The year in review: capital markets in Japan – Lexology
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The year in review
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). Securities token offerings are also regulated by the FIEA (see Section II.vi). In any event, careful legal due diligence is highly recommended before entering into securities transactions with residents in Japan.
On 18 May 2022, the Cabinet Order of the FIEA was amended to improve the best execution policy of the FIBOs. While many FIBOs currently present their best execution policy describing the best ways to execute customers’ orders of securities transactions, in most cases, the policy stated 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 other things).
However, according to the revised Cabinet Order taking effect on 1 January 2023, with regard to retail investors, the best execution will have to place more importance on prices in principle, and if an FIBO takes into consideration any factors other than prices, the reason will have to be clearly stated in the best execution policy (the ‘comply or explain principle’). Furthermore, if the FIBO may execute transactions by using smart order routing (SOR) or in dark pools, the information relating to the SOR or dark pool venue will have to be stated in the best execution policy.
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 was not available in Japan. Although the legislation did not prohibit margin trading of foreign-listed stocks, there were no rules for handling them. Given this situation, the JSDA has established self-regulatory rules regarding a margin trading system for foreign-listed stocks that took effect on 1 July 2022, providing investors with more diverse investment opportunities and methods.
As stated above, the FIEA provides for an exemption from disclosure obligation with respect to small-number private placement. If the number of investors to be solicited is no more than 49 in the aggregate during the previous six months, the obligation of an issuer of securities to file an SRS is exempted. The reason why the number of investors solicited is aggregated during a given period is to prevent evasion of disclosure requirements by issuing securities in multiple instalments, but it had been pointed out that a six-month period was too long and this restriction would hinder smooth fundraising. In order to address these points, the aggregation period was changed from six months to three months by the amendment to the Cabinet Order of the FIEA on 29 January 2022.
It had been understood that advertising an offering or secondary distribution of securities on the internet is subject to the disclosure requirement under the FIEA. However, the report issued by the FSA Working Group on Capital Market Regulations in June 2021 (the WG Report) emphasised the importance of supplying growth funds for a post-pandemic recovery and stated that the legal basis for the investment environment should be revised depending on the risk tolerance of institutional investors and retail investors, respectively. For this purpose, since 17 June 2022, the disclosure requirements have been relaxed for advertisements on the internet that can be accessed only by QIIs and certain professional investors (i.e., specified investors), and these advertisements are no longer subject to the obligation of filing an SRS.
From the same perspective, the Cabinet Office Ordinance on Financial Instruments Business, etc., was also revised, and the requirements of individuals who are eligible for as specified investors have been slightly revised and expanded since 1 July 2022.
The WG Report also proposed the establishment of regulations applicable to a private placement of over-the-counter (OTC) securities targeting for specified investors in order to facilitate the financing of unlisted companies and diversify their means of raising funds. Unlike private placements targeting only QIIs, private placements targeting specified investors had been difficult to be implemented for the reason that the JSDA’s rules prohibited FIBOs from soliciting investments in OTC securities. On 1 April 2022, the JSDA enacted the ‘Rules Concerning Solicitation of Investments in Over-The-Counter Securities for Specified Investors’ that went into effect on 1 July 2022. The Rules set forth two main regulations on: (1) the internal control systems required for the relevant FIBOs; and (2) the information to be provided to specified investors. With regard to (1), FIBOs are required to obtain designation as a member firm handling OTC securities from the JSDA, establish a rigid internal control system, conduct risk management properly, review the scope of the investors appropriate for the investment and comply with the relevant solicitation rules. With regard to (2), FIBOs have to comply with the regulations on the information to be disclosed or provided to specified investors and the regulations on methods of solicitation for investment. Likewise, the restrictions on trading foreign securities or investment trusts has been relaxed in respect of specified investors by the amendment to the JSDA’s relevant rules.
