Financial Services Agency of Japan proposes seven principles aimed at creating a customer-oriented financial services culture.
On January 19, the Financial Services Agency of Japan (JFSA) released a draft of its “Principles for Customer-Oriented Business Conduct” applicable to Financial Business Operators (FBOs) licensed and registered in Japan (FBO Principles Statement).
The FBO Principles Statement was drafted based on suggestions made in a report published by the Working Group on Financial Markets (MWG) of the Financial System Council (FSC) on December 22, 2016. The public comment period on the FBO Principles Statement ends on February 20, 2017.
The FBO Principles Statement adopts a “principles-based” (rather than “rules-based”) approach to financial services supervision and compliance. FBOs are expected to absorb the spirit of the FBO Principles Statement and use it as guidance to establish and follow clear policies that focus on the interests of customers.
At the general meeting of the FSC on April 19, 2016, the Minister for Financial Services requested that the FSC conduct an extensive review of issues relating to the financial markets and financial instruments exchanges, with the aim of securing the steady growth of the economy and steady accumulation of household financial assets in Japan. The MWG, which is part of the FSC, understands that customer-oriented business conduct is critical for the steady accumulation of household financial assets and, as such, the MWG reviewed various issues from this perspective. On December 22, 2016, the MWG published a report that suggested adopting a “principles-based” approach instead of a “rules-based” approach to financial services supervision and compliance.
The section titled “Background” notes that the MWG suggested the following in its report:
- Although in the past, relevant laws and regulations were revised to protect investors by making financial products easier to understand. . .as a side effect this regulatory framework came to be used as a minimum standard which. . .encouraged FBOs to superficially follow regulatory formalities.
- It is more desirable that FBOs demonstrate originality and ingenuity. . .to achieve best practices and to compete in providing high-quality, customer-oriented financial products and services, so that customers will be able to select among FBOs based on the quality of the services provided.
- It would be more effective to shift to a “principles-based approach” from a conventional “rules-based approach. More specifically, it would be appropriate that the regulators draft the FBO Principles Statement and encourage FBOs to adopt it, seriously consider the interests of their customers and compete in providing better, customer-oriented financial products and services.
Scope of Application
Although the FBO Principles Statement does not explicitly reference the financial institutions it covers, the broad description of Financial Business Operators suggests that all registered Financial Instruments Business Operators (FIBOs)—banks, trust banks, insurance companies, moneylenders, and other financial services providers—will be covered by the FBO Principles Statement.
We anticipate that, going forward, the FBO Principles Statement will be implemented in both the supervisory and inspection context by the relevant divisions and bureaus of the JFSA. Thus, we believe that all foreign financial groups with regulated financial intermediaries active in Japan will need to understand and implement the FBO Principles Statement.
Approach and Process
The FBO Principles Statement indicates that “when FBOs adopt the FBO Principles Statement, they are required to establish and follow a clear policy to implement customer-oriented business conduct.” Moreover, where any part of the FBO Principles Statement cannot be put into practice in light of the FBO’s circumstances, such part may be excluded, but the FBO is “required to fully explain the reasons therefore.” We believe that this “comply or explain” approach mirrors, in the financial supervisory context, the principles-based approach adopted in Japan’s recently implemented Japan’s Corporate Governance Code and Japan’s Stewardship Code.
More specifically, when FBOs adopt the FBO Principles Statement, they are required, pursuant to Principle 1 (described further below) to
- “establish” and “publish” a clear policy to implement customer-oriented business conduct,
- regularly “publish” the status of relevant activities covered by the policy, and
- “review” the policy adopted on a regular basis.
With respect to Principles 2 through 7, an FBO’s policy needs to describe the following in an easily understandable manner:
- Where the Principles are adopted, the measures by which the Principles (including the Notes to the Principles) will be implemented; and
- where the Principles are not adopted, the reason for not adopting (part of) the Principles and what alternative measures will be taken.
The FBO Principles Statement sets forth seven principles, which are as follows:
Principle 1. FBOs should establish and publish a clear policy for the implementation of client-oriented business conduct, and publish reports on the status of activities relating to this policy. The policy needs to be regularly reviewed to improve business conduct.
