Capital-Raising Regulations

Regulatory Environment

Japan is no exception to the heightened regulatory sensitivity regarding securities distribution that has been evidenced around the world. In fact, many fund lawyers argue that it is one of the most highly regulated of all jurisdictions.

Consequently, asset managers seeking to access investors here need to be aware of the securities regulations as they relate to the placement of their funds.

There are two fundamental elements to the securities regulations concerning the marketing of funds: the first relates to fund registration and the form or type of notification that is required; and the second relates to the licenses necessary for the purpose of soliciting investors on behalf of the fund.

Marketing corporate or trust structures

Any fund that is structured as either a corporate entity that issues shares to investors or a trust entity that issues units to investors must, under the Investment Trust and Investment Company Law (“ITICL”), file a notification with the local finance bureau of the Financial Services Agency (“FSA”) prior to engaging in any solicitation activities in Japan. If the filing is made in Tokyo as most are, that branch will be the Kanto Local Finance Bureau (“KLFB”). In the case of a private placement that is organized for the purpose of marketing a fund to qualified institutional investors (“QIIs”) and professional investors, the filing consists of a relatively simple notification informing the FSA that a specific fund will be marketed within Japan. It is not, as some managers fear, a registration of the asset management company with the FSA.

The private placement regime in Japan is an excellent way by which to target institutional investors because by filing this one-time only notification, a fund can be marketed to an unlimited number of QIIs without the requirement for annual reporting. The Expanded Private Placement can be used to target individual investors in addition to QIIs and professional investors but it is fairly inefficient because only 49 non-QII and non-professional investors may be solicited within a rolling six-month period. Moreover, any private placement that targets non-QIIs must submit annual reports to the appropriate Local Finance Bureau.

Once the ITICL Notification has been completed and submitted to the KLFB, a fund may be marketed by an appropriately registered Financial Instruments Business Operator or “FIBO”, the Japan equivalent of a US FINRA registered Broker-Dealer. Asset Managers should note that a “Type-1” FIBO License is required for the solicitation and sales of any collective investment scheme that issues shares or units. There are no safe-harbours allowing for self-marketing nor is there a statutory exemption for reverse enquiry.

The only means of targeting a larger number of individual investors is by way of submitting a full Securities Registration Statement and making a public offering. Teneo Partners has filed several of these and will be pleased to discuss those mechanics should you have an interest.

Marketing Partnerships

The securities laws concerning limited partnerships are quite different from investment trusts and investment corporations. Under Article 63 of the Financial Instruments and Exchange Act (“FIEA”), a general partner (“GP”) may under certain conditions manage assets of Japanese limited partners (“LPs”) without an asset management license and also solicit potential LPs without a FIBO license. In order to meet this exemption, a GP will need to file a Form 20 and appoint a representative in Japan. They will also need to file an annual management report each year within three months of the close of the asset manager’s fiscal year end. It is important to note that this report relates to the asset management company, not the fund. Moreover, portions of the report must be made available on a website accessible to the public.

Many GPs however have opted out of the exemption for various reasons, none the least of which is to avoid having to file the annual reports. A GP may opt out of reporting under Article 63 and continue to manage assets for Japanese investors without a requisite fund management license provided the fund meets certain criteria:

  1. the fund only accepts up to nine LPs from Japan, all of whom must be professional investors (QIIs);
  2. that no more than one-third of the fund’s total assets come from investors in Japan; and
  3. that the fund engages a registered Type-2 FIBO like Teneo Partners to market to and solicit Japanese LPs.

We should point out that the limitation on the number of LP’s from Japan and the criteria for exemption are on a per fund basis, not a total across all of the funds run by the asset manager.

