Investment funds in Japan: regulatory overview

A Q&A guide to investment funds law in Japan.

This Q&A is part of the PLC multi-jurisdictional 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-mjg.

Yusaku Ono, Ryutaro Oka and Pierre Chiasson, Baker & McKenzie GJBJ, Tokyo Aoyama Aoki Koma Law Office (Gaikokuho Joint Enterprise)
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

Domestic and foreign open-ended retail funds are publicly offered and sold in Japan. Domestic open-ended retail funds predominate in Japan. The volume of assets managed through domestic and foreign investment funds has been gradually increasing (although the collapse of the Lehman Brothers global financial services firm in 2008 caused a substantial reduction). Investment funds investing in emerging countries are gaining popularity. Investment funds with a denominated currency that can be selected by the unitholders are also popular.

Funds investing in domestic stocks are continuing to lose popularity as a result of the weak stock market in Japan following Lehman's collapse and the global financial crisis. Domestic money management funds have also fared poorly, principally because of the very low official discount rates. By contrast, domestic funds investing in foreign sovereign or corporate bonds which provide monthly distributions are still quite popular.

As a general trend, net assets held by investment funds in the Japanese market over the last year, including foreign investment funds (which account for about 6% of the total net assets held by investment funds offered and sold in Japan), increased slightly from JPY98.6 trillion at the end of 2009 to JPY101.4 trillion at the end of 2010 (as at 1 November 2011, US$1 was about JPY77.9).

Closed-ended retail funds

Most closed-ended retail funds offered and sold in Japan are corporate type Exchange-Traded Funds (ETFs), Real Estate Investment Trusts (REITs) or contractual type securities investment funds that do not accept new applications for subscription or redemption after the initial offering period.

ETFs can be domestic or foreign funds, while REITs are almost exclusively domestic funds. The REIT market in Japan has developed rapidly since 2001, when REITs first became available in Japan. From 2001 to 2007, about 40 REITs were established. One of these REITs became insolvent after the global financial crisis, and REITs subsequently became less popular in Japan. There has since been no further increase in the number of REITs, and the REIT market is currently considered stagnant.

During the last year, several REITs merged with other REITs and the total number of REITs decreased accordingly. ETFs (domestic and foreign) also first became available in 2001 and have been developing successfully.

 

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. Domestic funds are established under and regulated by the Investment Trusts and Investment Corporations Act (Investment Trust Law) (Law No 198 of 1951, as amended) and its regulations. The creation of domestic open-ended retail funds is also regulated by the rules of the Investment Trusts Association of Japan (JITA), a self-regulatory organisation.

The management of a domestic fund is conducted by an investment trust management company, which must be registered with, and is subject to the supervision of, the Financial Services Agency (FSA). As contractual type investment funds, domestic funds are established by means of a trust agreement between a Japanese trust bank and an investment trust management company. The offer and sale of units of domestic investment funds is governed by the Financial Instruments and Exchange Law (FIEL) (Law No 25 of 1950, as amended).

Foreign investment funds are generally subject to FSA supervision and the offer and sale of units of foreign investment funds in Japan is subject to the FIEL (together with the relevant regulations under it). However, they are also regulated by the Japan Securities Dealers' Association (JSDA), a self-regulatory organisation.

Regulatory bodies. The Kanto Local Finance Bureau (KLFB) regulates disclosure in relation to retail funds that offer units or shares to the public in Japan.

The FSA regulates most matters, including the supervision and administration of securities businesses.

Closed-ended retail funds

Regulatory framework. The shares of ETFs and REITs are listed on a stock exchange:

  • ETFs can be either domestic or foreign. Foreign ETFs can be corporate type investment funds or contractual type investment funds. Domestic ETFs are only corporate type investment funds.

  • REITs are almost exclusively domestic. REITs in Japan are a corporate type investment fund.

