Contributed By Mori Hamada & Matsumoto
In Japan, investment funds are one of the most popular financial instruments for investors. Not only institutional investors but also retail investors make investments in various funds.
For the purpose of the laws of Japan, investment funds are generally divided into three different categories: an investment trust, an investment company and a limited partnership. Among others, an investment trust (sometimes referred to as a contractual type investment fund) is the most popular investment fund for Japanese investors. In fact, so many investment trusts are established in Japan every year, and units of these investment trusts are actively offered/sold to Japanese investors by securities companies and banks.
It should be noted that not only investment funds established in Japan, but also investment funds established outside Japan (such as FCP in Luxembourg or unit trusts in Cayman Islands) are offered to investors in Japan, and a significant amount of money is invested into those foreign investment funds from Japan.
While Japanese investors actively make investments in investment funds established outside Japan, most of the investors purchasing Japanese domestic investment funds are Japanese investors. Therefore Japan would not be the jurisdiction which is generally used for the raising of capital from investors internationally.
Under the laws of Japan, an investment trust (a contractual type investment fund) is formed by way of a two-party deed between a manager and a trustee. An investment company (a corporate type investment fund) is established by memorandum and articles of incorporation. A limited partnership (a partnership type investment fund) is established by executing a limited partnership agreement.
Under the laws of Japan, a manager of a Japanese domestic fund must hold an investment management licence. Accordingly, it is not allowed for foreign investment managers/advisers which do not hold a licence under the laws of Japan to establish an investment trust in Japan. However, it is allowed for Japanese managers holding a licence to delegate their investment management function to foreign investment managers/advisers and in fact there are Japanese domestic funds, the investment management function of which is delegated to managers/advisers outside of Japan.
Also, a fund of funds structure is quite common in Japan, and there are many investment trusts feeding into other funds established and managed outside of Japan. In this case, the actual management activities are conducted outside of Japan.
Under the laws of Japan, unitholders of investment trusts, shareholders of investment companies, and limited partners of limited partnerships all benefit from limited liability. Thus, the maximum loss should not be greater than their investment capital.
In the case that investment funds mainly invest in marketable securities, such as listed stocks, government bonds and corporate bonds, securities investment trusts under the Law on Investment Trusts and Investment Companies (ITICL) are commonly used by Japanese investment managers. Securities Investment Trusts are tax-exempted trusts under the Japanese tax regime and are not treated as pass-through entities.
A securities investment trust is an investment trust which aims to invest more than 50% of its trust assets in Type I Securities (as defined in the Financial Instruments and Exchange Law (FIEL)) and derivatives whose underlying assets are Type I Securities. Type I Securities includes stocks, bonds, and units of investment trusts and shares of investment companies (Article 2, paragraph 1 of the FIEL).
However, mainly because of practical reasons, if these investment funds are denominated in currencies other than Japanese yen, foreign investment trusts under the ITICL are commonly used. Under the Japanese tax regime, foreign investment trusts are tax exempted and not treated as pass-through entities. A foreign investment trust is defined under the ITICL as a trust which is established in a foreign country under a foreign law and has natures similar to investment trusts established under the ITICL.
Investment funds which are used for real estate investments are typically structured as investment companies (Toshi Hojin) under the ITICL (ie, Japanese real estate investment companies, or J-REITs). Taxation is imposed on investment companies at the fund level. However, if certain conditions are fulfilled (eg, more than 90% of distributable profits must be distributed to investors), dividends paid to investors may be deducted for Japanese corporation tax purposes.
Investment funds formed as Japanese limited partnerships which are primarily used for private equity investments are pass-through entities for Japanese tax purposes, with taxes being levied on the investors in the fund rather than the fund itself. Also, investment funds formed as non-Japanese limited partnerships are generally pass-through entities for Japanese tax purposes.
Japan is not particularly popular with investment sponsors from any particular jurisdictions and/or for investment in particular jurisdictions or regions.
Under the FIEL, it is unlawful to make a public offering of securities unless an issuer of the securities has filed a securities registration statement (SRS) with the authorities. The FIEL, and a cabinet order and cabinet office regulations thereunder (collectively, the Cabinet Order) specify matters that need to be described in the SRS, which includes an investment objective, risk factors, subscription/repurchase procedures and a valuation method. Once filed, the SRS is to be disclosed to the public through the internet. In the case of a public offering, in addition to the SRS filing requirements, an issuer also needs to prepare a prospectus.
