Explanation of 'Special Provisions for Qualified Institutional Investors, etc.' under Japan's Financial Instruments and Exchange Act

The Financial Instruments and Exchange Act of Japan mandates that, as a general rule, anyone engaged in financial instruments business must be “registered” with the Prime Minister’s Cabinet. This requirement aims to protect investors and ensure the fairness and transparency of the market. However, this stringent registration system has been a significant time and cost burden, particularly for certain financial businesses, such as the formation and management of funds targeting professional investors, creating a barrier to market entry.

In light of this, the “Special Provisions for Qualified Institutional Investors, etc.” were established under Article 63 of Japan’s Financial Instruments and Exchange Act. This system allows specific fund operations to be conducted merely by “notification” to the competent local finance bureau, without the need for registration as a financial instruments business operator. As a result, the time from fund formation to the start of operations is expected to be significantly reduced, which is anticipated to invigorate the market.

This system is positioned as a clear exception to the “registration” principle of financial instruments business, adopting a “notification” system instead. This approach aims to relax regulatory strictness and promote market entry by targeting professional investors, for whom the need for investor protection is relatively low. The legislative intent is evident in the assumption that the state does not need to provide excessive protection when investors’ knowledge, experience, and financial status are deemed to be above a certain level. Consequently, a reduction in regulatory costs and more efficient capital supply to the market are expected. Such regulatory flexibility could serve as a model for designing regulations in other financial sectors and for future new financial products, building a flexible regulatory system tailored to the attributes of the target customers.

Key Features of This Special Business Operation

One of the most notable features of the Qualified Institutional Investor Exemption Business is that it allows operations to commence not through the usual “registration” required for financial instruments business, but through a “notification” process. This simplification of procedures provides a significant advantage, enabling operators to form funds and start management within a relatively short period.

To be eligible for this system, the target investors are strictly limited. Specifically, business can only be conducted with “Qualified Institutional Investors” and “Specified Investors for Special Business Operations.” Furthermore, the scope of this special business operation is limited to the “private placement” and “self-management” of collective investment schemes, and does not generally include “public offerings” as a rule. This limitation of business scope is an important constraint in exchange for lighter regulation.

Moreover, those who file a notification for this special business operation are subject to ongoing obligations even after the notification. These include the submission of business reports for each fiscal year and the public inspection of explanatory documents. This means that even under a notification system, the business is subject to a certain level of supervision by the authorities.

The legal nature of being a “notification” rather than a “registration” implies a difference in the depth of administrative review. Registration involves substantive examination and requires time and strict criteria, whereas notification primarily involves formal examination, allowing for swift procedures. This difference is particularly beneficial in terms of time and cost for entities such as venture capital (VC) and private equity (PE) funds, which require rapid fundraising and investment execution. By enabling quick market entry, it is expected to prevent the loss of investment opportunities and, consequently, promote the circulation of funds in the economy as a whole. Additionally, it can reduce the high costs associated with professional fees and the establishment of internal control systems required for registration, thus lowering the barriers for small funds and new entrants. This system is expected to encourage the entry of diverse players into the Japanese financial market and particularly accelerate the supply of risk money to emerging industries.

Definition and Business Scope of Special Provisions for Qualified Institutional Investors in Japan

Financial Instruments and Transactions Targeted for Self-Offering and Self-Management

The financial instruments and transactions that can be conducted as Exempted Business Activities for Qualified Institutional Investors in Japan primarily involve “self-offering and private placement” as well as “self-management” related to “interests in collective investment schemes” .

“Interests in collective investment schemes” refer to rights related to mechanisms that distribute profits to investors by soliciting capital contributions from them and using that capital for business or investment purposes . These are considered “deemed securities” (Type II securities) under the Japanese Financial Instruments and Exchange Act and are also part of the financial products handled by Type II Financial Instruments Firms .

“Self-offering” refers to the act of an operator acquiring interests in a collective investment scheme for a specific few, while “self-management” refers to the act of managing the contributed property by oneself . In particular, “self-management” becomes the subject of these Exempted Business Activities when more than 50% of the contributed property is invested in rights related to securities or derivative transactions .

