Investment funds in Japan: regulatory overview

A Q&A guide to investment funds law in Japan

This Q&A is part of the global guide to investment funds. It provides a high level overview of investment funds in Japan, looking at both retail funds and hedge funds. Areas covered include a market overview, legislation and regulation, marketing, managers and operators, restrictions and requirements, tax and upcoming reform.

To compare answers across multiple jurisdictions, visit the Investment Funds Country Q&A tool. For a full list of jurisdictional Q&As visit www.practicallaw.com/investmentfunds-guide.

Contents

Retail funds

1. What is the structure of the retail funds market? What have been the main trends over the last year?

Open-ended retail funds

Open-ended retail funds are generally structured as investment trusts (Toshi Shintaku) as regulated under the Act on Investment Trusts and Investment Corporations (Act No. 198 of 1951, as amended (ITICA)), which are contract-type domestic investment funds (Contract-type DIFs). Retail funds sold in Japan are primarily open-ended funds.

Closed-ended retail funds

Closed-ended retail funds are generally structured as Contract-type DIFs, investment corporations (Toshi Hojin) under the ITICA, which are company-type domestic investment funds (Company-type DIFs, and together with Contract-type DIFs are collectively referred to as DIFs) or foreign investment funds (FIFs).

Domestic ETFs are typical closed-ended retail funds, which are structured as Contract-type DIFs.

Typical Company-type DIFs are J-REITs. The J-REITs market has recently been active and growing.

Some retail investors invest in foreign ETFs, which are classified as FIFs. FIFs include but are not limited to unit trusts and mutual funds established under foreign laws.

Regulatory framework and bodies

2. What are the key statutes, regulations and rules that govern retail funds? Which regulatory bodies regulate retail funds?

Open-ended retail funds

Regulatory framework. Open-ended retail funds are primarily governed by the Financial Instruments and Exchange Act (Act No. 25 of 1948, as amended (FIEA)). The ITICA also governs Contract-type DIFs.

Regulatory bodies. The Financial Services Agency (FSA) is the primary regulatory body in respect of open-ended retail funds. The Securities Exchange and Surveillance Commission (SESC) has the authority to inspect registered Financial Instruments Business Operators. Subsequently, to some extent, the FSA and the SESC delegate their authority to each Local Finance Bureau (LFB).

Closed-ended retail funds

Regulatory framework. Closed-ended retail funds are primarily governed by the FIEA. The ITICA also governs DIFs and FIFs.

In addition, the Building Lots and Buildings Transaction Business Act (Act No. 176 of 1952, as amended) governs J-REITs.

The rules of securities exchanges also govern domestic and foreign ETFs.

Regulatory bodies. The FSA is the primary regulatory body in respect of closed-ended retail funds. SESC has the authority to inspect registered Financial Instruments Business Operators. Subsequently, to some extent, the FSA and the SESC delegate their authority to each LFB.

In addition to the FSA, the Ministry of Land, Infrastructure, Transport and Tourism (MLIT) is the regulatory body in respect of J-REITs.

The rules of securities exchanges also regulate domestic and foreign ETFs.

 
3. Do retail funds themselves have to be authorised or licensed?

Open-ended retail funds

The investment manager of an open-ended Contract-type DIF is required to file the trust deed of the Contract-type DIF with the relevant regulatory body.

Closed-ended retail funds

Contract-type DIFs. See above, Open-ended retail funds.

Company-type DIFs. The founder of the investment company is required to file a notification with the FSA prior to the establishment of the investment company. The investment company is required to be registered with the FSA in order to engage in investment management.

FIFs. An issuer of units or shares in FIFs is required to file a notification with the FSA prior to commencing offering of such units or shares in Japan.

Marketing

4. Who can market retail funds?

Open-ended retail funds

Under the FIEA, the sale, offering (including marketing) or distribution of units in Contract-type DIFs fall within the definition of Type I Financial Instruments Business, and any person conducting such activities is, in principle, required to be registered with the FSA as a Type I Financial Instruments Business Operator.

Closed-ended retail funds

The above explanation on open-ended retail funds will apply equally to closed-ended retail funds (see above, Open-ended retail funds).

 
5. To whom can retail funds be marketed?

Open-ended retail funds

Generally, Contract-type DIFs that will be offered or distributed through a public offering can be offered or distributed to any investor.

Closed-ended retail funds

See above, Open-ended retail funds.

Managers and operators

6. What are the key requirements that apply to managers or operators of retail funds?

Open-ended retail funds

Several requirements are required to be satisfied in an application to be registered as an investment manager of a Contract-type DIF. Based on the authors' experience, the problematic requirements are as follows.

