Securitisation 2024 Comparisons

According to the report by the Japan Securities Dealers Association and the Japanese Bankers Association (Securitisation Market Trends Survey Report – Issuance Trends in Fiscal 2022), the total issuance amount of securitisation products in fiscal year 2022 was JPY4,819.9 billion, decreasing 13.0% from fiscal year 2021, while the number of issues was 190, 1.0% down year-on-year.

The report also shows that there was an increase in the securitisation product issuance amount for fiscal year 2022 by underlying assets, the amount of consumer loan, whereas RMBS, CDO, leases, shopping credits, sales receivables/commercial bills and “others” decreased. In addition, looking at the securitisation product issuance amount by product type, the amount of “trust beneficiary rights” was JPY2,679.7 billion (55.6% of the total), followed by bonds with JPY1,639.5 billion (34.0%).

From the viewpoint of the transaction structure, the following three types are to be considered in most transactions.

Godo Kaisha (GK) Structure

A GK used as an SPE for securitisation could finance its purchase of assets by way of debts (loans and bonds) and/or equities (shares). However, a GK is not eligible for the special tax treatment applicable to tokutei-mokuteki-kaisha (TMKs), and a GK’s profits are subject to corporate tax in the same way as standard corporations conducting actual business. Therefore, tokumei-kumiai (TK) investments are more frequently used than shares, due to the impact on the GK’s taxable income. The distribution of profits to TK investors may be regarded as “expenses” to be deducted from profits for corporate tax purposes. The structure in which TK investments are used to reduce a GK’s taxable income is generally referred to as the “GK-TK structure”, where the originator sells the assets to a GK for the purchase price, which is funded by way of bonds and/or loans and TK investments.

Theoretically, the GK-TK structure is available for any type of asset securitisation. However, in practice, the GK-TK structure is predominantly used for real estate securitisation or non-recourse financing for real estate, while monetary claims are securitised by the trust structure discussed under Trust Structure.

For the GK-TK structure for real estate securitisation, it is important to note that the Real Estate Specified Joint Enterprise Act (the “Joint Enterprise Act”) will apply if the GK owns real estate itself. This will require the GK to obtain pre-approval (kyoka) from the government (the Ministry of Land, Infrastructure, Transport and Tourism, the Financial Services Agency, or the local municipality).

The Act was amended in 2013 to facilitate a GK being used as an SPC to implement the GK-TK structure. The rules for conducting business by a GK were relaxed and GKs could utilise the GK-TK structure through a filing, rather than seeking permission. However, new GK-TK structures have rarely taken advantage of this amendment because the new filing scheme requires the delegation of the business of real estate transactions to approved real estate operators (3-go-jigyosha) and of the solicitation for the purchase of TK investments to approved brokers and dealers (4-go-jigyosha) for TK investments. The Act was further amended in 2017 to facilitate the GK-TK structure by requiring merely filing rather than permission and without the aforementioned delegation requirements, to the extent that the investors are limited to certain “qualified specifically exempted investors” (tekikaku-tokurei-toshika).

The most common GK-TK structure involves a GK owning the beneficial interests in real estate rather than the real estate directly, to avoid the application of the Joint Enterprise Act. However, since beneficial interests constitute “securities” under the Financial Instruments and Exchange Act (FIEA), a GK owning beneficial interests funded by TK investments is subject to the self-investment regulation under the FIEA (for further details, see 4.10 SPEs or Other Entities).

Furthermore, since TK investments also constitute securities under the FIEA, solicitation for the purchase of TK investments is subject to the business regulations under the FIEA. Where the GK’s principal assets comprise beneficial interests that also constitute “securities”, the disclosure regulations under the FIEA will apply (for further details, see 4.1 Specific Disclosure Laws or Regulations).

TMK Structure

The TMK is a type of entity introduced by the Act Concerning Asset Securitisation of 1998 specifically to facilitate asset securitisation. A TMK is required to file the commencement of business with government authorities, and is not authorised to conduct any acts outside those set out in the asset liquidation plan.

A TMK is subject to the supervision of the FSA by way of various supervising measures, and particular requirements apply to TMKs (see 6.2 SPEs for details).

Trust Structure

Trusts are generally considered the most appropriate vehicle for securitisation because they are recognised as having legally assured bankruptcy remoteness under the Trust Act and are generally subject to “pass-through” taxation, whereby taxation at the trust level (double taxation) can be avoided. Furthermore, the trust structure and the terms of TBIs can be created flexibly under the trust agreement.

In the standard trust structure, the originator entrustor (itakusha) entrusts its assets with a trustee in exchange for TBIs in the entrusted assets and then obtains funding by selling TBIs to third persons.

However, if investors prefer loans rather than purchasing TBIs, the originator entrustor can obtain cash by seeking redemption of its TBIs through the trustee borrowing loans from investors. Depending on investors’ demand, the trustee can seek funds by issuing trust bonds to investors instead of receiving loans.

Furthermore, if some investors prefer loans and others prefer TBIs, some TBIs can be redeemed by loan investors providing loans to the trustee, while other TBIs can be sold to investors.

The relevant legislation includes the Companies Act, Commercial Code, Act on Special Measures Concerning Taxation, Act Concerning Liquidation of Assets, Trust Act, Trust Business Act, FIEA, and Act on General Incorporated Associations and General Incorporated Foundations.

When the legal framework for securitisation was first developed in the late 1990s, exempted companies in the Cayman Islands were predominantly used for standard securitisation transactions.  However, with the enactment of new laws (such as the Act Concerning Liquidation of Assets and the Act on General Incorporated Associations and General Incorporated Foundations) and the inclusion of GKs as a new type of corporation under the Companies Act, it has become standard practice to set up SPEs in the form of TMKs or GKs in Japan.

Subordination and cash reserves are often used as credit enhancement. In cases where an originator retains subordinated portions of securitisation products, or guarantees payments to owners thereof, a true sale issue will arise.

The issuer’s responsibilities are to originate and transfer their assets to SPEs. In most cases involving the securitisation of monetary claims, transferors and originators will continue to collect receivables and provide servicing of the securitised assets on behalf of the transferee SPEs. In real estate securitisation, they will also sometimes act as master lessees in respect of the assets that they have sold and leased back.

