## cr17284 ## Source details **Canonical URL:** [cr17284](https://www.imf.org/-/media/files/publications/cr/2017/cr17284.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17284.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17284.pdf.json) --- ### Executive summary — market structure and firm heterogeneity - Japanese securities firms range from major global players to purely domestic firms that conduct only limited activities. - The group includes two major independent securities groups designated as Domestic Systemically Important Banks (D-SIBs) and securities subsidiaries of Japanese megabanks that are G-SIBs. - Foreign-owned securities firms that are part of global G-SIB banking groups account for more than half of the trading value at Tokyo Stock Exchange (TSE). - The remainder of the almost 2,000 firms range from very small investment advisers to medium-sized firms providing Internet-based trading services to retail clients. - Total number of Japanese securities firms mentioned: almost 2,000 firms. ### Market size, trading statistics, and key numeric details - Equity market capitalization of JPX’s Tokyo Stock Exchange (TSE): US$4,955 billion. - Annual equity trading value at TSE: US$5,618 billion. - Osaka Exchange ranked 17th in the world in 2016 for derivatives trading with about the tenth of the trading volume of CME Group. - Total number of FIBOs (as of February 28, 2017): 1,942. - Firms registered only for one business category: 1,337. - Individuals registered: 31. - Breakdown by registration type: - Type I: 286 firms; 138 firms registered only for Type I. - Type II: 1,157 firms; 657 firms registered only for Type II; Individuals: 1. - IAAB: 987 firms; 475 firms registered only for IAAB; Individuals: 30. - Investment management: 350 firms; 67 firms registered only for investment management. - Firms registered for all four categories: 25. - Financial institutions permitted to conduct securities activities: - Banks: 152. - Cooperatives: 882. - Other financial institutions: 21. - Note: 216 firms are registered only for Type II financial instruments business and IAAB; therefore a total of 1,348 firms conduct only relatively narrow securities activities. - Special FIBOs: - Asset threshold for Special FIBO designation: JPY 1 trillion. - Number of Special FIBOs: 21. - Currently 21 Special FIBOs include firms belonging to the two major independent securities groups, main securities subsidiaries of megabanks, three other Japanese-owned securities firms and 12 foreign-owned securities firms. - Market concentration (fiscal year 2015): - Two major independent securities groups = 30 percent of the revenue of all firms engaged in Type I financial instruments business. - Two majors + megabank subsidiaries = 56 percent of industry net operating revenue. - Trading membership and market share (Tokyo Stock Exchange, Jan 1–Nov 30, 2016): - Total trading participants: 93. - Japanese owned FIBOs: Number of Members 73; Market Share, Value of Trading 46.93 percent. - Foreign owned FIBOs: Number of Members 15; Market Share, Value of Trading 52.30 percent. - Japanese branches of foreign securities firms: Number of Members 4; Market Share, Value of Trading 0.54 percent. - Regulated remote members by home country: Number of Members 1; Market Share, Value of Trading 0.22 percent. - Osaka Exchange (Jan 1–Nov 30, 2016) membership and market share: - Total members 108; Market Share, Number of Equity Derivatives Contracts 100 percent; Market Share, Number of Fixed Income Derivatives Contracts 100 percent. - Japanese owned FIBOs: Number of Members 65; Market Share, Number of Equity Derivatives Contracts 30.86 percent; Fixed Income Derivatives Contracts 33.78 percent. - Foreign owned FIBOs: Number of Members 13; Market Share, Number of Equity Derivatives Contracts 68.92 percent; Fixed Income Derivatives Contracts 55.88 percent. - Japanese branches of foreign securities firms: Number of Members 4; Market Share, Number of Equity Derivatives Contracts 0.22 percent; Fixed Income Derivatives Contracts 0.54 percent. - Other members (Japanese owned banks, cooperatives and other financial institutions): Number of Members 26; Market Share, Number of Fixed Income Derivatives Contracts 9.81 percent. ### Division of regulatory responsibilities and institutional arrangements - Principal authorities and structure: - JFSA (Japan Financial Services Agency): integrated financial supervisory authority; JFSA Commissioner responsible for regulatory, supervisory and enforcement activities related to securities firms; delegation framework under FIEA Articles 194-7(2), (3), (4), and (6). - SESC (Securities and Exchange Surveillance Commission): independent body exercising delegated authority from the JFSA Commissioner; mission to ensure market integrity and investor protection; staff 411. - Local Finance Bureaus (regional branch offices of MoF): 11 Local Finance Bureaus with Financial Supervisory Divisions conducting supervisory work under delegation or sub-delegation. - Role allocation: - All JFSA Commissioner’s inspection and investigation authority is formally delegated to the SESC. - Local Finance Bureaus undertake registration of all securities firms and conduct offsite monitoring and onsite inspections of the majority of securities firms (by number). - JFSA (in cooperation with SESC) directly responsible for offsite monitoring of large securities firms; 321 FIBOs are subject to direct offsite monitoring by JFSA and onsite inspections by SESC. - Footnote breakdown for the 321: 78 registered for Type I, 205 for Type II, 171 for IAAB, 211 for investment management. - Self-regulatory organizations (SROs): - JSDA staff: total 366 as of April 1, 2017; approximately 150 involved in self-regulatory activities. - JPX-R supervises trading participants; JPX-R staff 38; JPX-R supervises 120 trading participants in total. - Other certified associations and SROs (FFAJ, JITA, JIAA, Type II Association) provide inspections and rule-making. - Conclusion on division: - The structure is complex but responsibilities appear to sufficiently cover prudential and conduct supervision; authorities and SROs strive for coordination while reducing overlaps. ### Transition to new supervisory approach and supervisory resources - New supervisory approach: - Combines more intensive offsite monitoring and risk-based onsite inspections. - Offsite assessment based on viability of business model, governance effectiveness, and appropriateness of risk management. - Evaluates the three lines of defense: front-office; risk management and compliance; internal audit. - Offsite monitoring results, with risk-based analysis, determine which firms receive onsite monitoring; risk profiles updated quarterly. - Implementation and transitional challenges: - Transitional issues include providing sufficient training and guidance to Local Finance Bureaus and ensuring onsite inspections remain an important supervisory tool. - Offsite monitoring alone is unlikely to identify all risks; balance between offsite and onsite work must be maintained. - Supervisory staff and resources (numbers preserved): - JFSA Supervisory Bureau staff devoted to securities firm supervision: 44 persons. - SESC relevant staff: 129. - Local Finance Bureaus staff: 232. - Total staff exclusively involved in Nomura and Daiwa supervision: 25 (3 in JFSA Supervisory Bureau; 14 in JFSA Inspection Bureau; 8 at SESC). - Megabank subsidiaries supervision: five staff from Inspection Bureau; dedicated team includes three from Supervisory Bureau and seven from SESC. - SRO resources: JSDA’s Inspection Headquarters 57 staff; JPX-R 38 staff; smaller SROs total 88 supervisory staff (Type II Association 8; FFAJ 22; JITA 38; JIAA 20). - Inspection activity (SESC statistics): - 04/2013-03/2014: FIBOs Inspections Completed 230; Recommendations Made 18. Type I Inspections Completed 63; Recommendations Made 3. - 04/2014-03/2015: FIBOs Inspections Completed 232; Recommendations Made 15. Type I Inspections Completed 86; Recommendations Made 3. - 04/2015-03/2016: FIBOs Inspections Completed 128; Recommendations Made 18. Type I Inspections Completed 58; Recommendations Made 12. - JSDA inspection activity (fiscal years): - FY2013 JSDA regular members (securities firms) inspections: 87 total; joint inspections with JPX-R 28; JSDA’s own inspections 59. - FY2014: 84; joint 31; own 53. - FY2015: 80; joint 30; own 50. - Recommendations on supervisory resources: - Continue to ensure supervisory teams for major Japanese groups and megabank subsidiaries have access to sufficient experienced staff. - Continue to provide training and guidance to Local Finance Bureaus during transition. - Continue to use onsite inspections as an important complement to offsite monitoring. - Continue to enhance onsite monitoring of Japanese securities firms’ overseas operations jointly with foreign authorities and ensure cooperation with foreign supervisory authorities responsible for parent banks. ### Prudential framework, capital and liquidity requirements - Initial capital requirements (by registration type): - IAAB only: no minimum capital requirement, but JPY 5 million business security deposit required. - Underwriters (lead underwriters): JPY 3 billion. - Other underwriters: JPY 500 million. - Any other Type I financial instruments business and investment management business (other than investment management solely to qualified investors): JPY 50 million. - Type II financial instruments business and investment management business to qualified investors: JPY 10 million. - Risk-based ongoing capital requirements: - Apply only to firms engaged in Type I financial instruments business. - Firms must calculate their capital adequacy ratio every business day and report end-of-month ratio to JFSA or relevant Local Finance Bureau by the 20th day of the following month. - JFSA applies a net capital rule approach on a solo basis for all Type I FIBOs. - Trigger levels and supervisory actions: - Capital adequacy ratio formula preserved: Non-fixed capital x 100 / Risk-equivalent amount. - < 140 percent: must report (FIBO must immediately notify JFSA if below 140 percent and submit improvement plan; report when ratio reaches or exceeds 140 percent). - < 120 percent: business improvement order; JFSA may order changes of business methods, order assets to be deposited, or issue orders necessary from supervisory perspective. - < 100 percent: business suspension order (suspension up to three months); if remains under 100 percent after suspension and no recovery outlook, JFSA may revoke registration. - Historical supervisory actions (fiscal years 2014−16): - Two firms fell below 140 percent. - One firm fell below 120 percent; JFSA issued a business improvement order and a business suspension order. - Liquidity requirements: - Largely qualitative; Type I FIBOs must have liquidity risk management framework compliant with JFSA’s Supervisory Guidelines. - Firms must submit a monthly liquidity report to JFSA or relevant Local Finance Bureau. - JFSA monitors liquidity risk regularly through reports, hearings and offsite monitoring. - Consolidated supervision and group-wide requirements: - Special FIBOs subject to consolidated supervision, consolidated capital adequacy requirements, and consolidated business reports within three months after year-end. - Only five out of 21 Special FIBOs are required to prepare consolidated financial statements and capital adequacy calculations at subgroup level because others do not have subsidiaries; firms listed: SMBC Nikko Securities Inc., Mitsubishi UFJ Morgan Stanley Securities Co., Ltd., Mizuho Securities Co., Ltd., SBI Securities Co,. Ltd and Rakuten Securities, Inc. - Highest designated parent company supervision can be applied where group control or funding arrangements warrant; Daiwa Securities Group, Inc. and Nomura Holdings, Inc. identified as highest designated parent companies and subject to consolidated supervision. - Those groups may choose between Japanese capital adequacy framework or Basel III–aligned requirements; they have opted for Basel III–aligned requirements. - Nomura and Daiwa were designated D-SIBs in December 2015 and are subject to a 0.5 percent surcharge in addition to their Basel III capital adequacy ratio; additional capital required by the surcharge must be in place by March 2019. The surcharge has been maintained at 0.5 percent to date. - Conclusions and recommendations on prudential framework: - Prudential requirements address risks from the most systemically important firms in an internationally