## 1jpnea2024006 ## Source details **Canonical URL:** [1jpnea2024006](https://www.imf.org/-/media/files/publications/cr/2024/english/1jpnea2024006.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1jpnea2024006.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1jpnea2024006.pdf.json) --- ### Executive overview - Purpose: Review of the functioning and effectiveness of the regulation, supervision, and systemic risk monitoring of investment funds in Japan, focusing on requirements directly relevant to financial stability: valuation, segregation and safekeeping of fund assets, liquidity risk management and redemption of fund units. - Scope: Assessment of (i) how authorities analyze and monitor systemic risk from fund management activities in Japan; (ii) application of the domestic regulatory framework pertinent to investment funds; and (iii) supervision of compliance with the regulatory framework. - Outcome: Series of recommendations to strengthen domestic regulatory, supervisory, and risk monitoring frameworks. ### Size and structure of the investment fund industry - Key statistics (end 2022 unless otherwise stated): - Total assets under management (AUM) of the investment fund sector in Japan: ¥419 trillion (as of end 2022). - AUM composition (end 2022): - ¥338 trillion held by publicly offered investment trust funds and privately placed investment trust funds. - ¥28 trillion in real estate-related corporation-type investment funds. - ¥52 trillion in privately placed investment funds (partnerships). - Foreign exposure and outsourcing: - Over ¥7.2 trillion AUM in “foreign investment trusts” distributed in Japan (as of July 2023). - Of total net flows into publicly offered investment trusts in 2022, approximately 61 per cent was invested in foreign equity; of that foreign equity exposure, approximately 90 per cent of active fund management was outsourced. - Retail investor portfolio context (Q1 2023): - Investments in funds (investment trusts) represented 4.4 per cent of retail investors' financial portfolio. - Deposits represented 54.2 per cent. - Insurance and pension products represented 26.2 per cent. - Market segments and concentration: - Majority of publicly offered investment funds invested in equity and bonds; industry dominated by IMBOs affiliated with major financial groups. - Hedge funds: 1 per cent of AUM of publicly offered investment trusts. - MMF sector: small and composed exclusively of Money Reserve Funds (MRFs). - Market concentration: out of 111 IMBOs for investment trusts, the top 10 control about 60 per cent of total AUM. - Ownership: out of the 20 largest IMBOs, more than 70 per cent are affiliated with financial institution group companies; less than 30 per cent are independent IMBOs. ### Industry participants, legal forms and licensing - Institutional roles and SROs: - FSA: integrated regulator; policy formulation, off-site monitoring, enforcement on FIBOs (including IMBOs). - SESC: independent bureau within the FSA; on-site inspections of FIBOs and recommends enforcement actions to FSA. - Local Finance Bureaus (LFBs): registration of FIBOs, off-site monitoring and on-site inspections of smaller firms; review of funds registration statements and periodic information. - JITA: self-regulatory association for management companies for investment trust and/or investment corporation; rule making, inspections and disciplinary action; membership voluntary but almost all fund managers are members. - JIAA and JSDA: additional associations with supervisory/self-regulatory functions for specific FIBO categories. - FIBO and IMBO categories: - Four main FIBO types under FIEA: Type I FIBO, Type II FIBO, IMBO (investment management business operator), Investment Advisor and Agency Business. - IMBO license categories: - Category A — for investment trusts. - Category B — for investment corporations (REITs and J-REITs). - Category C — Discretionary Investment Management (segregated accounts). - Category D — fund management business for partnerships. - Specially Permitted Business (SPB) exemptions (notifications, not full IMBO license): SPBQII, SPB for Overseas Investors, SPB for the Transitional Period. - Numbers under supervision (As of July 2023): - FSA supervises: IMBO Category A: 111; IMBO Category B: 110; IMBO Category C: 181; IMBO Category D: 20; SPBOQII: 1. - LFB supervises: IMBO Category C: 149; IMBO Category D: 25; SPBOQII: 3,503. - Total: IMBO Category A: 111; IMBO Category B: 110; IMBO Category C: 330; IMBO Category D: 45; SPBOQII: 3,504. - Note: * LFB supervises one SPBOOI. ### Regulatory framework for funds, valuation and accounting - Primary statutes: - Investment Trusts and Investment Corporations Act (ITIC). - Financial Instruments and Exchange Act (FIEA). - Legal distinctions and practice: - Investment trusts: “trust whose purpose is for trust property to be invested mainly in securities, real property, and other assets that Cabinet Order specifies as those in which it is necessary to facilitate investment (“specified assets”) (...) and whose purpose is for the beneficial interest to be divided and for multiple persons to acquire it.” - Investment corporations: “association incorporated based on this Act for the purpose of investing assets, mainly in specified assets.” - In practice: securities investment trusts dominate; investment corporations mostly invest in real estate (REITs). - Accounting and valuation: - All funds must follow Japanese Accounting Standards (J-GAAP). - J-GAAP: non-listed securities are valued at acquisition cost. - IFRS: non-listed securities are required to be valued at fair value. - JITA Valuation Rules: currently being revised to require that non-listed securities be priced at fair value. - Investment trusts’ assets required to be calculated at market value and on a daily basis. - Audit: accounting of public investment trusts and investment corporations subject to periodic auditing by independent auditors for each accounting period (which cannot exceed one year). Audited report must be filed with the LFBs and disclosed to investors. - Deviations from JITA Valuation Rules: methodology and background must be recorded in writing and kept for seven years. ### Safekeeping, segregation, delegation and fees - Custody and segregation: - Custody of investment trusts’ assets must be entrusted to a trust bank that must segregate trusts’ assets from its own and from assets of other clients. - Custody of investment corporations’ assets must be entrusted to an asset custody company required to segregate assets. - Trust banks are regulated under the Banking Act and supervised by the banking supervision group of the FSA. - Regulation does not require custodians to be structurally independent from IMBO group; functional independence safeguards are expected (separate board, separate compliance functions, separation of portfolio management and sales). - Delegation and oversight: - IMBOs may delegate partial authority; full delegation of all authority is not permitted. - IMBOs and delegates are jointly and severally liable for damages to beneficiaries from delegated activities. - Delegation conditions must be included in the Terms and Conditions of the CIS. - In practice, most IMBOs delegate management of foreign assets in domestic investment trusts’ portfolios. - Fees and commissions: - Fee types: purchase distribution commissions, holding management fees, redemption fees, success fees. - FSA 2023 review: irrespective of active or passive management, fees are approximately split between distributors and IMBOs on a 50-50 ratio; noted contrast with other jurisdictions where distributor shares are smaller. ### Liquidity risk management, valuation practices and stress testing - Regulatory upgrades: - Amendments in June 2020 (Cabinet Office Order, Ordinance for Enforcement of ITIC and JITA Management Rules) to incorporate IOSCO’s Recommendations for Liquidity Risk Management for CIS (February 2018) for publicly offered investment trusts. - Upgraded framework entered into force in January 2022. - IMBOs with publicly offered investment trusts must take reasonable measures to ensure appropriate management of liquidity. - Liquidity classification (JITA Management Rules): - (i) highly liquid assets: those that can reasonably be deemed to be sold within three business days or less, taking into account market impact; - (ii) medium-liquidity assets: those that can reasonably be deemed to be sold within four to seven business days; - (iii) low-liquidity assets: those reasonably deemed to take eight business days or more to sell; - (iv) non-liquid assets: those deemed to take eight business days or more to sell and to have a significant market impact. - Classification is internal; IMBOs must monitor proportions and escalate if thresholds crossed. - Stress testing: - JITA Rules: IMBOs must draft internal rules specifying implementation of stress tests considering fund characteristics. - Management companies must carry out stress tests on a regular basis and “as necessary”. - The FSA does not currently carry out stress tests of investment funds, nor is this under consideration for the near future. - Permitted liquidity tools and suspension of redemptions: - Laws do not prescribe specific tools; tools must be detailed in Terms and Conditions. - Common practice: fixed anti-dilution levies, deferral/limitation of withdrawals for large redemption requests, order amount limits and prior notice for open-ended REITs (often with limited redemption frequency, e.g., semi-annually). - JITA Rules contemplate suspension of redemptions as “measures to be taken in the event of an emergency”; IMBOs must promptly notify distributors, JITA and FSA when suspending. JITA may form a Special Measures Committee for widespread emergencies. ### Leverage, derivatives and securities financing transactions (SFTs) - Borrowing: - Investment trusts: borrowing permitted only for limited purposes (payment of redemptions, payment of dividends for dividend reinvestment type, limited incident handling). - In practice, borrowing by investment trusts is virtually non-existent. - Investment corporations: no regulatory limitations on leverage; in practice many IMBOs consider a 50 per cent limit of the fund’s NAV. - Derivatives: - FIEA and JITA Rules: derivatives not allowed if value at risk from specified fluctuations exceeds the net assets of the fund. - Calculation must follow a reasonable predetermined formula by