That being said, the roles and responsibilities of transferors and originators vary, depending on the type of asset securitised.

The term “sponsors” generally refers to “arrangers” who arrange securitisation transactions, or to the parents, affiliates or banks (including commercial banks, investment banks, trust banks and securities companies) that provide originators with financial support for the securitisation transaction.

Originators are securitising their assets by transferring them to SPEs. With respect to securitisation of monetary claims, originators usually remain as servicers to collect funds on the securitised monetary claims. This is achieved through delegation by SPEs of collection functions to originators.

Underwriters and placement agents are essentially the parties who market and sell securitised products to investors. For regulatory purposes, underwriters (hikiuke-nin) are defined as persons who acquire securities (yuka-shoken) for the purpose of reselling them, or commit to acquiring securities that are unsold. Placement agents, however, are defined as persons who engage in brokerage activities or in the sale and purchase of securities in connection with the private placements or public offerings of securities pursuant to the FIEA.

Underwriters are subject to greater regulatory oversight, regardless of the kind of securitised product they deal with, because they shoulder the risk of having to acquire unsold securities. On the other hand, there are two categories of placement agents:

• type I financial instruments business operators (dai-isshu-kinyu-shohin-torihiki-gyosya) that deal in type I financial instruments such as bonds (shasai-ken) issued by GKs or kabushiki kaisha (KKs) and preferred shares (yusen-shosshi-shoken) issued by TMKs; and
• type II financial instruments business operators (dai-nishu-kinyu-shohin-torihiki-gyosya) that deal in type II financial instruments, such as trust beneficiary interests, standard or preferred equities in GKs and TK equities in a TK under a GK-TK investment structure.

Underwriters are typically securities companies, whereas placement agents can be securities companies, banks, trust banks and asset sale or management companies registered as type II financial instruments business operators.

In transactions involving the securitisation of monetary claims, the originator would usually act as the servicer after the assets have been transferred to the relevant SPE because the originator is expected to service the assets more efficiently based on its existing business relationship with the obligors. Additionally, since the transfer of monetary claims is frequently made without any notice to obligors, the originator would need to continue servicing the assets as if they were the asset-owner.

However, if there is any default in respect of the monetary claims, or if the monetary claims are not collectible through ordinary means (for instance, in situations of dispute or litigation with an obligor), the servicer’s involvement in the servicing of the monetary claim will give rise to legal concerns as to whether such involvement is deemed an activity that falls within the “legal business” that can be undertaken only by qualified attorneys under the Attorney Act. In such events, a third-party claim-collection company licensed to conduct claim-collection business as a “special servicer” under the Act on Special Measures Concerning Claim Management and Collection Businesses would usually be engaged, or the transferee SPEs would be engaged in the servicing of such monetary claim by themselves.

Furthermore, if an originator servicer becomes insolvent or unable to continue to provide collection services, the servicing role will be transferred to another third-party servicer as a “back-up servicer”. As part of the typical process of structuring a securitisation transaction, the questions of whether to appoint a back-up servicer from the outset and, if so, which party to be appointed as such will be discussed between the relevant sponsor arranger and a credit rating agency.

The role of an investor is to provide funds to the originator through SPEs. Investors are split into two categories for purposes of disclosure under the FIEA:

• qualified institutional investors; and
• non-qualified institutional investors.

Additionally, investors are split into two categories for purposes of the regulation of product sales activities of brokers/dealers or placement agents:

• “specified investors” (tokutei-toshika), which includes QIIs and quasi-institutional investors (as defined in the FIEA); and
• non-specified investors.

There is no legal concept under Japanese law of bond or note trustees who act as trustees for bond or noteholders.  With that said, the Companies Act requires bond issuers to appoint bond administrators, which will be entrusted with the performance of certain functions, such as receipt of payments and preservation of rights of claim, on behalf of bondholders unless (i) the amount of each bond is 100 million yen or more or (ii) the number obtained by dividing the total amount of bonds of a certain class by the minimum amounts of the number of each bond of that class is less than 50 (Article 702). 

However, given the cumbersome mandatory provisions under the Companies Act, most sophisticated securitisation transactions for institutional investors do not, in practice, involve the appointment of “bond administrators”, in reliance on either of the exemptions described above. Instead, financial advisers or fiscal agents (FA) are appointed and their rights and obligations may be provided for in the bond documents.

Security trusts became available in Japan pursuant to amendments to the Trust Law, which were proposed in 2006 and came into effect in 2007. Trust banks usually act as security trustees that owe fiduciary duties to multiple lenders, typically in the context of syndicated loans for project finance, such as renewable energy projects. However, secured “bonds” are rarely used because of the provisions of the Secured Bond Trust Act, which require trust agreements to be executed with trust banks, etc, having a special licence. Accordingly, the use of security trusts for securitisation purposes is extremely rare.

To ensure the bankruptcy remoteness of a transfer (ie, a true sale), the asset transfer agreements or trust agreements should contain provisions covering the following:

• the parties’ intent to effect a true sale; and
• representations and warranties on the parties’ solvency, including the fact that no event has occurred that would result in the parties’ bankruptcy or expose them to insolvency proceedings.

However, provisions covering the following should be avoided:

• grant of full recourse to the transferor or a covenant by the transferor to compensate for credit risks in transferred assets;
• grant of control over the transferred assets to the transferor; and
• commitment by the transferor to repurchase the transferred assets and the like.

In addition to the standard representations and warranties by the transferor (covering matters such as due incorporation, full authority to transfer, compliance with applicable laws and constitutional documents, legality, validity and enforceability of obligations under the transaction documents, absence of litigation and absence of violation of any court or governmental order), warranties relating to true sale, the absence of the possibility to exercise any right of avoidance, the parties’ intention to effect a true sale, the absence of or reasons for the commencement of bankruptcy, civil rehabilitation, corporate reorganisation or other similar insolvency proceedings, the absence of fraudulent intent and the like are also used in securitisation documentation.

