What is the Type II Financial Instruments Business?
Contents
Example of the Type II Financial Instruments Business Operator
Regulations for Type II Financial Instruments Business
Obligation to join Type II Financial Instruments Firm Association
Relationship with Type II Small-amount Electronic Public Offering Service
The form of the Type II Financial Instruments Business
Example of the Type II Financial Instruments Business Operator
The Type II Financial Instruments Business is a license to sell partnership-type or collective investment scheme-type funds to investors residing in Japan for foreign companies. It is necessary to set up an office in Japan to register as a Type-II Financial Instruments Business.
Overseas company may carry out the Type-II Financial Instruments Business by themselves or entrust the solicitation business to the domestic Type-II Financial Instruments Business Operator.
The Type-II Financial Instruments Business is to sell the low liquidity securities such as collective investment scheme equity and trust beneficiary right (i.e. other than major securities such as stocks and corporate bonds) stipulated at Article 2.2 of Financial Instruments and Exchange Act. Registration is required to sell these products to Japanese residents.
The self-offering (private placement and offering) of certain securities such as investment trust beneficiary certificates(which are not deemed securities) and currency-related derivative trading are also classified as the Type II Financial Instruments Business.
The Type II Financial Instruments Business for deemed security is to buy, sell, mediate, solicit or privately placement, handling of solicitation or offerings, or handling of private placements or solicitations for sales to specific investors (Partnership-type funds listed in Article 2.2, Item 5 or 6 of the Financial Instruments and Exchange Act (hereinafter, “Fund” means a Collective Investment Scheme in this section) and self-offering of certain securities designated by government ordinance).
In addition to deemed securities, the scope of the Type II Financial Instruments Business is classified in detail such as services of beneficiary securities of trustee-directed investment trusts, foreign investment trust beneficiary certificates, mortgage securities, foreign mortgage securities, solicitation or private offering (self-offering) of certain securities designated by government ordinance, and market transactions of currency-related derivatives trading.
However, in practice, the business of registered the Type II Financial Instruments Business Operator is handling fund solicitation or private placement (self-offering) and offering or private placement, and the sale, purchase, brokerage, or private placement of real estate trust beneficiary rights.
| Collective investment scheme equity | Buy, sell, mediate, solicit or privately placement, handling of solicitation or offerings, or handling of private placements or solicitations for sales |
| Trust beneficiary right etc… (low liquidity securities ) | Buy, sell, mediate, solicit or privately placement, handling of solicitation or offerings, or handling of private placements or solicitations for sales |
| Investment trust beneficiary certificates, beneficiary right of trustee-directed investment trusts, foreign investment trust beneficiary certificates, mortgage securities, foreign mortgage securities, solicitation or private offering (self-offering) of certain securities designated by government ordinance | The self-offering |
| Market transactions of currency-related derivatives trading | Acceptance of entrustment of sales etc… |
Category of Type II Financial Instruments Business
Once registered as the Type II Financial Instruments Business, you can set up a fund (which do not consist of investment to Financial Instruments) and solicit residents to invest in leveraged leasing funds for ships and aircraft, debt funds, business funds for restaurants, and content funds such as movies.
Restriction on Number of Investors and Scope of Service
Once registered the Type II Financial Instruments Business, you can solicit investors for deemed securities (including funds) without restrictions on the number of people. However, if you want more than 499 people to acquire the deemed securities that mainly invest in securities, it is necessary to notify relevant authorities in advance for the document delivered before the conclusion of the contract as it is considered as “Offering” (public offering).
If it applied one of the conditions below, you can offer the fund
managed by the rights related to securities or derivative transactions under the Type II Financial Instruments Business.
In case registering investment management business and carry out a fund management business (No. 15 business),
In case concluding a discretionary investment contract with an investment manager (No. 12 business)
– In case to carry out the fund management business under the Specially Permitted Businesses for Qualified Institutional Investor, etc. (Article 63 of the Financial Instruments and Exchange Act) or
In case exempted the requirements for the obligation to register as a financial instruments business related to the management of certain professional funds (Stipulated at the Cabinet Ordinance Paragraph 1.13 related the definition of Article 2 of the Financial Instruments and Exchange Act or Article 61 of the Financial Instruments and Exchange Act)
Upon conducting an “offering” of deemed securities, it is necessary to submit the Securities Registration Statement if the fund falls under the securities investment business right (the right to manage the asset with more than 50% of the assets with “securities”). Therefore, due to disclosure costs, partnership-type securities investment funds tend to be issued within the range of private placement of up to 499 holders.