IMBOs. - FSA does not receive systematic information on funds’ derivatives exposures but expects IMBOs to report breaches of IMBO-calculated limits. - SFTs: - Investment trusts: margin transactions, securities lending and borrowing, repos, short selling allowed but value must be within total NAV of the particular fund (article 15 of JITA Rules). - Investment corporations: no limit on use of these transactions. - FSA monitoring and data initiatives: - FSA expects policies on SFTs (collateral valuation, contingency plans, margin call management). - FSA currently relies on self-reporting by management companies regarding SFTs but is considering proactive monitoring. - New reporting survey pilot includes leverage information for funds with over JPY 50 billion in AUM; FSA will consider expanding leverage data requests after analysis of survey results. ### Supervision, monitoring, onsite inspections and resourcing - Offsite monitoring and data collection: - Asset Management Monitoring Office within the Securities Business Division (headcount around 20 staff) conducts offsite monitoring, reviews data reported by IMBOs, imposes administrative actions and decides policy needs. - Information sources: Basic Terms and Conditions, business reports by IMBOs, ad-hoc notifications, complaints/whistleblowers, SRO audit results, data from SROs (JITA monthly high-level fund composition, net inflows/outflows and NAV; JIAA annual and quarterly company/AUM reports), discussions with firms. - New Fund Survey: - Coverage: annually from all IMBOs and SPBOQIIs for all funds with more than JPY 50 billion in NAV. - Report items: investment strategy (hedge funds), breakdown of regions, types of assets, counterparty risk, leverage and liquidity risk management (including liquidity bucketing). - Pilot: 14 large IMBOs in 2023; FSA received pilot information in July 2023. - Rollout: to all entities starting January 2024. - Deadline for first full survey submission: end of July 2024. - Onsite inspections: - Selection criteria: offsite monitoring indicators, AUM ranking, time since last inspection, complaints/problematic conduct, outsourcing and related-party issues; no standardized risk score. - SESC resources: total of 78 staff for offsite monitoring and onsite inspections for all FIBOs, including two teams (12 staff) dedicated to IMBOs. - Typical inspection: team of 8 people; inspection duration about 6 months. - Inspection activity (2018–2022, 5-year total): - IMBO inspections per year: 2018: 4; 2019: 5; 2020: 4; 2021: 4; 2022: 7; 5-year total: 24. - Concluded in administrative action (IMBOs): 2018: 0; 2019: 1; 2020: 1; 2021: 1; 2022: 1; 5-year total: 4. - SPBOQII inspections: 2018: 2; 2019: 2; 2020: 0; 2021: 0; 2022: 2; 5-year total: 6. - Concluded in administrative action (SPBOQII): 2018: 0; 2019: 2; 2020: 0; 2021: 0; 2022: 1; 5-year total: 3. - Observations: about five IMBO onsite inspections per year on average; only four of the top 11 IMBOs have been subject to an onsite inspection in the last ten years. - Coordination with SROs and LFBs: - JITA headcount: 50 people, with 10 assigned to onsite inspections; JITA conducts about 10 to 12 inspections annually and focuses on medium and smaller firms. - LFBs: approximately 300 staff members, 200 assigned to inspection for FIBOs as a whole. - Regular communication and data sharing between FSA, SESC, LFBs, JITA and JIAA. ### Enforcement processes - Administrative measures available under FIEA: - Business Improvement Order (require measures and submission of improvement reports). - Business Suspension Order (stop particular practice or suspend part of business for up to six months). - Cancellation of IMBO registration. - FSA or LFB cannot impose administrative monetary penalties on IMBOs. - Post-inspection follow-up: - Firms produce reports explaining remedial measures; FSA conducts interviews/discussions until satisfied; orders published on FSA/LFB websites. - Criminal enforcement: - SESC can file criminal charges for serious and malicious cases; investigative powers include witness questioning, search warrants and filing charges with public prosecutors. ### Systemic risk monitoring and international cooperation - Domestic systemic risk roles: - Risk Analysis Division: coordinates research and analysis concerning risks common to multiple financial institutions and the broader financial system; can carry out inspections to understand risk management under coordination with SESC. - Asset Management Monitoring Office collaborates with Risk Analysis Division to improve data collection and sector assessment. - FSA-BOJ coordination: biannual meetings at the Council for Cooperation on Financial Stability and Financial Monitoring Council; frequent working-level liaison meetings; collaboration on data collection through the “Common Data Platform” expected operational later this year. - International cooperation: - Bilateral cooperation as required; Memorandum of Cooperation with National Securities Regulators in the European Union for information exchange on investment funds supervision. - FSA is a signatory to the IOSCO Multilateral Memorandum of Understanding (MMoU) and uses it actively for enforcement cooperation. - Recommendations on systemic monitoring: - Continue efforts to incorporate the investment funds sector into systemic risk analysis framework. - Asset Management Monitoring Office and Risk Analysis Division should actively review the new survey data and other enhanced offsite information. - FSA should consider whether reporting provides sufficient granularity or whether new data points are needed. - Consider expanding data collection to include all funds in the future, balanced against burden on IMBOs given many small inactive funds. - Consider stress testing of funds as a component of systemic risk analysis to monitor sector-wide vulnerabilities and build supervisory expertise. ### Key supervisory findings and recommended priorities - Key observations: - The sector has grown significantly, increasing potential systemic importance. - Implementation of liquidity risk management rules requires continued supervisory engagement and industry guidance (stress testing, asset liquidity classification). - Offsite monitoring improvements should be complemented by broader onsite coverage and resource planning to match expected sector growth from government initiatives. - Collaboration across regulators (FSA, SESC, LFBs) and SROs (JITA, JIAA) needs strengthening for effective supervision. - Suggested supervisory enhancements and recommended actions (timing and lead as provided): - Regulatory actions: - Continue to engage with industry on implementation of liquidity risk management rules, including (i) practicalities of the stress testing requirement and (ii) liquidity classification of assets. Timing: I (Immediate, within 1 year). Lead: FSA/JITA. - Expand engagement with ETF service providers to understand robustness of arrangements with authorized participants and market makers. Timing: NT (Near Term). Lead: FSA. - Monitor the money market fund/money reserve fund (MMF/MRF) market for potential developments that may warrant regulatory updates. Timing: MT (Medium Term). Lead: FSA/JITA. - Continue to monitor sector developments and newly permitted asset classes (e.g., crypto) to assess any need to update the regulatory perimeter. Timing: MT. Lead: FSA. - Supervisory actions: - Continue to strengthen cooperation to ensure effective supervision of the investment funds sector (FSA, SESC, LFBs) and ensure adequate resource allocation for the FSA to carry out its coordination role. Timing: I. Lead: FSA, SESC, LFBs. - Consider expanding coverage of the data reporting framework for a more comprehensive view of the industry, and increasing the frequency of the Fund Survey to allow for prompt identification of risks. Timing: ST (Short Term, within 1–2 years). Lead: FSA. - Strengthen on-site monitoring approach, including: - More frequent visits to large IMBOs. - Incorporate newly licensed firms into the criteria to identify firms for inspection. - Onsite inspections to the JITA and other SROs as needed. - Timing: ST. Lead: SESC. - Continue to monitor relationships of IMBOs and trust banks. Timing: I. Lead: FSA, SESC. - Assign more resources to enhance supervision of the asset management sector as it continues to grow. Timing: ST. Lead: Government, FSA. - Systemic risk monitoring: - Continue efforts to incorporate investment funds sector as part of the systemic risk analysis framework. Timing: I. Lead: FSA. - Introduce stress testing for investment funds as a component of systemic risk analysis. Timing: MT. Lead: FSA. *Source: EXECUTIVE SUMMARY and selected sections extracted from 1jpnea2024006 (Technical Note prepared for the IMF FSAP; information current as of January 2024).* ### EXECUTIVE SUMMARY__________________________________________________________________________________ 4 ### 1jpnea2024006 - EXECUTIVE SUMMARY ### Executive overview - Purpose: Review of the functioning and effectiveness of the regulation, supervision, and systemic risk monitoring of investment funds in Japan, focusing on requirements directly relevant to financial stability: valuation, segregation and safekeeping of fund assets, liquidity risk management and redemption of fund units. - Scope: Assessment of (i) how authorities analyze and monitor systemic risk from fund management activities in Japan; (ii) application of the domestic regulatory framework pertinent to investment funds; and (iii) supervision of compliance with the regulatory framework. - Outcome: Series of recommendations to strengthen domestic regulatory, supervisory, and risk monitoring frameworks. ### Size and structure of the investment fund industry - Total assets under management (AUM) of the investment fund sector in Japan: ¥419 trillion (as of end 2022), almost 1.5 times larger than at the time of the last FSAP in 2017. - AUM composition (end 2022): - ¥338 trillion held by publicly offered investment trust funds and privately placed investment trust funds. - ¥28 trillion in real estate-related corporation-type investment funds. - ¥52 trillion in privately placed investment funds (partnerships). - Asset allocation and market segments: - Majority of publicly offered investment funds invested in equity and bonds; industry dominated by IMBOs affiliated with major financial groups. - Hedge funds appear small: 1 per cent of AUM of publicly offered investment