Overview of ''Financial Instruments and Exchange Law'' (Part 1)

The law for amending the Securities and Exchange Law and other financial laws (2006 Law No.65) and the law for abolishing and amending the related laws to implement the law for amending the Securities and Exchange Law and other financial laws (2006 Law No.66) were promulgated on June 14, following the approval and passage of the respective bills at the 164th Diet session held on June 7, 2006.
The said Laws consist of legislations including reorganizing the Securities and Exchange Law into the Financial Instruments and Exchange Law (so-called ''Investment Services Law'') in response to the report titled ''Legislation for the Investment Services Law (provisional title)'' released by the First Subcommittee of the Sectional Committee on Financial System of the Financial System Council on December 22, 2005, which was featured in the February edition of the FSA Newsletter. Their aim is to adapt to changes in the environment surrounding financial and capital markets, strictly enforce rules on user protection, improve user convenience, secure market functions to shift funds from savings to investments, and adapt to the globalization of financial and capital markets.
  More specifically, the legislations can broadly be divided into the following four basic elements:
(1) Development of a cross-sectoral legal system to protect investors regarding financial instruments with strong investment characteristics (legal system based on so-called ''Investment Services Law'');
(2) Enhancement of the disclosure system;
(3) Reinforcement of self-regulatory functions of stock exchanges; and
(4) Strict approach to unfair trading, etc.

The key adjectives here are ''comprehensive and cross-sectoral'', ''flexible (increased structural flexibility)'', ''fair and transparent'' and ''strict''.
This is the first of the three-part series featuring the latest set of legislations.

Provisions regarding the enhancement of punitive clauses in disclosure documents and unfair trading, including fictitious orders, in the law for amending the Securities and Exchange Law and other financial laws came into force on July 4, 2006 (20 days after the promulgation date). In conjunction with the enforcement of these provisions, the Cabinet Order for implementing the Securities and Exchange Law (1965 Ordinance No.321) was amended.
1. Building a Cross-sectoral Legal System to Protect Investors regarding Financial Instruments with Strong Investment Characteristics (Legislation for ''the Investment Services Law'')
1)  Transition from Securities and Exchange Law to Financial Instruments and Exchange Law
  - The latest legislations involved abolishing four laws, including the Financial Futures Trading Law, and consolidating them into the Securities and Exchange Law, in view of reviewing the existing sectional business laws. Furthermore, they involved amending 89 laws, including the Law Concerning Investment Trusts and Investment Corporations, and consolidating some of the amended provisions into the Securities and Exchange Law.
- As a result, the Securities and Exchange Law covers a wider scope of financial instruments than before. Accordingly, it is renamed ''Financial Instruments and Exchange Law''.
  (Note*) The Securities and Exchange Law and the Financial Instruments and Exchange Law are hereinafter referred to as ''SEL'' and ''FIEL'', respectively.
  - In conjunction with this, regulated businesses are now legally referred to as ''financial instruments firms'' instead of ''securities companies'', and exchanges are now legally referred to as ''financial instruments exchanges'' instead of ''securities exchanges''. (However, these are just legal names so securities companies and securities exchanges can continue using their existing names.)


 Expansion of Scope of Regulated Products
  In recent years, financial instruments that are not regulated by SEL and other user-protection laws have started to appear on the back of the progress in financial technology, etc., and users have been victimized in some cases. FIEL has expanded the scope of regulated products as follows, in order to close the loopholes in the existing legal system for user protection.
a) Expansion of Definition of Securities
The definition of ''securities'' as products regulated by the existing SEL has been expanded. For example, interests in trusts in general are regarded as securities (paragraph 2 (1) and (2) of Article 2 of FIEL) and holdings of so-called collective investment schemes (funds) are comprehensively regarded as securities (paragraphs 5 and 6 of Article 2 of FIEL).

b) Expansion of Definition of Regulated Derivative Transactions
Under the existing SEL, only ''derivative transactions'' related to securities are regulated. Under FIEL, transactions relating to a wide range of underlining assets and indexes and various types of transactions are regulated, including transactions subject to the Financial Futures Trading Law under the existing system (such as foreign exchange margin trading). So-called currency swaps, interest rate swaps, weather derivative and credit derivative transactions are also regulated. (Paragraphs 20 through 25 of Article 2 of FIEL).

(Reference) Comprehensive Definition of Collective Investment Schemes
Holdings of arrangements (collective investment schemes) with the following characteristics are regarded as securities under the Financial Instruments and Exchange Law:
  i) Receives investment (contribution) of money, etc. from other parties;
ii) Runs a business by using those assets; and
iii) Distributes proceeds, etc. from the business to the investors, etc.
It is a comprehensive definition in that it does not matter whether it is a partnership contract under the Japanese civil code or in any other legal format, or what kind of business is operated by using the invested money, etc.
(Assuming the above, certain schemes in which all investors participate in the business are excluded from the definition of securities.)