Under the FIEL, there is an exemption to the SRS/prospectus requirements: a private placement. If the requirements for the private placement exemption are met, an issuer is not required to file the SRS and prepare the prospectus.
There are basically two different types of private placement exemption: Private Placement to Small Number of Persons and Private Placement to Qualified Institutional Investors.
In general, the first category (Private Placement to Small Number of Persons) focuses on the number of offerees, and the second (Private Placement to Qualified Institutional Investors) focuses on offerees’ qualifications.
In addition to a filing requirement under the FIEL, the ITICL also requires an issuer of an investment trust/company to file a registration statement concerning an investment trust/company (FSA Registration Statement) with the authority (Financial Services Agency of Japan (FSA)). Unlike the SRS to be filed under the FIEL, the FSA Registration Statement needs to be submitted, not only in the case of a public offering, but also in the case of a private placement.
In contrast to the SRS that is to be disclosed to the public through the internet, the FSA Registration Statement is not publicly disclosed.
In Japan, an investment trust established by way of a two-party deed between a manager and a trustee is quite popular. There are so many investment trusts with various ranges of investment objectives in Japan. For instance, some funds focus on Japanese equities, while other funds focus on global bonds.
In Japan, an investment company (sometimes referred to as a corporate type investment fund) is mainly used in the context of REITs. In other words, an investment company established in Japan is not generally utilised for the purpose of investment into securities (such as equities or bonds). However, it is also true that some securities firms actively offer various types of SICAVs established in Luxembourg to Japanese retail investors.
A limited partnership (sometimes referred to as a partnership type investment fund) is mainly utilised for the purpose of private equity investments. This type of investment fund is not so common for Japanese retail investors and most investors are institutional. Similarly, other types of investment funds, not only Japanese domestic funds but also limited partnerships established outside Japan, are offered in Japan.
In addition to the disclosure requirements to investors with respect to investment funds, licence requirements should be also noted.
Under the laws of Japan, it is unlawful for any person to provide investment management services, unless this person holds an investment management licence, in principle. Also, it is unlawful for any person to offer a security unless this person holds the Type I/II licence, in principle.
Thus, a manager of an investment trusts/company and a general partner of a limited partnership need to hold an investment management licence, in principle. Also, distributors which offer a unit/share of investment trust/company need to hold the Type I licence. Similarly, distributors which conduct a solicitation of limited partnership interests need to hold the Type II licence.
This firm does not expect any material legal, regulatory or tax legislative changes in process which may impact the current environment.
In Japan, investment funds (particularly investment trusts) are one of the most popular financial instruments for investors. Many securities companies and banks sell various types of investment trusts to retail investors. In addition to these retail investors, institutional investors also actively make investments into investment funds.
In Japan, an investment trust is the most popular structure, while an investment company or a limited partnership is also available.
From the managers’ perspective, there are certain legal and regulatory themes that always need to considered in Japan (such as licence or disclosure issues). However, from the investors’ perspective, there are no specific themes or issues in Japan.
There is no specific restriction on an investor in Japan investing in any types of investment funds.
Theoretically speaking, the filing of a SRS/FSA Registration Statement is only required if an offer is made. Therefore, if no offer is made, it should not be necessary to file the SRS/FSA Registration Statement with the Japanese authorities. Generally, an offer of a security is construed as a solicitation of an application to acquire newly-issued securities. While there is no clear and specific definition of 'solicitation' of a security, it is generally understood that the concept of solicitation includes any act that has the effect of stimulating investors’ motivation towards making investments in specific products. The concept of solicitation is thus very general and broad, and there are no safe harbour rules or other detailed guidelines that an issuer (or a distributor) may rely upon. Accordingly, it is advisable to take a conservative position to the extent which is possible.
Nevertheless, before an issuer of investment fund completes the filing, in order to determine potential investor interest in a fund, a practical approach would be to:
This procedure is called 'sounding' and is similar to the process used by broker-dealers to determine preliminary investor interest in products. Once a filing has been completed, it is possible for the fund to re-contact the Japanese potential investors to provide fund documentation and explain the specifics of the fund.
