An Introduction to Japan FinTech
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Establishing New Services and Promoting Businesses after the Pandemic
Following on from 2019, important legislative changes related to the fintech industry emerged in 2020 and will take effect in 2021. Although intermediary services for regulated financial industries, such as banking, securities, and insurance, were required to be registered under different regulatory regimes for each industry, a new "Financial Services Intermediary Business" has now been introduced, which allows for the one-stop provision of products and services provided by multiple industries and multiple financial institutions. For the fund transfer business, three categories have been established depending on the maximum amount of transfer, and the regulation of post-pay services will be made more flexible. Meanwhile, new regulations for digital platform providers also were enacted. After the pandemic, in order to promote working from home, transform the business practice of requiring a written document and seal, and promote the use of electronic contracts and electronic signatures, the government issued FAQs on relevant legal issues that were unclear. In 2021, regulatory changes are also expected to affect the services provided by banking groups.
Newly Introduced “One-Stop” Financial Services Intermediary Business
“One-Stop” Financial Services Intermediary Business
On June 5, 2020, the “One-Stop” Financial Services Intermediary Business for banking, securities, insurance and money lending transactions was introduced under the “Act Concerning Provision of Financial Services” (the “Financial Services Act”), which was previously known as the “Act on Sales, etc. of Financial Instruments” (Act No. 101, 2000). The Financial Services Act will take effect during 2021 at a date to be determined.
Under the current legislation, licences for providing intermediary services (such as securities transaction intermediary services) concerning financial products are regulated by separate statutes. For example, an operator who provides an intermediary business for securities transactions is required to register under the Financial Instruments and Exchange Act (Act No. 25, 1948). After the Financial Services Act takes effect, an intermediary service provider may provide intermediary services concerning financial products in various business sectors (banking, securities, insurance and money lending) by obtaining a single registration as a “Financial Services Intermediary Business Operator”.
Products handled under the new intermediary service
The financial instruments that can be handled under the new One-Stop intermediary licence will be limited to those that do not require a sophisticated explanation to be given to customers by the provider of intermediary services. As such, the scope of services may be limited to relatively simple, straightforward financial products. For example, a Financial Services Intermediary Business Operator focused on banking transactions would handle ordinary deposits and housing loans, while it may not be permitted to handle foreign currency deposits. The permitted products and other details will be set out in the regulations promulgated by the Financial Services Agency of Japan (“FSA”).
Fintech companies, especially electronic settlement agency service providers, are expected to be potential One-Stop financial services intermediaries. These companies have sufficient information on customers’ financial status and preferences gained through their electronic payment service and, as such, are expected to utilize that information to provide this new intermediary service.
Business operators of price comparison websites (such as travel insurance comparison websites) and non-financial service providers are also expected to be potential participants.
Newly Introduced categories of Fund Transfer Services
On June 5, 2020, new categories of fund transfer services were introduced under the amended Payment Service Act (the “Amended PSA”). The Amended PSA introduces three different classes of fund transfer businesses (Type I, II and III). The Amended PSA will take effect during 2021 at a date to be determined.
Under the current Payment Service Act (Act No. 59 of 2009), a fund transfer service provider is permitted to engage in fund transfer services under certain restrictions, which include (a) a JPY 1 million limit on the maximum transfer amount per transaction, and (b) a security deposit in the amount calculated based on the total value of funds to be transferred.
With regard to the limit on the maximum transfer amount, there will be no statutory limit on any fund transfer transaction carried out by a Type I operator. On the other hand, other stricter restrictions will be imposed. A Type I operator will be required to post a security deposit within a short period of time (two business days has been suggested). Also, the Type I operator may be required to take strict information security measures and comply with AML/CFT rules.
With regard to a Type II operator, the applicable restrictions and transfer amount limit are basically the same as those imposed on current fund transfer service providers.
A Type III operator is permitted to engage in fund transfers handling a smaller amount designated by Cabinet Order (JPY 50,000 has been suggested) and under less strict restrictions.
The Amended PSA also clarifies that a fund transfer service provider is required to take necessary measures to prevent the retention of customers’ funds that are not expected to be used for fund transfer transactions. Different measures will be required corresponding to each type of fund transfer.