comparable manner, but requirements for other firms have atypical features (risk-based capital only for Type I; limited application of financial audits; consolidation threshold at JPY 1 trillion). - Recommendation: review the prudential regulatory framework for all securities firms within the medium term (3−5 years) to ensure it appropriately addresses financial stability and investor protection risks and moves toward global best practice. ### Client asset segregation, custody, and investor protection - Segregation and custody rules: - Only FIBOs registered for Type I financial instruments business are, in principle, permitted to hold client assets. - FIBOs must manage customers’ securities separately from their own assets (FIEA Article 43-2). - Exceptions exist for rehypothecation with written customer consent; third-party custody is permitted and the third party is subject to same segregation requirements. - Handling of client money requires establishment of a trust with a trust company in Japan to manage refund money if the firm discontinues business. - FIBOs engaged in Type I business must submit reports on client assets they hold. - Supervision and audits: - Compliance supervised by JFSA, SESC and Local Finance Bureaus. - Compliance with client asset segregation is audited at least once a year by a CPA or audit firm under JSDA rules; JSDA revised rules in July 2016 with implementation deadline March 2017 to unify external audit process for asset segregation. - Investor protection scheme (JIPF): - Japan Investor Protection Fund (JIPF) provides compensation up to JPY 10 million per customer for missing assets where segregation fails. - Membership in JIPF is compulsory for all FIBOs engaged in Type I financial instruments business. - JIPF fund balance approximately JPY 57 billion at end of fiscal year 2015; amount deemed sufficient is JPY 50 billion. - JIPF has not collected levies since fiscal year 2003 because balance has been at or above required amount. - Last time JIPF was tapped was in 2015, paying approximately JPY 172 million to 635 customers of Marudai Securities (bankrupt in March 2012). - Risks and recommendations on client assets: - Risks identified: investment management firms’ ability to hold client assets without segregation during settlement period; complexity of asset segregation rules across multiple laws and orders; legal framework alone cannot eliminate misappropriation or operational errors. - Recommendation: enhance supervision of compliance with client asset segregation requirement. Support measures could include: - external auditors reviewing compliance more often than annually; - surprise examinations by authorities; - surprise audits by external auditors. ### Outsourcing, technological developments, and high-speed trading - Outsourcing: - Outsourcing regulated activities generally requires the service provider to be registered as a FIBO. - Investment management business may be outsourced to a foreign firm conducting equivalent business. - FIBOs remain responsible for risk management of outsourced activities; JFSA’s Supervisory Guidelines require policies and control systems for outsourcing. - Supervision of outsourcing compliance primarily through offsite monitoring; authorities hold hearings, track improvements, and require reports when concerns arise. - Technological trends and regulatory actions: - JFSA’s Strategic Directions and Priorities 2016-2017 references FinTech, cyber security and algorithmic trading. - 2016 metrics: share of orders placed through TSE’s co-location area around 70 percent; share of transactions executed in co-location area 40−50 percent. - December 2016: Financial System Council proposed new regulatory requirement for high-speed trading including registration framework. - March 2017: JFSA submitted a bill proposing a regulatory framework for high-speed traders covering organizational/system requirements, notification and provision of information (including trading strategy descriptions), maintaining trading records, and submission of business reports. - Recommendation: ensure specifics of requirements and measures can be flexibly adapted to future developments in other major financial markets. ### Enforcement, failure frameworks, and crisis arrangements - Enforcement powers: - JFSA can issue business improvement orders, suspend business activities (up to three months), rescind registration, and impose other measures; administrative monetary penalties can be issued for insider trading, market manipulation or fraud but not for systems and control deficiencies. - Enforcement action generally taken on basis of SESC recommendation. - Publication practice: enforcement actions and SESC recommendations are generally published with consideration of confidentiality and transparency. - SRO disciplinary powers: - JSDA can expel members, suspend or limit membership up to six months, fine up to JPY 500 million (plus amount of any improper gain), reprimand, or issue non-public admonition or written warning. - JSDA fiscal years 2014-2016 disciplinary use: expelled one member; fined 14 members (one also suspended); reprimanded one member. Largest fines JPY 30 million (two firms). - Failure and protection arrangements: - Segregation of client assets is primary protection; JIPF compensation up to JPY 10 million per customer for missing assets. - JIPF excludes certain transactions and certain classes of institutional clients. - Deposit Insurance Act amendment (June 2013) introduced an orderly resolution regime applicable to securities firms; Prime Minister can trigger resolution after Financial Crisis Response Council confirms systemic risk. - Securities firms qualify for Bank of Japan lending under Article 38(1) of Bank of Japan Act; emergency liquidity assistance possible if Policy Board approves. - Authorities have engaged in recovery and resolution planning in Crisis Management Group (CMG) arrangements with foreign authorities. - Conclusions on enforcement and failure frameworks: - Enforcement and disciplinary framework appears sufficiently effective and transparent. - Legal framework includes asset segregation and investor protection fund and an orderly resolution regime, though operational details for non-bank application of the resolution regime need elaboration. ### Main recommendations (regulation and supervision) — timing and priorities - Division of regulatory responsibilities: - Continue to enhance cooperation between regulators to ensure effective supervision of securities firms (JFSA, SESC, Local Finance Bureaus). Priority: High. Timing: I. - Continue to engage with the SROs to benefit from their ability to focus on investor protection and market fairness (JFSA, SESC, Local Finance Bureaus). Priority: Medium. Timing: I. - Regulation: - Review the prudential regulatory framework for all securities firms to ensure that it appropriately addresses financial stability and investor protection risks, striving towards the global best practice (JFSA). Priority: Medium. Timing: MT. - Supervision: - Enhance supervision of compliance with the client asset segregation requirement (JFSA, SESC, Local Finance Bureaus). Priority: High. Timing: NT. - Continue to ensure that the teams responsible for the supervision of the systematically important securities firms have access to sufficient number of experienced staff (JFSA, SESC). Priority: High. Timing: I. - Continue to provide sufficient training and guidance to the Local Finance Bureaus during the transition to the new supervisory approach (JFSA, SESC). Priority: High. Timing: I. - Continue to use onsite inspections as an important complement to more intensive offsite monitoring (JFSA, SESC). Priority: High. Timing: I. - Continue to enhance onsite monitoring of Japanese securities firms’ overseas operations jointly with foreign supervisory authorities (JFSA, SESC). Priority: High. Timing: I. - Continue to ensure that the cooperation with the foreign supervisory authorities responsible for the global banking groups sufficiently covers their Japanese securities subsidiaries (JFSA, SESC). Priority: Medium. Timing: NT. - Timing notation: I = immediate (within one year); NT = near term (1−3 years); MT = medium term (3−5 years). *IMF staff report (cr17284).* ### EXECUTIVE SUMMARY __________________________________________________________________________ 4 ### EXECUTIVE SUMMARY ### Key findings on market structure and firm heterogeneity - Japanese securities firms range from major global players to purely domestic firms that conduct only limited activities. - The group includes two major independent securities groups designated as Domestic Systemically Important Banks (D-SIBs) and securities subsidiaries of Japanese megabanks that are G-SIBs. - Foreign-owned securities firms that are part of global G-SIB banking groups account for more than half of the trading value at Tokyo Stock Exchange (TSE). - The remainder of the almost 2,000 firms range from very small investment advisers to medium-sized firms providing Internet-based trading services to retail clients. ### Supervisory and regulatory framework observations - The authorities take heterogeneity in business models into account by combining government regulators and various self-regulatory organizations (SROs) to achieve sufficient supervisory coverage. - The overall supervisory structure is complex; authorities and SROs strive for coordinated work to achieve common objectives while trying to reduce overlaps. - Continued enhancement of cooperation between regulators and engagement with SROs is recommended to ensure effective supervision and to benefit from SROs’ focus on investor protection and market fairness. ### Transition to a new supervisory approach - Authorities are transitioning to a new supervisory approach combining more intensive offsite monitoring and risk-based onsite inspections. - If consistently applied across authorities, the new approach enables better focus on emerging risks and firms’ governance and controls. - Transitional challenges need to be addressed, including: - Providing sufficient training and guidance to the Local Finance Bureaus in implementing the new approach. - Ensuring onsite inspections remain an important supervisory tool. ### Supervision of systemically important and cross-border firms - Supervision of the two major Japanese securities groups and Japanese subsidiaries of global banking groups requires special attention due to domestic and cross-border interconnectedness. - Authorities should ensure supervisory teams for major Japanese groups have access to a sufficient number of experienced staff. - Enhance international cooperation in supervision of Japanese firms’ overseas operations and foreign-owned firms’ activities in Japan, including: - Continuous enhancement of joint onsite monitoring of Japanese securities firms’ foreign business. - Cooperation with foreign authorities responsible for the parent banks of Japanese securities firms. ### Prudential framework and client asset segregation - Supervision of other securities firms builds on stringent requirements on client asset holding and segregation, which have been used as a basis for tailoring the current prudential framework. - Prudential requirements address risks from the most systemically important firms in an internationally comparable manner. - Requirements for other firms differ from models used elsewhere (e.g., consolidated supervision only above a certain threshold). - Given the emphasis on asset segregation, it is recommended that authorities enhance supervision of compliance with the segregation requirement. - A recommended review of the prudential framework within the medium-term should ensure it appropriately addresses financial stability and investor protection risks potentially arising from smaller firms’ activities and remains appropriate when markets change. ### Numeric and scope highlights - Total number of Japanese securities firms mentioned: almost 2,000 firms. --- ### Table 1 summary: Main Recommendations on Regulation and Supervision of Securities Firms - Recommendation categories: Division of regulatory responsibilities; Regulation; Supervision. - Timing notation used: I = immediate (within one year); NT = near term (1−3 years); MT = medium term (3−5 years). Key recommendations and priorities (as presented) - Division of regulatory responsibilities - Continue to enhance cooperation between regulators to ensure effective supervision of securities firms (JFSA, SESC, Local Finance Bureaus). Priority: High. Timing: I. - Continue to engage with the SROs to benefit from their ability to focus on investor protection and market fairness (JFSA, SESC, Local Finance Bureaus). Priority: Medium. Timing: I. - Regulation - Review the prudential regulatory framework for all securities firms to ensure that it appropriately addresses the financial stability and investor protection risks, striving towards the global best practice (JFSA). Priority: Medium. Timing: MT. - Supervision - Enhance supervision of compliance with the client asset segregation requirement (JFSA, SESC, Local Finance Bureaus). Priority: High. Timing: NT. - Continue to ensure that the teams responsible for the supervision of the systematically important securities firms have access to sufficient number of experienced staff (JFSA, SESC). Priority: High. Timing: I. - Continue to provide sufficient training and guidance to the Local Finance Bureaus during the transition to the new supervisory approach (JFSA, SESC). Priority: High. Timing: I. - Continue to use onsite inspections as an important complement to more intensive offsite monitoring (JFSA, SESC). Priority: High. Timing: I. - Continue to enhance onsite monitoring of Japanese securities firms’ overseas operations jointly with foreign supervisory authorities (JFSA, SESC). Priority: High. Timing: I. - Continue to ensure that the cooperation with the foreign supervisory authorities responsible for the global banking groups sufficiently covers their Japanese securities subsidiaries (JFSA, SESC). Priority: Medium. Timing: NT. *I=immediate (within one year); NT=near term (1−3 years); MT=medium term (3−5 years).