Securitisation 2020

Last Updated January 13, 2020

Japan

Law and Practice

Authors



Anderson Mori & Tomotsune has a securitisation team of more than 20 partners and 40 other qualified lawyers who provide comprehensive strategic advice for maximising returns in a variety of tax-effective and innovative structures. As one of the Tokyo market's leaders and innovators in establishing and structuring securitisation and other structured finance transactions, the firm has represented the entire range of global market participants including underwriters and other arrangers, originators, issuers, trustees and investors in securitisations across a wide variety of asset classes. Anderson Mori & Tomotsune's securitisation and structured finance attorneys have extensive experience in the most complex Japanese and cross-border securitisations, real-estate financings, and other structured finance transactions, including the completion of a large number of private transactions. Working with a number of investment banks and international investors in devising securitisation structures for single-property, multi-property and conduit-type transactions, the firm offers a full range of expertise at every level of the transaction. Building on its strong experience and knowledge in structured finance, the firm also provides advice on cutting-edge transactions that involve relatively new and evolving structured products in Japan, including covered bonds and security trusts, and self-trusts.

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, or 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 and in the case where 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, 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, the trustee can petition the court to extinguish the security right (subject to some provision for value to the security holder). 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, in addition to the relevant sale itself, will be examined. 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 (i) the asset sold or entrusted by the originator is not regarded as collateral and (ii) the asset, upon being sold, ceased to be part of the bankruptcy or insolvency estate of the originator.

Factors to be considered, among others, are:

  • 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: (i) the bankruptcy remoteness of a special purpose company (SPC) and (ii) the isolation of an asset from the originator’s bankruptcy or insolvency estate. Each of these issues is discussed in turn below.

Bankruptcy remoteness of an SPC

Two types of measures are typically used in Japan to make a special purpose company 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
  • equity interest with voting rights to be held by an independent party, such as a general incorporated association (ippan-shadan-hojin) established specifically for that purpose.

Second, "non-petition" provisions are used to prohibit the creditors and directors of an SPC from filing for 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.

Second, the asset transfer must be perfected against third persons (that is, 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 such 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.

Third, 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

Issues in respect of an originator’s insolvency should also be considered and are discussed below.

Defence against right of avoidance

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 so as 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, Japanese courts 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, so as 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 turn 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 (i) terminating an agreement and (ii) 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 goes bankrupt, the claim will be considered a bankruptcy claim and, as such, may not be satisfied in large part. To mitigate 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, otherwise the assets will be treated as assets of the originator and will then be included in the insolvency estate and exposed to the financial risk of the originator. Therefore, it is usual to utilise an SPE structure.

Available legal formalities or entities for SPEs under Japanese law are (i) corporations – kabushiki kaisha (KK), godo kaisha (GK) and tokutei-mokuteki-kaisha (TMK) – and (ii) 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. A GK is generally deemed a more appropriate form of entity for securitisation than a KK since a GK is not subject to the Corporate Reorganisation Act and a GK is not subject to the onerous limitations or requirements in relation to management and financial compliance applicable to a KK described above. Since GKs are subject to corporate tax, equity investments in the form of tokumai kumiai (TK) similar to limited partnership are frequently used for profit distribution to TK investors to be deducted as expenses for GKs' corporate tax purposes (see 2.2. Taxes on SPEs and 9.2 Common Structures).

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 to 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:

  • prohibition of acquisition of certain assets by the TMK;
  • 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
  • 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 transfer" which are subject to approval of the board of directors or shareholders' meeting) and TMKs may be summarised as follows.

  • Application of Corporate Reorganisation Act – GK: no; KK: yes; TMK: no.
  • Bond issue – GK, KK, TMK: applicable.
  • Required approval and other internal process for bond issue – GK: representative members' approval; KK: directors' (directors' meeting) approval; TMK: directors' approval and preparation and filing of an ALP.
  • Taxation – GK, KK: corporate taxation but profit distribution for TK investments to be deductible for corporate tax purposes; 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 – GK, KK: not available; TMK: available (see 2.1 Taxes and Tax Avoidance).
  • Registration tax on incorporation – GK: JPY60,000; KK: 0.7% of capital amount (JPY150,000 minimum); TMK: JPY30,000.
  • Public notice obligation on financial information – GK: no; KK: yes; TMK: yes.
  • Large company regulations – GK: no, 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); TMK: no.
  • Accounting auditor – GK: not required; KK: required if it is a large company; TMK: required if the total debt is JPY20 billion or more.
  • Statutory auditor – GK: not required; KK: required for a large company unless that is a corporation with committees; TMK: required.
  • Internal control system – GK: not required; KK: required for a large company; TMK: not required.
  • Transferability of shares – GK: approval of other members is required unless otherwise provided in the Articles of Incorporation; KK: approval of the company is required; TMK: for specified shares, TMK's approval is required for transfer to non-members, whereas for preferred shares, restrictions on the transfer of shares are prohibited.

Apart from corporate vehicles (ie, TMKs, GKs or KKs set out above), trusts are also commonly used as an SPE for securitisation because trusts 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 duty, 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.

Further, the trust structure and the terms of trust beneficial interests (TBIs) can be created flexibly under the trust agreement as described in 9.2 Common Structures.

