales over a long period but maintain a high growth potential may remain listed. More specifically, even if a TSE Mothers-listed company has posted total sales of less than ¥100 million in the past 12 months, the company can remain listed on condition that the company submit a document presenting its high growth potential. If the company has a market capitalisation of ¥4 billion or more, it does not have to submit a high-growth potential presentation document. Similarly, even where the operating profit of a JASDAQ-listed company has fallen into negative numbers for five consecutive years, the company may remain listed if the company meets the criteria equivalent to those for the initial listing examination.
Expansion of exceptions to insider trading prohibitions
The FSA amended the Cabinet Office Ordinance on Definitions under Article 2 of the FIEA in September 2020. In light of a current trend for diversification of corporate group management (including staffing allocation), the scope of employees who may be exempt from insider trading prohibitions has been expanded because employees of affiliate companies can often be seen as participants in the same employee stock ownership plan under the same business group.
In addition to the above amendment, the FSA revised the FAQ on insider trading regulations in July 2019. Unlike the previous edition, which focused on describing the transactions that conflict with insider trading regulations, the revised version of the FAQ has shifted its focus to explain the circumstances under which investors can trade without worrying about insider trading regulations. Among other things, because it had been said that many Japanese companies have their own internal rules prohibiting or restricting trading of listed stocks more broadly to prevent insider trading, the FAQ has clarified that a transaction would not be prohibited if the person did not know material facts or knew only the material facts that had been published. With the amendment to the FAQ, the FSA aims to increase stock trading volume in Japanese stock markets by providing an easy understanding of the basics of insider trading regulations.
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 with the financial benchmark administrator. Manipulative activities by FIBOs or registered financial institutions (RFIs) are prohibited and sanctioned. The FSA has designated the Japanese Bankers Association (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 the JBA TIBOR.
JBATA has implemented and is still promoting a JBA TIBOR reform in line with IOSCO principles. For example, JBATA amended its rules in July 2017 to prescribe the integrated and clarified calculation or determination process that all reference banks need to follow, and reformed the financial index (TIBOR) to reflect the actual funding cost of the reference banks or financial institutions. Further, although the TIBOR currently consists of Japanese yen TIBOR and Euroyen TIBOR, the consolidation of those rates to Japanese yen TIBOR is now under consideration to deal with the shrinking of the Japan offshore market.
In addition, to establish an alternative to interbank offered rates for yen, the Tokyo Overnight Average Rate (TONA), which is an uncollateralised overnight call rate, was chosen as a risk-free rate (RFR) in 2016. Further, the calculation and publication of the Tokyo Term Risk Free Rate (TORF) based on the yen overnight index swap started in February 2020. It should be noted that the calculation and publication of the TORF has required a two-phase approach, with Phase 1 consisting of publication of the TORF as a 'prototype rate' so that market participants and benchmark users can prepare for use, and Phase 2 consisting of publication of the TORF as a 'production rate' to be used for actual transactions in and after 2021. Although some other countries are considering a transition from interbank offered rates, such as LIBOR, to RFRs, Japan is pursuing the multiple rate approach recommended in the FSB 2014 report Reforming Major Interest Rate Benchmarks – TIBOR and RFRs – which means that TONA or TORF 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 derivatives markets. The Bank of Japan and market participants will continue to discuss the planning necessary to establish TONA and TORF best practices by the end of 2021.
Furthermore, the discontinuation of LIBOR is expected to have a significant impact on the financial markets in both Japan and other major countries. LIBOR is mainly referenced in derivatives contracts such as interest rate swaps and also quoted in a significant number of cash products, including corporate loans and bonds. The FSA and the Bank of Japan have taken several actions cooperatively so that market participants can make a smooth transition from LIBOR; for example, conducting a survey on the use of LIBOR and sending letters to the chief executive officers of financial institutions to request submission of materials so that the FSA can review the progress of preparedness in individual firms. In addition, the JBA, the International Swaps and Derivatives Association Japan working groups, the Accounting Standards Board of Japan and other industry associations are also taking initiatives to support the financial institutions by providing information and preparing many materials regarding the transition.
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.