trusts falls in this category. - Money Market Fund (MMF) sector is small and composed exclusively of Money Reserve Funds (MRFs), used for settlement of securities transactions by retail investors and mainly invested in cash and some commercial paper. - Retail investor portfolio context (Q1 2023): - Investments in funds (investment trusts) represented 4.4 per cent of retail investors' financial portfolio. - Deposits represented 54.2 per cent. - Insurance and pension products represented 26.2 per cent. - Foreign exposure and outsourcing: - Over ¥7.2 trillion AUM in “foreign investment trusts” distributed in Japan (as of July 2023). - Of total net flows into publicly offered investment trusts in 2022, approximately 61 per cent was invested in foreign equity; of that foreign equity exposure, approximately 90 per cent of active fund management was outsourced. ### Industry participants and market dynamics - Concentration: Out of 111 IMBOs for investment trusts, the top 10 control about 60 per cent of total AUM. - Ownership: Out of the 20 largest IMBOs, more than 70 per cent are affiliated with financial institution group companies; less than 30 per cent are independent IMBOs. - Distribution and management arrangements: Many domestic funds invest in foreign equity and outsource the management to overseas firms; foreign asset managers distribute funds through local Type I Financial Instruments Business Operators. ### Regulatory and supervisory developments - Recent enhancements: - Regulatory framework recently amended to reflect increased attention to liquidity risk management for IMBOs, aligned with global standard-setting efforts. - Authorities engaged with industry to ensure adequate implementation of liquidity risk management requirements. - Supervisory approach: - FSA implemented a new supervisory approach relying on enhanced offsite monitoring, increased data collection, and targeted initiatives on priority practices (notably liquidity risk management). - Onsite monitoring framework inspects a limited number of firms per year; onsite inspections also conducted by SESC/LFBs as relevant. - Systemic risk monitoring: - FSA is increasingly incorporating investment fund sector risks into its systemic risk monitoring framework. - Historically fragmented reporting is being enhanced via newly increased data collection to enable a more comprehensive assessment of risks to financial stability. ### Key observations and recommended supervisory priorities - Observations: - The sector has grown significantly, increasing potential systemic importance. - Implementation of liquidity risk management rules requires continued supervisory engagement and industry guidance, including on stress testing and asset liquidity classification. - Offsite monitoring improvements should be complemented by broader onsite coverage and resource planning to match expected sector growth from government initiatives. - Collaboration across regulators (FSA, SESC, LFBs) needs strengthening for effective supervision. - Suggested supervisory enhancements: - Broaden coverage of onsite inspections while maintaining enhanced offsite monitoring. - Conduct in-depth, forward-looking assessment of resources needed for adequate supervision given expected growth. - Continue strengthening inter-agency cooperation and industry engagement on liquidity risk management implementation. - Consider introducing investment fund stress testing into the systemic risk monitoring framework. ### Recommendations on regulation and supervision (excerpted with timing and lead) - Regulatory framework actions: - Continue to engage with the industry on implementation of liquidity risk management rules, including (i) practicalities of the stress testing requirement and (ii) liquidity classification of assets. Timing: I (Immediate, within 1 year). Lead: FSA/JITA. - Expand engagement with ETF service providers to understand robustness of arrangements with authorized participants and market makers. Timing: NT (Near Term). Lead: FSA. - Monitor the money market fund/money reserve fund (MMF/MRF) market for potential developments that may warrant regulatory updates. Timing: MT (Medium Term). Lead: FSA/JITA. - Continue to monitor sector developments and newly permitted asset classes (e.g., crypto) to assess any need to update the regulatory perimeter. Timing: MT. Lead: FSA. - Supervision actions: - Continue to strengthen cooperation to ensure effective supervision of the investment funds sector (FSA, SESC, LFBs) and ensure adequate resource allocation for the FSA to carry out its coordination role. Timing: I. Lead: FSA, SESC, LFBs. - Consider expanding coverage of the data reporting framework for a more comprehensive view of the industry, and increasing the frequency of the Fund Survey to allow for prompt identification of risks. Timing: ST (Short Term, within 1–2 years). Lead: FSA. - Strengthen on-site monitoring approach, including: - More frequent visits to large IMBOs. - Incorporate newly licensed firms into the criteria to identify firms for inspection. - Onsite inspections to the JITA and other SROs as needed. Timing: ST. Lead: SESC. - Continue to monitor relationships of IMBOs and trust banks. Timing: I. Lead: FSA, SESC. - Assign more resources to enhance supervision of the asset management sector as it continues to grow. Timing: ST. Lead: Government, FSA. - Systemic risk monitoring actions: - Continue efforts to incorporate investment funds sector as part of the systemic risk analysis framework. Timing: I. Lead: FSA. - Introduce stress testing for investment funds as a component of systemic risk analysis. Timing: MT. Lead: FSA. ### Government initiatives to promote the sector (Box 1 summary) - Policy intent: Government plan to promote Japan as a leading international asset management center, including enhancing management capabilities of domestic IMBOs and promoting competition by removing barriers to entry. - Key elements and recent measures: - Doubling Asset-based Income Plan announced November 2022 to channel household cash and deposits into investments, including through an updated Nippon Individual Savings Account (NISA) program (“New NISA” starting January 2024) with increased tax-exempt holding limits and indefinite investment period; New NISA excludes trusts with trust period < 20 years, monthly dividend trusts, and certain derivative-using trusts. - FSA initiatives to improve competitiveness, review product structure and governance, consider impacts of double NAV calculation, and Financial Market Entry Office (2021) to facilitate foreign asset manager licensing in English. - Prime Minister’s September 2023 announcement to address barriers to entry, assist new entrants, and promote deregulation to enable outsourcing of back-office operations. - December 2023 Cabinet Policy Plan overview: designation of “special zones” to promote domestic and overseas asset management business, with potential use of deregulation tools; implementation will not, at this stage, affect the overall regulatory framework for asset management services. - Supervisory caution: When designing special zones, FSA should address regulatory arbitrage risks and ensure frameworks do not deviate from international standards. *Source: EXECUTIVE SUMMARY, 1jpnea2024006 - EXECUTIVE SUMMARY (Technical Note prepared for the IMF FSAP; information current as of January 2024).* ### 10. The regulation and supervision of CIS in Japan is primarily entrusted to the FSA, ### 10. The regulation and supervision of CIS in Japan is primarily entrusted to the FSA ### Institutional responsibilities and supervisory architecture - The FSA is an integrated regulator responsible for regulation and supervision of entities that carry out financial services in Japan, including credit institutions, insurance companies and securities firms. - The responsibilities of the FSA are delegated by the Prime Minister through the Financial Instruments and Exchange Act (FIEA). - The FSA’s mandate: ensure the stable functioning of Japan’s financial system; the protection of depositors, policy holders and securities investors; and the facilitation of finance. - Other authorities and institutions sharing responsibilities: - The FSA: mainly responsible for policy formulation, off-site monitoring, and imposition of enforcement actions on Financial Instruments Business Operators (FIBOs), which include IMBOs. - Securities and Exchange Surveillance Commission (SESC): an independent bureau within the FSA, governed by a Chairman and two Commissioners appointed by the Prime Minister; exercises authority under delegation from the FSA Commissioner; Executive Bureau responsible for main functions; in charge of on-site inspections of FIBOs and can recommend enforcement actions to the FSA. - Local Finance Bureaus (LFBs): carry out registration of FIBOs, including IMBOs, notification process for certain non-registered institutions, registration of investment corporations; off-site monitoring and on-site inspections of smaller firms; review of funds registration statements and periodic information (including prospectus and offering documents). - Investment Trusts Association, Japan (JITA): association for management companies for investment trust and/or investment corporation; performs rule making, inspections and disciplinary action; membership is voluntary but almost all fund managers are members; required to enforce its rules and oversee compliance by members and is considered a Self-Regulatory Organization (SRO) from the point of view of the IOSCO Principles. - Footnote data: out of the 422 IMBOs, there are 111 IMBOs that have a license to provide investment trust management services and only 3 out of 111 IMBOs were not members of JITA but all of them belong to Japan Investment Advisers Association (JIAA). - Japan Investment Advisers Association (JIAA): association of FIBOs registered for investment management that conduct discretionary investment management business and/or fund management business for partnership as well as for investment advisory and agency business; some JIAA members provide only investment advisory and/or agency services. - Japan Securities Dealers Association (JSDA): association of certain Type I FIBOs; main SRO for securities firms licensed, inter alia, for distribution of units of investment trust funds to the public. ### Financial Instrument Business Operators (FIBOs) and IMBOs - Four main types of FIBOs under FIEA: - Type I FIBO: 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, which include units of investment trusts and investment corporations). Generally referred to as “securities firms”. - Type II FIBO: 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). These include rights in partnership agreements, anonymous partnership agreements and investment limited partnership agreements. - Investment Management Business Operator (IMBO): the license for the management of investment funds that is the focus of this TN. - Investment Advisor and Agency Business: Firms providing investment advice and intermediary or agency for conclusion of investment advisory contracts or discretionary investment contracts. - Banks and other financial institutions can conduct only limited securities business unless registered under the FIEA. - SROs conducting self-regulatory activities vis-à-vis FIBOs include: JSDA, Type II Financial Instruments Business Operators Association, Financial Futures Association of Japan (FFAJ), JITA, and JIAA. ### Regulatory framework for investment funds (ITIC and FIEA) - Primary statutes: - Investment Trusts and Investment Corporations Act (ITIC): main body of regulation for investment vehicles that take the form of either investment trusts or investment corporations. - Financial Instruments and Exchange Act (FIEA): deals with entities that can provide offering and management services of these vehicles; considers units of both investment trusts and investment corporations as securities pursuant to Article 2. - Legal definitions and asset focus: - Investment trust (ITIC Art. 2): “trust whose purpose is for trust property to be invested mainly in securities, real property, and other assets that Cabinet Order specifies as those in which it is necessary to facilitate investment (“specified assets”) (...) and whose purpose is for the beneficial interest to be divided and for multiple persons to acquire it.” - Investment corporation: “association incorporated based on this Act for the purpose of investing assets, mainly in specified assets.” - In practice: investment trusts mainly invest in securities (including units of other investment trusts — “securities investment trusts”); investment corporations mostly invest in real estate (REITs). A vast majority of the industry is represented by securities investment trusts; real estate corporations constitute a much smaller segment. - Partnerships: - Partnerships generally based on Civil Code or a silent partnership under the Commercial Code; two types depending on assets: (i) mainly securities; or (ii) other assets (e.g., solar energy plants). - If partnership invests more than 50 per cent of its assets in securities, it is subject to FIEA for both offering/solicitation and management requirements. - Partnerships investing in other assets would not be subject to FIEA for management requirements but would need to be subject to FIEA for offering and solicitation. - Sector size: total of about ¥4 trillion in AUM (footnote clarifies this figure includes partnerships managed by SPQOII, not offered to the general public; AUM for partnerships managed by IMBOs amounts to ¥750 billion). - Note on crypto: Recent media announcements point to the possibility of some of these vehicles investing in crypto assets in the near future, which is currently not permitted under the Limited Partnership Act for Investment. Partnerships can already invest in crypto assets when taking the form of Silent Partnerships under the Commercial Code; there is currently one Silent Partnership investing in crypto assets. ### IMBO licensing, categories, and special permissions - IMBO registration required to manage investment trusts, investment corporations and partnerships (except where SPB applies). - IMBO categories (four within the IMBO license): - Category A — for investment trusts. - Category B — for investment corporations (REITs and J-REITs). - Category C — Discretionary Investment Management (segregated accounts). - Category D — fund management business for partnerships (fund management license for General Partners). - IMBOs must specify each category of funds they wish to manage. - Specially Permitted Business (SPB) categories under FIEA do not require an IMBO license but only a notification: - SPB for Qualified Institutional Investors (SPBQII): entity wishing to market and manage partnerships that (i) invest more than 50 per cent in securities, and (ii) are exclusively offered to: (a) one or more Qualified Institutional Investors (as defined by FIEA) and (b) 49 or less non-QIIs. No IMBO license required to manage their assets in these cases. - Two more SPB sub-categories introduced in 2021: SPB for Overseas Investors and SPB for the Transitional Period; these permit foreign IMBOs to provide certain management services in Japan without being licensed by the FSA (following only a notification requirement), but have been rarely used as they require having an office presence in Japan, which triggers corporate tax requirements. - Distribution rules linked to vehicle type: - Units of investment trusts and investment corporations can be offered by Type I FIBOs, and by Type II FIBOs only when distributing units of funds they have themselves established (self-offering). - Units of partnership funds can generally be offered by Type II FIBOs (except where SPBOQII can distribute, in which case no Type II FIBO distributor is required). ### Money Market Funds (MMFs) - MMFs are regulated via the JITA Regulations Concerning the Operation of MRFs and MMFs. - MMF investment limits and features: - Must keep a weighted asset life of no more than 90 days, and a weighted average maturity of maximum 60 days. - Offer a constant NAV and rules permit amortized accounting for assets. - IMBOs for MMFs (Category A) must formulate and regularly review a contingency plan for the event that the principal of the MRF is damaged; the plan must be submitted to the FSA for its review. - Market note: Currently, MRFs are the only MMF product in the market; offered by Type I FIBOs for settlement of their retail clients’ transactions in the primary and/or secondary market. Due to the negative interest rate environment, these instruments are mainly invested in cash and CPs. ### Conduct of business and supervisory reporting - IMBOs subject to a general duty of care; FIEA imposes duty of loyalty and due care of a prudent manager and prohibits conduct detrimental to beneficiaries. - FIEA establishes requirements applicable to all FIBOs intended to protect investors: disclosure of relevant documents and carrying out suitability assessments (prohibition of inappropriate solicitation in light of investors’ knowledge and experience). - Incident reporting: - IMBOs must notify the FSA or LFBs of any internal problematic conduct. - When aware of officers or employees violating any law or regulation (including duty of loyalty and due care), IMBOs must submit an “Incident Report” to their head supervisor, the FSA or the LFBs. - The report must include relevant background and measures to prevent recurrence. - The FSA and LFBs follow up as needed; Incident Reports are considered in offsite monitoring and for determining the need for onsite inspection. - IMBOs must also notify both the FSA and their SROs should internal problematic conduct breach SRO rules. ### Asset allocation, investment policy and limits - Investment funds must follow an investment policy that adequately manages credit and liquidity risk. - FIEA and ITIC prohibit IMBOs from making investments that do not comply with the investment method determined in advance to manage credit risk. - IMBOs are prohibited from making investments without taking reasonable measures for liquidity risk management. - Investment trusts and investment corporations have limits on assets incorporated in portfolios, depending on trust/corporation type: - JITA Management Rules set specific limitations depending on whether set up as Securities Trusts (more than 50 per cent of NAV invested in securities as per ITIC Art. 2) or trusts/corporations investing in other than securities (in practice real estate: more than 50 per cent of NAV invested in real estate and asset-backed securities). - Securities trusts/corporations have limitations in total exposure to one issuer, as well as total investment in units of other trusts/corporations. ### Valuation and accounting rules - All funds must follow Japanese Accounting Standards (J-GAAP). - Specific accounting and valuation requirements for different types of funds are set in SRO rules: - “Rules for Valuation and Accounting of Investment Trust Properties” (JITA Valuation Rules). - “Rules Concerning Calculation of Investment Trust Assets”. - Specific requirements for real estate and infrastructure trusts and corporations in the “Rules for Real Estate Investment Trusts and Infrastructure investment Corporations” and “Rules on Investment Reports for Investment Trusts and Investment Corporations”. - “Accounting Rules for Investment Trusts”, “Rules on Accounting for Investment Corporations” and the “By-laws for Accounting Rules for Investment Trusts”, both issued by JITA, provide main requirements for financial statements of trusts and corporations. *Source: 1jpnea2024006 - 10. The regulation and supervision of CIS in Japan is primarily entrusted to the FSA* ### 26. The main difference between J-GAAP and the International Financial Reporting ### 26. The main difference between J-GAAP and the International Financial Reporting Standards (IFRS) ### Valuation of non-listed securities and IMBO valuation rules - J-GAAP: non-listed securities are valued at acquisition cost. - IFRS: non-listed securities are required to be valued at fair value. - JITA Valuation Rules: currently being revised to require that non-listed securities be priced at fair value. - Investment trusts’ assets: required to be calculated at market value and on a daily basis. - JITA Valuation Rules: assets in the portfolios of investment trusts and investment corporations should in principle be valued at market value and continuity should be maintained (i.e., calculated on a daily basis for investment trusts). - When IMBOs deviate from JITA Valuation Rules, the methodology and background must be recorded in writing and kept for seven years. - Specific provisions for investment corporations investing in real estate and infrastructure: requirement to involve an independent third party for valuation