Human resources. The most difficult requirement to satisfy for those applying to register as an investment management business is the human resource requirement, which requires the applicant to have "sufficient human resources" to properly operate an investment management business. Applicants which do not have such human resources are precluded from registration of an investment management business.

The FIEA only contains abstract provisions in respect of this requirement and provides no clear statutory definition of sufficient human resources. However, the General Guidelines for Financial Instruments Business Operators, Etc. issued by the FSA (FSA Guidelines) offers some general guidance for applicants, including guidance on the human resource requirement, such as clarifying that the applicant must have a compliance officer with sufficient knowledge and experience (including knowledge and experience with regard to the FIEA) separately from the investment management aspect of the business.

However, the other aspects of the human resource requirement are not clearly specified in any statutes or guidelines and are, in effect, partly subject to the authority's discretionary judgment. This makes it necessary for informal consultation to be held with the relevant authority regarding this matter and the business plan before formally applying for registration as an investment management business.

Minimum capital and net asset requirements. Those applying for registration as an investment management business must have paid-in capital of at least JPY50 million and net assets of at least JPY50 million.

Organisation. The applicant must be a stock company (Kabushiki Kaisha) with a board of directors or an equivalent foreign company that has a Japan branch. It must also have company auditors or such committees as prescribed in the Companies Act.

In addition, prospective applicants that possess certain disqualifying characteristics listed in the FIEA are precluded from submitting an application to register as an investment manager.

Closed-ended retail funds

Contract-type DIFs. See above, Open-ended retail funds.

Company-type DIFs. See above, Open-ended retail funds. Regarding J-REIT, an investment manager must also be registered with the MLIT.

FIFs. An investment manager is, in principle, not required to be registered with the FSA when it manages FIFs according to the laws of a foreign jurisdiction. In contrast, an investment manager that manages FIFs from within Japan will be subject to the FIEA and must be registered as an investment manager with the FSA.

Assets portfolio

7. Who holds the portfolio of assets? What regulations are in place for its protection?

Open-ended retail funds

Contract-type DIFs. The asset portfolio of Contract-type DIFs which are open-ended funds must be held by a trust company or a financial institution engaging in the trust business (collectively, a Trust Company etc.).

A Trust Company etc. must segregate the asset portfolio from its proprietary assets and other assets it is holding on trust.

Closed-ended retail funds

Contract-type DIFs. See above, Open-ended retail funds.

Company-type DIFs. The asset portfolio of Company-type DIFs must be held by any of the following (collectively, a Custodian Company):

  • A Trust Company etc.

  • A Financial Instruments Business Operator engaging in the securities management business.

  • A company with sufficient financial and human resources to be a custodian of real estate, monetary claims and other assets.

A Custodian Company must segregate the portfolio assets from its proprietary assets and other assets it is holding as custodian.

FIFs. The holder of an FIF's assets varies, depending on the governing law of the FIF.

Legal fund vehicles

8. What are the main legal vehicles used to set up a retail fund and what are the key advantages and disadvantages of using these structures?

Open-ended retail funds

Legal vehicles. Contract-type DIFs are one of the main legal vehicles used to establish open-ended retail funds.

Advantages. These are:

  • Retail investors can invest in DIFs in small amounts.

  • Since a retail fund is generally offered through a public offering, disclosure documents are publicly available for retail investors.

Disadvantages. Costs borne by investors are relatively high.

Closed-ended retail funds

Legal vehicles. ETFs, which are Contract-type DIFs, are one of the main legal vehicles used to establish closed-ended retail funds.

Advantages. These are:

  • Retail investors can trade in ETFs at market price.

  • Since a retail fund is generally offered through a public offering, disclosure documents are publicly available for retail investors.

  • Costs borne by investors are relatively low.

Disadvantages. The minimum amount required to invest in ETFs is relatively high.

Investment and borrowing restrictions

9. What are the investment and borrowing restrictions on retail funds?

Open-ended retail funds

Contract-type DIFs. A Contract-type DIF primarily invests in the following assets:

  • Securities.

  • Rights pertaining to derivative transactions.

  • Real property.

  • Leasing rights in respect of real property.

  • Superficies rights.

  • Promissory notes.

  • Monetary claims.

  • Certain types of investment equity.

  • Commodities.

  • Rights pertaining to transactions related to commodities investment, and so on.

  • Renewable energy power generation facilities.

  • Rights to operate public facilities.

