An extract from The International Capital Markets Review, 11th Edition

The year in review

i Developments affecting debt and equity offeringsFramework 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 only made 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 Act13 and the Act Controlling Contributions, Deposits and Interest.14 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 regulationsBond 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 on 1 March 2021 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 would 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 bond administrative assistant. 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 bondholders' meeting.

Bondholders' meeting

Additionally, there are two revisions in the amended Companies Act that were implemented to make the bondholders' meeting system more convenient. 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. With this amendment, it has become possible to reduce the amount of bond principal or interest without obtaining consent from all bondholders or without taking insolvency procedures. This amendment has also provided that if the consent from all bondholders has been obtained, the resolution of the bondholders' meeting and court approval will not be necessary for the reduction of the amount of bond principal or interest. Second, a new written resolution system is allowed at a bondholders' meeting. These amendments came into effect on 1 March 2021.

Applicability of the Interest Rate Restriction Act to corporate bonds

In Japan, there has been much argument over whether the Interest Rate Restriction Act applies to corporate bonds. More specifically, the Interest Rate Restriction Act15 sets the maximum interest rate of money lending at 15–20 per cent per annum depending on the types of lending, and provides that if the amount of interest exceeds this limit, the excess will be deemed invalid. With respect to whether this provision applies to corporate bonds, on 26 January 2021, the Supreme Court ruled that such provision of the Interest Rate Restriction Act is not applicable, except for cases where the issuer was forced to issue the corporate bond so that the bondholders could obtain an unreasonably high interest rate. This ruling may affect the practice of interest rate determination for bond issuance or dispute resolution relating to bond interest in the future.

Disclosure rules

Over the past few years, following the Japanese government's action plans for the growth strategy, there has been a continuous movement to enhance disclosure in various aspects for the purpose of enhancing competitiveness and obtaining investors' trust in Japanese companies.

For example, on 18 January 2021, the METI published the 'FAQs on Companies' Integral Disclosure of Business Reports, etc. and Securities Reports' to enhance integral disclosure. Business reports and financial statements under the Companies Act and SRSs under the FIEA are allowed to be disclosed in an integrated manner, but such integral disclosure has not been implemented very often by Japanese corporations. If many corporations implement the integral disclosure, which would enable disclosure of important information before the shareholders' meeting, discussion between companies and investors can be expected to become more constructive at the shareholders' meeting. From this perspective, the METI has published the FAQs.

As another example, on 5 March 2021, the Tokyo Stock Exchange, Inc. (TSE) launched 'JPX English Disclosure GATE', which is a web portal for English disclosure to promote better English disclosure of listed companies and increase investment opportunities for overseas investors. Additionally, for listed companies preparing for the transition to the new markets of the TSE (see Section II.iv below), the TSE provides guidance on disclosure requirements for the new markets, which specifies samples of descriptions in the disclosure documents, including business plan and growth potential, that will be newly required in the growth market. Furthermore, the TSE published the Practical Handbook for ESG Disclosure in March 2020 to promote environmental, social and governance (ESG) disclosure.

Utilisation of Key Information Sheet

From the perspective of promoting customer-oriented and efficient disclosures, the Cabinet Office Ordinance on Financial Instruments Business, etc. was amended on 25 February 2021 to allow that if FIBOs provide the customer with a summary of material information by using a Key Information Sheet and have clarified key contents of the pre-contract documents for customers, then the prospectus for customers may be delivered online and pre-contract documents for customers may also be delivered online. In other words, if an FIBO has created a Key Information Sheet and has clarified the important information by using it, the FIBO can be exempted from the obligation to deliver paper pre-contract documents face-to-face or by post. In this context, a Key Information Sheet means material that provides customers with important information, including risks, fees and conflicts of interests, in a concise and easy-to-understand manner so that the customers can easily compare financial products.

Best execution policy

The FSA published the report on the best execution of securities transactions submitted by the Task Force under the Financial System Council on 2 June 2021. While many FIBOs currently present their best execution policy describing the best ways to execute customers' orders of securities transactions, there are few rules regarding the items to be described in the best execution policy. As a result, in most cases, the policy states that almost all transactions are going to be executed on the TSE and that the execution on the TSE would be the best way in view of overall circumstances (based not only on price but also on cost, speed and stability of execution, among others).

