Inspection Manual Released
Contents of the Manual
Asset management regulatory compliance has long been ignored by the international investment industry. This is especially true in Japan, where the supervision of insider trading, money laundering and other compliance issues has historically been lax. This is about to change.
On June 22 2002 the Japanese Financial Services Agency (FSA) released the final version of its long-awaited Inspection Manual for Investment Trust Managers and Investment Advisers. The manual outlines the processes by which the recently expanded asset management inspection division of the FSA will examine asset managers in Tokyo over the next two to three years.
The manual is the latest in a series of guidelines for financial regulatory inspectors. These have included manuals for the insurance, banking and securities industries. Ministry of Finance and FSA internal inspection manuals have also been updated as part of Japan's financial regulatory reforms. This is a response to criticisms of Japan's regulatory enforcement as inconsistent and non-transparent.
The manual clarifies what inspectors will expect to see when they arrive unannounced to review the operations of Japan's:
- 445 investment advisers (including 85 offshore advisers registered to advise domestic companies);
- 135 discretionary investment managers (which undertake the discretionary investment management of securities portfolios for Japan's insurance and pension fund industries); and
- 58 investment trust management companies (which organize and operate Japanese mutual funds).
The experience of securities compliance managers over the past 20 months proves that asset managers operating in Tokyo would be unwise to ignore the standards and expectations announced in the manual.
The manual is divided into two parts. Part 1 specifies basic compliance expectations and covers most of the activities of investment advisers. The guidelines in Part 2 are directed at the activities of investment managers in investment trust management companies, and include a detailed list of standards for the creation and maintenance of compliance control and risk management systems. Part 2 also controls the activities of discretionary investment managers.
The manual notes that its provisions should be implemented "in a manner suitable to the scale and characteristics" of each investment adviser and investment trust manager. Therefore
"even where an investment adviser or investment trust manager is not managing its business in the manner indicated in the checklists, its practice should be deemed sufficient (depending on the size of the investment adviser or investment trust management company) if its procedures are rational and ensure proper management, fair/sound business practices and protection of investors."
However, it is anticipated that the burden will mostly fall on smaller investment advisers and investment trust managers, which lack the resources to conduct full-scale compliance or employee education campaigns.
A core feature of the manual is its focus on ensuring that the upper-level management of investment advisers and investment trust managers understands the regulatory environment and its responsibility to ensure compliance.
The manual indicates that
"note should be taken of the roles and responsibilities of the board of directors, internal and external auditors, and inquiry should be made...as to whether these functions are sufficient and the locus of responsibility for internal management and external auditing [is well established]."
Further, it notes that
"inspection should endeavour to work 'from the top down' by first confirming whether executives are fully cognizant of the weak points of the institution in respect to compliance with relevant laws and regulations, the various risks to which the institution is exposed, the need to allocate sufficient resources [to compliance] and the need for sufficient internal management."
These requirements pose particular challenges to non-Japanese executive managers, who are often unfamiliar with the Japanese regulatory environment. Thus, much of the manual should be viewed as required reading not only for foreign executives on secondment, but also for all executive and group compliance staff who are to be dispatched to Japanese operations. Group compliance officers must also consider establishing basic orientation and education programmes for seconded executives and trading staff to ensure that they understand the expectations set forth in the manual.
The experiences of foreign executives and compliance officers in recent FSA examinations in the banking and securities areas indicate how seriously Japanese regulators take the substance of such inspection manuals. They are used as reference for management standards during inspection proceedings. Interviewed executives who cannot answer basic questions about their compliance responsibilities or firm risk management systems can be penalized. Penalties have ranged from requests to write apology letters admitting ignorance of the rules, to fines imposed on some individuals.
Compliance officers at asset management companies throughout Japan are now using the manual's insights to update their own internal compliance manuals, inspector 'welcome packages' and compliance education programmes. The arrival of FSA inspectors is imminent, and some will face a difficult six months of inspection. Regulatory compliance is no longer to be ignored by international participants in the Japanese asset management industry.
Copies of the Japanese language version of the manual can be found at http://www.fsa.go.jp/manual/manualj/tousi.pdf. An English translation can be obtained through Japan Financial Translations at http://www.jfti.co.jp.
For further information on this topic please contact Christopher P Wells at White & Case LLP by telephone (+81 3 3259 0200) or by fax (+81 3 3259 0150) or by email ([email protected]).