Domestic ETFs and REITs, as corporate type domestic investment funds, are regulated by the Investment Trust Law. As with open-ended funds, the investment management of a REIT or domestic ETF is conducted by an investment trust management company, which must be registered with, and is subject to the supervision of, the FSA.

The offer and sale of shares of foreign ETFs in Japan is regulated by FIEL and the rules of the JSDA. Foreign ETFs are supervised by the FSA and the JSDA (through the relevant securities brokers and banks).

Regulatory bodies. See above, Open-ended retail funds: Regulatory bodies.

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

Open-ended retail funds

There are certain disclosure requirements, and a securities registration statement (SRS) (see Question 22) must be filed with the KLFB. A prospectus must be delivered to any potential investor before they invest. The issuer of units of a retail investment fund must also file a specified form of notification with the FSA under the Investment Trust Law before it can offer or sell the shares/units of a fund.

The notification requirements, and its contents, are determined by whether the investment fund is:

  • Domestic or foreign.

  • A contractual or corporate type investment fund.

The content of a notification for domestic funds generally includes:

  • The trust agreement.

  • Information regarding the distribution of units and certain other matters.

Notifications for foreign funds require a more detailed explanation of the fund structure. The notification requirements for contractual and corporate type investment funds differ slightly, though these differences are largely administrative.

Closed-ended retail funds

A foreign ETF is generally exempt from filing a notification, although a domestic ETF must file a notification when it is established. REITs, whether domestic or foreign, must file a notification.

 

Marketing

4. Who can market retail funds?

Open-ended retail funds

Both domestic and foreign open-ended retail funds are marketed principally by securities companies and commercial banks. Securities companies are licensed to engage in Type 1 financial instruments and exchange business, including the offer and sale of shares, bonds, units or shares of open-ended investment funds. Commercial banks are authorised to offer and sell the units or shares of open-ended investment funds.

Closed-ended retail funds

Closed-ended retail funds, which are usually listed on a stock exchange, are offered and sold by securities companies. Closed-ended retail funds which are not listed on a stock exchange can be offered by securities companies or commercial banks, though they are also usually marketed by securities companies.

Local closed-ended retail funds consist of:

  • Contractual type securities investment funds. These do not accept applications for new subscription or redemption after the initial offering period.

  • Corporate type REITs and ETFs. These are listed on the Japanese stock exchanges.

Foreign closed-ended retail funds are mainly ETFs and REITs, which are listed on a foreign stock exchange.

 
5. To whom can retail funds be marketed?

Open-ended retail funds

Open-ended retail funds are principally marketed to individuals, since units or shares of these funds are normally publicly offered in Japan. There is no difference between domestic retail funds and foreign retail funds.

Publicly offered funds can be marketed to all recipients, irrespective of their level of sophistication.

Closed-ended retail funds

Closed-ended retail funds (generally REITs and ETFs) are principally marketed to individuals, as they are normally publicly offered in Japan. To the extent such funds are REITs or ETFs, there is no significant difference in the marketing of local closed-ended retail funds and foreign closed-ended retail funds, or in their prospective target investors.

 

Managers and operators

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

Open-ended retail funds

Domestic open-ended retail funds can only be established and managed by an investment trust management company, which must be registered with the KLFB as an investment trust management company.

Foreign open-ended retail funds are regulated by foreign laws and are managed or operated by a foreign manager licensed under the foreign law. A foreign manager cannot manage a domestic fund unless registered with the KLFB as an investment trust management company. However, an investment trust management company that is registered with the KLFB, and which manages a domestic retail fund, can delegate the management of that retail fund to a foreign manager.

Closed-ended retail funds

This is the same as for open-ended retail funds (see above, Open-ended retail funds).

 

Assets portfolio

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

Open-ended retail funds

Japanese contractual type investment funds are structured as trusts. As such, the portfolio of assets is held by a trust bank, which enters into a trust agreement with the investment trust management company.