The Task Force's report states, however, that, with regard to retail investors, the best execution should place more importance on prices in principle, and if an FIBO takes into consideration any factors other than prices in the best execution policy, the reason should be clearly stated in the policy ('comply or explain principle'). The Task Force's report also specifies that, when transaction may be executed by using smart order routing (SOR) or may be executed in dark pools, the appropriate information relating to the SOR or dark pool venue should be stated in the best execution policy. It is likely that the Cabinet Office Ordinance on Financial Instruments Business, etc. would be revised in response to this Task Force's report, by which more securities transactions may be executed at trading venues other than the TSE, such as proprietary trading systems (PTS).

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 regarding clarification of (a) and (b) have been enforced since 1 September 2020, and the amendments regarding price improvements of (c) and (d) have been enforced since 1 September 2021. Correspondingly, the TSE has amended its trading rules for a dark pool venue (the ToSTNeT Market) to flag orders matched in dark pools that are routed to the ToSTNeT Market. Furthermore, the TSE has prohibited all margin transactions in the ToSTNeT Market, with limited exceptions.

Margin transaction of foreign listed stocks

In recent years, the number of retail investors investing in foreign-listed stocks (especially US-listed stocks) through FIBOs has increased, but margin trading of foreign stocks has not yet become available in Japan. Although the current legislation does not prohibit margin trading of foreign-listed stocks, there are no rules for handling them. Given this situation, JSDA has established self-regulatory rules regarding a margin trading system for foreign-listed stocks that will take effect on 1 July 2022, which would provide investors with more diverse investment opportunities and methods.

Expansion of exceptions to insider trading prohibitions

In light of a current trend for diversification of corporate group management (including staffing allocation) since 1 January 2021, the amendment to the Cabinet Office Ordinance on Definitions under Article 2 of the FIEA has expanded the scope of employees who may be exempt from insider trading prohibitions. The amendment has been made in consideration of the fact that employees of affiliate companies can often be seen as participants in the same employee stock ownership plan under the same business group.

Financial benchmarks

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. Furthermore, 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 backward-looking rate, was chosen as a risk-free rate (RFR) in 2016. Furthermore, the calculation and publication of the Tokyo Term Risk Free Rate (TORF) based on the yen overnight index swap started in February 2020 and, thereafter, QUICK Benchmarks Inc. (QBS), which has been designated as a financial benchmark administrator under the FIEA in January 2021, has commenced issuing the TORF, which is a production rate that has been used for actual transactions as a forward-looking rate since April 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 using TIBOR and RFRs as recommended in the FSB 2014 report Reforming Major Interest Rate Benchmarks, which means that TONA and TORF will not replace TIBOR. The RFR is intended to be used as an alternative to TIBOR as the RFR is stable, easy to understand and already widely used in the wholesale derivatives markets. The Bank of Japan and market participants continuously discuss the planning necessary to establish TONA and TORF best practices.

Furthermore, the discontinuation of LIBOR is expected to have a significant impact on the financial markets in both Japan and other major countries. LIBOR was 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, so that the FSA can review the progress of preparedness in individual firms and publishing the FSA's views on legal issues regarding tough legacy or capital adequacy requirements. 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 a great deal of material regarding the transition.

ii Developments affecting derivatives, securitisations and other structured productsFramework 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 regulationsMargin 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 a 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). Since 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 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, lowering 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 after September 2022 if:

  1. 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
  2. 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, the competent authorities defined under Article 2 of the European Markets Infrastructure Regulation, and the Prudential Regulatory Authority and the Financial Conduct Authority of UK have been designated, respectively.

Exemption from the licensing requirement for foreign commodity derivatives brokers

Under the Commodity Derivatives Act, there is an exemption from the licensing requirement when a foreign broker handles an order of commodity derivatives transactions on the commodity exchange that was received from certain investors residing in Japan, to the extent that the foreign broker has not made any solicitation to that investor. Although commodity derivative transactions may be handled based on the Commodity Derivatives Act or based on the FIEA, depending on the types of underlying commodity (see Section II.iv below), there was no similar exemption under the FIEA. Therefore, the Cabinet Office Ordinance on Definitions under Article 2 of the FIEA was amended on 9 July 2021 to newly provide a similar exemption. As a result, a licence of the FIBO would not be required for a foreign broker when it handles an order of commodity derivatives transactions that was received from a certain investor residing in Japan, to the extent that the foreign broker has not made any solicitation, regardless of whether the order would be executed on the commodity exchange or the financial instruments exchange.

