Sales Representatives Manual

Sales Representatives Manual

2020

Volume 2

Volume 2

Table of Contents

Chapter 1

Equity Business …………………………………………… 1

Chapter 2

Bond Business …………………………………………… 169

Chapter 3

Investment Trusts and Investment Corporations Business

……………… 263

Chapter 4

Incidental Businesses ………………………………… 377

Chapter 5

Sales Operations ………………………………………… 399

Chapter 1 Equity Business

Introduction ∙∙∙∙∙∙∙∙ 5

Section 1. Types of Transactions ∙∙∙∙∙∙∙∙ 71.1 Exchange Trades ∙∙∙∙∙∙∙∙ 71.2 Off-Exchange (Market) Trading ∙∙∙∙∙∙∙∙ 111.3 Over-the-Counter Transactions ∙∙∙∙∙∙∙∙ 11

Section 2. Forms of Trading ∙∙∙∙∙∙∙∙ 112.1 Purchase or Sale of Shares (Principal Transactions) ∙∙∙∙∙∙∙∙ 122.2 Brokerage for Purchase or Sale of Shares (Brokered Transactions)

∙∙∙∙∙∙∙∙ 122.3 Agency Services for Purchase or Sale of Shares ∙∙∙∙∙∙∙∙ 122.4 Intermediating for Purchase or Sale of Shares ∙∙∙∙∙∙∙∙ 122.5 Intermediary, Brokerage, or Agency Services for Entrustment of

Trading on Financial Instruments Exchange Markets ∙∙∙∙∙∙∙∙ 13

Section 3. Accepting a Trade ∙∙∙∙∙∙∙∙ 133.1 Matters to Be Observed upon Accepting a Trade, Etc. ∙∙∙∙∙∙∙∙ 143.2 Execution and Settlement of Orders (Delivery) ∙∙∙∙∙∙∙∙ 433.3 Commissions Pertaining to Share Trading ∙∙∙∙∙∙∙∙ 48

Section 4. Sale and Purchase of Shares on Financial Instruments Exchanges ∙∙∙∙∙∙∙∙ 494.1 Types and Outline of Share Trading on Financial Instruments

Exchanges ∙∙∙∙∙∙∙∙ 494.2 When-Issued Transactions (Date-of-Issue Transactions) ∙∙∙∙∙∙∙∙ 514.3 Transactions Other Than Those During Trading Sessions

(Trading on a Market Outside of Trading Sessions in the Exchange) ∙∙∙∙∙∙∙∙ 57

Section 5. Over-the-Counter Share Transactions ∙∙∙∙∙∙∙∙ 625.1 Types of Over-the-Counter Securities ∙∙∙∙∙∙∙∙ 625.2 Trading Methods ∙∙∙∙∙∙∙∙ 645.3 Shareholders Community ∙∙∙∙∙∙∙∙ 655.4 Equity-based Crowdfunding ∙∙∙∙∙∙∙∙ 69

Section 6. Trades Off the Financial Instruments Exchange Market in Listed Share Certificates, Etc. ∙∙∙∙∙∙∙∙ 716.1 Differentiation from Trades on Financial Instruments Exchange

Market ∙∙∙∙∙∙∙∙ 726.2 Compliance with Law and Regulations, Etc. ∙∙∙∙∙∙∙∙ 726.3 Forms of Trading ∙∙∙∙∙∙∙∙ 72

6.4 Eligible Listed Share Certificates, Etc. ∙∙∙∙∙∙∙∙ 736.5 Exemption from Off-Market Trading Rules ∙∙∙∙∙∙∙∙ 736.6 Confirmation of Sale and Purchase Price and Record Keeping

∙∙∙∙∙∙∙∙ 746.7 Prohibition of Sale and Purchase, Etc. Imposed on Association

Members ∙∙∙∙∙∙∙∙ 746.8 Suspension of Sale and Purchase, Etc. Imposed by the JSDA ∙∙∙∙∙∙∙∙ 756.9 Report and Announcement, Etc. of Sale and Purchase, Etc. (Reports

and Public Announcement, Etc. of Off-Exchange Sale and Purchases Other Than Those Conducted Through Approved Business) ∙∙∙∙∙∙∙∙ 75

6.10 Explanation to Customers ∙∙∙∙∙∙∙∙ 776.11 PTS (Proprietary Trading System) ∙∙∙∙∙∙∙∙ 77

Section 7. Cumulative Stock Investments ∙∙∙∙∙∙∙∙ 847.1 Definition of Cumulative Stock Investments ∙∙∙∙∙∙∙∙ 847.2 Features of Cumulative Stock Investments ∙∙∙∙∙∙∙∙ 847.3 Structure of Cumulative Stock Investment Contracts ∙∙∙∙∙∙∙∙ 85

Section 8. Mini Stock Investments ∙∙∙∙∙∙∙∙ 888.1 Definition of Mini Stock Investments ∙∙∙∙∙∙∙∙ 888.2 Features of Mini Stock Investments ∙∙∙∙∙∙∙∙ 888.3 Structure of Mini Stock Investment Contracts ∙∙∙∙∙∙∙∙ 88

Section 9. Listing of Shares ∙∙∙∙∙∙∙∙ 919.1 Merits of a Listing ∙∙∙∙∙∙∙∙ 929.2 Listing of Shares and Determination of IPO Price ∙∙∙∙∙∙∙∙ 92

Section 10. Margin Transactions ∙∙∙∙∙∙∙∙ 9410.1 Outline of Margin Transaction System ∙∙∙∙∙∙∙∙ 9410.2 Margin Transactions in Listed Issues ∙∙∙∙∙∙∙∙ 97

Section 11. Foreign Securities Transactions ∙∙∙∙∙∙∙∙ 13811.1 Establishment of a Foreign Securities Transaction Account ∙∙∙∙∙∙∙∙ 13911.2 Modes of Foreign Securities Transactions ∙∙∙∙∙∙∙∙ 140

Section 12. Securities Investment Computations ∙∙∙∙∙∙∙∙ 14512.1 Stock Yield ∙∙∙∙∙∙∙∙ 14512.2 Cum Rights, Ex-Rights Market Prices ∙∙∙∙∙∙∙∙ 14712.3 Price/Earnings Ratio (PER) ∙∙∙∙∙∙∙∙ 14912.4 Price/Cash-Flow Ratio (PCFR) ∙∙∙∙∙∙∙∙ 15112.5 Price/Book-Value Ratio (PBR) ∙∙∙∙∙∙∙∙ 15412.6 Return on Equity (ROE) ∙∙∙∙∙∙∙∙ 15512.7 Return on Assets (ROA) ∙∙∙∙∙∙∙∙ 15712.8 Earnings-Price Ratio ∙∙∙∙∙∙∙∙ 15812.9 Yield Spread (Difference in Yield) ∙∙∙∙∙∙∙∙ 158

12.10 The EV/EBITDA Multiple ∙∙∙∙∙∙∙∙ 15812.11 Average Share Price and Share Indexes ∙∙∙∙∙∙∙∙ 16012.12 Delivery Amount for Share Trading ∙∙∙∙∙∙∙∙ 16512.13 Margin Transactions and Security Deposit/Minimum Maintenance

∙∙∙∙∙∙∙∙ 167

IntroductionGenerally the term “stock” or “shares” is understood to mean share certificates; legally,

however, it refers to one’s status as a shareholder in a corporation. In other words, stock represents the owner’s share in a corporation, and his or her rights as a shareholder.

Stock is divided into units of one share, and the rights accompanying each share are equal unless more than one class of stock is issued, so that the extent of the rights is determined by the volume of shares held. From the shareholder’s perspective, stock is a unit of investment; from the corporation’s perspective, stock is a unit of capital. Investing in shares means becoming a shareholder by investing funds in a corporation in return for the shares issued by such corporation.

The primary rights of shareholders are: (i) voting rights; (ii) the right to demand the payment of dividends from retained earnings; (iii) rights to the residual assets of the corporation upon liquidation; and (iv) preemptive subscription rights (shinkabu hikiuke ken) (for details, see Volume 3, Chapter 1, “Stock Company Law in General”).

What is the purpose for which general investors engage in share trading? They may be seeking a capital gain, which is a difference between the price at which they bought shares and the price at which they sold them. They may also be seeking an income gain, that is, a dividend from shares. In recent years, while market interest rates for deposits and savings have been extremely low since the Bank of Japan introduced the negative interest rate policy for its current account balances on January 29, 2016, some issues yield dividends as high as 5% or more. Some investors buy shares to obtain gift certificates for shareholders, whereas others use shares in margin transactions, in which they sell shares at a high price and buy them back at a low price. Thus, investors buy and sell shares for various purposes.

Shares are freely transferable (saleable). This means that while investors can invest in shares using short-term funds, companies are able to procure stable, long-term capital. Needless to say, if there were no secondary market where shares could freely circulate among sellers and purchasers at a fair price, not only would investors be unable to purchase shares with confidence, but issuing companies would also be precluded from procuring equity capital. Therefore, it is important that the respective functions be performed properly by each of the intermediaries, e.g., financial instruments business operators, the financial instruments exchanges (hereinafter referred to individually as an “exchange”) where orders of financial instruments are executed, the securities finance companies, which provide liquidity, and in addition, the financial instruments business firms associations, which are self-regulatory organizations that are formed from among financial instruments business operators, registered financial institutions and Specified Business Members.

The share operations performed by financial instruments business operators generally can be divided into the following:

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Sales Representatives Manual 2020 ● Volume 2　5

Introduction

This Chapter mainly explains the “share trading operations of financial instruments business operators”; but in this Chapter, “financial instruments business operators” shall be limited to persons conducting type 1 financial instruments business who are mainly engaged in securities-related business (securities companies under the former SEL).

(Note) The following is a list of abbreviations for laws and orders that are used in this Chapter:・Financial Instruments and Exchange Act = (FIEA)・�Enforcement Order for the Financial Instruments and Exchange Act = (FIEA Enforcement

Order)・�Cabinet Office Ordinance Concerning Definitions Specified in Article 2 of the Financial

Instruments and Exchange Act = (Definition Ordinance)・Cabinet Office Ordinance Concerning Financial Instruments Business, Etc. = (FIBCOO)・�Cabinet Office Ordinance Concerning Restrictions on Transactions, Etc. in Securities =

(Securities Transaction Ordinance)・�Cabinet Office Ordinance Concerning Transactions Specified in Article 161-2 of the FIEA

and the Security Deposits Therefor = (Security Deposit Ordinance)・Act on Prevention of Transfer of Criminal Proceeds = (CPTPA)・ Act on the Use of Numbers to Identify a Specific Individual in Administrative Procedures

= (My Number Act)・�Ordinance on Terminology, Forms, and Preparation Methods of Consolidated Financial

Statements = (Consolidated Financial Statements Ordinance)・�Ordinance on the Terminology, Forms, and Preparation Methods of Financial Statements,

Etc. = (Financial Statements Ordinance)・�Self-Regulatory Rules of the Japan Securities Dealers Association Rules Concerning Over-The-Counter Securities = (OTC Securities Rules) Rules Concerning Phoenix Issues = (Phoenix Rules) Rules Concerning Sale and Purchase of Foreign Securities = (Foreign Securities Rules) Rules Concerning Solicitation for Investments and Management of Customers, Etc. by

Association Members = (Investment Solicitation Rules) Rules Concerning Establishment of Confidential Corporate Information Management

System by Association Members = (Rules on Confidential Corporate Information) Rules Concerning Employees of Association Members = (Employee Rules) Rules Concerning Acceptance, Etc. of Deposit of Securities = (Deposit Rules)

Issuing Operations

Trading Operations

Other

Underwriting shares, dealing in public offerings Secondary distribution of shares, dealing in secondary distributions

Purchase/sale of shares, intermediary/brokerage/agency services for purchase/sale of sharesHandling share operations as an agent, etc.

Chapter 1. Equity Business

6　Sales Representatives Manual 2020 ● Volume 2

Detailed Rules Related to Rules Concerning Acceptance of Deposit, Etc. of Securities = (Detailed Rules on Deposit)

Rules Concerning Shareholders Community = (Shareholders Community Rules) Rules Concerning Equity-based Crowdfunding Business = (Crowdfunding Rules) Rules Concerning Elimination of Relationships with Antisocial Forces = (Rules on

Elimination of Relationships with Antisocial Forces) Rules Concerning Handling of Document Delivery, Etc. through Electromagnetic Method

= (Document Delivery Rules) Rules Concerning Sale and Purchase, Etc. of Listed Share Certificates, Etc. Conducted

Outside of Financial Instruments Exchange Market = (Off-Market Trading Rules) Rules Concerning Handling of Cumulative Stock Investment and Mini Investment in

Stocks = (Cumulative/Mini Stock Investment Rules)

1 Types of Transactions

Transactions in shares can be classified depending on the listing category of the traded shares and the market on which they are traded. Listing category refers to whether or not the shares are listed on an exchange, while the trading market refers to the categorization based on whether the share certificates are traded on or off the exchange. Furthermore, transactions involving over-the-counter securities, which involve shares not listed on an exchange, are called over-the-counter transactions.

Shares listed on an exchange and traded on the exchange Exchange (Market) Trades Shares listed on an exchange but traded outside of the exchange Off-Exchange (Market) TradesTrades of unlisted shares (over-the-counter securities) Over-the-Counter Transactions

1 1 Exchange Trades

Facilities where securities can be purchased and sold on the spot in Japan include the Tokyo Stock Exchange (hereinafter referred to as the “TSE”), the Nagoya Stock Exchange (hereinafter referred to as the “NSE”), the Fukuoka Stock Exchange (hereinafter referred to as the “FSE”) and the Sapporo Securities Exchange (hereinafter referred to as the “SSE”). Financial instruments exchange markets are hosted on each of these exchanges. As a result of the integration of the spot markets of the Osaka Securities Exchange (hereinafter referred to as the “OSE”) into those of the TSE as of July 16, 2013, the OSE became an exchange that exclusively deals with derivative products. The integration of the derivative markets of the TSE into those of the OSE took place on

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March 24, 2014. Upon this market integration, the OSE changed its trade name to the “Osaka Exchange.”

Stock Exchanges and Cash Equity Market Categories

Main Markets New MarketsTSE First Section Second Section Mothers　JASDAQNSE First Section Second Section CentrexFSE Main market (not separated by section) Q-BoardSSE Main market (not separated by section) Ambitious

* The TSE also provides a stock market for professional investors: TOKYO PRO Market. As of July 16, 2013, the country fund and venture fund markets of the OSE were integrated into those of the TSE which were newly established.

Trades on financial instruments exchanges are called exchange trades (trades on market).

TSE JASDAQ MarketOn April 1, 2010, the OSE and the JASDAQ Securities Exchange (hereinafter referred

to as the “JSE”) integrated their operations, and the JSE became the JASDAQ market of the OSE.

Moreover, on October 12, 2010, the Hercules, JASDAQ and NEO markets were merged, creating a new JASDAQ market (hereinafter referred to as the “New JASDAQ Market”). Following the integration of the cash equity markets of the OSE into those of the TSE on July 16, 2013, the New JASDAQ Market became the TSE JASDAQ Market.

TOKYO PRO MarketOn June 1, 2009, the TSE opened a market for professional investors, the TOKYO AIM

exchange, as a joint venture with the London Stock Exchange. On July 1, 2012, the TOKYO AIM exchange was merged with the TSE and reorganized as the TOKYO PRO Market.

Exchange trades aim to increase the market liquidity of the listed shares and promote fair pricing by gathering all the buy/sell orders of customers (as well as financial instruments business operators themselves) on the exchange market, and matching the large volume of supply and demand for shares. However, in response to diversifying trading needs such as increasing size of order lots, etc., transactions other than those during trading sessions which are different from the transactions during trading sessions were introduced in November 1997. This enabled institutional investors making large volume trades to execute their trades without having an influence on other general investors.

A listing system is employed for the shares that trade on the exchanges, and in order to list its shares, the issuing company must submit a listing application that is subject to an eligibility examination conducted by the relevant exchange, and the exchange will make a notification to the Prime Minister in relation to the listing (FIEA, art. 121).

Furthermore, post-listing issuing companies are obligated to report certain financial



information, and are also required to disclose to investors in a timely manner other necessary company information (FIEA, Chapter II; Cabinet Office Ordinance Concerning Disclosure of Corporate Matters, Etc.).

In order to ensure that the large volume of buy/sell orders for listed shares are executed fairly and smoothly, thus allowing the secondary markets to fully realize their potential, exchange trading (auction trading) employs the use of standardized terms (e.g., session time, ask price method, trading unit, settlement methods).

Unless otherwise specified, the rules concerning exchange trading explained herein are based on the TSE’s articles of association and related rules.

(1) Trading HoursStock trading is conducted during predetermined hours on every day except for holidays.

Such hours are called trading hours.(i) Holidays

The TSE is closed on the following holidays: Sundays; national holidays; if a national holiday falls on a Sunday, the first non-national holiday after that national holiday; the day between two national holidays; Saturdays; the first three days of the year; and December 31 (TSE/NSE/SSE/FSE Business Regulations, art. 3, para. 1).(ii) Trading Sessions

The period of trading hours in the morning is called the morning session, and the period in the afternoon is called the afternoon session. The trading sessions for domestic shares on the TSE are slightly different from those on other exchanges (TSE/NSE/SSE/FSE Business Regulations, art. 2, para. 1, item 1).

TSE NSE, SSE, FSEMorning session 9:00 - 11:30 9:00 - 11:30

Afternoon session 12:30 - 15:00 12:30 - 15:30

(2) Method for Concluding Trading ContractsTrading is conducted under the double auction system, whereby purchase and sale orders are

matched according to the principles of price and time priority (TSE Business Regulations, art. 10, para. 1).

The contract prices of transactions executed at the exchanges (i.e., highest, lowest, and closing prices) are announced daily by the exchanges (FIEA, art. 130; TSE Business Regulations, art. 23).

(3) IncrementofBidsandOffersIf a financial instruments business operator who participates in trading on an exchange

(trading participant) intends to execute a transaction in a trading session, it must make a bid or an offer (TSE Business Regulations, art. 14, para. 1). The increment of bids and offers for domestic shares in general is classified into 11 stages by price per share. For example, a bid or offer may be made in increments of JPY 1 when the price per share is JPY 3,000 or less, and JPY 5 when the

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price per share is more than JPY 3,000 but equal to or less than JPY 5,000. On the other hand, the increment for constituents of TOPIX 100 is subdivided, e.g., JPY 0.1 when the price per share is 1,000 or less, and JPY 0.5 when the price per share is JPY 3,000 or less (TSE Business Regulations, art. 14, para. 3, item 1) (for details, see Volume 1, Chapter 5, “Articles of Incorporation and Various Regulations of the Exchanges”).

TOPIX 100 is a market value-weighted share index calculated by the TSE which is composed of 100 issues with high liquidity selected by the TSE from those listed on the TSE First Section (for details, see this Chapter, “12-11(4) TOPIX 100”).

(4) PriceLimitsonBidsandOffersBids and offers shall not be made at prices exceeding the price limits defined by the

Exchange in accordance with regulations (TSE Business Regulations, art. 14, para. 5). Specifically, the Exchange sets a price range which is called price limits on bids and offers or daily price limits, within which price fluctuations on a single day are limited on the basis of the previous day’s closing price (base price). The price limits on bids and offers for shares are classified into 34 stages by the base price (TSE Rules Concerning Price Limits on Bids and Offers, art. 2, para. 1).

The limited price is called the “stop price.” When the share price rises to the upper price limit, it is called “limit up,” and when it declines to the lower price limit, it is called “limit down.”

If the base price (previous day’s closing price) of a particular share is not less than JPY700 and JPY 1,000 or less, the price limit is JPY 150. If the previous day’s closing price is JPY 800, the limit up is JPY 950 and the limit down is JPY 650 (TSE “Rules concerning Price Limits on Bids and Offers,” art. 2, para. 1; for details, see Volume 1, Chapter 5, “Articles of Incorporation and Various Regulations of the Exchanges”).

(5) Trading UnitsFor domestic stocks, if a listed company has set a certain number of shares as one share unit,

that number of shares shall be the trading unit; and if not, one share shall be the trading unit (TSE Business Regulations, art. 15, item 1 (a)).

There were eight trading units (1 share, 10 shares, 50 shares, 100 shares, 200 shares, 500 shares, 1,000 shares, and 2,000 shares) at the peak time. In April 2014, the classification was changed to comprise only two units, 100 shares and 1,000 shares. These units were unified into a single unit of 100 shares on October 1, 2018.

If there is only one unit, traders will no longer need to check the trading unit they are to use. The adoption of the single unit is also expected to considerably reduce mistakes in trading.



1 2 Off-Exchange (Market) Trading

In order to respond to the diversifying needs of investors as well as to increase inter-market competition, the duty to gather all trades on the exchange board was abolished in December 1998, and the trading of listed shares outside of the financial instruments exchange markets (hereinafter referred to as “off-exchange trading”) commenced the same day.

Certain regulations are imposed on off-exchange trading that cover such matters as the duty of financial instruments business operators to report to the Japan Securities Dealers Association (hereinafter referred to as the “JSDA”) and explain to their customers items deemed necessary such as delivery settlement conditions, etc. (Off-Market Trading Rules).

1 3 Over-the-Counter Transactions

The concept of over-the-counter transactions is loosely made up of two ideas: “trading conducted outside of the exchange (via the trading desks of financial instruments business operators) irrespective of the listing category of the securities involved,” and “trading in securities that are not listed on an exchange.”

“Over-the-counter securities,” or securities that are not listed on an exchange, can be divided into: 1) “over-the-counter handled securities,” requiring the issuer to meet a certain minimum level of disclosure, etc.; and 2) “over-the-counter securities other than over-the-counter handled securities” (also known as blue-sky issues). Furthermore, over-the-counter handled securities include Phoenix issues, securities for which financial instruments business operators may conduct investment solicitations on the condition that they conduct their own screening and provide quotations, etc. for the said issues (OTC Securities Rules, Phoenix Rules).

Based on the review of regulations concerning the trading system of unlisted shares released on May 19, 2015, “shareholders community issues” under the Shareholders Community Rules and “share certificates handled in the equity-based crowdfunding business” under the Crowdfunding Rules have been included in the scope of over-the-counter securities for which Association Members may solicit customers (in the case of shareholder community issues, limited to customers who are members of the relevant shareholders community) for investment (OTC Securities Rules, art. 3; Shareholders Community Rules and Crowdfunding Rules).

2 Forms of Trading

The forms of share trades can be broadly categorized as follows:

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2 1 Purchase or Sale of Shares (Principal Transactions)

Trades that a financial instruments business operator conducts on its own account are called principal transactions. Principal transactions are separated into trades that are executed on a market operated by an exchange, as is the case with brokered transactions below, and sales to customers or purchases from customers conducted outside of the exchange market (dealer transactions).

2 2 Brokerage for Purchase or Sale of Shares (Brokered Transactions)

Brokered transactions are transactions in which, upon receiving an order from a customer, a financial instruments business operator conducts a trade in its own name but for the customer’s account. Since execution of the trade is entrusted to the financial instruments business operator, it is called a brokered transaction. Most customer buy/sell orders executed on the exchanges take this form.

2 3 Agency Services for Purchase or Sale of Shares

This means a form of transaction in which a financial instruments business operator executes a transaction in the name of a customer while disclosing the fact that the financial instruments business operator is acting as an agent and enters into an agency contract with the customer. Transactions executed by the financial instruments business operator as an agent in a tender offer bid also fall within this category.

2 4 Intermediating for Purchase or Sale of Shares

This means, upon a purchase or sale of shares, actions taken in an endeavor to facilitate a trade between the buyer and seller, e.g., financial instruments business operators acting as middlemen in off-exchange market trades if requested to do so by a customer.



2 5 Intermediary, Brokerage, or Agency Services for Entrustment of Trading on Financial Instruments Exchange Markets

This includes transactions where, for example, a financial instruments business operator that is not a trading participant (or member) of an exchange (including a foreign exchange) receives an order from a customer to purchase or sell securities that are listed on that exchange, and the financial instruments business operator re-entrusts the order to a trading participant of the said exchange for execution.

3 Accepting a Trade

Several verification requirements are imposed on a financial instruments business operator when it accepts trades in securities, under a compliance framework that provides for matters such as investor protection and the prevention of unlawful transactions, etc.

To protect investors, financial instruments business operators are required to undertake appropriate investment solicitations; for each transaction type, ensure relevant transaction initiation criteria are satisfied (Investment Solicitation Rules, art. 6); deliver a document prior to conclusion of a contract (FIEA, the main clause of art. 37-3, para. 1); and inspect identifying documentation (Investment Solicitation Rules, art. 8). Similarly, a variety of conditions are imposed on the execution and settlement of orders from the viewpoint of investor protection, such as the requirement to prepare order slips (Investment Solicitation Rules, art. 18, para. 2) and deliver a document upon conclusion of a contract and on other occasions (FIEA, art. 37-4, para. 1).

From the standpoint of preventing unfair transactions, financial instruments business operators are required to confirm the customer’s identity (CPTPA, art. 4; Investment Solicitation Rules, art. 5) at the time of accepting a trade to check whether the transaction falls within the transactions prohibited by the law and regulations, such as those concerning insider trading (FIEA, art. 166) and pseudonymous transactions (Investment Solicitation Rules, art. 13, para. 1).

Financial instruments business operators are also obligated to verify the identity of the customer (CPTPA, art. 4) in order to allow trades to be settled in an efficient manner.

In addition to customer verification, the matters to be observed upon accepting trades are many and varied, and include the duty to clarify in advance the mode of the transaction (FIEA, art. 37-2), verification of whether or not the transaction is a short sale (FIEA Enforcement Order, art. 26-3, para. 2), finance regulations, and measures to ensure the transaction does not fall within one of the transactions prohibited by the laws and regulations, etc.

Moreover, under the Act on Sales of Financial Instruments, Etc. (hereinafter referred to as the “Financial Instruments Sales Act”) that became effective in April 2001, if a financial instruments business operator wishes to sell (buy) securities to (from) a customer or engage in other transactions with a customer, the financial instruments business operator is required to explain the material matters regarding such transaction ((i) price fluctuation risk, (ii) credit risk,

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and (iii) restrictions on periods for the exercise of rights or contract cancellation for the said securities) prior to the sale (purchase).

In addition, the Financial Instruments Sales Act has been amended in accordance with the implementation of the FIEA in September 2007.

Firstly, in addition to the existing “risk of losses in the principal,” there are several new matters subject to accountability, including “material portions among the transaction scheme” and “the risk of losses in excess of the initial principal.” Here the “risk of losses in excess of the original principal” means the “risk that the amount of a loss will exceed the amount of the customer margin or any other security deposit or other amount as prescribed by Cabinet Office Ordinance” as set forth in the FIEA. In addition, it has been provided that such explanation shall be in the method and extent necessary to be understood by the customer in light of the customer’s knowledge, experience, status of assets and the purpose of execution of the sales agreement of such financial instrument.

Secondly, a provision to prohibit the provision, etc. of definitive judgments has been newly set forth. A financial instruments business operator, etc. shall owe no-fault liability with respect to the violation of accountability, and in such case, the amount of loss in the principal shall be presumed to be the amount of damages incurred by the customer. The provisions concerning accountability liability for compensation for damages shall not apply to professional investors*.

* “Professional investors” mean (i) qualified institutional investors, (ii) the Government of Japan, (iii) the Bank of Japan, and (iv) Investors Protection Funds and other corporations prescribed by the Cabinet Office Ordinance (FIEA, art. 2, para. 31). Among these, “qualified institutional investors” mean institutional investors prescribed by Article 10 of the Definitions Ordinance. Professional investors, set forth in categories (i) through (iii) above, cannot switch over to become general investors, but such a transition can occur for category (iv), such as Investors Protection Funds and government-affiliated financial institutions, etc., upon their application. As of April 1, 2011, local governments were included in the scope of general investors who may shift to become professional investors (FIEA, art. 34-2 and art. 34-3; Definition Ordinance, art. 23).

3 1 Matters to Be Observed upon Accepting a Trade, Etc.

(1) InspectionoftheCustomer’sAddress,Name,Etc.andIdentityVerificationuponTransaction, and Presentation of the Individual NumberIn accordance with the implementation of the Act Concerning the Verification, Etc. of

Customer Identity, Etc. by Financial Institutions, Etc. and Prevention of Improper Use of Deposit Accounts, Etc. (hereinafter referred to as the “Customer Verification Act”) in January 2003,



financial instruments business operators are required by law to verify each customer’s identity before commencing transactions with that customer. Thereafter, in March 2008, the Act on Prevention of Transfers of Criminal Proceeds (hereinafter referred to as the “CPTPA”) fully came into force, implemented a comprehensive toughening of measures to prevent money laundering, the provision of funds for terrorism, etc. and also incorporated the content of the Customer Verification Act, with this law thereby being abolished.

Financial instruments business operators are required to maintain for customers, who conduct purchase and sale or other transactions in securities, “customer cards” on file, which contain certain information about each customer, such as the customer’s name, address, and contact information, etc. (Investment Solicitation Rules, art. 5). Upon commencing transactions with the customer or at other occasions prescribed by the CPTPA, the financial instruments business operator must verify the identity of the customer by having the customer present or submit certain identifying documentation. Moreover, due to an amendment to the CPTPA, from April 1, 2013, financial instruments business operators must also verify other matters concerning the transaction, such as the purpose of the transaction and the customer’s occupation (the verification of these matters in combination with the verification of the customer’s identification data (name, address, date of birth, etc.) is referred to as “identity verification upon transaction”). In some cases, they have the obligation under law to verify the purpose of the transaction and the customer’s occupation even when conducting a transaction with an existing customer.