Therefore, the offering of overseas hedge funds, VCs, PEs are generally aimed at less than 500 residents. Furthermore, in many cases, Specially Permitted Businesses for Qualified Institutional investors are also applied. In that case, the number of holders will be smaller depending on the investor attributes to limit investors to qualified institutional investors.
If deemed securities (paragraph 2 securities) including a collective investment scheme fall under the electronic record transfer right (security token), the handling business of the offering or private placement is the Type I Financial Instruments Business rather than the Type II Financial Instruments Business.
Regulations for Type II Financial Instruments Business
While the Type II Financial Instruments Business has a high degree of freedom to carry out the fund business, various strict regulations are imposed by laws and regulations and associations such as but not limited to segregation management, document issuance, and legal account books as a Financial Instruments Business Operator.
The Type II Financial Instruments Business Operator can sell a fund, i.e. a collective investment scheme as securities, and receive deposits from the customers (a company with a capital of more than JPY 50 million can open a customer’s account to conduct specific securities management. However, there is a heavy responsibility as a “financial institution” such as trust protection obligation in case of the Electronic-application-style Electronic Public Offering Service.
Furthermore, the handling of offering or sale of funds (excluding those listed in Article 15.4 of the Order for Enforcement of Financial Instruments and Exchange Act for Loans Type, etc.) on the Internet, or private placement or the handling of sales solicitations for the specific investors(including posting of recruitment guidelines, etc.), has classified as an Electronic Public Offering Service from May 29, 2015. Therefore, it is necessary to register not only the Type II Financial Instruments Business but also the electronic Public Offering Service if conducting offering other than own funds on the Internet.
In addition, among the Electronic Public Offering Service for those who carry out the “Electronic-application-style Electronic Public Offering Service” completing the application for purchasing securities online (receive online applications such as funds), additional obligations have been newly introduced such as examination of issuers, securing of information disclosure to investors, cooling off, clarification of target offering amount which enhances to regulate crowdfunding.
There are self-regulatory rules regarding examinations and monitoring by the Type II Financial Instruments Firms Association. It is necessary to comply with these rules when carrying out the Electronic-application-style Electric Public Offering Service of the business-type fund.
Regarding loan-type funds such as social lending that is” the amount exceeding 50 % of the total value of money and other property invested or contributed by the investors to be allocated to lending,” it does not fall under the Electronic Public Offering Service according to the provisions of Article 15-4-2, Item 7 of Order for Enforcement of the Financial Instruments and Exchange Act. Still, it is necessary to comply with “the Q & A provision for loan-type funds” introduced on May 23, 2019.
Type II Financial Instruments Business Operators are subject to on-site inspections by the Securities and Exchange Surveillance Commission (Finance Bureau), and many inspections are carrying out. If you wish to register for the Type II Financial Instruments Business, it is necessary to establish a sufficient system to carry out the business properly without violating relevant laws and regulations.
Obligation to join Type II Financial Instruments Firm Association
The rules and regulations of Type II Financial Instruments Firms Association are self-regulatory rules from a legal perspective; however, they bind as laws. The association members should comply with the self-regulation and the law requests to establish internal rules for the Type II Financial Instruments Business Operator even though they are not a member of the association.
Article 29-4, Paragraph 1, Item 4-2 of the Financial Instruments and Exchange Act states that the following company may be refused to register the Type II Financial Instruments Business.
A company that is not a member of the Type II Financial Instruments Firms Association, and
A company that does not establish the corresponded rules of the Association’s Articles of Incorporation and other rules (the rules that the officers or employees should comply with limited for the fair and smooth trading of securities and other transactions, or protection of investors), and
A company that does not have the system to comply with such relevant internal rules.
Type II Financial Instruments Firms Association is a voluntary organization. We have been asked whether it is possible to register for the Type II Financial Instruments Business without joining the Association. However, administrative unwritten guidance is issued to newly registered companies to join the Type II Financial Instruments Firms Association. It should be considered that the newly registered business operator is obliged to join the Association that is engaging in fund and trust beneficiary rights-related business.