* --- ### INTRODUCTION ### Market size and trading statistics - Equity market capitalization of JPX’s Tokyo Stock Exchange (TSE): US$4,955 billion (TSE is the third largest exchange in the world). - Annual equity trading value at TSE: US$5,618 billion (TSE ranks sixth in value of trading). - Osaka Exchange (part of JPX) ranked 17th in the world in 2016 for derivatives trading with about the tenth of the trading volume of CME Group. ### Scope and purpose of the note - The note reviews the functioning and effectiveness of the regulation and supervision of securities firms in Japan, using IOSCO documents as benchmarks. - The note also discusses the regulatory and supervisory framework for the securities business conducted by banks and other financial institutions. - Discretionary investment management business conducted by securities firms is covered where relevant; management of collective investment schemes by securities firms is outside the scope. - Analysis is based on authorities’ questionnaire response; limited review of legal and regulatory framework, in particular the Financial Instruments and Exchange Act (FIEA); and discussions with authorities and market participants. - The main author and timing details: The main author is Ms. Eija Holttinen, Senior Financial Sector Expert from the Monetary and Capital Markets Department of the IMF. The onsite work supporting the findings and conclusions was conducted during April 6-27, 2017. The information in this note is current as of April 2017. --- ### MARKET AND REGULATORY STRUCTURE ### A. Firms Permitted to Conduct Securities Business — Legal framework and registration - Both securities firms and other financial institutions can conduct securities business in Japan. Scope of permitted activities varies by registration type. - Firms seeking to provide securities services must generally apply for registration as a Financial Instruments Business Operator (FIBO). - Four main types of financial instruments business; a FIBO registration can cover one or more: - Type I financial instruments business: brokerage, dealing, and corporate finance activities in a wide variety of “liquid” financial instruments (shares, government bonds, corporate bonds, and other securities defined in Article 2(1) of the FIEA). - Type II financial instruments business: brokerage and dealing in and distribution of certain “illiquid” financial instruments (beneficial interest and other securities specified in Article 2(2) of the FIEA and related derivatives, including trust beneficial rights, rights in partnership agreements, anonymous partnership agreements and investment limited partnership agreements). - Investment advisory and agency businesses (IAAB). - Investment management business. - Registration must specify subcategory of service and instrument, though registration reflects only one or more of the four main categories. ### Branches of foreign securities firms - Foreign securities firms may conduct securities business through a branch, subject to registration as a FIBO; registration categories are the same as for Japanese FIBOs. - Registration requires the firm to establish a physical presence (office) in Japan. ### Cross-border provision of certain securities services - Foreign securities services providers may, in certain cases, conduct business without specific registration or office in Japan: - If investment advisory services are provided to a FIBO registered for investment management business. - If the counterparty of a transaction (other than OTC derivatives transaction) is a FIBO, the government or Bank of Japan. - Certain other services may be provided without an office in Japan subject to specific permission; e.g., permission to participate in an underwriting contract requires at least three years of experience in the same type of business in a foreign jurisdiction and a minimum of JPY 500 million of capital. ### Other financial institutions - Banks and other financial institutions can conduct only limited securities business without FIEA registration: they can invest on their own account as permitted by other laws or invest on behalf of a trustee under a trust agreement. - By registering under the FIEA, such institutions may also distribute unit trusts and trade in Japanese government bonds and related derivatives. ### Nature and scope of business by registration type — numeric detail (as of February 28, 2017) - Total number of FIBOs: 1,942. - Number of firms registered only for one business category: 1,337. - Number of individuals registered: 31. - Breakdowns: - Type I: 286 firms; 138 firms registered only for Type I; Individuals: N/A. - Type II: 1,157 firms; 657 firms registered only for Type II; Individuals: 1. - IAAB: 987 firms; 475 firms registered only for IAAB; Individuals: 30. - Investment management: 350 firms; 67 firms registered only for investment management; Individuals: N/A. - Firms registered for all four of the above: 25. - Financial institutions permitted to conduct securities activities: - Banks: 152. - Cooperatives: 882. - Other financial institutions: 21. - Note: In addition, 216 firms are registered only for Type II financial instruments business and IAAB. Therefore, a total of 1,348 firms conduct only relatively narrow securities activities. - Source: JFSA. --- *International Monetary Fund — Japan: Executive Summary and selected sections (content current as of April 2017).* ### 12. Large securities firms engaged in Type I financial instruments business are designated ### 12. Large securities firms engaged in Type I financial instruments business are designated as so called Special FIBOs ### Designation of Special FIBOs - A firm is designated a Special FIBO if the total value of the firm’s assets exceeds JPY 1 trillion and the firm notifies the JFSA. - Special FIBOs become subject to additional requirements under the FIEA, such as consolidated capital adequacy requirements. - There are currently 21 Special FIBOs. - These include firms belonging to the two major independent securities groups and the main securities subsidiaries of the megabanks. In addition, three other Japanese-owned securities firms and 12 foreign-owned securities firms are Special FIBOs. ### Registration categories and impact on risk - The registration category limits the type of business a FIBO can conduct and thereby impacts the risks arising from the FIBO’s business. - Persons registered for Type I or Type II financial instruments business can deal on their own account, but dealing is limited to the instruments covered by their registration category. - Firms engaged solely in Type II business create limited systemic risk. - Firms engaged in IAAB and investment management business cannot deal on their own account; investment risk is carried by the investors. ### Market concentration and revenue shares - A few major securities firms dominate the Type I business. - During the fiscal year 2015, the net operating revenue of the firms belonging to the two major independent securities groups accounted for 30 percent of the revenue of all firms engaged in Type I financial instruments business. - Together with the megabanks’ securities subsidiaries registered for Type I business, they reached 56 percent of the industry’s net operating revenue. - The major independent securities groups and the megabank subsidiaries typically have some market and counterparty risk arising from their trading operations, which is managed at the group level. - Large securities firms’ dependence on wholesale funding may expose them to funding risk. ### Foreign-owned and other market participants - After the two major independent securities groups and megabank subsidiaries, foreign-owned securities firms form the next most important group of market participants. - The 71 foreign-owned firms represent fewer than 1/4 of FIBOs registered for Type I business (by number), but are very active in many business areas, including trading and corporate finance activities. - Foreign-origin firms undertake the majority of trading on TSE and Osaka Exchange (see Table 3). ### Heterogeneity of remaining Type I firms - The rest of the firms engaged in Type I financial instruments business form a heterogeneous group with diverse business models. - They include 32 securities firms that are subsidiaries of a total of 28 banks. - The rest are independent, small to medium-sized securities firms, often specialized to serving a certain type of client base (e.g., those trading over the Internet). - The main source of these firms’ operating revenue is typically commissions (Figure 1). - More than half of the 286 firms registered for Type I financial instruments business can also provide other securities services. ### Key statistics (from text and Table 3) - Special FIBOs: 21. - Asset threshold for Special FIBO designation: JPY 1 trillion. - Fiscal year 2015: two major independent securities groups = 30 percent of Type I net operating revenue. - Two majors + megabank subsidiaries = 56 percent of industry net operating revenue. - Foreign-owned firms: 71 (fewer than 1/4 of Type I FIBOs by number). - Total firms registered for Type I financial instruments business: 286 (more than half can also provide other securities services). - Table 3 — Tokyo Stock Exchange (Jan 1–Nov 30, 2016): - Japanese owned FIBOs: Number of Members (as of Nov. 30, 2016) 73; Market Share, Value of Trading (In percent) 46.93. - Foreign owned FIBOs: Number of Members 15; Market Share, Value of Trading (In percent) 52.30. - Japanese branches of foreign securities firms: Number of Members 4; Market Share, Value of Trading (In percent) 0.54. - Regulated remote members by home country: Number of Members 1; Market Share, Value of Trading (In percent) 0.22. - Total: Number of Members 93; Market Share, Value of Trading (In percent) 100. - Table 3 — Osaka Exchange (Jan 1–Nov 30, 2016): - Japanese owned FIBOs: Number of Members (as of Nov. 30, 2016) 65; Market Share, Number of Equity Derivatives Contracts (In percent) 30.86; Market Share, Number of Fixed Income Derivatives Contracts (In percent) 33.78. - Foreign owned FIBOs: Number of Members 13; Market Share, Number of Equity Derivatives Contracts (In percent) 68.92; Market Share, Number of Fixed Income Derivatives Contracts (In percent) 55.88. - Japanese branches of foreign securities firms: Number of Members 4; Market Share, Number of Equity Derivatives Contracts (In percent) 0.22; Market Share, Number of Fixed Income Derivatives Contracts (In percent) 0.54. - Other members — Japanese owned banks, cooperatives and other financial institutions: Number of Members 26; Market Share, Number of Equity Derivatives Contracts (In percent) N/A; Market Share, Number of Fixed Income Derivatives Contracts (In percent) 9.81. - Total: Number of Members 108; Market Share, Number of Equity Derivatives Contracts (In percent) 100; Market Share, Number of Fixed Income Derivatives Contracts (In percent) 100. ### Conclusion