Trading, etc. with or providing funds or other services to antisocial forces such as violent criminal organizations became prohibited under the rules which came into effect on July 1, 2010, and consequently, when opening an account, a financial instruments business operator is required to obtain an affidavit that the customer is not an antisocial force, and to enter into an agreement for the purpose of eliminating antisocial forces (Rules on Elimination of Relationships with Antisocial Forces, art. 3, art. 5 and art. 6).

In addition, under the My Number Act, the Income Tax Act, and other related laws, new customers who begin transactions with financial instruments business operators on or after January 1, 2016 are required to, among other procedures, present a document by which their individual numbers can be verified. Customers who have been conducting transactions with financial instruments business operators from before December 31, 2015 must present such documents no later than the point at which they receive the payment of proceeds for the transfer of shares or investment trusts, etc. or receive dividends, etc. for the first time on or after April 1, 2022 (My Number Act, art. 2, para. 10; Income Tax Act, art. 224, para. 1 and art. 224-3, para. 1; Enforcement Order of the Income Tax Act, art. 336).

(Note) Upon the amendment to the Act on General Rules for National Taxes, starting from April 1, 2020, the Japan Securities Depository Center, Incorporated will provide the individual numbers and other information of its participants that it retains to issuers of shares, etc. or account management institutions upon their request.

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(2) Investment SolicitationWhen soliciting investments, financial instruments business operators must endeavor to

conduct solicitations for investments that are compatible with the customer’s intention and present condition, after fully ascertaining the customer’s investment experience, investment objectives, financial resources, etc. (investment solicitation pursuant to the principle of suitability, Investment Solicitation Rules, art. 3, para. 2). Financial instruments business operators shall make sure the customer understands that he or she should engage in investments based on his or her own judgment and at his or her own responsibility (thorough implementation of the principle of self-responsibility, Investment Solicitation Rules, art. 4).

Furthermore, financial instruments business operators are prohibited from conducting acts of solicitation by telephone or visits at a time that customers feel inconvenienced (all customers are covered for mortgage securities, commodity funds and financial futures transactions, but only individual customers are covered for other transactions) (FIBCOO, art. 117, para. 1, item 7).

In addition, financial instruments business operators should make advertisements or other similar acts (this is a wide-ranging concept which includes the provision of the same content to many persons through means such as advertisements, postal mail, facsimile, e-mail, distribution of flyers and brochures, etc.) with clear and accurate representation of “existence of risk” in characters and figures in a size that is not substantially different from the largest size of those used in advertisements, etc., and are required to represent information on fees, risk information and other facts that are disadvantageous to customers; provided, however, that only the “existence of risk” and “that the document should be read carefully” need to be represented on TV/radio commercials, signs and novelty goods (FIEA, art. 37; FIEA Enforcement Order, art. 16, para. 2; FIBCOO, art. 72, art. 73 and art. 77).

In addition, when entering into a contract for financial instruments transaction, a financial instruments business operator must provide to the customer in advance a document stating the outline of these transactions, charges and fees, etc., something to the effect that there is a risk of loss due to fluctuation in the market, etc., that the loss may exceed the amount of customer margin, etc. to be deposited, and cautionary matters to be notified to the customer (such document shall hereinafter be referred to as a “document to be delivered prior to conclusion of a contract”; FIEA, art. 37-3; FIBCOO, art. 82). Such document must state risk information, etc., in particular, in an easy-to-be-understood manner. The obligation to deliver such document shall not apply in cases where there are no issues from the standpoint of investor protection (such as where such a document has already been delivered in the past) (FIBCOO, art. 80).

With respect to the delivery of the document to be delivered prior to conclusion of a contract, acts of executing a contract without giving an explanation in the manner and to the extent necessary for a customer to understand risk information, etc. is prohibited (FIBCOO, art. 117, para. 1, item 1).

In addition to the general matters to be noted above, it is necessary to note the following points per the type of transaction. The transaction initiation criteria stated below consist of criteria that are determined separately for each financial instruments business operator based on the principle of suitability, including the client’s investment experience and the assets deposited, and



are especially applicable for commencing high risk transactions.(i) Margin Transactions and When-Issued Transactions

a) Financial instruments business operators must establish transaction initiation criteria, and may accept margin transactions from qualifying customers. Each financial instruments business operator establishes these criteria regarding the investment experience of the customer, assets on deposit, or other matters it deems necessary (Investment Solicitation Rules, art. 6).

b) Upon establishing a margin account, financial instruments business operators must receive from the customer a Written Agreement for Establishment of a Margin Transaction Account in the format prescribed by the exchange (TSE Brokerage Agreement Standards, art. 5, para. 2). This rule similarly applies to when-issued transactions, and a written agreement must be obtained in connection with entrusting a when-issued transaction (TSE Brokerage Agreement Standards, art. 4, para. 1).

c) Upon receiving orders for margin transactions from a customer, financial instruments business operators must confirm matters including the intent of the customer as to whether the transaction is a standardized margin transaction (including PTS Standardized Margin Transaction) or a negotiable margin transaction (including PTS Negotiable Margin Transaction) for each case (Investment Solicitation Rules, art. 7).

(ii) Transactions of Over-the-Counter Handled Securities (Phoenix Issues)“Phoenix issues” are “handled securities,” stipulated under Article 67-18, item 4 of the

FIEA (Phoenix Rules, art. 1). “Handled securities” are share certificates (excluding securities listed on a financial instruments exchange) for which the JSDA’s rules do not prohibit the solicitation for purchase, sale or performance of other transactions pertaining to them (FIEA, art. 67-18, item 4).

“Phoenix issues” are, among over-the-counter handled securities, those which are determined by a Regular Member, who intends to be a handling member, as securities whose holders should have been given the opportunity to distribute them since they had been listed on the financial instruments exchange. Phoenix issues are designated by the JSDA as securities that an Association Member or a financial instruments intermediary service provider could handle in its investment solicitation (Phoenix Rules, art. 2, item 5).

An Association Member other than a handling member, etc. cannot conduct solicitations for investment in Phoenix issues, except in relation to a sale of Phoenix issues for the account of a customer (Phoenix Rules, art. 20, para. 1).

a) An Association Member must establish transaction initiation criteria with respect to Phoenix issues, and accept transactions from qualifying customers. Each Association Member establishes these criteria with regard to the investment experience, assets on deposit, etc. of the customer and the matters it deems necessary (Investment Solicitation Rules, art. 6, para. 1, item 6).

b) An Association Member must deliver to customers (excluding professional

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investors) trading Phoenix issues, a written statement fully demonstrating the characteristics, transaction structure of Phoenix issues, transaction methods of such issues by the Association Member, the method to notify information in respect of such issues, and risks of investing in Phoenix issues, and the contents of the statement must at the same time comply with the “document to be delivered prior to conclusion of a contract” (FIEA, art. 37-3, para. 1, all items), and provide ample explanation on the same to the customer (Phoenix Rules, art. 19, para. 1). Furthermore, from a customer that is entering into a transaction in a Phoenix issue for the first time (excluding a customer that will sell a Phoenix issue), the Association Member must collect a written confirmation in the prescribed form that the customer understands that the transaction in Phoenix issues, is made at the customer’s discretion and responsibility (Investment Solicitation Rules, art. 8; Phoenix Rules, art. 19, para. 2).

In substitution of the collection of a written confirmation concerning a transaction of Phoenix issues, an Association Member may use methods employing electronic information processing systems or other information technologies to receive the items of information to be described in the document. In such cases, the Association Member shall be regarded as having collected the document (Phoenix Rules, art. 40; Document Delivery Rules, art. 4).

c) An Association Member, when soliciting investments in Phoenix issues (excluding the handling of a public offering, etc.), must give a full explanation to customers (excluding qualified institutional investors) with respect to the details of the issue and the issuing company by using the latest explanatory note on business conditions and a document describing the contents reported to the JSDA under the provisions of Chapter 3 of the Phoenix Rules (Disclosure of Company Information), after the reporting date of such latest explanatory note on business conditions (Phoenix Rules, art. 20, para. 2).

d) If at the time that an Association Member is soliciting investments in Phoenix issues, the Association Member is requested by a customer to provide an explanation concerning, e.g., the method of calculation of the transaction price, the Association Member must provide an explanation using, inter alia, the quotations and trading prices, etc. of the Phoenix issues which are to be published under Article 35 of the Phoenix Rules (Provision, Report, Publication, Etc. of Quotations) (Phoenix Rules, art. 20, para. 3 and art. 35).

e) Each time an Association Member receives an order from a customer for a transaction of a Phoenix issue, the Association Member must clearly inform the customer of the fact that such issue is a Phoenix issue (Phoenix Rules, art. 22).

f) Where the customer is a professional investor provided for by the Definition Ordinance, Etc., the explanation and delivery of the document to be delivered prior to conclusion of a contract described in b) above, or the disclosure described in e) above is unnecessary (Phoenix Rules, art. 19 and art. 22).



(iii) ShareOptionCertificatesTransactionsa) Financial instruments business operators must establish transaction initiation

criteria with respect to transactions in share option certificates (including securities or certificates issued by a foreign government or foreign person which have characteristics of share option certificates; and excluding share option certificates in connection with the allotment of share options without contributions as prescribed in Article 277 of the Companies Act that are listed or are to be listed on a financial instruments exchange market; the same applies in b) below) (also excluding a sale other than by margin transactions for the account of a customer), and accept transactions from qualifying customers (Investment Solicitation Rules, art. 6, para. 1, item 2). Each financial instruments business operator establishes these criteria regarding the investment experience, assets on deposit, etc. of the customer and the matters it deems necessary (Investment Solicitation Rules, art. 6, para. 2).

b) When executing a contract concerning share option certificates for the first time, a financial instruments business operator must receive a written confirmation concerning the transaction, etc. from a customer (excluding professional investors) in order to confirm that the customer understands the risks and fees, etc. concerning the contract for financial instruments transaction stated on the document to be delivered prior to conclusion of a contract concerning the said agreement and conducts the transaction, etc. at the customer’s decision and responsibility (Investment Solicitation Rules, art. 8).

In substitution of the collection of a written confirmation, an Association Member may use methods employing electronic information processing systems or other information technologies to receive the items of information to be described in the document. In such cases, the Association Member shall be regarded as having collected the document (Investment Solicitation Rules, art. 29, para. 2; Document Delivery Rules, art. 4).

(iv) Foreign Securities Transactionsa) When a financial instruments business operator (Association Member) receives an

order (including for the handling of public offerings or secondary distributions or the handling of private placements) from a customer for foreign securities transactions (including foreign securities listed on a domestic exchange), they must enter into an agreement concerning foreign securities transactions with the said customer (Foreign Securities Rules, art. 3, para. 1). With regard to the conclusion of an agreement concerning foreign securities transactions, the Foreign Securities Rules of JSDA have the following provisions:(A) When an Association Member intends to conclude an agreement concerning a

transaction of foreign securities with a customer (in the case of having a customer acquire foreign securities by dealing in private placement, excluding professional investors), it must deliver an agreement on a foreign securities

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trading account (hereinafter referred to as the “Account Agreement”) to the customer, and receive an application from the customer for establishing a trading account pursuant to the Account Agreement (Foreign Securities Rules, art. 3, para. 2).

In substitution of the delivery, etc., of an Account Agreement, an Association Member may use methods employing electronic information processing systems or other information technologies to provide the matters to be written in the document. In such a case, the Association Member shall be regarded as having delivered, etc., the relevant document (Foreign Securities Rules, art. 32, para. 1; Document Delivery Rules).

(B) In the case referred to above, the Association Member must ensure that the fact that it has received an application from the customer can be confirmed by receiving an application form from the customer stating that the customer wishes to establish a trading account pursuant to the Account Agreement or by any other method specified by the Association Member (Foreign Securities Rules, art. 3, para. 3).

In substitution of the collection of a document (an application for establishment of a trading account), an Association Member may use methods employing electronic information processing systems or other information technologies to receive the matters to be written in the document. In such a case, the Association Member shall be regarded as having collected, etc. the relevant document (Foreign Securities Rules, art. 32, para. 2; Document Delivery Rules).

(C) Notwithstanding the provisions of (A), an Association Member shall not be required to deliver the Account Agreement to a customer with whom it intends to conclude an agreement concerning a transaction of foreign securities if it has already delivered the Account Agreement to the customer and the customer does not request the additional delivery of the Account Agreement (Foreign Securities Rules, art. 3, para. 4).

(D) When an Association Member receives an application for establishing a trading account filed by a customer under the provisions of (A) and it accepts such application, it must establish a trading account and notify the customer thereof (Foreign Securities Rules, art. 3, para. 8).

Under the TSE Brokerage Agreement Standards, the principle is that a trading participant must receive an application form from a customer for establishing a foreign securities trading account, and under certain conditions, it may receive an application by electromagnetic means, instead of receiving a hardcopy application form (TSE Brokerage Agreement Standards, Rule 3-2. para. 1 and para. 4).



(Extracted from the TSE Brokerage Agreement Standards, Rule 3-2)・�When a trading participant intends to establish for a customer an account

upon acceptance of an order from such customer to buy or sell a foreign share certificate, etc. or a foreign share option certificate, etc., it must deliver to such customer an agreement concerning foreign securities trading account prescribed by the trading participant and receive an application form from such customer which states something to the effect that such customer wishes to establish an account pursuant to such agreement (para. 1).

・�Where a trading participant informs a customer of the type and details of an electromagnetic means to be used and obtains the approval of the customer for such use in writing or by the electromagnetic means, or where a method specified by the trading participant allows the said trading participant to confirm the intent of the customer to apply for establishing an account in accordance with the agreement concerning foreign securities trading accounts, which should be stated in the application form, the said trading participant may receive an application that should be made using such application form from the said customer by such electromagnetic means or such method specified by the trading participant, instead of receiving an application form as prescribed in Paragraph 1. In this case, the trading participant is deemed to have received the said application from the customer (para. 4).

b) In cases where a financial instruments business operator acts as a broker for a customer in placing a sell order received from a customer in a tender offer of foreign securities, it must receive from the customer a completed “Consent to Sale of Foreign Securities in a Tender Offer” form (Foreign Securities Rules, art. 3, para. 9).

c) A financial instruments business operator must process the execution of a customer-ordered sale or purchase transaction of foreign securities, the settlement of the sale or purchase proceeds and the custody, etc. of the said foreign securities as provided in the agreement concerning foreign securities trading accounts or Consent to Sale of Foreign Securities for Tender Offer (Foreign Securities Rules, art. 4).

(3) Prevention of Unlawful Transactions(i) Prohibition on Acceptance of Insider Trading

Corporate insiders who are in the position where they can easily obtain material facts concerning the relevant listed company, etc. (including a listed company, etc. that is an investment corporation (hereinafter referred to as a “listed investment corporation, etc.”)) are prohibited from trading, etc. in the specified securities, etc. of such listed company prior to

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the time at which those facts, which they have obtained by taking advantage of their position, are publicized (FIEA, art. 166).

Financial instruments business operators or their officers and employees must not knowingly accept an order from a customer when the customer’s trade, etc. of securities falls or could fall within the definition of insider trading (FIBCOO, art. 117, para. 1, item 13).

[Corporate Insider, Etc.] Under the FIEA, “corporate insider” means (a) an officer of a listed company, etc. (including the parent and subsidiary companies of a listed company, etc., and where the listed company, etc. is a listed investment corporation, etc., an asset management company of the listed company, etc. or a corporation in a specified relationship) (in the case of an accounting advisor that is a corporate entity, members of such entity), or an agent, employee or other worker of the listed company, etc.; (b) shareholders with the right to inspect the books and records of a listed company; (c) persons who have authority over a listed company, etc. pursuant to the applicable laws and regulations; (d) persons who have entered into a contract with a listed company, etc., and persons who are negotiating the conclusion of a contract; and (e) the officers and employees, etc. of a corporate entity that falls within terms (b) and (d) above. Further, anyone ceasing to have the status of a “corporate insider” shall be considered to retain such status for one year following such cessation (FIEA, art. 166, para. 1).[Prohibition Against Insider Trading] A corporate insider who has knowledge of a material fact of the business, etc. of a listed company, etc. must not trade in specified securities, etc. of such listed company, etc. before such material fact is publicized (FIEA, art. 166, para. 1).[Material Facts] A material fact would include a decision by the organ that makes decisions on the execution of the operations of a listed company, etc., such as to make a public offering of shares, or to reduce the capital of the company, or a decision not to carry out a matter that had been decided. It would also include a change in the major shareholders. A specific listing is made in the FIEA, art. 166, para. 2 (a material fact pertaining to business or other matters) and the FIEA Enforcement Order, art. 28 (a material fact pertaining to the decision by the organ of the listed company, etc. which is responsible for making decisions on the execution of the operations of the listed company, etc.), art. 28-2 (a material fact pertaining to an event that occurred to the listed company, etc.), art. 29 (a material fact pertaining to the decision by the organ of the subsidiary company of the listed company, etc. which is responsible for making decisions on the execution of the subsidiary



company’s operations) and art. 29-2 (a material fact pertaining to an event that occurred in the subsidiary company of the listed company, etc.), of other matters that might constitute a material fact (the same rules apply to regulate investment corporations, etc.) (for details, see Volume 1, Chapter 2, 12-4, “(1) (ii) Material Facts”).[Major Shareholder] Shareholders who hold in their own name or in the name of another own at least 10% of the voting rights held by all the shareholders, etc. (provided, however, that shares held as part of trust property by a person engaged in the trust business, shares acquired by a financial instruments business operator in an underwriting or secondary distribution, and shares held by a securities finance company in the performance of its business shall be excluded) (FIEA, art. 163, para. 1; Securities Transaction Ordinance, art. 24).[Publicized]・�A material fact shall be deemed to have been publicized when a listed

company has given notice of the material fact to the exchange on which it is listed, as required by the regulations of the said exchange, and when in accordance with certain requirements the material fact has been stated and made available for public inspection on the Internet via the website of the exchange (FIEA Enforcement Order, art. 30, para. 1, item 2 and item 3). The publication is completed when the material fact is posted on the Timely Disclosure Network (TDNet) operated by the TSE.

・ A material fact shall be deemed to have been publicized when 12 hours have passed since the material fact has been disclosed to two or more newspaper companies, etc. (FIEA Enforcement Order, art. 30, para. 1, item 1, and para. 2).

・ A material fact shall be deemed to have been publicized when it is stated in the prescribed documents of a listed company (e.g., securities registration statement, shelf registration statement, annual securities report, quarterly securities report, extraordinary report, etc.) and made available for public inspection (FIEA, art. 166, para. 4).

JSDA rules state that an Association Member must develop a system to control and manage insider trading by establishing internal rules on the prevention of insider trading and other means (Investment Solicitation Rules, art. 15, para. 7). Moreover, in order to prevent insider trading, Association Members must endeavor to develop their internal administration systems concerning insider trading by such means as establishing internal rules concerning the management of unpublicized information in respect to issuing companies that have been acquired by its officers or employees in connection with its business operations, customer management and trading monitoring (Investment Solicitation Rules, art. 25).

In order to prevent insider trading, when a customer engages for the first time in trading,

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etc. in specified securities, etc. of a listed company, etc. as set forth in the FIEA at Article 166, the financial instruments business operator must require that the customer file a notification of whether it is a person as set forth below (hereinafter an “officer, etc. of a listed company, etc.”). If the customer is an officer, etc. of a listed company, etc., the financial instruments business operator must, in accordance with the internal regulations of the financial instruments business operator, such as its rules on managing insider trading, create an insider registration card prior to the time of conduct of the trading, etc. of the specified securities, etc. of the listed company, etc. (Investment Solicitation Rules, art. 15, para. 1).

[Officer, Etc. of a Listed Company, Etc.](i) (a) A director, accounting advisor, corporate auditor or executive officer

(hereinafter collectively referred to as an “officer”), of a listed company, etc.;

(b) An executive director or supervisory director of a listed investment corporation, etc.; or

(c) An officer of an asset management company of a listed investment corporation, etc.

(ii) (a) An officer of the parent company or a major subsidiary of a listed company, etc.; or

(b) An officer of a major corporation in a specified relationship(iii) A person which has ceased being any of the persons set forth in (i) or (ii)

within the past year;(iv) The spouse or housemate of a person set forth in (i);(v) An employee or other staff of a listed company, etc. or an asset

management company of a listed investment corporation, etc. who is in a position equivalent to an executive officer (excluding an executive director of a listed investment corporation, etc.) or other officer;

(vi) An employee or other staff of a listed company, etc. or an asset management company of a listed investment corporation, etc. in a department in which there is a high possibility of coming to know material facts (excluding (v));

(vii) An employee or other staff member of a parent company or major subsidiary of a listed company, etc., or a major corporation in a specified relationship who is in a position equivalent to an executive officer or other officers;

(viii) An employee or other staff member of a parent company or major subsidiary of a listed company, etc., or a major corporation in a specified relationship who is in a department in which there is a high possibility of coming to know material facts (excluding (vii));

(ix) A parent company or major subsidiary of a listed company, etc. or a major corporation in a specified relationship; or



(x) A major shareholder of a listed company, etc. (meaning a major shareholder recorded in the latest annual securities report, semiannual securities report or quarterly securities report)

[Matters to Be Stated on Insider Registration Cards](i) Name;(ii) Address or domicile, and a mailing address;(iii) Date of birth (limited to cases where the customer is a natural person);(iv) Company name, title, and section; and(v) Name and issue code of the listed company, etc. in which the customer

falls under the definition of an officer, etc. of a listed company, etc.

An Association Member must have a customer promise to notify the Association Member without delay when there is any change concerning whether the customer falls within the category of officer, etc. of a listed company (Investment Solicitation Rules, art. 15, para. 3).

If an Association Member receives a customer’s notification of change as to whether the customer falls within the category of officer, etc. of a listed company, it must revise the insider registration card without delay (Investment Solicitation Rules, art. 15, para. 4).

Moreover, on May 25, 2009, the JSDA launched the Japan-Insider Registration & Identification Support System (hereinafter referred to as “J-IRISS”) from the perspective of preventing unfair trading, etc., and maintaining the transparency as well as the fairness of the markets. This system is designed to register and verify the information on officers of listed companies namely: (i) name; (ii) date of birth; (iii) address; (iv) company name; and (v) job title.

The number of companies registered to use this system increased from 267 at the end of May 2009, when the system was put into operation, to 3,284 as of October 16, 2019; 86.79% of all listed companies (3,784 companies) are now registered users.

The officer information of the listed company that has been registered with J-IRISS is compared periodically with the customer accounts of financial instruments business operators (securities firms) who are Association Members. If as a result of this comparison the account of a customer of a financial instruments business operator is confirmed to be that of an officer, an insider registration card will be prepared in connection with the relevant customer, and will be used, e.g., to prevent insider trading.

Under the JSDA rules, an Association Member must verify the name, date of birth, and address of each customer (excluding juridical persons) who conducts sale and purchase, etc. of the specified securities, etc. of a listed company, etc. prescribed in Article 166 of the FIEA as stated in their customer card, with the data registered in J-IRISS at least once a year (Investment Solicitation Rules, art. 15-2, para. 1).

Specifically, an Association Member will compare the customer account information retained thereby with the information registered at the J-IRISS, and will confirm whether there are any officers, etc. of listed companies, etc. among the customers who hold their

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accounts with the member, by using the J-IRISS.

Scheme and Advantages of J-IRISS (conceptual diagram)

Based on the result of the verification, an Association Member must confirm whether the customer is an officer, etc. of a listed company, etc. and prepare the insider registration card without delay (Investment Solicitation Rules, art. 15-2, para. 2).

Accounts that are confirmed by J-IRISS to be the account of an officer of a listed company will be registered by the financial instruments business operator, and used, e.g., to prevent unfair trading.

If an Association Member receives information from J-IRISS, it must not use such information for any purpose other than the preparation of an insider registration card (Investment Solicitation Rules, art. 15-2, para. 3).

J-IRISS also has the following advantages for a listed company:(i) Preventing unintentional unfair trading by the officer of the listed company or any

person living with the officer of a listed company(*1)

(ii) Raising an alert on non-compliance with the law(iii) Preventing officers in listed companies from committing a legal or regulatory violation

in connection with securities transactions(*2)

(*1) This program does not take the approach of refusing orders entirely from all customers who are registered. Instead, when an order is received from a registered customer for shares in the relevant listed company, unintentional unfair trading is prevented by confirming at the financial instruments business operator whether or not, e.g., a “material fact” is known.

(Source) JSDA website

(Company P)

* No need to have information of officers’ housemates registered with J-IRISS!

I want to buyCompany P’sshares!

Housemate of Company P’sofficer

I want to buyCompany P’sshares!

Officer information

Entrust businessoperations

Caution

Operate systems andprovide services

Request for verification

Notification of result

“Do you have any insider information?”“Does this trade correspond to a short-term sale or purchase?” (FIEA, art. 164)

Caution“Have you heard any insider information from Company P’s officer with whom you live?”

Customer list

Insider registration system Obligation to verify with J-IRISS

Person falling within the scope of insiders

Insider registration card - Officer- Former officer (within one year

after resignation)- Officer’s housemate, etc.

* An officer’s housemate is identified based on the similarity of his/her address and the address of the officer registered with J-IRISS.

After the execution of the trade of Company P’s shares by the officer

Statutory reporting (FIEA, art, 163)

Reg

istra

tion

Ver

ifica

tion

Insi

der

iden

tific

atio

n

Company P’s officer

* Caution to former officers: J-IRISS has the former officer data deletion function, which enables cautioning former officers during one year after their resignation. Personal information of former officers is automatically deleted upon the expiration of this period.

Securities companyListed company

J-IRISS(Officer

information)

Order for sale or purchase of Company P’s shares

Tokyo Stock Exchange



(*2) FIEA, art. 163: Fulfilling the duty to report trading by an officer, etc. of a listed company, etc.

FIEA, art. 164: E.g., confirmation of whether there is a return of gains from short-swing transactions by an officer, etc. of a listed company, etc.

In accepting an order from a registered insider for a trade, etc. in the said company’s specified securities, etc., the division responsible for trade monitoring should carefully inspect the trade by confirming the customer’s motive for the trade or checking a relationship with any confidential corporate information, based on the insider registration card as well as collected records (in paper or on electronic file) regarding confidential corporate information, etc.

The insider registration card may be prepared and kept by electromagnetic means (Investment Solicitation Rules, art. 15, para. 5). A customer card may also be used as an insider registration card as long as the customer card satisfies the particulars that are to be stated in the insider registration card (Investment Solicitation Rules, art. 15, para. 6).

ConfidentialCorporateInformationThe FIBCOO defines “confidential corporate information” as “undisclosed

important information concerning the operation, business or property of a listed company, etc. as prescribed in Article 163, Paragraph 1 of the FIEA that may have a significant influence on investors’ investment decisions, and undisclosed information concerning a decision on the execution or suspension of a tender offer or any equivalent action to buy share certificates, etc.” (FIBCOO, art. 1, para. 4, item 14).

“Confidential corporate information”, for which Association Members are required to implement strict management, is regarded as a broader concept than “material facts and facts concerning tender offer, etc.”

Therefore, the JSDA requires Association Members to prepare insider registration cards under the Investment Solicitation Rules (art. 15), and also require them to take measures under the Rules on Confidential Corporate Information, namely, clarification of the confidential corporate information management section (art. 3), establishment of internal rules (art. 4), procedures to be followed upon acquiring confidential corporate information (art. 5), management of confidential corporate information (art. 6), and enhancement of the management system (art. 7).

In 2012, multiple financial instruments business operators were charged for a number of violations of the relevant laws and regulations arising from the inadequacy of their internal rules for handling confidential corporate information, and were subject to administrative penalties given by the FSA.

Financial instruments business operators must reinforce their shields to protect confidential corporate information, generally called Chinese Walls (or firewalls).

In this respect, the JSDA’s Rules on Confidential Corporate Information, Article 6 (Management of Confidential Corporate Information), have the following provisions:

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(1) An Association Member must manage the confidential corporate information management section so that confidential corporate information is not communicated to other sections that do not need such information for their business, by e.g., physically isolating the confidential corporate information management section from other sections (para. 1).

(2) An Association Member must manage documents that describe the confidential corporate information or information that could be confidential corporate information so that such documents are not communicated to other sections that do not need such information for their business, in a manner such as managing such documents in an isolated environment from other sections (para. 2).

(3) An Association Member must manage electronic files that contain confidential corporate information or information that could be confidential corporate information so that such electronic files are not communicated to other sections that do not need such information for their business, by e.g., managing such electronic files in a way that people cannot easily view them (para. 3).

(ii) Prohibition on the Acceptance of Orders for Transactions Under a Fictitious Name or Name-LendingAn Association Member must not accept an order for purchase and sale or other

transactions in securities with knowledge that the transaction is under a fictitious name (Investment Solicitation Rules, art. 13, para. 1; Employee Rules, art. 7, item 9). Furthermore, upon accepting a request for title transfer from a customer, the customer must not be allowed to use the company name of the Regular Member or the personal name of its relevant employee, or the name or address of, inter alia, a relative of the employee (Investment Solicitation Rules, art. 13, para. 2; Employee Rules, art. 7, item 8).

