An extract from The Virtual Currency Regulation Review, 3rd Edition
Introduction to the legal and regulatory framework
Japan has one of the largest cryptoasset markets globally, and was the first country to establish a regulatory framework for cryptoassets. In addition to enabling the registration of cryptoasset exchange service providers (CAESPs) wishing to provide cryptoasset exchange services (CAES) to residents in Japan, this framework seeks to protect cryptoasset exchange customers and prevent cryptoasset-related money laundering and terrorism financing.
The cryptoasset regulatory framework in Japan has fuelled the growth of the Japanese cryptoasset market. However, this development was disrupted in January 2018 when one of the largest cryptoasset exchanges in Japan announced losses of approximately US$530 million from a cyberattack on its network, giving rise to concerns about the adequacy of the existing regulatory framework. Adding to the unease is that cryptoassets are also increasingly being used for speculative purposes, rather than as a means of settlement.
This situation eventually led to the revision of certain legislation governing cryptoassets, including the Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA). These revisions, the primary purpose of which is to strengthen the regulatory framework surrounding cryptoassets, came into force on 1 May 2020.
The key provisions of the revised FIEA (the FIEA Revisions) are to: (1) establish electronically recorded transferable rights and regulations applicable thereto; (2) introduce regulations governing cryptoasset derivative transactions; and (3) introduce regulations governing unfair acts in cryptoasset or cryptoasset derivative transactions.
The key provisions of the revised PSA (the PSA Revisions) are to: (1) revise the term 'virtual currency' to 'cryptoasset'; (2) enhance regulations governing cryptoasset custody services; and (3) tighten regulations governing CAES.
Securities and investment lawsi Establishment of electronically recorded transferable rights and tokenised securities
The FIEA has traditionally classified securities into: conventional securities, such as shares and bonds (Paragraph 1 Securities); and contractual rights, such as trust beneficiary interests and interests in collective investment schemes that are deemed securities (Paragraph 2 Securities). Paragraph 1 Securities, which are more liquid, have been subject to relatively more stringent disclosure and licensing (registration) requirements. Paragraph 2 Securities, being less liquid, have been subject to relatively more lenient requirements. Against this backdrop, securities issued using an electronic data processing system such as blockchain, are expected to be even more liquid than Paragraph 1 Securities. For this reason, the FIEA Revisions have introduced a new regulatory framework for securities transferable through electronic data processing systems. More specifically, under the FIEA Revisions, securities transferable by electronic data processing systems have been classified into the following three categories:
- Paragraph 1 Securities (such as shares and bonds) that are transferable through electronic data processing systems (tokenised Paragraph 1 Securities);
- contractual rights (such as trust beneficiary interests and interests in collective investment schemes) that are conventionally categorised as Paragraph 2 Securities and transferable through electronic data processing systems (also known as electronically recorded transferable rights (ERTRs)); and
- contractual rights (such as trust beneficiary interests and interests in collective investment schemes) that are conventionally categorised as Paragraph 2 Securities and are transferable through electronic data processing systems, but whose negotiability is restricted to a certain extent (non-ERTR tokenised Paragraph 2 Securities).
ERTRs refer to the rights conventionally treated as Paragraph 2 Securities (such as trust beneficiary rights and interests in collective investment schemes) that 'are represented by proprietary value transferable by means of an electronic data processing system (but limited only to proprietary values recorded in electronic devices or otherwise by electronic means)', excluding 'those rights specified in the relevant Cabinet Office Ordinance in light of their negotiability and other factors'. In this connection, 'those rights specified in the relevant Cabinet Office Ordinance in light of their negotiability and other factors' are generally understood to mean rights in respect of which technical measures have been taken to prevent the transfer of the proprietary value of these rights to persons other than:
- qualified institutional investors; or
- investors eligible to conduct specially permitted businesses for qualified institutional investors (the 'Article 63 Exemption') such as:
- listed companies;
- corporations with capital or net assets of ¥50 million or more; and
- individuals with investment assets (including cryptoassets) of ¥100 million or more, who have maintained their securities accounts for more than one year.