These Exempted Business Activities allow for the consistent handling of fund formation to operation; however, they are personalityized by being limited to “interests in collective investment schemes.” For example, “trading of trust beneficiary rights,” which is included in the scope of Type II Financial Instruments Business, is generally not covered by these Exempted Business Activities . This limitation of the business scope suggests that these Exempted Business Activities are specialized for the specific form of collective investment known as “funds.” Additionally, the condition of “primarily investing in securities, etc.” is to clarify the boundary between the business subject to investment management regulations . It is indicated that real estate trust beneficiary rights are not considered “real estate funds,” suggesting that there are higher hurdles for forming real estate funds . By limiting the business scope, it is expected to reduce the supervisory burden on regulatory authorities and promote fundraising in specific fields (especially venture investments). Moreover, areas like real estate-related businesses, which require coordination with other legal regulations (such as the Real Estate Brokerage Act), are kept to a stricter registration system to avoid the complexity of overlapping regulations. This limited scope setting demonstrates the Japanese financial regulatory stance of responding to specific market needs while maintaining the consistency of the overall regulatory framework.

Scope and Limitations of Special Business Operations

When conducting fund operations beyond the scope of Qualified Institutional Investor Exemption Services, such as soliciting an unspecified number of investors, registration as a Type II Financial Instruments Business is required. Additionally, if the operations primarily involve investment in securities or derivatives trading, registration as an Investment Management Business is necessary. Crossing the regulatory boundary triggers more stringent registration obligations.

Furthermore, these special business operations are subject to “two-tiered regulation” (fund-of-funds regulation). When a collective investment scheme receives investments from another collective investment scheme, it may not meet the exemption requirements depending on the investor layer. Specifically, investments from funds where non-qualified institutional investors acquire asset-backed securities issued by a Special Purpose Company (SPC) or become partners in an anonymous partnership do not, as a rule, satisfy the requirements for special business operations. This measure is to prevent the loophole in special business operations that effectively gathers funds from general investors. This regulation can be interpreted as an expression of “substance over form,” aiming to exclude schemes that, despite formally meeting the requirements of special business operations, necessitate a higher need for general investor protection in substance.

However, there are exceptions where a two-tiered structure is permitted if certain conditions are met, such as in the case of Investment Business Limited Partnerships (LPS) or Limited Liability Business Partnerships (LLP), where the total number of non-qualified institutional investors in both the upper and lower funds is less than 49. Regulatory authorities focus not only on the legal form but also on the ultimate source of funds and the location of risk. This approach is expected to prevent the misuse of special business operations and protect investors from undue risk. It suggests that fund organizers must be constantly aware of the flow of funds and the ultimate investor layer, not just the legal form, and ensure thorough compliance with the substantive regulations.

Target Investors and Their Requirements Under Japanese Law

Definition and Specific Examples of Qualified Institutional Investors Under Japanese Law

Exemption services for qualified institutional investors and specified investors are, in principle, conducted with “qualified institutional investors” and “specified investors” as counterparties. A “qualified institutional investor” as defined by the Japanese Financial Instruments and Exchange Act, refers to an institutional investor with specialized knowledge, experience, and financial resources related to investments.

Specific examples of qualified institutional investors include:

• Type I Financial Instruments Firms (securities companies)
• Investment management companies
• Investment corporations
• Banks, insurance companies, and credit unions
• Limited partnership investment enterprises with net assets of over 500 million yen
• Individuals or corporations with a securities portfolio balance exceeding 1 billion yen, who have had a securities account for over one year and have filed a notification with the Commissioner of the Financial Services Agency.

Qualified institutional investors are considered to require a lower level of regulatory protection than general investors due to their expertise. The definition of a qualified institutional investor is detailed and strict because they are presumed to have the ability to assess risks associated with financial product transactions and make investment decisions on their own responsibility. It is on this premise that the state can exempt them from registration obligations and relax some of the disclosure requirements and behavioral regulations. The recognition of being a “professional” reduces the supervisory burden on regulatory authorities and contributes to enhancing market efficiency. If the definition of a “professional” were ambiguous, there would be an increased risk of misuse of the exemption services and a lack of investor protection. The definition of a “professional” is extremely important in clarifying the responsibility for risk-taking in the financial markets and ensuring the efficiency of regulations.

