Japan: Alternative Investment Funds 2023

1 Regulatory Framework

1.1 What legislation governs the establishment and operation of Alternative Investment Funds?

The Financial Instruments and Exchange Act (Act No. 25 of 1948; the "FIEA") and the regulations promulgated thereunder primarily govern the marketing, investment management and disclosure of Alternative Investment Funds in Japan.

Alternative Investment Funds that are categorised as investment trusts or investment corporations are also subject to the Investment Trusts and Investment Corporations Act (Act No. 198 of 1951; the "ITICA") and the regulations promulgated thereunder as well as rules of the Investment Trusts Association, Japan (the "ITA"), which is a self-regulatory body for investment managers of investment trusts and investment corporations.

A person engaging in the business of marketing interests in investment trusts or investment corporations is required to be licensed as a Type I Financial Instruments Business Operator ("Type I FIBO"), and a person engaging in the business of marketing interests in a collective investment scheme ("CIS") such as a limited partnership is required to be licensed as a Type II Financial Instruments Business Operator ("Type II FIBO") in accordance with the FIEA by the Financial Services Agency of Japan (the "FSA"), unless some relevant exemption applies.

A person engaging in the business of discretionary investment management of Alternative Investment Funds is required to be licensed as an investment manager ("Investment Manager"), and a person engaging in the business of non-discretionary investment advisory to Alternative Investment Funds is required to be licensed as an investment adviser ("Investment Adviser") in accordance with the FIEA by the FSA, unless some relevant exemption applies.

If interests in Alternative Investment Funds are publicly offered in Japan, certain disclosure requirements, including the filing of a securities registration statement, annual securities report and other relevant documents, will be triggered under the FIEA.

Please note that if an Alternative Investment Fund is categorised as a CIS that directly (i.e., not indirectly through SPVs or REITs) invests in real estate, the Act on Specified Joint Real Estate Ventures (Act No. 77 of 1994; the "SJREVA") will be applicable instead of the FIEA. We have, however, omitted an explanation of Alternative Investment Funds that fall under this category in the interest of brevity.

1.2 Are managers or advisers to Alternative Investment Funds required to be licensed, authorised or regulated by a regulatory body?

As noted in question 1.1 above, a person engaging in the business of discretionary investment management, or non-discretionary investment advisory for Alternative Investment Funds, is, in principle, under the FIEA, required to be licensed as an Investment Manager or an Investment Adviser, respectively, by the FSA. However, if both the Alternative Investment Funds and its managers or advisers are domiciled outside Japan, then such managers or advisers will be exempted from such licensing requirements.

It should be noted that if the Alternative Investment Fund is structured as a CIS that invests more than 50% of its assets in securities or derivatives transactions, and if any Japanese investor invests in such a CIS, the sponsor (e.g., general partner) of the CIS is, in principle, required to be licensed as an Investment Manager by the FSA unless it delegates all of its investment authority to a locally licensed Investment Manager and meets certain requirements under the FIEA. There are, however, several exemptions to this general principle, which we set out below.

• The general partner will be exempted from the licensing requirement as an Investment Manager if:
  1. Japanese investors in the CIS consist of (a) one or more qualified institutional investors as defined under the FIEA ("QIIs"), and (b) not more than, if any, 49 eligible investors other than QIIs as set forth in the FIEA;
  2. none of such QIIs and eligible investors other than QIIs are certain unqualified investors as set forth in the FIEA; and
  3. the general partner has submitted a Form 20 under Article 63 of the FIEA to the relevant Local Finance Bureau prior to the commencement of the management of the assets of the CIS.
• The general partner will be exempted from the licensing requirement as an Investment Manager if:
  1. all of the direct investors (i.e., Japanese investors who directly hold interests in the CIS) are either (a) QIIs, or (b) those who satisfy the requirements under the Article 63 exemption as summarised above;
  2. if there are indirect investors (i.e., Japanese investors that indirectly invest in the CIS through a Japanese CIS that directly invests in the said CIS) in the CIS, such indirect investors must be QIIs;
  3. the number of Japanese investors in the CIS (including indirect investors) is not more than nine; and
  4. the aggregate amount of investment in the CIS by direct investors is not more than ? of the aggregate amount of all investors' investment in the CIS.

