Regulations under the Financial Instruments and Exchange Act, etc.
There are four main types of crowdfunding: rewards, donation, debt, and equity.
Of these, the type of crowdfunding that broadly encourages the purchase of goods or services (including pre-orders) is generally classified as Reward-based Crowdfunding.
From a legal standpoint, Reward-based Crowdfunding is basically considered to be the same as e-commerce platforms such as Rakuten or Amazon, depending on the nature of the products, of course. Therefore, it is not subject to regulations under financial laws such as the Financial Instruments and Exchange Act, the Act on Specified Joint Real Estate Ventures, or the Money Lending Business Act, etc.
Similarly, Donation-based Crowdfunding is a mechanism where individuals contribute funds to the fundraisers without expecting any rewards. As it is same as traditional donations, where contributors do not seek financial gains, it is not subject to regulations under financial laws such as the Financial Instruments and Exchange Act, etc..
Donation- based (same as donations)
Reward-based (same as e-commerce sites)
The two types of crowdfunding, Debt-based Crowdfunding and Equity-based Crowdfunding, fall under the financial regulations such as the Financial Instruments and Exchange Act etc.
Equity-based Crowdfunding is a form of crowdfunding where selling the rights, divided into smaller portions, to receive distributions of business profits to investors, such as shares in the fundraiser’s company or the distribution of the fundraiser’s business earnings.
The solicitation on the internet of unlisted shares or securities such as fractionalized securities of businesses is generally subject to regulation of the Financial Instruments and Exchange Act.
However, in the case of fractionalized securities of real estate assets, it is subject to regulation of the Act on Specified Joint Real Estate Ventures, and the applicability of the Financial Instruments and Exchange Act may vary depending on the scheme.
When selling certain fund-type securities (collective investment schemes, etc.) Equity-based Crowdfunding, depending on the nature of the operations, there may be cases where investment management or commodity investment advisory business may be required.
Debt-based Crowdfunding is a business in which investors lend funds to fundraisers at a fixed interest rate through crowdfunding platforms.
In such cases, crowdfunding, operators are subject to the regulation of the Financial Instruments and Exchange Act, they are also required to register as money lenders under the Money Lending Business Act.
Self-offering and handling of funds: Type II Financial Instruments Business
Handling of unlisted stocks, etc.: Type I Small-Amount Electronic Public Offering Service Provider
Real Estate Funds: Specified Joint Real Estate Ventures License (in some cases, Type II Financial Instruments Business)
Others: Depending on the nature of the operations, there may be cases where additional licenses and permits, including Type II Financial Instruments Business, are required.
Type Ⅱ Financial Instruments Business and Money Lending Business
Necessary Permission and Registration, etc.
To engage in Equity-based or Debt-based Crowdfunding business as described above, it is necessary to go through the prescribed procedures, such as registering a financial instruments business based on the Financial Instruments and Exchange Act, or licensing a real estate specific joint venture based on the Specified Joint Real Estate Ventures Act.
The handling of offerings or private placements of shares or subscription rights for new shares requires registration as a Type I Financial Instruments Business (in practice, only the Type I Electronic Offering Handling Business is allowed under the rules of the Japan Securities Dealers Association).
And, the solicitation, private placement, or self-offering of funds (including both Equity-based and Debt-based funds) generally requires registration as a Type II Financial Instruments Business.
As mentioned above,
in regard to loan-based funds, additional registration of the money lending business is required.
However, in cases of real estate funds there are schemes where both Type II Financial Instruments Business Registration and a Specified Joint Real Estate Ventures permission are required, while in other cases, and it is possible to conduct business solely with the permission of Specified Joint Real Estate Venture.
In the Specified Joint Real Estate Ventures, the act of accepting online contract applications is classified as an electronic transaction business.