of the assets. - When a third party sets prices of assets, the validity of this price must be periodically verified by the management company (in practice done in discussion with the auditor of the IMBOs), which must also maintain an internal system for such verification. - Footnote: Investment corporations do not have a daily NAV requirement, given that they typically invest in real-estate. While it is possible for investment corporations to invest in securities and be publicly offered, this has never happened, due to tax and other administrative reasons that make this option not attractive. There is currently only one corporation which invests in non-public shares, and it is privately offered. ### Audit and JITA flexibility on valuation - Assets of public investment trusts and investment corporations are subject to audit. - Further to FIEA: accounting of public investment trusts and investment corporations are subject to periodic auditing by independent auditors for each accounting period (which cannot exceed one year). - An audited report must be filed with the LFBs and disclosed to investors. - JITA retains ability to revise or tailor its Rules for exceptional circumstances affecting valuation (e.g., conflict, natural disaster). - JITA can provide specific recommendations for particular scenarios. ### Treatment of Pricing Errors - IMBOs must appropriately manage NAV calculation to ensure accurate calculation of the NAV. - Notable fluctuation in NAV: IMBOs must identify cause; if serious problem is found, report to internal control division or Board of directors. - “Notable fluctuation” is defined by each IMBO in the Terms and Conditions of the funds they manage. - In practice, domestic funds very rarely incur pricing errors as a deviation of 1 yen is considered unacceptable. - Both IMBOs and the trust bank daily independently calculate and reconcile the NAV price to ensure 100 per cent accuracy. - Further to ITIC: an IMBO that due to negligence causes damages to investors must compensate them. - No requirement for IMBOs to report pricing errors to the FSA or LFBs, although in practice entities voluntarily report pricing errors. ### Management of Liquidity Risk — regulatory upgrades and expectations - Liquidity risk regulation for investment trusts upgraded: Cabinet Office Order on Financial Instruments Business, etc., Ordinance for Enforcement of the Act on Investment Trusts and Investment Corporations and relevant JITA Management Rules amended in June 2020 to incorporate IOSCO’s Recommendations for Liquidity Risk Management for CIS (February 2018) for publicly offered investment trusts. - Upgraded framework entered into force in January 2022. - IMBOs with publicly offered investment trusts must take reasonable measures to ensure appropriate management of liquidity. - JITA Management Rules require liquidity risk management systems to consider: size of the Investment Trust during product design to redemption, nature of trading conditions, assets held, investment strategy, points of sale (Type I FIBOs or registered financial institutions), characteristics of anticipated investors, conditions for establishment and early cancellation, product characteristics, market trends and market environment, impact on liquidity risk, and results of any stress tests carried out. ### Liquidity classification and monitoring - JITA Management Rules require internal classification of assets by liquidity for publicly offered investment trusts: - (i) highly liquid assets: those that can reasonably be deemed to be sold within three business days or less, taking into account market impact; - (ii) medium-liquidity assets: those that can reasonably be deemed to be sold within four to seven business days; - (iii) low-li quidity assets: those reasonably deemed to take eight business days or more to sell; - (iv) non-liquid assets: those deemed to take eight business days or more to sell and to have a significant market impact. - Classification is internal; newly introduced pilot survey includes some of this information as a reporting requirement. - IMBOs must monitor proportions of assets to comply with trust’s Terms and Conditions and maintain a trail of monitoring methods and results. - If trust crosses established thresholds for liquidity categories, IMBOs must escalate to appropriate internal committee (or the Board) and, if appropriate, carry out more detailed liquidity analysis and determine whether communication to investors is needed. ### Stress testing requirements - JITA Rules: IMBOs must draft internal rules specifying implementation of stress tests considering fund characteristics. - Management companies must carry out stress tests on a regular basis and “as necessary”. - Depending on results, conduct further detailed liquidity analysis and take actions such as considering portfolio changes. - The FSA does not currently carry out stress tests of investment funds, nor is this under consideration for the near future. ### Permitted liquidity risk management tools and industry dialogue - Laws and regulations do not prescribe specific liquidity risk management tools; investment trusts and investment corporations are free to use any tools if detailed in their Terms and Conditions at incorporation. - Terms and Conditions can be amended to incorporate more tools without investors’ approval if considered beneficial to investors. - In practice, some investment trusts use a fixed anti-dilution levy charged to all redeeming investors irrespective of net inflows or outflows. - Trusts generally incorporate the possibility of deferring or limiting withdrawals for large redemption requests. - Open-ended REITs (investment corporations) generally include an order amount limit and prior notice system for redemptions; most set a redemption frequency that is very limited (e.g., semi-annually) to account for asset illiquidity. - FSA is discussing use of liquidity risk management tools with industry and has gathered data via a sample survey of IMBOs. - Ongoing working group between the FSA, JITA and the industry to understand the appropriateness and practical challenges of introducing variable anti-dilution levies in Japan. ### Suspension of Redemptions - JITA Rules contemplate suspension of redemptions of CIS units as “measures to be taken in the event of an emergency.” - Emergency situations include suspension of trading on exchanges and foreign markets, turmoil in trading markets, failure of market infrastructure, etc. - IMBOs can determine need to suspend subscriptions and redemptions and must promptly notify distributors, the JITA and FSA. - For widespread emergencies, JITA will form a Special Measures Committee to decide a general “Acceptance Suspension Measure” and notify members and distributors. - In practice, all investment trusts and investment corporations include possibility to suspend redemptions in their basic Terms and Conditions; FSA/LFBs check this upon receipt. - IMBOs may also suspend redemptions to manage unusually large requests; this possibility must be included in Terms and Conditions and is in practice done by all IMBOs. ### Use of Leverage and Securities Financing Transactions - Investment trusts: borrowing permitted only for limited purposes: - (i) providing funds for payment of redemption orders; - (ii) payment of dividends for dividend reinvestment type investment trusts; - (iii) in connection with incident handling (e.g., when expected cash collateral delay requires day funding), during a limited period and under certain conditions. - In practice, borrowing by investment trusts is virtually non-existent. - Investment corporations: no regulatory limitations on use of leverage; in practice many IMBOs consider a 50 per cent limit (of the fund’s NAV), as banks would not typically lend beyond that level. - Use of derivatives: - FIEA and JITA Rules: if value at risk from fluctuations in interest rate, currency value, quotations on a financial instruments market or other indicators exceeds the net assets of the fund, derivatives transactions are not allowed. - Calculation of value of these risks must be done further to a reasonable formula predetermined by the IMBOs. - FSA does not receive information on funds’ derivatives exposures but expects IMBOs to report if the relevant limit, as calculated by IMBOs, has been breached. - Any investment trust or investment corporation that can use derivatives for purposes other than hedging must clearly indicate this in their Terms and Conditions. - Securities financing transactions (SFTs): - Investment trusts can enter into margin transactions, securities lending and borrowing, repos, short selling and other similar transactions, but value of these transactions must be within the total NAV of each particular fund (further to article 15 of the JITA Rules). - Investment corporations don’t have a limit on the use of these transactions. - FSA expectations and monitoring: - FSA expects policies regarding SFTs, including collateral valuation and management, contingency plans for failure of significant counterparties, and management of margin calls. - FSA currently relies on self-reporting by management companies regarding use of SFTs but is considering proactive monitoring. - New reporting survey pilot includes reporting of some leverage information: IMBOs required to report information on leverage for funds with over JPY 50 billion in AUM. - FSA will consider whether to expand requests for information on leverage use with more granular data on derivative balances and details on long-short positions and counterparty exposure after analysis of current Survey Results. ### Safekeeping and Segregation of Fund Assets - Regulatory framework prevents IMBOs from receiving assets of CIS they administer and requires custodians to segregate entrusted assets. - Further to ITIC: custody of investment trusts’ assets must be entrusted to a trust bank that must segregate trusts’ assets from its own and from assets of other clients. - Custody of investment corporations’ assets must be entrusted to an asset custody company, which is required to segregate the assets. - “Asset custody company” can be either a bank or other regulated institution authorized to be custodians. - In practice, both investment trusts and investment corporations entrust custody to trust banks. - Trust banks are regulated further to the Banking Act and supervised by the banking supervision group of the FSA. - Offsite