Technical measures have been taken to prevent the proprietary value of these rights from being transferred without an offer from the owner and approval from the issuer for every transfer.
The key purpose of the FIEA Revisions is to subject ERTRs to the disclosure and licensing (registration) requirements applicable to Paragraph 1 Securities.Definition of tokenised securities
Tokenised securities refer to dematerialised (paperless) securities that are 'represented by proprietary value transferable by means of an electronic data processing system (but limited only to proprietary values recorded in electronic devices or otherwise by electronic means)'. Tokenised securities can be classified into the following rights:
- tokenised Paragraph 1 Securities (such as tokenised shares and bonds);
- ERTRs; and
- non-ERTR tokenised Paragraph 2 Securities.
Under the FIEA Revisions, rights under points (a) and (b) above are deemed Paragraph 1 Securities, while rights under point (c) are treated as Paragraph 2 Securities. This classification creates a significant difference in the disclosure and licensing (registration) requirements applicable to the respective rights.2Disclosure requirements
As a result of the application of disclosure requirements to ERTRs, issuers of ERTRs are (in principle) required, upon making a public offering or secondary distribution of ERTRs, to file a securities registration statement and issue a prospectus. A person who causes other persons to acquire ERTRs or who sells ERTRs to other persons through a public offering or secondary distribution must deliver a prospectus to the other persons in advance or at the time of the acquisition or sale.Licensing (registration) requirements
As ERTRs are expected to constitute Paragraph 1 Securities, a person acting as a broker, agent or intermediary in respect of the sale or purchase of ERTRs or the handling of an offering of ERTRs in the course of a business is required to undergo registration as a Type I financial instruments business operator (FIBO) under the FIEA.ii Introduction of regulations governing cryptoasset derivative transactions
Regulations governing cryptoasset derivative transactions have been introduced by the FIEA Revisions to protect users and to ensure that such transactions are appropriately conducted. More specifically, for the purposes of subjecting derivative transactions involving financial instruments or financial indicators to certain entry regulations and rules of conduct issued under the FIEA, cryptoassets have been inserted in the definition of 'financial instruments' under the FIEA Revisions. Furthermore, the prices, interest rates and other aspects of cryptoassets have been incorporated into the definition of 'financial indicators'.
As cryptoassets are now included in the definition of financial instruments, the conduct of over-the-counter derivative transactions related to cryptoassets or intermediary or brokerage activities in relation thereto will also constitute Type I financial instruments business under the FIEA.iii Introduction of prohibitions against unfair acts in cryptoasset or cryptoasset derivative transactions
In respect of cryptoasset spot transactions and cryptoasset derivative transactions, the FIEA Revisions contain prohibitions against the following: wrongful acts; dissemination of rumours, fraudulence, assault or intimidation; and market manipulation. These prohibitions (which are without limit as to the violating party) are intended to enhance the protection of users and to prevent the obtainment of unjust benefits. Breach of these prohibitions is punishable by penalties.
Insider trading, however, is not regulated under the FIEA Revisions, owing to difficulties both with the formulation of a clear concept of cryptoasset issuers and the identification of undisclosed material facts.
Banking and money transmissioni Approach of the central bank
Cryptoassets are neither deemed money nor equated with fiat currency. No cryptoasset is backed by the government or the Bank of Japan (the central bank).ii Money transmission
Only licensed banks or registered fund transfer business operators are permitted to engage in money remittance transactions as a business. The Supreme Court, in a case precedent, has defined money remittance transactions to mean 'the planned or actual transfer of funds, as requested by customers, through utilisation of a fund transfer system without physical transportation of cash between physically distant parties'. As funds do not include cryptoassets, however, a cryptoasset remittance transaction is unlikely to be deemed a money remittance transaction.