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 recently. (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, implementing the margin requirements for non-centrally cleared derivatives stipulated by the Basel Committee on Banking Supervision and IOSCO (BCBS-IOSCO). These rules require that FIBOs engaged in Type I financial instruments business (Type I FIBOs) 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, IM obligations have been applied to entities with an initial de minimis threshold of ¥105 trillion. In line with the announcement made by BCBS-IOSCO suggesting a one-year extension for the completion of the final two implementation phases of IM obligations because of the impact of the spread of covid-19, the start dates of the subsequent phase-in periods would each be delayed by one year. As a result, after the current phase-in period ends on 31 August 2021, IM obligations will be applied to entities with an initial de minimis threshold of ¥7 trillion from 1 September 2021 to 31 August 2022, which will be lowered to ¥1.1 trillion on 1 September 2022, which will be the first day of the final portion of the IM phase-in period. After the IM phase-in period ends, IM will be required from 1 September 2022 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 FIBOs 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.
Under the FSA regulatory notice designating foreign margin rules for non-centrally cleared OTC derivatives pertaining to the adoption of substituted compliance based on equivalence assessments, which is intended to prevent the duplicative application of Japanese and foreign margin requirements, foreign margin rules under the control of the US Commodity Futures Trading Commission (CFTC), Canada's Office of the Superintendent of Financial Institutions, the Australian Prudential Regulation Authority, the Hong Kong Monetary Authority, the Monetary Authority of Singapore and the competent authorities defined under Article 2 of the European Markets Infrastructure Regulation have been designated respectively.
Close-out netting upon an event of default of insolvency
In relation to IM requirements, the amendment to the Close-out Netting Act14 came into force on 1 May 2020. Under the former provisions of the Close-out Netting Act, collateral in the form of borrowing or lending assets was validly netted out even if the counterparty became insolvent, but the Act did not provide for the validity and enforceability of the close-out netting arrangement of collateral in the form of a pledge or charge. There had been a concern, therefore, that collateral taking the form of a pledge or charge (a form of security used among foreign financial institutions) was subject to the restriction under the corporate reorganisation procedure and was not fully enforceable, especially under Japanese corporate reorganisation proceedings. Following this amendment, however, the Close-out Netting Act now clearly stipulates that a close-out netting arrangement of collateral taking the form of a pledge or charge is 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 is considered to be limited to collateral posted as IM, because this amendment was made 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. Details of eligible assets and eligible transactions are set out in the Cabinet Office Ordinances of the Close-out Netting Act.
Liquidity risk management for investment funds
In accordance with the IOSCO report of 2018 Recommendations for Liquidity Risk Management for Collective Investment Schemes, the FSA amended the Ordinance for Enforcement of the Act on Investment Trusts and Investment Corporations and the Cabinet Office Ordinance on Financial Instruments Business, etc. Also, the Investment Trusts Association revised its self-regulatory rules. All these amendments are aimed at introducing regulatory requirements for the liquidity risk management of open-ended funds in line with the IOSCO 2018 Liquidity Recommendations contained in the above-mentioned report. These amendments will be enforced on 1 January 2022.
Temporary operation in Japan of foreign funds
Under the amendment to the Cabinet Office Ordinance on Definitions under Article 2 of the FIEA in July 2020, if a foreign investment manager were to have difficulty in continuing its business because of disasters or other events in a foreign country, he or she would be allowed to temporarily continue the business for up to three months in Japan subject to an approval by the commissioner of the FSA. If the situation making it difficult to continue its business were not resolved in three months, it would be possible to apply for an approval to continue the business for another three months. According to media reports, this amendment is intended to attract to Japanese markets foreign funds that are suffering as a consequence of political instability, the outbreak of covid-19 or the occurrence of natural disasters overseas.
Derivative transactions referring to crypto assets have been specifically regulated by the FIEA since 1 May 2020 (see Section II.v).
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 (a 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. In contrast, the National Tax Agency (NTA) published its statement in February 2017 that it would no longer challenge the fiscally transparent entity treatment with respect to any US limited partnership. As there exist various arguments on the relationship between the Supreme Court's ruling and the NTA's statement, it is recommended to seek advice from tax experts about taxation on limited partnerships if necessary.
It should also be noted that the government has in recent years placed emphasis on the importance of the Organisation for Economic Co-operation and Development and G20's Base Erosion and Profit Shifting (BEPS) project aimed at tackling and preventing 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). The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS came into force for Japan in 2019.