Regulations issued by the Investment Trusts Association of Japan (Self-Regulations) restrict the assets that can be invested in by Contract-type DIFs which invest more than half of their assets in securities or securities-related derivative transactions (Securities-Related Contract-type DIFs).

Although there are no statutory borrowing restrictions on Securities-Related Contract-type DIFs, the Self-Regulations impose on DIFs certain borrowing restrictions with respect to Securities-Related Contract-type DIFs. Specifically, the Self-Regulations permit borrowing by Securities-Related Contract-type DIFs only where such borrowing is intended for the payment of redemption money or the payment of dividends with respect to reinvestment-type DIFs. Additionally, the Self-Regulations limit the amount that can be borrowed for such purposes.

Closed-ended retail funds

Contract-type DIFs. See above, Open-ended retail funds.

Company-type DIFs. See above, Open-ended retail funds.

FIFs. The investment and borrowing restrictions applicable to an FIF vary, depending on the governing law of the FIF.

 
10. Can the manager or operator place any restrictions on the issue and redemption of interests in retail funds?

Open-ended retail funds

Contract-type DIFs. Restrictions are permitted to be imposed on the issuance of units in open-ended retail funds. Units in open-ended funds are generally redeemable.

Closed-ended retail funds

Contract-type DIFs/Company-type DIFs. Restrictions are permitted to be imposed on the issuance of in closed-ended retail funds. Shares or units in closed-ended funds are generally irredeemable.

FIFs. Restrictions that are permitted to be imposed on the issuance or redemption of interests in an FIF vary, depending on the governing law of the FIF.

 
11. Are there any restrictions on the rights of participants in retail funds to transfer or assign their interests to third parties?

Open-ended retail funds

Contract-type DIFs. There are no statutory restrictions on the right of investors in Contract-type DIFs to transfer or assign their units to third parties.

Closed-ended retail funds

Contract-type DIFs. See above, Open-ended retail funds.

Company-type DIFs. See above, Open-ended retail funds.

FIFs. Restrictions on the right of investors in an FIF to transfer or assign their interests to third parties vary, depending on the governing law of the FIF.

Reporting requirements

12. What are the general periodic reporting requirements for retail funds?

Open-ended retail funds

Investors. The investment manager of a Contract-type DIF is required to prepare and deliver a management report for every financial period.

Regulators. The investment manager of a Contract-type DIF is required to file a management report with the FSA without delay upon the report being prepared.

Closed-ended retail funds

Investors. The following applies:

  • Contract-type DIFs. See above, Open-ended retail funds.

  • Company-type DIFs. The investment manager of a company-type DIF is required to periodically prepare and deliver management reports.

  • FIFs. The reporting requirements to investors in respect of an FIF depend on the governing law of the FIF.

Regulators. The following applies:

  • Contract-type DIFs. See above, Open-ended retail funds.

  • Company-type DIFs. The investment manager of a company-type DIF is not required to file a management report with any regulatory body.

  • FIFs. The reporting requirements to regulators in respect of an FIF vary, depending on the governing law of the FIF.

Tax treatment

13. What is the tax treatment for retail funds?

Open-ended retail funds

Funds. In relation to Contract-type DIFs, no fund-level taxation is imposed towards Contract-type DIFs that publicly offer their interests in Japan.

Resident investors. In relation to Contract-type DIFs (individuals):

  • Income withholding tax at the rate of 15.315% and local withholding tax at the rate of 5% will be imposed on profit distributions (to be treated as interest income under Japanese tax law) from Contract-type DIFs that invest in public and corporate bonds (Bond-Related Contract-type DIFs).

  • Income withholding tax at the rate of 15.315% and local withholding tax at the rate of 5% will be imposed on profit distributions (to be treated as dividend income under Japanese tax law) from Contract-type DIFs that are Securities-Related Contract-type DIFs other than Bond-Related Contract-type DIFs (Equity-Related Contract-type DIFs), where such DIFs publicly offer their shares or units in Japan.

  • Profit distributions from other Contract-type DIFs, with some exceptions, will be subject to income withholding tax at the rate of 20.42% (but no local withholding tax).

In relation to Contract-type DIFs (corporations):

  • Income withholding tax at a rate of 15.315% (but no local income withholding tax will be imposed on profit distribution (to be treated as interest income) from Bond-Related Contract-type DIFs.

  • Income withholding tax at the rate of 15.315% (but no local income withholding tax) will be imposed on profit distributions (to be treated as dividend income) from Equity-Related Contract-type DIFs.

  • Profit distributions from other Contract type DIFs, with some exceptions, will be subject to income withholding tax at the rate of 20.42% (but no local withholding tax).