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

A transferee of a true sale that complies with the perfection requirements is completely protected and entitled to keep the property, and 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 obtaining consent from, the obligor is required. For perfection against third persons, including a trustee, such 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 and 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 special purpose companies or trusts, as stated previously; practically, there are no other means for a bankruptcy remote transaction in a material sense.

In securitisation transactions involving real estate, transfers from originators to SPEs are subject to (i) real estate acquisition tax (which is levied on the transferee) and (ii) 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, (i) the rate of real estate registration tax for transfer of ownership will be discounted to 1.3% (from 2%) and (ii) 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 such net profits are extracted by tokumei kumiai (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 transfer of loan receivables is subject to corporate tax of that transferor corporation. However, if the transferor is a foreign corporation having a permanent establishment in Japan, capital gain on transfer of loan receivables is subject to corporate tax whereas no corporate tax will be levied on a foreign corporation having no permanent establishment in Japan.

No corporate tax will be levied on capital gain on transfer of securities by a foreign corporation having no permanent establishment in Japan. However, capital gain is taxed on transfer of stocks in certain exceptional cases, for example:

  • sales of stocks of the identical issuer that the transferor has bought up;
  • sale of stocks in a domestic corporation by the foreign corporation that falls into the "special relationship shareholders" with that domestic corporation;
  • sale of a certain type of stock of the company having real estate of 50% or more; and
  • 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 and the domestic corporation is required to pay withholding tax.

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

In respect of the taxes on the payment of dividends, interests, etc, to investors of SPEs, the following applies:

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

Tax opinions are obtained in most of the above transactions. In Japan, such tax opinions are usually issued by an accounting or tax firm, instead of 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 such 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 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 such on-balance sheet accounting treatment.

In most cases, true sale legal opinions are rendered (i) without reference to the originator's accounting treatment of the relevant transaction, or (ii) 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.

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 are as follows: (i) 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, and (ii) TBIs issued under a trust structure and TK Interests 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 interests 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 is, for public offerings, 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.

For private placements, there is no filing requirement, but a financial instruments business operator who solicits purchase of a financial instrument has to (i) notify a prospective purchaser of certain matters provided in the FIEA and (ii) 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 Financial Services Agency of Japan is the principal regulator of such disclosure. 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.

The public market overall, which contains various investors including general consumers, is larger than the private market. The size of individual issues and investments in the public market is also larger than in the private market. However, since the private market is "private", not all information can be obtained. As already noted, the public market is subject to more restrictive and complicated disclosure requirements than the private market.

In terms of whether legal practitioners obtain legal opinions as to compliance with such rules, this depends on each deal; naturally enough, a legal opinion will be requested when the fact situation surrounding the issuer, buyer, or place of offering raises questions about the applicability of regulatory disclosures and/or filings.

No response provided.

The FSA has published guidelines recommending that an originator retain 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.

Further, since 31 March 2019, an amendment to the FSA’s capital adequacy regulations has become effective, under which banks are required to use three times (or 1,250%) of risk-weight on their securitisation exposure unless the originators fulfil certain risk retention criteria such as retention of 5% or more of the junior exposure, etc, or origination of underlying assets being not improperly conducted. 

As far as laws and regulations specifically relating 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 a tokutei mokuteki kaisha, 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 tokutei mokuteki kaisha, a further requirement to submit business reports every business year applies. Separately from the vehicle used for a securitisation, when the special provisions under the FIEA concerning specially permitted business of a qualified institutional investor, etc (tekikaku kikan toshika tou tokutei gyomu), which exempt the registration requirement for certain private placements and/or certain acts of investing money, apply, the submission of business reports for every business year is required.

Regarding the regulator and the enforcement of the reporting requirements, for the disclosure of financial statements under the Companies Act, the Ministry of Justice is the regulator, 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 an RA. However, the FIEA has provided for:

  • registration of an RA;
  • certain requirements for registered RAs to comply with, including fiduciary duty, no conflict of interest rule and reporting requirement;
  • 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.

No response provided.

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.

No response provided.

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 prohibition against conflicts of interest, duty of due care of prudent management (zenkan chui gimu), duty of loyalty (chujitsu gimu), duty of self-execution and duty of separate management of assets.

The FSA regulates these matters. For a breach of an obligation under the FIEA, criminal and administrative sanctions will apply.

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 (tokutei mokuteki kaisha) or a company similar to the US limited liability company (godo kaisha) is used.

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

Specific laws applicable to SPEs or their businesses relevant to securitisation in Japan are as follows.

SPC Act

The SPC Act enables use of the TMK structure in securitisation transactions. Since the promulgation of the SPC Act, the TMK structure has been frequently used in real estate securitisation transactions (see 2.2 Taxes on SPEs for a discussion of real estate securitisation through the TMK structure).

Key advantages of using the TMK structure under the SPC Act include the following.