In order to provide risk money to new growth companies, the requirement to take advantage of the eased rules that is applicable to FIBOs dealing with investment crowdfunding has only been relaxed since 29 January 2022. Before the revision, in order to take advantage of the eased rules applicable to an investment crowdfunding business (an ‘electronic small amount subscription business’), it was necessary to satisfy the conditions: (1) the total issue amount of securities in the aggregate was less than ¥100 million in a previous year; and (2) the subscription amount was less than ¥500,000 per each investor. However, it had been pointed out that conditions (1) and (2) were too strict and made it difficult that venture companies to collect money from a large number of individual investors. Thus, the condition (1) has been revised to require that the total amount of securities issued ‘through equity crowdfunding’ in the aggregate is less than ¥100 million in the previous year, which means that amounts raised by the issuer through methods other than equity crowdfunding are not aggregated. Condition (2) has been revised to require that the subscription amount for each investor (other than certain professional investors) is less than ¥500,000, which means that there are no longer maximum investment limits for professional investors.
In order to raise funds to achieve the sustainable development goals (SDGs) adopted at the United Nations in 2015 and to achieve carbon neutrality by 2050, the Ministry of the Environment revised its Green Bond and Sustainability Linked Bond Guidelines in July 2022, and the FSA published the Social Bond Guidelines in October 2021 prescribing examples of indicators that are recommended to be used in the disclosure documents in order to present the expected or achieved benefits of the social project for which the social bond proceeds will be used. The contents of these guidelines are aligned with the ICMA’s Green Bond Principles, Social Bond Principles, Sustainability Bond Guidelines and Sustainability-Linked Bond Principles. The Japanese government encourages private sectors to use these guidelines to facilitate the issuance of these bonds.
See Section II.v for digitally tracked green bonds was issued by the JPX in 2022.
Over the past few years, 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, and non-financial information (including information on management policies, business risks and remuneration of directors) has been becoming increasingly recognised as important for the communication between companies and investors. In light of the growing importance of sustainability and corporate governance when investors make investment decisions, the Working Group on Corporate Disclosure of the Financial System Council has discussed enhancing non-financial information, and published a report in June 2022 including the following proposals.
It is anticipated that laws and regulations will be amended to enhance disclosure based on this report, which may be applied as early as 2023.
Under the current rule, documents containing information required to be provided to customers (including prospectuses, pre-contract documents, reports on outstanding balance of transactions and investment reports) must be delivered in paper form in principle, but with the consent of the customer, information can be provided digitally. However, the FSA Working Group on Capital Market Regulations of the Financial System Council is proposing to make digital delivery the principal means of provision. In this regard, the relevant issues such as how to inform customers that they can choose to receive the information in paper format, who should bear the cost of delivering the information in paper format, or how to confirm the customer’s intention will continue to be discussed.
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 TIBOR Administration (JBATA), a subsidiary of the Japanese Bankers Association (JBA), 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 JBA 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 discontinuation of LIBOR was expected to have a significant impact on the financial markets in Japan as in other major countries, because 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. However, the FSA and the Bank of Japan took actions cooperatively so that market participants could make a smooth transition from LIBOR, and as a result, according to the survey findings published in January 2022 by a cross-industry committee on financial benchmarks, the transition has been completed by the end of December 2021 with respect to approximately 99 per cent of contracts in which yen LIBOR had been referenced.
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.
In light of statements made by leaders at G20 summits calling for improvements in 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 recent reforms on margin requirements on OTC derivatives have been implemented as follows. For reforms related to central clearing and trade reporting, see Section II.v.
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 had been phase-in periods during which margin obligations applied to a given entity only if certain de minimis thresholds were met, but the VM phase-in period ended on 1 March 2017 and the IM phase-in period ended on 31 August 2022.
Under the current FIEA, IM is required 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.
Also, 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’s 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.
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 took effect on 1 January 2022.
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 characteristics of 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 are 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 ratio on leveraged ETFs will be increased for margin trading of leveraged ETFs from 10 January 2023.
In the Action Plan for the Growth Strategy published 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 and venture firms cannot obtain funding efficiently. The government has also suggested therein the introduction of a special purpose acquisition company (SPAC).