(4) Other Matters to Be Noted at the Time of Acceptance(i) Duty to Clarify in Advance the Mode of Trading

Upon accepting an order from a customer for securities trading, the financial instruments business operator, etc. must clarify in advance whether the financial instruments business operator itself will act as counterparty to consummate the sale and purchase (a principal order), or whether it will perform intermediary, brokerage, or agency services to effect the said sale and purchase or transaction (an agency order) (FIEA, art. 37-2).(ii) Short Selling Restrictions

No person shall conduct “short selling” in violation of the Cabinet Order. “Short selling” refers to selling securities despite the seller not being in possession of the securities or selling by borrowing the securities, or making entrustment, etc. or accepting an entrustment, etc. for such sales of securities (FIEA, art. 162, para. 1, item 1). This provision applies in cases where it is not clear whether the securities concerned may be provided without delay after the sales thereof (FIEA Enforcement Order, art. 26-2).

The short selling restrictions were introduced at the time of the financial crisis in 2008



(caused by the collapse of Lehman Brothers) and were tightened on several occasions since then. However, in light of the regulatory trends in foreign countries, the FSA made a “Comprehensive Review of the Short Selling Regulations,” including the adoption of the trigger method (i.e., a framework whereby the price restriction (uptick rule) is applied only when the price falls below a certain threshold (10 percent fall in price relative to the previous day’s closing price). As a result, the short selling restrictions were relaxed on November 5, 2013.A. ConfirmationofBackupwithBorrowedSecurities,Etc.

A member, etc. of a financial instruments exchange who has accepted the entrustment of short selling of borrowed securities shall not conduct such short selling if the member cannot confirm that settlement measures have been taken (FIEA Enforcement Order, art. 26-2-2). This rule that prohibits naked short selling also applies to selling on its own account (FIEA Enforcement Order, art. 26-2-2, para. 4). A customer is also required to clearly indicate to the financial instruments business operator that the settlement measures have been taken for the securities related to the short selling (FIEA Enforcement Order, art. 26-2-2, para. 3).

These rules also apply to the selling of over-the-counter traded securities on an over-the-counter securities market established by the JSDA, and the selling of securities on the PTS (proprietary trading system) established by an approved financial instruments business operator (FIEA Enforcement Order, art. 26-2-2, para. 6 and para. 7).B. ObligationofIndicationandConfirmation

When receiving an order for the sale of securities from a customer, the financial instruments business operator must confirm whether the said sale is a short sale or not (FIEA Enforcement Order, art. 26-3, para. 2 and para. 3; Employee Rules, art. 7, item 21). A duty is also imposed on the customer to clarify to the financial instruments business operator whether or not such sale is a short sale (FIEA Enforcement Order, art. 26-3, para. 4).

The financial instruments business operator must clearly indicate to the exchange short sales performed on markets in cases where it conducts sales on its own account, or accepts short sales from its customer (FIEA Enforcement Order, art. 26-3, para. 1; TSE Business Regulations, art. 14, para. 1, item 2).

These rules also apply to the selling of over-the-counter traded securities on an over-the-counter securities market established by the JSDA, and the selling of securities on the PTS (proprietary trading system) established by an approved financial instruments business operator (FIEA Enforcement Order, art. 26-3, para. 6 and para. 7).

The share order systems of exchanges have all been computerized, so that if a financial instruments business operator inputs an order under “classification-short-sale,” the system automatically flashes “short sale” on the terminal screen and checks the price.C. Price in the Case of Short Selling, Etc.

Following the introduction of the trigger method for the price restriction on November 5, 2013, the price at which a short sale is made is an important factor in the short selling restrictions. First, we provide the definition of the price in the case of short selling.

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a. Base PriceAn exchange must notify its members, etc. of, and also disclose to the public, the

daily total transaction volume on its markets and the highest price, lowest price, closing price, agreed figure, amounts of consideration, and other particulars, for each day and for each issue of the listed financial instruments, etc. (FIEA, art. 130). The amount calculated by a method specified by the Cabinet Office Ordinance (Securities Transaction Ordinance, art. 12) on the basis of the closing price or any price equivalent thereto is referred to as the base price (FIEA Enforcement Order, art. 26-4, para. 1, item 1).b. Trigger Method

As a result of the “Comprehensive Review of the Short Selling Regulations,” the price restriction system (uptick rule) that was applicable to all issues at all times has been changed to a system that uses a trigger method on and after November 5, 2013, whereby the price restriction is applied only to such issues that meet certain conditions.

i. The price restriction is applied when a contract for an issue involved in a short sale is executed at a price lower than the base price by 10% or more as calculated on the basis of the previous day’s closing price, etc. (on the TSE, the said base price is the same as the “base price for the price limits for bids and offers”) (such case is hereinafter referred to as “when the trading price falls below the trigger price”) (FIEA Enforcement Order, art. 26-4, para. 1, item 1; Securities Transaction Ordinance, art. 12, para. 5 and para. 6).

ii. When the trading price falls below the trigger price in the principal market of the issue involved in the short sale on a certain day, the price restriction is applied in all markets (including PTS) on which the said issue is traded all day on the following day (FIEA Enforcement Order, art. 26-4, para. 1, item 2; Securities Transaction Ordinance, art. 12, para. 7). This measure takes place irrespective of whether the trading price falls below the trigger price on each market on the first-mentioned day.

On the other hand, if the trading price does not fall below the trigger price in the principal market of the said issue on a certain day, the price restriction is not applied and trading is commenced in any market (including PTS) where the said issue is traded on the following day. This measure takes place irrespective of whether the trading price falls below the trigger price on each market on the first-mentioned day.

Principal Market・�The category of principal markets includes only those markets established by

the TSE, the NSE, the FSE, and the SSE, excluding PTS.・�The market with the largest trading volume of securities over the past six

months from the last day of each month can be the principal market (FIEA Enforcement Order, art. 26-4, para. 1, item 2; Securities Transaction Ordinance, art. 12, para. 7).



c. When the Trading Price Does Not Fall Below the Trigger PriceWhen the trading price does not fall below the trigger price, short selling is

permitted irrespective of the latest price.d. Application of the Price Restriction When the Trading Price Falls Below the

Trigger PriceWhen a financial instruments business operator intends to make a short sale on his/

her own account or make a short sale entrusted thereto, if the trading price falls below the trigger price, the financial instruments business operator must not make such a short sale at a price lower than the price that the exchange has publicized immediately before such short selling (hereinafter referred to as the “latest publicized price”) (FIEA Enforcement Order, the main clause of art. 26-4, para. 1).

However, the short selling at the latest publicized price is permitted if the said latest publicized price exceeds another price publicized by the exchange immediately before the publication of the said latest publicized price (FIEA Enforcement Order, art. 26-4, para. 1, proviso).

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Application of the Price Restriction to Short Selling After the Trading Price Falls Below the Trigger Price

When the Trading Price Is Determined by a Method Other Than the Method of Auction

The method for determining the trading price is the method by which a market maker quotes bids and offers on a regular and continuous basis, and is obliged to conduct sales and purchases based on the said bid and offer quotes (Securities Transaction Ordinance, art. 12, para. 1).

The price to be determined by the said method is the highest bid price quoted by a market maker which was publicized immediately before a short sale of securities by the exchange that operates the market on which the said short sale is to be made with regard to the securities subject to the said short sale (hereinafter referred to as the “latest publicized best bid price”) (Securities Transaction Ordinance, art. 12, para. 2).

The trading price is a price different from the latest publicized best bid price on the market, which was publicized immediately before the publication of the said last publicized best bid price by the exchange that publicized the said latest publicized best bid price, and which is the highest bid price quoted by a market maker (Securities Transaction Ordinance, art. 12, para. 3).

Price Price

Last trading price

Last trading priceLatest

publicized price

Latest publicized price

Short selling permitted

Short selling prohibited

Time Time







Transactions Exempted from the Short Selling Restrictions

Transactions Exempted from Restrictions

Exemptions Applied/Not AppliedObligation to

Confirm the Backup with Borrowed

Securities

Obligationof Indication

and Confirmation

Price Restriction

(a) Financial instruments futures transactions among market derivatives transactions ○ ○ ○

(b) When-issued transactions ○ ○ ○(c) Japanese government bonds, local

government bonds, bonds issued by a corporation under a special law, and straight corporate bonds

○ ○ ○

(d) Securities or certificates issued by a foreign government or a foreign person, that have the same characteristics as those of (c), as well as beneficiary certificates of securities in trust for which these securities are the entrusted securities

○ ○ ○

(e) Among short sales of listed foreign securities, etc. (foreign investment securities, etc.) performed by a financial instruments business operator on its own account, where the financial instruments business operator purchases securities related to the short sale on a foreign financial instruments market, sales made in cases where continuous trading is conducted in order to secure smooth circulation, and sales to match purchase orders

○ ○ ○

(f) Transactions in which a market maker makes a short sale on its own account on the financial instruments exchange market on which it quotes offer prices

○ ○ ○

(g) Sales of securities, after purchase but before settlement of such securities, to settle the said sale with the said purchased securities

○ ○ ○

(h) Sales of loaned securities (other than securities that were borrowed) in cases where it is clear that the said securities will be returned by the settlement date

○ ○ ○

(i) Trading on a financial instruments exchange that is conducted outside of trading sessions (e.g., ToSTNeT operated by the TSE, etc.)

○ ○ ○

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Securities


and Confirmation

Price Restriction

(j) Hedge sales (the exercise of bonds with share options or share option certificates, requests to exchange exchangeable bonds, the exercise of the rights in share certificates with put options or share certificates subject to call, the decision to redeem shares in bonds with a clause for redemption in shares of another company, share split, etc., allotment of shares without contribution, allotment of new shares as a result of a merger, company split, share exchange or share transfer, applications for public offering or secondary distributions of shares, purchases in when-issued transactions)

○ ○ ○

(k) Hedge sales of the underlying shares of an ETF (Exchange Traded Fund) after a request to exchange ETF is made, and, in cases where an additional ETF is created, short sales of beneficiary certificates after an purchase application is submitted

○ ○ ○

(l) Market making-like sales of ETFs and listed investment securities, etc. ○ ○ ○

(m) Margin transactions ○ × ×(n) Sales in margin transactions conducted by

individual investors, etc. (excluding qualified institutional investors), the volume per transaction of which is equal to 50 times or less of the trading unit

× × ○

(o) Sales of securities of the same issue for hedge transactions conducted by financial instruments business operators that committed to purchase the securities held by the customer by VWAP(Note 1) guarantee transactions(Note 2) or VWAP target transactions; (Note 3)

○ × ○

(p) Sales of share certificates of the same issue for arbitrage transactions between such securities and share certificates to be acquired through the exercise of rights in the securities (bonds with share options, share option certificates, depositary receipts, exchangeable bonds, and share certificates with put options)

○ × ○






Securities


and Confirmation

Price Restriction

(q) Sales of share certificates of the same issue for hedge transactions between such securities and share certificates to be acquired through the exercise of rights in the securities (bonds with share options, share option certificates, depositary receipts, exchangeable bonds, and share certificates with put options)

○ × ○

(r) Sales of multiple securities of different issues for arbitrage transactions pertaining to securities futures transactions or securities index futures transactions (where such securities to be sold are selected from among those closely tracking the securities index, etc. pertaining to the securities index futures transaction, etc.)

○ × ○

(s) Sales of multiple securities of different issues for the hedging of securities index futures transactions, etc. (where such securities to be sold are selected from among those closely tracking the securities index, etc. pertaining to the securities index futures transaction, etc.)

○ × ○

(t) Sales of securities of the same issue for arbitrage transactions pertaining to securities option transactions

○ × ○

(u) Sales of securities of the same issue for the hedging of securities option transactions ○ × ○

(v) Sales of ETFs for arbitrage transactions between ETFs that target the same securities index

○ × ○

(w) Sales of ETNs (Exchange Traded Notes) for arbitrage transactions between ETFs and the securities index

○ × ○

(x) Sales of ETNs for the hedging of ETFs ○ × ○(y) Sales of ETFs for arbitrage transactions

pertaining to the securities index futures transactions or the securities index and ETFs

○ × ○

(z) Sales of ETFs for the hedging of securities index futures transactions or ETNs ○ × ○

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Securities


and Confirmation

Price Restriction

(aa) Sales of ETNs for arbitrage transactions pertaining to ETF option transactions and the securities index

○ × ○

(bb) Sales of ETNs for the hedging of ETF option transactions ○ × ○

(cc) Sales of ETFs, etc. for averaging the target securities index ○ × ○

(dd) Sales of the share certificates of the target company, etc. for arbitrage transactions pertaining to the shares of a merging company, etc., and those of the target company, etc. based on the ratio of merger, share exchange or share transfer

○ × ○

(ee) Odd lot short sales ○ × ○(ff) Price averaging transactions between

financial instruments exchanges ○ × ○

○: Exemptions applied ×: Exemptions not applied

(Note) 1. VWAP (Volume Weighted Average Price) is the price calculated by a weighted average, using the contract prices executed on the exchange during the day and considering the trading volumes for each of the contract prices. VWAP is defined as an indicator reflecting the trading volumes of all transactions during the day and is widely recognized among institutional investors as a benchmark indicating an average contract price that is closer to actual trading conditions.

2. VWAP guarantee trading: A type of transaction that aims to guarantee VWAP-based executions. Cross-match them with clients’ sell or buy order at the pre-arranged VWAP net price (including brokerage commissions).

3. VWAP target trading: Aiming for VWAP, traders execute transactions in the auction market in which the name/number of stocks are pre-arranged, and cross-match them with clients’ sell or buy orders at the VWAP of the execution result. Transactions at the VWAP net price of clients’ execution results (including brokerage commissions) are also available.

e. Transactions Exempted from the Short Selling RestrictionsThere are three major types of transactions that are excluded from the short selling

restrictions: (i) transactions exempted from the obligation to confirm the backup with borrowed securities (Securities Transaction Ordinance, art. 9-3); (ii) transactions exempted from the obligation of indication and confirmation in the case of short selling



(Securities Transaction Ordinance, art. 11); and (iii) transactions exempted from the price restriction in the case of short selling (Securities Transaction Ordinance, art. 15).

D. Reporting and Publication System (Two Tier Model)a. Providing Information on Short Selling (Reporting)

With regard to securities listed on a financial instruments exchange and designated by the Commissioner of the Financial Services Agency as having the risk of impairing fair price formation due to the large volume of short selling thereof (hereinafter referred to as the “designated securities”), a financial instruments business operator must report to the principal financial instruments exchange (meaning the person who operates the principal market; the same shall apply hereinafter) (i) the financial instruments business operator’s balance and other information related to the designated securities for which the financial instruments business operator made a short sale on its own account; and (ii) the customer’s balance and other information related to the designated securities for which the financial instruments business operator made a short sale as entrusted by the customer (FIEA Enforcement Order, art. 26-5, para. 1).b. Reporting of Information on Short Selling

A financial instruments business operator which has made a short sale of the designated securities must report its balance and other information related to the designated securities to the principal exchange by ten o’clock in the morning on the day two business days after the day of such short sale or change if: (i) as a result of said short selling, the outstanding short selling positions ratio of the designated securities reaches 0.2% or more and the number of outstanding short selling positions expressed in trading units (meaning the number obtained by dividing the number of outstanding short selling positions by the trading unit specified by the principal financial instruments exchange for the designated securities for which the short selling has been conducted) exceeds 50; or (ii) there are any changes in the outstanding short selling positions ratio (Securities Transaction Ordinance, art. 15-2 and art. 15-3).

The “number of outstanding short selling positions” mentioned above refers to, among the total number of the designated securities for which a short sale was made until the trading of the designated securities on a certain day is closed, the number of designated securities or of ownership rights of designated securities that must be acquired after said certain day (Securities Transaction Ordinance, art. 15-3, para. 2). The “outstanding short selling positions ratio” mentioned above refers to the figure obtained by dividing the number of outstanding short selling positions by the total number of the issued shares or the number of units in issue of the designated securities (Securities Transaction Ordinance, art. 15-3, para. 1, item 7).c. Publication by Financial Instruments Exchanges, Etc. of Information on Short

SellingWhen the outstanding short selling positions ratio is 0.5% or more or when the

outstanding short selling positions ratio is less than 0.5% and the latest outstanding short selling positions ratio is 0.5% or more, the principal exchange must publicize the

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relevant balance and other information without delay (FIEA Enforcement Order, art, 26-5, para. 5; Securities Transaction Ordinance, art. 15-4, para. 1).

E. Settlement of Borrowing of Securities Pertaining to Short SellingA person who has made a short sale of securities during a period from the time when a

company publicizes a capital increase to the time when it decides the issue price of new shares, etc. must not settle the borrowing of the securities subject to such short sale by the new shares, etc. acquired as a result of such capital increase (FIEA Enforcement Order, art, 26-6).(iii) Prohibition of Stop Orders

A “stop order” refers to an order made to entrust, etc. a person with making an immediate purchase of securities if the market price rises above the market price at the time of the entrustment to at least the level that the entrusting person indicates, or with making an immediate sale of securities if the market price falls below the market price at the time of the entrustment to at least the level that the entrusting person indicates (FIEA, art. 162, para. 1, item 2). A stop order is not completely prohibited at present because, while it is prohibited for any person to make a stop order in a way that constitutes a violation of Cabinet Order (FIEA, the main clause of art. 162, para. 1), the relevant Cabinet Order has not been enacted. However, financial instruments business operators should have in place an adequate management system whereby they confirm, upon soliciting customers for investment or accepting or issuing orders, that the relevant orders will not hinder fair pricing of securities traded on markets or will not constitute unfair trading.(iv) Check for Regulated Issues

A. Acceptance in a Period of Stabilizing OperationsUnder the FIEA, no person shall conduct, in violation of the provisions of the

Cabinet Order, a series of actions of trading, etc. of securities or the offering, commission or acceptance thereof, taken in the financial instruments markets for the purpose of pegging, fixing, or stabilizing the price of listed financial instruments, etc. in a financial instruments exchange market. Such acts are prohibited as a type of manipulation (prohibition against acts of market manipulation, etc.) (FIEA, art. 159, para. 3). In exceptional cases, however, for the purpose of facilitating a public offering of securities or solicitation for acquisition of securities targeting professional investors, or a secondary distribution of securities or solicitation for selling, etc. of securities targeting professional investors, transactions designed to stabilize the price of a security such as price support transactions are permitted under certain conditions. These transactions are called stabilization transactions (FIEA Enforcement Order, art. 20).

The period during which stabilization transactions can be performed is known as the stabilization period, and is generally defined as the period from the day following the date of pricing relating to the public offering of securities or solicitation for acquisition of securities targeting professional investors, or the secondary distribution of securities or solicitation for selling, etc. of securities targeting professional investors until the last day on which applications for such public offering or secondary



distribution will be accepted (for allotment to shareholders, until the paid-up date; FIEA Enforcement Order, art. 22, para. 2, para. 3 and para. 4). In addition, the period from the day following the announcement date for the public offering of securities or solicitation for acquisition of securities targeting professional investors, or the secondary distribution of securities or solicitation for selling, etc. of securities targeting professional investors (limited to cases where there are 50 or more potential subscribers) until the paid-up date is generally known as the financing period. It is necessary to carefully monitor order acceptance and execution during the financing period, to ensure that no orders that may cause an artificial price formation are undertaken.

(Note) Stabilization Period From the provisions of the FIEA Enforcement Order, Article 22,

Paragraph 2, the “stabilization period” can be construed as the “period of time from the day that is two weeks or 20 days before the due date of offering, to the date on which this period expires.” In actual cases, however, the stabilization period is often set as a shorter period, such as only two days. Why does this happen?

Stabilizing operations may be carried out in the case of public offerings of securities as well as upon solicitation for acquisitions targeting professional investors, allotment of preferred equity investments, and secondary distributions. To provide a simple explanation, stabilizing operations in the case of a public offering are described below.

The FIEA Enforcement Order, Article 22, Paragraph 2 provides that “stabilization transactions shall not be conducted except during any of the following periods:”

(1) In the case of a public offering of securities (i) Public offering by granting shareholders an entitlement to the

allotment of shares The period from the day that is two weeks before the date

prescribed in the Companies Act, Article 202, Paragraph 1, Item 2 regarding the public offering (day for the application for subscription for the shares for subscription) to the payment date (FIEA Enforcement Order, art. 22, para. 2, item 1 (a)).

(ii) Public offering other than (i): The period from the day that is 20 days before the date of

expiration of the offering period to the day on which the offering period expires (FIEA Enforcement Order, art. 22, para. 2, item 1 (c)).

(2) If the issue price, etc. of the securities has not been determined before the start of the period referred to in (1), the stabilization transaction must not be conducted until the financial instruments exchange is

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notified by the issuer of the issue price, etc. (FIEA Enforcement Order, art. 22, para. 3). Accordingly, the stabilization period in this case is shorter than the period referred to in (1).

(3) In the case referred to in (1), if the issue price, etc. of the securities is determined not by relying on any definite value but by multiplying, by a certain rate, the final price of the securities issued by the issuer of the securities on a certain day on which a financial instruments exchange market is operating, the stabilization transaction must not be conducted until the issuer notifies the financial instruments exchange of the definite value of the issue price, etc., notwithstanding the provisions of (1) (FIEA Enforcement Order, art. 22, para. 4). Accordingly, the stabilization period in his case is shorter than the period referred to in (1).

(4) The notification of public offerings or secondary distributions shall, in principle, become effective 15 days after the day on which the Prime Minister receives the notification (FIEA, art. 8, para. 1). Because of this rule, the stabilization period is substantially reduced to only a few days.

a. Acceptance Falling Under the Prohibited Conduct of a Principal Underwriting Financial Instruments Business Operator (FIEA Enforcement Order, art. 20, para. 2; FIBCOO, art. 117, para. 1, item 22)I. Making purchases on one’s own account

The principal underwriting financial instruments business operator is prohibited from making purchases on its own account during the stabilization period. However, this prohibition does not apply to the following: purchases based on the sale and purchase of securities effected by the exercise of the rights acquired or granted under the transactions of securities-related derivatives; stabilization transactions; purchases provided for in the regulations of a financial instruments exchange as a purchase which would be necessary for facilitating smooth distribution of securities on the financial instruments exchange market established by such financial instruments exchange; or purchases which are regarded not to be based on an investment decision on the respective issues.

Accordingly, the principal underwriting financial instruments business operator cannot accept a transaction from a customer in which the financial instruments business operator would be the opposing party in the transaction.

Nevertheless, cumulative stock investments and mini stock investments may be accepted even though they would involve a purchase on the account of the financial instruments business operator, since they are considered as not being based on an investment decision in an individual issue (for details, see Chapter 4, 2-7, “(3) Cumulative Stock Investments,” and this Chapter, “8 Mini



Stock Investments”).II. Entrusting of purchases, etc. to another financial instruments business

operator (excluding entrusting of brokerage for clearing of securities, etc.).III. Accepting purchase orders for share certificates, etc. (excluding acceptance

of entrustment of brokerage for clearing of securities, etc.) to be made for the account of the company that is the issuer of the securities involved in the stabilizing transaction.

IV. Accepting purchases on the account of officers or other persons of the issuing company who may commission a stabilization transaction (other than accepting entrustment of brokerage for clearing of securities, etc., purchases by way of a trade in securities that occurs due to the exercise of a right acquired or granted under a securities related derivatives transaction, and acceptance of stabilization transactions, etc.).

V. Purchases based on discretionary trading agreements (e.g., excluding those regarded not to be based on an investment decision on the respective issues).

b. Prohibited Conduct of a Financial Instruments Business Operator That Engaged in or Accepted a Stabilization Transaction (FIBCOO, art. 117, para. 1, item 23)A financial instruments business operator that engaged in or accepted, etc. a

stabilization transaction is prohibited from accepting an offer to purchase or sell share certificates, etc. of the relevant issue or accepting a securities-related derivatives transaction, etc. relating to trading in the said securities, during the stabilization period, without declaring to the customer something to the effect that stabilization transactions have been conducted.c. Other Prohibited Conduct of Financial Instruments Business Operators

(TSE Rules Concerning Just and Equitable Principles of Trade, art. 7)I. Accepting a purchase of securities conditioned on the execution of the

transaction during the stabilization period, from a company that the financial instruments business operator knows to be the issuer of securities subject to stabilization transactions (limited to the acceptance of purchase orders for listed shares).

II. Accepting a purchase (other than stabilization transactions), conditioned on the execution of the transaction during the stabilization period, from a person the financial instruments business operator knows to be a person who may entrust such stabilization transaction.

III. Accepting purchases of securities (limited to public offering or secondary distribution in areas other than the territory of Japan) subject to stabilization transactions, from a person that the financial instruments business operator knows to be a foreign corporation that engages in business similar to the financial instruments business in a foreign country and that has concluded

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an underwriting contract with the issuer of the securities.IV. Conducting purchases on its own account or purchases pursuant to a

discretionary trading agreement or entrusting purchases (excluding stabilization transactions), if notice has already been given to the financial instruments exchange from an issuer of securities (limited to public offering or secondary distribution in areas other than the territory of Japan) subject to stabilization transactions that the financial instruments business operator may entrust stabilization transactions.

B. Checks for Regulations on Margin Transactionsa. Self-Restraint of Solicitation for Restricted or Prohibited Issues in Margin

TransactionsFinancial instruments business operators must refrain from soliciting margin

transactions with respect to the following enumerated issues (Investment Solicitation Rules, art. 12, para. 2):

I. Issues that a financial instruments exchange or an Approved Member has restricted or prohibited from being used in margin transactions, and

II. Issues which a securities finance company has restricted or suspended from being used as lending securities, etc.

b. Measures in Cases Where Margin Transactions Are AcceptedWhere a financial instruments business operator accepts a margin transaction for

the “issues for which it must refrain from soliciting margin transactions” mentioned in a. above and the following issues, it must inform the customer that the said measures are in effect, and explain the contents thereof (Investment Solicitation Rules, art. 12, para. 3):

I. Issues with respect to which a financial instruments exchange or an Approved Member has taken measures to raise the security deposit ratio for margin transactions involving the said issue (including e.g., restrictions on substituting securities for security deposits); and

II. Issues for which a securities finance company has given a warning notice concerning the use as lending securities, etc.

(v) ProhibitiononSeparatePurchasesDuringthePeriodaTenderOfferisinEffect(Cases of Purchases by Persons Other Than the Issuing Company)Tender offerors, etc. are generally prohibited from engaging in purchases, etc. of the

share certificates, etc. issued by the takeover target company during the offer period other than through the tender offer (FIEA, art. 27-5), and consequently, if a customer places an order to purchase share certificates, etc. in a target company once a tender offering has commenced, it will be necessary to confirm that the customer in question is not a tender offeror, etc.



3 2 Execution and Settlement of Orders (Delivery)

(1) ConfirmationofEntrustmentOrderDetailsEntrusted share orders often have several conditions imposed upon their execution. On the

exchange, however, the brokerage agreement standards provide that a customer should give instructions to its financial instruments business operator (trading participant) regarding the following matters each time the customer entrusts a trade in securities (TSE Brokerage Agreement Standards, art. 6):

a) Type of trade;b) Issue;c) Classification of sale or purchase;d) Quantity (trading unit);e) Limits on price;f) Time during the trading session to execute the sale or purchase (opening,

close, continuous session (zaraba), range limit order (hakarai));g) Effective period of an entrusted order (day order, good sale XX, GTW (good

this week), etc.); andh) Classification of a spot transaction or margin transaction.

There are two major order methods of limiting price, a limit order, which specifies a price limit (lower limit in the case of a sale, or upper limit in the case of a purchase), and a market order, which does not so specify.

Moreover, there are other order methods of limiting price, such as market residual limit orders, market residual cancellations, current price limit orders and preferred limit orders.

Furthermore, for transactions other than those during trading sessions, the parties may specify a limit for the price of a single issue transaction or the price of a basket transaction, and may specify that either the closing price or the VWAP (Volume Weighted Average Price) be used for a closing price transaction.

In addition, regulations stipulate that if a customer with a margin transaction account does not give instructions for the transaction to be carried out as a margin transaction the sale or purchase cannot be treated as a margin transaction (TSE Brokerage Agreement Standards, art. 6, para. 2).

Practically speaking, it will be necessary to confirm the following matters as well:

a) Market where the transaction is to be executed;b) For margin transactions, categorization as a standardized or negotiable

margin transaction;c) Classification of a principal (dealer) or entrusted trade (clarification of the

transactional mode); and

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d) In case of a sales transaction, whether or not such transaction is a short sale.

(2) Preparation of Order SlipsUpon accepting a trade from a customer, the financial instruments business operator

must prepare an order slip (FIEA, art. 46-2, art. 188; FIBCOO, art. 157, para. 1, item 3; art. 158, para. 2; Investment Solicitation Rules, art. 18, para. 2).

Matters to be stated on the order slip are (i) whether the transaction is a principal transaction or a brokered transaction, (ii) for orders from customers, the personal name or firm name of the customer, (iii) type of transaction, (iv) issue, (v) sale or purchase, (vi) order quantity received, (vii) contracted quantity, (viii) limit order or market order, (ix) order date and time received, (x) contract date and time, and (xi) contracted price (FIBCOO, art. 158, para. 1). In addition, the method of preparation, etc. is prescribed in detail under the Cabinet Office Ordinance (FIBCOO, art. 158, para. 2). If certain requirements are met, it is also permissible to prepare the order slips as an electromagnetic record (by inputting the relevant data directly into a computer) (FIBCOO, art. 158, para. 2, item 3).