Non-resident investors. Income tax will only be imposed on non-resident investors with regard to income classified as domestic source income.

Closed-ended retail funds

Funds. In relation to Contract-type DIFs, see above, Open-ended funds.

For Company-type DIFs, taxation will be imposed on Company-type DIFs at the fund level. If certain requirements are fulfilled (such as the requirement that more than 90% of distributable profits must be distributed to investors), dividends paid to investors may be counted as tax deductible expenses.

For Contract-type FIFs, no corporate income taxation at the fund level is applicable. However, passive income received by the fund from Japanese sources will generally be subject to withholding tax in Japan.

Income received by Company-type FIFs from any Japanese source will generally be subject to taxation.

Resident investors. In relation to Contract-type DIFs, see above, Open-ended funds.

In relation to Company-type DIFs (individuals):

  • Income tax at the rate of 15.315% and local tax at the rate of 5% will be imposed on profit distributions (to be treated as dividend income) from listed closed-ended Company-type DIFs (such as ETFs).

  • Income withholding tax at the rate of 20.42% (but no local withholding tax) will be imposed on profit distributions (to be treated as dividend income) from Company-type DIFs that are not ETFs or open-ended Company-type DIFs.

In relation to Company-type DIFs (corporations), taxation applicable to individuals will apply equally to corporations, except that corporations will not be subject to local withholding tax on profit distributions from listed closed-ended Company-type DIFs.

In relation to Contract-type FIFs:

  • Contract-type FIFs that publicly offer their units in Japan that invest in public and corporate bonds (Bond-Related Contract-type FIFs) (and privately placed Contract -type FIFs) are generally treated identically for tax purposes to their equivalent Contract-type DIFs when investors receive profit distributions through a domestic payment handling agent.

  • When individual investors receive profit distributions through a domestic payment handling agent, income withholding tax at the rate of 15.315 % and local withholding tax at the rate of 5% will be imposed on profit distributions (to be treated as dividend income under Japanese tax law) from Contract-type FIFs other than Bond-Related Contract-type FIFs that publicly offer their units in Japan.

  • When corporation investors receive profit distributions through a domestic payment handling agent, income withholding tax at the rate of 15.315% (but no local withholding tax) will be imposed on profit distributions (to be treated as dividend income under Japanese tax law) from Contract-type FIFs other than Bond-Related Contract-type FIFs that publicly offer their units in Japan.

In relation to Company-type FIFs:

  • When individual investors receive profit distributions through a domestic payment handling agent, income withholding tax at the rate of 15.315% and local withholding tax at the rate of 5% will be imposed on profit distributions from Company-type FIFs that publicly offer their units in Japan.

  • When corporation investors receive profit distributions through a domestic payment handling agent, income withholding tax at the rate of 15.315% (but no local withholding tax) will be imposed on profit distributions from Company-type FIFs that publicly offer their units in Japan.

Non-resident investors. In relation to DIFs, see above, Open-ended funds.

Dividends from FIFs are not taxable in Japan.

Quasi-retail funds

14. Is there a market for quasi-retail funds in your jurisdiction?

There is no quasi-retail funds market in Japan.

Reform

15. What proposals (if any) are there for the reform of retail fund regulation?

The author is not aware of any proposal to reform retail fund regulations in Japan.

 

Hedge funds

16. What is the structure of the hedge funds market? What have been the main trends over the last year?

An FSA-published report entitled Results of Monitoring of Funds, which sets out information regarding investment funds in Japan as of October 2015, states that the number of hedge funds established from April 2014 to March 2015 and types of those hedge funds are as follows:

  • FIFs: 71 (JPY355.9 billion).

  • Contract-type DIFs: 244 (JPY1628.4 billion).

  • Collective Investment Scheme (CIS): 58 (JPY10.9 billion). CIS are generally structured as NI (Nini Kumiai), LPS (Toshi Jigyo Yugen Sekinin Kumiai) or TK (Tokumei Kumiai).

Regulatory framework and bodies

17. What are the key statutes and regulations that govern hedge funds in your jurisdiction? Which regulatory bodies regulate hedge funds?

Regulatory framework

Hedge funds are primarily governed by the FIEA. Additionally, hedge funds which are FIFs are regulated under the ITICA.

Regulatory bodies

The FSA is the primary regulatory body for hedge funds. The SESC has authority to inspect registered Financial Instruments Business Operators.

 
18. How are hedge funds regulated (if at all) to ensure compliance with general international standards of good practice?

