Unofficial and Provisional Translation
Readers are advised to refer to the original
Japanese text before quoting from this document.

Summary of the Interim Report of the First Committee of the Financial System Council

(July 6, 1999)

I. Financial services fit for the 21st century


Financial and economic internationalization and advances in financial and telecommunications technologies have enabled the provision of a diversity of attractive financial products and services which go beyond the bounds of the existing framework for financial institutions. The role of asset management and financing through the market is, moreover, expected to grow in importance. Finance will play an increasingly important role in not only lending (as in the past) but also in a wide range of areas such as efficient national wealth creation to help meet the needs of an aging society, the creation of new businesses and industries with promising growth potential, and corporate governance. Finance will thus come to impact even more significantly upon the shape of the national economy.


To enable risks to be shared widely through the market, it is necessary to further clarify and render transparent the relationship between the risks and returns inherent in financial transactions. It is also hoped that a diverse range of financial products (including medium-risk/medium-return financial products) will be made widely available to meet the needs of a variety of investors, one means of doing so being through "collective investment schemes", whereby funds pooled from a number of investors are entrusted to the management of professional fund managers. A framework that will both provide suitable protection for investors and give rise to a more diverse and attractive range of financial products is therefore required for such schemes.


The ultimate goal of deliberations on a Japanese version of a "Financial Services Law" may be considered to be to transfer the focus of the concept of financial services from institutions to the functional aspect of transactions per se. It is also important to not only regulate the actions of institutions but also to clarify civil (private law) rules for ensuring its effectiveness. Given the difficulty associated with making the necessary changes to create the framework for such a radical system on a theoretical basis alone, concrete changes should instead be considered on the basis of a thorough understanding of the state of progress in reform of the financial system and of the actual situation of market participants.

What is therefore required at present is:


To consider the rules required concerning the sale of and solicitation for customers for a broad cross-section of financial products in readiness for the appearance of a diverse range of financial products in the future; and


To consider the rules required concerning collective investment schemes (which provide products combining various risks and returns to the public).

II. Framework of rules underpinning new developments in finance

The financial system must be made fair and effective and be regulated by clear and transparent rules. In view of the growing diversity and speed of change in finance, it would be inadvisable to enshrine all such rules in law. The aim should instead be to form the various rules at various levels (such as laws and ordinances, rules for self-regulating organizations, and civil legislation) into a single integrated rule system founded on the principle of self-responsibility.

"Rule" here means the totality of agreements (norms and standards) concerning the division of responsibilities between and the rights and obligations of parties to transactions and determining what each party may or may not do. These determine in advance, for example, under what circumstances a person should enjoy returns and bear risks. In this sense, therefore, rules do not directly mean just statutory rules and administrative regulations, but also include everything such as agreements between parties and arrangements concerning the internal management of financial service providers.

III. The scope of financial products covered by the framework for new financial rules

In view of the purpose of "the Financial Services Law," in which a broad interpretation of finance is adopted, financial products should be defined broadly to include not only securities covered by the Securities and Exchange Law and traditional financial products such as savings, insurance and lending, but also derivatives and the various products created through the collective investment schemes covered by "the Financial Services Law." Problems arising due to the different attributes of various kinds of products should be addressed in the light of the relationship of such products to the application of rules and the purpose of regulation.

Where the user is the recipient rather than the lender of funds (as in the case of lending), proper disclosure and proper methods of recovering loans (conditions for extending credit) become significant for ensuring user protection. Accordingly, such financial products will need to be considered in more depth from a different perspective to other financial products.


Broad-ranging rules on sales and solicitation for customers, and the distinction between professionals and non-professionals


In order to determine broad-ranging rules on sales and solicitation for customers, it is first necessary to imagine what sorts of users will be using financial products. In this regard, therefore, users should be assumed to be capable of making independent decisions aware of their own responsibilities. More specifically, there may be assumed to be three categories of users:


Users capable of acting on their own responsibility unconditionally (wholesale/professionals)


Users who can bear risks acting on their own responsibility assuming that they have access to certain information (ordinary retail/ordinary users)


Users who cannot be held partly or wholly personally responsible (specified retail/specified users)

With these three categories in mind, the best approach is to consider rules for category (b) (ordinary retail and ordinary users), and then move on to the other categories to avoid any omissions.


In order to ensure the fairness and effectiveness of finance, it is thus important to distinguish between wholesale and retail transactions and (with respect to trading entities) between professionals and non-professionals (ordinary and special users), and to consider rules applicable to each category. Detailed criteria by which to make the above classifications need to be worked out in the future, while bearing in mind the need to ensure clarity and objectiveness and also focusing on the categories determined mainly on the basis of the entities involved in transactions. It will also be useful from the perspective of respecting freedom of choice of users if use can be made of selections and conversion regarding these categories


The main rules governing sales and solicitation activities for financial products are those concerning information provision requirements, the suitability rules, and solicitation.


Information provision requirements are the obligation of institutions (financial service providers) to provide information on important matters to users. Important matters may be considered to mean information on common minimum standards for financial products as defined by law, and other more specific matters as determined by rules established autonomously by the private sector.
In order to clarify the rights and obligations of institutions and users under private law, it should be made clear in the rules that if an institution fails to provide a user with important information that should be provided, that institution will be liable to pay compensation under private law.