Chart 1-1 Matters to Be Stated on Order Slips

1. Whether the order is a dealer or broker (dealer in the event of a principal transaction).

2. In the event of an order from a customer, the personal or firm name of the customer.

3. Type of transaction: (i) Margin transaction or when-issued transaction (a statement to that effect

and the payment deadline in the event of a margin transaction); (ii) Gensaki repo transactions (a statement to that effect, whether the

transaction is in the start portion or the end portion, whether it is a broker gensaki or a dealer gensaki, and the yield over the term);

(iii) Short selling of securities (a statement to that effect); (iv) Futures transaction (contract month or date of delivery, and whether a new

or settlement or cancellation); or (v) Securities option transaction or a trade in bonds with options (rights

exercise period, strike price, whether a put or a call, new, rights exercise, resale, repurchase or set-off, and contract month, etc.).

4. Issue (including the contract number of the contract agreement that states the financial instrument or financial index that is the object of the transaction, or the conditions of the transaction, and other information that identifies the object of the transaction).

5. Whether the order is a sell or buy.



6. Order volume (if there is no volume, then the number of cases, or the equivalent to the volume).

7. Contract volume (if there is no volume, then the number of cases, or the equivalent to the volume).

8. Whether the order is a limit or market order (and in the event of a limit order, including the price thereof and the effective period of the order).

9. The date and time of the order.10. The date and time of the contract.11. The contract price.

Order slips must be classified into the customer’s orders and proprietary orders, and preserved in files in date order (FIEA, art. 46-2; FIBCOO, art. 158, para. 2, item 4 (a)).

(3) Preparation of the Document to Be Delivered upon Conclusion of a ContractIf an order from a customer has been executed and the sale or purchase has been

completed, the financial instruments business operator must prepare a document delivered upon conclusion of a contract as provided for in the Cabinet Office Ordinance and deliver the same to the customer without delay (FIEA, art. 37-4). In this context, “without delay” means as promptly as possible. If delivery of the transaction report is delayed without good cause, it will be considered late. The financial instruments business operator must preserve a copy of the document (FIEA, art. 46-2).

(Note) Purposes of the preparation by financial instruments business operators, etc. of the document delivered upon conclusion of a contract and the duty to deliver:

(i) To allow the customer to promptly confirm whether the customer’s order was faithfully executed (customer protection); and

(ii) Because share prices are highly volatile, to allow the customer to confirm that the trade was completed as per the customer’s order, and to facilitate delivery (financial instruments business operator self-protection).

The matters to be stated in a document to be delivered upon conclusion of a contract may be provided by a method that uses an electronic data processing system or a method that uses other information communications technology, instead of the delivery, etc. of the paper document, as provided by Cabinet Order, if consent is obtained in writing or by electromagnetic means from the customer (FIEA, art. 37-4, para. 2; FIEA Enforcement Order, art. 15-22, para. 1; FIBCOO, art. 56 and art. 57; Deposit Rules, art. 14, para. 1, item 3; Document Delivery Rules, art. 2 and Annex, 4). In the event that the above has been provided by electromagnetic means, the financial instruments business operator shall be deemed to have delivered the document to be delivered upon conclusion of a contract (FIEA, art. 37-4, para. 2; FIBCOO, art. 110, para. 2; Deposit Rules, Art. 14, para. 1, item 3).

Where the customer is a corporation or other similar association, when the chief manager(Note)

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of the financial instruments business operator or an employee approved by the chief manager delivers the document to be delivered upon conclusion of a contract by hand directly to the customer’s office, the document will be deemed to have been sent by mail (Deposit Rules, art. 13, para. 2).

In addition, in cases prescribed by the Cabinet Office Ordinance as being considered as not causing disruptions for public interest or investor protection even if the document is not delivered to the customer in consideration of the contents of the contract for financial instruments transaction or other circumstances, the document does not need to be delivered (FIEA, art. 37-4, para. 1 proviso; FIBCOO, art. 110).

(Note) The chief manager is a responsible person in sales, inspection, auditing or administration department to be appointed in each business office or other office (Deposit Rules, art. 11, para. 5).

Chart 1-2Matters to Be Stated on the Document to Be Delivered upon Conclusion of a Contract

<Common Matters to Be Stated in the Document to Be Delivered Upon Conclusion of a Contract (FIBCOO, art. 99)>1. The trade name, business name, or name of the financial instruments business

operator, etc.2. The name of the business office or outlet of the financial instruments business

operator, etc.3. A summary of the contract for financial instruments transaction, cancellation or

redemption4. Date of formation, cancellation or redemption of the contract for financial

instruments transaction5. Matters concerning charges, etc. associated with forming, the contract for

financial instruments transaction, or cancellation or redemption6. Personal name or firm name of customer7. Method by which customer will communicate with the financial instruments

business operator, etc.<Matters to be Stated in the Document to Be Delivered Upon Conclusion of a Contract, Depending on the Financial Instruments Involved (FIBCOO, art. 100 and art. 101)>1. Common matters to be stated for purchase and sale or other transactions in

securities Whether a dealer or broker trade, whether a buy or sell, etc., the issue, the

contract volume, the unit price, the amount of consideration, the contract price or other monetary amount per contract unit, the monetary amount that the



customer is to pay and the method of calculation, the type of transaction, and matters that are necessary in order to accurately state the content of the transaction.

2. Special provisions on matters to be stated in the event of purchase and sale or other transactions in securities

In the event of a trade in securities, in addition to the matters set forth in 1. above, whether the trade is a cash transaction or a margin transaction, and if it involves a margin transaction, the payment deadline and whether it is new or a settlement.

(4) DeliveryAfter shares are traded, “delivery” occurs when the transaction is settled and a customer

surrenders the purchase price and receives the share certificates, or surrenders the share certificates and receives the sales proceeds. Since listed shares have been digitized and these certificates are not issued, when a customer purchases shares of stock, these shares are entered or registered in the settlement account of the transacting financial instruments business operator (the securities firm) as “book-entry shares.” When the reverse occurs and a customer sells shares, the decrease in shares is entered or recorded in the settlement account of the transacting financial instruments business operator.

Delivery in trading of regular transactions on the exchange takes place on the second business day following the date of the transaction (TSE Business Regulations, art. 9, para. 3).

Conventionally, the delivery date in regular transactions of domestic listed shares was the third business day following the contract date. As a result of the shortening of the settlement cycle of domestic listed shares, etc.(implementation of T+2), the delivery date has been changed to the second business day following the contract date, which is applicable from July 16, 2019 (trade date basis)). It should be noted that traders who purchase listed shares are not allowed to pay for the purchase by selling, on the date of purchase, the investment trusts or domestic bonds for which the delivery date is the third business day following the contract date.

Settlement of trading, etc. of securities that is executed on a market of an exchange will be conducted between the clearing participant (a financial instruments business operator, i.e., a securities firm) and the Japan Securities Clearing Corporation (hereinafter referred to as the “JSCC”) in accordance with the Business Rules of the JSCC (TSE Clearing and Settlement Regulations, art. 4).

The sales proceeds of securities that are sold are paid to the customer after the delivery date for the said transaction, and securities that are purchased are transferred to the account of the customer after the financial instruments business operator (trading participant) receives delivery from the settlement counterparty on the second business day following the contract date and concludes the necessary clerical procedures.

In principle, delivery and receipt of money pertaining to securities trading between a customer and a trading participant should be made in the Japanese yen, but a foreign currency

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designated by the customer may be used if the trading participant agrees to that effect (TSE Brokerage Agreement Standards, art. 52).

Credit cards are now available for the settlement of equity-based crowdfunding transactions which are less likely to cause problems in terms of protection of investors (FIBCOO, art. 149, item 1(a)).

(Note) Major products handled by financial instruments business operators for which the delivery date has been changed to the second business day following the contract date (T+2): Domestic listed shares, ETFs, ETNs, REIT, margin transactions, foreign shares

3 3 Commissions Pertaining to Share Trading

There are two basic forms that a transaction may take when a customer engages in share trading through a financial instruments business operator―brokered transactions (the financial instruments business operator is entrusted a trade, which it then executes) and dealer transactions (negotiated transactions made directly between the financial instruments business operator and the customer on off-exchange).

In a brokered transaction, the financial instruments business operator receives a brokerage commission from the customer when the trading order is concluded. The amount of commission was formerly determined according to the “Brokerage Agreement Standards” established by the exchange based on the trading volume. Since October 1999, however, commissions and fees in share brokerage have been completely liberalized. Commissions are now determined based on an agreement between the financial instruments business operator and the customer.

In a dealer transaction, the financial instruments business operator may, as is the case with brokered trades, collect a commission determined based on an agreement with the customer, or not collect a separate commission and simply include an equivalent amount in the contract trading price.



4 Sale and Purchase of Shares on Financial Instruments Exchanges

4 1 Types and Outline of Share Trading on Financial Instruments Exchanges

Trading shares on an exchange can be classified according to (i) differences in the settlement date, such as in regular transactions, cash transactions and when-issued transactions, (ii) the extension of credit by a financial instruments business operator or a securities finance company, such as in spot transactions and margin transactions, and (iii) whether transactions take place during trading sessions, such as by transactions during trading sessions and transactions other than those during trading sessions.

(1) ClassificationAccordingtoDifferencesintheSettlementDate(i) Regular Transactions

The most common transaction, where the transaction is completed and settlement occurs on the second business day after the trading contract was concluded (TSE Business Regulations, art. 9, para. 3).(ii) Cash Transactions

Transactions where settlement takes place on the date the trading contract is concluded (TSE Business Regulations, art. 9, para. 2).(iii) When-Issued Transactions

When-issued transactions are transactions targeted at the share certificates that an issuer (company) of domestic share certificates will newly issue through an allotment to shareholders, where trading takes place after the ex-rights date in the case of an offering to shareholders until the date determined by the exchange. All settlements of the transactions contracted during the said period take place on the second business day following the final day of when-issued transactions (TSE Business Regulations, art. 9, para. 7) (for details, see this Chapter, “4-2 When-Issued Transactions”).

DVP SettlementDVP settlement was introduced on the TSE and OSE in May 2001 for settlement

of transactions between financial instruments business operators on the exchange. DVP stands for Delivery Versus Payment, and settlement is conducted by “delivery of funds and securities simultaneously, or within the same day.” This removes the principal risk (the risk that the consideration for the funds or securities will not be received after they are delivered) arising from counterparty default (TSE Brokerage Agreement Standards, art. 15; JASDEC DVP Clearing Corporation Business Rules, art. 3). Following the integration of the spot (cash equity) markets of the TSE and OSE on July 16, 2013, DVP settlement on the OSE was discontinued.

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Section 4. Sale and Purchase of Shares on Financial Instruments Exchanges


(2) ClassificationAccordingtotheExtensionofCredit(i) Spot Transactions

Where an individual or corporation intends to engage in trading, when it sells securities it holds, or makes a purchase of securities using its own funds, on its own account, the transaction is known as a spot transaction.(ii) Margin Transactions

When an investor borrows money from a financial instruments business operator to buy securities, or when a financial instruments business operator borrows from a securities finance company, or alternatively, when securities are borrowed and then sold, the transaction is called a margin transaction (FIEA, art. 156-24, para. 1; TSE Business Regulations, art. 1-3. para. 3; for details, see this Chapter, “10 Margin Transactions”).

(3) ClassificationAccordingtoWhetherTransactionsOccurDuringTradingSessions(i) Transactions During Trading Sessions (Trading on a Market during Trading

Session in the Exchange)Transactions during trading sessions involve trading by means of competitive sale and

purchase (trading under auction system) (TSE Business Regulations, art. 10, para. 1). Trading under the auction system involves transactions that proceed through an individual competitive sale and purchase whereby all investor bid and ask orders for each issue at each price are first gathered, and, where a contract is formed when the lowest bid price and the highest asked price match (TSE Business Regulations, art. 12, para. 2).

Orders are processed according to the principles of price and time priority. Under the principle of price priority, the highest bid price has priority over other orders, and the lowest ask price takes priority over other orders (TSE Business Regulations, art. 10, para. 2, item 1). Also, market orders have priority over limit orders. Under the principle of time priority, when two bid or asked orders at the same price are received, the one that arrived first has priority (TSE Business Regulations, art. 10, para. 2, item 2). All bids and offers made prior to determination of an opening price in the trading sessions and all bids and offers made prior to determination of an initial price following resumption of trading of a particular issue of securities halted (by the Exchange) shall be regarded as having been made simultaneously (TSE Business Regulations, art. 10, para. 3).

Trading SessionsThe trading sessions consist of a morning trading session and an afternoon trading

session. The morning trading session starts at 9:00 and ends at 11:30. The afternoon trading session starts at 12:30 and ends at slightly different times depending on the exchange, namely, 15:00 at TSE and 15:30 at NSE, SSE and FSE.

(ii) Transactions Other Than Those During Trading Sessions (Trading on a Market Outside of Trading Sessions in the Exchange)In contrast to individual competitive sale and purchase as is conducted during trading



sessions, buyers and sellers conducting transactions other than those during trading sessions will almost always reach an agreement with respect to price, volume, settlement dates, etc., and then close the contract through a cross trade. Transactions other than those during trading sessions are classified according to its content, such as single issue transactions, basket transactions, closing price transactions, and purchase transaction outside of trading sessions of company’s own shares (TSE Special Regulations of Business Regulations and Brokerage Agreement Standards Concerning ToSTNeT Market, art. 4; for details, see this Chapter, “4-3 Transactions Other Than Those During Trading Sessions”).

4 2 When-Issued Transactions (Date-of-Issue Transactions)

(1) DefinitionandSignificanceofWhen-IssuedTransactionsWhen-issued transactions (Date-of-issue transactions)(Note) mean a transaction whereby a

financial instruments business operator undertakes the sale or purchase, or other transaction with respect to unissued securities on behalf of the customer, and makes delivery of the said securities or the said certificates after the passage of a certain number of days following the issue of the said securities (Security Deposit Ordinance, art. 1, para. 2).

When-issued transactions not only present a way to avoid the risk of price fluctuation to investors who hold rights under the shares which will ultimately be issued following the specified time period, but they are also useful in providing investors with a diversified means of investment. It is expected that smooth and fair pricing will be conducted by using this transaction type.

“Offset trade” means a trade in which the same issue of securities as the securities to be purchased in a when-issued transaction are sold in a corresponding amount prior to the delivery of the securities purchased, or the same issue of securities as the securities to be sold in a when-issued transaction are purchased in a corresponding amount prior to the delivery of the securities sold (Security Deposit Ordinance, art. 1, para. 4).

(Note) Although “When-Issued Transactions” and “Date-of-Issue Transactions” are different terms, they refer to the same transaction. The Security Deposit Ordinance and the NSE use the term “Date-of-Issue Transactions,” while the TSE, the FSE and the SSE use the term “When-Issued Transactions”. This text adopts “When-Issued Transactions”.

(2) Securities Covered by When-Issued TransactionsIssues which are covered by when-issued transactions are new shares, issued by a domestic

company that is currently listed on an exchange, accompanying a shareholder-allotted capital increase, for which the said issuing company has completed the necessary listing procedures and which the exchange approves.

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(3) Trading Period and Settlement Date of When-Issued TransactionsTrading commences, in connection with instruments that are issued as a result of an

allotment to shareholders, on or after the ex-rights date prescribed by the exchange, and is conducted until a date following the issuance of the new share certificates prescribed by the exchange.

Settlement takes place on the second business day following the final day for transactions (TSE Business Regulations, art. 9, para. 7). All contracts completed during the trading period are settled uniformly on the same settlement date.

However, if the exchange deems it necessary, the exchange may change the commencement day of transactions to a day which falls on or comes after a day specified as an ex-rights date (TSE Business Regulations, art. 9, para. 7, proviso).

(4) Collection of Security Deposit for When-Issued TransactionsSince when-issued transactions concluded during the trading period are settled after a

considerable period of time, and coupled with the fact that the underlying securities in the transaction are unissued, they have a greater possibility of being used for speculative purposes. Therefore, in order to mitigate this tendency, regulations require that a certain amount of money be submitted as a security deposit with the financial instruments business operator (FIEA, art. 161-2; TSE Brokerage Agreement Standards, art. 31).

(5) Acceptance of When-Issued Transactions(i) When-Issued Transactions Agreement and Consent Forms

When a customer entrusts when-issued transactions to a financial instruments business operator, the customer must fill in the requisite matters on the Agreement Concerning the Commission of When-Issued Transactions in the prescribed form, and submit this form to the financial instruments business operator upon signing or sealing it (TSE Brokerage Agreement Standards, art. 4). In certain conditions, this can be carried out by electromagnetic means in lieu of the written agreement (TSE Brokerage Agreement Standards, art. 4, para. 2).

If the customer deposits securities in lieu of the security deposit, the financial instruments business operator must receive the consent of the said customer in writing, as provided for by Cabinet Office Ordinance, in cases where the financial instruments business operator offers the margin securities as collateral, or if it loans them to a third party (FIEA, art. 43-4).(ii) Trading Unit in When-Issued Transactions

In principle, the trading unit is the number of shares the listed company determines as constituting one round lot (TSE Business Regulations, art. 15).

(6) Calculation of Security Deposit for When-Issued TransactionsFollowing the revision of the Security Deposit Ordinance and the TSE Brokerage Agreement

Standards, a review of the calculation methods of security deposit for when-issued transactions was launched from January, 2013. As a result, when-issued transactions are now conducted more



efficiently than before.(i) Collection of Margin

When a trading order for a when-issued transaction is carried out, the financial instruments business operator must collect a security deposit equivalent to 30% or more of the contract price by a day and time designated by the financial instruments business operator no later than the noon on the third business day counting from the day on which the transaction is effected (TSE Brokerage Agreement Standards, art. 31, para. 1; FIEA, art. 161-2; Security Deposit Ordinance, art. 2, para. 1, item 2, art. 3 and art. 4).

The money to be submitted as a security deposit must be in the Japanese yen or US dollars. The amount of security deposit to be submitted in US dollars shall be 95% of the contract price converted into the Japanese yen at the foreign exchange rate designated by the trading participant (TSE Brokerage Agreement Standards, art. 32 and art. 39-2, para. 1 and para. 2)

The percentage of margin to be collected, etc. may be modified according to the regulations, etc.(ii) Margin Securities

Security deposit is generally a cash deposit, but securities may also be used in lieu of cash (FIEA, art. 161-2, para. 2; Security Deposit Ordinance, art. 6). The type of such margin securities and their cash conversion ratio (called daiyo kakeme) will be determined in a manner similar to the regulations pertaining to margin transactions established by the exchanges (Security Deposit Ordinance, art. 6; TSE Brokerage Agreement Standards, art. 32 and art. 40).(iii) Variation Margins (Maintenance of the Security Deposit)

In cases where the total amount of security deposit received from a customer for when-issued transactions falls below 20% of the contract price of all securities involved in the when-issued transactions conducted by the customer, a financial instruments business operator must require the customer to deposit an additional security deposit, as a variation margin, sufficient to maintain the said total amount of security deposit at 30% of the said contract price, by a date and time designated by the financial instruments business operator no later than the “noon on the third business day counting from the day on which the implicit loss is incurred (TSE Brokerage Agreement Standards, art. 31, para. 1, art. 36 and art. 37, para. 1).

In cases where a customer was required to deposit an additional margin, and such customer conducted a purchase or sale which corresponds to the sell or buy position pertaining to his/her when-issued transactions by the due date of deposit of an additional margin, the financial instruments business operator may subtract the amount equivalent to 20% of the contract value of securities pertaining to such buy or sell positions from the security deposit that must be additionally deposited (TSE Brokerage Agreement Standards, art. 37, para. 2).

In cases where a financial instruments business operator requested a customer to deposit an additional security deposit, and received from the customer a margin of an amount

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equivalent to (i) losses from a purchase or sale which corresponds to the buy or sell position pertaining to the when-issued transactions and (ii) the amount to be borne by the customer pertaining to the when-issued transactions, by the due date of deposit of an additional margin, the financial instruments business operator may subtract these amounts from the security deposit that must be additionally deposited during the period before the settlement of the when-issued transactions (newly introduced; TSE Brokerage Agreement Standards, art. 37, para. 3).(iv) Withdrawal of Security Deposit, Etc.

With regard to money or securities which have been received from a customer as a margin pertaining to when-issued transactions, a financial instruments business operator is able to allow the customer to withdraw money up to the amount obtained by subtracting (A) an “amount equivalent to 30% of the contract value of all securities pertaining to the when-issued transactions of the customer” from (B) the “total amount of security deposit received pertaining to the when-issued transactions of the customer” (Security Deposit Ordinance, art. 7, para. 5; TSE Brokerage Agreement Standards, art. 33, para. 1).

In addition, with regard to money or securities which have been received from a customer as security deposit pertaining to when-issued transactions, a financial instruments business operator may allow the customer to withdraw such money or securities only in the following cases (Security Deposit Ordinance, art. 7, para. 6; TSE Brokerage Agreement Standards, art. 33, para. 2):

a. In cases of partial delivery of securities pertaining to when-issued transactions (limited to cases of withdrawing up to an amount equivalent to the amount obtained by subtracting (A) from (B) mentioned above);

b. In cases of partial delivery of securities pertaining to the when-issued transactions, subject to deposit of all securities purchased, or all money equivalent to the sales proceeds from securities sold, via the when-issued transactions pertaining to such partial delivery, as margin pertaining to when-issued transactions (limited to cases where (B) is equal to or larger than (A) after such deposit);

c. In cases of delivering all securities pertaining to when-issued transactions; ord. In cases of replacing such money or securities in whole or in part.Furthermore, when a financial instruments business operator conducts new when-issued

transactions for its customer, it may allocate money or securities that have already been deposited from the customer as margin pertaining to when-issued transactions, to the amount of money or securities which should be deposited as margin pertaining to such new when-issued transactions, up to the following amount (Security Deposit Ordinance, art. 7, para. 7; TSE Brokerage Agreement Standards, art. 33, para. 3):

The amount obtained by subtracting:(A) An amount equivalent to 30% of the contract value of all securities pertaining to

the when-issued transactions of the customer; from(B) The total amount of the security deposit received pertaining to the when-issued

transactions of the customer.



(v) Calculation Method for the Amount of Deposited MarginThe total amount of security deposit received from a customer shall be calculated by

subtracting the amounts mentioned in (A) to (C) below (Security Deposit Ordinance, art. 8; TSE Brokerage Agreement Standards, art. 34, para. 1). However, in the calculation of the total amount of security deposit received for the customer’s when-issued transactions, the amount mentioned in (A) below pertaining to the when-issued transactions to be settled shall not be subtracted (TSE Brokerage Agreement Standards, art. 34, para. 1, proviso).

(A) The amount equivalent to the amount consisting of (i) the amount computed by deducting (a) profits due to fluctuations of price of securities and profits due to offsetting transactions pertaining to when-issued transactions of the said customer from (b) losses due to fluctuations of prices of securities and losses due to offsetting transactions pertaining to when-issued transactions of the said customer, and (ii) the amount to be borne by a customer in relation to the when-issued transactions of the customer, including brokerage commissions;

(B) In cases where the customer is provided with credit for the customer’s when-issued transactions, the amount equivalent to such provided credit; and

(C) In cases where the customer has remaining obligations to the financial instruments business operator after the settlement of securities pertaining to the when-issued transactions of the customer (including loans and other obligations related to new claims and other obligations with the financial instruments business operator), the amount equivalent to such remaining amount of obligations.

(7) Restriction on Withdrawal, Etc. of Computational GainsIf in when-issued transactions a computational gain arises as a result of a fluctuation of the

market price of the relevant securities or as a result of an offsetting trade (i.e., unrealized gains), cash or securities corresponding to such gain must not be delivered prior to the relevant settlement, or allotted to cash that is to be provided as a security deposit (Security Deposit Ordinance, art. 9, para. 1 and para. 2; TSE Brokerage Agreement Standards, art. 35).

(8) ReturnofSecuritydepositsPertainingtoanOffsettingTradeWhen a trading participant (financial instruments business operator) receives a request for the

return of a security deposit from a customer whose short position and long position pertaining to when-issued transactions of the same issue match each other, the trading participant must return the security deposit pertaining to such matching quantity. Provided, however, that when a computed loss arises on the said trade, the customer is required to contribute moneys equal to the said loss (TSE Brokerage Agreement Standards, art. 38, para. 1 and para. 2).

(9) Settlement MethodsSettlement for when-issued transactions is conducted by 9:00 a.m. on the settlement date

provided by the exchange by means of the sold securities (certificates) or purchase price (TSE Brokerage Agreement Standards, art. 13, para. 1).

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Nevertheless, if a financial instruments business operator designates the time and date within the specified settlement period that has been separately stipulated by the JSCC when it has accepted a request from a customer to perform a when-issued transaction, the customer must deliver to the financial instruments business operator the sold securities certificates or the purchase amount by such time and date (TSE Brokerage Agreement Standards, art. 13, para. 2).

(10) Treatment of Computational Gain/Loss and Margin Pertaining to When-Issued Transactions (in the Case of a Transaction Between Clearing Participants)(i) Treatment of Computational Gain or Loss

When a clearing participant (an entity that is qualified to settle its transactions through the JSCC) concludes a contract for when-issued transactions, it must exchange the difference between the contract price and the clearing price (meaning the price determined by the JSCC on the basis of the closing price on the contract date) (the so-called “revalued difference”) with the JSCC by the deadline for non-DVP settlement(Note) on the third business day after the contract date (JSCC Business Rules, art. 67).

In addition, where a difference arises between the settlement value for the current day compared to the settlement value for the prior day, a clearing participant is required to exchange an amount of cash equal to the difference with the JSCC by the deadline for non-DVP settlement on the third business day after the date the said difference arose (JSCC Business Rules, art. 68).

(Note) Securities subject to DVP settlement (share certificates issued by domestic corporations, preferred equity investment certificates, beneficiary certificates in an investment trust, convertible-type bonds with share options, etc.) are those for which the contracts can be settled by DVP settlement (the JSCC delivers the securities being cleared to the clearing participant entitled to them, within the amount of other securities and/or payment, etc. that the clearing participant delivers to the JSCC); securities other than securities subject to DVP shall be settled by non-DVP settlement (JSCC Business Rules, art. 47).

(ii) Treatment of Trading MarginWhen a clearing participant concludes a contract for when-issued transactions, it must

deposit with the JSCC a trading margin equal to or greater than the amount prescribed by the JSCC by 2:00 p.m. on the third business day after the contract date. Given, however, that regulations provide that if the clearing participant will conduct an offsetting purchase (sale) against its sale (purchase), then a deposit of margin calculated based on the net amount (the difference between total sales and total purchases) will suffice.

The trading margin may be deposited only in any of the currencies designated by the JSCC. In this case, the appraisal value of the trading margin deposited in a currency other than the Japanese yen is an amount equal to the value of the trading margin in that currency converted to Japanese yen at the telegraphic transfer spot buying rate (TTB) per 1 unit of that



currency in the Tokyo foreign exchange market on the day which is two days before the day on which the trading margin is deposited, multiplied by a certain rate determined by JSCC.

Clearing participants may deposit securities in lieu of a cash trading margin as provided by the JSCC (JSCC Business Rules, art. 70, para. 1, para. 2 and para. 3).

(11) Measures to Be Taken in Cases of Settlement Default by CustomerA financial instruments business operator may, at its discretion, conduct a sale or purchase on

a customer’s account in order to carry out settlement for when-issued transactions if the customer does not deposit a security deposit which should be deposited, or an amount of money corresponding to a loss when it arises concerning when-issued transactions, to the financial instruments business operator (TSE Brokerage Agreement Standards, art. 53, para. 1).

If the financial instruments business operator has suffered a loss or damage in such transaction, the financial instruments business operator may appropriate money and securities which it holds for the customer or which are recorded in an account under the Book-Entry Transfer Act for such loss or damage. If there is still a shortage after such appropriation, the financial instruments business operator may claim the payment of such shortage amount from the customer (TSE Brokerage Agreement Standards, art. 53, para. 2).

4 3 Transactions Other Than Those During Trading Sessions (Trading on a Market Outside of Trading Sessions in the Exchange)

(1) DefinitionTransactions other than those during trading sessions mean a trading system conducted over

an electronic trading network system of an exchange, and contracts are usually completed using cross transactions based on an agreement between the seller and buyer regarding price, volume, etc. Ordinarily, this trading method is employed to execute block transactions of an individual issue or for basket transactions, which treats a portfolio comprising multiple issues as one set. The majority of transactions are concluded when the sell orders or buy orders of institutional investors correspond to the investment portfolio activities of financial instruments business operators.

Formerly, transactions other than those during trading sessions could not be conducted during the trading hours of the trading sessions, and were referred to as transactions outside of trading session hours, so that these transactions also used to be called “off-hours trades,” or “off-hours transactions.” However, at present, the transactions other than those during trading sessions for some single issue trading at TSE and NSE as well as basket trading at TSE are allowed to be conducted even during trading session hours.

