Close-Out Netting of OTC Derivative Transactions Referencing Digital Assets Under the Laws of Japan

The growing prevalence of OTC derivative transactions referencing digital assets (“OTC digital asset derivative transactions”) has led to extensive discussions about whether and to what extent close-out netting arrangements for such transactions would be valid and enforceable in events of insolvency under Japanese law.

Article 2, Paragraph 14 of the Payment Services Act (Act No 59 of 2009, as amended; the PSA) provides the definition of crypto-assets. However, the legal nature of crypto-assets (such as Bitcoin and Ether) and other digital assets is still a fluid concept under Japanese law. Moreover, every digital asset has its own distinct characteristics. Accordingly, in a discussion of the validity and enforceability of netting arrangements in respect of OTC digital asset derivative transactions, product-by-product analysis is required. It is in this context that this article summarises the basic legal framework relating to the validity and enforceability of close-out netting arrangements under Japanese law. It should also be noted that an amendment act providing for the transfer of the principal regulatory framework for crypto-asset transactions from the PSA to the Financial Instruments and Exchange Act was passed on 15 July 2026. The relevant amendments will come into effect within one year of promulgation.

Close-out netting under the Netting Act

Close-out netting arrangements in respect of OTC digital asset derivative transactions would be valid and enforceable if the relevant requirements of the Act on Close-out Netting of Specified Financial Transactions entered into by Financial Institutions, etc, (Act No 108 of 1998, as amended; the “Netting Act”) are satisfied.

More specifically, close-out netting will be enforceable under the Netting Act if:

• at least one of the parties is a Financial Institution;
• the parties have entered into Specified Financial Transactions;
• the Specified Financial Transactions are governed by a Master Agreement;
• the Master Agreement contains provisions on Eligible Close-out Netting; and
• one of the parties has become subject to a Japanese insolvency event.

In respect of the above, the concepts of “Financial Institution”, “Specified Financial Transactions” and “Master Agreement” are particularly relevant. Accordingly, the authors now turn to each of these concepts.

Financial Institution

The term “Financial Institution” encompasses the following entities:

• banks;
• Type I Financial Instruments Business Operators (ie, broker-dealers);
• insurance companies;
• Federation of co-operative banks (shinnyo kinko rengou kai);
• Norinchukin Bank;
• Shoko Chukin Bank;
• Japan Bank for International Cooperation;
• securities financing companies;
• call loan dealers; and
• commodities futures transaction dealers.

A dealer that engages in the business of OTC derivative transactions referencing crypto-assets as a principal, agent, intermediary or broker is generally required to undergo registration as a Type I Financial Instruments Business Operator under the Financial Instruments and Exchange Act (Act No 25 of 1948, as amended; FIEA). On the other hand, a dealer that engages in the business of trading crypto-assets as a principal, agent, intermediary or broker, providing custody services for customers’ fiat currency in connection with such trading, or managing crypto-assets for the benefit of others is generally required to undergo registration as a crypto-asset Exchange Services Provider under the PSA. Type I Financial Instruments Business Operators fall within the scope of Financial Institutions for the purpose of the Netting Act. Crypto-Asset Exchange Services Providers, however, do not constitute Financial Institutions under the Netting Act.

Specified Financial Transactions

The term “Specified Financial Transactions” includes the following transactions:

• (i) OTC Derivative Transactions (as such term is defined under the FIEA);
• (ii) financial derivative transactions under Article 10, Paragraph 2, Item 14 of the Banking Act (Act No 59 of 1981, as amended);
• (iii) conditional sale and purchase of securities;
• (iv) securities lending;
• (v) sale and purchase of securities with options;
• (vi) forward foreign exchange transactions;
• (vii) OTC commodity derivative transactions defined under the Commodity Derivatives Transaction Act (Act No 239 of 1950, as amended); and
• (viii) loans for consumption or deposits for consumption of cash or securities as collateral for the purpose of securing any of the transactions listed in (i) through (vii) above.

It should be noted, with respect to item (i) above, that OTC derivative transactions referencing crypto-assets fall within the scope of OTC Derivative Transactions. This is because crypto-assets fall within the definition of Financial Instruments under the FIEA. In this regard, it is also worth noting that the Financial Services Agency of Japan (FSA) has discretion in designating any given Electronic Payment Instruments (based on its definition in the PSA, Electronic Payment Instruments essentially means stablecoins) as a Financial Instrument, although the FSA has not exercised such discretion to date. In view of the foregoing, it is important to determine whether the digital assets referenced by a specific OTC digital asset derivative transaction constitute crypto-assets under the PSA, for purposes of ascertaining whether the Netting Act applies to such OTC digital asset derivative transaction.