Risk

Generally, the governing law of FIFs regulates risks related to FIFs. Japanese law does not impose particular requirements with respect to risk management of FIFs.

Valuation and pricing

Generally, the governing law of FIFs regulates the valuation and pricing of shares or units offered by FIFs. Japanese law does not impose particular requirements with respect to the valuation and pricing of shares or units offered by FIFs.

Systems and controls

Generally, the governing law of FIFs regulates the systems and controls of FIFs. Japanese law does not impose particular requirements with respect to the systems and controls of FIFs.

Insider dealing and market abuse

The FIEA prohibits the sale and purchase of listed securities by affiliated persons, and persons receiving information from affiliated persons, who know or who have access to significant insider information concerning the listed securities of a listed company prior to the disclosure of such significant insider information.

Wrongful acts are generally prohibited, that is:

  • Use of wrongful means, schemes or techniques.

  • Misrepresentation on important matters, or lack of representation about important matters necessary for avoiding misunderstanding.

  • Use of false quotations.

Spreading rumours, using fraudulent means, committing assault or intimidation is prohibited. Market manipulation is also prohibited.

Transparency

See Question 23.

Money laundering

The Act on Prevention of Transfer of Criminal Proceeds (Act No. 22 of 2007, as amended (APTCP)) stipulates that a Specified Operator (as defined in the APTCP) who conducts any transaction that falls within a category of Specified Transactions (as defined in the APTCP) is required to adequately perform verification of the identity of its client upon commencement of the Specified Transaction (Verification). 

In performing Verification, the Specified Operator is required, at the time of the transaction, to verify the following matters with respect to its clients and the client's personnel who are in charge of the Specified Transaction:

  • Name.

  • Domicile (or location of principal office).

  • Date of birth (or date of birth of the representative).

  • Purpose of the transaction.

  • Occupation (or description of business).

  • Identification of every shareholder of the client which holds more than 25% of the voting rights in the client.

The Verification must be conducted through the use of prescribed official identification documents (such as a registration certificate, an insurance certificate, a driver's licence, or a resident card).

The APTCP requires a Specified Operator to report suspicious transactions to the FSA if any property accepted from its client in connection with the Specified Operator's business is suspected to be criminal proceeds, or if the client is suspected to have committed the crime of concealment of criminal proceeds or drug-related criminal proceeds.

The matters required to be reported to the FSA include:

  • Information on the Specified Operator filing the report (such as name, address and telephone number).

  • Information regarding the suspicious client (such as the name, address, telephone number, nationality and the date of establishment).

  • The reason for the report.

Short selling

Naked short selling of securities is prohibited in principle, and certain short selling that exceeds the amount prescribed under the FIEA must be reported to the relevant securities exchange.

Marketing

19. Who can market hedge funds?

FIFs/Contract-type DIFs. See Question 4.

There are, however, certain exemptions from this registration requirement. Specifically, an offshore entity that is allowed to operate securities-related services in its home jurisdiction (Foreign Securities Firm) may qualify for the Foreign Securities Firms exemption if it engages in the following:

  • Provision of securities-related services to (including solicitation of securities investments from) a Financial Instruments Business Operator providing securities-related services.

  • Provision of securities-related services from outside of Japan to financial institutions (only for the investment purposes of such financial institutions or for account of settlors under trust agreements) and investment management companies (for such companies' investment management purposes).

  • Sale and purchase of already issued securities to or from banks pursuant to the sale and purchase orders from the clients of such banks.

  • Provision of sale and purchase, intermediary, brokerage or agency services from outside Japan for the sale and purchase of already issued securities to or from a person in Japan, according to the sale and purchase orders of that person, provided that the Foreign Securities Firm providing the services does not engage in any solicitation.

  • Sale and purchase of already issued securities to or from a person in Japan via a Financial Instruments Business Operator (which acts as an agent or intermediary) provided that the Foreign Securities Firm providing the services does not engage in any solicitation.

CIS. Under the FIEA, the sale, offering or distribution of interests in CIS fall within the definition of Type II Financial Instruments Business, and any person conducting such activities is, in principle, required to be registered with the FSA as a Type II Financial Instruments Business Operator.

The Foreign Securities Firm exemption is also applicable to CIS (see above).

Despite this, the general partner of the CIS may be able to engage in sales, marketing or distribution, without any registration, subject to certain conditions in Article 63 of the FIEA (QII Business Exemption). The QII Business Exemption is available if:

  • The investors in the CIS consist of at least one Qualified Institutional Investor (as defined in the FIEA) (QII) and up to 49 Eligible Non-QIIs (as defined in the FIEA), and none of them are Unqualified Investors (as defined in the FIEA).