from this section - The authorities take the heterogeneity in securities firms’ business models into account in organizing regulatory and supervisory work. This is discussed further in subsequent sections on regulation and supervision. --- ### B. Division of Regulatory Responsibilities ### Japan Financial Services Agency (JFSA) - The JFSA is the integrated financial supervisory authority in Japan, primarily guided by the FIEA. - Its mandate: ensure the stable functioning of Japan’s financial system; the protection of depositors, policyholders and securities investors; and the facilitation of finance. - In principle, the Prime Minister is responsible for regulation and supervision of securities business. The FIEA obliges the Prime Minister to transfer (“delegate”) most of his authority under the FIEA to the JFSA Commissioner. No exceptions have been made with regard to securities firms. - The JFSA Commissioner is responsible for all regulatory, supervisory and enforcement activities related to securities firms. - The FIEA provides that the JFSA Commissioner must or may further delegate his authority to other public authorities. Delegation arrangements are of four types: - Authority that the JFSA Commissioner must delegate to the Securities and Exchange Surveillance Commission (SESC) and that he can no longer exercise with the exception of requiring the submission of reports or materials (FIEA Article 194-7(2)); - Authority that the JFSA Commissioner may delegate to the SESC (FIEA Article 194-7(3)); - Authority that the JFSA Commissioner must delegate to the SESC but that he can also exercise directly in parallel to the SESC (FIEA Article 194-7(4)); and - Authority that the JFSA Commissioner may delegate to the Director General of a Local Finance Bureau (FIEA Article 194-7(6)). ### Securities and Exchange Surveillance Commission (SESC) - The SESC was established in accordance with the Act for the Establishment of the Financial Services Agency but exercises its authority independently. - Its mission: ensure the integrity of capital markets, protect investors, and contribute to the sound development of markets and sustainable economic growth. - Composition: a Chairman and two Commissioners; each appointed by the Prime Minister with the consent of the upper and lower houses of the Parliament. - The SESC exercises authority under delegation from the JFSA Commissioner and may sub-delegate some authority to a Local Finance Bureau (FIEA Article 194-7(7)). - The SESC’s Executive Bureau comprises six divisions: Coordination, Market Surveillance, Inspection, Administrative Monetary Penalty, Disclosure Statements Inspection, and Investigation Divisions. - Total number of SESC’s staff: 411. ### Local Finance Bureaus - Local Finance Bureaus are regional branch offices of the Ministry of Finance (MoF) and play an important role in supervision of securities firms. - Eleven Local Finance Bureaus have a Financial Supervisory Division that conducts supervisory work either under direct delegation from the JFSA Commissioner or under sub-delegation from the SESC. Delegated functions are undertaken under the guidance and supervision of the JFSA Commissioner or the SESC. ### Division of responsibilities between JFSA, SESC, and Local Finance Bureaus - All JFSA Commissioner’s inspection and investigation authority is formally delegated to the SESC. - Local Finance Bureaus have an important overarching role in supervision of small- and medium-sized securities firms. They undertake registration of all securities firms and conduct offsite monitoring and onsite inspections of the majority of securities firms (by number of firms). - The JFSA (in cooperation with the SESC) is directly responsible for offsite monitoring of large securities firms, determined based on criteria such as number of branches, number of clients, and value of client assets. - A total of 321 FIBOs are subject to direct offsite monitoring by the JFSA (in cooperation with the SESC) and onsite inspections by the SESC. - Footnote breakdown: Out of these 321 firms, 78 are registered for Type I financial instruments business, 205 for Type II financial instruments business, 171 for IAAB, and 211 for investment management business. This information is publicly available, since the JFSA issues a notice about each firm that will be subjected to its supervision. - The SESC may recommend enforcement measures to the Prime Minister and the JFSA Commissioner, including administrative actions or orders to pay administrative monetary penalties, and may file formal complaints to public prosecutors when convinced a criminal offence occurred. --- ### Self-regulatory organizations (SROs) and JSDA ### Types of SROs under FIEA - Associations (authorized and certified associations). - Exchanges (licensed under Article 80 of the FIEA). - SROs established by exchanges (authorized under Article 102-14 of the FIEA). - All SROs must conduct regulatory, supervisory and disciplinary activities vis-à-vis their members. Authorized associations must have rules and controls to prevent and detect violations; certified associations must provide guidance and have rules ensuring appropriateness of solicitation activities; exchanges/SROs must create/amend/repeal self-regulatory rules and inspect members. In case of violations, SROs must impose administrative surcharge, order suspension or restriction of membership, or expulsion. ### Japan Securities Dealers Association (JSDA) - JSDA is a financial instruments firms association authorized under the FIEA. It conducts self-regulatory activities and provides a vehicle for policy dialogue, investor education, and market development studies. - Total number of JSDA staff: 366 as of April 1, 2017; approximately 150 are involved in self-regulatory activities (regulation, inspections, sales representative registration, and disciplinary activities). - JSDA members engage in securities-related business and OTC derivatives transactions (excluding financial futures transactions). Member groups: - Regular members: FIBOs conducting Type I financial instruments business (262 members as of April 3, 2017). - Specified business members: FIBOs exclusively engaged in OTC derivatives transactions or equity-based crowd funding (4). - Special members: registered financial institutions (banks, life insurance companies, general insurance companies, etc.) (211). - JSDA’s main self-regulatory activities: rule-making (consulting with the JFSA to avoid duplication), inspection and monitoring of members’ business activities and internal controls, and disciplinary actions. ### Exchanges and JPX-R - FIEA requires exchanges to conduct self-regulation; exchanges can delegate self-regulation to an authorized SRO. - TSE and Osaka Exchange have delegated self-regulatory services to Japan Exchange Regulation (JPX-R), a subsidiary of JPX. Regional exchanges (Nagoya, Fukuoka, Sapporo) undertake their own self-regulatory services. - JPX-R must consent to TSE’s and Osaka Exchange’s operational rules before exchanges apply for JFSA approval; JPX-R organizes qualification examinations for trading participants and inspects them. - TSE has 93 trading participants (all securities firms). All 81 securities firm trading participants of Osaka Exchange are also TSE trading participants. In addition, 26 banks and one securities firm trade JGB futures and similar instruments at the Osaka Exchange. JPX-R supervises a total of 120 trading participants. ### Certified associations (four examples) - Type II Financial Instruments Business Operators Association: members are FIBOs registered for Type II financial instruments business (in practice engaged in fund distribution business). - Financial Futures Association of Japan (FFAJ): as of April 30, 2017, FFAJ had 146 members (142 regular and 4 special members); regular members are FIBOs and registered financial institutions carrying out financial futures business. - Japan Investment Trusts Association (JITA): as of April 1, 2017, members included 161 full members that are FIBOs registered for investment management and managing investment trusts, and 20 supporting members (other securities firms and banks). - Japan Investment Advisers Association (JIAA): members consist of FIBOs registered for investment management that conduct discretionary investment management business and/or fund management business; some JIAA members provide only investment advisory or agency services. --- ### Conclusions and recommendations - The Japanese regulatory and supervisory structure is fairly complex, but the authorities and SROs’ responsibilities appear to sufficiently cover both prudential and conduct of business supervision of securities firms. - Complexity applies to allocation of responsibilities between the JFSA, SESC and Local Finance Bureaus and the role of multiple SROs. Despite this, the authorities and SROs strive to work in a coordinated manner to achieve common objectives while trying to reduce overlaps. - The current structure does not seem to lead to any significant gaps of coverage, due in part to the JFSA’s key role in defining regulatory and supervisory strategy. The strong role of Local Finance Bureaus and SROs ensures JFSA and SESC can focus on supervision of firms most relevant for financial stability. - Recommendation: the authorities should continue to enhance cooperation to ensure effective supervision of securities firms and continue to engage with SROs to benefit from their focus on investor protection and market fairness. --- ### Regulation — A. Prudential Requirements: Capital adequacy requirements - The initial capital requirement depends on the type of securities business for which the firm is registered. - Securities firms registered only for IAAB are not subject to minimum capital requirements, but must provide a JPY 5 million business security deposit. - Minimum capital requirements for securities firms registered for Type I or Type II financial instruments business and investment management business are: - JPY 3 billion for underwriters of securities with a significant need to manage the risk of loss (i.e., lead underwriters); - JPY 500 million for other underwriters; - JPY 50 million for any other Type I financial instruments business and investment management business (other than investment management business solely to qualified investors); and - JPY 10 million for Type II financial instruments business and investment management business to qualified investors. *Italic source attribution: IMF staff report (cr17284).* ### 36. Risk-based ongoing capital requirements apply only to firms engaged in Type I ### 36. Risk-based ongoing capital requirements apply only to firms engaged in Type I financial instruments business. Such firms are required to calculate their capital adequacy ratio every business day and report the end of month ratio to the JFSA or relevant Local Finance Bureau by the 20th day of the following month. The JFSA applies the net capital rule approach to determining the capital adequacy requirement on a solo basis to all securities firms registered for Type I financial instruments business. The calculation method is summarized in Box 1. ### Risk-based capital requirements: scope and reporting - Apply only to firms engaged in Type I financial instruments business. - Firms must calculate their capital adequacy ratio every business day. - Firms must report the end-of-month capital adequacy ratio to the JFSA or relevant Local Finance Bureau by the 20th day of the following month. - JFSA applies a net capital rule approach to determine capital adequacy on a solo basis for all securities firms registered for Type I business. ### Trigger levels, supervisory notifications, and possible JFSA actions - Capital adequacy ratio minimum and monitoring: - The capital adequacy ratio is not permitted to fall below 120 percent and is subject to close monitoring even above that level. - If the capital adequacy ratio falls below 140 percent, the FIBO must immediately notify the JFSA. - Further trigger levels are applied at 120 percent and 100 percent based on automatic alerts created by the reporting system. - Required submissions and reporting: - If below 140 percent: FIBO must submit a plan on specific measures to improve the ratio and report without delay when the ratio reaches or exceeds 140 percent. - Possible JFSA supervisory actions: - If the capital adequacy ratio falls below 120 percent, the JFSA may order changes of business methods, order assets to be deposited, or issue orders with respect to matters