Compensation for damages incurred is the principal remedy for breaches of representations and warranties.

The appropriate method of perfection depends on the type of asset in question. Securitisation of real estate, movable assets and monetary claims is perfected by way of registration (toki), registration or transfer of possession, and registration of claim assignment or provision of notice to, or procurement of consent from, the obligor, respectively. The relevant transaction documents would typically stipulate the method of perfection required.

Securitisation documentation typically contains standard covenants to comply with the applicable laws and the terms of the applicable transaction documents, and to ensure that no adverse changes occur in respect of the securitised assets.

In transactions involving the securitisation of monetary claims, where the collection and servicing of the monetary claims will usually be delegated to the transferor servicer, a transferor will typically also covenant not to make material changes in its collection policy and to comply with its fiduciary duties (including segregating the management of its proprietary accounts from the management of accounts containing the securitised assets).

Damages are the principal remedy available for breach of covenants because specific performance and injunctive relief are, in principle, unavailable for such a breach.

In transactions involving the securitisation of monetary claims, collection and other services in respect of the monetary claims will usually be delegated to the originator under a servicing agreement between the originator and the transferee SPE. Such servicing agreements usually contain provisions requiring the servicer to service the monetary claims in the same way as before, based on fiduciary duties that the servicer owes to the transferee SPE and, ultimately, investors in the transferee SPE.

Delegation to a third person, including the originator, to collect receivables, raises issues under the Attorney Act, which prohibits any person other than a qualified attorney from engaging in the business of providing legal advice or representation, handling arbitration matters, aiding in conciliation, or providing other legal services in connection with any lawsuit, non-contentious case (or a case similar thereto), or other general legal services, for the purpose of obtaining compensation. Violation of this prohibition is punishable by criminal sanction. An exception to this prohibition is where the service provider is licensed under the Act on Special Measures Concerning Claim Management and Collection Businesses (the Servicing Act) to perform the relevant services.

Principal defaults typically used in securitisation documentation include:

• the repurchase of all the securitised assets upon the occurrence of certain tax events;
• the exercise of a clean-up call option if the exposure underlying the securitised assets has decreased to 10-15% of the initial exposure; and
• early amortisation in the event of the servicer’s default or deterioration in the performance of the securitised assets.

Damages are the principal remedy available for such a default, because specific performance and injunctive relief are, in principle, unavailable for such a default.

Damages constitute the principal indemnity in securitisation transactions, because specific performance and injunctive relief are, in principle, unavailable in such transactions.

The standard set of documents involved in an issuance of bonds include (i) a bond purchase agreement containing the terms and conditions of the bonds and (ii) a fiscal agency agreement.

Interest swap derivatives are typically used to hedge risks associated with interest rate fluctuations in situations where the instruments invested in adopt fixed rates while the underlying assets are based on floating rates. On the other hand, currency swap derivatives are typically to hedge foreign exchange risks where there is mismatch in the currency between underlying assets and the instruments invested in.

Certain forms of offering memoranda are required be delivered to investors under the FIEA for public offerings of bonds. Private offerings – ie, solicitation for purchase of bonds vis-à-vis 49 or less investors or qualified institutional investors, are exempted from the requirement to deliver offering memoranda under the FIEA. Nevertheless, it is a customary practice for certain disclosure documents similar to the statutory offering memoranda to be delivered to investors in private placements, too. Furthermore, the Japan Securities Dealers Association has promulgated certain voluntary “Rules Concerning Marketing Securitization Products”. Under these rules, delivery of documents of certain formats setting out specific disclosure items (depending on the type of assets be delivered to investors) is recommended even in private placements.

The Financial Instruments Exchange Act of Japan (FIEA) provides disclosure requirements and procedures. Article 5.1 of the FIEA provides disclosure rules applicable to “regulated securities”, including securitisation products.

Examples of regulated securities in respect of securitisation products include the following.

• TMK bonds and preferred shares issued by TMKs under a TMK structure are considered “type I financial instruments”, and solicitation, sale and purchase and brokerage activities in respect of TMK bonds and preferred shares accordingly have to be handled by type I financial instrument exchange business operators licensed under the FIEA.
• TBIs issued under a trust structure and TK interest issued under a GK-TK structure are considered “type II financial instruments”, and solicitation, sale and purchase and brokerage activities in respect of TBIs and TK interest accordingly have to be handled by type II financial instrument exchange business operators licensed under the FIEA.

For a public offering, forms are provided in the Appendices to the Cabinet Office Ordinance on Disclosure of Corporate Affairs, etc, which is an ordinance related to the FIEA.

The basic form for disclosure for public offerings is the filing of a security registration statement (yuka shoken todokede sho) by the issuer pursuant to Article 5.1 of the FIEA. The security registration statement will describe matters pertaining to the public offering, the trade name of the issuer, the financial condition of the issuer and the corporate group to which the issuer belongs.

There is no filing requirement for private placements, but a financial instruments business operator who solicits the purchase of a financial instrument has to notify a prospective purchaser of certain matters provided in the FIEA and deliver a document to the prospective purchaser explaining the details of the financial instrument being offered, among other requirements.

For sales of financial products by way of a private placement (eg, those sold to sophisticated investors that satisfy the requirements for a private placement), filing by the issuer and, in some cases, explanation by a financial instruments business operator are not required, but the notification requirement applies.

The principal penalty for violation of the filing requirement or obligation to deliver a document explaining details of the financial instrument is criminal imprisonment and/or a fine. For a violation of the notification requirement, a minor administrative penalty will apply. If a financial instruments business operator violates any requirement under the FIEA, an administrative sanction will apply.

See 4.1 Specific Disclosure Laws or Regulations.

The FSA has published guidelines recommending that an originator retains a part of the risks associated with the securitisation products. The guidelines also recommend checking whether the originator continues to retain a part of the risks and, if not, to review and analyse the involvement by the originator in the securitised assets and the quality of the securitised assets.

Furthermore, an amendment to the FSA’s capital adequacy regulations became effective in March 2019, under which banks are required to use three times (up to 1,250%) the risk-weight on their securitisation exposure unless the banks can confirm that the originators fulfil certain risk-retention criteria, such as the retention of 5% or more of the junior exposure, etc, or the origination of underlying assets being not improperly conducted.

