Non-retail pooled funds
Available vehicles
What are the main legal vehicles used to set up a non-retail fund? How are they formed?
Among the various types of non-retail funds, an investment limited partnership (Japanese LPS) formed under the Investment Limited Partnership Act of Japan (Law No. 90 of 1998, as amended) (the LPS Act) is a legal vehicle frequently used for private equity and other non-retail funds. The Japanese investment limited partnership (LPS) is formed upon the execution of a limited partnership agreement by and among the general partner and the limited partner in accordance with the LPS Act.
Laws and regulations
What are the key laws and other sets of rules that govern non-retail funds?
The LPS Act sets out rules for a Japanese LPS, covering such matters as the role and responsibility of the general partner and the limited partner, and the investment restrictions of a Japanese LPS.
Under the LPS Act, a Japanese LPS must have at least one general partner and at least one limited partner. The general partner manages the operation of the Japanese LPS and has unlimited liability for the obligations of the Japanese LPS. The general partner shall execute the business of the Japanese LPS in accordance with due care of prudent managers. By contrast, the limited partner does not have the authority to execute the business of the Japanese LPS and is liable for the obligations of the Japanese LPS only to the extent of its capital contribution.
With respect to investment restrictions, the LPS Act provides for a wide range of asset classes in which a Japanese LPS can invest; however, the acquisition of shares, warrants, equity interests and debt securities issued by foreign corporations must be less than 50 per cent of the total amount of capital contribution.
Solicitations for the acquisition of partnership interest and the management of the fund assets are regulated by the Financial Instruments and Exchange Act (Law No. 25 of 1948, as amended) (FIEA).
Authorisation
Must non-retail funds be authorised or licensed to be established or marketed in your jurisdiction?
The solicitation of investors for acquisition of partnership interests in a Japanese LPS is regulated under the FIEA as a Category II security. If more than half of the assets of the Japanese LPS are to be invested in securities and partnership interests are to be publicly offered (ie, the number of investors who acquire the partnership interest as a result of solicitation is expected to be 500 or more and gross amount (including the solicitation of same kind of security made within one year) of the solicitation is not less than 100 million), the issuer of such interests must file a securities registration statement before solicitation of investors and must prepare a prospectus to be delivered to the investors, which can be quite time-consuming and cumbersome. Accordingly, in practice, limited partnership interests are often solicited by way of private placement.
In addition, if the general partner of the LPS wishes to solicit investors on its own initiative, it must register as a Type II financial instruments firm before such solicitation, with the following three exceptions: the first applies if the general partner delegates all of the solicitation activities to an outside firm that is registered as an operator of a Type II financial instruments business; the second is the article 63 (QII) exemption, where the general partner can solicit investors by means of private placement after filing a notification with a local finance bureau in accordance with article 63 of the FIEA; and the third is the recently introduced Specially Permitted Business for Foreign Investors, etc. exemption (article 63-8 (Foreign Investors, etc) exemption), where the general partner can solicit investors, whether by public offering or private placement, after filing a notification, if more than 50 per cent of the capital invested in the LPS are from residents outside of Japan, such as a foreign corporation or offshore individual residents.
Marketing
Who can market non-retail funds? To whom can they be marketed?
The solicitation of investors for the acquisition of a partnership interest must be made by one of the following:
- a general partner that has registered itself as a Type II financial instruments firm;
- a third party registered as a Type II financial instruments firm and that is given the entire authority to solicit investors from the general partner;
- a general partner that has submitted a notification to the local finance bureau in reliance upon the article 63 (QII) exemption; or
- a general partner that has submitted a notification to the local finance bureau in reliance upon the recently introduced article 63-8 (Foreign Investors, etc) exemption.
As long as a registered Type II financial instruments firm solicits investors by means of 1. or 2. above, there is no express restriction on the qualification of investors. By contrast, if the general partner solicits investors using the article 63 (QII) exemption in 3. above, there must be at least one qualified institutional investor (QII). Among the investors being solicited, the number of non-QIIs must be no more than 49. The general partner shall not solicit investors who are included in the list of disqualified investors under the FIEA, unless otherwise exempted thereunder.
In response to scandals in which unsophisticated individuals suffered loss as a result of their investment in funds making use of the article 63 (QII) exemption, the FIEA was amended and became effective in 2016 to strengthen governmental supervision over general partners making use of this exemption. The key elements of the amendment are as follows:
- limiting the scope of non-QII investors eligible for the article 63 (QII) exemption only to those particular sophisticated investors enumerated in the enforcement order of the FIEA;
- clarification of the situation where the article 63 (QII) exemption is not available even if there is a QII investor in the fund (eg, in the event that there are no QII investors except for a Japanese LPS with net assets of less than ¥500 million);
- a requirement of additional information at the time of filing notifications to the regulator (such as the location of the office or the place where the general partners will conduct their business in reliance upon the article 63 (QII) exemption);
- imposing record-keeping and annual business reporting obligations on the fund operators;
- providing eligibility requirements for the article 63 (QII) exemption and disqualifying applicants that satisfy certain conditions under the FIEA;
- the introduction of a code of conduct equivalent to those applicable to registered financial instrument business operators; and
- public disclosure of certain information (such as part of the notification and the annual business report).