  • Where corporate reorganisation proceedings apply, secured creditors are unable to enforce their rights outside the proceedings. However, a TMK incorporated under the SPA Act is not subject to corporate reorganisation proceedings. Accordingly, lenders prefer to lend under a TMK structure (which permits lenders to make a claim outside the corporate reorganisation proceedings) as opposed to a KK structure.
  • No tax issues will arise under a TMK structure even if the TMK shareholders are given certain rights of control over the TMK’s business (see 2.2 Taxes on SPEs). By contrast, tax issues could arise under a GK-TK structure if TK investors are given rights of control over the GK’s business. Accordingly, investors in general (and international investors in particular) prefer a TMK structure over a GK-TK structure.
  • Real estate brokerage licence (takuchi tatemono torihikigyo menkyo, or REB licence) requirements will generally be triggered whenever a person or corporation engages in the procurement or provision of brokerage activities in respect of fee simple real estate. A TMK, however, is exempt from such licensing requirements.

Practical points to note include the following.

  • Before acquiring any property, a TMK is required under the SPC Act to file (i) a business commencement notification (gyomu kaishi todokede) and (ii) an asset liquidation plan (shisan ryudoka keikaku, or ALP) with the Kanto Local Finance Bureau. Both these documents have to be prepared in Japanese. As the preparation of such documents takes time, a timetable up to the point of completion of acquisition of the relevant property, taking into account the time needed to satisfy these filing requirements, should be prepared.
  • A tax adviser should be consulted when determining the structure of a TMK, such as the number and value of common and preferred shares the TMK should issue, because the tax benefits applicable to a TMK vary according to the TMK’s structure (see 2.2 Taxes on SPEs).
  • A TMK has to comply with various tax requirements to be eligible for certain tax benefits. Such requirements include issuance of TMK bonds to qualified institutional investors (see 2.2 Taxes on SPEs). This requirement raises the question of whether a TMK should issue secured TMK bonds, since secured bond issues (as opposed to unsecured bond issues or specifically structured bond issues) may trigger licensing requirements under the Secured Bond Trust Act (SBTA).

Trust Act and Trust Business Act

The Trust Act of Japan (the Trust Act) governs civil rights and obligations in respect of trust structures and the Trust Business Act of Japan (the Trust Business Act) provides a licence framework for trust-related business activities in Japan. Both these statutes should therefore be carefully considered when structuring a trust.

Key advantages of using a trust structure regulated under the Trust Act and Trust Business Act are as follows.

  • A trust enables 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 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: (i) the underlying asset level, where underlying assets are converted to TBIs; (ii) 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 (iii) 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 Financial Instruments and Exchange Act. Accordingly, 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 the 2006 Trust Act Amendments, 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 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 the coming into effect of the 2006 Trust Act 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 holders of security interests from holders of secured claims. The security trust structure is now permitted as a result of the 2006 Trust Act Amendments. A security trustee is, however, required to hold a trust business licence under the Trust Business Act.

Real Estate Specified Joint Enterprise Act

The Real Estate Specified Joint Enterprise Act (RESJEA) provides a licensing regime for securitisation structures in which (i) investments are made in the form of undisclosed partnerships (tokumei kumiai) or other partnerships and (ii) an investment vehicle acquires fee simple properties.

One of the disadvantages of a TMK structure under the SPC Act is that a TMK is subject to stringent regulations under the SPC Act. However, the RESJEA structure makes it possible to (i) achieve flexibility by using a GK-TK structure and (ii) trade fee simple properties by relying on the licensing regime under the RESJEA.

Practical points to note include the following.

  • In principle, GKs (ie, TK operators) that hold fee simple properties are required to be licensed under the RESJEA. However, since it is impractical for an SPC (such as a GK) to hold such a licence, the GK-TK structure under the RESJEA is not commonly used in Japanese securitisation markets.
  • The RESJEA was amended in 2013 and 2017 to address the concerns above. Specifically, a GK will be exempt from the licensing requirements under the amended RESJEA if certain conditions are satisfied, such as if (i) investors in the GK are limited to certain qualified institutional investors and (ii) the GK delegates its asset management activities to a licensed asset manager. Furthermore, another category of an exempted business, limited only to “qualified specifically exempted investors” (tekikaku-tokurei-toshika), was introduced by the 2017 amendment to the RESJEA whereby a GK will be (i) only required to file a notification (todokede) rather than to obtain a permission (kyoka) and (ii) exempt from having standard terms and conditions (yakkan) if certain conditions are met, including conducting businesses limited to "qualified specifically exempted investors".

Financial Instruments Exchange Act

The FIEA provides a regulatory regime that applies to business related to financial instruments and various instruments that are typically used in securitisation structures: (i) 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 a type I financial instrument exchange business operator licensed under the FIEA, and (ii) TBIs issued under a trust structure and TK Interests 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 interests accordingly have to be handled by a type II financial instrument exchange business operator licensed under the FIEA.

Additionally, an asset manager that provides investment advisory services or discretionary investment management services to a TMK or a GK that holds financial instruments (such as TBIs) is also generally required to obtain an investment advisory licence or an investment management licence under the FIEA.

Furthermore, GKs that (i) acquire investments in the form of a TK and (ii) invest in financial instruments such as TBIs are required to obtain an investment management licence. However, there are certain exemptions from such requirements available to GKs, including (i) where the GK’s investors are limited to qualified institutional investors as defined under the FIEA and a limited number of non-QIIs, and (ii) the GK’s investment management activities are wholly delegated to a licensed investment manager.