As far as laws and regulations relating specifically to securitisation are concerned, there is no requirement for periodic reporting. However, requirements for periodic reporting may apply to the vehicle used for a securitisation transaction.

As an example, in a case where a stock corporation, kabushiki kaisha or TMK – which is designed to be used as a special-purpose vehicle for a securitisation transaction under the Act on Securitisation of Assets – is used as a securitisation vehicle, a periodic disclosure of its financial statements may be required under the Companies Act and the SPC Act, respectively. For a TMK, there is a further requirement to submit business reports every business year. Separately from the vehicle used for a securitisation, when the special provisions under the FIEA are applicable concerning specially permitted business of a qualified institutional investor, etc, tekikaku kikan toshika tou tokutei gyomu, which exempts the registration requirement for certain private placements and/or certain acts of investing money, the submission of business reports for every business year is required.

The Ministry of Justice is the regulator for the disclosure of financial statements under the Companies Act, while requirements under the SPC Act and the FIEA are governed by the FSA.

The penalties for non-compliance vary depending on the requirement. For example, a failure to disclose financial statements under the Companies Act or SPC Act will be subject to a minor administrative fine, but a failure to submit business reports under the SPC Act or the FIEA is subject to a criminal sanction. In connection with a breach of the FIEA or SPC Act, an administrative sanction is also applicable.

There is no regulation prohibiting securitisation activity by a rating agency (RA). However, the FIEA has provided for:

• the registration of an RA;
• certain requirements for registered RAs to comply with, including a fiduciary duty, no conflict-of-interest rule and reporting requirements;
• monitoring registered RAs by requesting reports, on-site inspection and ordering business improvements; and
• certain disclosure requirements if credit ratings of unregistered RAs are used.

Under the Banking Act and other acts regulating financial institutions, the Japanese government may set the criteria to be used by banks and other financial institutions to determine the soundness in their management. In this connection, the FSA has issued official announcements regarding the criteria for maintaining certain capital adequacy ratios and liquidity coverage ratios. The official announcements implemented from 31 March 2019 correspond to the revisions to the securitisation framework published by the Basel Committee for Banking Supervision in December 2014.

Certain types of derivatives are defined in the FIEA, and dealing, brokering or other certain types of businesses on those derivatives cannot be done unless duly registered under the FIEA. However, there are no specific laws or regulations on the use of derivatives in the context of securitisation or SPEs.

The FIEA provides various obligations of a financial instruments business operator for the purpose of investor protection. Such rules are not securitisation-specific.

The basic obligations of a financial instruments business operator under the FIEA include a prohibition against conflicts of interest, a duty of due care of prudent management (zenkan chui gimu), a duty of loyalty (chujitsu gimu), a duty of self-execution and a duty of separate management of assets.

The FSA regulates these matters. Criminal and administrative sanctions will apply to any breach of obligations under the FIEA.

As part of the obligations under the Basel III regime, banks are obliged to disclose their “securitisation gain on sale” in conformity with the form for a capital position disclosure.

Depending on the securitisation scheme, a trust (TMK) or a company similar to the US limited liability company (godo kaisha) is used to accomplish securitisations.

Which entity is used varies in each transaction, taking into consideration bankruptcy remoteness, tax benefit, licences and other legal requirements, flexibility in terms of management of the entity, costs associated with the entity, etc.

A trust enables the separation of legal and beneficial ownership. Specifically, the trustee in a trust structure is the legal owner of the underlying assets, while the economic interests in the trust assets belong to the holders of trust beneficial interests issued by the trustee. It is also easier to generate cash flow from the underlying trust assets by issuing multiple or different classes of TBIs in a trust.

Assets held in trust will also be remote from risks of bankruptcy of both the originator and the trustee if the asset transfer from the originator to the trustee is deemed to be a true trust (shinsei shintaku). The factors to be considered in determining whether a true trust exists are similar to the factors involved in determining whether a true sale (shinsei baibai) has occurred.

Trustees are subject to various requirements, including licensing requirements under the Trust Business Act and fiduciary duty requirements. Due to these requirements, the trust structure is generally regarded as being stable and credible.

The transactional parties in a trust structure are eligible for certain tax benefits. For example, the transfer tax rate applicable to the sale and purchase of trust beneficial interests is much lower than the rate applicable to transfers of fee simple real estate.

Due to the advantages set out above, trust structures are used at various levels in securitisation transactions in Japan, including:

• the underlying asset level, where underlying assets are converted to TBIs;
• the securitisation vehicle level, where the underlying assets are transferred to the trustee who issues TBIs and/or to whom asset-backed loans are made; and
• the lending level, where the trustee advances loans to the securitisation vehicle through the issuance of TBIs and/or procuring asset-backed loans from end-investors.

Practical points to note include the following.

• TBIs are considered type II financial instruments under the FIEA, so the procurement and provision of brokerage activities in respect of TBIs have to be handled by a type II financial instrument exchange business operator licensed under the FIEA.
• The concept of self-declaration of trust or declaration of trust was introduced in Japan pursuant to amendments to the Trust Act that came into effect in 2006 (the “2006 Trust Act Amendments”), following which it is now possible for an operating company to securitise its assets through self-declarations of trust or declarations of trust, provided the operating company – if required to do so by the characteristics of the securitisation structure involved (such as the number of TBI holders) – holds a trust business licence under the Trust Business Act.
• The concept of a security trustee was also introduced by the 2006 Trust Act Amendments. Before these amendments, security trustee structures were not allowed in Japan (as was the case in other continental law jurisdictions such as France and Germany) because it was not possible to separate the holders of security interests from the holders of secured claims. The security trust structure is now permitted as a result of the 2006 Trust Act Amendments, but a security trustee is required to hold a trust business licence under the Trust Business Act.

There are many activities that a securitisation vehicle should avoid, including money-lending business, financial instruments business, joint real estate venture business, trust business and real estate brokerage.

How legal practitioners avoid engaging in such activities depends on the transactions (for example, see 4.1 Specific Disclosure Laws or Regulations).