With regard to the article 63-8 (Foreign Investors, etc) exemption provided in 4. above, solicitation can be made to certain types of domestic investors (including QIIs and certain qualified investors, etc) as long as more than 50 per cent of the capital invested in the LPS comprise capital invested by residents outside of Japan, such as foreign corporations or offshore individual residents.
Ownership restrictions
Do investor-protection rules restrict ownership in non-retail funds to certain classes of investor?
As long as a registered Type II financial instruments firm solicits investors for the acquisition of a partnership interest, there are no express restrictions on the qualification of investors. On the other hand, if the general partner solicits investors in reliance on the article 63 (QII) exemption or the article 63-8 (Foreign Investors, etc) exemption, there is a restriction on the qualification of investors.
Managers and operators
Are there any special requirements that apply to managers or operators of non-retail funds?
The general partner must, in principle, be registered as an operator of an investment management business if more than 50 per cent of the assets of the Japanese LPS are invested in securities or derivatives. The general partner, however, often employs one of the following exemptions to the registration requirement:
- delegation of the entire authority to handle investment management business to an outside registered investment management firm, by entering into a discretionary investment management contract with such outside firm;
- relying on the article 63 (QII) exemption, where the general partner can handle investment management activities after filing a notification with a local finance bureau in accordance with article 63 of the FIEA; or
- rely on the recently introduced article 63-8 (Foreign Investors, etc) exemption where the general partner can handle investment management activities after filing a notification with a local finance bureau in accordance with article 63-8 of the FIEA.
Tax treatment
What is the tax treatment of non-retail funds? Are any exemptions available?
Under Japanese tax law, a limited partnership is treated as a non-taxable (pass-through) entity and is not subject to corporate tax. Accordingly, income and loss arising from the investment by the partnership can be allocated to each investor without taxation at the partnership level.
Foreign investors are subject to corporate tax and income tax on their income generated in Japan. The scope of the income subject to Japanese taxation depends on whether foreign investors have a permanent establishment in Japan and the type of such establishment. A prevailing view is that if a foreign investor conducts investment in Japan through a limited partnership that has a place of business in Japan, such foreign investor is deemed to have a permanent establishment because its investments in Japan are jointly carried out with other partners through such place of business in Japan. If a foreign investor has a permanent establishment in Japan, the distribution of profit from the partnership will be subject to Japanese taxation. The tax reform of 2009, however, has created an exemption in which foreign investors in a Japanese LPS will not be deemed to have a permanent establishment in Japan under certain conditions.
Asset protection
Must the portfolio of assets of a non-retail fund be held by a separate local custodian? What regulations are in place to protect the fund’s assets?
Under the FIEA, a Type II financial instruments firm shall not solicit investors for acquisition of partnership interest, unless the governing document of the Japanese LPS ensures the segregation of the funds contributed from the limited partners and the assets of the general partner. Financial institutions such as commercial banks and trust banks can serve as a custodian of the funds contributed from the limited partners. In addition to the foregoing, if the general partner is a registered investment manager, it must segregate the assets of the Japanese LPS from the assets of other clients and its own assets.
Governance
What are the main governance requirements for a non-retail fund formed in your jurisdiction?
With respect to the registration of a Japanese LPS, once the limited partnership agreement becomes effective, certain information (including the type of business and name of the Japanese LPS) must be registered with the local legal affairs bureau with jurisdiction over the location of the Japanese LPS within two weeks. If there are any subsequent changes to the registered information, the general partner must register those changes with the local legal affairs bureau within two weeks.
As regards record-keeping, the general partners must prepare the balance sheet, profit and loss statement and business report, along with their detailed attachments for the business year concerned, within three months of the end of each business year. These documents are maintained at the principal office of the Japanese LPS for five years for inspection by limited partners and creditors. In addition, if a registered investment manager handles the management of the assets contributed by the limited partners, it must provide a periodical management report to the client at least once every six months.
Unless solicitation of investors constitutes a public offering of securities, the general partner is not required to file the securities registration statement. If the general partner wishes to make use of the article 63 (QII) exemption for either the private placement of a partnership interest or investment management activities, it must file a notification with the local finance bureau. In addition, by virtue of the 2016 amendment, the general partner who has made use of the article 63 exemption is now subject to ongoing bookkeeping and annual business reporting obligations. If the general partner is eligible to make use of the recently introduced article 63-8 (Foreign Investors, etc) exemption for either the offerings (including private placements) of the partnership interest or investment management activities, it must also file a notification with the local finance bureau, maintain the books and records, and submit the annual business report to the authority.
A Japanese LPS is composed of the general partner and the limited partner. The general partner manages the operation of the Japanese LPS and has unlimited liability for the obligations of the Japanese LPS.
Reporting
What are the periodic reporting requirements for non-retail funds?
The general partners must prepare the balance sheet, profit and loss statement and business report, along with their detailed attachments for the business year concerned, within three months of the end of each business year. These documents are maintained at the principal office of the Japanese LPS for five years for inspection by limited partners and creditors. In addition, if a registered investment manager handles the management of the assets contributed by the limited partners, it must provide a periodical management report to the client at least once every six months.