Recent amendments to the Japanese securities laws have introduced additional compliance burdens for private equity sponsors marketing their funds in Japan. These amendments have added potentially onerous requirements for general partners seeking to avoid registration with Japan’s regulators. While it is unlikely these new rules will cause fund sponsors to avoid marketing in Japan altogether, sponsors should take note of the new compliance requirements and, where possible, consider taking steps once fundraising is complete to limit the ongoing application of these new requirements.
QII Targeted Exemption for Marketing and Fund Management
Prior Regime. Many private equity sponsors have historically relied on the “QII Targeted Exemption” of Japan’s Financial Instruments and Exchange Law (the “FIEL”) to market private equity funds in Japan. This exemption allows the general partner to offer fund interests and serve as an “investment manager” of a fund with Japanese investors without registration with the Japanese regulator, so long as (1) there is at least one “Qualified Institutional Investor” (“QII”) and no more than 49 Japanese fund investors that are not QIIs and (2) the fund imposes certain restrictions on transfer by Japanese investors. Categories of QIIs include Japanese banks and insurance companies.
New Requirements. Prior to the recent amendments, the “QII Targeted Exemption” merely required the filing of a simple notice with the Japanese regulator. Under the amended law, which took effect on March 1, 2016, the general partner of a private equity fund is now also required to: (1) appoint a Japanese local representative; (2) comply with record-keeping requirements; (3) beginning April 1, 2017, file various annual reports with the Japanese regulator, certain of which (including, among others, financial statements for the entity making the notice filing, often the general partner of the general partner) will be made publicly available; (4) comply with certain new conduct requirements, including substantive fiduciary duty standards and prohibitions on certain conflicted transactions; and (5) submit additional information with the notification filing, including affidavits of good conduct. While these new requirements should largely be manageable for many sponsors, the rules are complex and, in certain cases less than clear, particularly as relates to certain of the new conduct requirements. Sponsors should consult Japanese counsel in specific cases.
No Grandfathered Status. Funds that made notification filings in reliance on the QII Targeted Exemption prior to March 1, 2016 are not exempt from these new compliance requirements. However, there is a grace period until September 1, 2016 solely with respect to the requirements to appoint a local representative and update notification filings.
Outsourcing Exemption for Marketing Only
There is a second exemption from registration (the “Outsourcing Exemption”) that applies to marketing activities carried out by a licensed placement agent in Japan. Historically, this exemption has received relatively little use, due in part to the fact that it imposes significant restrictions on the ability of a sponsor’s representatives to communicate directly with prospective investors in Japan, and in part to the fact that, in practice, the sponsor will still need to rely on another exemption for ongoing fund management. However, there may be renewed interest in exploring this alternative in light of the new requirements applicable to the QII Targeted Exemption.
De Minimis Exemption for Ongoing Fund Management
A third exemption (referred to as the “De Minimis Exemption”) allows fund sponsors to avoid registration with respect to ongoing management of a fund with Japanese investors. To qualify, (1) the fund, directly or indirectly, may have no more than nine Japanese investors, all of which must be QIIs or certain other permitted categories of investors, and (2) the aggregate capital contributions of these investors to the fund may not equal or exceed one-third of the total capital contributions to the fund.
Unlike the QII Targeted Exemption, the De Minimis Exemption does not trigger the new substantive compliance requirements described above. Therefore, fund sponsors should consider relying on the QII Targeted Exemption solely during fundraising, and thereafter relying on the De Minimis Exemption for ongoing fund management if the conditions are met. In such a case, a fund sponsor should file an abolishment notification with the Japanese regulator withdrawing its QII Targeted Exemption notification filing once fundraising in Japan is complete.
Similarly, fund sponsors should review their existing funds that previously relied on the QII Targeted Exemption and are no longer fundraising to determine whether those funds are able to withdraw the notification filing and rely instead on the De Minimis Exemption going forward.
Nevertheless, since the De Minimis Exemption provides an exemption from registration only with respect to ongoing investment management, sponsors will still need to rely on either the QII Targeted Exemption or the Outsourcing Exemption in respect of fundraising activities in Japan.
As noted above, these recent amendments to the QII Targeted Exemption will add additional layers of compliance obligations for private equity sponsors marketing their funds in Japan or to Japanese investors. While the full practical impact of these obligations remains to be seen, there are certain steps sponsors can take now to limit the need to rely on the QII Targeted Exemption, both with respect to funds that are currently in fundraising and, potentially, with respect to older funds.