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2007. 01.17
Impact of the Financial Products and Exchange Law on the Establishment and Management of Real Estate Funds (1)
By Narutake Takasu
The enforcement of the Financial Products and Exchange Law (Kinyu Shohin Torihiki Hou (Law No. 65 of 2006))1 (the "FPEL"), which was enacted on June 7, 2006, will broaden the scope of what constitutes "securities" (yukashoken) and will introduce certain new regulations regarding the establishment and management of real estate funds, such as regulations on Self Offerings (as defined below) of Collective Investment Scheme Interests (as defined below) and on investing and managing fund assets, which up to now have been exempt from regulation. The FPEL will balance these new regulations by relaxing regulations on business conducted with Qualified Institutional Investors, Etc. (as defined below).
This newsletter will outline the impact of the FPEL on the establishment and management of real estate funds; the following two newsletters will examine in more detail the impact of the FPEL on so called "single TK schemes" and "double TK schemes"2 .
Comment 1 Broader Scope of Securities
Under the FPEL, the concept of "securities" is defined comprehensively to include interests with respect to so-called "collective investment schemes"3 ("Collective Investment Scheme Interests") (Article 2(2)(v) of the FPEL)4 . In addition, the FPEL will broaden the scope of what is considered "securities" by generally including trust beneficiary interests, which include real estate trust beneficiary interests (Article 2(1)(xiv) and Article 2(1) of the FPEL).
Comment 2 Regulation of Self Offerings of Collective Investment Scheme Interests
Under the FPEL, "Financial Products Exchange Business" (kinyu shohin torihiki gyo) in principle includes not only businesses that handle5 public offerings6 and sales (boshu/uridashi no toriatsukai) of Collective Investment Scheme Interests or that handle private placements (shibo no toriatsukai) of Collective Investment Scheme Interests (Article 2(8)(ix) of the FPEL), but also businesses that conduct public offerings or private placements ("Self Offerings" (jiko boshu)7 ) of Collective Investment Scheme Interests (Article 2(8)(vii)(f) of the FPEL). Therefore, a person engaged in such a business will be required to be registered as a Type II Financial Products Trader (dai nishu kinyu shohin torihiki gyosha) (Article 28(2)(i) of the FPEL). To be registered as a Type II Financial Products Trader, a person will be required to satisfy capital requirements and other conditions which include posting a security deposit (eigyo hoshokin) (Article 29-4, Article 31-2, and other provisions of the FPEL). These requirements will, in practice, make it difficult to conduct Self Offerings of Collective Investment Scheme Interests by a person such as an employee seconded from a sponsor company, which has in practice been done in the past8 .
Comment 3 Regulation of Fund Asset Investment Management
The FPEL will, in principle, require any business involving the investment management of assets of a collective investment scheme9 to be registered as an "Investment Management Business" (toshi unyo gyo) (Article 28(4)(iii), Article 2(8)(xv)(c), and Article 29 of the FPEL). To be registered as an Investment Management Business, an entity must meet capital requirements and other requirements which include (i) being a stock company (kabushiki kaisha) with a board of directors and either a statutory auditor or so-called "committees" (iinkai), (ii) having a minimum level of net assets and (iii) satisfying regulations prohibiting the conduct of more than one business and other matters (Article 29-4 and other provisions of the FPEL)10 .
Because real estate trust beneficiary interests are not considered "securities" under the current Securities and Exchange Law, if an SPC invests in real estate trust beneficiary interests using funds received through a collective investment scheme such as a silent partnership (tokumei kumiai) investment, there is no requirement that the asset manager carrying out the asset management business on behalf of the SPC be authorized or licensed to provide securities investment advice and management services. Under the FPEL, however, trust beneficiary interests will also be considered "securities", as described above, so in principle the asset manager will have to obtain an investment management business11 registration.
Even if an SPC delegates all of its management authority to an investment manager that has obtained registration, the SPC itself might still need to be registered as an investment manager (see Article 42-3 of the FPEL). Under this interpretation, it will be extremely difficult for an SPC to meet the above investment management business registration requirements, which will have a significant effect on many real estate funds. It will therefore be necessary to closely monitor the effect of relevant Cabinet Orders and Cabinet Office Ordinances to be published and public comments on those orders and ordinances.
Comment 4 Deregulation of Businesses Conducted solely with Qualified Institutional Investors, Etc.
Notwithstanding the above, under the FPEL any business or investment management business involving Self Offerings of Collective Investment Scheme Interests conducted with "Qualified Institutional Investors, Etc." (tekikaku kikan toshika tou) 12 , will as a "Special Business Involving Qualified Investors" (tekikaku kikan toshika tou tokurei gyomu) not be required to be registered and will simply be subject to certain regulations13 and to certain notification/disclosure requirements (Article 63 through Article 63-4 of the FPEL)14 .
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In this way, the FPEL will make regulations on the establishment and management of real estate funds both more comprehensive and more flexible.