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. Furthermore, 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.

Inverse and leveraged ETFs

Although inverse and leveraged ETFs are considered not suitable for long-term investment, there are some cases in Japan where retail investors who do not understand the products may buy the inverse and leveraged ETFs for the purpose of long-term investment. In light of this situation, the FSA has amended the Cabinet Office Ordinance on Financial Instruments Business, etc., to strengthen the regulation on advertisement and accountability regarding inverse and leveraged ETFs, by which the FIBOs will be required to explain to investors the nature of ETF leverage indicators and whether or not relevant ETFs are suitable for long-term investment. Furthermore, a margin deposit of 30 per cent or more of the contract price will be newly required for margin trading of leveraged ETFs.

SPAC and IPO pricing

To foster start-ups and venture firms, in the Action Plan for the Growth Strategy in June 2021, the government has suggested a revision of the way in which the IPO price is determined because there are many cases in Japan where the first-day closing price has become much higher than the IPO price ('IPO underpricing'), which is considered one of the reasons start-ups cannot obtain funding efficiently. The government has also suggested therein the introduction of a special purpose acquisition company (SPAC). Following this Action Plan, the TSE, together with the METI, the FSA and the JSDA, has set up a working group for the legislation on the IPO pricing rules or SPACs, while some market participants seem to have negative views about these suggestions.

Attracting foreign funds

In recent years, there is a trend in Asia that some sites of global financial institutions are to be relocated or transferred in light of the situation in Hong Kong and other regions. In response to such movements, the amended FIEA was enacted in March 2021 to provide for two new schemes that will make it easier for foreign funds to establish their base in Japan. Even before this amendment, there have been schemes in which registration requirements for funds for professional investors in Japan or overseas have been relaxed, but there has been no special scheme for a fund that manages funds collected from investors outside Japan. This amendment permits the following:

  1. in the case of foreign corporations that have been licensed by the authorities overseas and carry out investment management business for overseas investors, these funds are now allowed to carry out investment management business in Japan for up to five years from the filing; and
  2. the investment management business of a collective investment scheme with overseas investors is now able to carry out its business in Japan by simply filing an application.

In addition, following the revision of the Cabinet Office Ordinance on Financial Instruments Business, etc., in November 2020, certain documents required for filing or registering an application that are normally submitted by overseas asset management companies to the FSA can now be prepared in English.

iii Relevant tax and insolvency lawTax 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 various arguments exist 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.

With respect to the recent tax reform that may affect foreign or domestic investors, it should be noted that the 2021 Tax Reform Act has been implemented following tax reforms from the perspective of promoting the employment of highly skilled foreign talent (including financial professionals) in Japan.

First, the tax deductibility of compensation paid to directors from an asset management company has been revised. Under the previous rule, in order for performance-linked compensation paid to directors to be deductible for corporate tax purposes, it is required that the details of the calculation method of compensation be disclosed in annual securities reports without delay. As a result, an unlisted company that is not obliged to submit a securities report did not satisfy this requirement and was unable to deduct performance-linked compensation paid to directors. Under the 2021 Tax Reform Act, however, in view of the peculiarity that performance-linked compensation of directors of an asset management company is under the supervision of stakeholders such as investors, certain performance-linked compensation is deductible if the calculation method of the compensation is posted on the website of the FSA.

Second, regarding income tax treatment of profit received by fund managers, it was unclear whether the compensation for fund managers based on the performance of their fund management is to be treated as financial income (i.e., separate taxation) or business income (i.e., comprehensive taxation). Under the 2021 Tax Reform Act, if the fund manager receives the distribution of profits, from the fund, in excess of the investment ratio (carried interest) at an economically reasonable ratio, the carried interest received by a fund manager is taxed separately as financial income at a flat rate, which means that carried interest would not be subject to comprehensive taxation that is considered to have discouraged foreign professionals from becoming fund managers of Japanese funds.

Third, the 2021 Tax Reform Act has expanded the scope of tax exemption for foreign investors who invest in Japanese limited liability partnerships that have a permanent establishment in Japan. Under the general tax rule, if a foreign investor is a limited partner in a Japanese limited partnership, tax on income attributable to the permanent establishment is exempted if the foreign investor holds less than a 25 per cent partnership interest. Although this requirement was difficult to satisfy in cases where the limited partner was not an individual but a 'fund of funds', the 2021 Tax Reform Act has now relaxed this requirement for a fund of funds. Consequently, in the case of a fund of funds, the 25 per cent threshold applies to the interest substantially held by the respective investors in the fund of funds.

