As part of an ordinance under the Foreign Account Tax Compliance Act (FATCA), US bond issuers will no longer be able to sell bearer bonds to overseas investors after March 18. Issuers instead will only be able to sell registered debt to global lenders, which implies that global markets have a system in place for investors to receive the necessary paperwork to comply with the rule. This is not the case in Japan.
Bearer bonds are largely antiquated in the modern debt arena but remain pertinent to some markets. The bonds – which can only be issued outside the US by an American issuer - mandate that individual bondholders have a physical certificate that validates their ownership of bonds, and holders receive their interest payments by submitting these certificates to the issuers.
However, after March 18, US issuers will only be able to sell registered bonds, for which each of its global investors will have to fill in the W-8BEN form. This will allow non-US citizens to elude a 30% withholding tax on their accrued interest.
While most countries’ central securities depositories have created digitalised systems to accommodate the required information for registered bonds, the Japan Securities Depository Center (JASDEC) has not. Reed Carey, an associate in Freshfields Bruckhaus Deringer’s US tax practice in Washington, D.C., explains that bearer bonds have slowly become defunct as debt securities become traded electronically. Yet, because JASDEC does not collect the same calibre of personal information from its investors, it’s impossible to know the name and whereabouts of each individual bondholder. This has essentially made each US- issued, yen-denominated bond – or Samurai - a traditional bearer bond, which require little personal information about each bondholder.
One Tokyo-based lawyer explains that, among the hurdles, Japan does not have an equivalent to a social security number, which monitors the investment and tax-specific movements of US investors. In Japan, there’s no taxpayer ID number and there is no system for instituting one.
“The tax authority does issue some ID numbers, but these numbers aren’t used throughout the financial system. There’s no single taxpayer number that you have to file for your income tax refunds, for example,” the lawyer said. “Having a taxpayer number in Japan is a really controversial subject. It’s been proposed before in the legislature but it’s always been objected by the ruling party.”
This has already led the IRS to make concessions to its tax-reporting guidelines, but after March 18, when these guidelines expire with bearer bonds, the status of tax-reporting becomes a gray area.
“In Japan, because of local market practices, issuers cannot deliver the proper withholding forms to bondholders,” Carey told Asiamoney PLUS. “Japan has already been given special dispensation within the scope of JASDEC’s system so US issuers treat their bonds as registered-form. The problem now is that the US treasury and IRS are looking to only work with bonds in dematerialised form, without issuers handing out physical certificates. If investors cannot meet certain reporting qualifications, they won’t have access to these bonds.”
With a deadline looming, Japanese regulators have put pressure on American financial authorities to come up with a workable solution around the repeal of the tax rule – called TEFRA D – else there will be consequences.
“The repeal of the TEFRA D rules to take effect on March 18 2012 would halt significant sources of Yen funding for US issuers,” JASDEC’s president and CEO Haruhiko Kato wrote in a letter to the IRS’ commissioner Douglas Shulman on February 28. “As the central securities depository of Japan, we, JASDEC, are extremely concerned about the lack of guidance from the IRS at this point. Accordingly, we would like to request your immediate release of guidance regarding this matter.”
In response, IRS officials said on Tuesday (March 6) that they will issue guidance “very soon” but did not elaborate on the nature of this guidance.
Ahead of the rule change, two US Samurai bond issuers – J.P. Morgan and Goldman Sachs – have sold yen-denominated debt in the early months of 2012 – collectively raising more than all US issuers raised the whole of 2011 and marking the most active start of the year since 2008, according to data provider Dealogic.
Legal tax sources suggest that the issuers, in part, rushed into the market in order to avoid the complications ahead as bearer bonds outstanding as of March 18 will be “grandfathered,” and the new accounting rules won’t apply.
J.P. Morgan issued JPY111 billion (US$1.3 billion) of five-year Samurai bonds on February 14, marking the first US financial institution to make such an issue since Lehman Brothers’ collapse and the largest issue in three years, the Financial Times reported. It further stated that the dearth of US financial issuers set a favourable stage for J.P. Morgan. The bank’s bond priced at 40 basis points (bp) over three-month yen Libor, the newspaper added, which was 6bp cheaper than ANZ’s Samurai issuance earlier this year.
On February 21, Goldman Sachs’ five-year Samurai issue was its first in four years, generating JPY82 billion. Bloomberg noted at the time that bank priced JPY76 billion of its fixed-rate notes at 2.55%, and JPY6 billion of floating-rate securities at 220bp over three-month yen Libor.
JASDEC’s Kato took aim at these issues in his letter to the IRS, saying that the stress of the upcoming regulatory change has prompted issuers to come to market under “less-than-satisfactory terms” as they push large-sized bonds into the market to take advantage of the space while they can.
“In anticipation of such potential chaos in the financial markets, recently some major US firms opted to issue Samurai bonds at less-than-satisfactory terms,” he wrote. “Furthermore, despite the fact that many US firms are doing significant business in Japan, they will lose major sources of funding Japanese Yen in this situation.
“According, in light of the situation, any further delay in the guidance regarding the expiration of TEFRA D rules would cause significant inconveniences to US issuers as well as underwriters and other participants in the Samurai bond market,” Kato continued.
One credit analyst at a Japanese bank told Asiamoney PLUS that Japanese investors largely favour US bond issuers because of their strong financial status and brand names. However, Samurai issuances on the whole have been increasing in 2012, and Japanese investors would easily turn to alternative international investors if US issuers were to avoid the market.
“Domestic investors are very familiar with US names like J.P. Morgan and Goldman Sachs, and they still intend to buy into such good names, but from now on they maybe cannot,” the analyst said. “Right now, the threat of this tax is only coming from the US, and it’s the only country that looks to be causing problems. This may make investors look differently – more appealingly – at European and Asian names that don’t have the same forms and requirements.”
Finding a solution
Even if US issuers or JASDEC find a way to issue the appropriate forms to domestic investors, the prospect of the added paperwork would likely be unappealing.
According to a Tokyo-based tax lawyer, outside of the country, more markets have become more comfortable with filling in forms to comply with their local regulatory requirement, but culturally this seems difficult for Japan because it hasn’t had this protocol before.
“This W8 form doesn’t have a lot of information on it, but there are bondholders that are wary about their home government or the US government will find out that they hold a specific bond,” saidAvrohom Gelber, partner at Clifford Chance’s tax practice in New York. “It’s not that complicated, but I say that as an American.”
Despite the simplicity of the problem, US regulators need to come up with a solution to ensure that issuers can still tap the Japanese yen market.
US tax and treasury authorities decided to institute the change in March 2010, explains Freshfields’ Carey – having a full two years to devise a solution to the bond problem regarding Japan. Carry suggests that a solution has yet to be announced because US regulators have been otherwise preoccupied by the full implementation of FATCA, an overarching legislation enacted by the US regulators aiming to stop American investors from evading taxes offshore. FATCA will be implemented in full on January 1, 2013, which will be a considerably larger change to enforce.
Yet, he’s confident that authorities will come up with a strategy to make US issuance into Japan an available option, likely by creating a special loophole for Japanese investors.
“March 18 is coming up fast, and without guidance yet, people are taking the deadline very seriously – we’ve already seen an increase of Samurai issuances,” he said. “US officials will get something out over the next week and a half, probably coming up with something broadly similar to what they had before in terms of qualifications for the Japanese market, allowing issued bearer bonds not to be electronically tracked. This guidance will probably say that the JASDEC system could be treated as the equivalent to registered from.”