Following this Action Plan, the JSDA is to establish a new system for determining IPO prices by amending the Rules Concerning Underwriting, Etc. of Securities and to make it available by December 2022. The main purposes of this revision are: allowing flexible determination of the price and number of shares based on the results of hearings with investors without regard to the upper and lower limits of the provisional terms; shortening the period from the listing approval date to the listing date; the accountability of the issuer for the basis of determining the IPO price; and easing the upper limit of the overallotment facility for the purpose of increasing institutional investors who can hold the shares in the medium to long term (including cornerstone investors).
On the other hand, the introduction of SPACs has been discussed at the FSA Working Group on Capital Market Regulations of the Financial System Council, but some are cautious about its introduction from the perspective of investor protection and have not yet to propose any specific new rules.
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 FIEA was amended several times to provide for new schemes that would make it easier for foreign funds to establish their base in Japan. Since January 2021, the FSA has established the Financial Market Entry Office for foreign funds or investment management firms, which provides a single point of contact for newly entering foreign funds or firms with regard to pre-application consultation or registration procedures with the FSA or LFBs. The communications are available online in English, and further, certain documents required for an application for filing or registration that were normally submitted to the FSA in Japanese can now be prepared in English, subject to certain conditions.
Japan’s legal system is structured as a ‘civil law’ system based upon codified statutes, not upon case laws. Theoretically speaking, under Japanese law, judicial precedents are not binding as a law, which means that judgements of the higher courts are binding on the lower courts only with regard to that specific case and that precedents of the Supreme Court may be altered by decisions of the Grand Bench of the Supreme Court in the future. Even so, in practice, legal judgments by the Supreme Court are highly respected and affect the interpretation of similar cases among market participants as well as the lower courts. Not only that, if the Supreme Court’s judgment is rendered in relation to something not expressly mentioned in the financial laws and regulations, it may give an impact even to the legislative authorities or the FSA, which may lead to new or amendments of legislation with respect to the Supreme Court’s ruling. Considering these characteristics of Supreme Court precedents, it is advisable for markets participants to keep an eye on developments in the Supreme Court precedents, even though they are not directly legally binding.
Having said that, the number of cases that result in court decisions is much smaller than that in the US or other countries, partly because Japanese people and Japanese companies tend to avoid disputes in the courts and prefer to resolve them through private negotiations. In particular, there are very few cases where financial institutions engage in disputes with the authorities (such as the FSA or LFBs) concerning administrative measures or sanctions imposed and obtaining a judgment or paying a settlement in the court, even though it is theoretically possible. For these reasons, although some cases make headlines in the economic news, precedents having legal significance do not appear frequently.
One such recent decision is the Supreme Court’s judgment (dated 26 January 2021) on the application scope of the Interest Rate Restriction Act.15 There has long been an argument as to whether the provision of the Interest Rate Restriction Act, which stipulates a maximum interest rate for contracts on loans for consumption and invalidates the portion exceeding this rate, is applicable to corporate bonds. The Supreme Court ruled that the Interest Rate Restriction Act does not apply to corporate bonds, because the issue of corporate bonds is not a transaction in which it is necessary to apply the purpose of the Interest Rate Restriction Act that prohibits loans at an unreasonably high interest rate to economically vulnerable debtors in the retail market.
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 (PE) 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.
The recent tax reform that may affect foreign or domestic investors has been implemented by the 2022 Tax Reform Act as described below.
First, it was not legally clear that whether foreign investors without a PE in Japan would be taxed on income generated from market or OTC derivatives in Japan, but the 2022 Tax Reform Act has made it clear that they will not be taxed in Japan.
Second, under the Japanese tax law, earnings stripping rules have been applied only to domestic corporations and foreign corporations having a PE in Japan. By the 2022 Tax Reform Act, however, foreign corporations that do not have a PE in Japan will be subject to the new restrictions under earning stripping rules when they file tax returns with respect to domestic source income.