After commencement on the TSE on November 14, 1997, transactions other than those during trading sessions have gradually been introduced on the OSE and NSE. Initially, contract processing was conducted by fax transmission between financial instruments business operators and the exchange, but now systems have been constructed consisting of ToSTNeT 1 (single issue transactions, basket transactions), ToSTNeT 2 (closing price transactions), and ToSTNeT 3

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(purchase transaction outside of trading sessions of company’s own shares) on the TSE, and N-NET on the NSE, which allow the financial instruments business operators to input the necessary data using the stock exchange terminals. Following the integration of the spot (cash equity) markets of the OSE into those of the TSE on July 16, 2013, the OSE discontinued handling spot transactions on J-NET.

Transactions other than those during trading sessions have two advantages: (i) trading can be conducted by cross transactions at the desired price and volume, and (ii) trading can be conducted outside of normal session hours. Regarding (i), there is the possibility that a cross transaction conducted during trading sessions cannot be accomplished at the desired price and volume due to the influence of the buy/sell orders of other market participants; however, since cross transactions under transactions in a market outside of trading sessions are processed separately, it is possible to engage in a transaction under the conditions desired. Furthermore, regarding (ii), since transactions other than those during trading sessions principally occur in the early morning, lunch break, and after the close each day, it is possible to decide on the transaction terms for transactions other than those during trading sessions after having seen the fluctuations in the market during trading sessions.

(2) Transaction Coverage, Etc.Transactions other than those during trading sessions are simply another kind of exchange

transaction, and the issues of shares to be traded, settlement dates, utilization of margin transactions, etc. are the same as those for transactions during trading sessions. In other words, transactions other than those during trading sessions are not limited to trading in listed domestic and foreign shares, but also include bonds with share options, ETF (excluding purchase transactions other than those during trading sessions of a company’s own shares), REITS, etc.

However, there are differences among trading hours, underlying volume, price limits, etc., depending on the exchange (for details, see this Chapter, 4-3(2) “(Ref.) Comparison of Share Transactions Other Than Those During Trading Sessions on the Major Exchanges”). Transactions other than those during trading sessions can be categorized depending on the trading method used into (i) single issue transactions, (ii) basket transactions, (iii) closing-price transactions, and (iv) purchase transactions other than those during trading sessions of company’s own shares.

(i) Single Issue Transactions Outside of Trading SessionsCross transactions in a single issue. Originally, a single issue transaction could not be

done unless the transaction was conducted above a certain multiple, such as 300 times the trading unit or more. Recently, however, as trading terms have been relaxed in response to investor needs, single issue transactions have become possible for any amount above the minimum trading unit. Transactions other than those during trading sessions can also be conducted on the TSE and the NSE, even during trading session hours.(ii) Basket Transactions Outside of Trading Sessions

Basket transactions are deals that trade a portfolio comprising multiple issues as one set. Basket transactions outside of trading sessions can be used for portfolios composed of 15 or more issues, and a total trading amount of JPY100 million or more. The content of rules of



the major exchanges for basket transaction outside of trading sessions is similar for the most part. However, as of January 15, 2008 it has become possible to trade basket transactions during trading session hours on the TSE.(iii) Closing-Price Transactions

Closing-price transactions are transactions conducted based on the closing price or VWAP. Particularly, ToSTNeT 2 and N-NET closing price transactions differ from regular transactions outside of trading sessions in that they allow orders to be placed for not only cross transactions, but also for sales only or purchases only. This feature means that investors who wish to buy or sell in a closing-price transaction issue their orders, and only when the terms of two orders match, a contract will be concluded, in conformity with the usual order time priorities. However, cross orders will have priority over other bid and offer orders.(iv) Purchase Transactions Other Than Those During Trading Sessions of Company’s

Own SharesThe NSE allows a company to conduct transactions other than those during trading

sessions of company’s own shares if prior disclosure of the transaction is made. Transactions other than those during trading sessions of company’s own shares are to be conducted by executing the purchase offer after publishing the content of the purchase offer in advance on the day before the offer date if there is an expectation that there will be sales from major shareholders, etc.

In the event of a company acquiring its own shares in the form of an advance announcement, the transactions by a company to acquire its own shares can be conducted through either of two programs: transactions other than those during trading sessions and N-NET closing price transactions outside of trading sessions. Nevertheless, short selling using margin transactions is not permitted for the transactions other than those during trading sessions, which to some extent prevents unforeseeable sell orders.

On January 15, 2008, the TSE commenced operation of a mechanism to allow transactions other than those during trading sessions (ToSTNeT 3) to be used by a company to purchase its own shares. Its use is limited to issuing companies acquiring their own shares. While the principle of time priority is strictly followed in the closing-price transactions, in ToSTNet 3 the number of shares a seller is allocated is determined on the basis of the number of shares being purchased, using the allotment method prescribed by the TSE.

Neither margin transactions nor loan transactions can be used in a purchase transaction other than that during trading sessions of a company’s own shares.

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(Ref.) Comparison of Share Transactions Other Than Those During Trading Sessions on the Major Exchanges

As of October 16, 2019Item Tokyo Stock Exchange (ToSTNeT Market)

Single Issue Transactions

Trading Hours

8:20 - 17:30VWAP Guarantee TradingVWAP Target Trading8:20 - 9:00, previous day’s VWAP (VWAP target not possible)11:30 - 12:30, morning session VWAP15:00 - 17:30, afternoon session and whole day VWAP

Trading Price

Price(Note 1) within 7% above or below the last contract price on auction market(Note 2)

(Note 1) The special quote price or sequential special quote price if a special quote or sequential special quote exists(Note 2) If the figure calculated by multiplying the last contract price by 7% falls below JPY5, the price within JPY5

above or below of the last contract price applies uniformly.VWAP guarantee trading: the price obtained from the VWAP plus or minus the commission.VWAP target trading: The weighted average price that is the result of executions on the auction market, targeting the VWAP.(It is also possible to trade at a price that reflects the amount of commission on the weighted average price as a result of executions.)

Quotation

Quotation units: Integral multiples of 1/10,000 of a yenTransactions are possible between the same participants or between different participantsVWAP guarantee trading or VWAP target tradingQuotation units: Integral multiples of 1/10,000 of a yenOnly cross transactions are possible.

Trading Unit At least the minimum trading unit on auction trading

Trading MethodSpecify matching conditions such as the matching counterpart (Trading Participant name), name of the stock, and number of stocks, and orders are matched when the quoted prices of each order match. (In case of cross trading, the trade is concluded at the quoted price)

Settlement T+2T+0 (Transaction between the same participant only)

Basket TransactionsTrading Hours 8:20 - 17:30

Trading Price Within 5% above or below the base price computed from the last contract price on the auction market of the issues composing the basket

Quotation Quotation units: Integral multiples of 1/10,000 of a yenTransactions are possible between the same participants or between different participants

Trading Unit At least 15 issues, JPY100 million or more in trading

Trading MethodSpecify matching conditions such as the matching counterpart (Trading Participant name), name of the stock, and number of stocks, and orders are matched when the quoted prices of each order match. (In case of cross trading, the trade is concluded at the quoted price).

Settlement T+2T+0 (Transaction between the same participant only)

Closing Price Transactions

Trading Hours (1) 8:20 - 8:45 (2) 11:30 - 12:15 (3) 15:00 - 16:00Orders accepted from 8:20 to 16:00.

Trading Price

8:20 - 8:45, closing price on the previous day (including a closing special quote price or a closing sequential special quote price, and if neither exists, the standard price on that day; hereinafter the same). Whole day VWAP of the previous day11:30 - 12:15, closing price on the previous day, morning session VWAP15:00 - 16:00, closing price on that day, afternoon session VWAP and whole day VWAP

Quotation

Quotation unitsClosing trade: Same as on auction marketVWAP Trades: VWAP calculated by TSEThe order of quotations shall follow the principle of priority of time, provided that cross orders shall have priority over other quotations.VWAP trades are only possible in the case of cross orders.

Trading Unit At least the minimum trading unit in auction tradingTrading Method Time Priority basis (In case of cross trading, the trade is concluded at the quoted price)Settlement T+2

Purchase Transactions Other Than Those During Trading Sessions by a Company in Its Own Shares

Trading Hours 8:45Sell orders accepted from 8:00 to 8:45.

Trading Price Closing price on previous day (including a closing special quote price or a closing sequential special quote price, and if neither exists, the standard price on that day)

QuotationQuotation units: Same as on the auction marketFirst priority of quotation: Entrustment orders; Second priority: Personal ordersAllocation to each trading participant in accordance with the above priority

Trading Unit At least the minimum trading unit on auction trading

Trading Method

- Entrusted orders have the highest priority.- Allocate the minimum trading unit per trading participant in descending order according to the amount of orders. Multiply the balancing amount of each participant by the allotment ratio (buy order balance/total sell order balance) and allocate the integral result (dropping the decimals). Allocate minimum trading units in descending order according to the number after the decimals are dropped.

Settlement T+2



Item Nagoya Stock Exchange (N-NET Market)Single Issue Transactions

Trading HoursTrading Price

8:20 - 16:30*Orders are accepted and remain effective during the trading hours, except for transactions with the designated counterparty being effective only for 15 minutes.Within 7% above or below the most recent contract price (including special quotes) of a regular transaction on the auction market

Quotation Integral multiples of 1/10,000 of a yen per shareEligible Volume At least the minimum trading unit on auction trading

Trading MethodCross trading: A transaction is effected upon placement of each order.Trading with the designated counterparty(Note): A transaction is effected when either a sell order or buy order matches an order that is placed to match it (limited to a transaction where the counterparties designated by both parties match).

Settlement T+2T+0 (Cross-trading only)

Basket Transactions

Trading Hours(1) 8:20 - 9:00(2) 11:35 - 12:30(3) 15:35 - 16:30

Trading Price Within ±5% based on the total price s of the issues composing the basket, computed from the closing prices, etc. on the auction market.

Quotation One yen per share for each issue composing the basketEligible Volume At least 15 issues, JPY100 million or more in tradingTrading Method A transaction is effected when either a sell order or buy order matches an order that is placed to match it



Trading Hours

Cross trades and actual trading(1) 8:20 - 9:00(2) 11:35 - 12:30(3) 15:35 - 16:30Orders are accepted during the trading hours and remain effective during the respective trading hours (e.g. orders made in the morning session are no longer effective in the afternoon or evening session).When a company is acquiring its own shares at the public price announced in advance using the closing price on N-NET:Time during which orders are accepted: 8:20 - 9:00Time during which orders are executed: Executed when a matching order occurs

Trading Price

Trading hours (1), previous day’s closing price (including special quotes) Trading hours (2), morning session closing price (including special quotes) Trading hours (3), closing price on that day (including special quotes)*If a closing price does not exist the NSE will determine this at such time as it occurs.When a company is acquiring its own shares at the public price announced in advance using the closing price on N-NET:Purchase by a company of its own shares at the public price announced in advance using the transactions other than those during trading sessions system for purchase of a company’s own shares

Quotation Same as the auction marketEligible Volume No requirement for a minimum purchase volume

Trading MethodCross trading: A transaction is effected upon placement of each order.Actual trading: A transaction is effected under the principle of priority of time each time a sell order and a buy order match during each period of trading hours (zaraba method).


Purchase Transactions Other Than Those During Trading Sessions by a Company in Its Own Shares

Trading Hours Time during which orders are accepted: 8:20 - 8:45Matching time: 8:45

Trading Price Closing price on the previous day of the purchase date (including a closing quotation price)

QuotationSame as the auction market1st: Entrusted Order2nd: Principal Order

Eligible Volume No requirement for a minimum purchase volume

Trading Method

- Entrusted orders have highest priority.- Allocate the minimum trading unit per trading participant in descending order according to the amount of orders. Multiply the balancing amount of orders of each participant by the allotment ratio (buy order balance/total sell order balance) and allocate the integral result (dropping decimals). Allocate the minimum trading unit in descending order according to the number of the decimals which are dropped.

Settlement T+2

(Note) A “transaction with the designated counterparty” is a transaction conducted by a method wherein the seller and the purchaser are determined in advance and they designate the securities firm with which they make orders.

(Attention) On the ToSTNet Market and the N-NET Market, margin transactions or loan transactions cannot be used for transactions other than those during trading sessions by a company in its own shares.

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5 Over-the-Counter Share Transactions

Here, we shall discuss transactions in securities that are not listed on a financial instruments exchange market (hereinafter referred to as an “exchange”, where appropriate).

Securities that are not listed on an exchange are defined as over-the-counter (OTC) securities (OTC Securities Rules, art. 2, item 1). Over-the-counter securities are classified into over-the-counter handled securities and other over-the-counter securities.

5 1 Types of Over-the-Counter Securities

(1) Over-the-Counter Handled SecuritiesWithin “over-the-counter securities” (share certificates, share option certificates, or bonds

with share options (hereinafter referred to as “share certificates, etc.”) that have been issued by domestic corporations in Japan which are not listed on financial instruments exchange markets), over-the-counter handled securities are those that have been issued by a company that is obligated to file securities reports or a company that prepares an explanatory note on business conditions in connection with the issuance of share certificates, etc. (OTC Securities Rules, art. 2, item 1 and item 4).

Association Members may solicit customers, etc. other than qualified institutional investors to invest in over-the-counter handled securities under transfer restrictions and those issued by issuers of listed securities if they meet certain conditions (OTC Securities Rules, art. 3, art. 6, para. 1, art. 7, para. 1, and art. 8, para. 1).

With regard to over-the-counter handled securities issued by issuers of listed securities, in substitution of the delivery of an explanatory document on securities information, etc., Association Members may use methods employing electronic information processing systems or other information technologies to provide customers with the items of information to be stated in the explanatory document. In such cases, the Association Members shall be regarded as having delivered the explanatory document (OTC Securities Rules, art. 18, para. 1; Document Delivery Rules, art. 4).

Association Members are still required to collect a written confirmation from customers for transactions in connection with the dealing, etc. of offering, etc. of over-the-counter handled securities under transfer restrictions and transactions of over-the-counter handled securities issued by issuers of listed securities, whereas the obligation to deliver to customers a copy of their written confirmation has been abolished (OTC Securities Rules, art. 7, para. 4, art. 8, para. 2, and art. 18, para. 1).

In substitution of the collection of a written confirmation concerning a transaction of over-the-counter handled securities, Association Members may use methods employing electronic information processing systems or other information technologies to receive the items of



information to be stated in the document. In such cases, the Association Members shall be regarded as having collected the document (OTC Securities Rules, art. 18, para. 2; Document Delivery Rules, art. 4).

(2) Phoenix IssuesPhoenix issues are those over-the-counter handled securities (limited to those issued by an

issuing company that is required to submit an annual securities report or issuing company that prepares an explanatory note on business conditions that meets certain requirements) for which the Regular Member intending to become the handling member has determined that it is necessary to offer an opportunity to sell to persons who have retained the securities since the time that the securities were listed on an exchange, and for which the JSDA designates the Association Member and a financial instruments intermediary as persons who are to carry out investment solicitation (OTC Securities Rules, art. 2, item 6; Phoenix Rules, art. 2, item 5).

Association Members other than the handling members are not allowed to conduct investment solicitations for Phoenix issues, with the exception of those involving offers to sell Phoenix issues on the account of a customer (Phoenix Rules, art. 20, para. 1).

(3) Over-the-Counter Securities Other Than Over-the-Counter Handled SecuritiesOver-the-counter securities other than over-the-counter handled securities are

commonly referred to as blue-sky issues. In principle, customers cannot be solicited to invest in these issues, but investment solicitation may be made only towards qualified institutional investors (as specified in art. 2, para. 3, item 1 of the FIEA) on the condition that a restriction on transfer be attached to the acquired over-the-counter securities (OTC Securities Rules, art. 3, and art. 4, para. 1).

Based on the review of regulations concerning the trading system of unlisted shares released on May 19, 2015, “shareholders community issues” under the Shareholders Community Rules and “share certificates handled in the equity-based crowdfunding business (type I small amount electronic offering handling business)” under the Crowdfunding Rules have been included in the scope of over-the-counter securities for which Association Members may solicit customers (in the case of shareholder community issues, limited to customers who are members of the relevant shareholders community) for investment (OTC Securities Rules, art. 3; Shareholders Community Rules, art. 2, item 5; and Crowdfunding Rules, art. 2).

From August 1, 2019, Association Members are allowed to solicit customers to invest in OTC securities in connection with a series of sales and purchases of securities intended to transfer a controlling interest, etc. or intermediary for such sales and purchases (OTC Securities Rules, art. 3-2).

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Section 5. Over-the-Counter Share Transactions


Chart 1-3 Conceptual Diagram of Securities

5 2 Trading Methods

(1) Trading in Over-the-Counter SecuritiesOver-the-counter transactions (sale and purchase or other transactions in over-the-counter

securities) are conducted in the form of either brokered or dealer trades, with trading involving negotiated transactions between two Regular Members or a Regular Member and its customer.

Brokered trades are transactions that are entrusted from a customer to a member and executed by the Regular Member or consigned to another Regular Member, etc. for execution.

Dealer transactions are transactions where the contract is established between the customer and the Regular Member acting as counterparty on its own account and does not consign, etc. the transaction.

For over-the-counter securities it is prohibited to accept market orders, conduct margin transactions or engage in over-the-counter transactions of unissued over-the-counter securities (OTC Securities Rules, art. 14).

(2) Investment Solicitation of Phoenix IssuesIf an Association Member will engage in the purchase and sale or other transactions in

over-the-counter handled securities, the Association Member must determine transaction commencement standards for each transaction, and enter into an agreement with a customer for the said transactions, etc. that is consistent with the transaction initiation criteria (Investment Solicitation Rules, art. 6). Consequently the transaction initiation criteria will also apply to Phoenix issues that are classified as over-the-counter handled securities.

Association Members must deliver to a customer who will carry out a transaction in Phoenix issues (excluding a professional investor) a document to be delivered prior to conclusion of a contract, which states the nature of the Phoenix issues, the structure of the transaction, the method of transaction in the Phoenix issues at the relevant Association Member, the method of

Issues Listed on a Financial Instruments Exchange Market

Over-the-Counter Securities (otherwise known as “blue-sky issues”)Over-the-Counter Handled Securities

(a company continuously disclosing corporate information or issue for which corporate

information may be disclosed at certain minimum level)

Phoenix IssuesIssues for which solicitation by Regular Members that maintain

quotes, etc. is allowed

ShareholdersCommunity Issues

Solicitation for investment is allowed (limited to solicitation

of members of a shareholders community)

Solicitation for investment is allowed

Equity-based crowdfunding

(only funding in small amount)



disseminating information concerning Phoenix issues and the risks, etc. associated with investing in Phoenix issues, together with the matters set forth in the FIEA, art. 37-3, para. 1 (matters to be stated in the documents to be delivered prior to conclusion of contract), and give a sufficient explanation thereof (Phoenix Rules, art. 19, para. 1).

Moreover, an Association Member must obtain in a prescribed form a letter of confirmation concerning transaction in Phoenix issues from customers who will engage in transactions in Phoenix issues for the first time (excluding the sale of Phoenix issues), in order to confirm that the transaction in the Phoenix issues is being made at the discretion and responsibility of that customer (Phoenix Rules, art. 19, para. 2).

In substitution of the collection of a written confirmation concerning a transaction of Phoenix Issues, Association Members may use methods employing electronic information processing systems or other information technologies to receive the items of information to be described in the document. In such cases, the Association Members shall be regarded as having collected the document (Phoenix Rules, art. 40; Document Delivery Rules, art. 4).

(3) Trading in Phoenix IssuesTrades of Phoenix issues are conducted in the same form as for over-the-counter securities.In soliciting investment in Phoenix issues, a handling member, etc. must either continually

display its ask quote or bid quote (hereinafter referred to as a “quote”) which serves as reference for sale and purchase prices, at the counter, etc. of its handling departments or branches that solicit investment in Phoenix issues, every business day for issues with a clear indication of daily publication, or at least once every week for issues with a clear indication of weekly publication (Phoenix Rules, art. 35, para. 1).

A handling member, etc. must report the latest quotes, and if a Regular Member has conducted transactions of Phoenix issues, the Regular Member report the details of the transactions to the JSDA with the same frequency as its displays quotes at its handling departments or branches. Finally, the JSDA publishes the quotes and the details of transactions of Phoenix issues reported from handling members, etc. (Phoenix Rules, art. 35, para. 3, para. 4 and para. 7).

5 3 Shareholders Community

(1) Shareholders CommunityThe shareholders community is a system that was established in May 2015 for distributing

unlisted shares and raising funds in order to meet the needs for trading in and cashing out unlisted shares for the purpose of supporting companies belonging to the local communities.

A shareholders community is a group of investors who intend to invest in a single issue of over-the-counter securities (Shareholders Community Rules, art. 2, item 3). A shareholders community issue is an issue of over-the-counter securities for which a single Operating Member

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operates a shareholders community and solicits customers for investment (Shareholders Community Rules, art. 2, item 5).

An Operating Member is a Regular Member (securities firm) designated by the JSDA to be engaged in operating a shareholders community (Shareholders Community Rules, art. 2, item 4).

(2) Prohibition of Concurrent Engagement in the Equity-based Crowdfunding BusinessWhen a Regular Member handles over-the-counter securities in the equity-based

crowdfunding business, it must not handle a public offering, etc. of the relevant over-the-counter securities in a shareholders community (Shareholders Community Rules, art. 3).

(3) Composition and Examination of a Shareholders CommunityAn Operating Member must set up a shareholders community for each issue (Shareholders

Community Rules, art. 4, para. 2).A Regular Member must not set up a shareholders community involving Phoenix issues

(Shareholders Community Rules, Supplementary Provisions, para. 2).An Operating Member must conduct strict examination of over-the-counter securities for

which it is to set up a shareholders community, in terms of certain matters including the issuer and the existence of its business, and the issuer’s financial condition, in accordance with the internal rules established by the said Operating Member, and if the relevant securities are not found to be suitable to be a shareholders community issue, the Operating Member must not set up a shareholders community for the said securities (Shareholders Community Rules, art. 5, para. 1). Issuers of shareholders community issues are subject to stricter regulations regarding elimination of antisocial forces than those of Phoenix issues (Shareholders Community Rules, art. 5, para. 1, item 4, art. 6, and art. 7).

(4) Solicitation for Participation in a Shareholders CommunityAn Operating Member must not perform the procedure to include an investor in a

shareholders community unless the investor so requests (Shareholders Community Rules, art. 9, para. 1).

Furthermore, an Operating Member must not solicit investors to participate in a shareholders community; provided, however, that this shall not apply if an Operating Member can confirm that the investor whom the Operating Member solicits is a holder of the shareholders community issue or an officer or employee of the issuer of the shareholders community issue (Shareholders Community Rules, art. 9, para. 2).

In other words, a securities firm which is an Operating Member is allowed to solicit investors who are members of a shareholders community face-to-face, by phone or via the Internet to invest in the shareholders community issue, but in principle, it is prohibited from soliciting investors who are not members of a shareholders community. This does not mean to prohibit investors from participating in a shareholders community voluntarily.



(5) CollectionofaWrittenConfirmation,Etc.In order to confirm that investors who are to participate for the first time in a shareholders

community operated by an Operating Member (excluding professional investors) understand the risks, fees and other matters concerning the act of financial instruments transaction as stated in the documents to be delivered prior to conclusion of contract and also intend to conduct over-the-counter transactions of the shareholders community issue at their own discretion and responsibility, the Operating Member must prepare in advance a document containing the matters stated in the documents to be delivered prior to conclusion of contract and deliver it to the customers while providing them with sufficient explanation on the risks, etc. Next, the Operating Member must collect a written confirmation from them regarding the over-the-counter transactions of the shareholders community issue (Shareholders Community Rules, art. 10).

In substitution of the collection of a written confirmation concerning over-the-counter transactions of shareholders community issues, an Operating Member may use methods employing electronic information processing systems or other information technologies to receive the items of information to be described in the document. In such cases, the Operating Member shall be regarded as having collected the document (Shareholders Community Rules, art. 31, para. 2; Document Delivery Rules, art. 4).

(6) Acquisition and Provision of Information About Shareholders Community IssuesAn Operating Member must provide an investor who has applied for participation in a

shareholders community with basic information on the issuer of the shareholders community issue (Shareholders Community Rules, art. 9, para. 3).

An Operating Member must publicly announce the information about respective shareholders community issues set forth in the following (Shareholders Community Rules, art. 12, para. 1):

(i) The issue name for the shareholders community issue handled by the Operating Member;

(ii) URL assigned to the web page on which the issuer of the shareholders community issue posts the information about the issuer (or its main telephone number if the issuer does not operate its own website);

(iii) Special benefits to shareholders of the issuer of the shareholders community issue;(iv) Handling, etc. of offerings, etc. for the shareholders community issue, if applicable, and

their subscription periods.However, except in the following cases, an Operating Member must not provide the

information about any shareholders community issue to any person other than the participants in the shareholders community for the shareholders community issue (Shareholders Community Rules, art. 12, para. 2):

(i) When providing the information set forth in (i) to (iv) above;(ii) When providing the information to a person who has applied for participation in the

shareholders community;(iii) When providing the information that falls under any of the following to any person

other than the participants in the shareholders community for the shareholder

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community issue at the request of such person:a. Information publicized or made available for public inspection by the issuer of the

shareholders community issue or information posted on a website accessible to many and unspecified persons;

b. Information that the issuer of the shareholders community issue has consented to provide to any person other than the participants in the shareholders community for the shareholders community issue; or

c. Information concerning the contract of the shareholders community issue.An Operating Member must acquire securities registration statements, etc. under the FIEA,

financial statements, etc. and any other information regarding the issuer of shareholders community issue (Shareholders Community Rules, art. 13).

If an Operating Member acquires any information mentioned above, the Operating Member must provide such information to participants in the shareholders community for the shareholders community issue or make such information available for inspection by the participants (Shareholders Community Rules, art. 14).

(7) Delivery of Documents to Be Delivered Prior to Conclusion of ContractAn Operating Member must also include, in the documents to be delivered prior to

conclusion of contract under Article 37-3, Paragraph 1 of the FIEA to participants in a shareholders community who conduct over-the-counter transactions of the shareholder community issue (excluding professional investors), at a minimum the information regarding risks specific to shareholders community issues. This information will include matters such as “there are no quotations or market prices regarding shareholders community issues which can be used as reference for trading and their liquidity is extremely low”, and “the value of the shareholders community issue may be significantly impaired due to circumstances of the issuer of the shareholders community issue or other related circumstances.” The Operating Member must then deliver such documents to participants pursuant to the provisions of the said Article while providing them with sufficient explanation on these matters (Shareholders Community Rules, art. 15).

(8) Prohibition of Acceptance of Market Orders, Margin Transactions, and Over-the-Counter Transactions for Unissued Over-the-Counter SecuritiesRegular Members must not accept market orders for shareholders community issues or

conduct margin transactions (including a sale and purchase conducted by a Regular Member based on credit granting) for shareholders community issues. Regular Members must not conduct over-the-counter transactions for shareholders community issues not yet issued (Shareholders Community Rules, art. 24, para. 1, para. 2 and para. 3).



5 4 Equity-based Crowdfunding

(1) Equity-based CrowdfundingThrough the amendment to the FIEA, the equity-based crowdfunding business (type I small

amount electronic offering handling business) has been included in the scope of type I financial instruments business (FIEA, art. 29-4-2, para. 10).

The equity-based crowdfunding business refers to type I small amount electronic offering handling business conducted by Regular Members, etc. in connection with share certificates or share option certificates among over-the-counter securities (Crowdfunding Rules, art. 2, item 2).

Regulations under the Crowdfunding Rules are applicable to Regular Members as well as Specified Business Members who are exclusively engaged in the equity-based crowdfunding business.

(2) ProhibitionofConcurrentEngagementinHandlingPublicOffering,Etc.inaShareholders CommunityWhen a Regular Member, etc. handles a public offering, etc. of a shareholders community

issue for which it operates a shareholders community as an Operating Member, it must not engage in the equity-based crowdfunding business with regard to the relevant shareholders community issue (Crowdfunding Rules, art. 3).

(3) Examination of the IssuerWhen engaging in an equity-based crowdfunding business, a Regular Member, etc. must

conduct strict examination of over-the-counter securities to be handled in the business in advance in terms of certain matters including the issuer and the existence of its business, and the issuer’s financial condition, in accordance with the internal rules established by the said Regular Member (Crowdfunding Rules, art. 4). Issuers of securities handled in the equity-based crowdfunding business are subject to stricter regulations regarding elimination of antisocial forces than those of Phoenix issues (Crowdfunding Rules, art. 4, para. 1, item 5, art. 5, and art. 6).

(4) Provision of Information via the WebsiteWhen a Regular Member, etc. conducts the equity-based crowdfunding business, it must

make the particulars to be stated in the document to be delivered prior to conclusion of contract, which are specified by Cabinet Office Ordinance as having a material influence on decisions by the other party to the electronic offering handling business, available for inspection by the said other party using the Internet (by means of an electronic data processing system or by any other means of information and communications technology), throughout the period in which it conducts the equity-based crowdfunding business. Specifically, a Regular Member must make available information regarding risks specific to over-the-counter securities to be acquired by customers, such as that “the duty of disclosure at a level equivalent to the duty of disclosure required under the FIEA or timely disclosure required by applicable rules of financial instruments

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exchanges does not apply” and “there are no quotes or market prices which can be used as reference for trading and that their liquidity is extremely low” (FIBCOO, art. 146-2; Crowdfunding Rules, art. 9).

