Nascent listed infrastructure market under the spotlight

Author: | Published: 18 Mar 2015
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Eiichiro Hata of Atsumi & Sakai looks at recent legal and market developments in Japan and asks where they may take the infrastructure market in the future

Some recent progress has been made in setting out the legal framework for developing a listed infrastructure market in Japan. The Tokyo Stock Exchange (TSE) and the Japan Exchange Group have announced a plan to set up a listed infrastructure market system during 2014, aiming to list the first stock during 2015. Legal amendments relating to investment corporations and investment trusts, the most likely investment vehicles, were announced in September 2014, and have come into force.

Recent developments

Japan is said to have an estimated ¥700 trillion ($5.8 trillion) in infrastructure assets including public real estate. However, most infrastructure investment has traditionally been controlled by government, with private infrastructure investment relatively low and a conspicuous absence of any kind of listed infrastructure market. With listed infrastructure markets emerging in many countries (particularly Canada and Australia) that have long led developments in the field, but now also in Singapore, South Korea, Thailand and elsewhere across Asia, Japan is seen as lagging behind. This is not for lack of want, as Japan is faced with a potential bill of some ¥190 trillion over the next 50 years to maintain and upgrade its ageing infrastructure assets just as the government's fiscal situation is becoming increasingly severe. Japan is clearly in need of some mechanism to leverage private funds in managing its infrastructure assets.

"Japan is clearly in need of some mechanism to leverage private funds in managing its infrastructure assets"

There has been some movement in this direction, however. In 2011, the Private Finance Initiative (PFI) Act was amended, introducing a concessions system intended to promote public private partnership (PPP) and PFI activities in Japan. In 2012, the Act on Special Measures Concerning Procurement of Electricity from Renewable Energy Sources by Electricity Utilities (the Fit Act) was enacted, introducing a feed-in-tariff (Fit) system in Japan for the first time, spurring huge private investment in mega-solar, wind and other renewable energy generation projects. The 2020 Tokyo Olympics is also drawing attention to the need for urgent infrastructure-related investment.

Spurred perhaps by this renewed urgency, the TSE in September 2012 set up a Listed Infrastructure Market Study Group (joujou infura shijou kenkyuukai) to investigate the possibility of providing a new asset class for investment and improving Japan's market competition. The Study Group has held discussions on numerous occasions and in May 2013 issued a report on its findings. The Report by the Listed Infrastructure Market Study Group sets out a number of proposals about which directions the listing system should take, the types of infrastructure it should include, and investment vehicle options.

Based on the Report a number of legal amendments were made in relation to investment corporations and investment trusts, which are expected to be the investment vehicle of choice for the listed infrastructure market. These changes to the Investment Trust and Investment Corporation Act (Investment Trust Act) and related regulations were introduced and came into force on September 3 2014.

Scope of infrastructure

The term infrastructure generally refers to the facilities that serve as a basis for industry or social life, including roads, airports, railways, power plants, gas pipelines, schools, hospitals, and parks. The Report suggests that while the scope of infrastructure that can be included on the new listed infrastructure market should be as broad as possible (given that the market will be accessible to a wide range of investor classes including individual investors) it is probably necessary to limit the types of infrastructure asset that can be included, at least until investors fully understand the characteristics of the products and until the market matures. From that perspective, issues were raised in three key areas: (i) the suitability of funds for investment (for example, whether a fund holds infrastructure assets with a suitable income stream); (ii) the characteristics of an investment asset (for example, whether or not it is possible to replace the operator of the asset); (iii) considerations for the public good.

To some extent, the amended Investment Trust Act and related laws and regulations address these issues. The scope of specified assets that investment corporations or investment trusts may mainly invest in and which already included securities, derivatives, and real estate, now include renewable energy power generation facilities (as defined in the Fit Act) and concessions (defined in the PFI Act), as well as equity interests in silent partnerships (tokumei kumiai) that manage such assets. It is now legally clear that listed infrastructure markets can target these assets through such vehicles. The converse is also true in that, based on these amendments at least, listed infrastructure funds still will not be able to invest in infrastructure assets that cannot be considered to be so-called specified assets, including certain real estate, and the newly added renewable energy power generation facilities and concessions.

From an investor protection perspective, the Report also suggests that the listed infrastructure market should only include certain infrastructure assets that are completed and have a demonstrated asset performance, and these limitations are likely to be included in listing requirements as the market framework is built up.

Types of investment vehicles

The Report suggests that investment corporations and investment trusts under the Investment Trust Act should be appropriate as an investment vehicle for listed infrastructure funds, because these vehicles have already achieved a certain success in JREITs as listed products investing in real assets. As recommended by the Report, the Investment Trust Act and related regulations were amended to enable the investment corporations and investment trusts invest in certain types of infrastructure.

In addition to investment corporations and investment trusts, the Report also suggests that 'beneficiary certificates of a trust that issues beneficiary certificates', which are in a form of tradable securities and are already widely used with Japanese depositary receipts (JDRs), although not being used as a vehicle for portfolio investment, may be appropriate on large scale infrastructure deals where the asset itself will not change. The Report also proposes that the listing market be set up so that it can handle listing of foreign infrastructure funds in the future.