The suitability rules mean that an institution' sales and solicitation activities should be appropriate given a user' knowledge, experience, wealth and investment objectives, etc.
It was the majority view that in the light of the principle of self-autonomy, while it may be considered prudent to limit certain transactions with specified users (the suitability rules in the narrow sense), institutions should be required to adopt internal standards of conduct, such as standards for developing sufficient means of knowing about users (the suitability rules in the broader sense).
Strictly speaking, the suitability rules in its broader sense will be a rule concerning internal codes of conduct to be observed by institutions, and although the inadequacy of internal systems thus required may to a certain extent be taken into account in individual lawsuits, it would be difficult to make the rule directly enforceable under private law.
The suitability rules in the narrow sense may also be applied to solicitation activities. Thus attempts to encourage ordinary users with no experience of such transactions to become excessively leveraged or agree to highly risky transactions that would leave them with considerable debts could be prohibited and compliance strictly enforced.


Other rules on solicitation include:


Prohibition of fraudulent solicitation activities, and


Prohibition of misleading solicitation activities.

The specific details of rules applicable under the civil code and rules on the conduct of institutions need to be examined.

V. Rules applicable to collective investment schemes


Broadly speaking, there are two types of collective investment scheme:


Asset management schemes: Schemes whereby funds from a number of investors are pooled and invested in various assets and managed by professional fund managers.
Existing schemes of this type include securities investment trusts, commodity funds and collective investment money trusts offering dividends proportionate to performance.


Asset securitization schemes: Schemes whereby the cash flows earned from specified assets are rearranged by professional arrangers, and securities sold to a number of investors.
Existing schemes of this type include securitized products covered by "the SPC Law (the Law on Securitization of Specified Assets by Special Purpose Companies)," and "the Law Regarding Regulation of Business Concerning Specified Claims' etc."


Collective investment schemes entail the pooling of investors' funds for management by a third party. Because of this, it is important to clarify rules to ensure schemes are properly managed and the allocation of risks between the parties concerned is clarified.
At present, investor protection is provided through laws on individual types of institutions which establish frameworks for protection corresponding to the characteristics of the vehicles for and targets of investment. In order to develop an environment capable of generating a broader, more diverse range of products that go beyond the scope of the current legislative framework while at the same time providing suitable protection for investors, the concrete details of a basic framework of rules that takes into account the differences between asset management and asset securitization schemes will need to be considered.


The U.S. and U.K. have made it clear that financial service providers involved in such schemes have certain duties as trustees, and the legal principle of fiduciary duty (which requires that the fiduciary discharge certain duties) has become firmly established. Fiduciary duty has not necessarily been clear in Japan, however. In order to develop a legislative and rule-based framework for collective investment schemes to create an environment capable of generating diverse and broad-ranging products, it is necessary to clarify specific rules concerning fiduciary duty in the wide sense and to see that they are actively adopted as codes of conduct for financial service providers.


Rules governing collective investment schemes may be broadly classified as follows:


Rules on arrangement of schemes,


Rules on operation of schemes, and


Rules on transactions in the financial products thus formed.

Rules should be clarified bearing in mind the need for such rules to differ depending on the different characteristics of asset management and asset securitization schemes.

VI. Enforcement of rules and education for consumers


In order to establish and ensure the effectiveness of rules, it is important to assign appropriate roles to rules such as laws and ordinances, legal principles established by judicial precedent, rules set by self-regulating organizations, customary rules observed by participants in transactions, and rules on internal risk control and compliance by individual businesses.


Self-regulating organizations should preferably be capable of dealing with matters relating to a broad range of financial products and services in a variety of fields, and further deliberation will be required concerning their legal authority (or lack thereof), the cost of their establishment and operation, and how to ensure their neutrality and specialist status.


The infrastructure for resolving matters judicially must be developed to provide the ultimate means of ensuring compliance. To complement this, it is also worth considering developing a system for settling disputes out of court.


In order to allow users of financial products to make independent choices between various financial products and services and enjoy their merits, it is essential to improve consumer education and access to information. The industry has in fact made a steady contribution in this regard by, for example, holding briefings, and it is to be hoped that businesses expand such activities in the future. The administration also has an active role to play in increasing public awareness of issues such as the scope of users·rights and liabilities under the new framework of rules, and it is important that consumers·basic knowledge of finance in general should be increased and consumer education (including education in financial matters) be expanded. Improved consumer education will thus need to be made more widely available, and if this is to be achieved the assistance of professionals in education will be required.

VII. Issues for further study and future approach


The Committee intends to continue studying the various remaining problems associated with rules relating to sales and solicitation taking into consideration the opinions given by various interested parties for this interim report. The development of electronic commerce (such as that conducted via the internet) and rules for non-face-to-face and cross-border transactions will also need to be considered.
Concrete rules for collective investment schemes will also be considered by the Committee taking into account the features of current systems.


While proceeding to examine such issues and bearing in mind progress in reform of the financial system, the Committee will also be considering legal matters with the ultimate aim of drastically revising the current legislative framework of individual laws covering specific types of institutions.

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