JAPAN: An Introduction to Banking & Finance: Domestic

The following three topics are currently attracting attention in the Japanese banking and finance sector: (i) the Creation of Security Interests Over the Corporate Value; (ii) Initiatives/Amendments of Laws to “Make Japan an Asset Management Centre”; and (iii) the Current Status of AML/CFT Measures (Measures in Response to the FATF’s 5th Screening).

The Creation of Security Interests Over the Corporate Value

There have been criticisms of the excessive reliance on real estate collateral and managerial guarantees (keieisha hosho) in Japanese lending practices but, in recent years, due to changes in the industrial structure, including the advance of digitalisation, there has been an increase in the number of companies that base their business on technology and know-how rather than tangible assets such as real estate, and the importance of focusing on the generation of cash flow based on these factors when assessing the value of collateral has been emphasised. Against this background, the Act on the Promotion of Cash Flow-Based Lending (the “Cash Flow-Based Lending Promotion Act”) was enacted on 7 June 2024, with the main aim of correcting financing practices that heavily rely on real estate collateral and managerial guarantees, and facilitating access to funding.

At the core of the Cash Flow-Based Lending Promotion Act is the creation of security interests over the corporate value (kigyokachi tanpoken). The security interests over the corporate value are the security interests that cover all of the total assets of the security provider, including goodwill value, contractual status and de facto economic benefits, permits and licences, and other items that constitute the security provider’s assets in the future, and have the following characteristics:

• Rather than a combination of multiple subjects of security (eg, shares and individual assets of target companies) to create security that has been utilised in LBO finance or project finance, the total assets of the security provider, including future cash flows, are subject to security.
• The security interests over the corporate value need to be created in accordance with the trust agreements from the perspective of debtor protection.
• The security interest holder acting as trustee for the above trust is limited to a trust company licensed by the Financial Services Agency of Japan (FSA) (however, where the security interest holder is a bank, etc, a notification is sufficient).
• The security interests over the corporate value become effective when registered in the commercial register at the location of the head office of the security provider, and the priority order in relation to other security interests is determined by the order of perfection.
• For the enforcement, the security interest holder petitions the court and the court appoints the administrator (jikko kanzainin), who then transfers the business of the security provider to the sponsor for realisation, and the security interest holder is entitled to receive dividends from the realisation proceeds in advance of other creditors.

Security interests in the corporate value are expected to be utilised by start-up companies with limited tangible assets, businesses that are hesitant to take over a business utilising managerial guarantees, and business operators undergoing a business turnaround to obtain loans from financial institutions, and further, for expanding the options for corporate financing and promoting business financing, in turn contributing to the growth and development of companies and to the sustainable development of Japan.

On the other hand, it has been pointed out that start-ups that have received loans secured by security interests over the corporate value may find it more difficult to obtain loans from other financial institutions, and start-ups that were previously able to obtain unsecured loans may be required to establish security interests over the corporate value. For the development of financing practices utilising the security interests over the corporate value, it is necessary for financial institutions and business operators to have an accurate understanding of the purpose and system of security interests over the corporate value and to accumulate examples of their utilisation.

The Cash Flow-Based Lending Promotion Act is expected to come into force by the end of 2026 and the FSA is planning to draw up guidelines for loans based on this Act, create model agreements and consult with related organisations by the enforcement date. Future developments will be closely observed.

Initiatives/Amendments of Laws to “Make Japan an Asset Management Centre”

The government of Japan is promoting a shift from savings to investment – especially a trend to increase income gained from financial assets by having households invest their cash and deposits – by developing policy plans such as the Doubling Asset-Based Income Plan, dated 28 November 2022, and the Policy Plan for Promoting Japan as a Leading Asset Management Centre dated 13 December 2023.

In response to such trends, the Working Group on Capital Market Regulations of the Financial System Council, which was established to conduct a professional review of matters such as systematic frameworks of asset management, developed the Report on Asset Management Task Force, dated 12 December 2023. This report focuses on the flow of household investment funds being entrusted to asset management companies, which in turn, invest in companies based on their investment decisions, and makes recommendations such as for the further development of the asset management industry, the supply of growth capital, and the diversification of investment targets. The proposals based on this report led to an amendment to the FIEA on 22 May 2024, which:

• eased the requirements for investment management business registration, the purpose of which is to promote the participation of investment management business operators;
• eased the requirements for registration of type-I financial instruments businesses which provide intermediary services for unlisted securities, the purpose of which is to stimulate the distribution of unlisted securities in the secondary market; and
• abolished the licensing requirement for the operation of a PTS (proprietary trading system) which handles only unlisted securities and is limited in transaction size.

Initiatives to make Japan a leading asset management centre, such as the promotion of the new NISA (Nippon Individual Savings Account), the establishment of the of J-FLEC (Japan Financial Literacy and Education Corporation) to promote financial literacy and education, and the establishment and publication of Common Principles Regarding Asset Owner Operations, Governance and Risk Management, are gaining attention.

The Current Status of AML/CFT Measures (Measures in Response to the FATF’s 5th Screening)

Pursuant to the Guidelines for Anti-Money Laundering and Combating the Financing of Terrorism developed on 22 November 2021, the FSA has demanded that financial institutions fully implement monitoring and continuous customer management. Immediately after the end of March 2024, which was set as the deadline for such implementation, the FSA revised the Frequently Asked Questions Regarding Guidelines for Anti-Money Laundering and Combating the Financing of Terrorism, and revealed that, as a new action policy, it was planning to demand that financial institutions: (i) strengthen the effectiveness of their frameworks for AML/CFT countermeasures; and (ii) take thorough measures corresponding to the degree of AML/CFT risks while broadly recognising the discretion/decisions of each financial institution on AML/CFT countermeasures. It is expected that the FSA’s future supervisory policy will also promote individual and flexible supervisory responses, etc, depending on the status of each financial institution’s previous AML/CFT countermeasures to develop a basic framework.

The Action Plan Regarding Anti-Money Laundering/Combating the Financing of Terrorism/Countering Proliferation Financing (FY2024–2026), which was developed focusing on the FATF’s 5th screening (scheduled for August 2028) and is also generally in line with the frequently asked questions mentioned above in terms of its basic concept, further enhances the understanding of risks incurred by financial institutions, and encourages financial institutions to take specific and effective initiatives on a case-by-case basis, based on risk assessments. Due to the fact that, in the FATF’s 5th screening, the risks unique to the respective countries and the important screening items which take into consideration the results of the 4th screening, as well as the screening on the effectiveness of the measures, will be more heavily focused than in the 4th screening, making it important to identify/implement necessary measures.

Furthermore, as a new development on AML/CFT countermeasures, there have been attempts to realise efficient and effective monitoring of transactions by integrating the advanced systems which use cutting-edge technology. In fact, Hiroshima Bank began operating an AI-based monitoring system in FY2023, which has produced some results in preventing fraudulent accounts from being overlooked, and the National Bankers’ Association is in the process of introducing an “AI scoring service for transaction monitoring” to be offered in phases from 2024 onwards.