Establishing A Retail Fund In Ireland For Sale In Japan - Fund Structures And Features

Author:Mr Brian Dillon
Profession:Dillon Eustace

1. Introduction to Establishing a Retail Fund for Sale in Japan The issuing of securities of offshore funds for public sale into Japan is governed by a combination of the Securities and Exchange Law of Japan (the "SEL") which is enforced by the Japanese Ministry of Finance ("MOF"), the Law Concerning Investment Trust and Investment Company of Japan (the "Investment Funds Law") which is enforced by the Financial Services Agency of Japan ("FSA"). In addition, the distributing securities companies must comply with the SEL and the selfregulatory rules of the Japanese Securities Dealers' Association ("JSDA"), including regulations relating to trading in foreign securities and the Standard Rules for the Selection of Foreign Investment Trust Funds (the "Selection Rules"). The Financial Product Sales Law which became effective in April, 2001, introduced additional measures for the protection of investors including additional risk disclosure requirements and heavier civil liabilities in order to compensate investors for losses suffered from distributors' non-compliance with the requirements. The SEL, the Investment Funds Law and the Financial Product Sales Law have been amended by the recently introduced Financial Instruments and Exchange Law. 1.1 Distribution Offshore funds are primarily sponsored and distributed in Japan by Japanese brokers although foreign brokers whose Japanese branch is registered for securities business with the relevant Japanese authorities may also sell securities of offshore funds. Public offerings of such securities are primarily marketed to individual investors and small sized corporations but may also be purchased by larger corporations. 1.2 Fund Types In terms of the types of fund being publicly offered in Japan traditionally domestic funds established in Japan have been structured as investment trusts. This investment trust structure would be similar to the unit trust structure (contractual-type fund) used in Ireland. The primary historical reason for this preference, until recently, was the favourable tax treatment afforded to individual investors investing in such foreign contractual-type funds. Prior to 31 December, 2003, income from the sale of units in such foreign stock investment funds was not subject to tax. Recent changes to the taxation system have resulted in such gains now being subject to tax at a rate of 10% (due to increase to 20% from 1 January, 2008). The rate for dividends has been reduced from 20% to 10% until 31 March, 2008 (when it will revert to 20%). Additional reasons why the contractual-type of fund is favoured for Japanese public offerings include such cases where in excess of 50% of a fund is owned by Japanese residents or in excess of 5% by a single Japanese institutional investor; in these cases the Japanese tax authorities may determine that such an investment, if in a corporate type fund, represents an equity shareholding in a tax haven company. Similarly, the Japanese Foreign Exchange Law provides that the acquisition of 10% or more of a foreign company, including a corporate-type fund, by a Japanese resident requires prior notification to the MOF through the Bank of Japan. To avoid filing such notification, contractual type structures are used instead. Whilst corporate-type funds are allowed by law to be offered publicly in Japan, their suitability will clearly depend on the investor profile in Japan and indeed in other jurisdictions where it is intended to market the product. Where it is not envisaged that any single Japanese investor may hold in excess of 10% of the fund's securities, there should not be any difficulty using the corporate structure. Funds have also been established in Ireland, by Japanese promoters, for Japanese retail investors with "limited liquidity". These funds are typically closed-ended for repurchase for a period of time (usually 1-3 years), while continuous sales may be made during this period. 1.3 Selection Rules As indicated above, the public sale of offshore funds into Japan is regulated by, amongst others, the Selection Rules. According to the Selection Rules:- a distributor may only sell securities in foreign investment funds where the distributor confirms that the issuer of these securities is established under the laws of a country or jurisdiction which has well established laws and regulations governing: the establishment of such funds the disclosures to be made in respect of such securities; and the supervisory requirements for the issuer of such securities the net assets of the fund after the initial offering must be at least JPY 100 million and those of the management company must be at least JPY 50 million the fund's financial statements must be audited by an independent auditor a bank or trust bank must be designated as custodian for the fund's assets a JSDA member company (usually the securities company which acts as the primary distributor in Japan) must be appointed as an agent member company in Japan to act as the agent of the management company to ensure compliance with JSDA rules and requirements a legal representative in Japan, usually the Japanese legal adviser to the fund, must be appointed and maintained within Japan to ensure Japanese jurisdiction over any related litigation and a clear provision must be made for the management company to submit to the Japanese courts in respect of any litigation regarding the units in the fund acquired by Japanese investors the value of securities sold short may not exceed the fund's net asset value borrowing must not exceed 10% of total assets (except temporarily in the event of a merger or similar event) where a restriction from investing more than 15% of the fund's assets in privately placed equity shares, unlisted shares and other assets without liquidity is not imposed, measures must be taken to ensure the clarity of the price determination of the fund's non-liquid investments. the total issued and outstanding shares in one company (excluding a securities investment company) held by the management company on behalf of the funds managed by it may not exceed 50% of the total issued and outstanding shares of such issuing company redemption or repurchase methods must be clearly prescribed in the country where the fund is established the management company, its affiliates, directors and holders of more than 10% of its issued and outstanding stock may not buy or sell the securities of the investment fund or grant or receive loans to or from it a fund may not enter a transaction that is not in accordance with proper management or is detrimental to the interests of the fund's investors changes to the composition of the board of directors of the management company must be subject to the approval of the supervisory body, the investors or the trustee adequate disclosure of the fund's investments must be made to the fund's investors and the supervisory body No such restrictions except for jurisdictional requirements apply to offshore funds that are offered privately to Japanese investors. Both a UCITS and a non-UCITS retail unit trust established in Ireland (further details contained in Part B, below) would fit well within the Japanese regulations in terms of exposure to a single issuer and leverage. The exposure with a single issuer and leverage in the case of a UCITS unit trust is obviously more restricted than what is permitted by the Japanese regulations whereas the Japanese regulations are slightly more restrictive than those applicable to a non-UCITS retail unit trust in terms of leverage. 1.4 Public Offering in Japan Where an offering of securities to Japanese investors does not come within the scope of the private placement exceptions set out below, it will be deemed to be a public offering and subject to the various rules governing such offerings. A public offering is the only method by which foreign investment fund securities can be distributed to the public in Japan in substantial quantities. Typically, a new public offering is initiated by a foreign investment management company or a Japanese securities company (the "Promoter"). The Promoter selects the relevant service providers, such as the custodian / trustee, administrative agent, manager, investment manager and sub-investment adviser, etc. In selecting these parties the following points should be borne in mind:- (a) Neither the fund nor its management company may sell foreign investment fund securities directly in Japan. Only a securities company registered in Japan or a financial institution registered for handling investment fund securities may sell such securities and all contact with the JSDA is handled by that securities company. Typically, Japanese legal counsel will liaise with the MOF and Financial Services Agency ("FSA") on behalf of the fund. It is...

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