Electronic Public Offering Services
Among the operations conducted by Financial Instruments Business Operators engaged in Equity-type Crowdfunding, the “handling” operations which involve soliciting securities issued by other companies (including SPCs and affiliates of financial instruments business operators) by posting offering documents on the internet are regarded as electronic public offering service except in certain cases such as loan funds.
Therefore, in such cases, in addition to the above-mentioned Type I or Type II Financial Instruments Business registration, registration of “Electronic Public Offering Service” is also required.
In addition, the scheme where subscribers can apply for or conclude contracts via the Internet is referred to as “Electronic- Application-Style Electronic Public Offering Service,” which is subject to stricter regulations than general electronic public offering service.
In addition to the segregation management, issuer examination, Cooling-Off period, and information disclosure obligations described below, the self-regulatory rules prohibited from solicitation through visits or telephone calls.
The handling of securities issued by parent corporations, or subsidiaries is also prohibited in the Electronic-Application-Style Electronic Public Offering Services.
As an exception, there is a registration system for Type I and TypeⅡ Small-Amount Electronic Public Offering Service, which allows for the conduct of Electronic-Application-Style Electronic Public Offering Service with the relaxed registration requirements compared to Type I and TypeⅡ Financial Instruments Business.
As of 2018, although there were multiple businesses registered as Type I Small-Amount Electronic Public Offering Service, there were no businesses registered solely as Type II Small-Amount Electronic Public Offering Service.
Social Lending and Debt based Crowdfunding
As mentioned above, loan-based funds do not require the registration of electronic public offering service as stated above. However, since around 2019, these types of businesses have been subject to extremely strict registration examinations, due to a series of administrative penalties imposed on loan-based fund operators (including so-called social or peer to peer lending) and Equity-based Crowdfunding operators.
The No Action Letter and Q&A related to the Loan-based Fund of the General Incorporated Association for Type II Financial Instruments Business states that the Loan-based Fund, in which the borrower is a corporation, can be structured without satisfying requirements of multiple borrowers and anonymity if the following requirements are met.
(1) Business Scheme
The contract is based on a silent partnership contract, and investors cannot execute the lending operations and do not have any rights or obligations to carry out the lending activities.
(2) Fund Operators (Loan Originators)
① In the terms and conditions of loans, it is clearly stated that the fund operator itself sets the lending conditions such as the loan amount, interest rate, and the use of funds, should be presented to the borrower by the fund operator itself, and ensures measures are in place to guarantee that there is no contact or interaction between the borrower and the investors regarding the lending transaction.
② The Fund Operator shall provide in its internal rules for measures to ensure that borrowers and investors do not have contact with each other regarding the lending transaction.
(3) Fund Distributors (Type II Business Operators)
① The silent partnership clauses, etc. clearly state that investors cannot carry out lending operations, and do not have rights or obligations in relation to the lending activities. Additionally, they state that they do not make contact with investors and borrowers in relation to the lending activities, and that measures are taken to ensure that they do not make such contact.
② Fund distributors explain to investors that borrowers are also prohibited from having any contact regarding the lending transactions.
Issuer Due Diligence, etc.
A key operational point common to both Electronic-Application-Style Electronic Public Offering Service and Debt-based Crowdfunding is the system for screening and monitoring funds.
The business concept of “selling and ending” with financial products is not permissible for financial instruments business operators.
In the case of Debt-based Crowdfunding, the “Rules on the Handling of Private Placement of Business-type Funds, etc.” and the “Q&A on Lending-based Funds” stipulated by the General Incorporated Association for the Type II Financial Instruments Business Firms Association apply. In accordance with the rules and guidelines of the Association, preliminary examinations and post monitoring must be conducted.
In the case of self-offering of business-type funds, the Rules on the Handling of Private Placement of Business-type Funds, apply.
For Electronic-Application-Style Electronic Public Offering Service Electronic-Application-Style Electronic, “Rules for Electronic-Application-Style Type Electronic Public Offering Service” stipulated by Type II Financial Instruments Business Association shall apply to Type II Financial Instruments Business Operators. And “Rules for Equity Investment-based Crowdfunding Investment Business” stipulated by the Japan Securities Dealers Association shall apply to Type I Small Amount Electronic Public Offering Service Operators.
