Japan: A Capital Markets: Domestic: Securitisation & Derivatives Overview

Securitisation

Recent trends of securitisation in the Japanese market

From 1999, Japan generally maintained a zero or negative interest rate policy. Under this interest rate environment, corporate financing became more common than asset financing, including securitisation. It was not until March 2024 that the Bank of Japan (BOJ) reversed its policy stance and raised interest rates.

Because of the BOJ’s new policy stance, the securitisation market has experienced an upward trend. Based on a report by the Japan Securities Dealers Association and the Japanese Bankers Association (titled Securitization Market Trends Survey Data), the total amount of securitisation products issued in fiscal year 2023, which represented a decline of 12.5% as compared to fiscal year 2022, has seen an uptick. More specifically, the total amount of securitisation products issued in fiscal year 2024 has increased by 4.9% in comparison to fiscal year 2023.

Moreover, the types of assets subject to securitisation are also expanding. Traditionally, securitised assets consisted mainly of receivables such as mortgage loans, consumer loans, and lease receivables. In recent years, however, particularly with the expansion of e-commerce, receivables commonly referred to as "buy-now-pay-later" are also being securitised.

Recent revisions to securitisation-related regulations

Major revisions have been made in recent years to laws relating to securitisation, including the following:

• The Financial Instruments and Exchange Act (FIEA), which came into force in 2007, was effectively an amendment of the Securities and Exchange Act. Under the FIEA, trust beneficial interests arising from originators' entrustment of securitised receivables are now included within the definition of "securities". As a result, the FIEA applies to securitisation transactions involving trusts.
• Major revisions, which came into force in 2007, have also been made to the Trust Act and Trust Business Act. These revisions are the first fundamental revisions to laws governing trusts and trust businesses in approximately 80 years. They have served to modernise the law, clarify the duties of care and loyalty applicable to trustees, as well as introduce new types of trusts including self-declared trusts.
• Risk retention rules were introduced in March 2019. Under these rules, originators are incentivised to retain a certain percentage of securitisation products (typically 5% of their most subordinated tranche) to allow Japanese financial institutions to apply lower risk weighting to their securitisation exposure under capital adequacy requirements.
• Major revisions were made to the Civil Code. These revisions, which came into force in 2020, include clarification of the validity of assignment of future receivables often used in securitisation transactions.
• Revisions, which came into effect in 2021, were also made to the Act on Strengthening Industrial Competitiveness. Previously, perfection against obligors of an assignment of receivables required written documentation in principle. Following the revisions, however, perfection against obligors is now possible via SNS or system notification using blockchain.

Securitisation practices based on the revised laws have now become established and entrenched.

Furthermore, the issue of true sale is almost always a major consideration in securitisation transactions. In Japan, the requirements for a true sale are not clearly defined by legislation. With that said, judicial precedents, particularly the decision of the Supreme Court in 2023, have been helpful. Although that decision does not relate specifically to securitisation transactions, it offers some measure of clarity on the issue of true sale in general. The court in that ruling recognised that factoring transactions involving assignment of receivables are not “true sales” of receivables but are in effect loans. This provides some clarity on the factors that Japanese courts would take into consideration in determining whether a transaction is a true sale.

In view of the above, the legal framework in Japan regarding securitisation in Japan is stable.

Prospects for securitisation in Japan

Interest rates in Japan are widely expected to continue on an upward trajectory. This, together with the stable legal environment concerning securitisation, are anticipated to result in an increase of securitisation transactions in Japan.

Derivatives

Key legislation

The FIEA regulates OTC derivatives referencing financial instruments such as interest rates, FX, equity, credit, electronic payment instruments or crypto assets. The Commodities Futures and Exchange Act (CFEA) regulates OTC derivatives referencing commodities such as oil, gas, electricity, precious metals and agricultural products. Although cash-settled forward transactions are regulated as derivatives, spot or forward transactions which are settled only physically are generally considered sales and purchases of underlying assets and are therefore not considered OTC derivatives under the FIEA or the CFEA.

Type of licence

Engaging in the business of acting as a principal, intermediary, broker or agent in OTC financial instruments derivatives regulated under the FIEA falls under the definition of a Type I Financial Instruments Business. Under the FIEA, a person who conducts a Type I Financial Instruments Business must be registered with the Financial Services Agency of Japan as a Type I Financial Instruments Business Operator (“Type I FIBO”).

A person is considered to engage in the business of OTC commodities derivatives if such person acts as a principal, intermediary, broker or agent in respect of such transactions as a business. Under the CFEA, depending on the type of commodities involved, a person who engages in such OTC commodities derivatives business must be licensed by the Ministry of Economy, Trade and Industry and/or the Ministry of Agriculture, Forestry and Fishery as a Commodity Derivatives Business Operator.

Exemptions

Exemptions from the Type I FIBO registration requirement or the Commodity Derivatives Business Operator licensing requirement are available, in cases where counterparties to OTC derivatives are limited to certain eligible investors as defined in the FIEA or the CFEA. The scope of such eligible investors is different depending on the types of underlying assets (i.e., securities, crypto-assets, other financial instruments and commodities) to which the relevant OTC derivatives refer.

Codes of business conduct

Type I FIBOs are subject to certain codes of business conduct under the FIEA such as the requirement of statutory disclosure to customers, the prohibition against loss compensation, the suitability principle, regulations in respect of advertisements, the leverage restrictions, the loss cut rule, and the prohibition against solicitation without consent. Commodity Derivatives Business Operators are also subject to certain codes of business conduct under the CFEA.

Implementation of OTC derivatives regulation initiated by G20

Following the global financial crisis in 2008, the G20-initiated OTC derivative regulatory reforms (ie, introductions of mandatory clearing, mandatory trade execution, trade data reporting requirements and margin requirements for uncleared derivatives) were implemented mainly under the FIEA and its subordinate legislation. These regulatory frameworks are directly applicable to dealers regulated in Japan (eg, Type I FIBOs), but may also indirectly affect foreign derivative dealers that are not regulated in Japan and enter into OTC derivatives with Japanese counterparties regulated in Japan.

Documentation

The industry standard for documentation of OTC derivatives in Japan is the ISDA documentation including but not limited to the ISDA Master Agreement, ISDA Credit Support Annex (CSA) and ISDA Definitions. When using ISDA documentation, a short form confirmation is typically prepared with reference to the relevant ISDA Definitions. Each Japanese bank may have its own standard form bespoke Japanese language derivative master agreement for its Japanese customers (eg, domestic Japanese corporations and individuals).