Third, as a general rule, dividends paid to individual shareholders on listed shares can be treated as financial income (i.e., separate taxation) if the individual’s shareholder ratio is less than 3 per cent. When the shareholding ratio is 3 per cent or more, dividends are subject to comprehensive taxation. However, there were cases in which, even though the shareholding ratio of the individual investor was legally less than 3 per cent, the actual shareholding ratio should be considered 3 per cent or more because controlled corporations with the same controlling investor were used. Therefore, from October 2023, corrective measures will be taken to address this problem such that shares held by a group of family-owned companies will be included when calculating the shareholding ratio.
Fourth, the period of tax exemption regarding dividends received by a non-resident or foreign corporation in respect of the bond-type beneficial interest issued by the special purpose trust interest (i.e., a Japanese version of sukuk used in Islamic finance) was extended for two years from the end of March 2022.
In addition to the above, not limited to the financial sector, the Japanese government aims to introduce a carbon tax on greenhouse gas emissions, as a special measure in the policy for promoting investment in digital transformation and for promoting investment for carbon neutrality, although the government could not decide to introduce it in the 2022 Tax Reform Act. Such a trend in the tax system will probably continue in Japan, which may affect investment strategy.
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.
Apart from the above, reflecting on the incident that the default by Arkegos Capital Management caused huge losses to several Japanese financial institutions, the FSA published a letter titled ‘Supervisory Focus Points and Actions in light of the Losses Resulting from the Default of a U.S. Investment Fund’ on 20 April 2022, which sets out points that financial institutions should keep in mind in order to prevent recurrence. In this letter, the FSA noted that this was due to the fact that risks were underestimated and not properly monitored and managed, and that the FSA will supervise more closely the governance and risk management framework of each financial institution and the management of counterparty credit risk in regard to derivative transactions.
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 three stock markets: Prime Market, Standard Market and Growth Market, which was restructured on 4 April 2022, as described 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 the Tokyo Commodity Exchange Inc (TOCOM), a wholly owned subsidiary and commenced commodity trading operations on the TOCOM and the 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, 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 the TSE and the OSE into the JPX. However, in recent years, the trading share of PTSs has increased, and since June 2022, the Osaka Digital Exchange (ODX) has begun its operation as the third PTS operator for equity trading in Japan. The government has indicated in its Action Plan that it intends to develop a PTS system in order to provide investment opportunities to a wide range of investors, and in light of this, it is worth noting the future revisions of regulations on the PTS along with the further review of the best execution policy and the exchange rules.
Further, the government is planning to establish the new trading market where carbon credit would be traded at a publicly available rate under the strategy of ‘GX League’. In respect of this project, see Section II.vi.
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. The JPX launched derivatives holiday trading at the OSE and the TOCOM on 23 September 2022 (the Autumnal Equinox Day of Japan).
Furthermore, the FSA and the TSE restructured the market sections of the TSE. Specifically, they have organised the previous four markets (First Section, Second Section, Mothers and the JASDAQ) into three markets (Prime Market, Standard Market and Growth Market) from 4 April 2022, improving convenience for investors by clearly presenting the concept of each market section and motivating listed companies to maintain sustainable growth and increase corporate value even after listing, while providing a wide range of companies with listing opportunities. The Prime Market is a market for companies satisfying the strictest criteria in respect of market capitalisation, liquidity, corporate governance and profitability, among other matters. The Standard Market is a market for companies satisfying the standard level of criteria, and the Growth Market is a market for start-ups with higher growth potential. According to the survey conducted by the TSE, approximately 85 per cent of companies listed on the First Section of the TSE had moved to the Prime Market, but approximately 16 per cent of them had not met the continued listing criteria of the Prime Market before 3 April 2022. As an transitional measure, relaxed continued listing criteria is being applied to those companies for the time being, and the companies are allowed to remain listed for the transition period on the condition that they satisfy the relaxed continued listing criteria and disclose their plan to satisfy with the unrelaxed listing criteria and the progress on that plan in accordance with the TSE rules. The length of the transition period is set individually in view of the relevant requirement and the situation of the company.