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.

As to how legal practitioners avoid engaging in such activities, this 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. For a breach, it is possible that a criminal sanction is imposed.

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

Government sponsored entities (GSEs) may participate in the securitisation market. Regulations applicable to each entity will vary depending on the particular law applicable to such 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.

To ensure the bankruptcy remoteness of a transfer (ie, a true sale), the asset transfer agreements or trust agreements should contain provisions covering, among others, the following: (i) the parties' intent to effect a true sale and (ii) 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. On the other hand, the 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, absence of possibility to exercise any right of avoidance, parties' intention to effect a true sale, absence of commencement or reasons for commencement of bankruptcy, civil rehabilitation, corporate reorganisation or other similar insolvency proceedings, absence of fraudulent intent and the like are also used in securitisation documentation.

Compensation for damages incurred is the principal remedy for breach 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 are perfected by way of (i) registration (toki), (ii) registration or transfer of possession and (iii) 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.

Standard covenants to comply with applicable laws and the terms of the applicable transaction documents, as well as to ensure that no adverse changes occur in respect of the securitised assets, are typically found in securitisation documentation.

In transactions involving 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 (which includes 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 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 such 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.

For purposes of complying with the Servicing Act, the service provider (which is often the assignor), who in many cases does not hold a licence under the Servicing Act, must be prohibited under the relevant servicing agreement from collecting a claim or receivable that involves legal services for a legal case.

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 in the event that 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 default because specific performance and injunctive relief are in principle unavailable for such default.

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

Other principal matters are various, depending on the types of assets to be securitised. 

Enforcements of documents related to securitisation are, in principle, implemented in accordance with the Civil Procedure Law (Act No 109 of 1996, as amended) and the Civil Execution Act (Act No 4 of 1979, as amended). Further, provisional enforcements are made in accordance with the Civil Provisional Remedies Act (Act No 91 of 1989, as amended).

It is generally recognised that enforcements by the court system take substantial time and involve significant costs and, thus, practically, settlements of disputes via agreement among the parties are usually preferred. 

The issuer's responsibilities are to originate and transfer their assets to SPEs. In most cases involving 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. Sometimes, in real estate securitisation, they will also act as master lessees in respect of the assets that they have sold and leased back.

The above 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 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.

Underwriters and placement agents are essentially the parties that market and sell securitised products to investors. For regulatory purposes, underwriters (hikiuke-nin) are defined as persons who (i) acquire securities (yuka-shoken) for the purpose of reselling them or (ii) commit to acquiring securities that are unsold. Placement agents, on the other hand, are defined as persons who engage in brokerage activities or engage 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: (i) 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 KKs and preferred shares (yusen-shosshi-shoken) issued by TMKs, and (ii) 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 only qualified attorneys under the Attorney Act may engage in. 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.

Further, 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: (i) qualified institutional investors and (ii) non-qualified institutional investors. Additionally, investors are split into two categories for purposes of regulation on the product sales activities of brokers/dealers or placement agents: (i) "specified investors" (tokutei-toshika), which includes QIIs and quasi-institutional investors (as defined in the FIEA), and (ii) non-specified investors.

"Trustees" generally means trustees in a trust structure in Japan. (It should be noted that "bond trustees", as frequently used in the UK/US markets, are not recognised under Japanese law except where the Secured Bond Trust Law applies.) It is unique to the Japanese market that the role of trustee is usually undertaken by trust banks or trust companies licensed and regulated under the Act on Engagement in Trust Businesses by Financial Institutions and the Trust Business Act.

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 proposal to the banks' capital adequacy regulations will, once it becomes effective, have material impacts 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. As noted in 8.3 Regulation, however, credit derivatives are subject to the FIEA regulations. Accordingly, 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 be applied toward redemption of the notes; where there occurs any credit event with respect to the reference obligations, however, proceeds from disposition of the collateral will be applied towards payments to the originator under the CDS.

In Japan, credit derivatives can generally be used by banks, insurance companies and other financial institutions as a means of reducing the amount of risky assets that they hold so as to enable them to comply with the capital adequacy ratio stipulated by the FSA, provided that:

  • the credit events in respect of the credit derivatives include
    1. default under the reference obligations,
    2. commencement of bankruptcy or other insolvency proceedings against the obligor of the reference obligations, 
    3. the restructuring of the terms of the reference obligations, and
  • certain other requirements stipulated by the FSA being met.

Further, the recent FSA’s amendment to the banks' capital adequacy regulations have imposed banks three times risk weights on securitisation exposure unless certain factors such as 5% or more risk retention by the originator or proper origination of underlying assets are met (see 4.3 Credit Risk Retention).

According to the report by the Japan Securities Dealers Association and Japanese Bankers Association (Securitisation Market Trends Survey Report (Issuance Trends in Fiscal 2018, published on 31 May 2019)), the total issuance amount of the securitisation products in fiscal year 2018 was JPY4,786.7 billion, increasing 6.5% from fiscal year 2017, while the number of issues was 160, 4.6% up year-on-year.

The report also shows that, as the securitisation product issuance amount for fiscal year 2018 by underlying assets, the amount of CMBS, leases, consumer loans and shopping credits increased, whereas RMBS, CDO, 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 JPY2,246.8 billion (46.9% of the total), followed by bonds with JPY2,221.7 billion (46.4%).