However, among the Type II Financial Instruments Business, the self-offering of investment trust beneficiary certificates and currency-related trade derivative transactions is not under the self-regulation of the Type II Financial Instruments Firms Association.
Relationship with Type II Small-amount Electronic Public Offering Service
For conducting investment-type crowdfunding, is it necessary to register the Type II Small-amount Electronic Public Offering Service In conclusion, it is not necessary to register.
The law states that in the case of
the handling of private placements and
Private placements of collective investment schemes, and
the total issue price and the amount paid by the acquirer are “small.” There are certain easing regulations for “Type I Small-amount Electronic Public Offering Service or “Type II Small-amount Electronic Public Offering Service if certain conditions are met.
In terms of the “small amount” requirement, the total issue price is less than JPY 100 million (Order for Enforcement of the Financial Instruments and Exchange Act Article 15-10-3 No. 1) and the payment amount per person is JPY 500,000 or less (No. 2 of the same Article). For the requirements totaling less than JPY 100 million, it is necessary to summate
the same type of securities offering or private placement conducted within 1 year before the start of the offering or private placement and
The total issuance price of securities of various types or private placement overlapping the same application period. (Article 16-3, Paragraph 1 of Cabinet Office Ordinance on Financial Instruments Business).
Regarding the requirement of JPY 500,000 or less per person, there is a summation requirement for the securities that have been applied or paid (paragraph 2 of the same Article) within 1 year before the payment date.
However, there are no Type II Small-amount Electronic Public Offering Service Provider. At the same time, there are several Type I Small-amount Electronic Public Offerings Service Provider that manage equity crowdfunding of stocks as of 2021. The easing regulation applied to the Type II Small-amount Electronic Public Offering Service Provider is very limited, such as the amount of capital. On the other hand, it is possible to carry out funds offering without any limitation of the amount, once registered for the Type II Financial Instruments Business or the Electronic Public Offering Service.
There is a misunderstood that you will be obliged to the above small amount requirements and total requirements if you register for the Electronic Public Offering Service The above small amount requirements and complete requirements do not apply, including the case of the Electronic-application-style Electronic Public Offering Service if you carry out the Electronic Public Offering Service as the Type II financial Instruments Business Operator.
The form of the Type II Financial Instruments Business
Except for the minor business such as market-traded derivative transactions and self-offering of investment trust beneficiary certificate, the Type II Financial Instruments Business is divided into the “Type II Financial Instruments Business for Fund” and the “Type II Financial Instruments Business for Trust Beneficiary Rights.” It is difficult to carry out the Type II Financial Instruments Business with market derivative transactions and self-offering of investment trust beneficiary securities only, and it is more appropriate to explain it in another clause.
Self-offering (private placement and solicitation) investment trust beneficiary certificate is effectively regarded as an ancillary business (investment trust direct sales) of investment trust business which is an investment management business. As per the comprehensive supervisory guideline V-2-2-1 for the Financial Instruments Business Operator, receiving a deposit from customers for currency-related derivatives business is necessary Type I Financial Instruments Business registration as it corresponds to securities management business.
The above-mentioned the “Type II Financial Instruments Business for Trust Beneficiary Rights” is, in effect, the Type II Financial Instruments Business that sells real estate trust beneficiary rights. They sell and mediate real estate that has been converted to trust beneficiary rights. It is like a senior qualification of a real estate trader. A real estate fund cannot be established by the Type-II Financial Instruments Business alone as the trust beneficiary rights are neither funds nor REITs.
Type II Financial Instruments Business for Funds” can take countless forms. However, if the intention is to mainly invest in securities (such as stocks, bonds, etc.) or derivative transactions (like foreign exchange margin transactions, Nikkei Futures Trading etc.), it’s essential to register as an Investment Management Business as well.
It is possible to legally carry out self-offering and manage the funds by the Type-II Financial Instruments Business Operator unless it is regulated by other laws such as and Act on Regulation of Business Pertaining to Commodity Investment the Real Estate Specified Joint Enterprise Act.
The most common business models for businesses engaged by the Type-II Financial Instruments Business Operator without the Investment Management Business registration are “ship/aircraft funds,” “renewable energy funds,” and “physical fund for paintings/racehorse,” “loan-type fund”, and “investment-type crowdfunding.”
