JAPAN: An Introduction to Investment Funds: Bengoshi

The Policy Plan for Promoting Japan as a Leading Asset Management Centre

In December 2023, the Japanese government issued its “Policy Plan for Promoting Japan as a Leading Asset Management Centre” prompting significant changes to laws and regulations in Japan that have had and will have a profound impact on the investment funds industry in the country. Some notable reforms made in relation to policy include amendments to the Financial Instruments and Exchange Act (FIEA) changing the requirements for registration as an investment manager by:

1. allowing the outsourcing of middle- and back-office functions (including compliance functions) of registered investment managers; and
2. eliminating the need for investment managers to perform asset management functions on their own without retaining sub-managers (which require their own portfolio managers to make investment decisions), thereby allowing registered investment managers that focus on the planning and structuring of funds.

The rules of the Japan Investment Trusts Association (JITA) have also been amended to relax the regulations on publicly offered domestic investment trusts to invest in low-liquidity assets such as foreign investment funds that invest in non-listed securities.

The FIEA Reform

The bill proposing amendments to the FIEA which include the amendments mentioned above and others (the 2024 FIEA Reform) was passed by the Diet on 15 May 2024. Regulations relating to the amended FIEA are currently being drafted and the government will seek comments from the public on the draft regulations before they are finalised and become effective. Although the specific timing for the regulations to become effective is not known, the amended FIEA discussed below is scheduled to take effect within one year from the date of the bill’s passage.

The 2024 FIEA Reform provides for several significant changes including a set of amendments to existing regulations that will promote the entrance of new investment managers into the Japanese market. The changes under the amendments (which are discussed below) include:

1. permitting outsourcing of middle- and back-office functions (including accounting of invested assets and compliance functions) to a "registered" service provider;
2. lowering the required amount of stated capital to register as an investment manager if the investment manager will not keep custody of a clients’ assets; and
3. allowing for investment managers that do not conduct investment management of assets but only fund management activities (which, according to Japan’s Financial Services Agency (FSA), does not include execution of trades). 

With respect to (1) above, outsourcing of the invested asset accounting function is permitted under the current regulations (ie, pre-2024 FIEA Reform) under certain conditions and is an accepted practice. However, the amended FIEA (from the 2024 FIEA Reform) stipulates that so long as the outsourcing of middle- and back-office functions will be to a “registered” service provider, the registered investment manager need not have such functions performed internally and is only required to have someone that can supervise the “registered” service provider.

This amendment is intended to contribute to resolving human resource issues. This amendment would not necessarily mean that outsourcing of middle-/back-office functions (other than the compliance function) to a non-registered service provider, which is permitted under current regulations, will no longer be permitted after the amended FIEA becomes effective. Interested parties should carefully review the drafts of the regulations and the FSA guidelines and watch out for any administrative guidance on this topic that may affect the existing practice therefore.

Additionally, permitting outsourcing of the compliance function of an investment manager to a "registered" service provider is a new development. However, outsourcing of the compliance function is permitted only if the compliance services provider is “registered” as a provider of compliance services, which is a new registration category introduced in the amended FIEA. Details of the requirements for the compliance services provider will be provided in the subordinated regulations of the FIEA and the FSA guidelines, and such compliance services provider will be regulated and supervised by the FSA and be subject to regulatory inspection.

With respect to (3) above, under the current FIEA, an investment manager is expected to have some asset management function in that it is prohibited from delegating its entire investment management authority for all of the assets under its management, and any registered investment manager must have a portfolio manager that makes investment decisions. However, the amended FIEA allows the asset management function to be fully delegated to another investment manager, allowing the registered investment manager to focus on fund management such as product structuring, planning, and management of asset managers that actually implement and execute the investment strategies and investments.

Type I FIBO

Another set of notable amendments relating to investment funds provides for the relaxation of requirements for registration as a Type I Financial Instruments Business Operator (Type I FIBO), which is required to solicit investors in Japan to invest in funds that are in the form of a corporation or trust. Under the current FIEA, unless an exemption from the registration requirements applies, Type I FIBO registration is required in order to offer, in Japan, interests in funds that fall under the definition of foreign investment corporation or foreign investment trust under the FIEA.

The requirements for the Type I FIBO registration for the offering of certain non-listed securities (including the interests in funds) will be relaxed under the amendments of the 2024 FIEA Reform so long as the applicant will not keep custody of clients’ assets. Details of the amendments will likely be included in the subordinated regulations of the FIEA.

The JITA Rule Reform

In order to promote investments in low-liquidity alternative investment assets by domestic investment trusts, the JITA rules were amended in June 2024 to allow for the net asset value (NAV) of domestic investment trusts not to be calculated on a daily basis if the relevant domestic investment trust does not accept subscription or redemption on a daily basis. Furthermore, in order to promote investments in offshore funds that invest in alternative investment assets by domestic investment trusts, the JITA rules were further amended in September 2024 to establish new rules pertaining to domestic investment trusts investing in these offshore funds.

These new rules require the investment trust manager of the domestic investment trust to make certain disclosures (including proper risk explanation) and to take certain measures (such as sufficient consideration for investor needs in the product structuring and design) to ensure that the interests of the investors will be protected.

A Leading Asset Management Centre

As part of the efforts to promote Japan as a leading asset management centre, the introduction of new initiatives, including amendments to regulations and/or guidance on regulatory interpretations, will likely continue. The FSA’s effort to introduce licensing procedures in English started in 2021, and there has been a notable rise in the number of offshore investment managers entering the Japanese market.

Following an amendment to the FIEA that expanded the options for high net worth individuals to be treated as “professional investors” there has been a notable increase in the formation of funds targeting high net worth individuals. These amendments, together with the 2024 FIEA Reform, will likely provide greater flexibility for asset managers in forming and marketing funds to both the institutional and non-institutional investors in Japan.