On 15 March 2019 Cabinet submitted a bill to the 198th session of the Diet to amend, among other acts, the Financial Instruments and Exchange Act (FIEA) and the Payment Services Act (PSA).(1) Among other things, the amendments introduce new regulations for security-type digital tokens (ie, initial coin offerings (ICOs) and security token offerings (STOs)) and aim to strengthen the regulation of virtual currency exchange service providers.
Currently, the PSA defines 'virtual currencies' and regulates providers of virtual currency exchange services. However, whether security-type digital tokens and their offerings (eg, initial coin offerings and security token offerings) should be regulated under securities regulations has been the topic of discussion, as:
- security-type digital token functions which are similar to other securities should be regulated in the same way as those securities; and
- investors in security-type digital tokens should be protected in the same way as investors in other securities.
Therefore, under the bill, rights or interests to receive dividends from funds or certain other types of interest or right which are represented by electronically transferable and electronically recorded proprietary values (ie, digital tokens) – excluding those to be specified by relevant regulations in light of assignability and other circumstances – are defined as 'electronically transferable and electronically recorded rights' and are regulated as securities under the Financial Instruments and Exchange Act (FIEA), rather than as virtual currencies.
Notably, under the bill, virtual currencies are renamed crypto assets and exchange service providers are renamed crypto asset exchange service providers.
Based on the literal wording of the current FIEA, when digital tokens are issued during an ICO or STO in consideration for crypto assets in lieu of cash or cash equivalents, the investors' rights represented by such digital tokens do not satisfy the criteria for a so-called 'collective investment scheme' (ie, they are not deemed to be securities under the FIEA (deemed securities)). However, according to the Financial Services Agency's (FSA's) interpretation of the current laws, if an investment by crypto assets is essentially equivalent to an investment by fiat currencies, the relevant investors' rights are regarded as deemed securities.
With regard to ICOs and STOs, the study group established by the relevant government council highlighted various problems during the reform of the legislation. In order to clarify the scope of the regulations and ensure investors' protection and the fairness of transactions, the bill deems crypto assets to be cash, which is eligible as consideration for certain transactions, including:
- the subscription of interests in a collective investment scheme; or
- the purchase of securities.
As such, the bill clarifies that digital tokens issued in consideration for crypto assets will be regarded as deemed securities and be subject to the FIEA.
When the bill is enacted and takes effect, security-type digital tokens which constitute electronically transferable and electronically recorded rights will be excluded from the definition of crypto assets under the PSA. Further, the rights represented by such digital tokens will become deemed securities subject to stricter regulation under the FIEA.
In short, 'electronically transferable and electronically recorded rights' (as defined above) are deemed securities for which investors' rights are represented by digital tokens. Given higher assignability, such digital tokens are subject to the strict public information disclosure system as Paragraph 1 Securities, a category of security under the FIEA (eg, stocks). In principle, the issuer of such digital tokens must file a securities registration statement (SRS), which will be available to the general public unless the strict statutory criteria for private placement can be satisfied. The issuer must also file annual reports and be subject to other continuous public disclosure obligations after the filing of the SRS (such obligations will also apply where no SRS has been filed, but the number of owners exceeds a certain threshold). The public disclosure requirements are strict compared with those applicable to other deemed securities.(2)
Under the bill, regulations concerning intermediaries that handle the rights represented by security-type digital tokens will be strengthened to the extent that such rights will be electronically transferable and electronically recorded rights.
Under the bill, rights represented by such digital tokens will be treated as Paragraph 1 Securities in a manner similar to stocks due to their high level of assignability. In principle, intermediaries will have to register as Type I Financial Instruments Business Operators (FIBOs), which are subject to stricter registration requirements and regulations than Type II FIBOs (the type of registration required for intermediaries of other deemed securities). Type I FIBOs are members of the Japan Securities Dealers Association and are subject to its self-regulatory rules. Thus, in practical terms, they are subject to the way in which such rules restrict general investors' solicitation of and access to such digital tokens.
The issuers of such digital tokens must generally be registered as Type II FIBOs if they make the solicitation themselves. In such cases, the self-regulatory rules of the Type II Financial Instruments Firms Association will apply. Conversely, non-issuers of such digital tokens must be registered as Type I FIBOs, in which case the self-regulatory rules of the Japan Securities Dealers Association will apply. While the bill does not clearly articulate how issuers will be regulated in the latter case, it is expected that they may be exempted from Type I FIBO or Type II FIBO regulations so long as they are not engaged in the solicitation.
Intermediaries and issuers registered as FIBOs are subject to the FIEA's sales and solicitation regulations. In general:
- the suitability principle applies; and
- the delivery of explanatory documents prior to closing is required with respect to the sales and solicitation of security-type digital tokens.
The bill newly prohibits the unfair trading of crypto assets in essentially the same manner as unfair securities and derivatives transactions are prohibited. However, as regards enforcement measures, the bill sets out criminal penalties for violators (unlike for unfair securities and derivatives transactions, where no administrative penalties apply). The bill introduces no insider trading regulations regarding crypto assets.
The bill will be enforced from a date to be specified by a Cabinet order, which will be within one year from the bill's date of promulgation, which is expected to occur in June 2020.
The bill also includes some grandfathering clauses. For example, if an ICO or STO commenced prior to the bill's effective date continues following such date, the ICO or STO will be subject to the current FIEA.
For further information on this topic please contact Masayuki Fukuda or Hideaki Suda at Nagashima Ohno & Tsunematsu by telephone (+81 3 6889 7000) or email (firstname.lastname@example.org or email@example.com). The Nagashima Ohno & Tsunematsu website can be accessed at www.noandt.com.
(1) This article discusses the changes to the FIEA. For more information on the changes to the PSA, please see "Amendments to Payment Services Act".
- the issuer invests more than half of the funds raised by issuing such securities back into securities; and
- the deemed securities are distributed to 500 or more investors through the offering.
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