The regulator will vary, depending on the law involved for each transaction, with the possibility of criminal sanctions being imposed for any breach.

Government-sponsored entities (GSEs) may participate in the securitisation market. Regulations applicable to each entity will vary, depending on the particular law applicable to that entity – eg, the Act on Development Bank of Japan, Inc, the Japan Finance Corporation Act, the Japan Bank for International Co-operation Act and the Shoko Chukin Bank Limited Act. The Japan Housing Finance Agency has been playing an active role, similar to GSEs such as Fannie Mae and Freddie Mac in the USA, in providing low-cost finance for the public to purchase houses or for financial institutions extending housing loans by way of securitisation businesses.

There are various laws and regulations generally regulating investments of financial products depending on the types of entities. However, there is no law specifically prohibiting or limiting investment in securitisation products by an entity.

The principal laws and regulations which are not already mentioned include the following.

• The Companies Act regulates the incorporation, membership, management, financing, and other such matters in respect of GKs.
• The Commercial Code also contains important provisions applicable to TKs in respect of the “GK-TK structure”.
• The Act Concerning Liquidation of Assets is the primary legislation regulating TMKs.
• The Act on Special Measures Concerning Taxation contains provisions on the special treatment of the taxable income of TMKs and deductible expenses in a GK-TK Structure.
• The Trust Act regulates the creation of trusts, trust beneficial interests and management of trusts.
• The Trust Business Act regulates applications for licences, and obligations of and requirements applicable to trust banks as professional trustees.
• The FIEA stipulates the requirements on disclosure of financial interests and other business-related matters applicable to the relevant parties under the various securitisation structures.
• The Act on General Incorporated Associations and General Incorporated Foundations regulates general incorporated associations (ippan-shadan-houjin) in their capacities as SPEs that hold equity interests in TMKs or GKs.

There are no laws or regulations that specifically prohibit synthetic securitisation in Japan.

Issuers/originators engage in synthetic securitisation for the principal purpose of transferring the credit and other default risks in the assets held on their balance sheets, improving their capital ratios and thereby – especially for banks or other regulated financial institutions – freeing up capital for making additional loans.

More generally, investors engage in synthetic securitisation because of stronger appetites for investment products that offer potentially better yields, given the current extremely low interest rate environment in the domestic market.

The FSA amendment to the banks’ capital adequacy regulations became effective in March 2019 and has had a material impact on structuring synthetic securitisation products, including the originators’ risk retention policies, etc (see 4.3 Credit Risk Retention).

As credit derivative transactions fall within the definition of “market derivative transaction”, those dealing in the brokerage, sale, purchase or arrangement of credit derivatives are required to register with the FSA and to comply with the relevant regulatory requirements under the FIEA. Synthetic securitisation transactions are not specifically regulated. However, since credit derivatives are subject to the FIEA regulations, synthetic securitisation transactions involving credit derivatives would similarly be subject to the provisions of the FIEA.

The principal difference between synthetic and regular securitisation transactions is that synthetic securitisation transactions involve the transfer of credit risks to SPEs, not through the physical transfer of assets, but by utilising credit derivatives or other types of derivatives or guarantees.

Synthetic securitisation transactions typically take the form of a synthetic CDO, the structure of which is as follows:

• an existing or newly established SPE will be used to acquire Japanese Government Bonds (JGBs) or other highly liquid financial products such as bank deposits (the collateral) through proceeds from the SPE’s issuance of notes to investors;
• the originator then enters into a credit default swap (CDS) with the SPE and, as part of the CDS, the originator will designate certain assets that it owns (such as loan receivables and bonds) as the reference obligations, and transfer the credit risks of the reference obligations to the SPE;
• the SPE will pay its investors interest on the notes, based on the CDS premiums it receives from the originator and the interests it receives on the collateral; and
• normally, the collateral will be invested during the term of the CDO transaction and applied toward redemption of the notes; where any credit event occurs with respect to the reference obligations, however, proceeds from the disposition of the collateral will be applied towards payments to the originator under the CDS.

Insolvency laws in Japan affect securitisation indirectly by causing the securitisation structure to be formed in a way that provides bankruptcy remoteness. A “true sale” of financial assets is a major requirement to ensure segregation from the financial risk of the originator and its affiliates.

In the case of a true sale, ownership of the assets is transferred to the transferee (special-purpose entity/vehicle – SPE/SPV).

In the case of a secured loan, ownership of the assets remains with the originator.

In a true sale, the asset is no longer related to the originator and is fully insulated from any originator risks. The transferee effectively becomes the owner of the asset and holds all rights and obligations for the assets.

In a secured loan, the transferee has a secured right only, and the underlying asset remains subject to the financial risk of the originator (although the transferee has a secured right over the asset, there could be cases where the security right does not prevail).

True Sales and Secured Loans

In a true sale, the transferee is the owner of the asset; if the asset has been taken by the trustee (kanzainin) or is mingled with the other assets of the debtor, the transferee has a right of recovery (torimodoshi-ken) in an insolvency proceeding.

In a secured loan, the transferee has a right to set aside (betsujo-ken) and receive payments outside the insolvency proceeding. However, the trustee can petition the court to extinguish the security right (subject to some provision for value to the security-holder) in reorganisation proceedings under the Corporate Reorganisation Act, in rehabilitation proceedings under the Civil Rehabilitation Act and in the case of straight bankruptcy under the Bankruptcy Act. In addition, where a reorganisation proceeding under the Corporate Reorganisation Act is made, no exercise of any security interest based on a reorganisation claim is allowed.

The Issue of True Sale

A true sale, in respect of an asset, is generally understood under Japanese law to mean that (i) the asset sold or entrusted by an originator is not regarded as collateral and (ii) the asset, upon being sold, ceases to be part of the originator’s bankruptcy or insolvency estate. As the true-sale concept is not expressly codified under Japanese law, interpretation of the Civil Code and/or insolvency laws of Japan is necessary to determine whether an asset sale constitutes a true sale. For purposes of the interpretation, the overall structure of the transaction for the relevant asset sale will be examined, in addition to the relevant sale itself. Where necessary, legal opinions on whether an asset sale constitutes a true sale will also be obtained from external legal counsel of the transacting parties.