In addition, the following reforms on domestic taxation that may affect foreign or domestic investors have recently been implemented.
First, a Japanese version of an individual saving account (ISA) system, called NISA, was introduced in 2014, which allows investments of up to ¥1.2 million per year tax-free if the investment is 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. For a five-year period after 2023, which will be the final year in which an ordinary ISA account can be opened, the 2020 Tax Reform Act will introduce a revised ISA programme, whereby an investor will be able to make investments of up to ¥1.02 million per year tax-free on condition that it completes certain cumulative investments of ¥200,000. As well as this ordinary ISA, another type of ISA, called the instalment-type NISA, was introduced in January 2018 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 2042. On the whole, the government continues to proactively promote the use of ISAs, because the ISA systems steadily increase individuals' participation in the stock market and have attracted the interest of retail investors.
Second, to address tax avoidance carried out by creating a capital loss for tax purposes by transferring stocks of a subsidiary with diminished value, the 2020 Tax Reform Act clarified that if a parent company receives from its subsidiary dividends exceeding 10 per cent of the book value of the shares of the subsidiary, the tax book value of the shares in the subsidiary shall be reduced by the amount of the dividends. By this amendment, the loss on transfer of stocks of a subsidiary, which was sometimes intentionally created for tax purposes, will be reduced as a result of the reduction of the book value of the stocks.
Third, for the purpose of promoting investment in innovative corporations, the 2020 Tax Reform Act has allowed a deduction in taxable corporate income in an amount equivalent to 25 per cent of an investment in certain start-ups.
Furthermore, by 2022, the 2020 Tax Reform Act will abolish the existing consolidated taxation system that treats a corporate group as if it were a single company, and a new group profit and loss sharing regime will apply from the business year starting in April 2022. This regime will allow each corporation in the group company to declare individually, while maintaining a system to aggregate profits and losses within the group. Although this regime will not be directly relevant to each financial transaction, this amendment may affect the group management scheme of Japanese companies from a tax perspective.
The insolvency laws in Japan mainly consist of the Bankruptcy Act,15 the Civil Rehabilitation Act,16 the Corporate Reorganisation Act,17 the Companies Act and the Act Concerning the Special Provisions for the Reorganisation of Financial Institutions.18 In addition, in line with the international agreement reached at the FSB and G20 Cannes Summit on 4 November 2011, the Deposit Insurance Act19 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 triggering close-out netting for a period designated by the Prime Minster. 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. See Section II.ii regarding the revision of the Close-out Netting Act setting out the enforceability of close-out netting of financial transactions under insolvency proceedings.
As in many other countries, the implementation of the Basel III standards began in 2013 in Japan and the government has established and is preparing for domestic implementation of the relevant regulations, including those on capital and liquidity requirements. Japanese financial institutions designated as global systemically important banks (or G-SIBS) or domestic systemically important banks (or D-SIBS) are taking actions to satisfy those requirements. On the whole, Japan is considered to be on track to implement most of the Basel III rules in line with the internationally agreed timeline.
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 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 (consisting of First Section, Second Section, Mothers, and the JASDAQ Standard and Growth markets), 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 investors, which consists of 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, on 1 November 2019, the JPX made Tokyo Commodity Exchange Inc (TOCOM) a wholly owned subsidiary and commenced commodity trading operations on TOCOM and OSE.
As well as these exchanges, 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).
The government has considered reform of the exchanges to be one of the most important issues from a policy and business perspective. In particular, it had been pushing for the creation of an integrated exchange to make the JPX more competitive among global financial hubs. After long talks, the JPX finally became a comprehensive exchange on 27 July 2020 by transferring most of the futures listed on the TOCOM to the OSE. By this reform, investors have become able to trade both financial and commodity derivatives – precious metals, rubber, agricultural products, sugar and oil – on a single trading account, with electricity futures still being listed on the TOCOM.
Further, the FSA and the TSE are in the process of restructuring the market sections of the TSE. Specifically, they plan to organise the existing five markets into three markets (Prime, Standard and Growth), improving convenience for investors by clearly presenting the concept of each market section and motivating listed companies to maintain sustained growth and increase corporate value even after listing, while providing a wide range of companies with listing opportunities. The Prime Section will be a market for companies satisfying the strictest criteria in respect of market capitalisation, liquidity, corporate governance, profitability, etc. The Standard Section will be a market for companies satisfying the standard level of criteria, and the Growth Section will be a market for start-ups with higher growth potential. The new market sections aim to launch in April 2022.