otherwise necessary from a supervisory perspective. - If the capital adequacy ratio is less than 100 percent, the JFSA may order the suspension of all or part of the firm’s business activities during a fixed period of no longer than three months. - If the capital adequacy ratio remains under 100 percent after three months has passed since the suspension of business order and the authorities determine that the business lacks a recovery outlook, the JFSA may revoke the registration of the FIBO. ### Historical supervisory actions - During fiscal years 2014−16: - Two firms fell below the 140 percent threshold. - One firm fell below the 120 percent threshold; in that case the JFSA issued a business improvement order and a business suspension order. ### Scope exclusions and ongoing capital expectations - Securities firms not registered for Type I financial instruments business are not subject to any risk-based capital requirements. - Authorities justify exclusion by noting such firms are not permitted to hold client assets. - All securities firms must maintain and enhance soundness, including meeting the initial capital requirement on an ongoing basis. - JFSA and Local Finance Bureaus can identify capital adequacy deficiencies from firms’ annual business reports. - Firms must notify the JFSA or relevant Local Finance Bureau immediately if their capital falls below the initial capital requirement. ### Liquidity requirements - Liquidity risk management requirements are largely qualitative. - FIBOs registered for Type I business must have a liquidity risk management framework compliant with the JFSA’s Supervisory Guidelines. - Supervisory Guidelines cover funding risk and market liquidity risk, focusing on appropriate liquidity risk management relative to the nature and scale of business. - A FIBO should develop a comprehensive control environment for liquidity risk management with clear allocation of roles and responsibilities. - Monitoring and reporting: - Despite lack of specific quantitative requirements, JFSA monitors liquidity risk of Type I firms regularly. - Firms must submit a monthly liquidity report to the JFSA or relevant Local Finance Bureau. - Supervisory staff conduct hearings and offsite monitoring to track liquidity risk status. ### Box 1 — Determination of the Capital Adequacy Ratio for FIBOs Registered for Type I Financial Instruments Business - Net capital rule approach: FIBOs must hold sufficient net capital to cover the risk-equivalent amount of their market, counterparty and operational risk. - Non-fixed capital (net capital) determination: - Non-fixed capital = Own capital (to be subtracted from own capital: fixed assets (subtract), deferred assets) + Liquid assets (deposits etc.) − Liabilities - (Exact layout preserved as in source) - Risk-equivalent amount = market risk equivalent amount + counterparty risk equivalent amount + operational risk equivalent amount. - (1) Market risk: Calculated using a standard method or internal model based method for risks due to price fluctuations of asset holdings. - (2) Counterparty risk: Credit equivalent amount multiplied by risk weighting for risks of counterparty non-performance. - (3) Operational risk: Determined as three months of operating expenses (risks in daily operations, e.g., clerical errors). - Trigger levels for capital adequacy ratio (formula preserved): - Non-fixed capital x 100 / Risk-equivalent amount - < 140 percent: must report - < 120 percent: business improvement order - < 100 percent: business suspension order - Source of framework: JFSA. ### Accounting, audit, and client asset audit requirements - Accounting standards: - FIEA permits use of JGAAP, IFRS or USGAAP for consolidated financial statements. - Regulatory reporting is based on JGAAP; for solo accounting and regulatory reporting all FIBOs must use JGAAP. - Example: Nomura’s consolidated accounts use USGAAP; Daiwa uses JGAAP. - External financial audit requirements: - Based on company size or status as a public issuer rather than financial instruments business type. - Companies issuing securities listed on a financial instruments exchange and large companies (equity more than JPY 500 million or debt more than JPY 20 billion) require an audit certification of their consolidated financial statements or financial statements by a CPA or audit firm. - Listed companies must receive audit certification of internal control reports assessing internal controls related to financial reports. - Approximately 200 of the 286 firms engaged in Type I financial instruments business are subject to a financial audit requirement. - Client asset segregation audit: - Compliance with client asset segregation and management requirement is subject to a specific audit at least once a year by a CPA or audit firm, conducted in accordance with JSDA rules. - JSDA published revised rules in July 2016 with an implementation deadline of March 2017 to unify the external audit process for asset segregation. ### Consolidated supervision and group-wide requirements - Special FIBOs are subject to consolidated supervision (downstream consolidation) covering the FIBO and its subsidiaries. - Must submit a consolidated business report within three months after the end of each business year. - Must comply with consolidated capital adequacy requirements. - JFSA may suspend all or part of group business activities for up to three months based on consolidated capital adequacy ratios, order subsidiaries or related entities to submit reports/materials, and conduct onsite inspections. - Current application and thresholds: - Only five out of 21 Special FIBOs are required to prepare consolidated financial statements and capital adequacy calculations at the subgroup level; the others do not have subsidiaries. - Firms covered: SMBC Nikko Securities Inc., Mitsubishi UFJ Morgan Stanley Securities Co., Ltd., Mizuho Securities Co., Ltd., SBI Securities Co,. Ltd and Rakuten Securities, Inc. - The requirement to prepare consolidated financial statements and determine a consolidated capital adequacy ratio applies only above a certain asset value threshold (JPY 1 trillion). - Supervision of parent companies: - The highest designated parent company can be subjected to supervision if it regularly manages/administers the Special FIBO or provides funding/guarantees such that suspension of assistance would substantially compromise the Special FIBO, and JFSA finds group supervision necessary in the public interest or for investor protection. - Only Daiwa Securities Group, Inc. and Nomura Holdings, Inc. have been identified as highest designated parent companies; consolidated supervision therefore applies to their entire groups. - These groups may choose between Japanese capital adequacy framework or Basel III–aligned requirements and have opted for the latter. - As a result, these groups are required to calculate a consolidated liquidity coverage ratio, have a group-wide system for liquidity risk management, and are subject to the Basel III leverage ratio requirement. - D-SIB designation and surcharge: - Nomura and Daiwa were designated D-SIBs in December 2015 and are subject to a 0.5 percent surcharge in addition to their Basel III capital adequacy ratio. - The additional capital required by the surcharge must be in place by March 2019. - The surcharge is subject to an annual review but has so far been maintained at 0.5 percent. - The two groups’ capital adequacy is currently significantly above the required minimum, including the surcharge. ### Conclusions and recommendations (findings and policy guidance) - Overall assessment: - Japanese prudential requirements address risks from the most systemically important firms in an internationally comparable manner, but requirements for other firms have atypical features (capital adequacy requirements scope, scope of financial audits, group-wide supervision). - Specific observations and comparative notes: - Many jurisdictions apply risk-based capital adequacy requirements to types of business beyond Type I equivalent; some apply a simple operational risk charge to investment advisors to ensure sufficient capital to wind up within a reasonable period (typically three months). - Type II financial instruments business is a Japanese peculiarity complicating international comparisons; FIEA permits limited other activities including trading on own account, and business expansion would require registration amendments. JFSA and Local Finance Bureaus should be able to assess risks from any expansion. - In other jurisdictions, financial statement audits generally apply to all prudentially supervised entities (analogy to Basel Core Principles). The authorities justify limited application of financial audits by noting most Type I FIBOs are listed or large companies subject to audit, and all Type I firms are subject to client asset segregation audits. However: - Almost 1/3 of FIBOs registered for Type I business are not subject to a financial audit requirement. - Objectives of financial audits and client asset audits differ. - Limited international standard support for the authorities’ approach. - Dual system for consolidated reporting (threshold JPY 1 trillion) is uncommon; JFSA has broad powers to request information and inspect related entities, but if group activities of below-threshold firms are not specifically monitored, emerging risks may remain undetected. - Recommendation and timeframe: - Authorities should review the prudential regulatory framework for all securities firms within the medium term (3−5 years) to ensure the framework appropriately addresses financial stability and investor protection risks and moves toward developing global best practice. - The relatively long timeline (3−5 years) recognizes the limited financial stability risks the current framework seems to create. ### Organizational requirements: risk management and control functions - Legal and supervisory expectations: - FIEA includes general requirements for securities firms’ control systems further specified in JFSA’s Supervisory Guidelines. - FIEA requires a FIBO to establish an operational control system for fair and appropriate performance of its financial instruments business. - Supervisory Guidelines require CEO and board of directors to be fully aware of the importance of risk management and to prioritize risk management in overall business strategy. - Supervisory Guidelines require strict compliance with laws and business rules and pursuit of sound and suitable management. - Board of directors must assume leadership to establish compliance policy and ensure full compliance. - Firms must establish systems for appropriate communication and reporting of compliance-related information among sales, compliance divisions/managers, and management, and must conduct an evaluation of internal controls. - Supervisory Guidelines require such evaluation to be conducted by the CEO, Board of Directors, internal auditors and, if applicable, external auditors. - Supervisory focus: - JFSA and SESC increasingly focus on supervising firms’ controls, assessing overall business management via daily supervisory activities including follow-up on business improvement reports, receipt of notifications regarding financial product incidents and related situations. - Supervision of internal management and risk management aims to identify firms’ risks and assess risk management framework through offsite monitoring and hearings. _Italic: Source — IMF staff report chapter: cr17284 - 36. Risk-based ongoing capital requirements apply only to firms engaged in Type I financial instruments business._ ### 58. The regulatory framework distinguishes between outsourcing of regulated and ### cr17284 - 58. The regulatory framework distinguishes between outsourcing of regulated and ### Outsourcing of Regulated and Unregulated Activities - When a FIBO outsources its regulated activities to a third party, the service provider must generally be registered as a FIBO. - A FIBO engaged in investment management business may outsource investment management to a firm conducting equivalent business in a foreign country. - Unregulated activities may be outsourced to any third party. - In all cases, the FIBO must take responsibility for maintaining sound risk management of the outsourced activities. - JFSA’s Supervisory Guidelines emphasize appropriate policies, procedures and controls when outsourcing administrative processes, including: - whether the FIBO has a policy and procedures for selecting business operations to be outsourced and the