Fund Distribution in Japan: The Article 63 Exemption and Investment Manager Licensing for Pro-Investors | White & Case LLP International Law Firm, Global Law Practice
Fund Distribution in Japan: The Article 63 Exemption and Investment Manager Licensing for Pro-Investors

Fund Distribution in Japan: The Article 63 Exemption and Investment Manager Licensing for Pro-Investors

Due to the strict regulations on the distribution of fund interests in Japan, raising capital in Japan has been historically challenging for offshore managers seeking Japan investors. Under Japanese law, any person that engages in the marketing of fund interests in Japan must either be registered as a Type 1 Financial Instruments Dealer or a Type 2 Financial Instruments Dealer depending on the type of fund sought to be distributed in Japan. [1] Furthermore, an additional filing may be necessary in connection with the offering itself if the offshore fund is an investment corporation or a unit trust.

This article is an overview of the Qualified Institutional Investor Exemption (tekikakukikan toushikatou tokurei gyoumu, the "Article 63 Exemption") set forth under Article 63 of the Financial Instruments and Exchange Law of Japan (Law No. 25 of 1948, as amended or supplemented from time to time, the "FIEL"). The Article 63 Exemption is an exemption from the business registration requirements normally applicable for managers of offshore funds in relation to self-offering and self-management activities in Japan. While the Article 63 Exemption is generally only applicable to investment funds in the form of limited partnerships, the Article 63 Exemption has been increasingly used by offshore managers as a viable and simple alternative to distribute their fund products in Japan.

This article will also briefly discuss the recent amendments to the FIEL which passed the Japan Diet in May of this year and the potential impact of such amendments on capital raising activities in Japan.

Part 1. The Article 63 Exemption

The Article 63 Exemption is a limited exemption from the business registration requirements which would normally be applicable to an entity engaging in self-offering activities in Japan. With respect to offshore investment funds, the Article 63 Exemption is generally only applicable to the general partner of a limited partnership and not available to managers of other types of fund structures (e.g. trusts, corporations, SICAV's, etc). However, if the limited partnership satisfies certain prescribed conditions and requirements, by filing a "Notification Concerning the Qualified Institutional Investors, Etc. Exempted Businesses" (the "Article 63 Notification"), the general partner may engage in a limited scope of self-offering activities in Japan without being registered as a Type 2 Financial Instruments Dealer. By being able to forgo such registration, the Article 63 Exemption is an attractive option for offshore managers that do not wish to commit significant resources in registering as a Type 2 Financial Instruments Dealer.

Furthermore, it is important to note that the Article 63 Exemption is a two-fold registration exemption for general partners. In addition to the exemption in relation to self-offering activities, the Article 63 Exemption is also an exemption from the registration requirements under Japanese law in relation to self-management activities of the general partner. [2] As discussed more fully in Part 5 below, subject to certain exemptions, the FIEL now requires a general partner of limited partnership with Japanese limited partners to be registered with the Japanese authorities as engaging in an Investment Management Business.[3]

Part 2. Requirements and Restrictions of the Article 63 Exemption

For the general partner to rely on the Article 63 Exemption, the limited partnership must satisfy certain requirements with respect to its composition of Japan investors.[4]

First, the limited partnership must have at least one Qualified Institutional Investor [5] and no more than forty-nine (49) non-Qualified Institutional Investors subscribed to the partnership. The foregoing requirements must be satisfied at all times and for this purpose, the FIEL imposes certain transfer restrictions on the limited partnerships interests offered in Japan.

Second, certain types of Japan investors are prohibited from subscribing to the limited partnership ("Disqualified Investors") under the Article 63 Exemption which includes certain types of special purpose companies (tokutei mokuteki kaisha, "SPC") and operators of an anonymous partnership (tokumei kumai, "TK"). As an investment by a Disqualified Investor will immediately invalidate the Article 63 Exemption, the fund documentation should be appropriately tailored to prohibit the subscription by Disqualified Investors.

Part 3. The Article 63 Notification

The Article 63 Notification is a straight forward notification submitted to the Kanto Finance Bureau of Japan which discloses basic information regarding the general partner, e.g. name and address, name of the representative, the amount of the paid-in capital, names of key personnel, etc. While the names of all entities that have filed an Article 63 Notification are publicly available, the Article 63 Notification themselves are not available for public viewing.