Recently, it was revealed that the linkage service between mobile e-money services and customers’ bank accounts provided by one of the Japanese major mobile telephone carriers, was misappropriated. The illegal withdrawals made following the hack might result in a strengthening of the restrictions on e-money transfer services. The Japanese Bankers Association issued, on November 30, 2020, the guideline regarding cooperation and collaboration between fund transfer business providers and banks, which was aimed at, inter alia, user protection, enhancement of information security and scrutiny of eligibility of fund transfer business providers. Also, the Center for Financial Industry Information Systems is reportedly considering tighter security regulations (e.g. strict e-KYC procedures).
Flexible regulation for post-pay services
The Installment Sales Act (Act No. 159 of July 1, 1961) was amended in June 2020 to respond to the progress of technological innovation and growing needs in the electronic payment field. The major amendments are as follows and will come into effect by June 2021.
Registration system for small-instalment/deferred-payment services
In the field of deferred-payment services, strict regulations have been applied uniformly regardless of the amount to be paid. In view of the increasing use of deferred payments for daily and low-value payments, and from the perspective of a risk-based approach, a new flexible registration system has been introduced for the small-instalment/deferred-payment service.
For example, there will be no capital requirement for registration of businesses that provide small-instalment/deferred-payment services with a credit limit of 100,000 yen or less, and the net asset requirement will be comparatively relaxed.
New methods for credit screening to prevent excessive credit
Currently, deferred-payment service providers are obliged to conduct an examination of amounts expected to be repaid by users as a framework to prevent granting the users excessive credit. While the methods of this examination (e.g. items to be surveyed, survey method and calculation method) are uniformly regulated under the Installment Sales Act, the amended Installment Sales Act will allow certain service providers to utilize other screening methods using technologies and data such as a credit scoring system provided that such screening method must be accredited in advance and checked periodically thereafter.
Security measures for QR code settlement operators and other businesses.
Due to the evolution of payment technology, businesses involved in new payment services, such as payment via QR code, are emerging. As a result, while consumer convenience has improved, the risk of leakage of consumers’ credit card numbers and other personal information has increased due to security vulnerability. Therefore, those businesses, including settlement service companies, QR code payment companies and EC mall companies, will be subject to new obligations to appropriately manage credit card numbers under the amended Installment Sales Act.
Digitization documents for services using smartphones and personal computers
As of now, it is basically mandatory for businesses to issue a document when a credit card company issues a credit card, when a consumer uses the credit card and when a credit card company requests a revolving payment (which means a payment method where a consumer pays a fixed amount or at fixed rate regardless of the total amount to be paid) to a consumer. Businesses are therefore forced to print and mail those documents. However, under the amended Installment Sales Act, for services that are completed using smartphones and personal computers, businesses will be able to provide “soft copy” electronic information only.
Electronic Contract and Electronic Signature
In 2020, the impact of COVID-19 has led to a dramatic shift away from the Japanese practice of using paper documents and stamping by seal (hanko), and to the development of the legal and social infrastructure for electronic contracts and signatures.
Japanese traditional practice has required not only contracts and administrative procedures, but even delivery slips, invoices, and receipts to be stamped, and written documents with a seal are presumed to be legally authenticated (i.e., the stamped document is deemed to have been prepared in accordance with the author's intention).
On April 7, 2020, the government declared a state of emergency due to COVID-19 and people were asked to refrain from going out of their homes. One reason for leaving home and going to work was the need to affix a seal to documents. The government then reviewed the regulations on written documents and seals that were impediments to working from home, and on June 19, the Cabinet Office, the Ministry of Justice, and the Ministry of Economy, Trade and Industry (METI) jointly issued a "Q&A on affixing a seal". It states that from a legal standpoint it is not necessary to insist on a seal as a means of proving the authenticity of a document, and that means other than a seal can be used as an alternative.
Also in November, the Cabinet Office indicated that it would abolish the use of seals in 99.4% of administrative procedures that currently require it.
In order to reduce paper documents, it is also necessary to promote electronic contracts. In Japan, it is possible to conclude a contract electronically, with a few exceptions such as fixed-term land and tenancy agreements. If a contract is signed by an “electronic signature” under the Act on Electronic Signatures and Certification Business (Act No. 102 of May 31, 2000), it is presumed that it is legally authenticated, and therefore, the use of electronic signatures under the Act is necessary to conclude electronic contracts.