The JPX is also planning the launch of derivatives holiday trading at the OSE in or around 2022.
See Section II.i for details of the revision of trading rules of dark pool venues (the ToSTNeT Market) of the TSE.
Since November 2012, FIBOs 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 (CDSs) on Markit iTraxx Japan referencing the credit of no more than 50 Japanese corporations, and plain vanilla yen-denominated interest rate swaps (IRSs) referencing three-month or six-month yen LIBOR or Euroyen 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 FIBO 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 FIBO 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 FIBO or RFI is ¥300 billion or more.
On a practical level, the JSCC provides clearing services for many listed products, such as OTC derivatives (CDSs and IRSs) and OTC JGB transactions traded on any financial instruments exchange in Japan. In line with the integration of the JPX and the TOCOM (see above), clearance functions of the JSCC and the Japan Commodity Clearing House Co, Ltd have been integrated and the JSCC has been providing clearing services for transactions conducted at any commodity exchange and OTC commodity derivatives transactions since 27 July 2020. The TFX also provides clearing services for products listed on the TFX.
Swap execution facilities
The FSA and the CFTC issued a joint statement regarding the comparability of certain derivatives trading venues in the United States and Japan on 11 July 2019. At the same time, the CFTC issued an Order of Exemption for electronic derivatives trading facilities (electronic trading platforms (ETPs)) authorised in Japan, to exempt those ETPs from the requirement to register with the CFTC as swap execution facilities. In this context, in April 2020, the FSA tightened the Cabinet Order and the Supervisory Guidelines to require ETP service providers to (1) preserve all order data, including modifications and cancellations, for a period of 10 years, and (2) obtain a consent letter satisfying certain requirements from each user.
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 publish regularly information regarding the number of transactions and total amounts. Following the amendment to the FIEA in 2020, the way of reporting from a financial institution or CCP directly to the FSA will basically no longer be available by mid 2021, and all transaction information will have to be reported via a trade repository. 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 crypto assets
The FSA is promoting the development of fintech. To date, the FSA has made amendments to the Banking Act, the FIEA and the Payment Services Act (PSA)20 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).
Since April 2019, it has become necessary to register as a crypto asset exchange service provider to conduct any business relating to (1) the sale and purchase or exchange of crypto assets, (2) an intermediary agency or delegation for a sale and purchase or exchange of crypto assets, and (3) the management of users' money or crypto assets in connection with (1) or (2). A registered crypto asset exchange service provider has certain obligations, such as:
- keeping customer information secure;
- providing users with adequate explanations to allow them to make informed decisions;
- segregating users' assets from its own assets;
- maintaining books and records; and
- submitting an annual business report.
The service provider is also subject to anti-money laundering regulations and regulations combating the financing of terrorism, including the Act on Prevention of Transfer of Criminal Proceeds.
To further strengthen protections for crypto asset investors, the PSA was amended again with effect from 1 May 2020 to require custody services or wallet services dealing with crypto assets other than securities tokens (see below) to be registered as crypto asset exchange servicers under the PSA, and crypto asset exchange servicers are subject to self-regulation under the oversight of the Japan Virtual and Crypto Assets Exchange Association. It is required to maintain customers' crypto assets with a safe and secure method, such as an offline wallet (cold storage), and keep customers' crypto assets segregated from its own assets. In addition, strict regulations on advertisements of or solicitations for crypto asset transactions have been newly implemented. Also, regulations on crypto asset margin trading similar to foreign exchange margin trading rules have been newly introduced.
Furthermore, security tokens offerings (i.e., any electronically transferable rights representing profits or losses arising from crypto assets issued in security token offerings (STOs)) and other similar investment schemes have become regulated as Type I securities under the FIEA, with a few exceptions. This means that the offering or trading of these rights through STOs or other collective investment schemes are subject to disclosure requirements that are applicable to securities transactions under the FIEA. As a result, a person engaged in a business that includes offering or trading highly liquid tokens of this kind, or derivatives transactions in relation to such tokens, must be registered as a Type I FIBO in principle, and is subject to certain conduct rules. Additionally, the amended FIEA prohibits unfair trading and price manipulation regarding highly liquid token transactions. The FSA also amended the Order for Enforcement Act on Investment Trust and Investment Corporations, such that investment trusts and investment corporations may not invest more than 50 per cent of their assets in crypto assets or crypto asset derivatives transactions.