QIIs include: banks; insurance companies; financial instruments business operators registered as Type I financial instruments businesses or discretionary investment management businesses; investment corporations and foreign investment corporations stipulated under the ITICA; the Government Pension Investment Fund; and investment limited partnerships stipulated under the Limited Partnership Act for Investment (Act No. 90 of 1998; the "Limited Partnership Act"). Whether a prospective investor is a QII can be ascertained by looking up the names of the QIIs that are enlisted on the FSA's website.

1.3 Are Alternative Investment Funds themselves required to be licensed, authorised or regulated by a regulatory body?

Alternative Investment Funds themselves are not required to be licensed or authorised by a regulatory body. However, in the case of public offering, filing of a securities registration statement is required. Further, if the Alternative Investment Fund is an investment trust or an investment corporation, a notification of an investment trust or investment corporation will be required. For details, please refer to question 3.4.

1.4 Does the regulatory regime distinguish between open-ended and closed-ended Alternative Investment Funds (or otherwise differentiate between different types of funds or strategies (e.g. private equity vs hedge)) and, if so, how?

The regulatory regime does not distinguish between open-ended and closed-ended Alternative Investment Funds; provided that, in the case of public offering, different rules established by the Japan Securities Dealers Association ("JSDA") (which is one of the self-regulatory bodies in Japan) will apply.

Also, the regulatory regime does not distinguish strategies of Alternative Investment Funds except for direct real estate investment of a CIS as noted in question 1.1 above. The regulatory regime differs depending on the legal structure of the Alternative Investment Funds (i.e., investment trusts, investment corporations or CISs).

1.5 What does the authorisation process involve for managers and, if applicable, Alternative Investment Funds, and how long does the process typically take?

Before submitting a formal application for the grant of a licence of an Investment Manager and/or an Investment Adviser, an applicant would be expected to first conduct informal discussions with the relevant Local Finance Bureau concerning the draft application. The duration of this discussion stage will depend on the scope and organisational structure of the applicant's business and the extent to which the relevant application documents have been prepared (including the extent to which the relevant information has been gathered). Once the relevant Local Finance Bureau and the FSA are satisfied with the draft application, a formal application can be submitted. Thereafter, the FSA may seek clarifications or supplements to the formal application. Only after there are no more questions or requests from the regulator will the application be accepted.

The time required for procuring a licence of an Investment Manager and/or an Investment Adviser under the FIEA varies on a case-by-case basis. In general, the process time required for procuring a licence of an Investment Adviser is less than that for the licence of an Investment Manager. In principle, the licence of an Investment Adviser or an Investment Manager, as the case may be, will be issued within two months from the date of filing the formal application.

1.6 Are there local residence or other local qualification or substance requirements for managers and/or Alternative Investment Funds?

The table below summarises the requirements for a licence of an Investment Manager and an Investment Adviser under the FIEA

1.7 What service providers are required?

If the Alternative Investment Funds are structured as investment trusts under the ITICA ("Japanese Investment Trusts") or investment corporations under the ITICA ("Japanese Investment Corporations"), then the authority to manage investments must be delegated to a locally licensed Investment Manager pursuant to the ITICA. Further, if the Alternative Investment Funds are structured as Japanese Investment Corporations, they are also required to appoint a custodian and an administrator. There are no such requirements for foreign investment trusts, foreign investment corporations or CISs under Japanese laws.

1.8 What rules apply to foreign managers or advisers wishing to manage, advise, or otherwise operate funds domiciled in your jurisdiction?

If foreign managers or advisers are licensed as Investment Managers or Investment Advisers under the FIEA, they must comply with certain codes of conduct for protection of investors under the FIEA. If foreign managers or advisers are not licensed as Investment Managers or Investment Advisers under the FIEA, no such regulations apply. For details, please refer to question 4.1.

1.9 What relevant co-operation or information sharing agreements have been entered into with other governments or regulators?

The Asia Region Fund Passport (the "ARFP"), formally launched on 1 February 2019, is an international initiative enabling crossborder offerings of eligible investment funds to retail investors, with investor protection in economies participating in the ARFP. Initial participating economies are Australia, Japan, the Republic of Korea, New Zealand, and Thailand.

Under the ARFP, a fund may be "exported" to another participating economy if that fund complies with the regulations of the home economy in which the fund is registered, applicable regulations relating to the offer in the host economy and the ARFP passport rules

2 Fund Structures

2.1 What are the principal legal structures used for Alternative Investment Funds (including reference where relevant to local asset holding companies)?