Part 4. Marketing by the Representatives of the General Partner

The Article 63 Exemption permits the general partner to engage in the marketing and distribution of its limited partnership interests in Japan. However, it is important to note that as the Article 63 Exemption is intended as exemption only with respect to self-offering activities, it does not extend to the marketing activities of any party other than the general partner (i.e. delegates of the general partner such as the investment manager may not rely on the Article 63 Exemption). In determining how to properly staff the general partner for the Article 63 Exemption, proper consideration must be given to both Japan tax and regulatory issues.

Part 5. Exemption from the Investment Management Registration

As noted above, the Article 63 Exemption also applies to "self managing" activities of the general partner. Under the FIEL, with respect to any limited partnership which has Japanese limited partners, [6] the general partner is deemed to be providing "self-managing" services to such Japanese limited partners and, by default, is required to be registered under the FIEL as engaging in an Investment Management Business.

However, as it is often not possible for the offshore general partners to register under the FIEL as engaging in an Investment Management Business, general partners are forced to rely on the second branch of the Article 63 Exemption – the exemption from registration for investment management activities. A general partner that has filed under the Article 63 Exemption is exempt from having to register as an investment manager under the FIEL in connection with the self management services provided to its Japan limited partners. However, the limited partnership will need to satisfy the various Article 63 Exemption requirements discussed in Part 2 above.

It is important to note that this second function of the Article 63 Exemption is independent and distinct from the exemption in relation to self-offering activities. In other words, irrespective of whether the general partner is engaging in self-offering activities in Japan, if the limited partnership has a Japanese investor, unless the general partner can satisfy an exemption from Investment Management registration, it will need to rely on the Article 63 Exemption. As this exemption for the Investment Management registration for general partners of offshore funds is extremely narrow, it is our experience that most general partners of offshore limited partnership funds that have Japan limited partners will be required to rely on the Article 63 Exemption irrespective of whether the general partner will be engaging in any marketing activities in Japan.

Part 6. Present and Future Applications of the Article 63 Exemption

The Article 63 Exemption has been increasingly used by offshore managers as a means to distribute their securities in Japan without relying on a third party distributor or having to register themselves as a financial instruments dealer. The Article 63 Exemption is an inexpensive alternative in comparison to having to register as a financial instruments dealer and most offshore managers view the investor limitations of the Article 63 Exemption to be immaterial to their contemplated offering in Japan. Based on this, the Article 63 Exemption is commonly held as an ideal alternative by which offshore managers can test the Japanese investor market prior to investing substantial resources in establishing a Japan distribution operation.

Furthermore, it should be noted that there is an increasing number of cases where an offshore manager utilizes the Article 63 Exemption to indirectly offer non-limited partnership fund products in Japan through the creation of limited partnership feeder funds which invest into either corporate or trust type master funds. While we are not aware of any regulatory restriction which would prevent the foregoing use of the Article 63 Exemption, we would recommend that managers seek both legal and tax counsel to ensure that the use of such limited partnership feeder funds are consistent with the desired goals of the manager while being in full compliance with the laws of Japan.

Part 7. Recent Development regarding Offerings under the Article 63 Exemption

While there has been a great increase in the number of Japan offerings made in reliance of the Article 63 Exemption in the past few years, there has also been an increase in the number of offerings which the Japan regulators deemed to be in violation of Japan law.[7] As a response to the increased abuses of the Article 63 Exemption, the Japanese regulators appear to be more cautious about a fund offering under the Article 63 Exemption and have recently required that all general partners who are operating under the Article 63 Exemption provide regular reports setting forth details of the fund interests being offered to investors in Japan.[8]

Part 8. Recent Amendment to FIEL in Relation to Fund Management and Distribution of Fund Interests to Professional Investors

On May 17, 2011, certain amendments to the FIEL passed the Japan Diet which is anticipated to significantly alter the investment funds landscape in Japan.

The first amendment is the creation of a new business registration for investment managers who deal exclusively with a new class of professional investors - Qualified Investors[9]. In response to criticism that the current law regarding investment managers did not properly differentiate between those investment managers that provided services to professional investors and those investment managers that provided services to general investors (e.g. retail investors), the Financial Services Agency of Japan is seeking to establish a new business registration for investment managers that deal exclusively with Qualified Investors ("Qualified Investor Investment Manager"). The requirements for this new registration would be less stringent than the normal investment manager registration (e.g. less capital requirement, no need for a board of directors, etc.)