Preqin Interview with Stanley Howard – June 2019

The recent equity market volatility and the prevailing minimal-to-negative interest rates have made it increasingly difficult for the Japan-based institutional investor to navigate the markets and achieve their desired returns. One point of constant concern is how they can avoid future potential drawdowns in Japanese Government Bonds (JGBs) and create stable income in their portfolios. Among the JGBs issued as of the end of 2018, JPY 109tn is scheduled to mature over the course of the coming fiscal year and investors in these bonds are seeking substitute investment strategies to what traditionally had been a roll-and-hold approach to their JGB exposure. Although they are currently finding it difficult to decide with conviction which assets to invest in, many investors view increasing their allocations to offshore assets as unavoidable. Moreover, it is clear that they are committed to expanding their exposure to alternative assets, particularly those in the areas such as credit, infrastructure and real estate that can provide a relatively stable and consistent yield. While US assets are still the dominant choice, euro-denominated assets are growing in popularity due to the relative affordability of the hedging costs between the euro and the yen.

As we look at the investor landscape in Japan, we typically segment the institutional investor market into the following categories, each requiring unique access routes and approaches: insurance companies, large-scale commercial and specialized banks, trust banks, mid-size banks, regional banks, asset management companies and pension funds.

Asset managers seeking to access these investors need to be aware of the regulatory environment as it relates to solicitation activities and the placement of their funds in Japan. There are two fundamental elements to the regulations concerning the distribution and marketing of funds, each addressed within the Financial Instruments and Exchange Law (FIEA). The first relates to the form of fund registration. The second relates to the licences required for securities solicitation and placement.

Any privately placed fund that is organized as either a corporate form that issues shares to investors or as a unit trust form that issues units to investors must be registered through a notification process with the Financial Services Agency (FSA) through the local branch, which in Tokyo is the Kanto Finance Bureau (KFB). Private placements are divided into three general types.

The first is the Professional Private Placement which restricts fund solicitation to professional investors only. This is frequently referred to as the Qualified Institutional Investor (QII) registration. With a Professional Private Placement, there are no subsequent reporting requirements beyond the initial notification.

The second is the General plus Professional Private Placement which allows the solicitation of all professional investors as well as a limited number of non-professional investors. In this case a fund may only be offered to up to 49 non-professional investors on a rolling six-month basis. Moreover, because this type of private placement may include non-professional investors, the FSA requires that the asset manager file an annual fund report from the year following the initial notification.

There is a third form, the General Private Placement, but because it is restricted to the solicitation of 49 non-professional investors without reference to professional investors, it is quite ineffective and generally not utilized.

For funds that are organized as limited partnerships, the registration process is quite different. The general partner (GP) to the fund will need to file a Form 20 under Article 63 of the FIEA and appoint a representative in Japan. They will also need to file a management report each year within three months of the close of the asset manager’s fiscal year end. It is important to note that this report relates to the asset management company, not the fund. Registration under Article 63 allows the GP to manage the assets of a Japanese entity or person and to market its fund without obtaining a fund management and a securities marketing licence in Japan. However, because the safe harbour does mandate compliance with certain reporting requirements, many GPs have opted out of the exemption in order to avoid filing the annual reports.

A GP may opt out of reporting under Article 63 and continue to manage assets for Japanese investors without a requisite fund management licence if the fund meets certain criteria: (a) it only accepts up to nine LPs from Japan, all of whom must be professional investors; (b) that no more than onethird of the fund’s total assets come from investors in Japan; and (c) that it engages a registered Type-2 Financial Instruments Business Operator or “FIBO” (read Broker-Dealer) to market the fund. We should point out that the limitation on the number of LPs from Japan is on a per-fund basis, not a total across the number of funds run by the manager.

The second fundamental piece of the regulation concerning fund distribution relates to the licences required for solicitation and placement. In Japan, only registered FIBOs are allowed to market securities, including fund interests; a Type-1 FIBO for the sale of fund shares or fund units and a Type-2 for the sale of partnership interests. Other than the one exemption referenced above for GPs who file under Article 63, there are no safe harbors within Japan for self-marketing by fund managers to investors. To be clear, offshore fund managers may approach and engage FIBOs for regulatory assistance in marketing but they may not directly solicit or market to investors.