Closed-ended retail funds

The portfolio of assets of a corporate type domestic fund is usually held by a trust bank, but it can also be held by a custodian (who must be registered under the FIEL as a financial instruments and exchange business operator to engage in the securities management business).

 

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. The main business vehicle for open-ended retail funds (whether foreign or domestic) is the contractual type investment fund (see Question 2). Domestic contractual type investment funds have long been established in Japan. Interests in contractual type funds are called units. Interests in corporate type funds are called shares.

Advantages. Domestic contractual type investment funds have relatively low establishment and maintenance costs as compared with domestic corporate type investment funds. Shares or units of a foreign ETF listed on a foreign stock exchange can be publicly offered and sold in Japan on the secondary market subject to minimal disclosure requirements.

Disadvantages. Domestic and foreign contractual type investment funds are subject to more stringent investment restrictions (as compared with foreign corporate type investment funds). However, foreign contractual type investment funds may be subject to Japanese taxation of entities operating in tax havens. Also, domestic contractual funds do not hold unitholders' meetings, which can lead to a lack of appropriate corporate governance.

Closed-ended retail funds

Legal vehicles. Most closed-ended domestic funds marketed in Japan are REITs and ETFs, which are corporate type investment funds. Interests in REITs and ETFs are called shares.

Advantages. Their structure is similar to a joint stock corporation listed on a stock exchange, and these funds are relatively easy for individual investors to both understand and deal with. Shareholders in a corporate type investment fund can protect their interests more effectively, since they have the ability to exercise voting rights at shareholders' meetings (they have a say in its corporate governance).

Disadvantages. A disadvantage of corporate type investment funds is that they can be more expensive to establish and operate than contractual type investment funds. A corporate type investment fund is subject to Japanese corporate tax at an effective rate of 42% unless certain conditions are met.

 

Investment and borrowing restrictions

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

Open-ended retail funds

The major investment restrictions to which domestic retail funds are subject include:

  • Limitations on short selling (see Question 17, Short selling).

  • Limitations on borrowing.

  • Restrictions on investing in illiquid securities.

  • Restrictions on major acquisitions (over 50%) of the shares of a single company.

  • Restrictions on investments in fund of funds structures.

Contractual type foreign retail funds are subject to the same restrictions as above (except for the last restriction), and corporate type foreign retail funds are only subject to the restrictions on major acquisitions (and certain ancillary restrictions).

Domestic funds can only borrow money in very limited circumstances (such as borrowing to redeem units or shares issued by it). Domestic funds therefore have no way to leverage themselves. Contractual type foreign retail funds are also prohibited from borrowing money, but they can achieve a leveraging effect through a fund of funds structure (where the master fund borrows money and invests it in portfolio securities).

Corporate type foreign investment funds (whether retail or not) and contractual type foreign investment funds (where the units are offered by way of a private placement in Japan) are not subject to borrowing restrictions.

Closed-ended retail funds

REITs can borrow money subject to certain limitations, but must invest primarily in real estate or trust beneficiary interests in relation to real estate. REITs can also issue bonds. ETFs are subject to the same restrictions as open-ended retail funds (see above, Open-ended retail funds).

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

Open-ended retail funds

The investment manager of a contractual type investment fund can place restrictions on the issue and redemption of interests in retail funds, in accordance with the relevant trust agreement.

If no such restrictions are provided in the trust agreement, the investment manager cannot place additional restrictions on the redemption of units in retail funds. While applications for subscription can be restricted by the investment manager of the fund, irrespective of the trust agreement, redemption requests for units of the fund cannot be restricted unless actually provided for in the trust agreement.

Closed-ended retail funds

Corporate type investment funds (including REITs) can place restrictions on the issue and redemption of interests in retail funds in accordance with their articles of incorporation.

 
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

It is possible to transfer units in a retail fund to a third party. However, there is no secondary market for units in retail funds in Japan. As unitholders can also request the redemption of their units, they do not need to transfer their units to third parties.