relevant service providers; - whether it has developed a control system that enables sufficient risk management of the outsourced business operations; - ensuring continued fulfillment of obligations to supervisory authorities, such as undergoing inspections and submitting reports. - In practice: - Many Japanese FIBOs outsource activities. - A number of FIBOs engaged in Type I financial instruments business outsource administrative tasks and systems (e.g., IT system development and maintenance) to third parties. - Some FIBOs outsource investment management of foreign securities to overseas investment advisors or managers. - Supervision of outsourcing compliance is primarily through offsite monitoring; when supervisory concerns are identified, authorities: - hold hearings with the FIBO or service provider; - track improvements; and - when necessary, require submission of reports. ### Organizational Requirements and Controls (Conclusions) - The organizational requirements for securities firms comply with international standards. - Supervisory activities are increasingly focusing on the sufficiency of firms’ control environment in ensuring compliance with relevant requirements. ### Segregation and Custody of Client Assets - Only FIBOs registered for Type I financial instruments business are permitted to hold client assets in principle. - This is because only they can provide securities management services where the FIBO receives deposits of money or securities from customers in connection with services (e.g., brokerage and corporate finance services). - FIBOs registered only for IAAB are not permitted to hold client assets. - FIBOs registered only for investment management business are generally not permitted to hold client assets, except: - The FIEA permits them to hold client assets temporarily where they conduct transactions on behalf of investment management customers and the deposit of securities or money is necessary for settlement of the transactions. - According to the JFSA, this possibility is seldom used in practice. - FIEA Article 43-2: basic rule requiring a FIBO to manage customers’ securities separately from its own assets; covers: - securities the customer is buying or selling; - securities provided as collateral for derivatives trading. - Exceptions: - Securities the FIBO may furnish as collateral or lend to another person pursuant to a written consent of the customer. - Such consent can in certain cases cover a predetermined scope of securities; otherwise consent must be provided for each occasion. - Article 136 of the Cabinet Office Ordinance of Financial Instruments Business, etc. specifies ways to ensure segregation, including engaging a third party to take custody of client assets; the third party is subject to the same segregation requirements as the FIBO. - Handling of client money: - Securities firm must establish a trust with a trust company in Japan to manage money to be refunded if the firm discontinues its financial instruments business or ceases to operate. - Requirement covers money related to customers’ securities trading and money given as collateral for derivatives trading. - If client consent is given and the firm rehypothecates customer securities, it must deposit equivalent value to the trust. - Supervision: - JFSA, SESC and Local Finance Bureaus supervise compliance with asset segregation requirements. - FIBOs engaged in Type I financial instruments business must submit reports on client assets they hold. - Supervision focuses on whether the board recognizes the importance of segregated custody and uses relevant information (e.g., periodic or as-needed status reports). - One registration criterion for Type I and investment management business is whether firms have sound risk controls for rigorous management of client assets. ### Conclusions and Recommendations on Client Asset Segregation - Review did not reveal fundamental gaps compared to international standards. - Risks identified: - Investment management firms’ ability to hold client assets without segregating them during the settlement period creates a risk if the firm fails during that period. - Asset segregation rules are covered by multiple laws, Cabinet Orders and Cabinet Office Ordinances, making it difficult to fully ascertain potential underlying legal deficiencies in the complex framework or from other legislation. - Legal framework alone cannot eliminate misappropriation or operational errors leading to shortfalls. - Recommendation: - Authorities should enhance supervision of compliance with the client asset segregation requirement. - Support measures could include: - external auditors reviewing firms’ compliance with the segregation requirement more often than annually; - surprise examinations by authorities; - surprise audits by external auditors to ensure ongoing compliance and maintenance of robust processes. ### Technological Developments - JFSA’s Strategic Directions and Priorities 2016-2017 specifically referred to FinTech, cyber security and algorithmic trading and noted consideration of appropriate regulatory options for algorithmic trading while monitoring other jurisdictions. - 2016 market activity metrics: - In 2016, the share of orders placed through the TSE’s co-location area amounted to around 70 percent and that of transactions executed reached 40−50 percent. - Measures taken: - December 2016: Financial System Council proposed introducing a new regulatory requirement for high-speed trading, including a registration framework to allow monitoring of high-speed traders’ trading strategies and trades. - March 2017: JFSA submitted a bill proposing a regulatory framework for high-speed traders covering: - Organizational/system requirements, including risk controls: - Proper management and operation of trading systems; - Appropriate organizational arrangements and capital requirements. - Notification and provision of information: - Notification of engagement in high-speed trading to the JFSA or the relevant Local Finance Bureau; - Provision of a description of trading strategies to the JFSA or the relevant Local Finance Bureau; - Maintaining trading records. - Other measures: - Submission of business reports to the authority. - Conclusion: - Given risks to market fairness and financial stability, the JFSA is commended for action. - It is necessary to ensure specifics of requirements and measures can be flexibly adapted in light of future developments in other major financial markets. ### Supervision — Organization and Resources - Supervisory responsibilities: - Within JFSA, primary responsibility for supervision of securities firms lies with the Supervisory Bureau (in cooperation with the SESC). - Supervisory Bureau conducts offsite monitoring of securities firms under its direct responsibility and guides Local Finance Bureaus supervising smaller firms. - Supervisory Bureau and SESC collect and analyze reports provided by securities firms; remaining reporting goes to Local Finance Bureaus. - Inspections undertaken by both the SESC and Local Finance Bureaus; JFSA’s Inspection Bureau involvement is very limited given the SESC’s role. - Supervision of major groups and megabank securities subsidiaries: - Supervisory teams for independent groups composed of staff from JFSA’s Supervisory and Inspection Bureaus and the SESC working in an integrated manner without strict separation of offsite/onsite roles. - Total staff exclusively involved in Nomura and Daiwa supervision is 25: - three in the JFSA Supervisory Bureau; - 14 in the JFSA Inspection Bureau; - eight at the SESC. - For megabank subsidiaries: - five staff members from the Inspection Bureau cover risk management; - dedicated team includes three staff members from the Supervisory Bureau and seven from the SESC. - Employer of staff is a formality; no strict separation of roles under the new supervisory approach with fewer onsite inspections. - Staff resources: - JFSA’s Supervisory Bureau has 44 persons devoted to securities firm supervision. - SESC relevant staff amounts to 129. - Local Finance Bureaus staff amounts to 232. - Additional resources include JFSA Inspection Bureau team engaged in supervision of the two major groups. - Continuity and expertise: - Authorities aim to secure continuity and expertise despite traditional staff rotation within government. - Supervisory teams typically composed of staff with prior involvement in supervision of other securities firms. - Rotation policy enhances senior management’s breadth of expertise and is seen positively by market participants. - Self-regulatory organizations (SROs) supervisory resources: - JSDA’s Inspection Headquarters engages 57 staff. - JPX-R has 38 staff conducting onsite and offsite inspections of trading participants. - Smaller SROs have a total of 88 supervisory staff (Type II Financial Instruments Firms Association 8; FFAJ 22; JITA 38; and JIAA 20). ### Conclusions and Recommendations on Supervisory Resources - The overall number of staff allocated to securities firm supervision appears sufficient. - Well resourced SROs provide additional support to government authorities. - Recommendation: - Authorities should continue to ensure relevant teams have access to sufficient numbers of experienced staff; authorities are conscious of this and consider it in team selection. ### Registration and Authorization of New Firms - Registration process: - Applicant submits application to Local Finance Bureau of region where firm is located or individual resides. - Registration can be sought for any number of business categories permitted for a FIBO (Type I/Type II financial instruments business, IAAB, investment management business). - The written application must specify the actual activities within each business category the applicant plans to undertake. - Refusal criteria: - Registration must be refused if certain criteria are not met, including personnel structure and execution of business operations requirements applicable to all FIBO types. - Applicants for Type I or Type II financial instruments business or investment management business must meet initial capital requirements and have an office in Japan. - Applicants for Type I financial instruments business and investment management business must have net assets equaling their initial capital requirement (see paragraph 35). - Applicants for Type I financial instruments business must also have a capital adequacy ratio of at least 120 percent (see paragraph 37). - PTS (Proprietary Trading System) authorization: - Operating a PTS requires registration for Type I financial instruments business and a separate authorization for operating the system. - Authorization is subject to having at least JPY 300 million of capital. - Applicant’s price formation method, settlement method, business plan and business methods must ensure public interest and investor protection are maintained. - JFSA’s Supervisory Guidelines include further authorization criteria (e.g., internal controls, disclosure of price information, reporting of transaction volume, etc.). - Foreign branches and financial institutions: - Branches of foreign securities firms are subject to same registration requirements as Japanese FIBOs and obtain full FIBO status. - Difference: must provide information on amount of stated capital or total amount of contributions and amount of brought-in capital; must appoint a representative based in Japan. - Financial institutions seeking to perform limited securities business permitted to entities other than securities firms are subject to similar registration requirements as an applicant for FIBO registration. - Application processing: - Local Finance Bureau follows the FIEA and JFSA’s Supervisory Guidelines to verify compliance. - Applicant and its staff must appear and answer questions; staff reviewer prepares internal report and recommendation for registration to superiors. - If recommended, a copy of the recommendation and an executive summary are sent to JFSA; notification given to applicant when JFSA decides to grant registration. - Date of registration and registration number are disclosed in the financial instruments business register. - Calendar year 2016: a total of 17 new registrations were granted: - 7 for Type I financial instruments business; - 1 for Type II financial instruments business; - 1 for IAAB; - 8 for investment management business. - Refusal practice: - Refusal of registration is subject to due process; Local Finance Bureau must notify applicant and conduct a hearing before refusal or attaching