The principal legal structure used for Alternative Investment Funds is Japanese Investment Trusts formed under the ITICA. Japanese Investment Trusts are formed by entering into a trust agreement between an Investment Manager and a trustee whereby investors will acquire divided beneficiary interests from such trusts.

Japanese real estate trusts ("J-REITs"), however, are structured as Japanese Investment Corporations under the ITICA. Alternative Investment Funds structured as foreign investment trusts or foreign investment corporations are also offered to Japanese investors.

CISs – more specifically, Japanese and foreign limited partnerships – are commonly used for private equity funds. Typically, a Japanese limited partnership (toshi jig yo yugen sekinin kumiai) is formed pursuant to the Limited Partnership Act ("Japanese Limited Partnership"). A Japanese Limited Partnership must consist of at least two partners: a general partner as a sponsor of the partnership; and a limited partner as an investor in the partnership.

Asset holding companies are commonly structured as joint stock companies (Kabushiki Kaisha).

2.2 Do any of the legal structures operate as an umbrella structure with several sub-funds, and if yes, is segregation of assets between the sub-funds a legally recognised feature of the structure?

There are no specific legal structures operating as an umbrella structure with several sub-funds in Japan.

2.3 Please describe the limited liability of investors in respect of different legal structures and fund types (e.g. PE funds and LPACs).

The liability of investors who hold interests in Japanese Investment Trusts, Japanese Investment Corporations and Japanese Limited Partnerships is limited to the amount of money invested by such investors.

It is possible for a Japanese Limited Partnership to operate on a capital call model where a limited partner owes obligations to make capital contributions up to the amount of its capital commitment in the limited partnership agreement.

2.4 What are the principal legal structures used for managers and advisers of Alternative Investment Funds?

As noted in question 1.6 above, it is a legal requirement for an Investment Manager to be a joint stock company (Kabushiki Kaisha) with a board of directors and a corporate auditor or such committees as prescribed in the Companies Act or an equivalent foreign company with a branch office in Japan.

There is no legal organisational requirement for an Investment Adviser; however, it is common for an Investment Adviser to be structured as a joint stock company (Kabushiki Kaisha) or a foreign company with a branch office in Japan.

2.5 Are there any limits on the manager's ability to restrict redemptions in open-ended funds or transfers in open-ended or closed-ended funds?

There are no legal limitations on the manger's ability to restrict redemptions unless the constitutional documents of the Alternative Investment Funds restrict redemptions; provided that a limited partner of a Japanese Limited Partnership may withdraw if there are unavoidable grounds regardless of the restrictions under the limited partnership agreement.

2.6 Are there any legislative restrictions on transfers of investors' interests in Alternative Investment Funds?

There are no legislative restrictions on transfer of investors' interests in Alternative Investment Funds unless the constitutional documents of the Alternative Investment Funds restrict such transfers.

As noted in question 3.3 below, if Alternative Investment Funds are marketed to Japanese investors by way of a private placement, certain transfer restrictions must be imposed. Further, as noted in question 1.1 above, if the sponsor (e.g., general partner) of the CIS relies on certain exemptions from the licensing requirement, the transfers that result in not meeting the exemption requirements cannot be carried out.

2.7 Are there any other limitations on a manager's ability to manage its funds (e.g. diversification requirements, asset stripping rules)?

Please refer to section 4 below.

2.8 Does the fund remunerate investment managers through management/performance fees or by a combination of management fee and carried interest? In the case of carried interest, how is this typically structured?

The fund remunerates the Investment Managers through management fees.

In addition to management fees, a hedge fund structured as an investment trust commonly sets out a high-water mark, pursuant to which a certain percentage of the amount exceeding the high-water mark will be paid to the Investment Manager as a performance fee.

A private equity fund structured as a Japanese Limited Partnership typically provides for a performance fee/carried interest, which is paid to the general partner at a certain percentage of the residual amount after distributing the amount equal to the total contribution or total commitment to limited partners from the distributable proceeds. Buy-out funds typically set out a waterfall, which includes a hurdle rate (by which limited partners receive preferred returns) and a general partner catch-up.

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Originally published by International Comparative Legal Guide.

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