Principle 2. FBOs must demonstrate a high level of expertise and professional ethics and operate their businesses in an honest and fair manner for the best interest of their clients. FBOs must endeavor to make this approach a part of their corporate culture.
Principle 3. FBOs should accurately monitor potential conflicts of interest with their clients in transactions and, when they become aware of the possibility of a conflict, manage such conflict appropriately. FBOs must have an established policy to specifically deal with such situations in advance.
Principle 4. FBOs must provide detailed information regarding commissions and fees to be borne by clients, regardless of how they are named, including a description of the services for which the fees are incurred, in a manner comprehensible by clients.
Principle 5. Considering the asymmetrical distribution of information between FBOs and clients, FBOs must provide clients with important information, including information relating to sales and recommendations of financial products and services as well as the information described in Principle 4 above, in an easy-to-understand manner.
Principle 6. FBOs must obtain information regarding a client’s assets, trading experience, knowledge, needs, and purposes in relation to a transaction, and provide suitable services to clients in the creation, sale, and recommendation of the financial products.
Principle 7. FBOs must adopt remuneration and performance evaluation systems that encourage employees to act in the best interest of clients and to treat clients fairly and that facilitate the proper management of conflicts of interest and similar issues, [and] must provide employee training programs and other appropriate incentives, and must establish appropriate governance structure to achieve these objectives.
Notes to the Principles
For each Principle (except for Principles 4 and 7), the FBO Principles Statement includes one or more “Notes” that elaborate on the expected implementation of the Principle. While providing some clarification of the relevant Principle, the Notes themselves highlight several “hot button” business issues that adoption of the Principles will bring into focus for individual FBOs, especially those owned or controlled by foreign financial intermediaries.
For example, the Notes to Principle 3 stress that, when FBOs evaluate the possibility of conflicts of interest, FBOs must consider the impact on their transactions or business in scenarios where
- the FBO (as distributor) receives commissions from the financial product provider (rather than the customer) in connection with the sale or recommendation of financial products to customers;
- the FBO (as distributor) sells or recommends to a customer a product provided by a group affiliate; and
- the FBO (or the FBO group) has both a corporate business department and an investment management department, and the investment management department decides to invest in a company that has a business relationship with the corporate business department.
Unfortunately, it is not clear from Principle 3 and its Notes that mere disclosure to the customer will be sufficient to address these potential conflicts of interest.
The Notes to Principle 5 are particularly challenging for asset managers. Among the elaborations related to disclosure to customers, the Notes to Principle 5 state the following:
- The reasons for selecting a particular financial product or service promoted and any potential conflict of interest in offering the product or service and its impact on the transaction and the business is important information that must be provided to customers and should be explained.
- The possibility of “unbundling” products or services (including fee unbundling) should be indicated.
- Explanations made to customers should be proportional to the complexity of the product or service offered (including presenting information in a way that allows customers to compare financial products or services).
Recommendations for Non-Japanese Service Providers
The shift to a principles-based approach may be particularly challenging for foreign financial intermediaries with Japan operations of modest or small size. Given the objectives and generality of the Principles, it is likely that rudimentary compliance materials and irregular and perfunctory training programs will no longer be viewed as sufficient by Japanese regulators.
At a minimum, foreign financial groups with Japan operations should start considering practical approaches to meet the expectations in the Principles by doing the following:
- Scheduling and documenting meetings of head office and local management and compliance staff and putting in place an implementation plan for the FBO Principles Statement, including a policy statement incorporating and satisfying the “comply or explain” requirement.
- Establishing and publishing a written policy that is clear, non-formulaic, consistent with real situations, and developed to address the regulatory expectations set forth in the FBO Principles Statement, including a training program for employees to explain the policy developed to address the FBO Principles Statement and develop a customer-oriented corporate culture.
- Periodically reviewing—both at satellite offices and the head office—the firm’s policy incorporating the FBO Principles Statement to ensure that it is kept up to date with the expectations of Japanese regulators, and making such review available to the public.
Read the full text of the FBO Principles Statement (available in Japanese only).