Scope and Verification Methods for Qualified Investors Under Special Business Regulations in Japan

Investors eligible for special business operations, other than Qualified Institutional Investors, are limited to those who are deemed to have the capability to make investment decisions. This category includes entities such as the national government, local public entities, listed companies, and individuals who meet specific requirements.

For individual investors, the requirements are as follows:

• Having investment securities assets expected to be worth at least 100 million yen.
• Having had a securities account for more than one year.
• Being an individual who is reasonably judged, based on transaction status and other circumstances, to have both net assets and investment securities assets of at least 300 million yen, and who has more than one year of trading experience.

Regarding the verification of these requirements, especially the asset criteria, a reasonable judgment based on transaction status and other circumstances is required. In practice, it is common to request the submission of documents such as securities company transaction balance reports.

Investors targeted for special business operations are considered ‘semi-professionals’ with a certain level of investment decision-making ability and asset size, although not as qualified as Qualified Institutional Investors. Verifying their eligibility is an important obligation for the notifier. Failure to fulfill this duty can lead to administrative sanctions, thus demanding strict compliance. In particular, for individual investors, proving asset status involves privacy concerns, which is considered a high psychological barrier. This verification duty is a crucial safeguard to maintain the nature of special business operations as ‘funds for a limited number of professionals.’ Strict verification obligations limit the use of special business operations to truly professional investors and prevent unregistered solicitation to general investors. However, it has been pointed out that this practical hurdle may also be limiting the use of special business operations to some extent. Notifiers are suggested to not only have a duty to explain to investors but also to rigorously verify their eligibility and establish a system for maintaining records.

Key Points on Investor Number Restrictions and Two-Tier Structure Regulations Under Japanese Investment Law

In the special business operations for Qualified Institutional Investors and others, there is a strict limitation on the number of investors (other than Qualified Institutional Investors) which must be 49 or fewer. While there is no clear upper limit on the number of Qualified Institutional Investors, the total number of rights holders in the collective investment scheme may be limited to 499 or fewer, which is within the private placement range. This means that even if a new fund is formed, if the operator and the investment target business are the same, it is not possible to solicit more than 49 new investors for the special business operations.

Furthermore, due to the aforementioned two-tier structure regulations (fund-of-funds regulations), if a fund receives investments from another fund, and the investors of the lower-tier fund are not Qualified Institutional Investors or similar, the fund may be excluded from the special business operations. This measure is to prevent schemes where a large number of general investors indirectly invest in a fund, thereby closing regulatory loopholes. However, there are exceptions where a two-tier structure is permitted under certain conditions, such as when the total number of non-Qualified Institutional Investors combined in the parent and child funds is 49 or fewer, in specific partnership agreements like Investment Limited Partnerships (LPS) or Limited Liability Partnerships (LLP).

The limit of 49 investors is a core requirement to ensure that the special business operations do not deviate from their nature as funds intended for a small number of professional investors. This limitation is intended to clearly distinguish from the act of “solicitation” which gathers funds from an unspecified large number of general investors, thereby ensuring the essence of a “private placement.” Additionally, the two-tier structure regulation is to prevent schemes that indirectly gather funds from general investors (regulatory evasion) by circumventing direct numerical restrictions. The restrictions on the number of investors and the two-tier structure regulation have the effect of preventing the special business operations from deviating from their original purpose (facilitating funds for professional investors) and slipping through the net of investor protection. This maintains the credibility of the system. Fund creators must carefully verify eligibility and investor number restrictions, not only for direct investors but also tracing back to the ultimate investor layer that forms the source of the fund’s capital, suggesting the complexity of compliance in intricate fund structures.

Notification System and Procedures Under Japanese Law

Requirements and Necessary Documents for New Notifications Under Japanese Financial Regulations

Entities intending to engage in Qualified Institutional Investor Exemption Services must notify the Prime Minister of Japan (authority delegated to the Director of the Finance Bureau with jurisdiction over the main office or business office) before commencing operations. This notification is a relatively simple procedure compared to the “registration” required for ordinary financial instruments business operators.

The notification must include the business operator’s trade name, the amount of capital (in the case of a corporation), the names of officers, the names of key employees, and the types of services to be provided.

