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Japan: Banking Review 2017

Growth Strategy 2017: Fine-Tuning Japan's Banking Act for Fintech

By Hiroo Atsumi and Yuri Suzuki of Atsumi & Sakai, Tokyo

Hiroo Atsumi and Yuri Suzuki at Atsumi & Sakai explore the recent legislative and regulatory developments affecting the fintech space in Japan. 

Hiroo Atsumi and Yuri Suzuki

Recent regulatory developments in Japan’s fintech field are primarily based on the Japanese government’s June 2017 policy paper, “Growth Strategy 2017”, which contains key performance indicators (KPIs) and specific measures to promote development of fintech.

This article covers the latest legal and regulatory changes affecting the fintech industry, including virtual currency legislation, relaxation of rules that restrict bank ownership of fintech companies, registration of payment services providers in the credit card industry and amendments to the Banking Act to implement a new regime of open banking application programming interfaces (APIs).

New Legislation Regime of Virtual Currencies

Japan is one of the few jurisdictions that have already introduced licensing for virtual currencies, such as bitcoins. In 2016, the Payment Services Act was amended to introduce a registration system for “VC exchanges”, which provide exchange services between virtual currency and fiat currency, and introduce user protection rules. The Act on Prevention of Transfer of Criminal Proceeds was also amended to make VC exchanges responsible for verifying the identity of exchange participants, thus enhancing the anti-money laundering regime. The new regulatory regime for virtual currencies came into force on 1 April 2017.

Under the new regime, VC exchanges must register with the FSA. Foreign entities may only operate a VC exchange through a business office in Japan or an entity incorporated in Japan. If a business office is used, it must have an individual resident in Japan as a representative in order to enhance the protection of investors. The VC exchange must have a minimum capital of 10 million yen and also must establish systems and procedures to enable it to comply with user protection rules, particularly the segregated management of virtual currency and money deposited by its users. VC exchanges also must submit to auditing by an accounting firm or certified public accountant, must conduct identification verification procedures, and must comply with the Act on Prevention of Transfer of Criminal Proceeds, which could be burdensome for VC exchange start-ups.

In Japan, just as in the US, “Initial Coin Offerings” is a hot issue among virtual currency market participants. Under the current laws and regulations, if certain digital assets fall under the definition of “virtual currency” provided in the Payment Services Act, the issuer of that virtual currency would be required to register with the Financial Services Agency (FSA). The FSA reviews both the issuer and the virtual currency before determining whether the applicant should be permitted to register as a VC exchange under the Payment Services Act. At present, however, “virtual currency” is not listed as a “security” or “financial instrument” under the current Financial Instruments and Exchange Act (FIEA), so it is unlikely that the FIEA would be applied to “virtual currencies”.

While an 8 per cent consumption tax had been applicable to the purchase of virtual currencies in Japan until recently, virtual currency purchases became non-taxable from 1 July 2017 under amendments to the Order for Enforcement of the Consumption Tax Act.

Relaxation of the 5 per cent or 15 per cent Ownership Rule under the Banking Act

The Banking Act generally prohibits banks from owning more than 5 per cent (or 15 per cent in the case of bank holding companies) of the voting rights of companies other than financial institutions, finance-related companies, and other specifically permitted businesses. In order to facilitate advanced technology, amendments to the Banking Act promulgated in 2016 allow banks and bank holding companies to have ownership in excess of these limits in companies engaged in businesses that contribute, or are expected to contribute, to banking sophistication and improve user convenience (such as fintech companies, for example), subject to permission from the FSA. Some of the standards envisaged for the granting of such permission include, for example, that the assets and income of the bank and its subsidiaries would remain sound even if the bank were to lose its entire investment in the subject company.

After these legal reforms came into force on 1 April 2017, one Japanese major bank group announced the incorporation of a joint venture to research and develop fingerprint or voice authorisation systems to be used in payments of e-commerce transactions. Another major bank group announced the incorporation of a subsidiary to research and develop a cashless settlement system. The FSA seems to intend that these reforms will stimulate fintech innovation by encouraging banks to incorporate fintech companies into their corporate groups.

Introduction of a Registration System for PSPs and Promotion of API Connections in Credit Card Industry

The credit card business is regulated by the Installment Sales Act (ISA) and supervised by the Ministry of Economy, Trade and Industry (METI). While the ISA is based on the assumption that a traditional credit card transaction is a tripartite transaction (“on-us” transactions) between merchant, card holder and credit card company, with credit card transactions through international card brands becoming more common, transactions are increasingly using an “off-us” format in which the roles of issuer (providing a credit line and issuing credit cards to users) and acquirer (entering into merchant agreements with merchants and advancing the transaction payment) are handled by different companies.

In response to an increase in credit card theft and the use of unauthorised credit cards, and also to prepare for fintech companies making inroads into the payment service business by intermediating between acquirers and merchants, amendments to the ISA were promulgated in December 2016 and will come into effect no later than 9 June 2018. These amendments will require:

  • either acquirers or payment service providers (PSP) to be registered with the government authorities (a foreign entity wishing to be registered as a PSP must have a business office in Japan);
  • merchants to take appropriate measures for the secure handling of credit card information by, for instance, implementing the Payment Card Industry Data Security Standard (PCI DSS); and
  • registered acquirers or PSPs to scrutinise the eligibility of merchants they intend to execute an agreement with. Fintech companies are expected to be involved in credit card transactions as PSPs via mobile terminals, among other things, and will be subject to these amendments if they are.