One-stop financial services intermediary
On 5 June 2020, the Diet adopted amendments to the Act on Sales of Financial Instruments that will introduce a registration system for one-stop intermediary service providers of financial services.
Under the current Act, licences or registrations for operating agency or intermediary services concerning financial products are required on a sector-by-sector basis. For example, in the case of intermediary services regarding securities trading, a person registered under the FIEA may operate an intermediate business only within the scope of securities trading subject to supervision by a particular FIBO and it is not allowed to handle other financial products governed by other financial regulations.
However, under the revised Act, it will become possible to operate an intermediate business relating not only to securities transactions, but also to, for example, bank deposit transactions and insurance transactions, without being subject to supervision by any particular company, if the business is registered as a financial services intermediary business operator. Importantly, the scope of financial products that may be intermediated by financial services intermediary business operators will be limited to relatively simple and straightforward products, which will be specified by a cabinet order or other regulations, and a certain set of conduct rules and other regulatory requirements will apply.
With these amendments, the Act on Sales of Financial Instruments will be renamed as the 'Act Concerning Provision of Financial Services', and it will come into effect within 18 months of June 2020.
In another significant amendment to the PSA, the types and classes of funds transfer service providers have been reorganised from a legislative perspective, to develop the security and convenience of payment services in a cashless society.
Corporate governance reform
Overall, the government has been making efforts on corporate governance reform, which was highlighted as one of the key aspects of Prime Minister Abe's growth strategy. For example, in 2014, the Companies Act was amended to enhance corporate governance and to establish a subsidiary governance framework. Accordingly, the METI revised the Practical Guidelines for Corporate Governance Systems in September 2018 and formulated the Practical Guidelines for Group Governance Systems in June 2019. Concurrently, the FSA has held regular follow-up meetings about the Corporate Governance Code and the Stewardship Code to review those codes and practice. In December 2019, the Companies Act was further amended to rationalise procedures for shareholders' meetings to make them more efficient and to improve transparency in determining executive compensation. Even with Abe's successor, Prime Minister Suga, having since been elected, corporate governance reforms are expected to continue in Japan.
Principles for Customer-Oriented Business Conduct and Stewardship Code
Over the past several years, one of the most significant tasks for the government has been raising the status of Tokyo as a global financial centre. To achieve this policy objective, the FSA has, since 2017, published and promoted several codes and principles. In 2020, the FSA reviewed the Principles for Customer-Oriented Business Conduct (commonly translated as the Principles of Fiduciary Duty) for financial institutions and the Principles for Responsible Institutional Investors (commonly known as Japan's Stewardship Code) for investors. According to the FSA Working Group on Financial Markets report regarding the Principles for Customer-Oriented Business Conduct, it is expected that it will be strongly recommended that FIBOs provide a key information document so that customers can easily compare financial products and services in light of many factors such as risks, fees and conflicts of interest. Also, FIBOs that create financial products are required to specify the scope of customers who are suitable for offers or sales of those financial products. Further, the Stewardship Code was amended to apply to investors in not only Japanese listed shares, but also other assets, including fixed income bonds. Investors are encouraged to consider and clarify their view and strategy on sustainability issues and to disclose their voting rationale with respect to either 'for' or 'against' votes on an agenda perceived to have conflicts of interest or that should be explained in light of the investors' voting policy.
Foreign direct investments
In light of the global trends for tightening regulations on foreign direct investments from the perspective of national security, the Foreign Exchange and Foreign Trade Act (FEFTA)21 and related regulations were amended in 2019. The important pillar of the amendment was to lower the threshold for prior notification of inward investments, which is required when foreign investors are going to acquire shares in Japanese listed companies, from 10 per cent or more to 1 per cent or more. Although this ratio of shares was previously calculated on only the number of all outstanding shares, the amendment has expanded this to include the ratio of shares calculated based on the number of voting rights as well.