Suppose the fund manager is registered as an Investment Management Business Operator. In that case, the Type-II Financial Instruments Business Operator can also setup and sell a fund that mainly invests in the rights related to securities or derivative transactions such as Venture capital, hedge funds, PE funds, GKTK sales of real estate that has been made into trust beneficiary rights. In other words, it is necessary to register the Investment Management Business for these investment management businesses. In principle, venture capital, hedge funds, PE funds, and GKTK of a real estate converted into trust beneficiary rights can’t be established by the Type II Financial Instruments Business only.
Venture capital and hedge funds are generally carried out as fund business (No. 15 business) in the investment management business and self-offering (No. 7 business) in the Type II Financial Instruments Business. For the GKTK scheme with trust beneficiary rights, it is usually carried out as a Discretionary investment business by the asset manager (No. 12 b business) and a private placement handling business (No. 9 business) among the Type II Financial Instruments Business.
Even if the rights related to securities or derivative transactions do not exceed 50% of the fund assets, and the fund issuer (GP or business operator) does not make investment decisions on the assets and engages the external asset manager, the asset manager is required to register as an Investment Management Business that engaging discretionary investment contract.
FAQ about Type II Financial Instruments Business
What kind of fund can we establish and make offerings by the Type II Financial Instruments Business license only?
Typically, you can carry out a fund for a small number of institutional investors who meet certain conditions, a loan business registered as a money lending business (social lending), a renewable energy business (solar power generation, etc.), ship/aircraft finance (Leveraged lease).
Can we establish a real estate fund with the Type II Financial Instruments Business license?
A real estate fund in-kind requires a real estate-specific joint venture license under the Real Estate Specified Joint Enterprise Act. There is a method of trusting the property and securitizing it using the GKTK scheme, but an Investment Management Business License is required.
In addition, in the particular business under the Real Estate Specified Joint Enterprise Act, the No. 4 business operator is required to register the Type II Financial Instruments Business at the same time. In any case, it is not possible to establish a real estate in-kind fund by the Type II Financial Instruments Business license.
However, there is a structure that incorporates money lending (it is necessary to formulate a scheme so as not to violate the Money Lending Business Act), such as establishing a fund that lends to SPC that engages in real estate transactions, which is able to establish by Type II Financial Instruments Business license only.
Are we able to establish a fund that mainly invests in financial instruments such as FX and stocks?
As mentioned above, a fund that mainly invests in securities or rights related to derivative transactions falls under the self-management business of a collective investment scheme. Therefore, the fund issuer can’t manage the fund unless the investment management contract is outsourced or the fund issuer registers the Investment Management Business. There is a certain exemption for the business with institutional investors such as the Specially Permitted Businesses for Qualified Institutional Investors, etc.
It is difficult to secure experienced employees, is it possible to outsource compliance jobs?
The Financial Services Agency has not completely ruled out that possibility except registering the Type II Financial Instruments Business in association with to carry out the Investment Management Business for qualified investor. However, it is difficult to outsource compliance when registering for the Type II Financial Instruments Business, in general.
Is it possible for the company representatives to serve as compliance in charge?
The supervisory guidelines require that the legal compliance department should be independent of the sales department. Therefore, the representative directors can’t concurrently serve as the compliance department as they are in charge of the entire company and control the sales department. Furthermore, it requires about 3 to 4 employees with working experience at financial institutions to register for the Type II Financial Instruments Business.
Is it possible to raise funds by incorporating crypto-assets such as tokens and STO?
The Financial Services Agency has set an extremely high entry barrier for blockchain-related businesses. The Crypto-asset Exchange Service provider, the Type I Financial Instruments Business Operator that provide crypto-currency related derivative transactions, and regular members of the Japan STO Association (that registered after the Coin Check incident), are all large companies or backed by large companies. Therefore, we have to say that it is not impossible to carry out the business other than such a large company. The STO is classified as Type I Financial Instruments Business, and a major securities company has completed change registration in 2021.
Special Feature: Passion of Social lending industry
The industry, which was on a steady growth trajectory, has hit a roadblock due to a series of scandals involving major social lending companies. The introduction of more stringent screening procedures for new registrations has made it increasingly challenging for newcomers to enter the industry. Meanwhile, established companies are grappling with tighter regulatory oversight. Let’s delve into the current state of the industry, which is finding itself constrained by the actions of its leading companies.