Many of the electronic contracting services currently available are cloud-based, where the service provider makes electronic signatures based on the user's instructions. It was not previously clear if an electronic signature under such services was considered an “electronic signature” under the Act. Therefore, the Ministry of Internal Affairs and Communications, the Ministry of Justice, and the METI jointly issued FAQs on July 17 and September 4, 2020, which clarified that cloud-based electronic signatures can be considered as electronic signatures by the parties concerned, as long as the service meets a sufficient standard, and that the authenticity of the formation of an electronic document can be presumed from the signature in question. This is expected to promote the use of electronic contracting services.
Development of Rules for the Digital Market
Large “Big Tech” companies such as the “GAFA” companies (Google, Apple, Facebook and Amazon) are being questioned regarding oligopolistic issues worldwide. The Japanese government set up the Digital Market Competition Division in 2019 and has discussed establishing digital market rules to respond to concerns regarding oligopolies specific to the digital market but at the same seeks to avoid any impediments to innovation in the digital market. In 2020, there have been two major reforms to the law; the establishment of a new law, the “Act on Improvement of Transparency and Fairness in Trading on Specified Digital Platforms” (Act No. 38 of 2020) (the “Transparency Act”) and amendments to the Act on the Protection of Personal Information (Act No. 57 of 2003) (the “Personal Information Act”).
Establishment of the new Act addressing transparency of transactions between Big Tech companies and SMEs
While Big Tech digital platform operators, such as the large-scale online malls and application markets, could enable small and medium sized enterprises (“SMEs”) to access and develop their markets, there are concerns regarding the transactions between such Big Tech companies and SMEs: (i) unilateral imposition of the terms and conditions of contracts by the Big Tech companies on the SMEs, (ii) imposition of services and excessive cost burdens by the Big Tech companies on the SMEs, and (iii) excessive restriction by the Big Tech companies of access to data by the SMEs. To address these issues, the Transparency Act was promulgated on 3 June 2020 and will come into effect within one year from the promulgation date. The Transparency Act intends to avoid impeding innovation while supporting transparency of transactional relationships between digital platform operators and users.
The Transparency Act targets online malls and application markets regardless of whether the digital platform operator is a Japanese/domestic or overseas company. It requires a digital platform operator to disclose to customers its terms and conditions for transactions, such as the reasons the digital platform operator might reject a transaction, the main elements which determine the display sequence of products or services on the digital platform, the conditions for giving preferential treatment to the digital platform operator’s own products and services, scope and conditions for customers to access data. The Transparency Act further requires the digital platform operators to establish a self-monitoring and reporting system in accordance with guidance to be issued by METI. The digital platform operators will be obliged to report the status of the disclosure and establishment of the self-monitoring and reporting system to METI every year.
The next objective of the Transparency Act is the digital advertising market. The Interim Report on the Evaluation of Competition in the Digital Advertising Market, published in June 2020, points out that the large digital platform operators operate as an oligopoly in the digital advertising market and concerning issues include sudden rule changes and system modifications by digital platform operators, lack of transparency in transaction details and prices, and consumers’ concerns regarding targeted advertising, etc.
Amendments to the Act on the Protection of Personal Information
Firstly, to address consumers’ concerns about how Big Tech handles their personal information, amendments to the Personal Information Act were made to strengthen an individual’s right to request that business operators delete or cease the use of the individual’s personal information. That is, the existing right to demand the cessation of utilization or deletion of retained personal data was limited to cases of violations of the law, such as illegal acquisition of data, but this amendment adds cases of potential risks that individual rights or legitimate interests may be harmed.
Secondly, to promote the companies’ internal use of personal data, the amended Personal Information Act introduced a new system of “pseudonymously processed information” which allows the utilization of personal data without the consent of the subject of the personal data if the data is "processed", such as by deleting the subject's name, and utilization of the data is limited to internal analyses within the company only. Provided that, as the pseudonymously processed data enables the identification of specific individuals through collating the data with other information, it will be prohibited to provide such processed data to third parties except in cases required by laws.
The amended Personal Information Act will come into effect within two years from 12 June 2020. The relevant detailed rules will be drafted prior to the Personal Information Act coming into effect.