Japanese regulations on asset management vary depending on whether an asset manager has been delegated discretionary authority to manage a client’s assets on the client’s behalf, or whether the asset manager is simply able to provide investment advice. The provision of asset management services in Japan requires registration with the FSA, regardless of whether an asset manager has discretion to manage a client’s assets on the client’s behalf.
A non-discretionary advisory business is a business providing advice on the value of securities or investment decisions, based on the value of financial instruments in return for fees.
Providing advice on the value of securities or investment decisions based on the value of financial instruments through newspapers, magazines or books available to the public will not fall under the scope of a non-discretionary advisory business. However, the provision of advice through a website requiring readers to register as members to pay fees where that advice is not otherwise publicly available will likely fall under the scope of a non-discretionary advisory business.
Registration of a non-discretionary advisory business is normally required under the FIEL for any person wishing to operate a non-discretionary advisory business in relation to securities or derivatives (an 'investment advisory business'). Any individual or corporation may register to perform an investment advisory business once it has met the various requirements for qualification. These include the satisfaction of certain registration requirements; for example, having in place compliance systems appropriate for an investment advisory business. Registration further requires an investment adviser to comply with certain conduct rules, including a restriction on providing advice to customers that is designed to encourage entry into transactions that would harm their interests while promoting another customer’s interests.
Successful registration of an investment advisory business also gives rise to a number of administrative obligations, such as the preparation of business reports for each business year, and submission of those reports to the FSA. The investment adviser will also be required to prepare and maintain books and documents in relation to the investment advisory business.
A discretionary investment management business is divided into the following four subcategories, where an investment management business manages assets of:
With regards to the first and second items, if the managed assets include real property, the investment manager will need to have a real property transaction licence under the Land and Building Transaction Act of Japan (LBTA). If the assets managed are predominantly invested in real property, the investment manager is required to have transaction discretionary representation approval under the LBTA. In addition, the management of the assets of an investment company (first item) or an investment trust (third item) by investing in real property falls under the definition of Specified Investment Management Activities and requires approval from the FSA under the ITICL. Almost all listed J-REITs are classified under the first item (investment company) rather than the third item (investment trust).
With respect to the second item, if the managed assets are invested in the beneficiary interests of a trust whose underlying assets are real property, this management is referred to as real property-related specified investment management and requires registration as a general real property investment adviser under the Real Property Investment Advisory Rules governed by the Ministry of Land, Infrastructure, Transport and Tourism of Japan (MLIT) as a prerequisite to the registration of the discretionary investment management services.
In a wrap account or separately managed account (SMA), assets deposited in the SMA are managed by investing in shares, bonds or other financial instruments in accordance with the investment policy agreed from the outset. As the operators of SMAs are delegated to the trading authority to manage the account by investing in securities, their services are classified as discretionary investment management, and the operator must be registered to provide discretionary investment management services.
To be registered as a discretionary investment manager, a person must meet a number of requirements, including the entity requirement. Under this restriction, only a joint-stock corporation incorporated under the Corporation Act of Japan, having a board of directors and a corporate auditor or a committee, or a foreign company that is similarly organised and has a business office in Japan, is eligible to register as a discretionary investment manager. The prospective discretionary manager must also meet the minimum capital amount and net worth requirements (in each case, JPY50 million or more), and certain compliance system requirements, such as a personnel structure appropriate to engage in discretionary investment management.
In contrast to the requirements of an investment advisory business, the requirements for registration as a discretionary investment manager are significantly more onerous. Like a non-discretionary investment manager, a registered discretionary investment manager is subject to certain codes of conduct, and is, for example, restricted from implementing investments that lead to transactions with itself, or to transactions involving any other assets managed by it. It is also required to prepare and maintain books and documents in relation to its investment management business, and prepare yearly business reports for submission to the FSA. A registered discretionary investment manager providing investment company asset management services or investment trust management services is also subject to certain additional obligations under the ITICL, such as a duty to procure a third-party appraiser to investigate the asset value when investing in real property.
A registered discretionary investment manager is in principle prohibited from engaging in any businesses other than financial instruments transactions, in order to insulate the discretionary investment management business from risks unrelated to financial instruments transactions. That said, a registered discretionary investment manager is permitted to engage in certain businesses that are ancillary to financial instruments transactions, such as M&A advisory and business consulting. On making further filings with the regulator, a registered discretionary investment manager will be permitted to engage in certain other businesses, such as commodities-related businesses, money lending and real property brokerage.