(5) Solicitation in Relation to Equity-Based Crowdfunding BusinessWhen conducting the equity-based crowdfunding business, a Regular Member, etc. must not

solicit investors for investment through the equity-based crowdfunding business by methods that do not use means of information and communications technology (e.g., websites and emails) such as calling or visiting customers (FIBCOO, art. 6-2; Crowdfunding Rules, art. 12).

(i) Documents to Be Delivered Prior to Conclusion of ContractWhen conducting the equity-based crowdfunding business, a Regular Member, etc.

must include, in the documents to be delivered prior to conclusion of contract, at the minimum matters including the fact that the relevant business is conducted as equity-based crowdfunding business, as well as the information on the offering procedure and risks, and deliver such documents to customers (excluding professional investors) (Crowdfunding Rules, art. 10).(ii) CollectionofaWrittenConfirmation

In order to confirm that customers, who are to acquire over-the-counter securities through the equity-based crowdfunding business for the first time (excluding professional investors) understand the risks, fees and other matters concerning the act of financial instruments transaction as stated in the documents to be delivered prior to conclusion of contract and also intend to acquire the securities at their own discretion and responsibility, a Regular Member, etc. must in advance prepare a document containing certain matters and deliver it to the customers. Next, the Regular Member must collect a written confirmation from them regarding the acquisition of over-the-counter securities through the equity-based crowdfunding business (Crowdfunding Rules, art. 11).

In substitution of the collection of a written confirmation concerning the acquisition of over-the-counter securities handled in the equity-based crowdfunding business, a Regular Member, etc. may use methods employing electronic information processing systems or other information technologies to receive the items of information to be described in the document. In such cases, the Regular Member, etc. shall be regarded as having collected the document (Crowdfunding Rules, art. 28, para. 2; Document Delivery Rules, art. 4).

(6) ConfirmationofAmountPaid-inSatisfyingSmallAmountRequirementsWhen intending to have customers acquire over-the-counter securities in equity-based

crowdfunding business, Regular Members, etc. must confirm that the amount paid in by each customer fulfills the statutory small amount requirements (FIEA Enforcement Order, art. 15-10-3; Crowdfunding Rules, art. 13).

The small amount requirements are that the amount calculated by a method specified by Cabinet Office Ordinance as the total issue value is less than JPY100 million and that the amount calculated by a method specified by Cabinet Office Ordinance as the amount to be paid in by



prospective acquirers is not more than JPY500,000 (FIEA Enforcement Order, art. 15-10-3).Credit cards are available for settlement of transactions handled in the equity-based

crowdfunding business which are less likely to be detrimental to investor protection, i.e., a customer makes payment in lump sum within less than two months and the amount of credit extended to the customer is not more than JPY100,000 (FIEA, art. 44-2, para. 1, item 3; FIBCOO, art. 149, item 1).

(7) Separate Management of Customer AssetsIf Regular Members, etc. in their equity-based crowdfunding business intend to have

customers acquire over-the-counter securities and keep money deposited by those customers, the Regular Members, etc. must ensure separate management for such deposited money in an appropriate manner in accordance with the FIEA (Crowdfunding Rules, art. 14).

(8) Proper AllocationWhen conducting equity-based crowdfunding business, Regular Members, etc. must ensure

fairness in allocation of over-the-counter securities handled in their equity-based crowdfunding business, taking investment needs and other trends into full consideration, and endeavor to avoid unfounded partiality so that the securities will not be preferentially allocated to specific investors without reasonable grounds (Crowdfunding Rules, art. 15).

(9) Subsequent Provision of Information by Issuers on Regular BasisRegular Members, etc. must conclude a contract with each of the issuers of over-the-counter

securities that they handle in their equity-based crowdfunding business in order to ensure that the issuers will regularly provide appropriate information about their business operations to customers acquiring relevant over-the-counter securities after they pay in their subscription amounts. The Regular Members, etc. must verify whether the issuers provide information in accordance with such contracts (Crowdfunding Rules, art. 16, para. 1 and para. 2).

6 Trades Off the Financial Instruments Exchange Market in Listed Share Certificates, Etc.

Trading off the financial instruments exchange market in the broad sense of the term involves one type of “over-the-counter transactions,” and is principally done in cases where a financial instruments business operator engages in a purchase (or sale) as counterparty to a block sale order (or purchase order) received from an institutional investor, etc.

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Section 6. Trades Off the Financial Instruments Exchange Market in Listed Share Certificates, Etc.


6 1 Differentiation from Trades on Financial Instruments Exchange Market

In general, trading on the financial instruments exchange market is conducted through the auction system, in conformity with the priority rules concerning price and time. In contrast, trades off the financial instruments exchange market (hereinafter referred to as “off-exchange” where appropriate) are not filtered through an exchange, but rather, in most cases, are conducted at the counters of financial instruments business operators through direct negotiations with the financial instruments business operator.

Accordingly, even if a trade on an exchange and a transaction off an exchange (hereinafter referred to as “off-exchange trades”) were to be concluded at the same time, the price may vary. Also, it is necessary for the parties to arrange for delivery and settlement.

6 2 Compliance with Law and Regulations, Etc.

Rules for off-exchange trades are established in the “Rules Concerning Sale and Purchase, Etc. of Listed Share Certificates, Etc. Conducted Outside of Financial Instruments Exchange Market” and the “Detailed Rules Related to the ‘Rules Concerning Sale and Purchase, Etc. of Listed Share Certificates, Etc. Conducted Outside of Financial Instruments Exchange Market” of the JSDA. It is also necessary to comply with the FIEA and other relevant laws and regulations, and other miscellaneous rules in addition to the said rules when conducting off-exchange trades (Off-Market Trading Rules, art. 3).

6 3 Forms of Trading

Many off-exchange trades are conducted through financial instruments business operators, whereby the financial instruments business operator acts as counterparty to conclude the trade in response to a customer order, which is a dealer transaction.

Apart from dealer transactions, there are brokered transactions in which a financial instruments business operator is entrusted a trade from a customer such as a transaction where the financial instruments business operator conducts intermediation to assist the parties to establish a trade (intermediary), a transaction where the financial instruments business operator will broker an entrusted order from the customer to another financial instruments business operator in its own name (brokerage), or a transaction where the financial instruments business operator carries out the order of the customer as its agent (agency services) (Off-Market Trading Rules, art. 1).



6 4 Eligible Listed Share Certificates, Etc.

The eligible listed share certificates, etc. refer to the following securities that are listed on a domestic exchange (Off-Market Trading Rules, art. 2, item 1):

(1) Share certificates;(2) Contribution certificates (including preferred equity investment certificates);(3) Convertible-type bonds with share options;(4) Exchangeable bonds;(5) Bonds with share options, and share option certificates;(6) Investment trust beneficiary certificates, foreign investment trust beneficiary

certificates;(7) Investment securities, investment equity subscription right certificates, foreign

investment securities; and(8) Depositary receipts of foreign shares.

6 5 Exemption from Off-Market Trading Rules

The Off-Market Trading Rules do not apply to, out of off-exchange sales and purchases conducted by Regular Members and off-exchange sales and purchases for which the intermediary services, etc. are conducted by Association Members, a sale and purchase with a volume of less than one sale-and-purchase unit and any of the sales and purchases listed below (Off-Market Trading Rules, art. 4, para. 1 and para. 2):

(i) Purchase of listed shares, etc. through a tender offer made by an Association Member who is to serve as a purchaser of listed shares, etc. through a tender offer on behalf of a tender offeror;

(ii) Purchase of listed shares, etc. through a tender offer made by an Association Member who is to be a tender offeror;

(iii) Purchase of treasury shares through a tender offer made by an Association Member who is to be the issuing company of listed shares, etc.; and

(iv) Sale of listed shares, etc. in response to a tender offer.Among off-exchange sales and purchases conducted by Regular Members and off-exchange

sales and purchases for which the intermediary services, etc. are conducted by Association Members, a sale and purchase concluded in over-the-counter transactions of derivatives is also excluded from the application of the Off-Market Trading Rules (Off-Market Trading Rules, art. 4, para. 3).

In the event that any of the acts set forth in Article 118, item 1, (a) through (e) of the

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FIBCOO (referred to as “problematic conduct”) were to take place in relation to a sale and purchase of listed share certificates, etc. entrusted to an Association Member from a customer, the Off-Market Trading Rules do not apply to an off-exchange sale and purchase for which the Association Member conducts intermediary services, etc. and which is conducted, with the customer’s consent, between the customer’s account and the account for handling problematic conduct in order to cancel the sales and purchase resulting from the problematic conduct or perform the obligation in compliance with the purpose of the customer’s order (Off-Market Trading Rules, art. 4, para. 4).

6 6 Confirmation of Sale and Purchase Price and Record Keeping

Association Members (which in the case of Special Members shall be limited to Special Members that engage in financial instruments intermediary services; hereinafter the same in this section) must whenever engaging in off-exchange trades confirm that the prices or the amounts of money involved in transactions were appropriate and keep the record of those confirmations (Off-Market Trading Rules, art. 1 and art. 5).

6 7 Prohibition of Sale and Purchase, Etc. Imposed on Association Members

If information that is found to be likely to materially influence investors’ investment decisions is circulating with regard to the share certificates, etc. listed on a financial instruments exchange or the issuer thereof, and an Association Member becomes aware that the financial instruments exchange plans to suspend or has suspended the sale and purchase of the listed share certificates, etc. on the grounds that the content of such information is unclear or that the financial instruments exchange finds it necessary to make such information public, the Association Member must not execute an off-exchange sale and purchase of the relevant listed share certificates, etc. until the financial instruments exchange resumes the sale and purchase of such listed share certificates, etc. (Off-Market Trading Rules, art. 6).

When an Association Member intends to conduct an off-market sale and purchase or intermediary, etc. thereof, it must have in place systems including a system for confirming information regarding the suspension of sale and purchase of listed share certificates, etc. imposed by a financial instruments exchange (Off-Market Trading Rules, art. 6-2, para. 1).

An Association Member must also have in place a system wherein, if, after the trading hours on the exchange, it acquires information that is found to be likely to materially influence investors’ investment decisions regarding listed share certificates, etc. or the issuer thereof, it will suspend an off-exchange sale and purchase of the relevant listed share certificates, etc. until the start of the trading hours for the listed share certificate, etc. (Off-Market Trading Rules, art. 6-2,



para. 2).Notwithstanding these rules, a Regular Member may conduct an off-exchange sale and

purchase of listed share certificates, etc. with its overseas affiliate company, in order to transfer the position in the sale and purchase of the listed share certificates, etc. conducted by the Regular Member or its overseas affiliated company with the customer thereof (Off-Market Trading Rules, art. 6-2, para. 3).

6 8 Suspension of Sale and Purchase, Etc. Imposed by the JSDA

In any of the following cases, the JSDA may suspend an off-exchange sale and purchase to be conducted by a Regular Member and an off-exchange sale and purchase for which an Association Member conducts intermediary, etc. if it deems necessary and appropriate to do so for public interest or protection of investors (Off-Market Trading Rules, art. 6-5, para. 1), and the suspension of an off-exchange sale and purchase shall continue for a period as deemed necessary by the JSDA each time (Off-Market Trading Rules, art. 6-5, para.2):

(i) if any information that is found to be likely to materially influence investors’ investment decisions is circulating with regard to listed share certificates, etc. or the issuer thereof, and the content of such information is unclear or the JSDA finds it necessary to make such information public;

(ii) if the JSDA finds something abnormal in the status of sale and purchase or finds the risk thereof, or finds it inappropriate to allow the sale and purchase to be continued for control purposes; or

(iii) if the JSDA finds it necessary to suspend the sale and purchase, etc. for other reasons.An Association Member must not execute an off-exchange sale and purchase while the JSDA

is suspending an off-exchange sale and purchase (Off-Market Trading Rules, art. 6-5, para. 3).

6 9 Report and Announcement, Etc. of Sale and Purchase, Etc. (Reports and Public Announcement, Etc. of Off-Exchange Sale and Purchases Other Than Those Conducted Through Approved Business)

(1) Reporting and Publication SystemThe JSDA manages and operates a system for reporting off-exchange trading and for

publishing price information, etc. in connection with off-exchange trading (hereinafter referred to as the “Reporting and Publication System”) (Off-Market Trading Rules, art. 2, item 4).

(2) Report on Sale and Purchase, Etc.Whenever a Regular Member makes an offer for the sale or purchase of listed securities

outside of a financial instruments exchange market (hereinafter referred to as “offers”) simultaneously to a large number of persons (excluding cases where a Regular Member makes

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such offer through their approved business), the Regular Member must report the following to the JSDA through the Reporting and Publication System: name of issues, distinction between sale and purchase pertaining to the offer, price pertaining to the offer (the highest price for the issue in the case of an offer for purchase; the lowest price for the issue in the case of an offer for sale), volume pertaining to the offer, and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 7, para. 1).

If a Regular Member concludes an off-exchange sale or purchase (excluding cases where a Regular Member concludes such sale or purchase through the approved business), the Regular Member must report the following to the JSDA through the Reporting and Publication System: name of issues; sale and purchase price; sale and purchase volume; date and time when the sale and purchase is concluded, distinction between sale and purchase, distinction between dealing and broking; name of the financial instruments exchange where a standard price pertaining to off-exchange sale or purchase is published and the price; the counterparty to the sale and purchase; distinction between a cash transaction and a margin transaction (for details, see this Chapter, “10. Margin Transactions”); in the case of a margin transaction, distinction between a standardized margin transaction and a negotiable margin transaction; if the Regular Member intends to conduct the sale or purchase in order to repay the purchase price or return the securities for sale that have been lent thereto in margin transactions, a statement to that effect; and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 7, para. 2). In the event of an offer or trade that is made between 8:10AM and 4:59PM on a business day, the report must be made within five minutes after the offer was made or the trade was carried out, and if at other times the report must be made within a certain period of time (Off-Market Trading Rules, art. 7, para. 3).

(3) Correction or Cancellation of Report on Sale and Purchase, Etc.If a Regular Member intends to correct or cancel the report on an offer for off-exchange sale

and purchase or the report of a sale and purchase, it must immediately report such correction or cancellation to the JSDA through the Report and Publication System (Off-Market Trading Rules, art. 8, para. 1).

(4) Publication, Etc. of Sale and Purchase Price, Etc.The JSDA shall, (i) immediately upon receiving from a Regular Member a report of an offer

for sale or purchase, or (ii) promptly upon receiving from a Regular Member a report of a sale or purchase, notify the Regular Member of and publicly announce the following: in the case of (i), name of issues, distinction between sale and purchase pertaining to the offer, price pertaining to the offer, volume pertaining to the offer, time when the offer is made, and other matters the JSDA deems necessary; or in the case of (ii), name of issues, sale and purchase price, sale and purchase volume, date and time when the sale and purchase is concluded, and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 9, para. 1 and the main clause of para. 2). Nevertheless, if the total price of the trade is JPY5 billion or more in one issue, because the possibility exists that publication of the same may have an impact on the market, and be to the significant disadvantage of parties to the trade, the announcement will be made at 4:00PM on the



following business day (Off-Market Trading Rules, art. 9, para. 2 (proviso), and the Detailed Rules Related to Off-Market Trading Rules, art. 6).

The JSDA shall, in accordance with the reports on offers and the reports on corrections or cancellations pertaining to offers, sum up and publicize on a daily basis the sale and purchase prices and volumes of each issue of listed share certificates, etc. and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 9, para. 3).

The JSDA shall, in accordance with the reports of off-exchange sales and purchases concluded and the reports on corrections or cancellations of sale and purchase reports which pertain to sales and purchases, sum up and publicize on a daily basis the sales and purchase volumes of each class of the listed share certificates, etc., the sale and purchase prices and volumes of each issue, and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 9, para. 4).

6 10 Explanation to Customers

When an Association Member receives an order from a customer for off-exchange trades, the Association Member must make an explanation in advance to the customer of the matters that the Association Member deems to be necessary, such as conditions relating to delivery settlements (Off-Market Trading Rules, art. 18).

6 11 PTS (Proprietary Trading System)

(1) What is PTS?PTS is a form of off-exchange transaction.PTS is an “electronic trading market” operated by a financial instruments business operator

under the approval of the Prime Minister in accordance with the provisions of the FIEA, with investors or financial instruments business operators placing orders, and conducting trades on this PTS (FIEA, art. 2, para. 8, item 10 and art. 30).

The word PTS first came into use in the United States, and is an abbreviation of Proprietary Trading System. In Japan, this is translated as “shisetsu torihiki shisutemu.”

Similarly, the “Proprietary Trading System Operating Business” was introduced into Japan as a part of the securities business under the 1998 amendments to the Securities and Exchange Law, and there are already financial instruments business operators who have established and operated a PTS after being approved to conduct the PTS operating business. Initially, these trading systems were only operated by a few e-brokerages, then in 2008 some of the major securities firms also opened their PTS systems and carried out transactions in the evening when exchanges did not receive orders. However, in 2011, securities firms stopped the operation of their

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PTS in succession.These securities firms discontinued operating the PTSs that were unprofitable presumably for

the purpose of saving costs, due to the deterioration of their business following the collapse of Lehman Brothers in 2008.

Night trading on the PTS was launched in an attempt to attract more investors with its advantage of allowing them to trade at night while watching the price movements on the major stock markets in Europe and the United States. However, this attempt failed mainly because margin transactions were banned and only spot transactions were allowed on the PTS, which rendered the system less convenient to day traders who had been expected to be its main users. The securities firms operating the PTS adopted smaller price limits (10% of an on-exchange transaction if the base price is not more than JPY3 million; or JPY100 if the base price exceeds JPY3 million) to make the system more user-friendly, but this increased the costs for making investments to enhance the system. They also incurred additional costs for holding a certain volume of share certificates to respond to buy and sell orders from customers.

In the “Report by the Working Group on Financial Markets under the Financial System Council —Initiatives toward Stable Asset Building and the Development of Institutional Systems related to Markets and Exchanges—” (December 22, 2016), lifting the ban on margin transactions on the PTS was discussed as a possible option, on condition that appropriate measures to prevent conflicts of interest were in place.

Following this, the JSDA’s Study Group on the PTS Margin Transaction, which was primarily composed of persons responsible at companies in this business field, compiled a report in June 2018.

In light of the public comments obtained with regard to the proposed partial revision to the Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc., the FSA decided to lift the ban on margin transactions at PTSs on April 1, 2019, on conditions that appropriate measures to prevent conflicts of interest have been taken (“Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc.,” IV-4-2-1, (ii) A. f.).

The JSDA discussed its self-regulatory rules concerning PTS Margin Transaction at via the “Working Group on Off-Exchange Trading,” and in light of the results of the public comment procedure by the FSA, it revised the Off-Market Trading Rules on March 19, 2019, and thereby lifted the ban on margin transactions at PTSs as of July 16, 2019 (for details, see this Chapter, “10-2 (9) PTS Margin Transactions”).

(2) PTS Price Fixing MethodsPricing on the PTS is determined either by the following methods or by methods similar to

these.Under the FIEA, PTS is “sale or purchase in securities or intermediary, brokerage or agency

services for the same that is performed using an electronic data processing system and through a method of determining the price that is as set forth below, with numerous persons at the same time, either as the party on one side or each as parties” (FIEA, art. 2, para. 8, item 10):



a) Auction (double auction trades) method (the total volume of securities traded cannot exceed the amount stipulated by cabinet order (FIEA Enforcement Order, art. 1-10));

b) For listed securities, methods using the trading price on the exchange where the said securities are listed;

c) For securities traded over-the-counter, a method using the trading price in the securities that is publicly announced by the JSDA;

d) Methods using the price determined based on negotiations between the customers;

e) In cases where the limit order presented by the customer matches with the limit order presented by another customer who will act as counterparty to the transaction, methods using the limit order presented by the said customer; and

f) Where a financial instruments business operator presents multiple bid/ask quotes for a single issue by itself or another financial instruments business operator, methods using the price based on such multiple bid/ask quotes (excluding cases in which more than one financial instruments business operator is constantly presenting bid/ask quotes, and has an obligation to trade based on the bid/offer quotes).

(FIEA, art. 2, para. 8, item 10 for a) through d); and FIEA, art. 2, para. 8, item 10 and the Definition Ordinance, art. 17 for e) and f)

(3) Rules Concerning Transactional Fairness and Investor ProtectionAlthough PTS is operated by Approved Members, since financial instruments business

operators do not possess self-regulatory functions, the following conditions are imposed on PTS approval from the standpoint of ensuring transactional fairness and protecting investors (Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, Etc., IV-4-2-1):

(i) External Announcement of Pricing InformationBest quotes and transaction pricing, etc. on the said PTS must be announced in a

manner allowing comparison with other PTS, and through methods allowing unrestricted external access in real time.(ii) Quantity Criteria Pertaining to Transaction Volume

If in a PTS business that determines prices according to a method other than an auction the securities that are traded on the said system are listed on an exchange, where the ratio of the average daily trading value in the most recent six months to the total trading value on all stock exchanges is 10% or more with respect to the individual issue, and is 5% or more of the total, measures must be implemented to:

a) Enhance and upgrade the programs that carry out trade management and

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monitoring for the purpose of assuring fairness in transactions;b) Put in place systems equivalent to default loss reserve systems at exchanges in

order to protect the certainty of settlement; andc) Conduct sufficient and periodic verification in order to preserve the security/

accuracy of the system’s capacity, etc.Moreover, where in the most recent six months, the above ratio is 20% or more with

respect to an individual issue, or 10% or more of the total, the license to open a financial instruments market has to be obtained.

Auction-method transactions on the PTS must follow the standards prescribed separately by Cabinet Order (FIEA Enforcement Order, art. 1-10).(iii) Other

The volume of monthly transactions (percentage, etc.) for each type and issue of securities shall be reported to the Commissioner of the Financial Services Agency (Director-General of the Local Finance Bureau). Also, adequate measures with respect to internal control regime, programs on, e.g., the duty to explain to customers, achieving security and accuracy of the capacity, etc. of the system, and policies on, e.g., preventive steps on order to protect the confidentiality of transaction information must be implemented.

(4) Development of Systems for Suspension of Sale and Purchase in the Approved BusinessAn Approved Member must have in place a system for confirming the existence of the

information regarding the suspension of a sale and purchase of listed share certificates, etc. imposed by a financial instruments exchange, during the hours for handling the Approved Business (Off-Market Trading Rules, art. 6-4, para. 1).

An Approved Member must have in place systems necessary for suspending an off-exchange sale and purchase of listed share certificates, etc. in the Approved Business immediately in the following cases (Off-Market Trading Rules, art. 6-4, para. 2):

(i) If the Approved Member becomes aware of the information regarding the suspension of a sale and purchase of listed share certificates, etc. imposed by a financial instrument exchange;

(ii) If any information that is found to be likely to materially influence investors’ investment decisions is circulating with regard to listed share certificates, etc. or the issuer thereof, and the content of such information is unclear or it is deemed necessary to make such information public;

(iii) If the Approved Member finds something abnormal in the status of sale and purchase or finds the risk thereof, or it is deemed inappropriate to allow the sale and purchase to continue for control purposes;

(iv) If an operational failure occurs with the trading system used in the Approved Business, and it is deemed difficult to allow the sale and purchase to continue due to a failure occurring with the Approved Member’s facilities used for sale and purchase of listed share certificates, etc. or for other reasons; or

(v) If redemption by drawing is made with regard to convertible-type bonds with share



option, and the suspension of a sale and purchase thereof is deemed necessary.When an Approved Member suspends an off-exchange sale and purchase under the

Approved Business, it must immediately publicize the name and code of the issue subject to the suspension of an off-exchange sale and purchase, the period of and reasons for the suspension, and other particulars that the JSDA deems necessary, by such method as making them freely accessible from the outside (Off-Market Trading Rules, art. 6-4, para. 3).

If an Approved Member suspends or resumes an off-exchange sale and purchase of listed share certificates etc. under the Approved Business, it must report to the JSDA, without delay, the name and code of the issue subject to the suspension of an off-exchange sale and purchase, the period of and reasons for the suspension, and other particulars that the JSDA deems necessary (Off-Market Trading Rules, art. 6-4, para. 4).

(5) ReportandPublicationofOff-ExchangeSaleandPurchaseThroughApprovedBusiness(i) ReportonOffer

When an Approved Member makes an offer through the approved business, it must report the following matters to the JSDA through the Report and Publication System by 8:30 a.m. on the business day following the date of the offer: name of issues, distinction between sale and purchase pertaining to the offer, price pertaining to the offer (the highest price for the issues in case of an offer for purchase as of the date of the offer or the lowest price for the said issues in case of an offer for sale as of the date of the offer), volume pertaining to the offer, and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 10, para. 1 and para. 2).(ii) Report on Sale and Purchase

An Approved Member must report the following matters regarding a sale and purchase concluded in the approved business to the JSDA through the Report and Publication System by 8:30 a.m. on the business day following the date of the conclusion of the sale and purchase: name of issues, sale and purchase price, sale and purchase volume, date and time when the sale and purchase is concluded, distinction between sale and purchase, distinction between dealing and broking, name of the financial instruments exchange where a standard price pertaining to off-exchange sale or purchase is published and the price, the counterparty to the sale and purchase, and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 11, para. 1 and para. 2).

If the sale and purchase concluded by an Approved Member in the approved business is a margin transaction at the PTS, the Approved Member must report the following matters in addition to those mentioned above to the JSDA through the Report and Publication System by 8:30 a.m. on the business day following the date of the conclusion of the sale and purchase: distinction between a cash transaction and a margin transaction at the PTS; in the case of a margin transaction at the PTS, distinction between a PTS Standardized Margin Transaction and a PTS Negotiable Margin Transaction; and if the Approved Member intends to conduct the sale or purchase in order to repay the purchase price or return the securities for sale that have been lent thereto in PTS Margin Transaction, a statement to that effect (Off-

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Market Trading Rules, art. 11, para. 1, para. 2, and para. 3).(iii) Correction or Cancellation of Report on Sale and Purchase, Etc.

When an Approved Member intends to make correction or cancellation of a report on an offer for off-exchange sale and purchase or report on a sale and purchase, it must report such correction or cancellation immediately to the JSDA through the Report and Publication System (Off-Market Trading Rules, art. 12, para. 1).(iv) Publication, Etc. of Sale and Purchase Price, Etc.

When the JSDA receives from an Approved Member a report on an offer or a report of cancellation of an offer through the approved business, it shall immediately notify the Approved Members of the following matters: name of issues, distinction between sale and purchase pertaining to the offer, price pertaining to the offer, volume pertaining to the offer, time when the offer is made, and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 14, para. 1). When the JSDA receives from an Approved Member a report on a sale and purchase or a report of correction or cancellation of a sale and purchase report, it shall immediately notify the Approved Members of the following matters: name of issues, sale and purchase price, sale and purchase volume, date and time when the sale and purchase is concluded, and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 14, para. 2).

The JSDA shall, in accordance with the reports on offers through the approved business and the reports on corrections or cancellations regarding offers, sum up and publicize on a daily basis the sale and purchase prices and volumes pertaining to the offers for each issue of listed share certificates, etc. and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 14, para. 3).

The JSDA shall, in accordance with the reports on sales and purchases concluded through the approved business and the reports on corrections or cancellations of sale and purchase reports which pertain to sales and purchases, sum up and publicize on a daily basis the sales and purchase volumes of each class of the listed share certificates, etc., the sale and purchase prices and volumes of each issue, and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 14, para. 4).(v) NotificationofUseofReportandPublicationSystem

If an Approved Member intends to report an offer made or sale and purchase concluded through the approved business using the Report and Publication System, it must notify the JSDA of the intention to use the system in advance in a designated form (Off-Market Trading Rules, art. 15, para. 1).(vi) MakingAvailableforInspectionofthePrice,Etc.ofOffersandSaleandPurchase

Price, Etc. Through Approved BusinessIf an Approved Member makes an offer through the approved business, it must make

the following information available for inspection within five minutes from the offer, using the website of the Report and Publication System: name of issues, distinction between sale and purchase pertaining to the offer, price pertaining to the offer, volume pertaining to the offer, time of the offer, and other matters the JSDA deems necessary (Off-Market Trading



Rules, art. 17-2, para. 1; Detailed Rules Related to Off-Market Trading Rules, art. 7, para. 1).If an Approved Member concludes a sale and purchase through the approved business,

it must make the following information available for inspection within five minutes from the conclusion of the sale and purchase, using the website of the Report and Publication System: name of issues, sale and purchase price, sale and purchase volume, date of the conclusion of sale and purchase, and other matters the JSDA deems necessary (Off-Market Trading Rules, art. 17-3, para. 1; Detailed Rules Related to Off-Market Trading Rules, art. 7, para. 1).

An Approved Member must ensure that the information on the price, etc. pertaining to an offer and the sale and purchase price, etc. that it has made available for inspection will be accurate and updated (Off-Market Trading Rules, art. 17-2, para. 2, and art. 17-3, para. 2).

An Approved Member must take the measures mentioned above with regard to the price, etc. pertaining to an offer and sale and purchase price, etc. in a manner that such information is comparable with the information provided by other Approved Members (Off-Market Trading Rules, art. 17-2, para. 3, and art. 17-3, para. 2).

An Approved Member must immediately notify all Participating Members involved in the Approved Business of the price and other particulars concerning an offer of an off-exchange sale and purchase under the Approved Business as well as the sale and purchase price and other particulars of the concluded sale and purchase (Off-Market Trading Rules, art. 17-4).

A Participating Member is a Regular Member who can intermediate an order from a customer that is to be executed under the Approved Business conducted by an Approved Member (Off-Market Trading Rules, art. 2, item 9).