conditions. - Applicants must be notified in writing, with grounds for refusal and right to request JFSA Commissioner examination and file claim against government. - Local Finance Bureaus have not refused registrations for any officially received applications during the past five years. - According to JFSA, prospective applicants discuss with Local Finance Bureau staff before submitting applications, effectively eliminating applicants that would need to be rejected. - JPX trading participant admission process: - JPX-R conducts examinations based on documents, hearings, onsite inspections of internal management systems at headquarters and branch offices, and interviews with senior executives. - Qualification criteria for FIBOs include: - Financial criteria: - Capital of at least JPY 300 million; - Net assets of at least JPY 500 million and an amount greater than capital; - Capital adequacy ratio exceeding 200 percent. - Operational criteria: - Sound management structure; - Order placement, execution, and clearing and settlement systems that contribute to fair and smooth trading; - Appropriate internal management system (compliance with laws and regulations, risk management, development of rules, etc.). - Conclusion: - Application and registration/authorization process for new FIBOs is generally in line with international standards. - Mission did not meet with Local Finance Bureaus; discussions focused on JFSA guidance rather than practical application. ### Supervisory Approach - JFSA and SESC are implementing new supervisory approaches with increased emphasis on offsite monitoring due to: - increasing number of supervised entities; - increased diversity and complexity of products and transactions. - New approach shifts focus from onsite inspections based on inspection manuals to a monitoring framework that integrates onsite and offsite monitoring. - Basic supervisory approach is made public by disclosing JFSA’s Supervisory Guidelines. - SESC released its first annual statement on monitoring priorities for securities business for July 2016−June 2017, setting forth its general approach to monitoring securities firms. *International Monetary Fund — Selected excerpts from cr17284* ### 89. The new process will be based on an offsite assessment of the viability of the firm’s ### cr17284 - 89. The new process will be based on an offsite assessment of the viability of the firm’s ### New supervisory approach and offsite monitoring - The new process will be based on an offsite assessment of: - the viability of the firm’s business model, - the effectiveness of its governance, and - the appropriateness of its risk management in light of its business model. - The approach will evaluate the effectiveness of the firm’s three lines of defense: front-office; risk management and compliance; and internal audit functions. - Assessments will take into consideration individual characteristics of each securities firm, including business model and scale of operations. - The JFSA and SESC will use offsite monitoring results, together with risk-based analysis, to determine which securities firms will be subject to onsite monitoring. - Key information sources and reporting: - All FIBOs are required to submit the annual business report to the JFSA or the relevant Local Finance Bureau within three months of the end of the business year. - Other reporting requirements cover, among others, the capital adequacy ratio and liquidity risk. - Reporting also occurs on a consolidated basis for groups that have the highest designated parent company. - Reports are submitted electronically and processed by Local Finance Bureaus in accordance with JFSA guidance. ### Dialogue, hearings, and borderline between offsite and onsite - Offsite monitoring is also conducted through dialogue and meetings (hearings); the borderline between offsite and onsite monitoring is not clear cut. - Informal dialogue is particularly important for major securities groups to ensure business strategy and risk management respond to changing market and economic environment. - The authorities engage in dialogue with other securities firms to ensure firms have a sound control system. - JFSA and SESC conduct interviews with foreign-owned securities firms with attention to their global business model. - For firms engaged only in Type II financial instruments business or IAAB, the JFSA and SESC work closely together to analyze and assess relevant data and conduct risk-based monitoring. - For firms engaged in investment management business, the JFSA and SESC work closely together to monitor that proper governance is in place. ### Risk profiling and prioritization for onsite inspections - Offsite monitoring information will be used to determine a risk profile for each securities firm; onsite inspection priorities will be determined on that basis. - The risk profile system follows the model used for the largest banks and is in the process of being implemented. - The system is well established for: - the two largest securities groups, and - the securities subsidiaries of the megabanks. - Risk profiles take into account: - information received through reports, other offsite monitoring, and a yearly questionnaire sent to the firms (A questionnaire is not sent to Nomura and Daiwa.), - the controls in place. - The system is being gradually extended to cover all firms engaged in Type I financial instruments business, independent of whether supervised by the JFSA or Local Finance Bureaus. - Risk profiles are updated on a quarterly basis and reported to management. ### Cooperation among authorities and SROs - SESC and Local Finance Bureaus are enhancing cooperation to ensure a uniform approach to monitoring. - SESC supports Local Finance Bureaus in planning and implementing offsite monitoring. - If offsite monitoring suggests a FIBO’s operational risk is significant or a FIBO falls under multiple bureaus, SESC conducts onsite monitoring alone or jointly with relevant Local Finance Bureau/Bureaus. - SESC works closely with SROs to share perspectives and raise efficiency, ensure fairness and transparency, and is considering optimal balance between SESC monitoring and SRO examinations. ### Onsite inspections: mandate, focus, process, and priorities - Primary responsibility for onsite inspections lies with the SESC. - Under the new approach, onsite inspections are to be conducted on the basis of risks identified through offsite monitoring; onsite inspections will be used in a more limited manner than in the past, though other onsite activities (such as hearings) can occur. - An onsite inspection finishes with an inspection completion notice urging improvements; if serious violations or governance deficiencies are found, the SESC recommends administrative action to the Prime Minister and the JFSA Commissioner. - Problems found in inspections are shared with the JFSA; in practice the JFSA always follows SESC recommendations and takes proposed enforcement actions. Inspection priorities in the past three years have included: - Major securities groups: internal controls, management controls, and risk management system from a forward-looking perspective; - Type I financial instruments business: corporate client information control system, financial soundness, countermeasures to prevent money laundering, risk management in response to FX market volatility; - Type II financial instruments business: compliance, risk management and suitability of solicitation for overseas funds; and - Investment management business: due diligence, suitability of solicitation, and conflicts of interest. ### Inspection activity and statistics (SESC) - Table 4 (Number of SESC Inspections and Recommendations to the JFSA) — inspections completed and recommendations made by category: - 04/2013-03/2014 - FIBOs: Inspections Completed 230; Recommendations Made 18 - Type I FIBOs: Inspections Completed 63; Recommendations Made 3 - Type II FIBOs: Inspections Completed 81; Recommendations Made 6 - IAAB: Inspections Completed 40; Recommendations Made 5 - Investment Management Business: Inspections Completed 46; Recommendations Made 4 - 04/2014-03/2015 - FIBOs: Inspections Completed 232; Recommendations Made 15 - Type I FIBOs: Inspections Completed 86; Recommendations Made 3 - Type II FIBOs: Inspections Completed 94; Recommendations Made 5 - IAAB: Inspections Completed 38; Recommendations Made 6 - Investment Management Business: Inspections Completed 14; Recommendations Made 1 - 04/2015-03/2016 - FIBOs: Inspections Completed 128; Recommendations Made 18 - Type I FIBOs: Inspections Completed 58; Recommendations Made 12 - Type II FIBOs: Inspections Completed 33; Recommendations Made 1 - IAAB: Inspections Completed 31; Recommendations Made 6 - Investment Management Business: Inspections Completed 6; Recommendations Made 0 - Note: Some firms are registered in multiple categories so totals for individual categories and recommendations do not match. ### Other monitoring and analytical tools - In 2015, the JFSA established the Macroprudential Policy Office to analyze financial market and macro-economic environment, including domestic and overseas market trends, fund inflows and outflows, and macroeconomic indicators. - Relevant information and analysis are shared with other divisions as a basis for firm-level monitoring; supervisory teams for the two major securities groups use this information as background in daily interactions with supervised firms. - In the current fiscal year, the JFSA is extending firm level stress testing to the largest securities groups using the same bottom-up scenarios as for banks; the process was initiated at the beginning of the fiscal year and is still in early stages. ### Self-regulatory organizations (JSDA and JPX-R) — roles and inspection practices - JSDA inspections: - Primary objective: investor protection. - Four inspection types: General inspection; Special inspection; Follow-up inspection; Inspection of new members. - Inspections can be onsite or offsite; selection factors include status of capital adequacy (regular members whose capital adequacy ratio has fallen below 200 percent or those whose ratio still exceeds that threshold but is declining rapidly), various information raising concerns, past inspection records, and nature of business and customer base. - JSDA reviews suitability principles and sales practices, segregation of customer assets, calculation of capital adequacy ratio, and overall internal administration system. - During fiscal years 2013−15, inspections identified violations of laws and regulations, JSDA’s rules, and deficiencies in internal administration systems. - JSDA offsite monitoring: focuses on members suffering financial deterioration, members raising concerns, and members subjected to significant disciplinary actions; information is shared with JFSA, SESC and Local Finance Bureaus. - JPX-R inspections: - Primary objective: ensuring market fairness. - Inspection types: General inspection; Follow-up inspection; Special inspection. - Risk-based approach considers recent JPX-R and SESC inspection results, financial condition assessed through offsite monitoring, reports by trading participants, and information from other JPX departments. - Majority of JPX-R inspections are conducted jointly with JSDA. - Fiscal year 2016 onsite inspections lasted on average 11 days and engaged 7 inspectors. - Priority inspection topics for financial year 2016−17: - Order management systems; - IT system risk management; - Underwriting systems for IPOs; - Systems for management of corporate information; and - Credit risk management concerning customer positions for margin trading. - JPX-R Trading Participants Examination and Inspection Department cooperates with regulators to exchange inspection-related information and reports regularly to SESC. - Table 5 (Number of JSDA Inspections and Joint JSDA and JPX-R Inspections) — fiscal years: - FY2013 - JSDA regular members (securities firms): 87 - Joint inspections with JPX-R: 28 - JSDA’s own inspections: 59 - Special members: 53 - FY2014 - JSDA regular members (securities firms): 84 - Joint inspections with JPX-R: 31 - JSDA’s own inspections: 53 - Special members: 48 - FY2015 - JSDA regular members (securities firms): 80 - Joint inspections with JPX-R: 30 - JSDA’s own inspections: 50 - Special members: 44 ### International cooperation - International supervisory cooperation occurs through: - hosting a supervisory college, - participating in supervisory colleges hosted by foreign authorities, and - ongoing contacts (including teleconferences). - The college hosted by the JFSA and SESC typically meets once a year with frequent interim exchanges. - JFSA Supervisory Bureau and SESC participate in supervisory colleges for large, globally active banks with securities subsidiaries in Japan. - The IOSCO Multilateral Memorandum of Understanding (MMoU) can be utilized; in the past three years, the JFSA has made nine requests under the MMoU in relation to inspections of FIBOs. ### Conclusions and recommendations Findings: - The adoption of the new supervisory approach by the JFSA and SESC is well justified and enables better focus on emerging risks and firms’ governance and controls if applied consistently across authorities. - Local Finance Bureaus have an important role in supervising smaller firms; SROs help ensure investor protection and market fairness. - Staff adjustment to the new approach and accumulation of expertise may take time. - Offsite monitoring and hearings alone are unlikely to be sufficient to identify risks and control deficiencies, particularly for firms subject to less intensive offsite monitoring. Recommendations: - Continue to address transitional challenges and carefully balance offsite and onsite activities. - JFSA and SESC should continue to provide sufficient training and guidance to Local Finance Bureaus, particularly during the transitional stage. - Continue to use onsite inspections as an important complementary tool to more intensive offsite monitoring after full implementation of the new supervisory approach. - Continue to enhance onsite monitoring of Japanese securities firms’ overseas operations jointly with foreign supervisory authorities. - Ensure sufficient cooperation with foreign authorities supervising parent banks of Japanese securities firms to maintain access to information on potential cross-border risk channels. *Source: SESC.