functions of the FSA (banking and asset management) exchange information as needed on custodian business findings. - Regulation does not require custodian be structurally independent from IMBO group; functional independence safeguards are expected: - Supervisory Guidelines require functional segregation in the form of a separate board and separate compliance functions, and separation of portfolio management and sales functions. - Both trust banks and IMBOs expected to draft internal rules to manage conflicts of interest. - These rules are not regularly reviewed as part of licensing, but FSA recently did a specific review related to monitoring process for enhancing asset management business and engaged firms on findings and required improvements. - Footnote: Both IMBOs and Trust Banks have to be incorporated as independent stock companies, therefore having separate boards of directors. ### Delegation and oversight - IMBOs are not permitted to delegate full authority to manage all investment trusts and investment corporations; partial delegation is allowed. - When partial authority is delegated, IMBOs and delegates are jointly and severally liable to compensate beneficiaries for any damage caused. - Delegation conditions must be included in the Terms and Conditions of the CIS. - In practice, most IMBOs delegate management of foreign assets in domestic investment trusts’ portfolios. - IMBOs expected to exercise appropriate due diligence when choosing delegates and to monitor compliance with appropriate regulation. - Monitoring is reviewed offsite on a reactive basis; no specific regular reporting by firms on how they carry out due diligence. - FSA will examine when a problematic issue is reported by the IMBO. - Supervisory framework considers extent of delegation and outsourcing when determining need for onsite inspections. ### Fees and Commissions - Investment trusts subject to multiple fees: - At purchase: investors often pay a distribution commission to the distributor, a percentage of the subscription amount. - During holding: a management fee based on the unit of the fund the investor holds. - At redemption: redemption fees may be paid to distributor for some funds. - Success fees may be charged depending on investment performance. - Details of all fees must be clearly reflected in fund disclosure documents. - FSA 2023 review on fees and commissions: - Found that irrespective of active or passive management, fees are approximately split between distributors and IMBOs on a 50-50 ratio. - Notes contrast with other jurisdictions (US example): distributor share much lower, around 1/3 of total fees for passive funds and 1/4 of total fees for active funds. - FSA continues discussions with largest IMBOs and expects reasonable explanations for fee regime or changes to fee structure. ### Winding Up / Liquidation of Investment Funds - Investment trusts can be liquidated per specifications in their Terms and Conditions. - Liquidation can occur after a set “trust period” or before expiration in specified conditions (e.g., number of remaining units or size of NAV fall below a specified level). - Early termination generally requires investors voting in favor of liquidation. - Many small funds without significant activity remain to be liquidated because investor approval is perceived as a burdensome activity by Type I FIBOs and IMBOs. *Source: 1jpnea2024006 - 26. The main difference between J-GAAP and the International Financial Reporting Standards (IFRS)* ### 53. J-REITS will be delisted and liquidated should they fall under specific conditions. These ### 1jpnea2024006 - 53. J-REITS will be delisted and liquidated should they fall under specific conditions. These ### Delisting and liquidation conditions for J-REITs - J-REITs will be delisted and liquidated should they fall under specific conditions. These include: - the expiration of the term for which it was set up, - a resolution of the investors in the REIT, - a merger (should the corporation disappear as a result), - a judicial decision ordering dissolution, - the revocation of the registration further to FIEA. ### Findings and Recommendations (paragraphs 54–58) - The enhanced approach to liquidity risk management is a welcome step. The new framework significantly enhances regulation for open ended public investment trusts and fills an important gap. - Industry engagement initiatives have helped authorities better understand practicalities and implications of particular liquidity risk management tools. - Recommendations and observations: - Expand bilateral engagement beyond one top ETF provider to a broader set of firms providing ETF services to assess robustness of arrangements with authorized participants and market makers and to promote smooth functioning of the sector, including in times of stress. - Continue engagement with the industry on implementation of liquidity risk management rules; most of the recently introduced framework appears to have been smoothly implemented, though some items remain under discussion (e.g., possibility to introduce variable anti-dilution levies). - Authorities should request more detailed information from IMBOs on how they have implemented the stress testing requirement to understand frameworks and adequacy of data for these exercises. - Regulators should monitor data received on liquidity classification through the new fund survey and, if they find material divergences in fund managers’ approaches to similar assets, provide guidance to promote consistency. - Remain alert to the need to adapt the regulatory perimeter as certain types of funds may be allowed to invest in new types of assets; this may involve adapting regulation, issuing guidance or updating reporting requirements. - In particular, ensure reporting for partnerships that may have the ability to invest in crypto assets (currently Silent Partnerships and potentially in the future Limited Partnerships) falls within the current framework to monitor developments (see paragraph 89). - Monitor the MMF/MRF market for potential developments warranting regulatory updates. Current facts: - the totality of MMF funds are MRFs, - MRFs are a highly domestic product used exclusively for settlement purposes, - MRFs are held entirely by retail investors. - These factors reduce risks traditionally associated with constant NAV MMFs, but authorities should actively monitor the sector as other MMF products could be introduced in the future. ### Registration framework (paragraphs 59–67) - Institutional responsibilities: - The registration or licensing framework involves both the LFBs and the FSA. - In general, the LFB is responsible for registration of investment management companies as IMBOs, although FSA is involved in some cases. - Some entities can provide certain investment management activities without a license, following a notification process with the LFBs subject to several conditions (e.g., offer to only qualified institutional investors or limited number of investors). - Investment corporations follow a registration process with the respective LFB. - Licensing process for IMBOs: - A firm seeking to be licensed as an IMBO generally needs to submit an application to the LFB in the geographical area where the firm is located, with one exception for applicants already licensed and supervised by the FSA who want to add the IMBO license. - Firms can request licensing for one or more business categories permitted for IMBOs; application must specify the specific category. - For Category A or Category B IMBOs, application reviews are conducted by both the LFB and the FSA, which will supervise these IMBOs after registration. - FIEA key criteria for prospective IMBO applicants include at least: - Minimum capital of ¥50 million (except for “investment management business for qualified investors” where this requirement is lowered to ¥10 million). - Establishment of board of directors including statutory auditors (except for “investment management business for qualified investors” which is required to have only statutory auditors). - Fit and proper directors and officers with no track record of misconduct or links to organized crime. - Adequate internal controls and risk management systems. - Establishment of an independent compliance unit (except for “investment management business for qualified investors” where outsourcing is permitted). - Physical presence in Japan. - Request membership with the respective SRO or establish internal rules similar to those governing members of the relevant SRO. - Application review and outcome: - LFBs engage in a preliminary unofficial review and discussion with applicants to ensure appropriate license request and expected requirements are met, checking capital, personnel structure, resumes and information of directors and officers, corporate governance, internal control and risk management policies and procedures. - For IMBOs managing real estate (Category B), additional requirements relate to professional knowledge of personnel on real estate. - Applicants and staff are summoned to a hearing at the LFBs and must submit the Summary of Applicant. - After formal registration request and documentation, LFB will issue a notice of completion of registration if satisfied; the IMBO then starts process to join relevant SRO before operations. Refusals are very rare due to prior review and discussions. - Specially Permitted Business Operators (SPBOQIIs and SPBOOI): - SPBOQIIs can carry out certain asset management business without a license, following a notification process with the LFB, if they intend to be General Partner of a CIS taking the form of a partnership for (i) at least one QII, and (ii) 49 or less non-QII. - Applicant must submit notification form prior to finalizing the partnership and include the name of the QII and relevant documentation regarding directors and officers; LFB reviews and communicates finalization of process. - Financial Market Entry Office (established January 2021): - Joint team of the Securities Business Division and Strategy Development Division of the FSA as well as relevant LFBs to assist foreign asset managers/investment advisors planning to take up business in Japan. - Provides assistance regarding legal interpretation and business models in English, followed by licensing and supervision. - All communications are done in English if requested, and most documents further to the licensing process can be presented