GK Structure

If a GK is used as an SPE for securitisation, the GK could finance its purchase of assets by way of debts (loans and bonds) and/or equities (shares). However, a GK is not an entity eligible for the special tax treatment applicable to TMKs and a GK's profits are subject to corporate tax in the same way as standard corporations conducting actual business. Thus, tokumei-kumiai 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 later.

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) of 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 delegation of (i) the business of real estate transactions to approved real estate operators (3-go-jigyosha) and (ii) the solicitation for purchase of TK investments to approved brokers and dealers (4-go-jigyosha) for TK investments. Recently, the Act was further amended in 2017 to facilitate the GK-TK structure by requiring merely filing rather than permission and without the above 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 Exchange Act, a GK owning beneficial interests funded by TK investments is subject to the self-investment regulation under the FIEA (for further details, see 4.11 SPEs or Other Entities).

Further, since TK investments also constitute securities under the FIEA, solicitation for 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

Tokutei-mokuteki-kaisha 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 to 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, 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:

  • prohibition of acquisition of certain assets by the TMK;
  • 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;
  • securitised assets must, in principle, be specified at the outset and 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
  • 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.

Trust Structure

Trusts are generally considered the most appropriate vehicle for securitisation because they are 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. Further, the trust structure and the terms of trust beneficial interests 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. Further, depending on investors' demand, the trustee can seek funds by issuing trust bonds to investors instead of receiving loans.

Further, 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.

Anderson Mori & Tomotsune

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Trends and Developments


Amendment to Japanese Risk Retention Rules for Securitisation Products

On 15 March 2019, the Japanese Financial Services Agency (JFSA) published certain amendments to its notices on the capital requirements for banks and certain other financial institutions; these became effective as of 31 March 2019. Such amendments overhauled the methods of calculating risk-weighted assets in the case of financial institutions holding securitisation products. In particular, in the event that a financial institution holds securitisation products but is unable to confirm that the originator holds 5% or more exposure concerning such securitisation products, a higher risk weight than normal (ie, triple risk weight, up to 1,250% – which means full capital deduction) shall be applicable in calculating such financial institution’s risk-weighted assets unless certain exemption requirements are satisfied.

Such risk retention itself was already required by the JFSA’s supervisory guidelines for financial institutions even before the above amendments were made, but, before these amendments, financial institutions were required only to check (i) whether or not the originator retains part of the exposure of the securitisation products, and, if not, (ii) whether or not the originator’s involvement in the underlying assets or the quality of the underlying assets is analysed in depth.

However, after the above amendments, more specific requirements, such as quantitative criteria and sanctions in case of a violation of such rules (ie, application of higher risk weight) were additionally introduced. In substance, similarly to the USA or the EU, the originator or sponsor is required to hold 5% or more exposure of the securitisation products in Japan. It should be noted that, differently from the USA or the EU (after January 2019), Japanese risk retention rules do not directly require the originator or sponsor to hold certain amount of exposure of securitisation products and only indirectly requires such risk retention by stipulating that financial institutions shall apply a higher risk weight to the securitisation assets for which the risk retention rules are not complied with. Such amendments will be applicable in respect of securitisation products acquired by financial institutions on or after 1 April 2019 and will not be applicable to securitisation products held by financial institutions on 31 March 2019.

To meet the risk retention requirements, in general, the originator must hold 5% or more of the aggregate amount of exposure of the underlying assets of the relevant securitisation. It should be noted that the portion of the exposure substantially not borne by the originator, due to hedging such exposure with guarantees or CDSs, is to be excluded from the percentage of the exposure held by the originator. More specifically, the originator shall hold:

  • (i) an equal portion of all tranches, the total amount of which is at least 5% of the aggregate exposure of the underlying assets of the relevant securitisation;
  • (ii) all or part of the most junior tranche, the total amount of which is at least 5% of the aggregate exposure of the underlying assets of the relevant securitisation;
  • (iii) if the most junior tranche is less than 5% of the aggregate exposure of the underlying assets of the relevant securitisation, all of such tranche and part of other tranches, the total amount of which is at least 5% of the aggregate exposure of the underlying assets of the relevant securitisation; or
  • (iv) an exposure that is equal to or greater than the exposure required to be held by the originator under the above three methods.

As an exception to the above general rule, even when a financial institution cannot confirm that the originator holds 5% or more of the aggregate exposure of the underlying assets of the relevant securitisation, if such financial institution can determine that the underlying assets were not inappropriately originated, taking into consideration the relevant circumstances such as the originator’s involvement in the underlying assets or the quality of the underlying assets, etc, then the financial institution will not be required to apply a higher risk weight in calculating its securitisation exposure. More specifically:

  • when it can be confirmed that the originator, etc, holds an exposure equal to or greater than the exposure required to be held under requirements (i) through (iv) above, such as,
    1. when the originator’s parent company, the arranger or any other entity who was deeply involved in the structuring of the relevant securitisation holds the exposure;
    2. when the originator provides credit enhancement to the subordinated portion; or
    3. when so-called “random selection” was conducted (eg, when the underlying assets were randomly selected from an underlying asset pool that included a large number of receivables, etc, and the originator continues to hold all of such receivables, etc, of the underlying asset pool other than the above selected assets, the exposure of which amounts to 5% or more of the aggregate exposure of the underlying asset pool);
  • when the quality of the underlying assets was analysed in depth and it can be determined that the underlying assets have not been originated inappropriately. For example, (x) when it can be determined that the underlying assets were not originated inappropriately, relying upon objective materials, etc, by which investors may determine the quality of the underlying assets (eg, where the underlying assets of the securitisation are real estate and appropriate appraisal documents and engineering reports were made for the origination of such securitisation); or (y) when the originator originated the securitisation products by purchasing the underlying assets from the market (like open market CLOs in the USA) and it can be determined, by relying upon objective materials, etc, that the quality of the securitisation products procured in the market is not inappropriate; or
  • when requirements (i) through (iv) above are no longer met due to changes in the factors surrounding the securitisation products after their acquisition, but it can be determined that the originator continues to hold the relevant exposure (eg, when the total amount of the exposure held by the originator becomes less than the required amount of exposure due to default or prepayment of the underlying assets during the securitisation period).

As mentioned above, the Japanese risk retention rules do not directly require that the originator or sponsor hold a certain amount of exposure and only indirectly requires the same by making a rule that a higher risk weight shall be applied when financial institutions acquire securitisation products that do not comply with the risk retention rules. Therefore, practically speaking, investors in securitisation products (many of which are financial institutions) should establish a due diligence framework and confirm compliance with the Japanese risk retention rules not only at the time of acquisition of the securitisation products but also at each time they are required to calculate the risk weighting of its assets for capital adequacy purposes. In addition, financial institutions should request of the originator the insertion of the following language in the relevant documents to confirm the compliance with the Japanese risk retention rules:

  • the originator shall continue to hold the subordinated exposure constituting 5% or more of the total exposure of the underlying assets;
  • the originator shall continue to hold the subordinated exposure substantially and may not hedge such exposure by way of third-party guarantees, risk participation or otherwise;
  • the originator may not transfer the subordinated exposure or may only transfer it if one of requirements (i) through (iv) above will continue to be met after the transfer; and
  • if the originator violates any of the above requirements, the originator shall indemnify the investors for damages or repurchase the subject receivables or be imposed other sanctions.

An information memorandum on securitisation products usually sets forth certain disclaimers such that financial institutions as investors shall calculate their own risk weights and that the amount of credit risk assets may increase due to future possible amendments by the JFSA to its notices and such amendments may have an adverse effect on the liquidity of the relevant securitisation.

These amendments to the Japanese risk retention rules are relatively new and we have to keep a close eye on the future application of and further amendment to these rules.

Implementation of STC Criteria under the Basel III Securitisation Framework

In July 2016, the Basel Committee on Banking Supervision (BCBS) finalised the majority of Basel III’s securitisation regulatory standards that adopt a more risk-sensitive, prudent and simple approach to calculating the risk-weighted assets of securitisation exposures held by financial institutions. On 15 March 2019, the JFSA incorporated such Basel III securitisation framework into Japanese regulations by amending its notices on the capital requirements for banks and certain other financial institutions and Q&As clarifying the interpretations thereof. The amended notices were implemented on 31 March 2019.

The new framework essentially requires a larger amount of regulatory capital, especially for financial institutions holding highly rated securitisations, as the risk weight (RW) applied to such securitisations is higher compared to the previous framework. At the same time, in an effort to improve its risk sensitivity, the new framework has introduced simple, transparent and comparable (STC) criteria and permits financial institutions to apply a lower RW to long-term securitisation products compliant with such criteria.

With respect to each component of the STC, "simplicity" refers to homogenous underlying assets with simple characteristics and a simple transaction structure. "Transparency" requires sufficient information on underlying assets, structure and relevant parties to be available to investors. "Comparability" is meant to enable investors to undertake a more straightforward comparison across securitisation products within an asset class. The STC criteria embodied by the amended notices are mapped to key types of risks in the securitisation process: (i) the asset risk, (ii) the structural risk, and (iii) the fiduciary and servicer risks, which is where the asset risk-related criteria would require the most attention from a practical point of view.

For example, one of the criteria requires the originator’s verification that none of the debtors of the underlying receivables meets certain conditions indicative of credit risks, such as recent insolvency proceedings, adverse credit history or contentious disputes. The important point here is that the assessment of such conditions should be carried out no earlier than 45 days prior to the closing date, not the portfolio cut-off date. The amended Q&As clarify practical ways for the originator to adhere to this criterion. 

Taking the example of recent insolvency proceedings, the originator is deemed to have undertaken the required verification if the originator has no knowledge of such insolvency proceedings prior to the closing date, and if the originator is contractually obliged to repurchase relevant underlying receivables in case it later learns about such insolvency proceedings of any debtors.

Another criterion prohibits a single obligor’s exposure from exceeding a certain ratio (in principle, 1%) of the aggregated exposures in the portfolio as of the portfolio cut-off date. In this case, depending on the types of underlying assets, compliance may not be practical or may at least require significant changes to the way assets are selected to constitute the portfolio.