  • The limited partnership agreement or other documents that bind the investors stipulates the requisite transfer restriction in accordance with the FIEA.

  • The requisite notification is filed with the relevant Local Finance Bureau (LFB).

Important amendments to QII Business Exemption came into effect from 1 March 2016 (see Question 28).

 
20. To whom can hedge funds be marketed?

FIFs/Contract-type DIFs. See Question 5. In terms of disclosure requirements, if the shares or units in a hedge fund are offered by way of private placement, the requirements applicable to the private placement must also be fulfilled. See also Question 23.

In terms of licensing requirements, if the Foreign Securities Firms exemption is applied, the requirements applicable to the exemption must also be fulfilled (see Question 19).

CIS. Generally, CIS can be offered or distributed to any investor. In terms of disclosure requirements, however, for interests in a hedge fund offered by way of private placement, the requirements applicable to the private placement must also be fulfilled (see Question 23).

In terms of licensing requirements, if the Foreign Firms Exemption or the QII Business Exemption is used, the requirements applicable to the exemption must also be fulfilled (see Question 19).

Investment restrictions

21. Are there any restrictions on local investors investing in a hedge fund?

Assets portfolio

22. Who holds the portfolio of assets? What regulations are in place for its protection?

FIFs/Contract-type DIFs. See Question 7.

CIS. The asset portfolio of CIS is held by a general partner.

Requirements

23. What are the key disclosure or filing requirements (if any) that must be completed by the hedge fund?

In addition to the filing requirements referred to in Question 3, the offering of units, shares or interests in a hedge fund by way of private placement should fall within either of the two private placement exemptions (the Small Number Placement exemption or the Professional Placement exemption) to avoid the burdensome requirement of filing a securities registration statement under the FIEA.

Small Number Placement

To qualify for the Small Number Placement exemption, placement by the hedge fund has to be made to less than 50 investors. In addition, the following have to be complied with.

Contract-type FIFs/Contract-type DIFs. The issuer of the units must not have issued any units which are of the same kind as those listed or traded on any stock exchange in Japan, or those previously offered in Japan through a public offering.

In addition, the private placement memorandum or other written material explaining the units to be placed to investors in Japan must include a warning to the effect that either:

  • The unit holder may be unable to transfer its units unless the unit holder transfers all of its units.

  • The total number of certificates evidencing the units or the total number of units is less than 50 and the certificates or units cannot be divided because of the nature of the units or cannot be divided into lots that are less than the units represented on the certificate.

Company-type FIFs. The issuer of units is not permitted to issue shares which are of the same kind as those listed or traded on any stock exchange in Japan, or those previously offered in Japan through a public offering.

CIS. If the fund is a CIS, a private placement for newly issued interests in the CIS is available if the number of investors is 499 or less (note that the threshold number is counted based on the number of subscribers, not the number of offerees).

Professional Placement

To qualify for the Professional Placement exemption the placement has to be made only to Qualified Institutional Investors. In addition, the following have to be complied with.

Contract-type FIFs/Contract-type DIFs. The issuer of the units must not have issued any units which are of the same kind as those listed or traded on any stock exchange in Japan, or those previously offered in Japan through a public offering.

In addition, the private placement memorandum or other written material explaining the units to be placed to investors in Japan must include a warning to the effect that any sale or transfer of the units to any person who is not a Qualified Institutional Investor is prohibited (Restriction on Transfer).

Company-type FIFs. The issuer of the units must not have issued any units which are of the same kind as those listed or traded on any stock exchange in Japan, or those previously offered in Japan through a public offering.

In addition, the issuer or offeror of the units and each investor thereof must enter into an agreement concerning the sale and purchase of the units, and the agreement has to contain a provision that the investor is subject to the Restriction on Transfer.

CIS. Professional placement is not available for CIS.

 
24. What are the key requirements that apply to managers or operators of hedge funds?

FIFs/Contract-type DIFs. See Question 6.

CIS. In principle, a general partner of CIS must be registered as an investment manager pursuant to the FIEA if at least one investor residing in Japan invests in the CIS. Irrespective of the foregoing, the general partner of the CIS would be able to engage in investment management, without any registration, subject to certain conditions prescribed in Article 63 of the FIEA (QII Business Exemption). The QII Business Exemption is available if the investors in the CIS consist of at least one Qualified Institutional Investor and up to 49 general investors, and the requisite notification is filed with the relevant Local Finance Bureau.

Legal fund vehicles and structures

25. What are the main legal vehicles used to set up a hedge fund and what are the key advantages and disadvantages of using these structures?