Opinion of Counsel

An opinion of counsel to support the true sale has normally been obtained because the concept and elements of a “true sale” have not yet been clearly stipulated in Japanese law, nor has there been any definitive judicial precedent with regard to it.

The material conclusions of such an opinion are that the asset sold or entrusted by the originator is not regarded as collateral, and that, upon being sold, the asset ceased to be part of the bankruptcy or insolvency estate of the originator.

Factors to be considered include the following:

• the intention of each of the transacting parties;
• whether the economic risks and interests in respect of the asset have been transferred;
• whether the right of control over the relevant asset has been transferred;
• whether the asset transfer has been perfected;
• whether the purchase price of the relevant asset is reasonable;
• whether the originator has the right or obligation to repurchase the asset and, if so, the terms of the right or obligation;
• whether the originator achieves credit enhancement and, if so, the details of the credit enhancement; and
• the accounting treatment of the asset transfer by the originator.

The typical qualifications of such an opinion are that a Japanese court may have a different opinion because there is no judicial precedent with regard to a true sale.

Bankruptcy-Remoteness

Bankruptcy-remoteness can refer to two issues under Japanese law, each of which is discussed in turn below:

• the bankruptcy-remoteness of a special-purpose company (SPC); and
• the isolation of an asset from the originator’s bankruptcy or insolvency estate.

Bankruptcy-remoteness of an SPC

Two types of measures are typically used in Japan to make an SPC bankruptcy-remote. First, SPCs are structured in a way that minimises the risk of their insolvency, which is primarily achieved through the following:

• restricting the objects and powers of the SPC;
• limiting the amount of debt the SPC may incur;
• appointing independent directors to the SPC;
• restricting the SPC’s capacity to undergo a merger or reorganisation;
• limiting the SPC’s capacity to amend its organisational documents (teikan);
• including limited recourse provisions in the agreements to be entered into by the SPC; and
• having equity interest with voting rights held by an independent party, such as a general incorporated association (ippan-shadan-hojin) established specifically for that purpose.

Secondly, “non-petition” provisions are used to prohibit the creditors and directors of an SPC from filing for the commencement of bankruptcy proceedings in respect of the SPC. There is, however, uncertainty as to whether Japanese courts will uphold the validity of such provisions.

Asset isolation

Certain requirements have to be fulfilled to isolate an asset from an originator’s bankruptcy or insolvency estate. First, there must be a mutual agreement between the transacting parties for the legal and valid “transfer” of the asset, as opposed to a pledge of the asset.

Secondly, the asset transfer must be perfected against third persons (ie, certain procedural steps have to be taken to make the acquisition of the asset effective against third persons). For this purpose, it should be noted that the originator’s receiver is regarded as a “third person” under Section 177 of the Civil Code. An SPC that fails to perfect promptly faces certain risks, such as being unable to effect perfection if the SPC subsequently goes bankrupt, or having that perfection voided by a receiver in bankruptcy proceedings if the date of perfection falls too close to the date of the bankruptcy of the SPC.

Thirdly, the asset transfer must fulfil true-sale requirements and must not be voided in bankruptcy proceedings in respect of the relevant originator.

Other Insolvency Issues

The following issues in respect of an originator’s insolvency should also be considered.

Defence against right of avoidance

The right of avoidance (hinin-ken) under insolvency proceedings is a right of the trustee/supervisor in an insolvency proceeding, which is similar to the right to demand rescission of a fraudulent act (sagai-koi-torikeshi-ken) of a creditor under the Civil Code. If the requirements under the insolvency law are satisfied, the acts of the bankrupt may be avoided in the interest of the insolvency estate in an insolvency proceeding. As such claims are difficult to defend against, it is important in practice to ensure that the originator is in good financial health at the time of completion of the transfer, in order to avoid any such claims of fraudulence.

“Piercing the corporate veil” doctrine (hojinkaku hinin no hori)

Japanese courts have affirmed the doctrine of piercing the corporate veil; specifically, they have disregarded corporate entities in certain situations where it is unfair to deem a corporate entity independent from its members. In determining whether an asset has been properly transferred to an SPC from the originator, it is necessary to examine whether the doctrine of piercing the corporate veil will apply.

Termination of the service agreement and replacement of service providers

An originator usually acts as a debt collection service provider through a service agreement with the SPC. The SPC should ensure that the service agreement is terminated on a timely basis and that an alternative service provider can begin debt collection services in respect of the underlying assets, in order to enable the SPC to avoid any interruption in the collection of debts (and in turn enable the SPC to pay the investors in a timely manner) should the originator become bankrupt or insolvent. Service agreements generally contain cancellation or termination provisions. It should be noted, however, that the validity of such provisions can be challenged by a receiver under Japanese bankruptcy laws, on the basis that Japanese laws allow a receiver to choose between terminating an agreement and demanding its specific performance, if the agreement is a bilateral contract and neither party has fulfilled its contractual obligations thereunder.

Commingling risks

Where an SPC holds a claim for collected cash against an originator (who is also a collection service provider) and the originator subsequently becomes bankrupt, the claim will be considered a bankruptcy claim and, as such, may not be satisfied in large part. To mitigate any such loss, a service agreement generally contains provisions that enable the SPC to terminate the agreement in situations where the originator is likely to become bankrupt or insolvent. In practice, however, it is sometimes difficult to know when the originator’s bankruptcy or insolvency is imminent, such that the SPC may not be able to terminate the agreement in time. Accordingly, the cash reserve is structured to cover the loss and enable an SPC to pay its investors as contracted.

The essence of securitisation is finance, based not on an entity owning assets but on cash flow from specific assets themselves. Therefore, the financial assets must be transferred to an SPE, or they will be treated as assets of the originator and be included in the insolvency estate and exposed to the financial risk of the originator. Therefore, it is usual to utilise an SPE structure.

See 6.1 Insolvency Laws (Bankruptcy Remoteness) regarding the required or desirable aspects of an SPE.