Closed-ended retail funds

Closed-ended retail funds (including REITs and ETFs) are normally listed on a stock exchange. Accordingly, these shares are traded and transferred on that stock exchange through a securities broker who is a member of that stock exchange.

 

Reporting requirements

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

Open-ended retail funds

Investors. Generally, a performance report (a portfolio management report) must be prepared by the manager of a contractual type investment fund for each fiscal year in accordance with the Investment Trust Law. This must be provided to each unitholder known to the fund, subject to certain exceptions, including where both:

  • Units are privately placed in Japan to qualified institutional investors only.

  • The preparation and delivery of the performance report is not required under the trust agreement.

Corporate type investment funds (including REITs and ETFs) do not need to prepare or deliver a performance report. However, they must prepare and deliver notices to each shareholder to convene shareholders' meetings.

Regulators. Generally, once the units or shares of a retail fund have been publicly offered and sold in Japan, the issuer of the retail fund (the manager) must file:

  • An annual securities report and a semi-annual report with the KLFB under the FIEL. The annual securities report must be filed within three months (for domestic funds) or six months (for foreign funds) from the end of the fund's fiscal year. The semi-annual report must be filed within three months from the end of the fund's first fiscal half-year (in each fiscal year).

  • An extraordinary report with the KLFB if certain material events occur (such as changes to the investment policy, investment restrictions, distribution policy or principal parties).

These reports are available for public inspection through the Electronic Disclosure Investors' Network (EDINET), a system enabling the disclosure of filings through the internet. EDINET is similar to the Electronic Data Gathering, Analysis and Retrieval System (EDGAR) in the US. It performs automated collection, indexing and acceptance of submissions by companies (and others) required to file forms with the KLFB.

If a performance report is prepared and delivered to the fund's unitholders, it must also be filed promptly with the FSA.

Closed-ended retail funds

Investors. This is the same as for open-ended retail funds (see above, Open-ended retail funds).

Regulators. This is the same as for open-ended retail funds (see above, Open-ended retail funds).

 

Tax treatment

13. What is the tax treatment for retail funds?

Open-ended retail funds

Funds. An open-ended retail fund itself (whether domestic or foreign) is not subject to any tax under Japanese law.

Resident investors. Japanese investors in domestic and foreign retail funds who invest in units or shares are subject to tax, which is payable on income and capital gains. Dividends paid by a retail fund (where its units or shares are publicly offered in Japan) to an individual unitholder or shareholder in Japan are classed as "dividend income". This is subject to withholding tax at a rate of 10% (7% income tax and 3% local tax).

Dividends paid by the fund to a Japanese corporation (excluding any public corporation) are subject to withholding tax at a rate of 7% (as income tax). The unitholder or shareholder can select the method of assessment, by comprehensive assessment income tax, separate assessment income tax or no tax-return filing. If the unitholder or shareholder has selected the no tax-return filing method, the taxation process is completed when the taxable amount is withheld with no tax-return filing obligation.

An individual unitholder's or shareholder's gains on the sale of units or shares (including capital gains arising from the repurchase or redemption of units or shares) are subject to separate income tax assessment at the rate of 10% (7% income tax and 3% local tax). If an individual unitholder or shareholder maintains a tokutei kouza (a special trading account relating to withholding tax), capital gains are withheld at the rate of 10% (7% income tax and 3% local tax) with no tax-return filing obligation.

If a retail fund invests only in bonds, notes or debt securities, distributions paid by the retail fund to an individual investor in Japan are subject to withholding tax at the rate of 20%. Gains on the sale of units or shares of these funds (including capital gains arising from the repurchase or redemption of units or shares) are not subject to tax in Japan.

Non-resident investors. Dividends paid by a domestic retail fund (where its units or shares are publicly offered in Japan) to a non-resident investor are subject to withholding tax at a rate of 7%, with no tax-return filing obligation. Gains on the sale of units or shares (including capital gains arising from the repurchase or redemption of units or shares) for a non-resident unitholder or shareholder are not subject to tax in Japan.