In recent years, the JPX has been engaged in a number of sustainability-related activities. In particular, the JPX issued the first unsecured bonds, which are the corporate bond-type security tokens that utilise a blockchain platform intended to increase the transparency of green investment data and convenience for parties concerned (called ‘digitally tracked green bonds’) in June 2022. This is the first publicly offered security token offering in Japan, and became available recently based on the amendments to the FIEA and relevant regulations. The JPX intends that many issuers and investors would participate in the scheme of digitally tracked green bonds with greater convenience in the future.
Additionally, in order to support listed companies working on ESG disclosure and improve their corporate value in light of sustainable growth, the JPX published the ‘Practical Handbook for ESG Disclosure’ describing important points regarding ESG information disclosure, and the ‘Anthology of ESG issues – For Promoting Information Disclosure’ covering 31 ESG issues, along with commentary on what kind of risks and business opportunities could arise, the possible impacts on corporate value, metrics that could be used for risk evaluations and management, and other aspects relating to each issue.
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 TONA or three-month or six-month 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.
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. Currently, the regulations on the OTC derivatives transaction information reporting are being developed so that they will harmonise with overseas reporting systems by introducing identifier (LEI, UPI, UTI) and other critical data elements. Part of the relevant Cabinet Office Ordinance was already revised in August 2022, and the FSA is now working on the guidelines in this regard to be implemented by 1 April 2024.
The DTCC Data Repository (Japan) has provided trade depository services in Japan as a foreign trade repository under the FIEA since March 2013.
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 took effect on 22 November 2022.
Another revision was to ease the financial industry firewall on 22 June 2022. Japanese law had long adopted a firewall policy that basically separates banking business and securities business. Under the firewall regulations (which had been slightly relaxed from the original regulations), securities business could be carried out by a subsidiary or an affiliate of a bank taking the form of a securities company (an FIBO), but there still remained the information firewall that prohibited the transfer of customer information between banks and securities companies. By the amendment to the Cabinet Office Ordinance on Financial Instruments Business, etc. and the Comprehensive Guidelines for Supervision of Major Banks, etc, information on customers (limited to corporate customers) became 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.
From the perspective of advancing digitalisation in the financial industry, the FSA has developed some legislation that provides a legal framework for fintech-related business while protecting investors in fintech-related transactions. In the recent developments, the PSA was revised to regulate business operators handling the trades of cryptoassets (e.g., Bitcoin, Ethereum) in April 2019, and to regulate business operators handling the trades of digital currencies issued at a price linked to the value of the legal tender and redeemed at the same amount when it is issued (e.g., stablecoins) in June 2022 that will take effect in 2023. Also, the FIEA was revised in 2019 to regulate fundraising by security token offerings (STOs) and other investment schemes similar to STOs. Concurrently, the anti-money laundering and countering financing of terrorism regulations have also been strengthened to include these business operators (see below).
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 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. On an ongoing basis, the FSA is working to expand and advance the Principle for Customer-Oriented Business Conduct. For example, there were amendments to introduce a new rule on the Key Information Sheet in February 2021 and to improve the best execution policy in May 2022 (see Section II.i). The FSA’s Supervisory Guidelines were also amended in November 2021 with respect to the solicitation for switching into other investment products, which was shifting from a rules-based approach to a principles-based approach, and thereafter each FIBO needs to consider specific matters to be explained to each customer taking into account the customer’s financial conditions, etc., respectively. The FSA not only revised the regulations, but will also closely monitor whether each FIBO’s business operations is really customer-oriented and proactively announce the relevant information.
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 been working to strengthen money laundering regulations. In particular, commercial registry offices under the Ministry of Justice have begun administering a list of beneficial owners (BOs) of joint stock companies of Japan since 31 January 2022. This is the new measure to record and certify information regarding BOs of stock companies in light of FATF Recommendation. Under the new registry system, a stock company may request a certified copy of the registered BO information, which would allow financial institutions to more easily confirm the controlling interests of their customers at the time of transaction. Another example is the amendment to the PSA and the Act on Prevention of Transfer of Criminal Proceeds, which will require business operators issuing electronic gift cards or prepaid cards that are transferred by sending a number, codes or URL by email or similar methods, (e.g., Amazon eGift Cards, Visa Prepaid Cards) to require KYC procedures and to report suspicious transactions from 2023 if the amount to be transferred exceeds the prescribed amount. With respect to FIBOs or securities transactions, there have been no major changes to the law and regulation regarding anti-money laundering and countering financing of terrorism even after 2021.