Revision of banking sector
Revision of the scope of business and limitation of bank subsidiaries
The Banking Act (Act No. 21 of 1927), which regulates the scope of business of banks and limits bank’s possession of subsidiaries has been revised multiple times recently to take fintech business into account. This year’s report on the growth strategy of the Japanese government stated that such regulations should be revised during the first half of 2021. After the publication of the report, the Financial Services Agency (“FSA”) established a working group for the discussion of revisions to the relevant regulations.
The regulations regarding banks owning companies to carry out sophisticated banking business will be changed from “approval by the FSA” to “notification to the FSA”. After the revision, it will be easier for banks to get involved in projects for digitization, regional revitalization and social development goals (“SDGs”). On May 20, 2020 the Diet passed new regulations enacting exemptions to the Act on Prohibition of Private Monopolization and Maintenance of Fair Trade (Act No. 54 of April 14, 1947). This law was enacted to respond to the challenging environment for regional banks due to the declining population in Japan. Regional banks are confronting the pressure of reconsidering their business in view of both regional revitalization (including corporate integration) and reorganization of banks and digitalization.
In addition, regulations limiting bank ownership of subsidiaries which don’t provide financial services stipulate that banks may only hold 5% of such subsidiary companies’ voting rights. Bank holding companies can possess 15% of the voting rights of their subsidiaries. The FSA initiated working group discussions in order to consider revision of regulations in view of the ongoing prolonged low interest rate environment and the growing need for business revitalization support.
Difficult discussions reviewing the “firewall” regulation between banks and securities companies
The FSA is also discussing (a) the deregulation of the scope of business of overseas subsidiaries of Japanese banks and insurance companies, and (b) exclusion of information about foreign corporate customers from the scope of firewall regulations limiting the exchange of information on customers between banks and securities companies. The necessity of reviewing firewall regulations affecting domestic customers will also be considered while paying attention to a fair competitive environment. As some securities companies have criticized such discussions (as the banks’ participation in the securities sector may cause the banks to abuse their dominant bargaining position) discussion regarding firewall regulations is more complicated than other regulatory reform topics for banks. As such, there is little possibility of revising such firewall regulations at present.
Construction of payment infrastructure associated with the progress of digitalization
In the midst of the expansion of cashless payments in Japan, people make payments more frequently and in smaller amounts. On the other hand, bank transfer fees are an obstacle to the spread of cashless payments because stores introducing cashless payments receive their sales from payment service providers via bank transfer.
Inter-bank fees have not changed for more than 40 years, but the fees are about to be reviewed and will become lower and more reasonable to properly reflect current costs.
Currently, non-bank payment service providers (non-banks) are not qualified to participate in the Japanese banks' Payment Clearing Network (“Zengin-Net”). Therefore, they must connect to banks when they withdraw funds from users and make deposits to affiliate stores. Qualification to use Zengin-Net will be reconsidered to allow the participation of blue-chip non-banks so that they can reduce remittance costs.
The Japan Bank’s initiative towards Central Bank Digital Currency (“CBDC”)
The Japan Bank, Japan’s central bank, published "The Bank of Japan's Approach to Central Bank Digital Currency" in October 2020. While the Bank of Japan currently has no plan to issue CBDC, from the viewpoint of ensuring the stability and efficiency of the overall payment and settlement systems, the Bank considers it important to thoroughly prepare to respond to changes in circumstances in an appropriate manner. The Bank decided that it would publish its approach to "general purpose" CBDC – that is, CBDC intended for a wide range of end users, including individuals and firms.
Establishing connection between social IDs and bank accounts
As one response to tackling the challenges presented by the COVID-19 virus, the Japanese government provided a fixed amount of financial benefits to individuals in Japan, but the payments took a great deal of time because there was not enough digital infrastructure to provide money to residents. In order to solve this underlying problem for digital activities, the government will connect ”My number”, the social ID for residents in Japan, to residents’ bank accounts. This project will contribute to the development of digital IDs for Japanese residents.
Due to changes in the regulations, 2021 will see more companies entering the industry or needing to change their existing business models. Fintech companies will therefore need to be flexible and responsive to regulatory changes.
Authored by Yuri Suzuki, Takafumi Ochiai, Ryosuke Oue, Naoki Kanehisa and Kenichi Tanizaki, Atsumi & Sakai