Closed-ended retail funds

Funds. A domestic corporate type closed-ended fund is itself subject to Japanese corporate tax at an effective rate of 42%, unless certain conditions are met.

Resident investors. Dividends paid by closed-ended funds are taxed in the same way as dividends paid on the shares of a listed domestic corporation. This is the same as for open-ended retail funds (see above, Open-ended retail funds: Resident investors).

Non-resident investors. This is the same as for open-ended retail funds (see above, Open-ended retail funds: Non-resident investors).

 

Reform

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

There are currently no firm proposals for the reform of retail fund regulation in Japan. However, the obligation on a distributor to explain financial products to prospective investors may be expanded or strengthened in the near future.

The FIEL and its related regulations were amended in 2009 in response to criticism that the Japanese prospectus for publicly offered investment funds was too lengthy and detailed to be useful to prospective investors in Japan. The new regulations came into force on 1 July 2010, and a simplified prospectus must now be prepared and delivered to investors in Japan where the units of a contractual type investment fund are publicly offered and sold in Japan.

An alternative dispute resolution system was adopted from 1 October 2010. Disputes relating to investment funds can now be referred to the relevant alternative dispute resolution institution.

 

Hedge funds

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

Most hedge funds offered in Japan are foreign funds established under the law of the Cayman Islands. The JITA rules do not allow a leveraged structure for domestic investment funds. Therefore, hedge funds (which usually use a financial leveraging model by borrowing funds, for example, long-short portfolios) cannot be established as domestic investment funds. Hedge funds have gained popularity in Japan over the last ten years. The global financial crisis dampened the market for hedge funds, particularly for those using fund of funds structures, but it is steadily recovering.

Hedge funds are steadily gaining popularity as a form of alternative investment due to the stagnation of the domestic stock market and domestic stock investment funds over the last year.

 

Regulatory framework and bodies

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

Regulatory framework

The statutes and regulations that regulate hedge funds in Japan are the Investment Trusts Law, the FIEL and the rules of the JSDA. These laws and regulations also apply to other investment funds, since they do not distinguish between hedge funds and other investment funds.

Regulatory bodies

See Question 2, Open-ended retail funds.

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

Risk

Japanese laws and regulations do not distinguish between hedge funds and other investment funds in relation to risk. If units or shares of hedge funds are publicly offered and sold in Japan, the risks relating to those hedge funds must be disclosed in the same manner as for other investment funds which are publicly offered and sold in Japan.

Valuation and pricing

Although both the frequency of valuation, and the level of pricing per unit or share, for hedge funds is usually lower than that of other investment funds, hedge funds that are publicly offered in Japan must calculate and publish the net asset value per unit or share at least once a month (as must all investment funds that are publicly offered and sold in Japan).

Systems and controls

There is no difference between a hedge fund and other funds in terms of the systems and controls in place. A contractual type domestic investment fund is managed and operated under a trust agreement, which is agreed between an investment trust management company (manager) and a trust bank (trustee). The investment trust management company manages the assets of a hedge fund by giving instructions to the trust bank to trade securities and derivatives through a securities broker or prime broker. The trust bank, which holds the assets of the fund, checks each transaction and records it. The investment trust management company and the trust bank are licensed to conduct their business and are supervised by the FSA.

Insider dealing and market abuse

Investment trust management companies (which are licensed and supervised by the FSA) are prohibited from engaging in insider dealing and market abuse in the same manner as other entities that are subject to the FIEL. The general restrictions on insider dealing and market abuse under the FIEL apply to hedge funds. There are no separate restrictions applicable solely to hedge funds, since Japanese law does not distinguish between hedge funds and other forms of investment funds.

Transparency

A contractual type domestic retail fund (where its units are publicly offered in Japan) is subject to full disclosure and must file:

  • Securities registration statements (see Question 22).