officially in English. - Initial focus on licenses for IMBOs, Investment Advisory and Agency Business Operators (IAABOs) and scope expanded to cover certain business of Type I FIBOs and certain business of Type II FIBOs. - Investment vehicle registration distinctions: - Investment trusts: - IMBOs must submit basic Terms and Conditions of the relevant trust to the FSA, who will review them primarily for formal deficiencies. - If the trust is intended for public offering (50 or more investors to be solicited), it must submit a “Securities Registration Statement” to the LFBs. - Investment corporations: - Investment companies are required to be registered as IMBOs (Category B) before starting registration of an investment corporation. - Project planners must file Basic Terms and Conditions with the LFBs and an application for registration of the corporation with relevant documentation. - Review focuses on whether it has the relevant asset management, administration and custody with its IMBO. - Once registration at the LFBs is completed, the investment corporation follows procedures to be listed at a stock exchange if it chooses to list and submits relevant public offering documentation to the LFBs at the time of listing. - Foreign funds: - Before a foreign investment fund can solicit the general public in Japan, it has to notify the FSA of its Terms and Conditions together with identification of a Type I FIBO to carry out distribution in Japan. ### Supervision and monitoring (paragraphs 68–75) - Institutional arrangements for supervision: - The FSA, LFBs, and SROs share supervisory powers over IMBOs. - All IMBOs authorized under categories A and B are supervised by the FSA. - IMBOs authorized under categories C and D will be under supervision of the LFBs, unless designated by public notice to be supervised by the FSA (e.g., larger entities, entities that belong to a financial group already under FSA supervision, affiliates of other financial sector entities). - All SPBOQIIs, with the exception of 1 SPBOQII, are under direct supervision of their respective LFBs. - JITA and JIAA exercise supervisory powers over their members (virtually all IMBOs licensed under the different categories). - Coordination: - FSA and LFBs are in regular communication and share relevant information; they also regularly receive information from JITA and JIAA and discuss supervisory planning and inspection results. - Supervision table summary (as provided) - FSA supervises: IMBO Category A, IMBO Category B, and other IMBOs designated by public notice. - LFB supervises: IMBO Category C and D (unless designated by public notice), SPBOQIIs, and SPBOOI (one SPBOOI). - Numbers of firms under supervision (As of July 2023): - Supervisory Authority / IMBO Category A / IMBO Category B / IMBO Category C / IMBO Category D / SPBOQII - FSA: 111 / 110 / 181 / 20 / 1 - LFB*: 0 / 0 / 149 / 25 / 3,503 - Total: 111 / 110 / 330 / 45 / 3,504 - Note: * LFB supervises one SPBOOI. - Supervisory approach and monitoring: - Since 2018 the FSA and SESC implemented a new approach to supervision aiming to better integrate onsite and offsite monitoring; the FSA discloses Supervisory Guidelines and SESC releases annual statement on monitoring priorities for securities business. - FSA and SESC rely on an enhanced offsite monitoring framework to assess need for onsite inspections; offsite monitoring carried out by the FSA in regular communication with SESC. - Offsite monitoring and reporting framework: - The bulk of offsite monitoring is carried out by the FSA and LFBs in close collaboration with the SESC, primarily by the Asset Management Monitoring Office within the Securities Business Division in the Supervision Bureau for IMBOs falling under direct FSA supervision. - The Asset Management Monitoring Office is in charge of reviewing data and information reported by IMBOs, imposing administrative actions and deciding policy needs in the investment fund sector; it undertakes engagement with firms and discussion groups and has a headcount of around 20 staff. - Information sources for offsite monitoring: - Basic Terms and Conditions of investment funds filed with the FSA and LFBs, and public offering disclosure documents filed with LFBs. - Business report prepared by IMBOs providing information on governance and corporate structure, information of the funds they manage such as the fund type, AUM, creation and liquidation of funds and financial statements. - Ad-hoc notifications related to the investment funds and IMBOs (e.g., notifications of incidents, changes to internal rules, changes to officers, capital amount, important employees etc.) - Complaints, tips and referrals from the public and other authorities. - Information obtained from whistleblowers. - Results of audits by SROs. - Data received from SROs: - JITA (for Category A and B IMBOs) provides to the FSA monthly information on high-level composition of funds’ portfolios, net inflows and outflows and NAV. - JIAA (for Category C and D IMBOs) receives an annual company overview report as well as a quarterly report of AUM. - Discussions with firms. - Additional monitoring initiatives: - JITA’s annual questionnaire for IMBOs covers governance, compliance, structure, investment and includes topical questions chosen yearly (e.g., liquidity risk management). - FSA’s monitoring process for enhancing the asset management business (since 2020) publishes annual Progress Reports on relevant findings and recommendations, focusing on the 11 largest IMBOs in Japan and regularly requesting data and information; recurring topics include governance and ad-hoc topics such as ESG issues. The initiative allows FSA to follow up on areas of concern or improvement and to collect additional information through discussions and meetings with firms. *Content unit: 1jpnea2024006* ### 76. The FSA is also rolling out a new survey for all fund managers that will improve its ### 1jpnea2024006 - 76. The FSA is also rolling out a new survey for all fund managers that will improve its ### Fund Survey and Data Collection - Survey coverage: - Requested annually from all IMBOs (irrespective of license type) and SPBOQIIs for all funds managed by them with more than JPY 50 billion in NAV. - Managers must report: investment strategy (in case of hedge funds), breakdown of regions, types of assets, information on counterparty risk, leverage and liquidity risk management (including their liquidity bucketing of assets further to the new JITA Rules). - Pilot and rollout timeline: - Piloted on the 14 large IMBOs in 2023. - FSA received pilot information in July 2023. - Rolled out to all entities starting January 2024. - Deadline for submission of the first full survey: end of July 2024. ### On-Site Inspections: scope, practices, and resourcing - Selection criteria for inspections (SESC uses offsite monitoring and discussions with the FSA): - High-priority firms criteria include: (i) have had no onsite inspections in the past several years, (ii) are in the top rank of firms based on their AUMs, (iii) could have a large impact on consumers due to number of retail clients. - Further quantitative and qualitative criteria include: (i) indicators like company profits, rate of change in AUM, rate of change in revenue, (ii) business characteristics like types of customers, outsourcing arrangements, related party transactions, (iii) audit framework, (iv) time elapsed since the last inspection, (v) complaints or problematic conduct reports, (vi) reports on problematic issues from SROs and other sources. - No specific weight assigned to these factors; no standardized approach to arrive at a risk score. - Inspection objectives and focus: - Establish full picture of problems, investigate root causes, focus on prevention of recurrence. - Assess status of firms’ systems for business operations, including internal controls, compliance and legal systems, and risk management frameworks. - SESC publishes annual Monitoring Priorities; 2022-23 priorities included suitability/customer-oriented conduct, business model changes along with digitalization, cybersecurity, internal controls for AML/CFT, and measures to prevent recurrence of problems identified via internal audits or SRO examinations. - IMBO focus: actual investment practices, control environment for managing investment (including outsourcing practices) and management of conflicts of interest. - Inspection resourcing and process: - SESC has a total of 78 staff for both offsite monitoring and onsite inspections for all FIBOs, including two teams (12 staff) dedicated to IMBOs. - Average onsite inspection team: 8 people; inspection duration: about 6 months. - Each inspection concludes with an Inspection Report to the SESC Chair and Commissioners; if no problem found, only notification of conclusion is sent to the firm. - If potential issues are found, options: - Send a notification to the firm identifying issues to be addressed, transferring the case to the FSA for follow-up; or - Recommend that the FSA take administrative disciplinary action. - FSA issues an Order for Production of Report to firms notified of issues; firms produce a report explaining measures addressing problems and submit to the FSA for review; FSA conducts interviews/discussions until satisfied. - Inspection activity statistics: - SESC/LFBs have carried out a total of 24 firm inspections since 2018, averaging about five IMBO onsite inspections per year. - Only four of the top 11 IMBOs have been subject to an onsite inspection in the last ten years. - SESC/LFBs have also carried out a total of 6 inspections of SPBOQIIs since 2018. - Table 6 figures (2018–2022, 5-year total): - IMBOs: 2018: 4, 2019: 5, 2020: 4, 2021: 4, 2022: 7, 5-year total: 24. - Of which, concluded in administrative action: 2018: 0, 2019: 1, 2020: 1, 2021: 1, 2022: 1, 5-year total: 4. - SPBOQII: 2018: 2, 2019: 2, 2020: 0, 2021: 0, 2022: 2, 5-year total: 6. - Of which, concluded in administrative action: 2018: 0, 2019: 2, 2020: 0, 2021: 0, 2022: 1, 5-year total: 3. - Coordination with other supervisors and SROs: - SESC engages closely with Local Finance Bureaus (LFBs); LFBs have approximately 300 staff members, 200 of whom are assigned to inspection for FIBOs as a whole. - JITA carries out onsite inspections of its members; JITA headcount: 50 people, with 10 assigned to onsite inspections; JITA conducts about 10 to 12 inspections annually. - JITA focuses on medium and