Anticipated investment schemes

There are certain kinds of investment schemes that could be developed using investment corporations as suggested by the Report and on the basis of which the legal framework has been adapted under the amended Investment Trust Act and related regulations. These might include: (i) schemes in which the investment corporation directly holds the infrastructure assets, which it leases to an operator who manages the assets under an operating agreement (a direct investment scheme); or, (ii) schemes in which the investment corporation holds the infrastructure assets indirectly via a special purpose vehicle (SPV), such as a trust or partnership (an indirect investment scheme). See Diagram.

JREITs tend to be direct investment vehicles, but in the case of infrastructure, there is probably a greater need for an indirect investment vehicle, given that it is an SPV that is at the heart of most Japanese domestic renewable energy projects. Similarly, it is an SPV that is likely to be granted the concession in a PFI project.

However, limitations still exist under the Investment Trust Act (article 194, and 221 of the corresponding enforcement order). Where an investment is to hold an equity interest in a SPV that is a company, the number of shares in any one company that a registered investment corporation may hold is limited to that which would not give it a majority of voting rights in such a company. In terms of conduit requirements, the tax system requires that an investment corporation cannot hold more than 50% of the shares or interests issued by another company (Act on Special Measures Concerning Taxation, article 67-15, paragraph 1, item 2).

Tax treatment

From a tax perspective, it is important that an investment corporation meets tax law conduit requirements for being able to pass through income to investors. Certain tax law amendments have been made (to the enforcement order in relation to the Act on Special Measures Concerning Taxation) in line with the amendments to the Investment Trust Act.

"The 2020 Tokyo Olympics is also drawing attention to the need for urgent infrastructure-related investment"

This means that in order to meet tax conduit requirements, as a general rule, an entity must hold more than 50% of its specified assets in assets other than renewable energy power generation facility or public facility management rights, or in equity interests in silent partnerships (tokumei kumiai) that hold such rights. However, as an exception to this general rule, if an investment corporation acquires renewable energy power generation facilities between September 3 2014 and March 31 2017, then regarding each fiscal year (ending during the period from the time of acquisition until 10 years from the time when the facilities are leased), the investment corporation can include such renewable energy power generation facilities for the purposes of the above calculation of its ratio of specified assets held, for the purpose of assessing whether it meets the conduit requirements. This is on condition that: (i) the amount of the investment corporation's investment units that were issued by public offering, at the time it was established, was not less than ¥100 million or the investment corporation's investment units are listed in financial instruments exchange; and (ii) its constitutional documents permit it only to be involved in the management of such renewable energy power generation facilities in the form of leasing.

Under existing tax rules, therefore, an investment corporation whose main investment asset is a concession would not meet conduit requirements. In the case of renewable energy power generation facilities, it would still only meet conduit requirements during the limited period described above, so there is very little tax incentive available under the existing system. The FSA, however, requested an adjustment of this rule so that the same tax incentives now available to investment corporations holding primarily (real estate) specified assets could be available. It is hoped that the tax rule changes next fiscal year will include these measures.

Risk management

The Report also points out that the listing system will need to take into account the peculiar risks from special characteristics of infrastructure assets, including: (i) a heavy reliance on the legal system and deal contracts; (ii) the peculiar characteristics of facilities and equipment needed to manage infrastructure; (iii) a reliance on the capabilities of the operator; and (iv) there is very little experience handling such assets as investment targets. The report highlights the need for measures in relation to adequate information disclosure and monitoring of operations, measures in relation to ensuring operator adequacy and prevention of conflicts of interest, and the need for a listing system that ensures that listed entities are adequately robust to survive having their investment units listed publicly over the long-term. In terms of information disclosure, the amended Investment Trust Act and related regulations have already gone some way to improving the situation, for example, by requiring in the Cabinet Office Ordinance on the Disclosure of Details of Specific Securities that an outline of the specified assets and description of other matters that may have a material impact on investment decisions be provided in a manner that is easy to understand. More detailed measures are expected to be set out in relation to the listing system in the listing rules and guidelines to be provided by the TSE.

Watching with interest

A legal framework that will allow for the creation of a listed infrastructure market is rapidly emerging, but there are still some areas such as tax handling that will need to be resolved. Detailed terms of the listing system will depend in large part on the listing rules and guidelines to be provided by the TSE.


Eiichiro Hata

Atsumi & Sakai
Fukoku Seimei Bldg. 12F
2-2 Uchisaiwaicho 2-chome
Tokyo 100-0011 Japan
T: +81 (0)3 5501 1143
F: +81 (0)3 5501 2211

In addition to creating a listing system and setting up the necessary legal framework, the success of infrastructure as an investment in Japan will depend in large part on the actual successful and sustained listing of solid infrastructure funds that can build up a track record of listed investments. To this end, a number of asset managers and developers appear to already be working on infrastructure deals in anticipation of possible listing. On the investor side also, there appears to be some expectation of interest from pension funds wishing to expand their investments to infrastructure and other alternative assets, as well as individual investors wishing to invest in overseas infrastructure investments via investment trusts. The Japanese infrastructure investment market is certainly still in a very nascent stage, but it is a space that should be watched in the coming months and years, not least for the potential stimulating effect that the flow of international and domestic investment into Japanese infrastructure may have on Japanese capital markets.