JAPAN: An Introduction to FinTech Legal

Chambers PA: FinTech 2023 Overview Japan

Stablecoins Legislation and Other Legislative Changes Affecting the Japan Fintech Industry

Introduction 

2022 saw the following legislative changes affecting the Fintech industry in Japan:

- The first legislation on stablecoins.

- Money laundering regulations were tightened through (i) a new form of licence, the "fund transfer transaction analysis business”, which applies to bodies operating money laundering monitoring systems, and (ii) issuers of electronic money, significant amounts of which can be transferable to others, even if it cannot be reimbursed now that there is an obligation to carry out KYC procedures on users.

- Enactment of the Act on the Promotion of National Security through Integrated Economic Measures.

- Deregulation such as salary payments to digital wallets other than bank accounts now being allowed and deregulation to promote investment in start-ups.

Regulations on stablecoins 

Amendments to the Payment Services Act (“PSA”), the Banking Act and other laws concerning electronic payments were promulgated in June 2022. The amendments include a new regulatory framework for stablecoins, which will be introduced in 2023. Under this new framework, stablecoins will be categorised as follows:

(i) Stablecoins that are issued at a price linked to the value of fiat currency (ie, 1 coin = 1 Japanese Yen) enabling redemption of the issued price; and

(ii) Stablecoins other than (i) above (ie, stablecoins that attempt to achieve price stability through algorithmic mechanisms).

While the category of stablecoins described in (ii) is regulated as “crypto assets” under the previous provisions of the PSA, stablecoin usage described in (i) is more akin to that of electronic money regulated as money transmissions and means of payment. The 2022 amendments are intended to regulate the stablecoins described in (i), and a new licensing regime will be introduced for intermediaries who handle such stablecoins.

Another key point to remember is that in order to protect users’ redemption rights, issuers of such stablecoins will be limited to: (a) banks regulated under the Banking Act; (b) Funds Transfer Service Providers regulated under the PSA; and (c) trust companies regulated under the Trust Business Act, as such financial institutions are already regulated under their respective bankruptcy protection regimes.

Creation of a licence for "fund transfer transaction analysis business"

The Financial Action Task Force (“FATF”) Fourth Round Mutual Evaluation Report of Japan pointed out the risk of false positives and the effectiveness of transaction filtering and transaction monitoring systems. To enhance those systems, the Payment Services Act was amended to create a licence for "fund transfer transaction analysis business”. The revised Act is expected to take effect during 2023.

The new business is expected to be entrusted by multiple financial institutions to (1) analyse whether clients are subject to sanctions and notify the financial institutions of the results (transaction filtering); and (2) analyse whether there are suspicious points in transactions and notify the financial institutions of the results (transaction monitoring). The service operators of this business are subject to concurrent business restrictions and additional regulations for the protection of personal information.

Introduction of "high-value electronically transferable prepaid payment instruments"

In recent years, electronic transfers of high charge balances in third-party prepaid payment instruments frequently happen and those raise Anti-Money Laundering and Know-Your-Client (“AML/CFT”) issues. To regulate those transactions, the concept of "high-value electronically transferable prepaid payment instruments" was introduced and the Payment Services Act was amended. Under the amended act, issuers of such payment instruments are categorised as "specified business operators" and obliged to conduct KYC procedures. While “high-value” will be defined by Cabinet Office Ordinance, it is expected to be defined as more than 100,000 yen per transfer or more than 300,000 yen per month. The amended act also is scheduled to take effect during 2023.

Economic security legislation 

On 11 May 2022, the Act on the Promotion of National Security through Integrated Economic Measures was enacted, and economic security legislation was put into place. This establishes a system to ensure the stable provision of key infrastructure services (Chapter 3), a system for supporting the development of cutting-edge key technologies (Chapter 4), and a system for keeping patent applications private (Chapter 5).

Chapter 3 was important for financial institutions and fintech companies because it will restrict outsourcing their business to third parties. In order to prevent interfering with critical infrastructure services by abusing service provided from outside of Japan, systems for critical infrastructure services must be established after competent authorities’ pre-screening related to outsourcing of such system’s installations, maintenance, and management, etc. Financial and credit card sectors are designated as target sectors for critical infrastructure; however, not all business operators in these sectors are subject to regulation. The actual scope of regulated business operators to be designated by detailed regulations in the near future are those whose services are at risk of causing a significant threat to citizens and the peace and tranquility of the social and economic order in the event of stoppage or degradation of the functions of their critical facilities.

Subject business operators are required to submit an advance notification of their plans for installation, maintenance, management, etc, of critical facilities. The advance screening period is generally 30 days from the receipt of the notification. The period can be shortened if there is no need for screening, but if necessary the period can be extended by up to four months from the receipt of the notification.

Wages to be paid into digital wallets 

Under Japanese law, wages shall be paid in cash in principle, with several exceptions (ie, payment to bank accounts and brokerage accounts). In addition to these exceptions, from 1 April 2023 payment to workers’ digital wallets of funds transfer service providers is to be allowed.

Funds transfer service providers need to be designated by the Minister of Health, Labour and Welfare to be a recipient of such payments. They are required to take several measures for this designation, which include that the account balance shall be reduced to JPY1 million or less within the same day when the account exceeds JPY1 million as a result of deposit of funds. It has been pointed out that it may be difficult to comply with these requirements from a practical viewpoint.

Development of capital markets, especially for start-ups

The following legislative amendments have been or will be made to facilitate investment in start-ups in Japan. The Private Placement for Professional Investors (tokutei toshika) (including certain individuals who have experience and sufficient assets for investment) was established as a method for unlisted companies/start-ups to raise funds. 2022 amendments to the Cabinet Office Ordinance on Financial Instruments Business, etc, have eased the requirements for individuals to become Professional Investors, and annual income, professional experience, qualifications held and frequency of transactions can also be taken into account to determine if an individual qualifies as a Professional Investor. It is expected that more individual investors will become Professional Investors and that this will promote start-up investments by angel investors and other individual professional investors.

Equity-investment crowdfunding is permitted as a means for ordinary investors to invest in start-ups and other unlisted companies. Platform operators handling crowdfunding through small investments (maximum JPY500,000 per investment) have been required to register as a Type 1 Small Amount Electronic Public Offering Service Provider, the registration requirements being relatively relaxed. 2022 amendments have removed the maximum amount per investment and this is expected to facilitate and diversify the supply of growth capital to start-ups.

The development of a secondary market for unlisted shares is also important for start-up company founders, employees and investors, and the enhancement of the secondary market will also help stimulate the development of the primary market. For this reason, there are discussions on relaxing the secondary market entry requirements for brokerage firms and Proprietary Trading Systems that only act as intermediaries for the purchase and sale of unlisted shares by Professional Investors.

Conclusion  

The new and revised laws and regulations referred to above will have an impact on the Fintech industry, with some having a significant impact on foreign firms. It is therefore important to keep these in mind when developing fintech businesses in Japan in 2023 and onwards.