Unlike some other jurisdictions in the world, there is no statutory exemption in Japan for reverse enquiry. Consequently, asset managers who decide to rely on this as a way of circumventing the Japanese FIEA regulations are taking the risk of running afoul with the regulator. We know of cases, and in fact were asked to mediate in one case, where an offshore manager was sanctioned by the FSA for accepting subscriptions from investors located in Japan without having properly registered the fund and using appropriately licenced distributors.

The marketing approach to financial institutions is quite a straightforward, direct sales transactional process. However, it does require registering the fund if other than a limited partnership and working with a distribution agent that has a Type-1 or Type-2 FIBO licence, depending on the form of the fund being presented. The institutions themselves are becoming more sensitive to regulations surrounding the solicitation process and more frequently ask offshore asset managers about the registration of their funds and their representative in Japan. The challenge is to identify which department in the investor organization is tasked with investments in offshore funds and then to find the right people to speak with. This is further complicated by the fact that within these large financial institutions there are multiple investment groups, divided by the nature of the asset class, the asset pools or the beneficial owners.

Once identified it is a matter of getting in touch and opening a dialogue, but this is easier said than done. Working with a fund distributor that has long experience in the Japanese marketplace and can provide the capacity necessary to service the multiple investor channels and clientele is critical. The sales cycle is typically a long one. The Japanese financial institutions ask many detailed questions and take time to advance discussions internally so patience is required when working towards an allocation. Understanding their process and doing things the right way is critical to success. An allocation within six to 12 months of initial discussions is unusual; a 12- to 24-month process is more typical.

The approach to pension funds in Japan is more complex. Corporate plan sponsors cannot allocate their own assets; they are required to delegate this activity to an outside Discretionary Investment Manager (DIM). Separately, pension plan assets must be custodied at a Trust Bank. Consequently, managers will see pension plan assets flow to them initially through a DIM gatekeeper, then into a Trust Bank which then subscribes to the administrator of their fund. In many cases, an offshore asset manager may not be informed from which pension fund a specific allocation has come. Due to competition the DIM gatekeepers, more often than not, intentionally keep that information confidential. To make matters just a bit more confusing, the large Trust Banks have integrated vertically, setting up their own in-house DIM departments or subsidiaries, leading many offshore asset managers to have the false impression that only Trust Banks can manage pension fund assets. Consultants are active as well, adding another layer of complexity to the selection process.

There are approximately 300 companies in Japan that hold a DIM licence which can be used for either fund management or for contracting with pension plans to allocate their assets. However, because of the difficulty for smaller companies to successfully contract with a plan sponsor, only about 40% of DIM licence-holders are involved in the business of allocating corporate pension assets.

The challenge for an offshore asset manager is to find a way to navigate this complex maze of relationships to receive a mandate for pension fund assets. The traditional approach is to target the gatekeepers and attempt to generate sufficient interest from them to include the fund on their portfolio platform offered to their pension clients. While this may be the obvious approach, it is both an indirect and highly competitive one that can take a long time with little or no feedback from the plan sponsors. The more difficult approach, and one that only licenced FIBOs can make, is to contact the pension funds directly. This is more effective and efficient than approaching a gatekeeper, but it requires a relationship with plan sponsor that has been nurtured over time. It also requires the skill to match the pension fund with a DIM that will agree to sponsor the product through the system and execute the business. Only experienced FIBOs with extensive industry networks like Teneo Partners can successfully orchestrate this kind of coordinated effort.

Asset Managers seeking to market their fund in Japan or planning to contact Japanese investors should seek legal advice before doing so. Teneo Partners is not a licensed legal firm nor are we trained lawyers. Consequently, the preceding text is not meant to be legal advice but rather a discussion of the regulations and the environment that managers will face.

This disclosure notwithstanding, Teneo Partners has been in the business of marketing offshore funds in Japan since 2003, and as a result have accumulated a wealth of experience and knowledge concerning securities regulations as they relate to fund sales and fund management.

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