3) Regulated Cross-sectoral Operations
Under the existing SEL, ''sales and solicitation'' operations relating to securities and derivative transactions are regarded as ''securities businesses'', and are basically regulated through a registration system. Under FIEL, the existing sectional business laws have been reviewed, and a wide range of operations including conventional securities businesses are regarded as ''financial instruments businesses'' and regulated across sectors through a registration system (paragraph 8 of Article 2 and Article 29 of FIEL).

a)  ''Sales and Solicitation'' Operations
-  Under FIEL, the scope of regulated operations (financial instruments businesses) has been expanded in conjunction with the expanded definition of securities and derivative transactions as referred to in 2) above: an example is the consolidation of financial futures trading business regulated by the Financial Futures Trading Law under the current system.
-  Furthermore, in contrast with SEL, which does not regulate ''sales and solicitation'' by the securities issuers themselves (so-called own offering), FIEL treats own offering such as holdings of collective investment schemes as newly-regulated operations (paragraph 8 (7) of Article 2 of FIEL).
b)  ''Investment Advisory'', ''Investment Management'' and ''Customer Asset Administration'' Operations
-  In addition to ''sales and solicitation'' relating to securities and derivative transactions, FIEL regulates ''investment advisory'', ''investment management'' and ''customer asset administration'' operations as core operations.
-  FIEL also clearly states that operations in which assets of collective investment schemes are invested mainly in securities or derivative transactions (so-called investment on own account) are also subject to regulation (paragraph 8 (15) of Article 2 of FIEL).

(Operations Regulated by Existing Business Laws)

4) Flexible Requirements on Market Entry according to Nature of Operations
FIEL regulates financial instruments businesses based on a registration system across sectors as referred to in 3) above. On the other hand, it categorizes financial instruments businesses according to the scope of their operations, and by category, sets forth requirements on market entry (criteria for rejection of registration), including the acceptability of entry by individuals and basic financial requirements (paragraph 4 of Article 29 of FIEL).
If a financial instruments dealer wishes to launch operations in a category that is different from the one it is engaged in, the dealer must go through procedures to modify the registration (paragraph 4 of Article 31 of FIEL).
The next edition will review the development of codes of conduct that should be observed by businesses in ''1. Building a System based on the Legislation for the Investment Services Law'' focusing on:
5) Relaxation of codes of conduct, etc. according to customer categories;
6) Treatment of deposits, insurance, etc. with strong investment characteristics; and
7) Development of other systems for user protection.

[Primer on Financial Literacy]

Hostile Corporate Takeover Bids

The takeover bid (TOB) disclosure system is a system designed to ensure transparency and fairness in securities transactions that might affect the controlling stake in a company. Specifically, in cases where shares are to be purchased in large volumes by non-exchange trade, the bidder is obliged to disclose the TOB period, bidding volume, TOB price, etc. in advance and give a fair opportunity to the shareholders of the targeted company to sell their shares.

There has been a rapid increase in the number of corporate mergers and acquisitions in Japan lately, and the number of cases of TOB as one of the measures of acquiring a company is on the increase as well. TOBs are also diversifying in form, as exemplified by the emergence of cases involving so-called hostile TOB, in which TOB is carried out without the consent of the management of the targeted company.

It is therefore indispensable to have a framework that enables shareholders and investors to receive sufficient information from both the bidder and the targeted company and properly determine whether or not to sell their shares after giving careful thought. For this reason, the TOB disclosure system was revised under the Law for the Partial Amendment of Securities and Exchange Law, etc. established in June 2006. The specifics of the revision are described below.
1)  Response to Law-evading Types of Transactions
Cases in which the bidder has acquired more than one-third of all outstanding shares after rapidly purchasing the shares based on a combination of trades including purchase at on-exchange and non-exchange markets were clarified as the type of transactions subject to TOB regulations.


 Enhancement of Provision of Information to Investors

In order to provide shareholders and investors with sufficient information so that they can decide whether or not to accept the TOB after giving careful thought, measures were taken including obliging the targeted company to declare its opinion on the TOB, giving the targeted company the opportunity to ask questions to the bidder, and allowing the targeted company to request an extension of the TOB period.


 Flexible Approach to Withdrawal of TOB, etc.

In order to prevent the bidder from being put in an extremely unreasonable position, rules on withdrawal of the TOB and changes in the terms of the TOB became more flexible in cases where the so-called anti-takeover measure is launched by the targeted company.


 Partial Introduction of Obligation to Purchase All Shares

For the purpose of ensuring fairness between shareholders and investors, purchasing pro-rate became a narrower option and acquiring all the shares responding to the TOB became mandatory in cases where the post-TOB shareholding ratio exceeds a certain percentage.


 Ensuring Fairness between Bidders

In cases where another shareholder who holds more than one-third of all outstanding shares of the targeted company rapidly accumulates certain shares while a bidder is executing a TOB, TOB became mandatory for such shareholders.

Further improvements in the transparency and fairness of the procedures are expected to be made in cases of so-called hostile TOB, relying upon due consideration given by the parties concerned with respect to the objective of the TOB system.

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