On 15 March 2019 Cabinet submitted a bill to the 198th session of the Diet to amend, among other acts, the Payment Services Act (PSA). The amendments to the PSA aim to strengthen the regulation of virtual currency exchange service providers.

Security-type digital tokens to be regulated by FIEA

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 crypto assets.

Notably, under the bill, virtual currencies are renamed crypto assets and exchange service providers are renamed crypto asset exchange service providers.

Method of custody and obligation to reserve crypto assets for repayment

Recently, there have been a series of incidents in which crypto assets held by crypto asset exchange service providers in so-called 'hot wallets' (which are directly connected to the Internet) have been misappropriated after being accessed illegally. Therefore, under the bill, crypto asset exchange service providers must generally keep customers' crypto assets in 'cold wallets' (which are not directly connected to the Internet). However, as an exception to this new rule, crypto asset exchange service providers may keep crypto assets in hot wallets if this is necessary for customer convenience and the smooth operation of their day-to-day transactions. However, in such exceptional cases, crypto asset exchange service providers must reserve the same amount of their own crypto assets (which must be the same type as those of their customers) as a performance guarantee of their repayment obligations. In the event of a crypto asset exchange service provider's bankruptcy, its customers will be entitled to receive preferential payment from the crypto assets deposited by them and the service provider's own crypto assets reserved for its performance guarantee (as outlined above).

Money deposited by customers with a crypto asset exchange service provider will be entrusted to trust banks or trust companies in order to protect the customers from misappropriation and the service provider's bankruptcy.

Regulation of crypto asset custody business

Currently, parties that engage in crypto asset custody business without selling or purchasing crypto assets are not regulated as crypto asset exchange service providers under the PSA. However, under the bill, such parties will be regulated as crypto asset exchange service providers under the PSA and will have to pursue know-your-customer and suspicious activity reporting and other obligations imposed by the Act regarding Preventing the Transfer of Criminal Proceeds.

Advance notification required for change in crypto assets

Crypto assets with an untraceable transfer record can be used for money laundering or terrorism financing. Therefore, under the bill, if a crypto asset exchange service provider changes the types of crypto asset which it manages or the content or method of its exchange operations, an advance notification must be filed with the regulator, unless otherwise exempted under a Cabinet ordinance. At present, only an ex post facto notification is required.

Regulation of advertisement and solicitation of crypto assets

Under the bill, crypto asset exchange service providers must provide customers with their trade name, registration number and certain other information. In addition, they will be prohibited from making:

  • false representations on executing contracts for the exchange of crypto assets or its solicitation or advertising of a crypto asset exchange business; or
  • representations that would cause customers to misunderstand the nature of crypto assets or induce them to buy or sell crypto assets solely for the purpose of gaining profit, rather than using them as a means of payment.

Regulation of crypto asset margin transactions

Crypto asset margin transactions have the same economic function and risks as crypto asset contracts for difference, which are categorised as derivative transactions of crypto assets. As such, crypto asset exchange service providers must:

  • provide customers with information concerning the content of crypto asset exchange contracts; and
  • take other measures necessary to protect customers and secure the appropriate and reliable conduct of the crypto assets exchange business pursuant to a Cabinet ordinance.

Recommendation to join certified self-regulatory organisation

As the content and methodology of crypto asset exchange services may change rapidly due to technological innovations, rules which are based solely on laws and regulations will be insufficient to ensure an appropriate and reliable crypto asset exchange industry. Conversely, the rules of self-regulatory organisations can respond flexibly and promptly to any changes in the market. Therefore, under the bill, the regulator must refuse the registration of a crypto asset exchange service provider under the PSA if:

  • it is not a member of a government-certified self-regulatory organisation; and
  • it has not established:
    • internal rules which are equivalent to the self-regulatory organisation's rules; or
    • an internal compliance system to comply with the abovementioned internal rules.

Effective date and transitional provisions

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.

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