Under these self-regulatory rules, both issuers are required to conduct reviews and monitoring.
Activity Management and Other Regulations Specific to Electronic Solicitation
Based on the provisions of Article 35-3 of the Financial Instruments and Exchange Act and Article 70-2 of the Cabinet Office Ordinance on Financial Instruments and Exchange Business, etc., individuals who engages in the Electronic Public Offering Service or a Financial Instruments Business Operator who engages in the Electronic Public Offering service in self-solicitation in a manner equivalent to the business of handling electronic solicitation must comply with the specific regulations.
Of these, what is particularly important is the measure to ensure that “if the method used involves the issuance of securities only when the total subscription amount from customers reaches the target amount within the application period, the issuer does not accept payment of the application funds until the target amount is reached.”
Under administrative guidance and practice, it is considered necessary, to entrust customer funds in order to meet this requirement.
Therefore, in order to conduct so-called Equity-based Crowdfunding, contracts with entrust banks are required.
Support for Opening Crowdfunding
We have a track record of acting as an agent or providing assistance in the registration application for the following businesses:
- Type I Small Amount Electronic Public Offering Service (Equity-based Crowdfunding)
- Electronic-Application-Style Electronic Offering Service for Type II Financial Instruments Business (Business-type Fund)
- Type II Financial Instruments Business involving money lending business as the funded business (Social Lending)
We are capable of providing practical advice is available to our clients on various practical and the detailed aspects including the establishment of internal systems, contracting with trust banks, and developing a handling examination flow.
In particular, since the voluntary regulations of the Japan Securities Dealers Association or the Type II Financial Instruments Firms Association will become extremely important in this field, comprehensive attention must be paid not only to laws and regulations, but also to association rules.
FAQs Regarding Crowdfunding
Q) How long will it take to register and open?
Basically, it will be over one year.
As the official standard application processing period is 2 months, we occasionally receive inquiries asking if it is possible to complete the registration within approximately 2 months. However, it takes a considerable amount of time for the pre-screening before the acceptance of the application. Therefore, we can assert that it is absolutely impossible complete the registration within such a short timeframe.
Based on our recent records, the actual distribution of processing time for registration has been around 12 to 20 months.
Cases that take a long period of time typically involve complex matters intended for the general public. On the other hand, cases that can be registered in about a year are often involve simpler matters targeted towards professional.
In practice, the goal is to proceed with the registration process aiming to complete it within 1 year from the initial submission.
Q) We are an IT company without any prior experience in the financial industry. Is it possible for us to enter the investment-based crowdfunding sector?
Registration would not be possible unless you can secure a number of individuals with experience working at Financial Instruments Business Operators or registered financial institutions.
Full-time officers and employees, including officers, need to have experienced individuals within various departments such as sales, compliance, internal auditing, and examination.
Q) What are the points for the review of other Equity-based Crowd funding?
The specific content of the funds to be handled (funded business) needs to be determined in detail.
In addition, strict scrutiny is applied for the internal control of managing systems that sell funds and other products.
It is necessary to establish a detailed management system that includes system management rules, system management standards, regulations related to cyber security, backup manuals, and other related documents.
It is also necessary to conduct system audits on a regular basis.
Q) We would like to raise funds for projects related to our my company through crowdfunding. Are there any matters to be noted?
In the Electronic- Application-System Electronic Public Offering Service, the handling of securities issued by parent corporations, etc. or subsidiary corporations, etc. is prohibited.
As a result, it is not allowed to sell funds with the company’s subsidiaries or other entities as operator.
In such cases, it is necessary to utilize adopt the “self-solicitation” method using electronic solicitation or to convert scheme into off-balance-sheet special purpose entity (SPCs) structuring.
Please contact us for details.