Fourth, while inheritance tax will be levied not only on properties in Japan but also on overseas properties when the total period of the foreign decedent being domiciled in Japan exceeds 10 years, the 2021 Tax Reform Act has introduced an exemption to this rule that if a highly skilled foreigner with a specific status of residence dies, inheritance tax will be levied only on the property existing in Japan, regardless of the residence period of the decedent, which means overseas properties inherited by the family residing in the foreign country is not subject to inheritance tax by Japan.

In addition to the above, not limited to the financial sector, the 2021 Tax Reform Act has introduced special measures for promoting investment in digital transformation and for promoting investment for carbon neutrality. Such a trend in the tax system in Japan will probably continue, which may affect investment strategy.

Insolvency law

The insolvency laws in Japan mainly consist of the Bankruptcy Act,16 the Civil Rehabilitation Act,17 the Corporate Reorganisation Act,18 the Companies Act and the Act Concerning the Special Provisions for the Reorganisation of Financial Institutions.19 In addition, in line with the international agreement reached at the FSB and G20 Cannes Summit on 4 November 2011, the Deposit Insurance Act20 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.

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 and the finalised Basel III standards will be implemented in Japan in March 2023.

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 (operating five markets of First Section, Second Section, Mothers, and the JASDAQ Standard and Growth markets, which will be restructured on 4 April 2022, as indicated below), and for derivatives trading through Osaka Exchange, Inc (OSE). 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 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.

In addition to 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 Exchange (ODE)).

Apart from these exchanges, after the 'concentration rule', which required that stocks be traded through stock exchanges, was abolished in 1998, listed shares can be traded through services provided by FIBOs with a special licence, without being routed to an exchange. These trading venues are called 'proprietary trading systems' (PTSs). Although PTSs have been used in Japan gradually, the TSE has long held an overwhelming position with the integration of TSE and OSE into JPX. However, in recent years, the trading share of PTS has increased owing to a variety of reasons, including the development of SORs, the lifting of the ban on margin trading and the occurrence of system failure in the TSE. Because the current regulations on the PTS licence do not seem to match off-exchange trading practices, it is worth noting the future revisions of regulations on the PTS, along with the further review of best execution policy and exchange regulations.

Exchanges

The government has considered reform of the exchanges to be one of the most important issues from a policy and business perspective. In particular, the government has 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 are now able to trade both financial and commodity derivatives – precious metals, rubber, agricultural products, sugar and oil – on a single trading account, with electricity and some commodity futures still being listed on the TOCOM.

Furthermore, 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 stated above 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 and profitability, among other matters. 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 are scheduled to launch on 4 April 2022. The TSE has already begun accepting applications from existing listed companies for selecting a new market section. According to the survey conducted by the TSE in July 2021, approximately 30 per cent of companies currently listed on the First Section of the TSE cannot meet the criteria for the new prime market as of the end of June 2021. Companies that have been determined not to meet the criteria for the new market segment after the examination of the application will be allowed to remain listed on the new market for the transition period, only if they disclose the improvement report in accordance with the TSE rules. The length of the transition period will be set individually depending on the situation of the company.

The JPX has also been making efforts to improve the convenience of investment by overseas investors. In March 2021, the TSE launched the JPX English Disclosure GATE, which is a web portal for English disclosure (see Section II.ii above). The JPX is also planning the launch of derivatives holiday trading at the OSE in 2022.

See Section II.i for details of the revision of trading rules of dark pool venues (the ToSTNeT Market) of the TSE.

CCPs

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 are 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 traded on any financial instruments exchange, and OTC derivatives (CDSs and IRSs) and OTC JGB transactions traded 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 July 2020. The TFX has also been approved as a CCP under the FIEA and provides clearing services for products listed on the TFX.