METI organised a Study Group for API-based Collaboration Involving Credit Card Utilization Compiles and published an interim report on 28 June 2017. By the end of March 2018, the Study Group will prepare guidelines for promoting API-based collaboration efforts between credit card companies and fintech companies. Further, Growth Strategy 2017 proposes specific measures relating to API coordination pertaining to the use of credit card data and facilitating computerisation of receipts, including standardisation of formats.

Open Banking API and New Regulation of PISPs and AISPs under 2017 Amendments to the Banking Act

In Japan, accounting is a common fintech service. The options range from smartphone apps for household account-keeping to accounting services for businesses. Currently, many of these services use an account scraping method which requires a user to provide their bank ID and password to the service provider to confirm the user’s internet banking account information. However, potential users may balk at the idea of providing their banking IDs and passwords to a third-party service provider. Open banking APIs would provide reassurance to users by enabling them to use these accounting services without surrendering their bank IDs and passwords. In order to accelerate movement toward banking systems using open APIs, amendments to the Banking Act were promulgated on 2 June 2017. We discuss these amendments in more detail below.

Firstly, the Banking Act amendments define two types of electronic payments service providers (EPSP): Payment Initiation Services Providers (PISP) and Account Information Services Providers (AISP). A PISP acts as an intermediary, electronically delivering a depositor’s instructions to its bank to transfer funds between accounts; an AISP provides account information to the depositor at its request, using electronic data processing systems. Operation of an electronic payment service business (PISP or AISP) requires prior registration with the FSA. A foreign entity may only operate as an EPSP through a business office in Japan or a locally incorporated entity. If a business office is used, it must have a representative resident in Japan. These amendments to the Banking Act will come into effect in the second quarter of 2018.

Within two years of the amendments’ implementation, banks must make efforts to establish a system enabling EPSPs to provide electronic payment services without obtaining IDs and passwords from users. Because one of the KPIs in Growth Strategy 2017 is the introduction of open API in at least 80 banks by June 2020, many banks will feel strong pressure to set up these systems. Under the amended Banking Act, banks will be required to set out and make public their policies regarding cooperation and collaboration with EPSPs by 1 March 2018.

Regulatory Sandbox and FSA’s Fintech Testing Hub

The FSA’s Fintech Support Desk provides a unified response to handle enquiries from the private sector and to exchange information regarding the fintech industry. This desk fields enquiries from a wide range of businesses currently in the fintech field as well as businesses considering various fintech-related innovations. The Fintech Support Desk also responds to questions regarding the finance aspects of these businesses. It also actively seeks public opinions, requests, and proposals, and shares general information and opinions related to fintech innovation. However, participants in the fintech industry in Japan have been eager for an additional scheme similar to the regulatory sandbox offered in the UK by the FCA.

Growth Strategy 2017 contains just such a regulatory sandbox scheme, and it is not limited to fintech. Its goal is to spur innovations such as AI, big data, distributed ledger technology, drones, and self-driving vehicles.

Growth Strategy 2017 also proposes a Fintech Testing Hub (tentative name) as a specific measure to facilitate a fintech testing service. This service would reduce compliance and surveillance risks that would pose concerns for fintech companies and financial institutions trying unprecedented experiments. Another specific measure provided in Growth Strategy 2017 is a platform for testing blockchain which will enable experiments on the enhanced financial infrastructure, including credit transactions, identification verification, and management of settlement or logistics information.

International Framework and Global Financial City Tokyo

In 2017, the FSA entered into international cooperation frameworks on fintech with financial authorities in the UK, Singapore and Australia. The FSA will assist with international efforts related to fintech and overseas expansion of fintech companies, and consider expanding the scope of this cooperative framework with overseas financial authorities.

The Tokyo Metropolitan Government (TMG) has redoubled its efforts to transform Tokyo into a global financial city that can attract human resources, capital and information from around the world. The TMG published its “Interim Report on Policy for Global Financial City Tokyo” on 28 June 2017, which discusses the TMG’s focus on the growth of asset management and fintech companies to revitalise the financial sector in Tokyo. The TMG’s goal (KPI) is to attract 40 foreign companies in the asset management and fintech fields by 2020.

In terms of specific measures, the TMG launched a programme to locate appropriate overseas financial companies and attract them to Tokyo; this includes assistance with formulating business plans, business matching to evaluate synergies with domestic institutional investors, and accelerator programmes. Further, the TMG, in cooperation with the FSA, has introduced a financial one-stop assistance service. In particular, the TMG staffs the Business Development Center Tokyo with a consultant experienced in both financial administration and the financial industry to assist with inquiries regarding applications for licenses with the FSA, as well as other related matters. The FSA consultation desks and the TMG consultants will share such inquiries and will work to respond in an integrated fashion, thus reducing regulatory burdens. 

***

Recent legal developments will not only help fintech companies do business in Japan (particularly cash or alternative settlement businesses, through the use of apps using banking APIs, and operating as VC exchanges) but also improve the protection of customers using such services. Participants in the fintech industry in Japan also expect the TMG’s measures to achieve the goal of realising Global Financial City Tokyo.

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