When making a new notification, the following documents are required:

• Notification form for Qualified Institutional Investor Exemption Services (Form 20)
• Oath (different forms for corporations and individuals)
• Resumes of officers and key employees
• Copy of the resident card (or certificate of registered matters for corporations)
• Certificate from a government office stating that the applicant does not fall under any registration refusal criteria
• Articles of incorporation
• Certificate of registered matters
• Most recent balance sheet and income statement
• Document to be submitted if all qualified institutional investors are investment limited partnerships
• Document certifying the total amount of contributions from closely related persons and those with knowledge and experience

Submissions are primarily made using the electronic application and notification system provided by the Financial Services Agency, with forms in Excel format and attached documents in PDF format. If it is necessary to submit in paper form, one original and one copy must be submitted to the Finance Bureau or Finance Office that has jurisdiction over the main business office or office.

Particularly for overseas operators (foreign corporations or individuals residing abroad) without a business or office in Japan, the submission destination for the notification form is the Securities Supervision Division 3, Financial Bureau of the Kanto Local Finance Bureau. This is an important point indicating that it is possible to submit notifications for this special exemption service even without a domestic base.

At the time of notification, a registration license tax of 150,000 yen must be paid.

The notification is subject to a “formal examination” under the Administrative Procedure Act, which does not involve substantive review. However, in practice, strict checks are conducted, including the number of submitted documents, the resumes and oaths of officers and key employees, and confirmation of registration refusal criteria. In particular, the pledge not to fall under any registration refusal criteria (e.g., lack of a domestic office, insufficient capital, inadequate human resources) is crucial. This suggests that even though the notification is formal, there is an intention to ensure a certain level of operator qualification. The gap between the principle of formal examination and the strictness in practice can be interpreted as a search for balance to ensure quick procedures while preventing the entry of unqualified operators. False notifications or deficiencies in attached documents can result in administrative sanctions or penalties, implying that operators must thoroughly verify the accuracy of the content and the fulfillment of requirements, not just compile the documents. Therefore, professional assistance is often essential.

Ongoing Obligations: Submission of Business Reports and Public Inspection in Japan

Entities that have filed for Special Business Activities for Qualified Institutional Investors, etc., in Japan, continue to bear ongoing obligations. One of the most important is the creation and submission of an annual business report for each fiscal year. This must be done within three months after the end of each fiscal year. The submission of the business report is generally carried out using the Financial Services Agency’s Integrated Business Support System (Integrated System). When using this system, it is recommended to use a PC with a Japanese version OS and Excel format, and input from non-Japanese OS may not be accepted, so caution is required.

In addition to the content of the new filing, there is also an obligation to create explanatory documents for each fiscal year and make them available for public inspection within four months after the end of each fiscal year. These explanatory documents can be substituted with a copy of the business report. Public inspection can be conducted by placing the documents at the main business office or office of the operator, at all business offices or offices where the special business activities are conducted, or by posting them on the company’s website.

The submission of business reports and the obligation of public inspection are crucial means for continuously monitoring the soundness of businesses after filing. Through this, authorities can grasp the financial condition and business operations of the entity and prepare a system to enact administrative measures (such as business improvement orders or business discontinuation orders) promptly in case of problems. The mandatory use of the Integrated System clearly demonstrates the promotion of digitalization aimed at enhancing the efficiency of regulatory authorities’ work and strengthening data collection. The ongoing reporting obligations maintain the compliance structure of the entity and enhance transparency towards investors. Digitalization leads to more efficient reporting and improved data analysis capabilities, enabling quicker and more accurate supervision. Therefore, entities must maintain legal compliance and an information disclosure system continuously, not only at the time of filing but also throughout their business activities, with particular emphasis on adapting to digital systems.

Notification Procedures for Changes and Cessations in Japan

When there are changes to the information previously reported, Qualified Institutional Investor Exemption Business Notification Filers in Japan must submit a Change Notification without delay. This applies to changes such as a company name, changes in officers, or relocation of business premises.

In cases of business suspension, resumption, cessation, dissolution, or when business continuity becomes significantly difficult, as well as in instances of legal violations, there is an obligation to promptly submit the prescribed notification. These notifications are also generally made using the Financial Services Agency’s electronic application and notification system.