Available legal formalities or entities for SPEs under Japanese law are corporations (ie, KK, GK, and TMK) and trusts.

Under Japanese law, the most common type of entity for conducting business is a KK. However, generally speaking, a KK is not deemed to be an appropriate form of entity for securitisation because:

• KKs are subject to the Corporate Reorganisation Act where secured creditors must exercise their rights in accordance with the corporate reorganisation procedures; and
• a KK’s compliance costs are higher in terms of its:
1. obligation to publish financial statements;
2. limitation on the term of directors; and
3. requirement to appoint accounting auditors, statutory auditors, etc, and establish a specified internal control system, if the KK’s total debts are JPY20 billion or more.

A GK is a relatively new form of corporation introduced by the Companies Act of 2005 and is generally deemed a more appropriate form of entity for securitisation than a KK, since it is not subject to the Corporate Reorganisation Act nor to the onerous limitations or requirements in relation to management and financial compliance applicable to a KK, as previously described. Since GKs are subject to corporate tax, equity investments in the form of a TK, similar to a limited partnership, are frequently used for profit distribution to TK investors to be deducted as expenses for GKs’ corporate tax purposes (see 7.2 Taxes on Profit and 1.2 Structures Relating to Financial Assets).

A TMK is an entity introduced by the Act Concerning Asset Securitisation of 1998 (the SPC Act) specifically to facilitate asset securitisation.

A TMK is required to file (todokede) the commencement of business with government authorities, and is not authorised to conduct any acts outside those set out in the asset liquidation plan (ALP).

A TMK is subject to the supervision of the Financial Services Agency of Japan (FSA) by way of various measures such as an on-site investigation, an order to correct illegal acts and an order to cease business. Compliance by a TMK with the SPC Act and other applicable laws is expected to be monitored by the government. Particular requirements apply to TMKs in specified circumstances, such as:

• a prohibition on the acquisition of certain assets by the TMK;
• an amendment to the ALP is subject to certain limitations and procedures under the SPC Act, and in many cases the unanimous approval of interested parties is required;
• lenders for “securitisation of assets” must be qualified institutional investors (QIIs);
• securitised assets must, in principle, be specified at the outset, and the acquisition of additional assets is subject to strict limitations except for certain cases;
• actual money transfer is required for the issuance of preferred shares and a certificate of preferred shares is required for their transfer; and
• the management and disposition of the assets must be delegated to certain qualified persons.

Accordingly, where a TMK is used as an SPC for securitisation, the above requirements and restrictions should be taken into account in the structuring of the transaction and the management of the TMK.

Comparison between GKs, KKs (so-called “closed KK share transfers”, which are subject to the approval of the board of directors or shareholders’ meeting) and TMKs may be summarised as follows.

• Application of Corporate Reorganisation Act:
1. GK: no;
2. KK: yes; and
3. TMK: no.
• Bond issue:
1. GK, KK, TMK: applicable.
• Required approval and other internal process for bond issue:
1. GK: representative members’ approval;
2. KK: directors’ (directors’ meeting) approval; and
3. TMK: directors’ approval and preparation and filing of an ALP.
• Taxation:
1. GK, KK: corporate taxation but profit distribution for TK investments to be deductible for corporate tax purposes; and
2. TMK: corporate taxation but pay-through treatment where profit distribution could be deducted as an expense for corporate tax purposes.
• Mitigation on real estate taxation:
1. GK, KK: not available; and
2. TMK: available (see7.1 Transfer Taxes).
• Registration tax on incorporation:
1. GK: JPY60,000;
2. KK: 0.7% of capital amount (JPY150,000 minimum); and
3. TMK: JPY30,000.
• Public notice obligation on financial information:
1. GK: no;
2. KK: yes; and
3. TMK: yes.
• Large company regulations:
1. GK: no;
2. KK: yes (where a KK’s capital is JPY500 million or more, or a KK’s total debt is JPY20 billion or more, the KK must appoint an accounting auditor and a statutory auditor, and set up an internal control system); and
3. TMK: no.
• Accounting auditor:
1. GK: not required;
2. KK: required if it is a large company; and
3. TMK: required if the total debt is JPY20 billion or more.
• Statutory auditor:
1. GK: not required;
2. KK: required for a large company unless it is a corporation with committees; and
3. TMK: required.
• Internal control system:
1. GK: not required;
2. KK: required for a large company; and
3. TMK: not required.
• Transferability of shares:
1. GK: approval of other members is required, unless provided otherwise in the Articles of Incorporation;
2. KK: approval of the company is required; and
3. TMK: approval is required for the transfer of specified shares to non-members, whereas restrictions on the transfer of preferred shares are prohibited.

Apart from corporate vehicles (ie, TMKs, GKs or KKs), trusts are also commonly used as an SPE for securitisation because they are legally assured bankruptcy remoteness under the Trust Act. Therefore, a trustee’s bankruptcy will not statutorily affect its trust assets. Also, trustees are subject to various requirements, including licensing requirements and fiduciary duties, and other regulatory requirements on their businesses under the Trust Business Act and related regulations. Due to such requirements and regulatory supervision by the FSA, the trust structure is generally regarded as stable and credible from the investors’ viewpoint.

In addition, trusts are generally subject to “pass-through” taxation, whereby taxation at the trust level (“double taxation”) can be avoided. The trust is merely a “conduit” and is not a taxable entity, and trust beneficiaries are deemed to hold the underlying trust assets for tax purposes.

Furthermore, the trust structure and the terms of trust beneficial interests (TBIs) can be created flexibly under the trust agreement, as described in 1.2 Structures Relating to Financial Assets.

A property title is in principle transferable and assignable under the laws of Japan, whether it is tangible or intangible and movable or immovable.

A transferee of a true sale that complies with the perfection requirements is completely protected and entitled to keep the property, and to enforce the claim against the obligor and any third persons.

Perfection procedures vary, depending on the type of asset to be transferred.

With regard to claims and/or receivables, for perfection against an obligor, a notice to or consent from the obligor is required. For perfection against third persons, including a trustee (kanzainin), such a notice or consent must have a certified date stamp affixed at a notary public office, or be delivered by content-certified mail certifying the date of delivery of the notice or consent.