As we mentioned above, hedge funds are typically structured as FIFs, Contract-type DIFs or CIS (commonly, as Foreign CIS).

FIFs/Foreign CIS

Advantages. The advantages of structuring hedge funds as FIFs or Foreign CIS vary, depending on the governing law of the relevant FIF or Foreign CIS.

Disadvantages. The disadvantages of structuring hedge funds as FIFs or Foreign CIS vary, depending on the governing law of the relevant FIF or Foreign CIS.

Contract-type DIFs

Advantages. See Question 8.

Disadvantages. See Question 8.

Domestic CIS

Advantages. The advantages of structuring hedge funds as Domestic CIS are:

  • Structure is flexible.

  • Costs to set up a vehicle are relatively low.

Disadvantages. The disadvantages of structuring hedge funds as Domestic CIS are:

  • The governance is relatively weak.

  • Not appropriate for a large number of investors.

Tax treatment

26. What is the tax treatment for hedge funds?

Funds

In relation to FIFs, see Question 13.

In relation to Contract-type DIFs:

  • No fund-level taxation is imposed on Contract-type DIFs that are Securities-Related Contract-type DIFs, where such DIFs privately place their interests in Japan.

  • Fund-level taxation is generally applicable to Contract-type DIFs that are not Securities-Related Contract-type DIFs, where such DIFs privately place their interests in Japan. To avoid double taxation, certain requirements must be fulfilled (such as the requirement that more than 90% of distributable profits must be distributed to investors).

In relation to Domestic CIS, NKs, LPSs and LLPs are not subject to fund-level taxation. TKs (TK operators) are subject to fund-level taxation, but dividends payable to investors (silent partners) can be counted as tax deductible expenses. In relation to Foreign CIS, no fund-level taxation is imposed on Foreign CIS, unless such Foreign CIS is treated as a corporation for Japanese tax purposes.

Resident investors

In relation to Contract-type FIFs, see Question 13.

In relation to Company-type FIFs, when individual/corporation investors receive profit distributions through a domestic payment handling agent, income withholding tax at the rate of 20.42% (but not local withholding tax) will be imposed on profit distributions from Contract-type FIFs that privately place their shares in Japan.

In relation to Domestic CIS (individuals), a tax at progressive rates up to 55.945% (aggregate income taxation) will be imposed.

In relation to Domestic CIS (corporations), a corporate income tax rate of approximately 33% will be imposed.

In relation to Contract-type DIFs, see Question 13.

In relation to Foreign CIS (individuals), a tax at progressive rates up to 55.945% (aggregate income taxation) will be imposed.

In relation to Foreign CIS (corporations), a corporate income tax rate of about 33% will be imposed.

Non-resident investors

In relation to FIFs/Contract-type DIFs, see Question 13. In relation to Domestic CIS, if non-resident investors are considered as having a permanent establishment in Japan, they will generally be required to file a tax return on income tax or corporate income tax on Japanese sourced income. Additionally, dividends from Domestic CIS will be treated as Japanese sourced income and will generally be subject to Japanese withholding tax at the rate of 20.42%.

In relation to Foreign CIS, dividends from Foreign CIS are not taxable in Japan.

Restrictions

27. Can participants redeem their interest? Are there any restrictions on the right of participants to transfer their interests to third parties?

Redemption of interest

FIFs/Contract-type DIFs. See Question 10.

CIS. Interests in a CIS are generally irredeemable.

Transfer to third parties

FIFs/Contract-type DIFs. See Question 11. In terms of disclosure requirements, however, if the shares or units in a hedge fund were offered by way of private placement, the transfer restriction would be imposed (see Question 23).

CIS. There are no statutory restrictions on the right of investors in a CIS to transfer or assign their interests to third parties. In terms of disclosure requirements, however, for interests in a hedge fund offered by way of private placement, the transfer restriction would be imposed (see Question 23). In terms of licensing requirements, if the QII Business Exemption is used, the transfer restriction would be imposed (see Question 19).

Reform

28. What (if any) proposals are there for the reform of hedge fund regulation?

The important amendments to the FIEA (Amendments) to strengthen the regulations concerning the QII Business Exemption came into effect from 3 March 2016. In summary:

  • Prior to the Amendments, the QII Business Exemption was available if the Japanese investors in the CIS consisted of at least one QII and, if the CIS had non-QIIs, up to 49 non-QIIs, and none of them were Unqualified Investors. After the Amendments, however, non-QIIs are limited to the investors who have appropriate abilities to make investment judgment such as:

    • Financial Instruments Business Operators

    • registered financial institutions

    • listed companies;

    • entities with a stated capital of JPY50 million or more;

    • entities with JPY50 million or more of net assets; and

    • foreign companies.