* ### 114. The JFSA can take certain enforcement action against a FIBO or financial institution ### The JFSA can take certain enforcement action against a FIBO or financial institution registered for securities business ### Enforcement powers and tools - Enforcement action is generally taken on the basis of a recommendation from the SESC. - The most important tool is a business improvement order that requires the firm to change its business methods or take other necessary measures to improve its business operations or state of assets. - A business improvement order can be given if the JFSA finds it necessary and appropriate in the public interest or for the protection of investors. - The JFSA may rescind the registration of a FIBO or order the suspension of all or part of its business activities as an enforcement measure in cases defined in Article 52 of the FIEA. - The JFSA can issue an administrative monetary penalty in relation to insider trading, market manipulation or fraud, but not for systems and control deficiencies. - JFSA considers that the current enforcement tools are sufficiently effective. ### Publication, transparency, and SESC practice - Enforcement actions are generally published. - The SESC’s recommendation to the JFSA is normally public, in which case the JFSA also publishes the final enforcement action. - In deciding on publication, the SESC considers confidentiality, transparency, fair enforcement and investor protection. - The SESC generally publishes the following information on its website: - Where administrative action is recommended, the SESC publishes relevant information immediately after completing the inspection. The information includes the inspected party’s name and trade name, representative name, registered business type, and non-compliant activities. - Where administrative action is not recommended, the SESC may publish relevant information but omit the inspected party’s name and trade name. - The SESC publishes a summary of actions related to inspections (overview of securities inspections) every year that summarizes problems identified in inspections and their root causes, with the aim of enhancing FIBOs’ internal controls. ### Self-regulatory organizations (SROs) — powers and recent activity - Under delegation from the Board of Governors, the Self-Regulation Board of the JSDA may take disciplinary action against JSDA members for violations of laws, regulations, JSDA articles of association and other rules. - Disciplinary process is initiated by an incident report that a member must file with the JSDA immediately when it becomes aware of a violation; this means JSDA is informed of SESC inspections and JFSA enforcement by the members themselves. - JSDA disciplinary actions can include: - Expulsion - Suspension or limitation of regular membership for up to six months - Imposition of a fine of up to JPY 500 million (the amount of any improper gain may be added to the fine, so the total fine may exceed JPY 500 million) - Reprimand - Non-public admonition or written warning - In determining the level of its fine, the JSDA takes administrative fines into account to avoid double penalty. - JSDA use of disciplinary powers in fiscal years 2014-2016: - Expelled one member - Fined 14 members (one of which was also suspended) - Reprimanded one member - The largest fines given were JPY 30 million to two firms (the same firms were also subject to JFSA’s enforcement action as well as JPX-R’s disciplinary measures). - JPX-R determines exchanges' disciplinary actions against TSE and Osaka Exchange trading participants; possible actions include fines, censure, trading suspension, and limiting or canceling trading qualifications. Disciplinary actions are published and several actions have been taken over the past years. - Other SROs’ disciplinary activity in fiscal years 2013-2015: - Total number of actions by other SROs: 14 (FFAJ 2 and JIIA 12) - JITA and the Type II Financial Instruments Business Operators Association took no disciplinary actions. ### Failure of a securities firm — client protection arrangements - The most important measure protecting clients from the consequences of a failure of a securities firm is the requirement to segregate client assets (securities and money). - As long as the segregation requirement is observed, customer assets are protected from creditors’ claims even if a securities firm goes bankrupt. - If customer assets cannot be returned on the failure of a firm, the Japan Investor Protection Fund (JIPF) provides compensation of up to JPY 10 million per customer for the missing assets. - Membership in the JIPF is compulsory for all FIBOs engaged in Type I financial instruments business. - Limitations in JIPF coverage: - Only individual customers and corporations are eligible for compensation; the government and local governments are excluded. - Corporations that are qualified institutional investors are not eligible for compensation. - Eligible client assets are limited to those entrusted by customers concerning the securities or commodity derivatives related business conducted by securities firms. - Transactions not eligible for JIPF compensation include: - Over-the-counter financial derivatives transactions - Financial derivatives transactions on overseas exchanges - On-exchange currency transactions - FX transactions - Transactions in financial instruments that fall under the Type II financial instruments business - Compensation procedure: - JIPF member securities firms must immediately notify JIPF if their registration is revoked or they file a petition for the commencement of bankruptcy proceedings. - Where the notifying member is unable, or highly likely to be unable, to return money and securities entrusted by customers, JIPF issues a public notice of difficulty in payment. - Customers submit documents requesting payment to JIPF; JIPF checks documents against the records of the notifying member and pays compensation up to a maximum of JPY 10 million. - JIPF then acquires the claim that was subject to compensation from the customer. - The bankruptcy trustee initiates liquidation proceedings of the notifying member in parallel; customers requesting payments exceeding JPY 10 million may be entitled to receive additional distributions from the bankruptcy estate. - JIPF fund and levies: - The balance of JIPF’s investor protection fund was approximately JPY 57 billion at the end of fiscal year 2015. - The amount deemed sufficient for investor protection activities is JPY 50 billion. - When the balance is less than JPY 50 billion, member securities firms must pay levies computed based on a basic calculation amount of JPY 5 billion per year. - Because the balance has been at or above the required amount, JIPF has not collected any levies since fiscal year 2003. - The last time the JIPF investor protection fund was tapped was in 2015, when JIPF paid the total amount of approximately JPY 172 million to the 635 customers of Marudai Securities, which went bankrupt in March 2012. ### Other crisis-management and resolution measures - The Deposit Insurance Act was amended in June 2013 to introduce an orderly resolution regime that can be applied to failures of securities firms. - The regime covers all financial institutions in principle, including securities firms, regardless of size and systemic importance. - The Prime Minister can trigger resolution only after the Financial Crisis Response Council has confirmed the existence of systemic risk; in practice the regime would likely be considered only for the failure of a large securities firm. - Securities firms qualify for lending by the Bank of Japan (BoJ) under Article 38(1) of the Bank of Japan Act: - The Prime Minister and the Minister of Finance may request the BoJ to conduct business necessary to maintain stability of the financial system, such as providing loans to the relevant financial institution. - The BoJ may provide emergency liquidity assistance if approved by its Policy Board. - Authorities have worked to enhance resolvability of major securities groups: - Recovery and resolution planning has been discussed in a Crisis Management Group (CMG) with relevant foreign authorities. - The authorities also participate in other relevant CMGs. ### Conclusions on enforcement and failure frameworks - The enforcement and disciplinary framework for securities firms appears to be sufficiently effective. - The JFSA and SROs have taken multiple enforcement and disciplinary actions over the past few years. - Their enforcement and disciplinary processes are transparent. - Despite the lack of administrative monetary penalties for JFSA use in the case of systems and controls failures, the system overall appears to be sufficiently comprehensive. - The Japanese legal framework includes various tools to address risks from a securities firm failure: - Asset segregation requirements and the establishment of an investor protection fund are important measures to protect non-professional clients. - An orderly resolution regime for banks and non-bank financial institutions has been established, although operational details for the application of the regime to non-banks still need to be elaborated. ### Annex — Types of Financial Instruments Business Operators (high-level list from source) - Type I Financial Instruments Business (FIEA Article 28(1)) — examples include: - Sales and purchases, market derivatives transactions, and foreign market derivatives transactions - Acting as intermediary, agent, or representative for such transactions - Underwriting securities - PTS business - Securities management business - Type II Financial Instruments Business (Article 28(2)) — examples include: - Public or private placement of investment trust beneficiary securities and equity in collective investment schemes (so-called "self-placement") - Intermediary/agent/representative roles for certain securities - Market derivatives transactions not related to securities - Acts specified by Cabinet Order as corresponding to financial instruments business - Investment Management Business (Article 28(4)) — examples include: - Investment corporation asset management business - Discretionary investment management business - Investment trust management business - Self-management - Investment Advisory and Agency Business (Article 28(3)) — examples include: - Investment advisory business (entering into investment advisory contracts and providing advice) - Acting as an agent or intermediary for entering into investment advisory contracts or discretionary investment contracts *Source: JFSA (as presented in IMF staff report).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17284.pdf_