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 regularly publish information regarding the number of transactions and total amounts. After the amendment to the method of trade reporting under FIEA that came into effect on 1 May 2021, all transaction information is basically to be reported to the FSA from a trade repository, which means that direct reporting from a financial institution or a CCP to the FSA is no longer permitted except for limited cases. 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 considerationsRevision of the Banking Act to enhance banks' function

In Japan, the banking industry has been in a difficult business environment, owing to the economic downturn and low interest rates for decades. In view of such a situation, for the purpose of strengthening the banks' business, the amendment law to the Banking Act and other relevant acts was enacted in May 2021. By this amendment, the scope of business in which banks or their affiliates can engage will be expanded, which means that banks or their affiliates will be allowed to provide services regarding digitalisation, developing or providing apps or other IT services, and regional revitalisation. This amendment is expected to take effect from the end of March 2022.

Enhancing competitiveness through the revision of the rules on information sharing and supplying growth funds

In June 2021, the FSA Working Group on Capital Market Regulations issued a report that contains some proposals to strengthen Japanese financial institutions and the Japanese financial market in a post-pandemic economy.

One of the proposals is to ease the financial industry firewall. Japanese law has long adopted a firewall policy that basically separates banking business and securities business. Under the current firewall regulations (which have been slightly relaxed from the original regulations), securities business can be carried out by a subsidiary or an affiliate of a bank taking the form of a securities company (an FIBO), but there still remains the information firewall that prohibits the transfer of customer information between banks and securities companies. The report states, however, that information on customers (limited to corporate customers) should be allowed to be shared between banks and securities companies except when the corporate client has notified the companies in advance that it does not want its information to be shared. This amendment aims to increase the competitiveness of financial institutions and to make it easier for companies to receive comprehensive financial services.

The report also states that, in light of the importance of supplying growth funds for a post-pandemic recovery, it is necessary to improve the legal basis for the investment environment, depending on the risk tolerance of institutional investors and retail investors, respectively. Specifically, the report has made the following proposals:

  1. requirements of eligibility for certain professional investors ('specified investors') should be revised to be more flexible;
  2. the private placement scheme for specified investors should be revised;
  3. regulations applicable to the secondary markets on unlisted products to be participated in by specified investors should be newly established; and
  4. the TSE's rules applicable to general investors investing in listed investment corporations (especially venture funds) should be more relaxed.

In line with this report, it is likely that some amendments to the FIEA and relevant regulations will take place in a few years.

One-stop financial services intermediary

On 1 November 2021, the Act on Sales of Financial Instruments will be amended and renamed as the Act Concerning Provision of Financial Services, by which a registration system for one-stop intermediary service providers of financial services will be introduced.

Under the prior 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 he or she 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.

Fintech and digitalisation

From the perspective of advancing digitalisation in the financial industry, the FSA is making ongoing efforts including legislation or relaxation of regulations in the financial services sector as below.

Notably, the FSA has announced that it will put 1,800 administrative procedures (e.g., applications and notifications from FIBOs, banks or insurance companies) online by the end of March 2022. In addition, the procedural provisions regarding signatures and seals of financial regulations have been reviewed and, as a result, many relevant financial laws and regulations have been revised to explicitly confirm the validity of electronic signatures or other electronic procedures and to abolish the prescribed procedures such as face-to-face procedures. In broader terms, there was an amendment to the Companies Act for not only financial institutions but also joint-stock corporations in general that will take effect in 2022. This amendment has introduced a new system whereby general shareholder meeting materials can be uploaded onto a website on the condition that the written notification of the website where related documents are uploaded has been sent to shareholders, although the current law requires the consent of each shareholder for sending general shareholder meeting materials in electronic format.

The FSA has also developed some legislation that provides a legal framework for fintech-related business while protecting investors of fintech-related transactions. To date, the FSA has made amendments to the Banking Act (see above), the FIEA and the PSA 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). Typically, under the PSA, since April 2019, it has been necessary to register as a crypto asset exchange service provider to conduct any business relating to the following:

  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 (a) or (b).

A registered crypto asset exchange service provider has certain obligations, such as:

  1. keeping customer information secure;
  2. providing users with adequate explanations to allow them to make informed decisions;
  3. segregating users' assets from its own assets;
  4. maintaining books and records;
  5. 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.

Furthermore, under the FIEA, 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 is 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 referring 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.

Another significant amendment to the PSA became effective on 1 May 2021 and its purpose is to develop the security and convenience of payment services in a cashless society. This amendment reorganises the types and classes of funds of transfer service providers under the PSA, depending on the amount of remittance to be handled.