    A general partner (GP) who filed a notification with the relevant LFB prior to 3 March 2016 based on the QII Business Exemption (Existing GP) can continue its investment management based on the requirements before the Amendments unless a new solicitation of interests in the fund is made to investors.

  • If a GP is a foreign company or individual, such GP must designate a representative in Japan. A representative in Japan must be a resident in Japan but is not required to be an officer or an employee of the GP. The Existing GP is also required to appoint a representative in Japan by 31 August 2016.

  • Prior to the Amendments, the notification and supporting documents required to be filed with the relevant LFB under the QII Business Exemption were simple and did not require much information to be included. After the Amendments, however, more information must be included in the notification and more supporting documents are required. The Existing GP is also required to file a notification with the relevant LFB which contains newly required information along with newly required supporting documents by 31 August 2016.

  • In addition, a GP is required to make most of the information included in the notification publicly available in all of their principal business offices or the offices of the relevant business. Alternatively, a GP can also make such information available on their website. Such disclosure is also required for the Existing GP after the Existing GP filed the notification as stated above.

  • A GP must:

    • prepare and preserve statutory books and records;

    • prepare and submit a business report to the relevant LFB; and

    • prepare and disclose a document which contains same contents as the business report.

    The Existing GP also owes such obligations after 1 March 2016.

  • A GP are subject to certain obligations (for example, delivery of statutory documents to investors). However, if proposed investors are limited to professional investors (Tokutei Toshika), most of these obligations will be exempted.

  • A GP could be subject to administrative sanctions if it is necessary and appropriate for the public interest or protection of investors.

 

Online resources

W www.japaneselawtranslation.go.jp/law/detail/?id=1911&vm=04&re02

Description. English translation of the FIEA maintained by Ministry of Justice, Japan. This translation is not an official translation, is potentially out-of-date, and is for guidance only.

W www.japaneselawtranslation.go.jp/law/detail/?id=1903&vm=04&re=01

Description. English translation of the ITICA maintained by the Ministry of Justice, Japan. This translation is not an official translation, is potentially out-of-date, and is for guidance only.



Contributor profiles

Koichi Miyamoto, Partner

Anderson Mori & Tomotsune

T +81 3 6888 5839
F +81 3 6888 6839
E koichi.miyamoto@amt-law.com
W www.amt-law.com/en

Professional qualifications. Japan, attorney-at-law; New York, attorney-at-law

Areas of practice. Investment funds; asset management; banking; financial regulation

Recent transactions

  • Advised an independent private equity firm on structuring PE fund (2016).
  • Advised a Japanese bank's affiliated company on structuring of PE fund (2015).
  • Advised an asset management company on structuring a renewable energy fund established through the joint initiatives between public and private sectors (2015).
  • Advised a Japanese bank on investment in Singapore real estate fund (2014).
  • Advised domestic and foreign companies on application for a licence with respect to fund offering/investment advice/investment management (2014).

Languages. Japanese, English

Professional associations/memberships. Daini- Tokyo Bar Association

Publications.

  • "Global Legal Insights - Banking Regulation 2nd Edition (Japan Chapter)", Global Legal Group (June 2015)

  • "Neate and Godfrey: Bank Confidentiality 6th Edition (Japan Chapter)" Bloomsbury Professional (January 2015).

Akira Tanaka, Associate

Anderson Mori & Tomotsune

T +81 3 6888 5676
F +81 3 6888 6676
E akira.tanaka@amt-law.com
W www.amt-law.com/en

Professional qualifications. Japan, attorney-at-law

Areas of practice. Tax; investment funds; financial regulation; litigation

Recent transactions

  • Advised a Japanese asset management company on investment funds regulations (2016).
  • Advised foreign financial institutions on tax implications of private placement funds (2015).
  • Advised domestic and foreign financial institutions on FATCA and Qualified Intermediary regulations (2014).

Languages. Japanese, English

Professional associations/memberships. Daini- Tokyo Bar Association

Publications

  • "Approaches to obtaining information on overseas financial assets and income in order to enforce a worldwide income tax system: developments of the QI regime and the FATCA regime in the United States", Monetary and Economic Studies (Kinyu Kenkyu) Vol.30 No.4 (October 2011).
  • "Information exchange as tax enforcement: new framework derived from FATCA", (Horitsu Jiho Vol.86 No.2/1069 (January 2014).

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