smaller firms for inspections; SESC works closely with JITA and shares perspectives to raise efficiency. - JITA is under FSA supervision; JITA reports once per year to the SESC and FSA senior representatives hold semi-annual meetings with JITA’s management. - Last onsite inspection of the JITA by supervisory authorities was carried out in 2007; no plans to carry out an inspection in the near term. ### Findings and Recommendations (supervisory coverage and resourcing) - Coordination and leadership: - Authorities should continue to strengthen collaboration and ensure adequate resource allocation for the FSA to carry out its coordination role. - Current complex structure does not appear to lead to significant gaps of coverage due to the FSA’s leading role; authorities are encouraged to continue cooperation and regular communication. - FSA asset management team should have adequate resources commensurate with potential risks as the sector grows. - Offsite monitoring and survey coverage: - New fund survey is a welcome development; expected to provide a more comprehensive view as all Types of IMBOs will report on their most significant funds. - Authorities presently lack an overall view of the investment funds sector, with only partial visibility over the SPQOII sector and of those trusts and corporations with less than JPY 50 billion. - Recommendation: once survey is rolled out, consider expanding coverage or supplementing with targeted data collection for entities outside of the survey. - Frequency recommendation: annual frequency useful for retrospective view, but unlikely to identify risks in time for ongoing supervision or systemic risk monitoring; collecting data semi-annually or quarterly would be more appropriate as a medium-term goal. - Onsite supervision frequency and breadth: - Offsite monitoring provides insight but should be supplemented with more frequent onsite visits, especially for overall functions like risk management and governance. - Recommendation: SESC should consider adapting onsite approach to deliver a more frequent cycle of inspections to the largest IMBOs, including targeted onsite thematic inspections where offsite monitoring is reactive. - Broaden onsite supervisory approach to allow larger coverage: only an average of five IMBOs inspected onsite per year out of 422 IMBOs. - Consider re-introducing onsite inspection of newly licensed firms and expand routine inspections to integrate findings into overall risk assessment. - SRO onsite supervision: - Supervisory program should include a more structured approach to onsite inspection of SROs, particularly the JITA, to better understand SRO supervisory and enforcement capacity. - IMBO–trust bank relationships: - Authorities should continue to closely monitor relationships between IMBOs and trust banks and follow up on findings from work on conflict-of-interest rules; engage with banking supervision as needed. - Resource constraints and recommendations: - Authorities face resource constraints to comprehensively supervise a growing industry; current approach risks becoming reactive rather than proactive. - More resources need to be assigned to enhance supervision of the asset management sector. - Recommendation: FSA and SESC should undertake an in-depth analysis of available resources and identify needs, taking into account the need to more frequently and routinely supervise firms and SROs, LFB resources, and expected sector growth. ### Enforcement: administrative and criminal processes - Post-inspection process: - Once SESC recommends administrative action, FSA or LFB initiates process and summons entity to a hearing; hearings intended to be public under FIEA, but IMBOs usually request closed hearings. - Firms typically accept facts and recommendations for administrative orders in most instances. - Types of administrative actions available under FIEA: - (i) Issue a Business Improvement Order requiring IMBOs to undertake relevant measures and submit business improvement reports to the FSA or LFB. - (ii) Issue a Business Suspension Order instructing firms to stop a particular practice or suspend part of its business for a maximum of six months. - (iii) Cancel the IMBO’s registration. - FSA or LFB cannot impose administrative monetary penalties on IMBOs. - Measures consider factors like seriousness of conduct, awareness by IMBOs’ management and boards of compliance and risk functions, and mitigation factors such as proactive corrective action by IMBO. - Administrative orders are published on FSA’s website and LFB’s website if supervised by the LFB. - Follow-up and compliance: - FSA or LFB follows up on actions; IMBOs file an Improvement Report for review; hearings or discussions held until satisfaction; cancellation of the order published when resolved. - FSA website contains a database of administrative actions on FIBOs indicating whether they have been cancelled. - Criminal enforcement: - SESC can file criminal charges for serious and malicious cases with public prosecutors’ offices. - SESC investigates violations such as insider trading, market manipulation and submission of false securities reports. - SESC powers: question and obtain information from any witness; request judge to issue search warrant to seize documents relevant to an investigation; file criminal charges based on investigation results. *Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1jpnea2024006.pdf* ### 101. International supervisory cooperation takes place as required, on a bilateral basis. The ### 1jpnea2024006 - 101. International supervisory cooperation takes place as required, on a bilateral basis. The ### International supervisory cooperation - Paragraph 101: International supervisory cooperation takes place as required, on a bilateral basis. - The FSA and SESC maintain contact as needed with foreign counterparts for supervisory processes. - Formal arrangements exist for some relationships based on supervisory needs, for example: - The Memorandum of Cooperation with National Securities Regulators in the European Union that allows the FSA and supervisory authorities in Europe to exchange information regarding supervision of their respective investment funds sectors. - Other bilateral cooperation happens ad-hoc as needed, including for the consultation of foreign authorities’ examinations towards their supervised entities located in Japan. - Paragraph 102: For cooperation in relation to enforcement matters, the FSA is a signatory to the IOSCO Multilateral Memorandum of Understanding (MMoU). - The FSA uses the IOSCO MMoU actively both to respond to requests from foreign regulatory authorities, as well as to obtain any needed information and documents for its own enforcement investigations. ### Systemic Risk Monitoring (Paragraphs 103–105) - Paragraph 103: - The FSA has a broad responsibility to contribute to the identification, monitoring and appropriate management of systemic risk in the Japanese financial markets. - The Risk Analysis Division is in charge of the coordination of research and analysis concerning the condition and trends of risks common to multiple financial institutions and the broader financial system, and conducts comprehensive or particularly specialized research and analysis. - This Division can also carry out inspections with the purpose of understanding the risk management situation of financial institutions, under the coordination with the SESC where necessary. - Paragraph 104: - The Asset Management Monitoring Office and the Risk Analysis Division collaborate to exchange information on the sector and improve data collection efforts. - Due to the smaller size of the sector relative to the securities market industry, the importance of the investment funds sector in the overall systemic risk monitoring framework of the FSA has up until now been more limited. - Example of evolving focus: collaboration between the Asset Management Monitoring Office and the Risk Analysis Division for designing the new investment fund survey and initially identifying data points relevant beyond micro prudential supervision (e.g., derivatives and counterparty exposures). - Paragraph 105: - The FSA coordinates with the Bank of Japan (BOJ) for the purposes of assessing systemic risk. - Biannual meetings are held with the BOJ senior officials at the Council for Cooperation on Financial Stability and Financial Monitoring Council. - The two institutions also hold more frequent working-level liaison meetings, as well as informal information sharing. - The FSA and BOJ collaborate on data collection efforts through the “Common Data Platform” that is expected to be operational later this year. ### Findings and Recommendations (Paragraphs 106–107) - Paragraph 106 — Findings and recommendations: - The authorities should continue their efforts to incorporate the investment funds sector as part of their systemic risk analysis framework. - Both the Asset Management Monitoring Office and Risk Analysis Division should continue to be actively engaged in reviewing the data obtained from the new survey and other relevant information that the FSA collects as part of its enhanced offsite monitoring. - The FSA should consider whether the reporting framework provides sufficient data for efficient systemic risk monitoring, or whether more granularity or new data points need to be requested from firms. - Authorities could consider expanding their data collection effort to include all funds in the future for a more comprehensive view of the sector. - Caveat: Expanding to include all funds may be too burdensome for IMBOs at this point given the large number of very small inactive funds. - Consideration: It could be more feasible if IMBOs restructure their products to focus on providing larger sized, longer-term vehicles, thereby reducing the number of small inactive funds. - Paragraph 107: - As the investment fund sector continues to grow, the FSA should consider stress testing of funds as a component of the systemic risk analysis approach. - Benefits of fund stress testing: - Serve as a monitoring tool to better understand any systemic risk implications of the sector. - Provide the FSA with the expertise needed for its supervisory activities when monitoring the implementation of the new requirement for IMBOs to carry out their own stress tests. *Source: Extract from 1jpnea2024006 (paragraphs 101–107).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1jpnea2024006.pdf_