Japan has pushed through important reforms to the regulatory framework for cryptoasset businesses which will force existing market players to re-register within six months. Akimoto Kawamura of Atsumi & Sakai takes a look
Important amendments to Japan's regulatory framework for cryptoasset businesses were adopted in the June 7 2019 Amendment Act, which is scheduled to be effective within one year. The Amendment Act amends the Financial Instruments and Exchange Act (FIEA) and the Payment Services Act to introduce more regulations for broker-dealers and custodians of cryptoassets. The Amendment Act will also change the terminology from 'virtual currency' to 'cryptoasset'.
To date, cryptoasset businesses have mainly been regulated under the Payment Services Act, which requires them to register as virtual currency exchange service providers. This did not cover a series of issues, which the Amendment Act will now address.
Several cryptoasset businesses offer margin trading, which is only regulated as an exchange service under the Payment Services Act. However, as margin trading involves leverage, it is obviously different from a simple exchange or a buy-and-sell and is a derivative transaction in nature.
Under Japan's regulatory framework, derivatives are regulated by the FIEA, provided that the underlying assets are on the FIEA's list of financial instruments; up till now however, cryptoassets were not on that list. The Amendment Act will add cryptoassets to the list and as a result, margin trading will be subject to derivatives regulations under the FIEA.
Most importantly, the Amendment Act will raise the threshold for entering the cryptoasset business because the business of OTC derivatives can only be conducted by a Type 1 financial instruments operator (Type 1 Operator) (equivalent to a full-service broker-dealer, and typically a securities company). Therefore, for current virtual currency exchange service providers to continue margin trading, they will need to apply for Type 1 Operator registration, the requirements of which are substantially stricter than for their current business. It is also expected that a statutory limit on leverage ratio will be introduced.
Custody businesses are currently unregulated, but the need to protect customer assets is as essential as it is for the customers of virtual currency exchange service providers. The Amendment Act will add custody businesses to the scope of virtual currency exchange services, so they will become regulated under the Payment Services Act.
Initial coin offerings
Under the FIEA, which mainly regulates the securities business (both sell-side and buy-side), investors' interests in a collective investment scheme (multiple investors make contributions to an asset manager which invests the funds in businesses to generate returns and then distributes the profits to the investors) are not typical securities, but the FIEA regulates them similarly to, provided though more lightly than, typical securities (like JGBs, stocks, bonds, mutual funds, etc.).
In an ICO, investors contribute cryptoassets and the interests often take the form of tokens delivered to the investors in return; the holders of tokens are therefore entitled to the distribution of profits from the business in which the contributions are invested.
An ICO is therefore effectively similar to a collective investment scheme, but the wording of the FIEA is not clear on this point. To address this, the Amendment Act will bring the following changes:
- A contribution by way of cryptoassets instead of money will qualify as a contribution for a collective investment scheme.
- Certain types of tokens can be easily transferred using blockchain technology, and as such, are easily tradable and so act more like typical securities; the FIEA will designate these types of tokens as falling in the category of typical securities. Specifically, those tokens will be designated as electronically recorded transfer rights (electronic rights), a new category of typical securities, and will be regulated solely under the FIEA (in response, the Payment Services Act's definition of cryptoassets will exclude electronic rights).
- The change in the second bullet point means that an ICO business (underwriting or distribution of electronic rights) can only be handled by Type 1 Operators, with the exception that if a collective investment scheme issues electronic rights as part of its business (issuance as principal), the business can still be handled by Type 2 financial instruments operators (Type 2 Operators), a more lenient registration threshold for sell-side businesses. Even so, certain virtual currency service providers are not yet Type 2 Operator registered, and this means more regulation over those virtual currency exchange service providers if they want to continue ICO business.
Prohibition of unfair trading
Japan's regulatory framework is to prohibit unfair trading, including insider trading, mainly under the FIEA, but for the reason mentioned above, such a general or 'in-principle' prohibition of unfair trading does not cover cryptoassets. As the FIEA will regulate cryptoasset derivatives, the Amendment Act will regulate both trading in cryptoassets and trading in cryptoasset derivatives under the FIEA, though insider trading is not included at this time.
Regulatory landscape and transition measures
Overall, lawmakers have raised the bar of the registration requirements for cryptoasset businesses and has decided to regulate them in principle under the FIEA. In response to this major change, several cryptoasset businesses engaging in margin trading or ICOs (currently as virtual currency exchange service providers) will be forced to apply for a Type 1 Operator registration, and some of them may not be registered due to the lack of sufficient governance or compliance organisation.
As a transition measure for current virtual currency exchange service providers, to apply for Type 1 Operator registration there is a six-month grace period, and when registration is applied for during that period, the applicant can continue its business as it is until up to one year, six months from the enforcement date of the Amendment Act (if an applicant is not registered by then, it must discontinue its business).
Procedure for enforcement
In order to provide for detailed regulations under the Amendment Act, the Financial Services Agency of Japan will publish draft regulations (enforcement ordinances subordinate to the Amendment Act) for public comments, and then, finalise the scope of the regulations.
|About the author|
Akimoto Kawamura is a partner in Atsumi & Sakai. He was general counsel for Citigroup Japan for six years before joining Atsumi & Sakai in 2018, prior to which he was in private practice for over 20 years. Leveraging the expertise and strengths developed throughout his career, Akimoto is highly experienced in all aspects of financial services regulation, regulatory investigation, corporate M&A and cross-border transactions and investment. He advises commercial banks, investment banks, asset management companies and insurance companies, as well as a wide range of general corporations, including food and beverage, pharmaceutical, entertainment and e-commerce businesses.
Akimoto has a bachelor of laws from the University of Tokyo Faculty of Law and an LLM from the University of Michigan Law School. He was admitted as an attorney (Bengoshi) in Japan in 1991 and in New York State in 1997.