A further criterion requires the initial and ongoing availability of the underlying receivables data for the purpose of assisting investors’ due diligence and monitoring. Loan-level data is required for a non-granular pool of assets while summary stratification data is sufficient for a granular pool. According to the amended Q&As, for providing a level of assurance about the accuracy of the underlying receivables data and the fulfilment of eligibility criteria, the initial portfolio must be reviewed by an appropriate legally accountable and independent third party such as an independent accounting practice or the calculation agent or management company for the securitisation. The amended Q&As require that the outcome of such review be disclosed to investors in the prospectus or other similar documents. The amended Q&As also clarify that the underlying receivables data must be updated at least on a quarterly basis.

It is also noteworthy that, for compliance with the STC criteria, the originator is also required to hold a part of the securitisation exposure in an appropriate manner. The amended Q&As clarify that this criterion can be met by complying with the risk-retention requirements by the originator holding 5% or more of the aggregate amount of exposure of the underlying assets of the relevant securitisation (please see “Amendment to Japanese Risk Retention Rules for Securitisation Products”, above).

The majority of the criteria appear unlikely to raise any serious practical issues, but further clarification from the financial institutions' perspective, who are in the unique position of being required to assess the practical impact of STC compliance and the appropriateness of less regulatory capital for a specific securitisation.

In the Japanese post-crisis market, there have been efforts driven by the government and industry to reduce the uncertainty of the risks pertaining to securitisation products, including measures to enhance the "traceability" of securitisation products. It is fair to say that the momentum towards adopting the underlying principles of the STC criteria has been growing in Japan in recent years. In that context, the STC criteria is being implemented with sufficient clarity and in a manner that is compatible with current securitisation practices in Japan. STC-compliant securitisation will also enhance transaction parties’ thorough risk and return analyses across similar securitisation products.

Amendment to the Civil Code – New Rules for Assignment of Receivables with a Non-assignment Covenant

The provisions of the Civil Code of Japan regarding claims and contracts will be amended to reflect socio-economic changes that have occurred in the approximately 120 years since the enactment of the Civil Code. The amendment, enacted on 26 May 2017, will enter into force on 1 April 2020 (ie, the effective date). This amendment will introduce new rules for the assignment of receivables with a contractual provision that prohibits or restricts a transfer of a right, receivable or claims (a non-assignment covenant; receivables with a non-assignment covenant will be referred to as non-assignable receivables). The purpose of the new rules is to promote securitisation and collateralisation of non-assignable receivables. The new rules will apply to the assignment of receivables for which the assignment agreement is concluded after the effective date, regardless of when the receivables were accrued or when the non-assignment covenant was concluded.

The purpose for which creditors and debtors agree on the prohibition of the assignment of receivables is, in general, to safeguard debtors’ interests by fixing the person to whom the receivables are to be paid. In other words, the purpose is to (i) eliminate or reduce burdensome clerical work for debtors, (ii) eliminate the risk of debtors making erroneous payments, and (iii) secure opportunities for debtors to offset against their counterclaims. Since debtors of non-assignable receivables often have high creditworthiness, securitisation and collateralisation of non-assignable receivables would be effective methods for creditors’ fund-raising transactions.

Under the current Civil Code, however, an assignment of receivables that violates a non-assignment covenant is null and void. Therefore, under the current rule, when creditors raise funds using non-assignable receivables, they must do so using methods other than the assignment of receivables, such as declaration of trusts or loan participation. The current rule is considered as a major obstacle to fund-raising transactions using assignment of non-assignable receivables. Accordingly, the amendment will make the assignment of non-assignable receivables a viable option. However, in order to safeguard debtors’ interests protected by a non-assignment covenant, the amended Civil Code will allow debtors to (i) continue making repayments to the assignor of the receivables, and (ii) assert their defence against the assignor of the receivables.

In an ordinary securitisation transaction, the assignor of the receivables is appointed as a servicer and continues to collect the receivables from the debtor. Accordingly, allowing the debtor to continue to make repayments to the assignor of the receivables does not immediately make it impossible to securitise such receivables. Therefore, it is expected that the amendment will enable financing by the assignment of non-assignable receivables to some extent.

However, even in an ordinary securitisation transaction, the assignor of the receivables may be removed as servicer, and another person may be designated to collect the receivables in the two circumstances outlined below. If the debtor can still make repayment to the assignor of the non-assignable receivables in such circumstances, the amendment would be an obstacle to financing by the assignment of non-assignable receivables.

First, a special servicer, as a collection agent of the assignee, may be designated to collect defaulted receivables. The amended Civil Code provides that, if a debtor fails to perform its obligation, the assignee may demand the debtor to pay the assignor within a reasonable period, and if the debtor fails to make payment to the assignor within such period, the debtor may no longer refuse to perform its obligations to the assignee. The provision allows the special servicer to collect the defaulted non-assignable receivables.

Second, if the assignor’s credit standing deteriorates in an ordinary securitisation transaction, the assignor may be removed as the servicer, and a new back-up servicer may be appointed to collect the receivables. If the assignor continues to collect the receivables, the risk may arise that the assignee’s claim for delivery of the collected money could rank pari passu with other claims, and the entire amount will not be recoverable (in other words, "commingling risk" exists). With respect to the money to be collected after the commencement of insolvency proceedings – such as a bankruptcy proceeding, a civil rehabilitation proceeding and a corporate reorganisation proceeding – against the assignor, the risk is limited.