A non-discretionary investment adviser or discretionary investment manager located and licensed in a foreign jurisdiction may provide, respectively, non-discretionary investment advice or discretionary investment management services to a registered Japanese discretionary investment manager without requiring registration under the FIEL.
As described previously, under the laws of Japan, in order to market investment funds, an issuer must make filings for the relevant fund. Also, a person who conducts this marketing must hold a proper licence. However, other than those filing/licence requirements, no regulatory approval is required in order to conduct marketing of investment funds.
Any marketing activities which could be regarded as a solicitation of units or shares of the investment fund require registration of the fund. These marketing activities include providing a prospectus of funds, advertisements of funds on newspapers or magazines, and presentation of the funds to the public.
The FIEL requires a financial instruments business operator to conduct its business in such a manner that the state of its business operations does not fall under one of the following items: (i) its issuance of a solicitation in connection with an act that constitutes a financial instruments transaction which is found to be inappropriate in light of customer knowledge, customer experience, the state of customer assets, or the purpose for which a Financial Instruments Transaction Contract is concluded results in or is likely to result in insufficient investor protection; and (ii) beyond what is set forth in the preceding item, the state of business operations is such that the financial instruments business operator is found not to have taken measures to ensure the appropriate handling of customer information it has obtained in the course of the business, or business operations are otherwise in a state specified by a Cabinet Office Order as one that is contrary to the public interest or that is likely to compromise the protection of investors.
There are no rules, however, which specify certain classes of investors who are inappropriate to invest in certain types of funds.
In general, the Financial Services Agency is open to discuss regulatory questions, and it regularly publishes guidance on regulatory matters, although it is generally reluctant to give exact timeframes or definite replies on hypothetical questions.
Under the rules of the Japan Investment Trust Association (JITA ), investment funds in Japan are not permitted to access fund finance for leverage.
Under the rules of the JITA, Japanese investment trusts are permitted to make borrowing only in cases necessary for the purpose of payment of redemption money or for the purpose of payment of distribution.
Finance necessary for redemption money or distribution is normally made through borrowing from banks. Borrowing can be secured by bonds or shares invested by the fund, but it is not, in practice, usually secured.
In the case of Japanese securities investment trusts, fund finance is not common in practice, while in the case of J-REITs, bank borrowing is usually utilised for leverage. Interest rates at refinancing affects the performance of a REIT. A REIT is required to borrow only from financial institutions.
Under the Corporation Tax Act, Collective Investment Trusts are treated as tax-exempted trusts.
The following investment trusts are categorised as Collective Investment Trusts under the Corporation Tax Act:
Collective Investment Trusts are not treated as pass-through entities; however, they are tax exempted. Accordingly, Collective Investment Trusts are not taxed in respect of capital gains and incomes paid to them. Investors in a Collective Investment Trust are subject to the relevant withholding taxes in respect of profit distribution as discussed in 5.4 Tax Structuring Preferences of Investors.
Taxation is imposed on investment companies at the fund level. However, if certain conditions are fulfilled (eg, more than 90% of distributable profits must be distributed to investors), dividends paid to investors may be deducted for Japanese corporation tax purposes. Investors in investment companies are subject to the relevant withholding taxes in respect of profit distribution as discussed in 5.4 Tax Structuring Preferences of Investors.
Limited partnerships are pass-through entities for Japanese tax purposes, with taxes being levied on the investors in the fund rather than the fund itself. Non-resident investors (both individuals and corporates) are subject to relevant withholding taxes in respect of profit distribution as discussed in 5.4 Tax Structuring Preferences of Investors, whereas resident investors are not subject to withholding taxes.
Japan has an extensive network of tax treaties, with 74 conventions applicable to 127 jurisdictions all over the world (as of 1 December 2018). There are cases in which withholding tax rates applicable to the dividend payment from a fund to its investors are reduced as per the relevant tax treaty.
Japan has made an agreement with the USA in complying with FATCA. Also, Japan enacted CRS-related laws and regulations on 31 March 2015. Therefore, fund managers are generally required to comply with the FATCA and CRS regimes in Japan.
The following description about the tax treatments is to briefly outline the typical tax treatment and therefore is not a detailed and exhaustive explanation.