Registration under the Act on Special Measures Concerning Claim Management and Collection Businesses would work as an alternative method of perfection against third persons.

A loan secured by way of an assignment of a claim and/or receivable will require the same perfection requirements.

A transferee of a true sale that has not been perfected is not entitled to claim that it is the holder of the claim or receivable against the obligor if the perfection requirements against the obligor are not met and/or against third persons if the perfection requirements against third persons are not met. In other words, the obligor may refuse to make payment of the claim on the ground that the transferee has not perfected against the obligor; if the same claim or receivable is purchased from the transferor by a third person, that person could be found to be the true holder of the claim or receivable.

The most standard means of constructing a bankruptcy-remote transaction is to use SPCs or trusts, as stated previously; practically, there are no other means for a bankruptcy-remote transaction in a material sense.

See 6.1 Insolvency Laws (Bankruptcy-remoteness of an SPC).

In securitisation transactions involving real estate, transfers from originators to SPEs are subject to real estate acquisition tax (which is levied on the transferee) and real estate registration tax (which is levied on the applicants of the registration upon registration of title transfers).

Where a TMK is the transferee, and if certain conditions are met, the rate of real estate registration tax for the transfer of ownership will be discounted to 1.3% (from 2%) and the tax base of the real estate acquisition tax will be reduced to 40% of the purchase price of the relevant real estate.

In view of such tax benefits, SPEs are frequently established in the form of TMKs in real estate securitisation transactions.

The net profits of SPEs are generally subject to corporate tax. Accordingly, the net profits of GKs and KKs that are used as SPEs will be subject to corporate tax unless they are extracted by TK investors through the so-called GK-TK structure, under which profits distributed to TK investors are deemed expenses that are deductible from a GK’s taxable income.

Similarly, “pay-through” TMKs are also entitled to certain tax exemptions. Specifically, TMK profits and the like that are distributed to preferred shareholders will be deemed expenses for tax purposes and are deductible from a TMK’s taxable income if certain requirements under the Act on Special Measures Concerning Taxation (ASMCA) are met.

Under a trust structure, the trust itself is merely a “conduit” and is therefore not subject to corporate tax. Beneficiaries of the trust, however, would be deemed to hold the underlying trust assets for tax purposes, except where the trust does not constitute an exceptional trust under any of the following categories:

• a group investment trust;
• a retirement pension trust;
• a specified charitable trust; or
• a corporation taxable trust.

If the transferor is a domestic corporation, capital gain on the transfer of loan receivables is subject to corporate tax of that transferor corporation. However, if the transferor is a foreign corporation with a permanent establishment in Japan, a capital gain on the transfer of loan receivables is subject to corporate tax; no corporate tax will be levied on a foreign corporation that has no permanent establishment in Japan.

No corporate tax will be levied on capital gain on the transfer of securities by a foreign corporation that has no permanent establishment in Japan. However, capital gain is taxed on the transfer of stocks in certain exceptional cases, such as:

• sales of stocks of the identical issuer that the transferor has bought up;
• the sale of stocks in a domestic corporation by a foreign corporation that falls into the “special relationship shareholders” with that domestic corporation;
• the sale of a certain type of stock of a company that has real estate of 50% or more; and
• the sale of membership of a golf club in stock means.

If a foreign corporation transfers real estate in Japan to a domestic corporation, the payment of the purchase price is subject to withholding tax, which must be paid by the domestic corporation.

In addition, capital gain on the transfer of real estate in Japan by a foreign corporation that has no permanent establishment is subject to corporate tax.

The taxes on the payment of dividends, interest, etc, to investors of SPEs are as follows:

• dividends of specified or preference shares of TMK/GK to residents or domestic corporations – 20% withholding tax is levied;
• interest on bonds of TMK/GK to residents or domestic corporations – 20% withholding tax is levied (15% if an investor is a corporation);
• dividends of specified or preference shares of TMK/GK to non-residents or foreign corporations – 20% withholding tax is levied, subject to the relevant tax treaties;
• interest on bonds of TMK/GK to non-residents or foreign corporations – 15% withholding tax is levied, provided that this tax will be exempted subject to certain conditions with respect to book-entry bonds; and
• income of TK to residents or non-residents or domestic or foreign corporations – 20% withholding tax is levied.

Tax opinions are obtained in most of the aforementioned transactions. In Japan, such tax opinions are usually issued by an accounting or tax firm, rather than a law firm.

Tax opinions typically cover the following, based on assumptions of certain facts, but without specific qualifications:

• the withholding tax implications in respect of interest income from notes, loans, beneficial interests and the like;
• the same issue as above, but as applied to foreign investors;
• the corporate tax implications for SPEs;
• the consumption tax implications in respect of asset transfers, collections and payments in respect of assets (if those assets consist of monetary claims) and the various fees involved;
• the tax implications in consideration of Japanese anti-tax haven legislation and the Japanese thin-capitalisation legislation in connection with SPEs;
• where the SPE is a TMK, whether that TMK is a tax-qualifying TMK; and
• where TK investments are involved, the validity of the TK arrangement from the Japanese tax perspective.

Accounting opinions on the off-balance sheet treatment of securitisation transactions are usually based on the true sale legal opinions on such transactions. However, in securitisation transactions, factors such as the originator’s accounting treatment of the transaction and whether the transacting parties intend for the transaction to constitute a true sale are critical factors for the purposes of issuing a true sale legal opinion. Accordingly, if a transaction is treated as on-balance sheet by the originator, an issue could arise as to whether a true sale opinion could be rendered, notwithstanding any such on-balance sheet accounting treatment.

In most cases, true sale legal opinions are rendered either without reference to the originator’s accounting treatment of the relevant transaction, or on the assumption that the originator’s accounting treatment is consistent with a legal true sale. However, where legal practitioners are specifically requested to opine on how the originator’s accounting treatment affects the legal nature of a transfer, the legal opinion will be rendered on the basis of certain assumptions and qualifications, based on the general understanding that legal analyses of true sale should be considered separately from the question of accounting treatment.