Regulatory change is vital to facilitate the dynamic developments in Japan's increasingly innovative financial markets. EuroWeek invited Tim Lester, managing partner and partner in charge of the capital markets practice at Lovells' Tokyo office, to discuss the most important regulatory developments in Japan.
There are of course in any one year a host of actual or proposed reforms to Japanese laws, all in general intended to stimulate the origination of capital market transactions and to facilitate investor demand. Due to their direct impact on capital market origination, I have chosen to highlight changes in the laws relating to insolvency, proposed amendments to the trust laws, and also the arrival of a new special purpose vehicle (SPV) most applicable to securitisation.
CHANGES TO THE BANKRUPTCY LAW
Japan's revised Bankruptcy Law was passed by the Diet on May 25, 2004. One of the principal features of the law is the removal of a significant legal risk in relation to securitising real estate.
Before the revision, a trustee in bankruptcy of a seller of real estate could nullify the sale on the grounds that the transaction is prejudicial to creditors of the originator. Under the new rules, the trustee in bankruptcy cannot block the sale of an asset, including real estate, if the purchase price represents a fair value for the asset.
The nullification risk in relation to real estate had of course not stopped the development of the securitisation of real estate as an asset class, but it had hampered the market's development. The Bankruptcy Law removes this concern and the changes will likely stimulate investments through real estate investment trusts (Reits).
PROPOSALS FOR TRUST LAW REFORM
It was back in July 2003 that a working group of the Financial System Council of Japan submitted a report to the prime minister's office recommending a number of changes to Japan's trust laws (the Trust Proposals). The Trust Proposals focus on expanding the scope of the classes of eligible assets a trust could legally own, as well as on revising the trust business licensing system.
Japanese trust law restricts eligible trust assets to cash, securities, rights to receive money, certain movable assets, land, buildings and other specified assets. The Trust Proposals seek to remove these restrictions in full so that any rights, including rights in relation to intangible assets, may be the subject of a trust.
If implemented, the changes to Japanese trust law contained in the Trust Proposals will increase the potential use of trust-based structures. By increasing the number of trust-based financial products available to investors and arrangers, there will inevitably be greater business opportunities for both existing and new market participants. For example, some market participants believe that the Trust Proposals are likely to encourage large Japanese companies that hold large portfolios of intellectual property rights to leverage such assets to raise funds.
Under Japanese law, trust business can only legally be carried out by banks. The Trust Proposals seek to remove this restriction and, subject to certain qualifications for trustees (such as maintaining a minimum capitalisation) and other relevant requirements (such as disclosing trust assets to beneficiaries), permit any corporate entity to conduct trust business.
By widening the scope of entities able to legally act as trustees, this should result in a more competitive and transparent market for trustees.
The discussion of the bill containing the Trust Proposals has been postponed until spring 2005. However, Japan's Financial Service Authority has publicly stated that the bill should pass through the Diet without any strong objection.
CHUKAN HOJIN ? A NEW STRUCTURE FOR JAPANESE SECURITISATION
Chukan hojin are corporate entities established under the 2001 Chukan Hojin Law. They have the purpose of achieving a common benefit for their members and do not distribute any surplus to members. Chukan hojin may either have limited or unlimited liability with members being legally responsible for the entity's management (although limited liability chukan hojin must have at least one executive officer as well as an auditor).
Although initially used for setting up social clubs and the like, chukan hojin have recently been employed as the parent holding companies for special purpose vehicles (SPVs) in relation to securitisation transactions due to their perceived bankruptcy remoteness.
Standard and Poor's (S&P) and Moody's Investors Services each produced reports, in November 2003 and January 2004 respectively, on the use of chukan hojin in securitisations.
Each rating agency confirmed that it would each accept the use of chukan hojin in triple-A rated transactions. The two reports set out in considerable detail the requirements of each rating agency for arrangers who wish to use chukan hojin in securitisation issues and both address legal concerns about bankruptcy remoteness of chukan hojin.
It remains to be seen the extent to which market participants will implement structures involving chukan hojin and how this may affect the use of SPVs incorporated in Cayman Islands-related transactions.
However, according to Fitch Ratings and the domestic rating agency, Rating and Investment Information, the use of chukan hojin in the Japanese market has been growing over the past 12 months. They have been used in a variety of structured finance transactions, including real estate and auto loan securitisation transactions.
It is probable that as familiarity with chukan hojin grows, they will become more common in securitisations. chukan hojin may become a more attractive option than SPVs incorporated in the Cayman Islands to Japanese originators. This is because it is likely that much of the documentation will be governed by Japanese law and in the Japanese language. And also because there is potential for cost savings, especially if used by parent companies for multiple issuing vehicles.