In response to considerable concerns expressed by market participants that this amendment would discourage inward investments into Japanese capital markets, the Ministry of Finance (MOF) has allowed some exemptions in its regulations under the FEFTA. In essence, most foreign investors, including hedge funds, who do not intend to participate in management are exempt from the obligation of filing a prior notification, except when investing in business sectors with material implications for national security (core sectors) designated by the MOF. Furthermore, foreign financial institutions subject to supervision under Japanese or foreign countries' financial regulatory authorities are exempted from this filing obligation, including when investing in core sectors. For investors to enjoy these exemptions, certain conditions must be satisfied, namely that the investor will not (1) become a board member of the investee company, (2) propose to transfer or dispose of the investee company's business activities, or (3) access non-public information regarding the investee company's technology.
Special measures for covid-19
Because of the spread of covid-19, the government declared a state of emergency on 7 April and lifted it on 25 May 2020. The worldwide outbreak of covid-19 has affected business activities and people's lives in Japan. Like the governments of many other countries, the Japanese government has taken various measures to cope with this situation.
With respect to policies regarding financial markets or financial institutions, the following measures have been taken: (1) establishing a consultation desk for cash flow support for business operators that need funds; (2) providing emergency loans or guarantees from public financial institutions and encouraging private financial institutions to provide similar cash flow support; (3) amending the Act on Special Measures for Strengthening Financial Functions stipulating government capital injections for private financial institutions in the event of an emergency; (4) allowing the extension of the deadline for, or a delay in the submission of, statutory applications, notifications and reporting, etc. required under the financial regulations; and (5) requesting listed companies to incorporate proper information about the effect and uncertainty resulting from the covid-19 outbreak in their securities reports and other disclosure documents.
In addition to the measures described above, the government has implemented a variety of support programmes related to covid-19, such as various grants and subsidies, support for maintaining employment, and deferral or reduction of tax, social security insurance and utility charge payments.
The purpose of these measures is basically to provide emergency support to people in difficulty because of the covid-19 outbreak and, so far, these measures do not affect the principles of Japanese financial law and regulations described above (see Section III).
Outlook and conclusions
In his recent presentation, Mr Ryozo Himino, the new Commissioner of the FSA, stated that the macro-economic model of the recovery from covid-19 towards the post-pandemic stage began with the commencement of the governmental operation starting from February 2020, followed by the provision of liquidity by the Bank of Japan (through commercial banks) in March to secure the solvency of all areas of industry, including the financial institutions. These liquidity and solvency supports should foster people's confidence in society, which should ultimately lead to future recovery. The FSA's 'JFSA priorities for July 2020–June 2021' lists its three priorities, namely '1. Fight against COVID-19 and develop a better post-COVID society', '2. Make the Japanese financial and capital market more sophisticated and attractive', and '3. Reform JFSA'.
The first priority aims to support financial institutions in this difficult time, while carrying out drastic regulatory changes that have never been undertaken before, such as lifting certain restrictions on the scope of business of banks to support the recovery of their customers and the local economy. Furthermore, it is intended to promote the digitalisation of financial transactions.
The second priority is to make Japan, especially Tokyo, a core international financial centre in the global context. Notwithstanding this, the FSA seems to be struggling with the issues of non-Japanese workers resident in Japan, including in matters relating to taxes.
The third priority is to reform the FSA to serve as an agency for the development of the financial industry and of financial 'literacy', rather than imposing regulations.
Although the stepping down of Prime Minister Shinzo Abe seems to have been viewed as indicative of political turmoil, even by some sophisticated non-Japanese people, it is in fact an orderly change by a democratic country, and the successor Prime Minister will honour current FSA policy. It should also be noted that the FSA is currently equipped with many talented international experts, who will seek to work with regulators outside Japan in a more proactive way in the years ahead.
1 Akihiro Wani is a senior counsellor and Reiko Omachi is an of counsel at Morrison & Foerster Law Offices.
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. 75 of 2004, as amended.
16 Act No. 225 of 1999, as amended.
17 Act No. 154 of 2002, as amended.
18 Act No. 95 of 1996, as amended.
19 Act No. 34 of 1971, as amended.
20 Act No. 59 of 2009, as amended.
21 Act No. 228 of 1949, as amended.