  • Annual securities reports.

  • Semi-annual reports.

  • Extraordinary reports.

  • Performance reports.

  • Prospectuses and related documents.

However, if the units or shares of a hedge fund are privately placed in Japan, virtually no disclosure requirements apply other than the need to deliver performance reports. Certain documentation must also be delivered to the investor before concluding a contract with a non-qualified institutional investor. A notification must be filed with the FSA under the Investment Trust Law (with certain exceptions) for public offerings and private placements (see Question 3).

Money laundering

Since most hedge funds offered and sold in Japan are foreign investment funds established under Cayman law, the administrator of the hedge fund is usually a foreign company, and the relevant foreign law concerning money laundering applies. For Japanese funds, the restrictions in the Japanese Anti-Money Laundering Law apply equally to Japanese distributors of hedge funds.

Short selling

Under the rules of the JITA and the JSDA, no retail investment funds publicly offered in Japan can engage in short selling of securities where, as a result of that short selling, the total market value of securities that the retail fund sells short exceeds the latest available net asset value of the retail fund. Corporate type foreign retail funds and privately placed funds are not subject to this short selling restriction.

 

Marketing

18. Who can market hedge funds?

Hedge funds are mainly marketed by securities brokers in Japan, who are familiar with high-risk financial products. Virtually no local hedge funds are offered and sold in Japan due to the stringency of the JITA borrowing rules (see Question 9). Most hedge funds in Japan are foreign hedge funds (particularly Cayman hedge funds), which are not subject to the JITA rules.

 
19. To whom can hedge funds be marketed?

There is no distinction between hedge funds and other funds under Japanese law, including foreign hedge funds. The method of offer and sale can differ depending on the type of investors (for example, qualified institutional investors, professional investors or members of the general public). However, hedge funds are not specifically restricted to certain types of investors under Japanese law. Virtually no local hedge funds exist in Japan (see Question 18).

 

Investment restrictions

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

Japanese laws and regulations do not distinguish between hedge funds and other investment funds. Accordingly, there are no additional restrictions imposed on local investors investing in a hedge fund, provided the hedge fund satisfies the conditions imposed on other (equivalent) investment funds offered and sold in Japan.

 

Assets portfolio

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

For domestic investment funds, a Japanese trust bank (as trustee under the trust agreement between the trust bank and the investment trust management company) holds the assets of the fund.

The Trust Act (Law No 108 of 2006, as amended) and the Trust Business Act (Law No 154 of 2004, as amended) regulate trust assets, which must be managed separately from the trust bank's own property. This protects the fund's assets (trust assets) from the creditors of the trust bank. This segregation further protects the fund assets from the insolvency of either the manager or the trustee.

 

Requirements

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

Japanese laws and regulations do not distinguish between hedge funds and other investment funds (see Question 20).

SRS

If units or shares of an investment fund are publicly offered and sold in Japan, an SRS must be filed with the KLFB. The SRS is equivalent to a US registration statement and must be filed in Japanese.

An SRS usually becomes effective 16 days after it has been filed with the KLFB. Sales promotions (for example, solicitations for the subscription of units or shares, road shows, and so on) can be completed once the SRS has become effective. During the 16-day waiting period after filing the SRS, sales promotions can be made using a preliminary prospectus. However, applications for the subscription of units or shares cannot be accepted during this period. The SRS is available for inspection through EDINET.

Prospectus

To publicly offer the units or shares of an investment fund, the issuer of the units or shares must prepare a prospectus, which is essentially an extract from the SRS. The issuer of units or shares of an investment fund must prepare both:

  • A mandatory prospectus (a simplified prospectus), which must be delivered to investors in Japan on or before the actual subscription for units of the investment fund, regardless of whether that prospectus is requested by the investor.

  • An optional prospectus (a full prospectus), which must only be delivered if requested by an investor in Japan.

