In 2019 the diet passed a bill that proposes to overhaul parts of the cryptoasset regulatory framework and revisit definitions of key terms, such as ‘virtual currency’. Takafumi Ochiai of Atsumi & Sakai investigates
On March 15 2019, the Financial Services Agency of Japan (FSA), which oversees virtual currencies and securities, submitted a proposal (the Bill) to the Diet to amend the Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA). The Bill was passed in the diet on May 31 2019.
The Bill proposes to redefine the legal term 'virtual currencies' to 'cryptoassets', reflecting the use of the term cryptoassets by the G20. The background to this change is the fact that most of cryptoassets do not function as money.
Furthermore, the definition of cryptoassets will exclude rights to receive the distribution of profits indicated by property value (limited to those recorded on electronic devices or other objects by electronic means) that may be transferred using an electronic data processing system (the 'rights to transfer electronically-recorded claims'). These will be defined by Paragraph (1) Securities (for example, as stocks).
This adjustment will solve the fundamental problem which was that the application of two regulations governing virtual currencies and securities was very unclear. The lack of clarity meant that companies could not legally issue security tokens in Japan, especially so after the FSA adopted its strict stance towards ICOs after December 2017.
Requirements for cryptoasset exchange service providers
In 2018, there were two theft cases where customers' cryptoassets kept in a hot wallet (online) by cryptoasset exchange service providers were lost in hacking attacks. To address the risks of cryptoasset leakages, additional requirements will set for exchange service providers.
A cryptoasset exchange service provider will be required to separately hold and manage users' cryptoassets by a method less likely to lack user protection (for example, in a cold wallet). Providers will also have to hold cryptoassets of the same type and amount (performance bond cryptoassets) as those of users that are managed by other methods (for example, in a hot wallet) and separately manage them by a method less likely to lack user protection. In addition, a user that engages a cryptoasset exchange service provider to manage its cryptoassets will have the right to repayment of its cryptoassets and performance bond cryptoassets that the provider is managing, ahead of the provider's other creditors.
The Bill will also require a cryptoasset exchange service provider to make prior notification when it intends to change the name of the cryptoassets it handles and the description and method of its business. Based on this notification, the FSA and the certified self-regulatory institution Japan Virtual Currency Association (JVCEA) will review whether cryptoasset exchange service providers can deal in the cryptoassets described in the notification. With respect to self-regulation, the FSA will refuse registration applications made by companies that have not entered the certified association nor established internal rules equivalent to those of the Association's self-regulation framework.
The Bill further proposes that a cryptoasset exchange service provider will be prohibited from making false statements in its advertisements and promotions and that regulations regarding advertising of cryptoasset exchange services will be established. In relation to providing credit to users and exchanging cryptoassets, a cryptoasset exchange service provider will have to take measures to protect the consumer. These will include providing information regarding the credit agreement.
Three new regulatory frameworks
When it comes to custody service providers, under the current PSA the administration of cryptoassets as a business in relation to a cryptoasset exchange is regulated, but custody service providers that exclusively manage cryptoassets are not. The Financial Action Task Force (FATF) recommends countries to ensure that virtual asset service providers, which include providers of services for the safekeeping and/or administration of virtual assets or instruments be regulated for AML/CFT purposes, are licensed or registered.
The result will be that not only are rights to transfer electronically-recorded claims regulated, but so will be the acquisition of cryptoassets
In response to the FATF's recommendation, custody services will be added to the definition of cryptoasset exchange services, so that custody service providers will be regulated by the AML/CFT regulations and required to be registered with the FSA.
The Bill also proposes the establishment of regulations similar to those for foreign-exchange margin trading (forex trading) by amending the FIEA.
The proposed amendments to FIEA include adding cryptoassets to the definition of financial instruments, and therefore making derivatives transactions using cryptoassets subject to the regulations. In terms of the services related to derivatives transactions using cryptoassets provided by financial instruments business operators, rules such as the obligation of accountability, etc. will be provided.
To clarify the regulatory framework of ICOs, investment type ICOs will also be regulated by the securities regulations (FIEA). Consequently, as with stocks, a system of disclosure to investors and regulations for offerings and solicitations will be established.
Rights to transfer electronically-recorded claims will be subject to the system of disclosure of corporate affairs, as established in Paragraph (1) Securities. In addition, selling and purchasing rights to transfer electronically-recorded claims as a business will become subject to the regulations pertaining to Type I Financial Instruments Business: securities companies.
It was reported that unfair activities are sometimes seen in cryptoassets transactions. As such, the Bill proposes to add provisions to prohibit improper conduct, the spreading of rumours and price manipulation in relation to cryptoasset transactions and derivatives transactions using cryptoassets.
With respect to the application of the Act on the sales of financial instruments, the Act revises the effect of civil contracts. The result will be that not only are rights to transfer electronically-recorded claims regulated, but so will be the acquisition of cryptoassets.
Applying for the right to receive the distribution of profits
Although many professionals argued that the word 'money', as used in the FIEA, only included fiat and not virtual currency, the FSA announced that virtual currencies could be regarded as 'money' in the FIEA in cases where the law had been circumvented. The Bill clarified that cryptoassets contributed by a person who has the right to receive a distribution of profits will be deemed to be money, for which the provisions of FIEA will be clearly applied.
|About the author|
Takafumi Ochiai is a partner in Atsumi & Sakai and a core member of the firm's fintech team. He is a member of the general secretariat of the Fintech Association Japan; the Ministry of Economic Trade and Industry's Committee to Discuss Legal System for Blockchain; Japan Bank Association's research committee for the promotion of open API; and the Innovative Technology/Business model Evaluation Committee for Regulatory Sandbox of the Cabinet Office.
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