(6) OthersIf an Approved Member conducts short sales (excluding margin transactions) on its

proprietary trading system, it must establish a method and system for eliminating unfair sale and purchase, etc. involving short sales and describe such method and system in its operational method statement (Off-Market Trading Rules, art. 6-6, para. 1).

If an Approved Member conducts a short sale (excluding margin transactions) on its proprietary trading system, and it receives an order for the short sale from its customer (excluding a Participating Member), it must confirm that, in connection with the securities that are subject to the short sale, settlement measures (the settlement measures prescribed in Article 26-2-2 of the FIEA Enforcement Order, such as confirmation of a guarantee of borrowed securities) have already been taken (Detailed Rules Related to Off-Market Trading Rules, art. 2, para. 1).

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7 Cumulative Stock Investments

7 1 Definition of Cumulative Stock Investments

Cumulative stock investment is a system whereby investors deposit funds with the financial instruments business operator, and the financial instruments business operator uses that pool of funds in order to purchase a predetermined issue of shares, etc. on a certain date each month (joint purchase cumulative investment) (FIEA, art. 35, para. 1, item 7; Cumulative/Mini Stock Investment Rules, art. 1).

This system enables investors to make investments in shares, etc. with a small amount of funds. Since it is designed to purchase the predetermined amount of shares, etc. on a monthly basis, it is expected to encourage long-term stable investments, and increase individual shareholdings.

In addition, by investing in multiple issues, investors can customize their portfolio and mitigate risks. When they make purchases via accounts under the NISA program (the tax exemption program for small-amount investments), they can receive a tax exemption for the dividends and capital gains from the invested shares (in order to enjoy tax exemption for dividends, investors must designate the method of receiving dividends in proportion to the number of shares held in their accounts).

Issues that investors can purchase through cumulative stock investment are those selected by a financial instruments business operator (hereinafter referred to as “selected issues”) (Model Contract for “General Contract on Cumulative Stock Investment,” art. 5, para. 1).

7 2 Features of Cumulative Stock Investments

(1) Allowing Investments in Shares, Etc. to Be Made with Minimal AmountsIn general, investment under the cumulative stock investment system can be made with the

minimum amount of JPY 10,000 per month, in increments of JPY 1,000.

(2) PurchasingaPredeterminedAmountofShares,Etc.ofaSpecificIssueontheDesignated Date Each MonthPurchases are made by the dollar cost averaging method,(Note) that is, purchasing a fixed

monetary amount of shares, etc. of a specific issue on the designated date on a monthly basis, e.g., 20th day of each month, regardless of the trends of the share price level.



(Note)The dollar cost averaging method refers to an investment method in which a fixed

monetary amount is used to make periodic and continuous share investments without regard to market conditions or timing, etc.

Under this method, when the share price is high, fewer shares will be purchased, whereas when the share price is low, more shares will be purchased. In the long run, the average purchase price per share will be lower than periodic purchases made for a set number of shares.

(3) No Restriction on Selling SharesIn principle, investors may sell at any time all or part of the shares purchased under the

cumulative stock investment system (the number of shares to be sold must be an integer, in principle). When investors seek to sell these shares, the financial instruments business operator must execute the transaction on a price in the predetermined exchange on the predetermined execution day of such sell order (FIBCOO, art. 66, item 5; Cumulative/Mini Stock Investment Rules, art. 6, para. 1).

7 3 Structure of Cumulative Stock Investment Contracts

(1) Conclusion of Cumulative Stock Investment Contract(i) When a handling financial instruments business operator receives an order for a

cumulative stock investment from a customer, it must conclude a transaction contract with the said customer based on the general contract on cumulative stock investments (hereinafter referred to as “general contract on cumulative stock investment”) predetermined by the handling financial instruments business operator (Cumulative/Mini Stock Investment Rules, art. 3, para. 1).

(ii) When a handling financial instruments business operator concludes a contract on cumulative stock investment with the customer, it must deliver the general contract on cumulative stock investment to the customer in advance (Cumulative/Mini Stock Investment Rules, art. 3, para. 2).

(iii) Regardless of (i) and (ii) above, when a handling financial instruments business operator receives an order for a cumulative stock investment from another financial instruments business operator, it must conclude a cumulative stock investment contract with the said other financial instruments business operator (Cumulative/Mini Stock Investment Rules, art. 3, para. 3).

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(2) Purchase Method under the Cumulative Stock Investment Contract Concluded with CustomersWhen a financial instruments business operator executes a purchase order using funds

deposited by the customer, it must execute the transaction properly, while paying attention to the following points (Cumulative/Mini Stock Investment Rules, art. 4) :

(i) When a financial instruments business operator executes a purchase order through a financial instruments exchange market, it must perform the transaction continuously under a certain plan and not based on individual investment decisions (Cumulative/Mini Stock Investment Rules, art. 4, item 1).

(ii) When a financial instruments business operator executes a purchase order on a dealer transaction in response to the purchase order within a branch, it must perform the transaction continuously under a certain plan and not based on individual investment decisions, at a price in the predetermined financial instruments exchange market on the predetermined execution date of the purchase order (Cumulative/Mini Stock Investment Rules, art. 4, item 2).

(iii) If the price for executing a purchase order is to be determined based on the price in the financial instruments exchange market, it must be set as either the price within a range of best quotes during a certain period of time or the VWAP on the financial instruments exchange market (Cumulative/Mini Stock Investment Rules, art. 4, item 3). Under a general contract, the contract price may be set as the opening price of the purchase order execution day (Model Contract for “General Contract on Cumulative Stock Investment,” art. 7, para. 2, item 2).

(3) Amount to Be PaidThe maximum purchase amount of an issue by a customer under the cumulative stock

investment contract executed between a financial instruments business operator and a customer must be less than JPY1 million (Cumulative/Mini Stock Investment Rules, art. 5).

(4) Sale(i) When a financial instruments business operator receives an offer for sale from a

customer, it must execute the transaction on a price during a certain period of time on the predetermined financial instruments exchange market on the predetermined execution day of such sell order (Cumulative/Mini Stock Investment Rules, art. 6, para. 1).

(ii) If the price for executing a sell order is to be determined based on the price on the financial instruments exchange market, it must be set as either the price within a range of best quotes during a certain period of time or the VWAP on the financial instruments exchange market (Cumulative/Mini Stock Investment Rules, art. 6, para. 2). Under a general contract, the contract price may be set as the opening price of the sell order execution day (Model Contract for “General Contract on Cumulative Stock Investment,” art. 9, para. 3).



(5) Segregated Management of Proprietary Shares in Cumulative Stock Investment(i) A financial instruments business operator must manage share certificates that are jointly

owned by several customers separately from other securities, and manage the portion held by each customer and dividends from such portion in the account set up specifically for each customer (Cumulative/Mini Stock Investment Rules, art. 7, para. 1).

(ii) A financial instruments business operator must manage its proprietary share certificates in the cumulative stock investment units separately from its proprietary share certificates other than those in the mini stock investment units (Cumulative/Mini Stock Investment Rules, art. 7, para. 2).

(iii) A financial instruments business operator must manage share certificates that are jointly held with customers in the cumulative stock investment units separately from its proprietary share certificates other than those in the cumulative stock investment units (FIBCOO, art. 66, item 4; Cumulative/Mini Stock Investment Rules, art. 7, para. 3).

(iv) When any share certificates are to be transferred between the cumulative stock investment units and other units as a result of sale and purchase transactions in cumulative stock investment, a financial instruments business operator must conduct such transfer in a single trading unit prescribed by the financial instruments exchange (Cumulative/Mini Stock Investment Rules, art. 7, para. 4).

(v) As a method for the management of deposits, a financial instruments business operator must provide in a cumulative stock investment contract that the fruits derived from the money paid and securities deposited by the customer, and the money which the financial instruments business operator keeps custody of due to acceptance of redemption shall be treated as the cumulative investment deposit and shall be subject to accounting separately from any other deposit (FIBCOO, art. 66, item 2).

(6) OthersUnder the general contract, when the portion held by a customer in the shares purchased by

the customer in the cumulative stock investment account reaches the number of sharers constituting one share unit (i.e., the portion held by the customer in the purchased shares reaches the number of shares constituting one share unit as of the day on which the customer’s rights as a shareholder are fixed (record day)), such portion shall be divided into those constituting a share unit and an odd lot, and those constituting a share unit are not covered by the cumulative stock investment contract (Model Contract for “General Contract on Cumulative Stock Investment,” art. 10, para. 5). More specifically, when the number of shares purchased by a customer in the cumulative stock investment account reaches the number of shares constituting one trading unit, these shares are transferred to the customer’s book-entry transfer account.

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8 Mini Stock Investments

8 1 Definition of Mini Stock Investments

Mini stock investments are transactions concluded between a customer and a financial instruments business operator for a number of shares less than the normal trading unit prescribed by an exchange, using standardized purchase methods and the book-entry transfer system of shares, etc. (Cumulative/Mini Stock Investment Rules, art. 1).

In order for the stock market to fulfill its role sufficiently, it is desirable that it be appealing and reliable for investors. In addition to fulfilling the three basic principles of convenience (marketability), stability, and profitability, it must also enable participation from a broad class of investors. To accommodate such needs, the mini stock investment program was founded in September 1995 as a system that would enable stock investment with a small amount of funds.

8 2 Features of Mini Stock Investments

The distinguishing features of the mini stock investment program become clearer when contrasted with the cumulative stock investment system explained in the previous section.

Mini stock investments allow automated purchases at any time for a number of shares as odd-lot shares, and allows the shares purchased to be sold as odd-lot shares. This method enables portfolio management similar to basket management for several issues, even where investments funds are relatively small.

8 3 Structure of Mini Stock Investment Contracts

(1) Conclusion of Mini Stock Investment Contract(i) When a handling financial instruments business operator receives an order for a mini

stock investment from a customer, it must conclude a contract with the customer based on the general contract on Mini Stock Investments (hereinafter referred to as “general contract on mini stock investment”) (Cumulative/Mini Stock Investment Rules, art. 3, para. 1).

(ii) When a handling financial instruments business operator concludes a mini stock investment contract with the customer, it must deliver the general contract on mini stock investment to the customer in advance (Cumulative/Mini Stock Investment Rules, art. 3,



para. 2).(iii) Regardless of (i) and (ii) above, when a handling financial instruments business operator

receives an order for a mini stock investment from another financial instruments business operator, it must conclude a mini stock investment contract with the said other financial instruments business operator (Cumulative/Mini Stock Investment Rules, art. 3, para. 3).

(2) Transaction Unit, Etc.The trading unit for mini stock investments conducted between a handling financial

instruments business operator and a customer shall be determined in accordance with the following:

(i) The transaction unit is set at 1/10 of one trading unit of share certificates as prescribed by the exchange (hereinafter referred to as the “mini trading unit”) (Cumulative/Mini Stock Investment Rules, art. 8, item 1);

(ii) The maximum number of shares of the same issue that can be accepted from a customer on the same business day is limited to the number of units calculated by multiplying one mini trading unit by nine (Cumulative/Mini Stock Investment Rules, art. 8, item 2); and

(iii) Notwithstanding the provisions of (i) above, as regards to the sales of share certificates less than one mini trading unit allotted as a result of a consolidation of shares, capital decrease or share split, or non-compensated share allotment, etc., the transaction may be made in such number of shares (Cumulative/Mini Stock Investment Rules, art. 8, item 3).

(3) Eligible IssuesA handling financial instruments business operator selects shares from among those for

which share certificates are listed on an exchange and which are subject to the unit system as issues eligible for transactions pertaining to the mini stock investment system (hereinafter referred to as the “selected issue”) (Cumulative/Mini Stock Investment Rules, art. 9).

(4) ComplianceA handling financial instruments business operator must comply with domestic laws and

regulations, the various rules and resolutions of the JSDA, the exchanges, and the Japan Securities Depository Center, Incorporated (hereinafter referred to as “JASDEC”) when engaging in mini stock investment transactions with customers (Cumulative/Mini Stock Investment Rules, art. 2).

(5) Order Methods (Model Contract for “General Contract on Mini Stock Investment”)A customer must clearly advise the financial instruments business operator regarding the

following matters upon placing a buy/sell order under a contract on mini stock investment (Model Contract, art. 4, para. 1, item 4):

(i) Issue;(ii) Classification of sale or purchase; and

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(iii) Volume.Furthermore, the financial instruments business operator may suspend the acceptance of

orders for a certain period under the following circumstances (Model Contract, art. 4, para. 2):A) Where due to trading restrictions, etc., the handling financial instruments business

operator or the designated financial instruments business operator cannot execute sales orders or purchase orders for the said issue on the exchange;

B) Where the issuing company of the said issue amends the number share unit prescribed by its articles of incorporation;

C) Where the closing period of the issuing company of the said selected issue nears, the period announced in advance by the handling financial instruments business operator; or

D) When other unavoidable circumstances arise, the period until the said circumstance can be rectified.

(6) Contract Date and Delivery DateWith respect to a mini stock investment, the contract date is the next business day

immediately following the day on which an order is received from a customer (the order date) (Cumulative/Mini Stock Investment Rules, art. 14, para. 1). The third business day counting from the contract date is the delivery date (Cumulative/Mini Stock Investment Rules, art. 14, para. 2).

(7) Contract PriceThe contract price of a mini stock investment between a financial instruments business

operator and the customer is determined based on the price on the predetermined exchange (hereinafter referred to as the “designated exchange”) on the contract date (Cumulative/Mini Stock Investment Rules, art. 15, para. 1).

If the contract price is to be determined using the price on the designated exchange, it is set as either the price within a range of best quotes during a certain period of time or the VWAP on the designated financial instruments exchange (Cumulative/Mini Stock Investment Rules, art. 15, para. 2). In the model contract, the buy/sell price is set at the opening price or the VWAP on the designated exchange for the next trading day after the day the trade order was made.

(8) Segregated Management of Proprietary Shares in Mini Stock InvestmentsA financial instruments business operator must manage, among the share certificates

managed in accounts opened by the JASDEC, the share certificates pertaining to mini stock investments in the entry book of mini stock investment units (hereinafter referred to as “the mini stock investment units”) (Cumulative/Mini Stock Investment Rules, art. 11, para. 1).

The financial instruments business operator must manage its proprietary share certificates separately from the customer portions of share certificates in the mini stock investment units (Cumulative/Mini Stock Investment Rules, art. 11, para. 2). Also, the financial instruments business operator must manage its proprietary share certificates in the mini stock investment units separately from its proprietary share certificates other than those in the mini stock investment



units (Cumulative/Mini Stock Investment Rules, art. 11, para. 3).When any share certificates are to be transferred between the mini stock investment units and

other units as a result of sale and purchase transactions in the mini stock investment units, the financial instruments business operator must conduct such transfer in a single trading unit prescribed by the exchange (Cumulative/Mini Stock Investment Rules, art. 11, para. 4).

The processing when a transaction cannot be established, delivery settlement methods, processing of rights such as dividends, treatment of voting rights, etc., limitations on the exercise of odd lot share repurchase rights, etc., treatment where rights are granted, treatment in cases of a share consolidation or share split, etc., treatment of shareholder preferences, treatment of in the case of de-listing, etc., and treatment of reduction of investment unit, are generally determined by the standard agreement prepared by each financial instruments business operator.

When the number of shares of an issue deposited by a customer to the mini stock investment account at a financial instruments business operator reaches the number of shares constituting that issue’s single trading unit, irrespective of whether the customer so requests, the financial instruments business operator must transfer the portion of such shares corresponding to the integral multiple of single trading units of the said issue held in the mini stock investment to a book-entry transfer account (not mini stock investment account) in the customer’s name (Cumulative/Mini Stock Investment Rules, art. 16, para. 1).

9 Listing of Shares

Listing of shares is an immensely effective means for investors to freely trade shares in the stock markets, and for companies to expand their ability to procure funds and bolster their financial base.

A listing of shares involves a company making a listing application to any of the exchanges located nationwide, and after proceeding through an examination by the exchange, notifying with the Prime Minister and listing the shares.

In order to make a listing, the issuing company must satisfy the “Listing Criteria” prescribed by the exchange to which it is making the application. In recent years, to promote the growth of venture businesses, “Emerging Company Criteria,” which are relaxed versions of the “Listing Criteria,” have been created to enable an enterprise to make a listing even in the initial stages of growth, and companies are being encouraged to make early listing of their shares. For emerging companies, respective listing criteria exist on each of the TSE’s Mothers and JASDAQ, the NSE’s Centrex, the SSE’s Ambitious, and the FSE’s Q-Board.

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9 1 Merits of a Listing

Some of the major advantages to making a listing are as follows:

(1) Expanded Fundraising CapabilityAs companies expand, their demand for funds increases, but a listing makes it possible to

procure the requisite funds from general investors using direct finance.

(2) Improvement in Social CredibilityBy being subject to the scrutiny of an exchange, companies boost their credibility with

customers, financial institutions and the public in general, which can be advantageous in expanding their business transactions and recruiting employees, etc.

(3) Public Relations for CompaniesWhen shares are listed, the company name, share price, and business conditions are

publicized in newspapers, magazines, TV, etc., which can result in tremendous PR opportunities, which is not only an advantage in securing talented personnel, but also improves the work motivation on the part of employees.

(4) Expansion of Asset Protection FunctionsThe price of shares formulated in the exchange, etc. serves as an important backdrop to a

variety of operative legal acts, and insures the fairness of computations regarding asset protection, inheritance, and gifts, etc., while liquidity, and collateral value increase.

(5) Establishment of Management Control SystemsPublic companies are required to establish management-control systems at or above a certain

minimum level. This contributes to the company profitability by further improving the establishment of management control systems in the company organization.

9 2 Listing of Shares and Determination of IPO Price

As for listing new shares, an allocation, etc. of the offered shares is made prior to the listing, by means of a public offering or secondary distribution or acquisition or sale or allocation to a third party, etc. of the shares. However, in regulation of the exchange on which the listing is to take place, there are necessary provisions to achieve fairness in bringing the shares public.

There are two methods of determining the IPO price (the price of the initial public offering, etc. prior to listing): the “book-building” method and the “competitive bid” method (TSE Securities Listing Regulations, art. 217, Enforcement Rules for Securities Listing Regulations, art.



233).

(1) DeterminationofOfferingPriceUsingtheBook-BuildingMethodIf an initial listing applicant (the prospective public company) as well as a financial

instruments business operator who is a principle underwriting participant(note) will conduct book-building, they shall determine the preconditions of the IPO price (meaning the range of prices, etc. presented to investors when conducting an examination of prospective investor demand for the offering) taking into account a comprehensive consideration of the financial condition and business performance of the prospective public company as well as the opinions of persons having specialized knowledge and experience in connection with investment in securities and other information and opinions that are of reference in determining the IPO price (TSE Enforcement Rules for Securities Listing Regulations, art. 243).

Thereafter, they determine the IPO price when making the public offering or secondary distribution prior to listing, by taking into account a comprehensive consideration of the facts and circumstances, including but not limited to the status of investor demand ascertained through the book-building process and the risks that may arise as a result of fluctuations in the securities market during the period until listing, as well as prospective demand (TSE Enforcement Rules for Securities Listing Regulations, art. 234).

Since the full-fledged introduction in 1997 of book-building, all companies have been setting their IPO prices using this method.

(Note) A principal underwriting participant refers to a financial instruments business operator, etc. that is a trading participant on the exchange and which enters into a principal underwriting agreement (meaning the principal underwriting agreement or the agreement by which the handling of the public offering or secondary distribution will be carried out), in connection with the public offering or secondary distribution (TSE Enforcement Rules for Securities Listing Regulations, art. 2, para. 3, item 24 and item 25). It is generally called the “managing securities company.”

(2) Determination of IPO Price Through Competitive BiddingIn a competitive bid, the general investors must participate in the bidding for 50% or more of

the number of shares to be issued in the public offering, etc. (number of shares publicly offered), with the IPO price being determined by those bids (TSE Enforcement Rules for Securities Listing Regulations, art. 246).

Bidding proceeds on a competitive basis, in which the financial instruments business operators that are general trading participants relay the bids received from investors (TSE Enforcement Rules for Securities Listing Regulations, art. 248). In the bidding process, the minimum price (minimum bid price) is the price obtained by having the prospective public company (company scheduled to list) and the principal underwriting participant select two or more listed companies that are comparable to the prospective public company (including at least

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one company selected by the exchange), and then multiplying the amount computed under the comparable company weighted formula by 85% (TSE Enforcement Rules for Securities Listing Regulations, art. 246, para. 2, item 3 and Exhibit 6: Standards for Computing Price Based on Comparative Companies).

The IPO price after bidding closes is determined by the company applying for listing and the principal underwriting participant based on the price derived from the weighted average of the winning bid prices (the weighted average price winning bid) by comprehensively taking into account the facts and circumstances including but not limited to the implementation status of the said bid, the risks that may arise during the period before listing, and the estimates of demand following the bid. In addition, the reasons for those determinations must be published (TSE Enforcement Rules for Securities Listing Regulations, art. 234, para. 1, item 2 and para. 2).

10 Margin Transactions

The Japanese margin transactions system, modeled on U.S. margin transactions, has been in place since June 1951. The feature of this system is that it effectively enables net cash settlement, even though trading is cast in the form of spot transactions.

With the digitization of share certificates, the certificates themselves have been abolished in the case of a listed company, but since e.g., the FIEA and other laws and regulations, as well as exchange regulations and rules of the JSDA refer to “share certificates” we use the term share certificates in this section.

10 1 Outline of Margin Transaction System

(1) Purpose of Margin TransactionsTo process share trading smoothly and formulate fair pricing, it is desirable for a large

volume of supply and demand to be concentrated in a central location. However, because the actual volume of supply and demand is insufficient to achieve those objectives, the introduction of so-called speculative supply and demand is indispensable. At the same time, a certain amount of speculation must be tolerated in order to spur such speculative supply and demand.

Considering the objectives of the FIEA, which is to secure the proper development of the national economy and to protect investors, financial instruments markets should be investment markets. However, investment and speculation are inextricably linked, and not only is the total prohibition of speculative transactions impossible, but an abundance of restrictions can also impede their aim to effectuate the circulation of securities, and obstruct the management of financial instruments markets.

Margin transactions introduce this speculative supply and demand by allowing customers to



use borrowed funds or loaned shares in return for a specified deposit amount, and if the danger of overheating the markets arises, speculation can be dealt with by manipulating the maintenance margin, etc.

(2) DefinitionofMarginTransactionsMargin transactions are defined as the “sale and purchase or other transactions in securities

conducted through the extension of credit from a financial instruments business operator to a customer” (FIEA, art. 156-24). The extension of credit means a loan or other advance of money or securities to the customer (including other financial instruments business operators).

In other words, when a customer engages in securities trading, the financial instruments business operator loans the securities sold or the purchase price to the customer (extension of credit) to make delivery, which enables a person who does not actually have the securities or money to engage in such trading.

“Sale and purchase and other transactions in securities” covers a broad scope of trades, and legally is not limited to on-exchange or off-market trades. However, in practice, margin transactions are limited to the trading of certain issues selected based upon exchange regulations, etc. Margin transactions are prohibited with regard to the following securities: share option certificates; investment securities; investment equity subscription right certificates; securities which have fallen under the delisting criteria; other issues that the exchange deems inappropriate; and securities in transactions of off-auction distribution (TSE Margin/Loan Trading Regulations, art. 3 and art. 4).

(3) License for Margin TransactionsA person who intends to engage in the business of lending money or securities as necessary

for the settlement of margin transactions by utilizing clearing systems of an exchange shall obtain a license from the Prime Minister (FIEA, art. 156-24).

(4) Types of Margin Transactions(i) Standardized Margin Transactions

These are margin transactions that have traditionally been conducted, in which target issues are shares, etc. listed on an exchange, where the issues, broker loan rate, repayment period and method for the processing of rights are uniformly determined by the exchange in its rules (Margin/Loan Trading Regulations and Brokerage Agreement Standards) (TSE Margin/Loan Trading Regulations, art. 2, para. 1). Since no particular stipulation is made in connection with the interest rate, it can be determined freely between a customer and a financial instruments business operator. The financial instruments business operator may borrow share certificates, etc. to sell or the purchase price of securities from a securities finance company through the clearinghouse of the exchange (hereinafter referred to as a “loan transaction”) (TSE Margin/Loan Trading Regulations, art. 1).

A securities finance company is a stock company specializing in securities financing under the FIEA, which engages in the business of lending money or securities necessary for

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Section 10. Margin Transactions


the settlement of margin transactions to financial instruments business operators, with the license granted by the Prime Minister. At present, Japan Securities Finance Co., Ltd. (hereinafter referred to as the “JSF”) operates as a financial securities company.

Moreover, as this type of transaction allows for the use of loan transactions, its trading volume is heavy compared to negotiable margin transactions.

Issues for which standardized margin transactions are allowed are referred to as standardized margin transaction issues, which include the following: (a) share certificates (including preferred equity investment certificates and foreign depositary receipts); (b) real estate investment trust (J-REIT: listed real estate investment trust) securities; (c) indicator-linked investment trust (exchange traded fund (ETF)) beneficiary certificates; (d) foreign investment trust beneficiary certificates; (e) foreign investment securities; (f) beneficiary certificates of a beneficiary certificate issuing trust; (g) beneficiary certificates of a foreign beneficiary certificate issuing trust; and (h) indicator-linked securities trust (exchange traded note (ETN)) beneficiary certificates (TSE Margin/Loan Trading Regulations, art. 7; TSE Business Regulations, art. 2, para. 1, item 1).(ii) Negotiable Margin Transactions

These are margin transactions in which the underlying securities are share certificates, etc. listed on an exchange and which are carried out with the broker loan rate, repayment date and interest rate agreed upon (negotiable) between a customer and a financial instruments business operator (TSE Margin/Loan Trading Regulations, art. 2, para. 2).

However, loan transactions cannot be used to settle this type of margin transaction (TSE Margin/Loan Trading Regulations, art. 11).(iii) PTS Margin Transaction (for details, see this Chapter, “10-2 (9) PTS Margin

Transactions”)

(5) Structure of Margin TransactionsIn trading share certificates, etc., the most general and largest volume of trading occurs

through regular transactions. In a regular transaction, settlement takes place on the second business day following the contract date, at which time the purchase price or sold share certificates, etc. are delivered, and the purchased share certificates, etc. or sales proceeds are received, to close out the trade (TSE Business Regulations, art. 9, para. 3).

In a margin transaction, the customer submits a predetermined margin (security deposits) as security and receives a loan from the financial instruments business operator of the necessary funds or share certificates, etc. to conduct settlement of such regular transactions. The funds loaned or share certificates, etc. will be repaid by a date fixed in advance, and repayment can be made by either net cash settlement if a party makes an offsetting trade in the interim (unless a margin transaction is explicitly ordered, net cash settlement may not be made (Security Deposit Ordinance, art. 10)), or through genbiki or genwatashi, which means repayments from cash on hand (meaning the customer’s receipt of actual share certificates, etc. purchased and collateralized) or by delivery of the equivalent share certificates, etc. borrowed (meaning customer’s receipt of proceeds of shares sold and funds collateralized).



Financial instruments business operators may procure the funds loaned or share certificates, etc. with their own inventory or by engaging in a loan transaction with a securities finance company, but loan transactions can only be used in standardized margin transactions, and in cases of a negotiable margin transaction, the financial instruments business operator must procure the loan or share certificates, etc. from its own inventory, and where it cannot, the use of that margin transaction may be restricted (for details, see this Chapter, 10-2(5) “(iii) Loans of Securities Finance Companies (Loan Transactions)”).

10 2 Margin Transactions in Listed Issues

(1) Actual Practice of Margin Transactions(i) Delivery of Explanatory Documents Concerning Margin Transactions

When executing a contract for financial instruments transaction, financial instruments business operators, etc. must deliver documents stating matters prescribed by laws and regulations (documents to be delivered prior to conclusion of a contract) to the customer in advance (FIEA, art. 37-3). If they are to execute a contract for margin transactions, they must deliver such documents prior to conclusion of the contract concerning margin transactions with the customer.

A margin transaction, where a customer can trade 3.3-fold of his/her own funds at the maximum, can bring greater profits and losses than those arising in a spot transaction (cash transaction). In particular, margin sale is a high-risk, high-return transaction that could produce unlimited losses. In light of such nature, financial instruments business operators, etc. must fully explain the risk of margin transactions to customers. They must also explain that margin transactions are not covered by the cooling-off system (FIEA, art. 37-6, para. 1; FIEA Enforcement Order, art. 16-3, para. 1).(ii) Establishment of Margin Transaction Initiation Criteria

Article 40 of the FIEA provides that financial instruments business operators, etc. may not conduct solicitations considered as inappropriate in light of the customer’s knowledge, experience, financial standing and purposes for executing the contract for financial instruments transaction (principle of suitability). In addition, since the trading of securities through margin transactions can easily become tainted with a speculative aura, the JSDA considers that margin transaction customers should be carefully selected from those customers with sufficient investment experience and financial resources, and requires each financial instruments business operator to set up “Margin Transaction Initiation Criteria” based on the size of the deposited assets, investment experience, and other matters deemed necessary (Investment Solicitation Rules, art. 6, para. 1, item 1).

Also, margin transactions by officers or employees of a financial instruments business operator are prohibited (Employee Rules, art. 7, item 4; TSE Margin/Loan Trading Regulations, art. 5).