Corporate governance reform

The government has been making efforts on corporate governance reform. In 2014, the Companies Act was amended to enhance corporate governance and to establish a subsidiary governance framework. Following this amendment, 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 revised disclosure rules under the FIEA and established relevant guidelines for the purpose of providing investors with appropriate corporate information. The TSE has provided the Corporate Governance Code and the Stewardship Code applicable to listed companies and has held regular follow-up meetings with the FSA to review those codes and practices.

On 1 March 2021, the amendment to the Companies Act came into effect to rationalise procedures for shareholders' meetings to make them more efficient and to improve transparency in determining executive compensation.

Furthermore, on 11 June 2021, the Corporate Governance Code was revised to enhance board independence, promote diversity and incorporate new principles of governance such as sustainability and ESG. Under the revised Corporate Governance Code, at least one-third of the board for a Prime Market listed company must be independent directors and the listed company should create and disclose a skill matrix of board members conforming to the company's business strategy. With respect to diversity, a listed company should disclose a policy and voluntary measurable targets about the promotion or appointment of women, non-Japanese and mid-career hires to senior managerial positions. A listed company should also develop a basic policy and present initiatives on the company's sustainability and, furthermore, Prime Market listed companies are expected to enhance the climate-related disclosure based on TCFD recommendations or equivalent international frameworks.

Principles for Customer-Oriented Business Conduct

For the purpose of stable asset-building by investors, the FSA published the Principles for Customer-Oriented Business Conduct (commonly translated as the Principles of Fiduciary Duty) in March 2017 and has encouraged FIBOs to adopt these principles and to engage in customer-oriented business operations. The principles were amended in March 2021 to add the principle that an FIBO should offer various products in a cross-sectional way that is appropriate to the customer's life plan and should conduct follow-up activities even after the customer has obtained the product. In connection with this principle, there was an amendment to introduce a new rule on the Key Information Sheet, and the rules regarding the best execution policy will also probably be amended shortly (see Section II.i above).

Anti-money laundering and countering financing of terrorism

In August 2021, the Financial Action Task Force (FATF) released a report that has placed Japan in a group to which 'enhanced follow-up' procedure would apply. Responding to this report, Japanese government has set up a council to compile measures against money laundering and terrorism financing, jointly chaired by the Ministry of Finance and the National Police Agency, and has published a three-year action plan. The action plan is designed to improve financial institutions' understanding of risks of financial crimes, to strengthen monitoring, and to enforce ongoing customer management on a risk basis. To embody this policy, it is expected that, in the next few years, there will be revisions to the Guidelines for Anti-Money Laundering and Combating the Financing of Terrorism and revisions to the relevant acts, such as the Act for Punishment of Organised Crimes, Control of Crime Proceeds and the Act on Punishment of Financing to Offences of Public Intimidation.

ESG

Japan has announced that it aims to achieve carbon neutrality by 2050. As an interim goal, Japan announced in April 2021 that it would reduce emissions 46 per cent relative to 2013 levels by 2030. While the government believes that many Japanese companies have the technology and potential to contribute to the realisation of a carbon-free society, a huge amount of money will be required to reach these goals. Thus, the government hopes to attract domestic and foreign ESG funds to the Japanese market so that these Japanese companies can be financed. From this point of view, the FSA is considering new rules, platforms and infrastructures that would be necessary for such ESG-related investments and, following this, the Expert Panel on Sustainable Finance held by the FSA published its report of 18 June 2021. Given this report, the FSA and the TSE have already taken action or are expected to take action.

First, although the Corporate Governance Code and the TSE disclosure rules have already been revised to add principles or rules so that investors may know the ESG-related information more easily as mentioned above, the TSE and the FSA will continuously review the Corporate Governance Code and disclosure rules and make appropriate revisions. Second, the TSE and the FSA are currently considering a new platform for green bonds or social bonds, such as a platform that incorporates a mechanism by which third-party organisations are able to scrutinise the issuance procedures of green bonds or social bonds and the usage of funds. Third, the FSA will consider:

  1. the effective methods to make institutional investors commit to ESG-related engagement;
  2. appropriate rules for explanations used when FIBOs sell ESG products to retail investors; and
  3. how to monitor fund managers of ESG-related funds.

Additionally, the FSA has indicated that it will support the business of financial institutions by helping them to develop ESG-related financial products and to conduct risk management of ESG-related investments.