The obligation to notify changes and cessations is essential for the authorities to always have up-to-date information on businesses and to maintain the integrity of the market. In particular, notifications of difficulties in business continuity or legal violations serve as triggers for the authorities to respond swiftly from an investor protection standpoint. This prevents problematic businesses from remaining in the market and helps to contain the spread of damage to investors. The duty to notify enforces self-regulation among businesses and enhances the overall trust in the market. Negligence or false notifications can lead to administrative actions, so businesses are always required to provide accurate information. Through the notification system, the financial authorities can grasp the dynamics of the market in real-time and enhance their ability to intervene when necessary.

Organizational Structure and Conduct Regulations

Human Composition and Internal Management System Required for Business Execution

Although the business of Qualified Institutional Investor Exemption is based on a “notification” system, the establishment of an appropriate human composition and internal management system is essential for the proper execution of its operations. Those conducting business must secure officers or employees with sufficient knowledge and experience related to the business and establish an appropriate organizational structure.

Specifically, managers are required to possess sufficient qualifications to carry out the business of financial instruments firms fairly and accurately, considering their background and capabilities. Additionally, officers engaged in executive management must understand and implement the points of focus in management control indicated by related Japanese regulations and supervisory guidelines, such as the Financial Instruments and Exchange Act, and possess adequate knowledge and experience in compliance and risk management necessary for the fair and accurate execution of financial instruments business.

Furthermore, it is desirable to establish a compliance department (or person in charge) independent of the sales division, and it is crucial that this person has sufficient knowledge and experience. It is also necessary to ensure personnel capable of creating, managing, and disclosing books and documents, reports, risk management, computer system management, trading management, customer management, advertisement review, customer information management, complaint and trouble handling, and internal auditing.

Because the Qualified Institutional Investor Exemption operates on a “notification” system, it does not undergo the strict pre-screening typical of regular financial instruments business. However, supervisory guidelines effectively require the same level of internal management system and human requirements. This is a measure to enable post-facto supervision to ensure investor protection is not compromised should any issues arise. In particular, the independence of the compliance department and the establishment of a risk management system are essential for maintaining the credibility of financial institutions. While there is a formal relaxation of regulations (notification system), maintaining substantial governance and risk management requirements ensures the integrity of the market. This reduces the risk of misuse of special exemption business. It suggests that operators have the responsibility to autonomously build and maintain a high standard of internal management system required of financial institutions, without being misled by the superficial simplicity of the procedures.

Applicable Conduct Regulations and Exemption Provisions

Principally, the same conduct regulations that apply to financial instruments firms also apply to Qualified Institutional Investor Exemption filers. This is the basic framework to ensure the fairness and transparency of business operations and to protect investors.

However, in this special exemption business, some conduct regulations may be exempted depending on the attributes of the customer, such as when the customer qualifies as a “Specific Investor.” This is based on the premise that professional investors make investment decisions on the principle of self-responsibility. For example, exemptions may apply to parts of the suitability principle or the obligation to provide written materials.

The application and partial exemption of conduct regulations are a concrete expression of the “suitability principle” according to the knowledge, experience, and financial circumstances of the investor. While general investors require substantial protection, excessive regulation can hinder business for professional investors, so regulations are relaxed within a reasonable range. This reflects the regulatory authority’s stance on pursuing a balance between efficiency and protection. The flexibility of regulations according to investor attributes enhances market efficiency while maintaining necessary investor protection, creating a market environment that can respond to diverse financial needs. It suggests that fund creators need to accurately understand the scope of conduct regulations that apply to each investor and provide appropriate information and responses.

Comparison with Other Financial Instruments Businesses in Japan

Differences Between Type II Financial Instruments Business and Specially Permitted Businesses for Qualified Institutional Investors, etc.

While Specially Permitted Businesses for Qualified Institutional Investors, etc., overlap with Type II Financial Instruments Business in some aspects of their operations, there are clear differences in their legal nature, target operations, investor restrictions, and requirements.

The Japanese Financial Instruments and Exchange Act sets different regulatory levels, registration (Type II Business) and notification (Specially Permitted Business), according to the nature of the business and the risk tolerance of the target investor class. This gradation provides flexibility for operators to choose the optimal legal framework that suits their business model and target customers. For example, if dealing with a wide range of financial products for general investors, Type II Business would be the choice, whereas Specially Permitted Business would be more strategic for those focusing on fund formation and management for professional investors. The difference in regulatory levels directly affects the compliance costs for operators and the ease of market entry. More stringent regulations mean higher costs and barriers to entry, while more relaxed regulations imply lower costs and easier entry. This suggests that operators need to carefully consider which license to choose, not just because ‘regulations are lighter,’ but also looking ahead to the potential for future business expansion and changes in the target customer base.