Securities Investment Trusts
For Publicly Offered Government/Corporate Bond Investment Trusts.
For Publicly Offered Stock Investment Trusts:
Foreign Investment Trusts
Basically, if distributions or redemption proceeds are paid by certain Japanese paying agents (such as securities firms or banks), profit distributions and profits arising from redemption are subject to the relevant withholding taxes and treated in the same manner as Securities Investment Trusts.
Profit distributions made by listed investment companies are treated as dividend income and subject to withholding tax at the rate of 20.315%.
Profit distributions are subject to withholding tax at the rate of 15.315%. Distribution is treated as taxable income for corporation tax purposes.
Non-Japanese residents/foreign corporations
Profit distributions are subject to withholding tax at the rate of 15.315%.
Individuals and corporations (resident)
A resident investor is not subject to withholding tax.
Non-Japanese residents/foreign corporations
If a non-resident investor is deemed to have a permanent establishment in Japan, this non-resident investor has tax filing obligations in Japan and is subject to withholding tax on distributions from the partnership’s business if both:
However, if certain requirements are met, a non-resident investor can become a limited partner in a limited partnership without being deemed to have a permanent establishment in Japan (even if another partner has a permanent establishment in Japan). These requirements include a notification to the tax authorities and certain provisions in the partnership agreement.
Asset management industry bodies consist of a large number of investment managers and advisers who are registered as an investment manager and non-discretionary investment adviser under the FIEL. As of 31 October 2018, the number of registered investment managers and non-discretionary investment advisers is 370 and 986, respectively. Most of the registered investment managers are also qualified as non-discretionary investment advisers.
In addition, more than half of the registered investment managers are qualified to act as an investment trust management company of Japanese investment trusts based on their business method statement which is approved by the FSA. As at the end of November 2018, the total net asset value of the publicly offered Japanese investment trusts and privately placed Japanese investment trusts was JPY112.5 trillion and JPY90 trillion, respectively. The publicly offered investment trusts are normally invested by retail investors. The privately placed investment trusts are mainly invested by institutional investors.
Courts are preferred in general in relation to fund documents which are governed by Japanese law, regardless of whether the fund is structured as an investment trust or partnership, or publicly offered or privately placed.
Most of the litigations were initiated by the investors against the distributors of the Japanese investment trusts due to a breach of duty of explanation imposed under the FIEL. A typical litigation initiated in connection with an investment fund is litigation between retail investors and the distributor of the investment fund which has promoted to the investors without making an appropriate explanation of the product.
Publicly Offered Fund
The following requirements are imposed under the FIEL, regardless of whether the fund is structured as investment trust or partnership, or within Japan or outside of Japan. Once the fund is distributed by way of public offering in Japan, the annual securities report, semi-annual report and extraordinary report shall be prepared and filed with the authority for the purpose of continuous disclosure under the FIEL. These continuous disclosure documents are disclosed to the public through the Electronic Disclosure for Investors' NETwork (EDINET) operated by the FSA which is an electronical filing and disclosure system being similar to EDGAR. The annual securities report shall be filed within three months (in case of foreign funds, six months) after the financial year end. The semi-annual report shall be filed within three months after the end of the semi-annual period.
Privately Placed Fund
No periodical disclosure is required under the FIEL. However, the performance report shall be prepared and submitted to the FSA and delivered to each shareholder of the investment fund, as mentioned in the following paragraph, except for the case where the investment fund in question is a corporate type fund or the private placement is made to qualified institutional investors as defined in the FIEL, provided that certain conditions are met. Please note that the performance report is not required for partnerships.
The performance report shall be prepared after the end of the financial period of the investment fund in question under the ITICL if the investment fund is not a corporate type fund. This requirement is applicable to both publicly offered investment funds and privately placed investment funds. However, if the investment fund in question is distributed by way of private placement to qualified institutional investors and if the constitutional document of the investment fund such as a trust agreement, trust deed, management regulations and agreement and declaration of trust has a provision that no performance report shall be prepared, this investment fund is exempted from preparing the performance report.
In the case of an investment trust and foreign investment funds under the ITICL, investors may not instruct the investment manager of the fund in connection with the fund’s management.
In the case of a Japanese limited partnership, investors outside Japan should not involve themselves in management of the fund or approve each investment decision to be made by the general partner or its delegated investment manager for the purpose of avoiding the private equity issue.