Financial Regulatory Alert
On 1 March 2016, an amendment (FIEA Amendment) to the Financial Instruments and Exchange Act of Japan (FIEA) came into effect. The FIEA Amendment has brought significant changes to the regulatory regime under which non-Japanese funds can be offered and sold to Japanese resident investors. The "best practice" under the changes has now become clear.
Outline of Article 63 Exemption
Self-offering, self-selling or self-managing of units of "Collective Investment Schemes", which include partnership-type funds, requires a certain type of registration under the FIEA. However, a licensing exemption under Article 63 of the FIEA (Article 63 Exemption) provides an exemption for such licensing requirements for non-Japanese fund operators.
The Article 63 Exemption is frequently exploited by non-Japanese fund operators because fund operators can enjoy the Article 63 Exemption by way of submitting the notification to the regulator and no prior approval or license is required.
These non-Japanese funds are typically structured as partnerships, limited partnerships or limited liability companies, which can be deemed as Collective Investment Schemes under the FIEA. The concept of partnership differs under Japanese laws as compared to laws in other jurisdictions, however, funds that are not otherwise structured as partnerships under foreign laws nonetheless may have to be treated as partnerships for the purpose of these Japanese regulations. For example, membership interests in limited liability companies, depending on the structure and the types of assets in which they invest, may be Collective Investment Schemes, or other types of securities for the purpose of Japanese regulations. In any event, funds that will have Japanese investors may need to examine their regulatory status under the FIEA to determine whether the funds can rely on the Article 63 Exemption.
The Article 63 Exemption permits non-Japanese fund operators to:
- Offer their interests to Japanese investors by way of a private placement without having to register as securities dealers on a self-solicitation basis by a general partner or a managing member of a fund
- Manage investment funds without having to register as investment managers on a self-management basis
The basic qualifications for the Article 63 Exemption are as follows:
- The type of fund is categorized as a "Collective Investment Scheme"
- The investors in the fund include at least one qualified institutional investor (QII) as defined in the FIEA
- If there are non-QII Japanese investors investing in the fund, the number of such non-QIIs must not exceed 49 and such non-QIIs must meet the requirements for eligible non-QIIs
- Prior to any offerings to Japanese investors, a notification as well as supporting documents has been filed with the Kanto Local Finance Bureau of Ministry of Finance
The FIEA Amendment effectively limits the availability of, and requires significant additional requirements to rely on the Article 63 Exemption then was previously the case. Many non- Japanese fund operators of partnership-type funds have relied on this exemption when offering and selling their funds to, and managing their funds on behalf of, Japanese resident investors.
The key changes to the Article 63 Exemption include:
Non-Japanese funds that do not have any representatives in Japan are disqualified from relying on the Article 63 Exemption. In practice, Japan offices of international law firms such as DLA Piper Tokyo often act as Japanese representatives of global companies for Article 63 filing purposes.
The notification to the Japan Financial Service Agency ("JFSA") must be accompanied by additional corporate documents such as the articles of incorporation, various regulatory registration certificates, a pledge statement and other items as detailed in the Cabinet Office Ordinance.
Under the FIEA, a limited liability investment partnership is categorized as a QII. However, under the Article 63(1) of the amended FIEA, if all QIIs in the fund are limited liability investment partnerships, such limited liability investment partnership will be required to have at least 500 million Japanese yen in invested assets (excluding loans).
The FIEA Amendment has limited the scope of non-QII investors to eligible investors equipped with the judgment to make investments and operators who have close relationships with fund operators. For example, the eligible non-QII investors are as follows:
- Limited availability of the exemption
- Funds managing firms
- Central and local governments
- Listed companies and their subsidiaries and affiliates
- Officers, employees and subsidiaries of fund managers
- Private companies with over 50 million Japanese yen of net assets
- Individual investors with at least 100 million Japanese yen of investment-oriented financial assets
- Employees' pension funds and corporate pension funds with at least 10 billion Japanese yen of investment-oriented financial assets
- In addition, if the fund is of venture capital in nature, the scope of the eligible non-QII will be broader. For certain venture capital funds that satisfy certain requirements including having the requisite internal governance structure and an accounting audit by certified public accountants, the following sophisticated investors (in addition to the investors listed above) are permitted to become eligible non-QII:
- Corporate officers and ex-corporate officers of listed companies
- Officers, employees and outside consultants (e.g., attorneys, accountants and tax accountants) who have experience in being involved in work such as starting up new businesses
Under Article 63(11) of the FIEA Amendment, exempt fund operators are now subject to an expanded code of conduct equivalent to those applicable to registered operator. Their obligations include:
- Increased activity restrictions
- To exercise the duty of care of a prudent manager
- To comply with investor suitability principles
- To meet contents requirements for advertisements
- To provide explanatory documents to investors prior to and at the time of entering into investment agreements, to segregate investor assets
- To provide investment reports
- To avoid conflicts of interest
Articles 63-5 and 63-6 of the FIEA Amendment empower the JFSA:
The notification form for an Article 63 Exemption now requires much broader information relating to the nature of the fund and investors then previously. The scope of the additional information required is detailed in Article 63(2).
- Increased oversight by the regulator
- To conduct onsite inspections
- To require submission of contracts between the funds and investors (for example, partnership agreements and trust agreements)
- To suspend violators
Article 63-4 of the FIEA Amendment imposes enhanced bookkeeping, annual reporting, and public disclosure requirements.
Fund operators are allowed to comply with the bookkeeping, annual reporting, and public disclosures in the English language, so the fund operators are not required to create and retain books or make annual reports or public disclosures in Japanese.
Fund operators should consider whether the confidentiality clauses in their fund documents such as partnership agreements permit such disclosures.
- Bookkeeping, annual reporting and public disclosure requirements
Under Articles 192 and 197-2 of the FIEA Amendment, noncompliance with certain provisions is punishable by up to five years of imprisonment and suspension of business.
- Increased penalties for noncompliance
Impact on funds operating under the Article 63 Exemption
Under the FIEA Amendment, existing funds that have already filed the notification pursuant to the Article 63 Exemption to manage investments without registering as investment manager may continue managing the fund assets by relying on the Article 63 Exemption until the termination of the investment schemes. However, as described above, under the amendments, those existing funds will have to comply with far greater requirements going forward including, for example:
- An expanded Code of Conduct
- A requirement for non-Japanese funds to have a representative in Japan
- Bookkeeping, annual reporting and public disclosure requirements