Comparison with Special Provisions for Overseas Investors

The “Special Provisions for Overseas Investors” newly established by the amendment to the Japanese Financial Instruments and Exchange Act in 2021 (Reiwa 3) share many similarities with the Special Provisions for Qualified Institutional Investors, yet there are significant differences in their purposes and specific requirements.

The establishment of the Special Provisions for Overseas Investors is part of a national strategy to enhance Japan’s appeal in competition with Asian financial hubs such as Singapore and Hong Kong. The system’s allowance for “solicitation” is intended to facilitate the gathering of funds from a larger number of overseas investors, thereby improving access to the Japanese capital market.

Administrative Actions and Penalties

The Qualified Institutional Investor Exemption Business operates under a “notification” system, which simplifies procedures compared to the “registration” required for standard financial instruments business. However, strict administrative actions and penalties are applied in the case of legal violations.

Failure to submit various notifications or business reports, or submitting false notifications or reports, can result in administrative actions. These actions include business improvement orders and business suspension orders. Business improvement orders are issued to correct issues in business operations, while business suspension orders are mandated when there are serious legal violations or when business continuation becomes difficult.

Furthermore, the Japanese Financial Instruments and Exchange Act stipulates criminal penalties, including imprisonment or fines, for those who violate laws and regulations. The Financial Services Agency of Japan publishes a list of non-communicative filers and explicitly states that if there is no contact within 30 days from the publication date, administrative procedures such as hearings will be conducted, followed by a business suspension order if necessary.

While the notification system has a simplified pre-screening process, rigorous post-facto supervision and strict measures against violations are crucial. The existence of administrative actions and penalties serves as a strong deterrent, encouraging continuous legal compliance by businesses. In particular, business suspension orders against unreachable businesses serve to eliminate non-substantive paper companies and inappropriate operators from the market, effectively protecting investors. Rigorous post-facto supervision maintains the credibility of the exemption business and, by extension, ensures the overall health of Japan’s financial markets. Businesses are suggested to have a responsibility not only to file notifications but also to maintain a continuous compliance system and to establish a structure that can promptly respond to communications from authorities.

Summary

Businesses considering the use of the Special Provisions for Qualified Institutional Investors in Japan must fully understand and comply with the stringent requirements and ongoing obligations that come with the convenience offered.

• Strict verification of eligible investors: Especially for individual investors targeted by the special provisions, verifying their eligibility, such as the requirements for investment-type financial assets, becomes a crucial practical hurdle. Failure to verify can lead to the risk of administrative sanctions.
• Ongoing disclosure and compliance: After filing, there is a demand to not neglect continuous obligations such as submitting annual business reports, public inspection of explanatory documents, and various change notifications. These serve as important sources of information for the supervision by authorities and the protection of investors.
• Establishment of internal control systems: It is essential to establish a human composition, organizational structure, and compliance and risk management systems to properly conduct business. It is necessary to understand that behind the formal filing system, financial institutions are substantively required to maintain a high standard of internal control.
• Dealing with two-tiered regulatory structures: When adopting a fund-of-funds structure, careful scheme design and collaboration with legal experts are essential to avoid conflicts with complex two-tiered regulations.
• Specific requirements for foreign operators: Even for foreign operators without a business or office in Japan, it is necessary to file with the Kanto Local Finance Bureau and to establish an appropriate system considering that a domestic presence is required for special provisions for foreign investors.

The Special Provisions for Qualified Institutional Investors continue to play an important role in facilitating the formation and operation of funds targeting professional investors in Japan’s financial markets.

Monolith Law Office has a wealth of experience in supporting numerous domestic and international clients in legal matters related to the Japanese Financial Instruments and Exchange Act. Our firm includes several English-speaking attorneys with foreign qualifications, enabling us to accurately explain the complex requirements of Japanese financial regulations within the context of international business and provide practical advice. We are fully prepared to support your company’s business in Japan, ensuring smooth operations in compliance with the law.