Furthermore, provided that the target investor in Japan is a Qualified Investor and the fund is being managed by a Qualified Investor Investment Manager, the new amendment will permit the Qualified Investor Investment Manager to market fund interests categorized as Paragraph 1 Securities in Japan, e.g. units of trusts or shares in companies if it holds a Type 2 Financial Instruments Dealer registration. This is a significant change to the existing securities distributions rules as currently only a Type 1 Financial Instruments Dealer registration holder may engage in any type of distribution of Paragraph 1 Securities in Japan.[10]

Based on the new amendments to the FIEL, offshore managers will be able to engage in a private placement of corporate or trust type funds in Japan through a Qualified Investor Investment Manager registration holder concurrently holding a Type 2 Financial Instruments Dealer registration. This is particularly relevant as most corporate investors in Japan have a strong preference for investments in trust form funds so that they may derive the tax benefits applicable to investments in securities investment trusts.

However, if the offshore manager only seeks to distribute limited partnership interests in Japan, the Article 63 Exemption is undoubtedly the more preferable option in consideration of the set up costs and on-going costs of maintaining a Qualified Investor Investment Manager and Type 2 Financial Instruments Dealer registrations.

While the amendments to the FIEL discussed above regarding the Qualified Investor Investment Manager have passed the Japan Diet, these amendments are not yet effective (it will become effective within one year of the enactment of the law) and we anticipate that detailed regulations will be forthcoming later regarding certain qualifications for Qualified Investor Investment Manger registration, e.g. total maximum amount of assets under management and maximum number of customers.

 

[1] The laws of Japan define two broad types of securities. The first type of security is those securities which are defined under Paragraph 1 of Article 2 of the FIEL ("Paragraph 1 Securities") and include interests of funds in the form of corporation or trusts. The second type of security is those securities which are defined under Paragraph 2 of Article 2 of the FIEL ("Paragraph 2 Securities") and includes interests of funds in the form of limited partnerships. Generally, the distribution of Paragraph 1 Securities in Japan would require a Type 1 Financial Instruments Dealers registration and the distribution of Paragraph 2 Securities in Japan would require a Type 2 Financial Instruments Dealers registration.

[2] Article 2(8)(xv) of the FIEL.

[3] Article 2(8)(xv) of the FIEL.

[4] It is not necessary to include any non-Japan investor for any of these investor profile requirements.

[5] As defined in Article 2, Paragraph 3, Item 1 of the FIEL and Article 10, Paragraph 1 of the Cabinet Office Ordinance on Definitions provided for in Article 2 of the Financial Instruments and Exchange Law of Japan (Ordinance No. 14 of Ministry of Finance of 1993, as amended ("Definition Order")). Qualified Institutional Investors include, but is not limited to, the following types of entities: securities brokers, banks, insurance companies, investment managers, and other corporations and individuals who have securities portfolio of at least 1 billion yen and registered as Qualified Institutional Investor with the Financial Services Agency of Japan.

[6] There is an exemption to the registration requirement on the general partner in cases where the partnership is not deemed to have a sufficient nexus to Japan (e.g. minimal number of Japanese investors, all of the Japanese investors are Qualified Institutional Investors).

[7] Violations of the Article 63 Exemption reported by the regulators include cases whereby the limited partnership did not have a Qualified Institutional Investor subscribed or cases whereby more than 49 non Qualified Institutional Investors purchased the fund interests.

[8] Please note that this does not include any information regarding the identity of specific investors in the partnership.

[9] Qualified Investors (tekikaku toushika) as defined under Article 29-5(3) of the revised FIEL. It should be noted that Qualified Investors includes not only Qualified Institutional Investors but also listed companies, companies having at least 500 million yen in assets, investment funds, etc. Please note that the detailed definition will be forthcoming later in this year.

[10] The Type 1 Financial Instruments Dealer registration is one of the most onerous business registrations under the FIEL (capital requirements, compliance, reporting, personnel, etc.)

 

First published in International Tax Review Capital Markets Guide, July 2011First published in International Tax Review Capital Markets Guide, July 2011

 

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