Since the Act on the Protection of Personal Information took into effect on 1 April 2022, the FSA has updated the Guidelines for Protection of Personal Information in the Finance Sector and the Practical Guideline on the Security Control Actions under the Guidelines for Protection of Personal Information in the Finance Sector (collectively, the Guidelines) accordingly. Generally speaking, many Japanese companies handling personal information had to take a lot of actions before the revised Act took effect, because the main purpose of the revision of the Act was to strengthen the protection of personal information while allowing the utilisation of data containing personal information. With respect to financial institutions, however, the revision of the Act did not seem to make a significant impact. The above Guidelines set by the FSA had previously imposed stricter obligations (including the obligation to ‘make efforts’) on financial institutions than the obligations under the Act in relation to the protection of personal information, and therefore, for financial institutions that had been complying with the FSA’s Guidelines, the revisions of the Act and the Guidelines in 2022 did not seem to have provided a significant impact.
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. Like some other countries, Japan is currently facing an energy crisis due to the situation between Russia and Ukraine, but the government is still pursuing a variety of policies to achieve this goal, some of which concern the capital market.
In order to attract domestic and foreign ESG funds to the Japanese market, the FSA is considering new rules, platforms and infrastructures that would be necessary for such ESG-related investments. For example, the FSA has published the Social Bond Guidelines (see Section II.i), and the FSA and the TSE have continuously reviewed and revised the Corporate Governance Code and the disclosure rules so that investors may know the ESG-related information more easily. More specifically, the Corporate Governance Code was revised on 11 June 2021 to enhance board independence, promote diversity and incorporate new principles of governance such as sustainability and ESG. Under the revised Corporate Governance Code, a listed company on the Prime Market must have at least one-third of the board directors who are independent directors, and all listed companies are encouraged to create and disclose a skill matrix of board members conforming to the company’s business strategy. With respect to diversity, listed companies are encouraged to disclose a policy and voluntary measurable targets about the promotion or appointment of women, non-Japanese and mid-career hires to senior managerial positions. Listed companies on the Prime Market are expected to enhance the climate-related disclosure based on TCFD recommendations or equivalent international frameworks.
The FSA also issued the guidance document titled ‘Supervisory Guidance on Climate-related Risk Management and Client Engagement’ in July 2022 and published the draft of the ‘Code of Conduct for ESG Evaluation and Data Providers’ in July 2022 for the transparency and fairness of evaluation by ESG evaluation and data provision organisations.
At the same time, the METI has announced a growth strategy of ‘GX (Green Transformation)’ that is designed to achieve a transformation of the entire economic and social system to decarbonisation while fulfilling the demands for economic growth and environmental protection. The METI intends to establish a platform called ‘GX League’ to be participated in by companies, academia and autonomous communities, etc., to take up the challenge of GX. Registration for the first participants in the GX League was closed at the end of March 2022, and the GX League plans to start a demonstration test from the second half of fiscal year 2022 with full-scale operations starting in April 2023 or later. One of the initiatives planned by the GX League is the establishment of a carbon credit market for emissions trading, and the METI intends to establish an international trading venue where the J-Credits (used within Japan), Joint Crediting Mechanism credits and high-quality carbon credits used in foreign countries can be traded at a publicly announced price. A demonstration project for the new carbon credit market was launched on the TSE in September 2022.
Apart from the above, the government is considering issuing new government bonds, tentatively called ‘GX economic transition bonds,’ as a means of raising funds, but no specific conditions or schedule have been set for their issuance. Another possible method of financing may be a carbon tax, but this also has not yet been introduced (see Section II. iv).
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