Retail funds

Available vehicles

What are the main legal vehicles used to set up a retail fund? How are they formed?

The legal vehicles most commonly used to set up a retail fund are open-ended investment trusts. For such an investment trust to be formed, the operator of the trust fund will prepare a trust deed and file its content with the Japanese regulator, and prepare and enter into a trust agreement with a trustee (normally a trust bank) to set up a trust. The fund interest will be issued to the beneficiaries of the trust. Typically, these funds are publicly offered to wide-ranging retail investors through securities companies, in which case a securities registration statement must be filed with the FSA.

A closed-ended investment corporation investing in real estate-related assets and foreign-domiciled unit trusts is also a popular investment structure for retail investors in Japan. However, for the purpose of this chapter, unless specifically stated otherwise, the explanation will be focused on publicly offered investment trusts, which are the most common type of retail funds offered in Japan.

Laws and regulations

What are the key laws and other sets of rules that govern retail funds?

The FIEA primarily governs the authorisation of investment management business and regulates the activities of investment managers, acting as fund operators, who are registered under the FIEA. It also regulates the offering, placement and marketing of Category I securities, which include interests in investment trusts. The LITIC regulates domestic and foreign investment trusts as well as investment corporations formed or offered in Japan, and governs the following:

  • the structure, organisation and operation of such funds;
  • information to be included in the trust deed;
  • rights of the beneficiaries; and
  • disclosures to investors including investment management reports.

Self-regulatory organisations such as the Investment Trusts Association of Japan (ITA) also provide detailed rules in relation to the above matters.

Authorisation

Must retail funds be authorised or licensed to be established or marketed in your jurisdiction?

As set out in question 12, the fund operator must file a trust deed with the regulator before entering into a trust agreement with the trustee. Under the LITIC, a trust agreement must be entered into between an operator, who must be an investment manager registered under the FIEA, and a trustee, who must be a trust company authorised under the Act on Concurrent Operation, etc, of Trust Business by Financial Institutions. (In the case of a foreign investment trust established under a foreign law, a notification must be filed with the FSA before beginning solicitation of the fund interest.)

Marketing

Who can market retail funds? To whom can they be marketed?

If a registered investment manager acting as an operator of the fund intends to market the interest of such fund directly to investors, registration as a Type II financial instruments firm will also be required. However, in the case of publicly offered investment trusts, an operator will normally retain a third-party securities firm (or other registered financial institution) to handle the marketing of such fund interests. To market such Category I security, a Type I financial instruments firm registration is required (see question 7). There is no restriction on the people to whom such fund interests can be marketed.

Managers and operators

Are there any special requirements that apply to managers or operators of retail funds?

As provided under question 14, an operator of an investment trust must be a registered investment manager (see question 3 for the eligibility requirement to register as an investment manager with the FSA). By law, an investment manager owes a duty of loyalty and the duty of care required of a prudent manager in managing the assets of the investment trust. In addition, investment managers and their officers and employees are required to perform their duties towards their customers with sincerity and fairness. They are also subject to certain rules of conduct, such as avoiding conflicts of interest.

Investment and borrowing restrictions

What are the investment and borrowing restrictions on retail funds?

There are certain investment and borrowing restrictions placed on a publicly offered investment trust under the FIEA, the LITIC and the self-regulatory rules of the ITA in Japan.

An investment trust may acquire no more than 50 per cent of the shares in a single issuer. Assets of the investment trust may be invested in other fund interests (but with a limitation of no more than 5 per cent of the net assets) but may not be invested in a fund of funds (an investment trust that makes investments in other investment trusts or investment corporations). An investment trust may invest in derivative instruments; however, such transaction may not be conducted when a risk equivalent amount calculated by a reasonable method (ie, any of the three methods proposed by the ITA) is expected to exceed the net assets of the investment trust. From the perspective of diversification of credit risks, no more than 20 per cent in total of the assets of the investment trust may be invested in securities of a single issuer (and no more than 10 per cent each in the stocks, bonds and derivative products of such issuer).

Borrowing of money by the investment trust is limited for the purpose of the payment of redemption amounts and, in the case of an investment trust where distributed amounts can be reinvested, the distribution of dividends, to the extent of the amount necessary to make such payments.

Tax treatment

What is the tax treatment of retail funds? Are exemptions available?

Under the tax laws of Japan, a publicly offered investment trust is not subject to taxation with respect to the profits or income gained through the investment of trust assets. Distributions made by the investment trust to investors are subject to a withholding tax at the rate of 20.315 per cent (as of January 2019), except that distributions that are, in substance, a return of the principle, are non-taxable. Profits gained upon redemption or liquidation of interests are also generally taxable at the rate of 20.315 per cent (as of January 2019). (Tax treatment of a publicly offered foreign investment trust is generally the same as that of a domestic investment trust.)

Asset protection

Must the portfolio of assets of a retail fund be held by a separate local custodian? What regulations are in place to protect the fund’s assets?

In the case of an investment trust formed under the LITIC, an investment manager and a trustee company will enter into a trust agreement, and accordingly, it is structurally expected that the portfolio of assets be held by a trustee company. Further, to protect the assets of the trust, a trustee is obliged to segregate its own assets and those of the fund under the Trust Law of Japan.

Governance

What are the main governance requirements for a retail fund formed in your jurisdiction?

A trust deed of an investment trust must be submitted to the FSA by the investment manager before the execution of the trust agreement with the trustee. When a public offering is to be made, a securities registration statement (or a short-form statement, together with a securities report, under certain conditions) must be filed with the local finance bureau before the solicitation of fund interests, and a prospectus must be prepared and delivered to the investor. If an investor intends to acquire the fund interest, a document setting forth, inter alia, the contents of the trust deed must be delivered to the investor (unless the same information is covered in the prospectus).

With respect to the governance exercised by the holders of the fund interest, the consent of two-thirds of the voting interests is required to approve a material change to the provisions of the trust deed or a merger between investment trusts (except for mergers with a minimal impact on the interest of investors).

See question 2 for the general record-keeping requirements and question 21 for the reporting requirements of retail funds.

Reporting

What are the periodic reporting requirements for retail funds?

A publicly offered investment trust is subject to ongoing disclosure requirements after its formation. The operator of the fund must file an annual securities report to the regulator containing such information as the details of the fund, status and performance of investments, financial statements and information on the operator, as well as prepare and submit a business report for each business year to the FSA. It must also prepare the investment management reports at the end of the calculation period of the fund assets and deliver a physical short-form version and an electronic comprehensive version to the investors.

Issue, transfer and redemption of interests

Can the manager or operator place any restrictions on the issue, transfer and redemption of interests in retail funds?

Retail funds in Japan are typically structured as open-ended investment trusts and, accordingly, redemption can be requested in principle at any time to ensure liquidity of fund interests. The operator of the fund may, however, place restrictions on the redemption or purchase of interests in such retail funds, provided that such restrictions are clearly set forth in the fund prospectus. In practice, there are often funds that, inter alia, have a limited window period, have restrictions on the volume of redemptions or are subject to suspensions or cancellations of redemptions owing to the suspension of trading on the exchange.