As for bankruptcy proceedings, the amended Civil Code provides that the perfected assignee of non-assignable receivables may request the debtor to make a deposit with an official depository, and only the assignee may make a request for a refund of the deposit. The burden of the deposit procedure under such provision allows the assignee to incentivise the debtor to accept the collection of the receivables by the back-up servicer, and even if the debtor does not accept the collection by the back-up servicer, the back-up servicer may request the refund of the deposit as an agent of the assignee after the debtor makes the deposit.

As for other insolvency proceedings, such as civil rehabilitation proceedings and corporate reorganisation proceedings, such provision under the amended Civil Code does not apply. However, the assignee may request the assignor to provide the money that the assignor collected after the commencement of insolvency proceedings, and the claim will be protected from the commingling risk to the extent that it, as a common benefit claim, will be ranked preferentially to other claims. With respect to the money that the assignor, as the servicer, collected but did not deliver to the assignee prior to the filing of the petitions for commencement of insolvency proceedings including bankruptcy proceedings, the claim for such money will not be protected from the commingling risk.

Since the assignor cannot be removed as the servicer, and the assignee cannot request the debtor to make a deposit with an official depository until the commencement of bankruptcy proceedings against the assignor, the commingling risk in the assignment of non-assignable receivables is relatively higher than that in the assignment of receivables without a non-assignment covenant. If the assignee is a bank and the assignor agrees to open its bank account, as a servicing account, in the assignee, and to demand the debtor to pay into that bank account, the assignee can avoid the commingling risk by offsetting the assignee’s claim for the collected money against the non-assignable receivables against the assignor’s counterclaim.

Separate from the new rules, other risks in the securitisation and collateralisation of non-assignable receivables exist. For example, if the assignor were to assign non-assignable receivables without the debtor’s consent, the risk could arise that, even if the assignment of the non-assignable receivables itself is effective under the new rules, it may constitute a breach of the agreement between the assignor and the debtor, which could lead to remedial actions being taken pursuant to the agreement. However, since the amended Civil Code protects the debtor’s interest by fixing the person to whom the receivables are to be repaid to a certain extent, it may be construed that the assignment of the non-assignable receivables does not necessarily breach the agreement between the assignor and the debtor. Since this issue is a matter of interpretation of individual agreements, its determination must be made on a case-by-case basis.

In addition, the amended Civil Code stipulates the judicial doctrine that future receivables (receivables accruing after the assignment agreement) can, in principle, be validly assigned and perfected at the time of the assignment agreement. The collateralisation of future receivables plays an important role in areas such as asset-based lending, acquisition financing and project financing. Furthermore, securitisation transactions of future receivables may be one of the useful schemes for raising funds for infrastructure businesses (ie, electric power, air transport, water supply, and similar infrastructure businesses).

Nagashima Ohno & Tsunematsu

JP Tower
2-7-2 Marunouchi
Chiyoda-ku
Tokyo 100-7036
Japan

+81 3 6889 7000

+81 36 889 8000

info@noandt.com www.noandt.com
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Anderson Mori & Tomotsune has a securitisation team of more than 20 partners and 40 other qualified lawyers who provide comprehensive strategic advice for maximising returns in a variety of tax-effective and innovative structures. As one of the Tokyo market's leaders and innovators in establishing and structuring securitisation and other structured finance transactions, the firm has represented the entire range of global market participants including underwriters and other arrangers, originators, issuers, trustees and investors in securitisations across a wide variety of asset classes. Anderson Mori & Tomotsune's securitisation and structured finance attorneys have extensive experience in the most complex Japanese and cross-border securitisations, real-estate financings, and other structured finance transactions, including the completion of a large number of private transactions. Working with a number of investment banks and international investors in devising securitisation structures for single-property, multi-property and conduit-type transactions, the firm offers a full range of expertise at every level of the transaction. Building on its strong experience and knowledge in structured finance, the firm also provides advice on cutting-edge transactions that involve relatively new and evolving structured products in Japan, including covered bonds and security trusts, and self-trusts.

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Nagashima Ohno & Tsunematsu has a structured finance and derivatives team of more than 50 lawyers (including approximately 15 partners) who have extensive experience dealing with a wide variety of structures in Japanese and cross-border transactions, including – in addition to the traditional methods of structured finance – WBS (whole business securitisation), CMBS (commercial mortgage-backed securities), CDO (collateralised debt obligations), BIS finance (dealing with financial institutions capital adequacy requirements under the Basel Accord) and other transactions involving derivatives. NO&T provides exceptional advice in all aspects of structured finance and derivatives transactions – for example, structure development, risk analysis, SPC or trust formation, documentation, negotiation, research and rendering of legal opinions. NO&T expertly represents clients that serve various functions in the structured finance and derivatives market, from arrangers, originators, fiduciaries (trust banks), and special purpose companies, to parties supplying supplementary financing and/or credit-enhancement (financial institutions), credit-rating agencies and investors.

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