Annual securities report and semi-annual report

Once units or shares of the fund are publicly offered in Japan, the issuer of the units or shares must, in accordance with the FIEL and its related regulations, file an annual securities report and a semi-annual report with the KLFB every year (see Question 12, Open-ended retail funds: Regulation).

If there is a continuous public offer and sale of the units or shares in Japan, the issuer of the units or shares must file an SRS at least once each year to cover the applicable offering period.

Extraordinary report

An extraordinary report must also be filed with the KLFB if certain material events occur (see Question 12, Open-ended retail funds: Regulators). This document is available for public inspection through EDINET.

Performance report

For contractual type investment funds, regardless of whether units or shares have been publicly offered or privately placed, an annual performance report must be prepared regarding certain matters concerning the fund's assets. The performance report must be promptly delivered to unitholders or shareholders known to the distributor of the contractual type investment fund, and must be filed with the FSA. This requirement does not apply to privately placed units for qualified institutional investors if the trust agreement specifies that performance reports are not required.

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

There is no difference between the legal requirements that apply to managers or operators of hedge funds and those that apply to managers or operators of other investment funds (see Question 6).

Managers or operators of a foreign investment fund are not usually subject to Japanese law. To the extent that such a manager or operator can validly, and legally, manage the assets of the foreign fund in the country where it is established under the laws of that country, Japanese law generally recognises that fund. The units or shares of that foreign fund can be either publicly offered or privately placed in Japan, provided the other conditions relevant to such an offering are satisfied. However, a manager or operator of a foreign partnership type fund is subject to Japanese law and must, subject to certain exceptions, be registered under the FIEL to manage the assets of the fund.

A foreign manager cannot directly manage a local hedge fund without being registered as a Financial Instruments and Exchange Business Operator under Japanese law. However, a foreign manager could become a sub-investment manager and manage the assets of a local hedge fund under the Sub-investment Management Agreement between the Japanese investment trust management company (which established the local hedge fund) and the foreign manager, though virtually no local hedge funds exist in Japan (see Question 18).

 

Legal fund vehicles and structures

24. 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?

Contractual Cayman investment funds

Most hedge funds in Japan are foreign investment funds, and contractual type Cayman investment funds are the most popular vehicle used. Since Cayman investment funds are not subject to the same strict regulations applicable to other investment funds in Japan, Luxembourg or Ireland, most hedge funds offered and sold in Japan are established under Cayman law. A participant's interests in a contractual type Cayman fund are normally called units.

Advantages. The key advantages to using the Cayman fund structures are that they are less regulated, and have more flexibility, than other structures. For example, Cayman funds are not usually subject to regulatory requirements concerning investment restrictions.

Disadvantages. The disadvantages of using Cayman funds include that the manager or operator of Cayman funds (and other relevant parties) does not necessarily have sufficient creditworthiness, and is not subject to sufficient supervision by the Cayman authorities.

 

Tax treatment

25. What is the tax treatment for hedge funds?

Japanese laws and regulations do not distinguish between hedge funds and other investment funds (see Question 20).

Funds

See Question 13, Open-ended retail funds: Funds.

Resident investors

See Question 13, Open-ended retail funds: Resident investors.

Non-resident investors

See Question 13, Open-ended retail funds: Non-resident investors.

 

Restrictions

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

Redemption of interest

If hedge funds are open-ended investment funds, participants can redeem their interests. However, the prior redemption notice period is normally longer than that for other investment funds.

Transfer to third parties

There are no regulatory restrictions on the right of participants to transfer their interests to third parties. For partnership type investment funds, the consent of the general partner for a transfer of the participants' interests to third parties is usually required under the partnership agreement.

 

Reform

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

Japanese laws and regulations do not distinguish hedge funds from other types of investment funds, and there are no current proposals for the reform of fund regulation in Japan. There is no ongoing litigation or enforcement action which could impact on the regulation of hedge funds in Japan.

 
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