- The FPEL will come into force within 18 months of the date on which it was promulgated (June 14, 2006).
- This is an investment structure that consists of two silent partnerships (tokumei kumiai): a "mother fund" whose operator is a parent SPC, and a "baby fund" whose operator is a subsidiary SPC.
- This covers any investment scheme that involves (i) collecting money or other assets from others, (ii) conducting business or makes investments using such money or assets, and (iii) distributing profits to investors generated from such business or investments, regardless of whether such scheme is established under a general partnership (nini kumiai) agreement under the Civil Code, a silent partnership (tokumei kumiai) agreement under the Commercial Code, an investment limited partnership (toshi jigyo yugen sekinin kumiai) agreement, a limited liability partnership (yugen sekinin jigyo kumiai) agreement, or in any other form.
- There are, however, certain exceptions under current law that remain in place, such as the exception that general partnerships (nini kumiai) and silent partnerships (tokumei kumiai) investing directly in real property assets are not considered "deemed securities" under the Real Estate Specified Joint Business Law (Fudosan Tokutei Kyodo Jigyo Ho) (Article 2(2)(v)(a) through (d) of the FPEL).
- To "handle" means to offer Collective Investment Scheme Interests by a third party (for example, a securities company) other than the issuer thereof.
- Under the FPEL, if a "large number of persons" "own" Collective Investment Scheme Interests, this is defined as a "public offering" (Article 2(3)(iii) of the FPEL). "A large number of persons" in this case will be defined in the relevant Cabinet Order and is expected to mean at least 500 persons (Yoshiyuki Taniguchi and Akifumi Nomura, "Kigyō Naiyō Tō Kaiji Seido No Seibi (Improvement of the Disclosure System for Corporate Information, etc.)," Shoji Homu, No. 1773 (2006), p. 43). Furthermore, under the FPEL, "a large number of persons" is determined based on "the number of owners" not "the number of persons solicited."
- This means offerings of Collective Investment Scheme Interests by the issuer thereof itself.
- Type II Financial Products Traders will be subject to a fiduciary duty to customers, an obligation to deliver documents before execution of an agreement, an obligation to deliver documents upon execution of an agreement, and other regulations on various acts (Articles 34 through 45 of the FPEL).
- This specifically means to manage, based on investment decisions in accordance with an analysis of the value of financial instruments and other factors, any fund moneys or other property received from a person who owns Collective Investment Scheme Interests where the investment portfolio focuses on securities and derivative transactions.
- Investment managers are subject to regulations imposing a fiduciary duty and a duty of care as a good manager to customers who have acquired Collective Investment Scheme Interests, prohibiting transactions involving self-dealing and conflicts of interest, imposing an obligation to deliver management reports, and other requirements, in addition to regulations to which Financial Products Traders are also subject (Article 42 through Article 42-7 of the FPEL).
- This is based on the assumption that an asset management business is considered an investment management business (toshi unyo gyo). However, depending on the terms and conditions or the substance of the asset management agreement, it is also possible it will be considered an investment advisory or agency business (toshi jogen/dairi gyo) to advise on the value or other factors of securities, etc. (Article 28(3)(i) and Article 2(8)(xi) of the FPEL).
- "Qualified Institutional Investors, Etc." means "persons other than qualified institutional investors that are designated as such by Cabinet Order (provided that the number of such designated persons is less than the maximum permitted by such Cabinet Order) and qualified institutional investors" (Article 63(1)(i) of the FPEL). The definition is expected to be further defined as at least one qualified institutional investor or no more than the number of general investors prescribed in the Cabinet Order (which is likely to be no more than 49 general investors) (Hidenori Mitsui and Yuichi Ikeda, Eds., Ichimon Itto Kinyū Shōhin Torihiki Hō (Questions and Answers on the Financial Products and Exchange Law), p. 217).
- If a person that has provided notification (Special Exception Notifying Party) conducts a Special Business Involving Qualified Investors, it will be subject to only the following regulations relating to financial products exchange transactions: (i) prohibition on informing customers of any misrepresentation with respect to the execution of a financial products exchange agreement or the solicitation thereof (Article 38(1) of the FPEL), (ii) prohibition on compensating losses (Article 39 of the FPEL), and (iii) penal provisions concerning (i) and (ii) (Article 63(4) of the FPEL).
- In a so-called "double TK scheme", however, there are exceptions to the Special Business Involving Qualified Investors provisions, such as a situation where if even one silent partner (tokumei kumiai-in) in the silent partnership (tokumei kumiai) agreement whose operator is a parent SPC is not a qualified institutional investor, the subsidiary SPC will not be considered a "Special Business Involving Qualified Investors" even if there is a qualified institutional investor among the silent partners (tokumei kumiai-in) under the silent partnership (tokumei kumiai) whose operator is the subsidiary SPC (Article 63(1) of the FPEL).