Master Agreement

The term “Master Agreement” is broadly defined in Article 2, Paragraph 5 of the Netting Act as “an agreement intended to govern two or more Specified Financial Transactions to be entered into on a continuing basis between a Financial Institution and a counterparty, stipulating the terms of such transactions and other basic matters relating thereto.”

The Master Agreement governing two or more other Master Agreements (ie, the ultimate Master Agreement) is generally understood as constituting the Master Agreement under the Netting Act.

Although the ISDA Master Agreement is a prime example of such “Master Agreement”, it may be necessary to analyse whether other Master Agreements tailored for OTC digital asset derivative transactions fall within the definition of the Master Agreement. In certain cases, such tailored Master Agreements may require revision to ensure that they fall within the ambit of the Netting Act.

Close-out netting under the Bankruptcy Act

An OTC digital asset derivative transaction that does not fall within the ambit of the Netting Act may nevertheless fall within the ambit of close-out netting under Article 58 of the Bankruptcy Act (Act No 75 of 2004, as amended), which provides as follows:

“(1) If an agreement with respect to transaction in instruments having quotations on organized exchanges or other markets may not achieve its objectives unless it is settled at a particular time and date and if the settlement time and date is scheduled after the commencement of bankruptcy proceedings, then the contract is deemed to be terminated upon the commencement of bankruptcy proceedings.

(2) In the case mentioned in paragraph (1) above, the amount of damages arising from termination of the agreement should be the difference between the market quotation prevailing at the relevant place and time and the contract price.

(3) (Omitted)

(4) In relation to matters set forth in paragraphs (1) and (2) above, if the relevant exchange or market provides otherwise, then paragraphs (1) and (2) should be interpreted in accordance with and give effect to such provision of the relevant exchange or market, as applicable.

(5) If a master agreement for repeated transactions of those set forth in paragraph (1) above provides that all such transactions should be settled by netting the amount of damages set forth in paragraph (2) above, then the amount of damages that a party owes to the other should be determined pursuant to that provision.”

With respect to paragraph (1) above, it is necessary to determine whether the digital assets referenced by an OTC digital asset derivative transaction have “quotations on organized exchanges or other markets”. Furthermore, in order to ensure that “the contract is deemed to be terminated upon the commencement of the bankruptcy proceeding”, as is the case with other derivative transactions, it may be advisable to insert an automatic early termination provision in the contract.

Article 58 of the Bankruptcy Act will apply mutatis mutandis to a party with respect to which a civil rehabilitation or corporate reorganisation proceeding is commenced (Article 51 of the Civil Rehabilitation Act (Act No 225 of 1999, as amended), Article 63 of the Corporate Reorganization Act (Act No 154 of 2002, as amended) and Article 41, Paragraph 3 and Article 206, Paragraph 3 of the Act on Special Measures for the Reorganization Proceedings of Financial Institutions (Act No 95 of 1996, as amended), respectively).

Close-out netting by way of set-off

Even if an OTC digital asset derivative transaction does not fall within the ambit of the Netting Act or Article 58 of the Bankruptcy Act, the non-defaulting party in such a transaction may still be able to exercise its statutory or contractual set-off rights. In this regard, the contractual set-off rights would be enforceable if the requirements of Article 505, Paragraph 1 of the Civil Code (Act No 89 of 1896, as amended), which are set forth as follows, are met:

• all the receivables and payables to be set off are held by parties bound to each other;
• the parties are bound by obligations, the nature of which are of the same kind; and
• the obligations of both parties under the agreement are due and payable.

Whether an OTC digital asset derivative transaction meets all of the requirements of Article 505, Paragraph 1 needs to be analysed on a case-by-case basis, and the type and nature of the specific OTC digital asset derivative transactions may be relevant to such analysis.

Conclusion

Although there is currently no standard practice in Japan regarding close-out netting arrangements for OTC digital asset derivative transactions, it is hoped that with the increasing prevalence of such transactions, and the corresponding need to analyse them, standardised practice for such close-out netting will soon emerge.