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(iii) Written Agreement for Establishment of a Margin Transaction Account and Consent FormCustomers who engage in margin transactions must open a margin transaction account

with their financial instruments business operator. Requests to open an account may be made orally, but when the financial instruments business operator approves the request, the customer itself must individually complete the requisite matters on the “Written Agreement for Establishment of a Margin Transaction Account” in the form specified by the exchange, sign or seal the agreement, and submit it. An English version of this written agreement may be used only with the consent of the trading participant. In lieu of the submission of this written agreement, the financial instruments business operator may receive the information that should be contained in the written agreement by the designated electromagnetic means if the customer has approved this in writing or by electromagnetic means (TSE Brokerage Agreement Standards, art. 5; TSE Agreement for Setting up Margin Transaction Account, art. 25). Furthermore, when conducting margin transactions at PTSs, customers must submit a “Written Agreement on Margin Transactions at the PTS” to their financial instruments business operators, in addition to a “Written Agreement for Establishment of a Margin Transaction Account” (Off-Market Trading Rules, art. 6-9).

In addition, if a salesperson receives a completed Written Agreement for Establishment of a Margin Transaction Account, he must deliver a copy of the said agreement to that customer (Employment Regulations on the part of each of the financial instruments business operators).

When a financial instruments business operator makes an agreement to conduct a margin transaction, it must receive a security deposit from the customer (FIEA, art. 161-2, para. 1; Security Deposit Ordinance, art. 4). Securities may also be used in lieu of a cash margin (FIEA, art. 161-2, para. 2). If the financial instruments business operator plans to rehypothecate the margin securities received, or loan them to another person, it must receive the written consent of the said customer (FIEA, art. 43-4).(iv) Content of the Written Agreement for Establishment of a Margin Transaction

AccountThe purpose of the Written Agreement for Establishment of a Margin Transaction

Account is to ensure that the parties, in executing trading pertaining to margin transactions, agree to follow the provisions relevant to the conditions of margin transactions in: (i) the FIEA and other laws and regulations; (ii) the various rules and resolutions of the JSDA; (iii) the brokerage agreement standards, articles of incorporation, business regulations, other miscellaneous rules and the resolutions of the stock exchanges; and (iv) conventions.

Sample: Preamble of a Written Agreement for the Establishment of a Margin Transaction Account

I fully understand the explanation provided by the Company regarding the characteristics and structure of the margin transaction system. Based on this understanding, I will engage in margin transactions at my own discretion and



responsibility. In establishing my margin transaction account with the Company, I will follow the provisions relevant to the conditions of margin transactions in the Financial Instruments and Exchange Act (Act No. 25 of 1948; hereinafter referred to as the “Act”), other laws and regulations, the brokerage agreement standards, articles of incorporation, business regulations and other miscellaneous rules. I will also follow resolutions of the financial instruments exchange operating the financial instruments exchange market that executes sales and purchases in margin transactions (hereinafter the “Exchange”), and conventions. I agree to the matters set forth in the following Articles, and, in order to prove this, I hereby submit this written agreement. The meanings of the terms in this written agreement are as prescribed in the relevant rules of the Exchange.

Major items are described below:a) Restrictions Under Lending Regulations

In standardized margin transactions, financial instruments business operators must undertake the measures prescribed under lending regulations of a securities finance company. An example of such measures is an extension, etc. where an application is made for repayment of financing when there is a shortage of lending securities (TSE Agreement for Setting up Margin Transaction Account, art. 6).b) Disposition of Security Deposit, Etc.

When the liabilities assumed under a margin agreement are not performed by the prescribed time, the financial instruments business operator can liquidate the security deposit, etc., without any notice or warning whatsoever, and without resort to any legal foreclosure procedures. An example of such default is the case when the security deposit falls below minimum maintenance and additional margin is not received, etc. (TSE Agreement for Setting up Margin Transaction Account, art. 10).

In addition, notwithstanding the terms of the agreement, in cases where the margin securities are loaned or hypothecated, a written consent from the customer must be received in accordance with the law (FIEA, art. 43-4).

(v) Order Instructions for Margin TransactionsEach time a customer with a margin transaction account places a buy/sell order, he must

instruct a financial instruments business operator that the transactions be done as a margin transaction. Orders without this instruction cannot be done as margin transactions (Security Deposit Ordinance, art. 10; TSE Brokerage Agreement Standards, art. 6, para. 1, item 9 and para. 2). Also, each time a financial instruments business operator receives an order for a margin transaction from a customer, it must confirm the type of margin transaction the customer intends to conduct, i.e. either a standardized margin transaction (including PTS Standardized Margin Transaction) or a negotiable margin transaction (including PTS Negotiable Margin Transaction) (Investment Solicitation Rules, art. 7; TSE Brokerage Agreement Standards, art. 6, para. 3). Moreover, a transaction not explicitly ordered as a margin transaction cannot make use of net

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cash settlement through offsetting transactions (Security Deposit Ordinance, art. 10).(vi) Term of Repayment

The term of repayment (return/repayment deadline) for a standardized margin transaction shall be within six months. For a negotiable margin transaction, the term is set by an agreement between the financial instruments business operator and the customer (TSE Brokerage Agreement Standards, art. 43; TSE Margin/Loan Trading Regulations, art. 2).(vii) Issues Which May Be Used in Margin Transactions

Exchanges prohibit margin transactions in share option certificates, investment securities (excluding preferred equity investment certificates), investment equity subscription right certificates, securities that fall under the delisted standards and other inappropriate issues (TSE Margin/Loan Trading Regulations, art. 3), which effectively limits the issues able to be used in margin transactions to listed share certificates. Margin transactions may also be conducted in foreign shares if they are listed on a domestic exchange. In addition, it is also possible to engage in margin transactions in real estate investment trust (J-REIT) securities, indicator-linked investment trust (exchange traded fund (ETF)) beneficiary certificates, infrastructure funds as well as indicator-linked securities trust (exchange traded note (ETN)) beneficiary certificates. Similarly, whereas any listed share certificate may be used in a negotiable margin transaction, in the case of a standardized margin transaction, even if the underlying security is a listed share certificate, it is limited to the standardized margin issues selected by that exchange (TSE Margin/Loan Trading Regulations, art. 7). Furthermore, off-auction lot sales/purchases cannot use margin transactions at all (TSE Margin/Loan Trading Regulations, art. 4).

The outline of the TSE’s selection criteria and disqualification criteria for standardized margin transaction issues is provided below, focusing on common shares listed on the main markets.

OutlineofSelectionCriteriaandDisqualificationCriteriaofStandardizedMargin Issues (TSE)

A) Timing of selecting a stock, etc. as a standardized margin transaction issueThe selection of a standardized margin transaction issue shall be made on the next

business day immediately following the day on which the first contract price is determined after listing (TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, art. 4, para. 1). However, the selection shall be made on the day of listing with regard to issues listed via another market (TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, art. 4, para. 3, item 3).B) Criteria for selecting a stock, etc. as a standardized margin transaction issue

A stock, etc. shall be selected as a standardized margin transaction issue from issues other than those already selected as standardized margin transaction issues if it satisfies each of the following requirements (TSE Rules Concerning Selection of Stocks Eligible for



Standardized Margin Transactions and Loans for Margin Transactions, art. 2, para. 1):(i) The first contract price of the stock, etc. has been determined after listing;(ii) The issuer has not fallen into a state of having liabilities in excess of assets as of

the last day of the previous fiscal year;(iii) The stock, etc. is not deemed to be delisted on and after the selection date referred

to in A);(iv) The stock, etc.is not designated as a security on alert, a security under supervision,

or a security to be delisted;(v) The stock, etc. is not under the grace period for delisting;(vi) The stock, etc. is not subject to regulatory measures for trading or margin

transaction; and(vii) The stock, etc. is not deemed inappropriate to be a standardized margin transaction

issue.C) Exceptions to the criteria for selecting a stock, etc. as a standardized margin transaction

issueRegardless of the provisions of B), a stock, etc. shall be selected as a standardized

margin training issue if it falls under any of the following cases (TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, art. 2, para. 2 through para. 6):

(i) Where the stock, etc. to be listed pursuant to the provisions of Article 207 of the TSE Securities Listing Regulations (“Listing Examination”) as well as preferred shares, etc. issued by the issuer of the said shares, etc. satisfy each of the requirements mentioned in (i) and (iii) to (vii) of B) at the time of the first selection examination (limited to that conducted in a period from listing until the first securities report is submitted after listing);

(ii) Where the stock, etc. falls under the case of technical listing*;* Technical listing on the main markets is each of the following cases:

・ Where a listed stock, etc. is delisted due to dissolution caused by a merger of a listed company on the main markets, and the newly created company or the surviving company, or the parent company of the surviving company pertaining to such merger applies for listing (TSE Securities Listing Regulations, art. 208, item 1); and

・�Where a listed company on the main markets becomes a wholly-owned subsidiary of another company by a stock swap, stock transfer and other means or comes to be in a state specified by the Enforcement Ordinance as being equivalent to this, and such other company or the parent of such other company applies for listing (TSE Securities Listing Regulations, art. 208, item 3).

(iii) Where the stock, etc. to be listed is to be delivered in exchange for class stock subject to wholly call, etc.;

(iv) Where a listed company, which is not an issuer of a standardized margin

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transaction issue, absorbs a listed company, which is an issuer of standardized margin transaction issues, through a merger, or where it carries out a stock swap which results in a listed company which is an issuer of a standardized margin transaction issue, becoming its wholly-owned subsidiary, and the stock, etc. of the listed company that is not the issuer of the standardized margin transaction issue satisfies each of the requirements mentioned in B), (ii) through (vii) at the time of the first selection examination of the stock, etc. after completion of the merger or stock swap.; and

(v) Where the stock, etc. that is listed on another market satisfies each of the requirements mentioned in B), (ii) through (vii) at the time of the first selection examination of the stock, etc.

D) Criteria for disqualification of a stock, etc. as a standardized margin transaction issueA stock, etc. shall be disqualified as a standardized margin transaction issue if it falls

under any of the following conditions (TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, rule 5):

(i) Where the issuer of the stock, etc. has an excess of liabilities over assets as of the end of the most recent business year (in the case of an issue selected as a standardized margin transaction issue pursuant to the provisions of the provisions of Article 2, Paragraph 2 of the TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions (mentioned in C), (i)), limited to the first or any subsequent business year after listing);

(ii) Where the stock, etc. is determined to be delisted; or(iii) Where the stock, etc. is deemed inappropriate to be a standardized margin

transaction issue.(viii) Issues for Loans for Margin Transactions

Among standardized margin transaction issues, issues that further satisfy certain standards may be selected as issues for loans for margin transactions (both cash and securities loans may be obtained from a securities finance company) by exchanges. Even issues that are not selected as issues for loans for margin transactions, however, may receive financing from a securities finance company (a company which loans the necessary funds or share certificates, etc. to a financial instruments business operator in a margin transaction) with respect to a standardized margin issue.

A margin transaction is a trading transaction in which the financial instruments business operator extends credit to a customer. In order for the financial instruments business operator to supply the funds or securities necessary to extend credit to its customer, the financial instruments business operator can draw such funds or securities from its own inventory, and may also procure them from a securities finance company in the case of standardized margin transactions. Such transactions between financial instruments business operators and securities finance companies are called loan transactions (TSE Margin/Loan Trading Regulations, art. 1). “Issues for loans for margin transactions” means issues with respect to



which a loan of cash and securities may be received in a loan transaction, and they are selected by exchanges from among the standardized margin issues (TSE Margin/Loan Trading Regulations, art. 10).

The outline of the TSE’s selection criteria and disqualification criteria for issues for loans for margin transactions is provided below, focusing on common shares listed on the main markets.

OutlineofSelectionCriteriaandDisqualificationCriteriaofIssuesforLoansfor Margin Transactions (TSE)

A) Timing of selecting a stock, etc. as an issue for loans for margin transactionsThe selection of an issue for loans for margin transactions shall be made, on a monthly

basis, on the first day (if such first day falls on a non-business day, it shall be moved down accordingly) of the fifth month following the month containing the last day of the issuer’s business year (TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, rule 4, para. 2).

(i) Periodical selection (selection made for listed issues for each accounting period)On the first day of the fifth month following the month containing the closing day

(art. 4, para. 2)(Note) The periodical selection may be postponed until the last day of the seventh

month following the month containing the said day (art. 4, para. 5).(ii) Early selection (selection made for new issues to be listed)

a. issues listed via another market: the day of listing (art. 4, para. 3, item 3)b. issues directly listed on the First Section Market: the fifth business day following

the day on which the first contract price after listing is determined (art. 4, para. 3, item 5)

(Note) The early selection may be postponed for six months from the said selection day (art. 4, para. 5).

B) Criteria for selecting a stock, etc. as an issue for loans for margin transactionsA stock, etc. which is a standardized margin transaction issue shall be selected as an

issue for loans for margin transactions from issues other than those already selected as issues for loans for margin transactions if it satisfies each of the following requirements (the different requirements apply to a foreign stock, etc.; TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, rule 3):

(i) The stock, etc. has been listed for more than six months;(ii) The number of tradable shares is not less than 20,000 units;(iii) The number of shareholders (meaning the number of persons holding one or

more units of the issue) is not less than 1,700;(iv) The trading volume, etc. of the stock, etc. during, in principle, the past six

months backdated from the last day of the second month immediately following

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the month containing the last day of the fiscal year of the issuer, satisfies either of items a. or b. below:

a. The average monthly trading volume is not less than 100 units on the market of the TSE and the rate of active trading days* is 80% or more; or

b. Where, on a market of any domestic exchange other than the TSE, the average monthly trading volume of the stock, etc. is not less than 100 units and its rate of active trading days is 80% or more, and on the TSE market, its average monthly trading volume is not less than 50 units and its rate of active days is 40% or more;

* The rate of active trading days means the rate of the number of active days (which is the number of days when the issue is traded) to the number of trading days.

(v) The stock, etc. is not deemed to be delisted on and after the selection date referred to in A);

(vi) The stock, etc. is not designated as a security on alert, a security under supervision, or a security to be delisted;

(vii) The stock, etc.is not under the grace period for delisting;(viii) The stock, etc. is not subject to regulatory measures that restrict trading;(ix) The stock, etc. is not deemed inappropriate to be an issue for loans for margin

transactions according to its number of shares available for loan trading; and(x) The stock, etc. is not deemed inappropriate to be an issue for loans for margin

transactions.C) Exceptions to the criteria for selecting a stock, etc. as an issue for loans for margin

transactionsRegardless of the provisions of B), a stock, etc. shall be selected as an issue for loans for

margin transactions if it falls under any of the following cases (TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, rule 3, para. 3, para. 4, para. 5, para. 6, para. 7, para. 8 and para. 9):

(i) Where the stock, etc. is an issue directly listed the First Section Market (an issue assigned to the First Section Market at the time of listing);

(ii) Where the stock, etc. falls under the case of technical listing, and satisfies the following requirements:

� ・�The issuer has not fallen into a state of having liabilities in excess of assets as of the last day of the previous fiscal year;

・ The stock, etc. satisfies the requirements set forth in (vii), (ix) and (x) of B); ・ The stock, etc. is expected not to fall within the category of an issue with the

number of tradable shares being less than 10,000 units as of the last day of the first business year ending after listing (a different requirement applies to foreign stocks, etc.);

・�The stock, etc. is expected not to fall within the category of an issue with the number of shareholders being less than 1,200 as of the last day of the first



business year ending after listing; and ・�The average monthly trading volume during, in principle, the past six months

backdated from the last day of the month immediately following the month containing the day of listing of the stock, etc. is not less than 100 units either on another domestic financial instruments exchange or a foreign financial instruments exchange, etc., and the number of active days accounts for 80% or more of the number of trading days during the period;

(iii) Where the stock, etc. to be listed is to be delivered in exchange for class stock subject to wholly call, etc.;

(iv) Where a listed company, which is not an issuer of an issue for loans for margin transactions, absorbs a listed company, which is an issuer of issues for loans for margin transactions, through a merger, or where it carries out a stock swap which results in a listed company, which is an issuer of issues for loans for margin transactions, becoming its wholly-owned subsidiary, and the stock, etc. of the listed company that is not the issuer of the issue for loans for margin transactions satisfies the following requirements at the time of the first selection examination of the stock, etc. after completion of the merger or stock swap:

・�The issuer has not fallen into a state of having liabilities in excess of assets as of the last day of the previous fiscal year;

・The stock, etc. satisfies the requirements set forth in (v) through (x) of B); ・�The stock, etc. is expected not to fall within the category of an issue with the

number of tradable shares being less than 10,000 units (in the case of foreign share certificates, etc., the number of listed share certificates, etc. being less than 20,000 units) as of the last day of the first business year after the merger or stock swap; and

・�The stock, etc. is expected not to fall within the category of an issue with the number of shareholders being less than 1,200 as of the last day of the first business year after the merger or stock swap;

(v) Where the stock, etc. that is listed on another market satisfies each of the following requirements at the time of the first selection examination of the stock, etc.; and

・�Where the period between the day on which the stock, etc. is listed on another domestic financial instruments exchange to the day on which it is listed on the TSE exceeds six months:

・�Where the stock, etc. satisfies the provisions referred to in the following sub-items a. through c. according to the classification specified in said sub-items:

a. An issue assigned or to be assigned to the first section market at the time of listing: B), (ii), and (v) through (x);

b. A preferred equity investment certificate with 100,000 or more units: B), (iii), and (v) through (x); and

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c. An issue other than those prescribed in the above sub-items a. and b.: B), (ii), (iii), and (v) through (x).

・�Where the average monthly trading volume of the stock, etc. is no less than 100 units and its rate of active trading days is 80% or more in any other domestic financial instruments exchanges during, in principle, the past six months backdated from the last day of the month immediately preceding the month containing the listing date of the stock, etc. on the TSE.

(vi) Where the stock, etc. (excluding an issue directly listed on the First Section and a stock listed on another domestic financial instruments exchange) satisfies each of the following requirements at the time of the first selection examination after listing:

・�Where the number of shareholders is 2,200 or more at the time of listing; ・�Where the stock, etc. satisfies the requirements set forth in (ii) and (v) through

(x) of B);(vii) Where the stock, etc. falls under the case of technical listing for which the record

date for shareholders, etc. is not the last day of a business year, and it satisfies the following requirements:

・�The stock, etc. is expected not to fall within the category of an issue with the number of tradable shares being not less than 10,000 units as of the first record date for shareholders, etc. after listing (a different requirement applies to foreign stocks, etc.); and

・�The stock, etc. is expected not to fall within the category of an issue with the number of shareholders being less than 1,200 as of the first record date for shareholders, etc. after listing;

(viii) Where a listed company, which is not an issuer of an issue for loans for margin transactions and for which the record date for shareholders, etc. is not the last day of a business year, absorbs a listed company, which is an issuer of issues for loans for margin transactions, through a merger, or where it carries out a stock swap which results in a listed company, which is an issuer of issues for loans for margin transactions, becoming its wholly-owned subsidiary, and the stock, etc. of the listed company that is not the issuer of the issue for loans for margin transactions satisfies the following requirements at the time of the first selection examination of the stock, etc. after completion of the merger or stock swap:

・�The stock, etc. is expected not to fall within the category of an issue with the number of tradable shares being less than 10,000 units as of the first record date for shareholders, etc. after the merger or stock swap (a different requirement applies to foreign stocks, etc.); and

・�Where the stock, etc. is expected not to fall within the category of an issue with the number of shareholders being less than 1,200 as of the first record date for shareholders, etc. after the merger or stock swap.

D) Criteria for disqualification of a stock, etc. as an issue for loans for margin transactions



A stock, etc. shall be disqualified as an issue for loans for margin transactions if it falls under any of the following conditions (TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, rule 6):

(i) Where the number of tradable shares is less than 10,000 units; or in the case of a foreign stock, etc. (limited to those listed on multiple markets) the number of listed shares is less than 20,000 units;

(ii) Where the number of shareholders is less than 1,200;(iii) Where the trading volume of a foreign stock, etc. falls under any of the conditions

prescribed in the following sub-items a. or b.:a. The average monthly trading volume for each year backdated from the last day

of December is less than 10 units; orb. Where no trade was executed for the past three months backdated from the last

day of each month.(iv) Where the issuer has an excess of liabilities over assets as of the end of the most

recent business year (in the case of an issue selected as a standardized margin transaction issue pursuant to the provisions of the provisions of Article 2, Paragraph 2 of the TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions (“Outline of Selection Criteria and Disqualification Criteria of Standardized Margin Issues (TSE),” C), (i)), limited to the first or any subsequent business year after listing);

(v) Where the stock, etc. is determined to be delisted; or(vi) Where an issue is deemed inappropriate to be an issue for loans for margin

transactions.E) Special Provisions for Criteria for Disqualification of Stocks, Etc. as Issues for Loans

for Margin TransactionsNotwithstanding the criteria for disqualification of stocks, etc. as issues for loans for

margin transactions, a stock, etc. shall not be disqualified as an issue for loans for margin transactions in the case where, in principle, the stock, etc. falls under any of the provisions of (i) or (ii) of D), except when it is found to have fallen under these provisions within the period of one year counting from the day following the last day of a business year containing the day on which the stock, etc. falls under the relevant provisions (hereinafter referred to as the “grace period”) (TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, rule 7, para. 1).

With regard to the application of the abovementioned provisions to an issue for which the record date for shareholders, etc. is changed to a date other than the last day of a business year within the grace period, and an issue for which the record date for shareholders, etc. is not the last day of a business year, the numbers of shareholders and tradable shares as of the record date for shareholders, etc. pertaining to the business year to which the last day of the grace period belongs shall be deemed to be those numbers as of the last day of the grace period (TSE Rules Concerning Selection of Stocks Eligible for Standardized Margin Transactions and Loans for Margin Transactions, rule 7, para. 2).

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(ix) Unit of Trading in Margin TransactionsThe trading unit for margin transactions is the number of shares that a listed company

fixes as one round lot (If a company does not fix it, the trading unit refers to one share.) (TSE Business Regulations, art. 15, item 1).

(2) Security Deposit Requirements on Margin TransactionsThe rules concerning security deposit requirements on margin transactions are provided in

the FIEA, the Security Deposit Ordinance and the TSE Brokerage Agreement Standards.(i) Collection of Security Deposit

The FIEA states that the percentage at which a financial instruments business operator must collect a security deposit from the customer pertaining to a margin transaction shall be set by the Prime Minister in consideration of fair and equitable trades (FIEA, art. 161-2); provided, however, that in practice the Prime Minister delegates his/her authority to the Commissioner of the Financial Services Agency (FIEA, art. 194-7). Specifically, Cabinet Office Ordinance (Security Deposit Ordinance, art. 2) prescribes that in the case of margin transactions, the security deposit ratio shall be thirty per cent and also prescribes other matters concerning security deposit requirements. Exchanges also prescribed certain matters concerning margin transactions that govern trading participants or members, with a license or approval from the Prime Minister, and provide that when a trade is concluded in a margin transaction, a security deposit of 30% or more of the contract price must be collected from the customer by a date and time designated by the financial instruments business operator no later than the noon on the third business day counting from the day on which the transaction is effected (FIEA, art. 161-2, para. 1; Security Deposit Ordinance, art. 2, para. 1, item 1, and art. 4; TSE Brokerage Agreement Standards, art. 39).

The money to be submitted as a security deposit must be in Japanese yen or US dollars. The amount of security deposit to be submitted in US dollars shall be 95% of the contract price converted into Japanese yen at the foreign exchange rate designated by the trading participant (TSE Brokerage Agreement Standards, art. 39-2, para. 1 and para. 2).

In addition, in order to restrict the use of margin transactions by investors with small assets levels, the minimum security deposit requirement is JPY300,000 (FIEA, art. 161-2; Security Deposit Ordinance, art. 3; TSE Brokerage Agreement Standards, art. 39). In other words, even if 30% of the contract price would result in a number below JPY300,000, the necessary margin is JPY300,000. Also, at each exchange, in cases where the use of margin transactions is deemed to be excessive, etc., restrictive measures such as raising the security deposit ratio or establishing a cash collateral ratio may be instituted (TSE Business Regulations, art. 65; the Rules on Regulatory Measures Concerning Securities Trading, etc. or Its Brokerage, art. 1, item 1, item 2, item 3 and item 4).(ii) Margin Securities

Generally security deposits must be made in cash, but securities may be substituted in lieu of cash (FIEA, art. 161-2, para. 2; TSE Brokerage Agreement Standards, art. 40, para.



1). The types of margin securities and their respective cash conversion ratios (daiyo kakeme) are specified in the table below (TSE Brokerage Agreement Standards, art. 40, para. 2).

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Cash Conversion Ratio of Margin Securities (Daiyo Kakeme)(As of October 16, 2019)

SecuritiesCash

Conversion Ratio

a)

Share certificates listed on a domestic exchange (meaning share certificates issued by a domestic corporation, preferred equity investment certificates, foreign share certificates, etc., and beneficiary certificates of trusts issuing beneficiary certificates; hereinafter the same)

80/100

b) Japanese Government Bonds 95/100

c)Local Government Bonds (limited to cases where a financial instruments business operator executes the principal underwriting agreement at the time of issuance)

85/100

d)

Bonds issued by corporations under a special act:-Bonds for which the government guarantees redemption of principal and payment of interest.-Other bonds.

90/100

85/100

e)

Corporate bonds listed on domestic exchanges (but excluding convertible bond-type bonds with share options and exchangeable bonds; hereinafter the same), or corporate bonds issued by corporations whose share certificates are listed on a domestic exchange and issued by a corporation other than a foreign corporation (limited to cases where a financial instruments business operator executes the principal underwriting agreement at the time of issuance)

85/100

f)

Convertible bond-type bonds with share options listed on a domestic exchange or bonds with share options issued by a company whose share certificates are listed on a domestic exchange and issued by corporations other than a foreign corporation (limited to cases where a financial instruments business operator executes the principal underwriting agreement at the time of issuance)

80/100

g)Exchangeable bonds listed on a domestic exchange (limited to cases where a financial instruments business operator executes the principal underwriting agreement at the time of issuance)

80/100

h) Foreign government bonds listed on a domestic exchange 85/100i) Foreign municipal bonds listed on a domestic exchange 85/100

j) International Bank for Reconstruction and Development Yen-Denominated Bonds 90/100

k) Asia Development Bank Yen-Denominated Bonds 90/100

l)Yen-denominated foreign bonds issued by foreign corporations other than the issuers described in h)-k) above (limited to those listed on a domestic exchange)

85/100

m)

Investment trust beneficiary certificates and investment securities (limited to the securities listed on a domestic exchange and those whose market price on the previous day are announced by the Investment Trusts Association, Japan):-Beneficiary certificates of bond investment trusts-Others

85/10080/100

n)

Foreign share certificates, etc. listed on an exchange that is registered as a national securities exchange under Section 6 of the US Securities Act of 1934 (excluding securities similar to investment equity subscription rights or investment corporation bonds)- Those with the latest market prices at the time of submission

60/10070/100

* The same rules are provided in JSF’s “Detailed Rules concerning Acceptance of Margin Securities for Loan Trading.”



Also, the cash conversion ratio can be modified under the regulations of an exchange or the internal rules of a financial instruments business operator (the JSDA allows its Regular Members to change the loan-to-value ratio of substitute securities at their discretion under certain requirements, as provided in the Rules Concerning Change, etc. of Assessment Rates for Substitute Securities Related to Margin Transactions).

Finally, the valuation of these margin securities cannot exceed the market price on the day before deposit multiplied by the applicable cash conversion ratio (TSE Brokerage Agreement Standards, art. 40, para. 2).

The market prices of margin securities are prescribed in accordance with the classification of securities enumerated as follows (TSE Brokerage Agreement Standards, art. 40, para. 3).

Securities Market Price1 Out of share certificates set forth in a),

convertible bond-type bonds with share options set forth in f), exchangeable bonds set forth in g), and investment trust beneficiary certificates and investment securities set forth in m), those listed on a financial instruments exchange in Japan:

Last price on a financial instruments exchange in Japan (in cases where a quote is displayed on a financial instruments exchange in Japan, the last quote price)

2 Out of investment trust beneficiary certificates and investment securities set forth in m), those whose market price of the previous day is published by the Investment Trusts Association, Japan

Market price published by the Investment Trusts Association, Japan

3 Out of securities other than the securities referred to in 1 and 2, those whose Reference Statistical Prices for OTC Bond Transactions are published by the JSDA

The average value of the Reference Statistical Prices for OTC Bond Transactions published by the JSDA (in the case of inflation-linked government bonds, the value obtained by multiplying said average value by an interlocking coefficient published by the Ministry of Finance)

4 Out of securities other than the securities referred to in 1 to 3, those listed on a financial instruments exchange in Japan

Last price on a financial instruments exchange in Japan (in cases where a quote is displayed on a financial instruments exchange in Japan, the last quote price).

5 Foreign share certificates, etc. set forth in n) Closing price or quotation price (the price converted into Japanese yen at the foreign exchange rate designated by the trading participant

(iii) Security deposit CalculationThe amount of money to be deposited with a financial instruments business operator by

a customer as a margin is calculated by deducting any amount of credit extended to the customer for a margin transaction in addition to the extension of credit equivalent to the contract price of the securities pertaining to the margin transaction (Security Deposit

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Ordinance, art. 5).

(Example)The security deposit in a case where the contract amount is JPY20 million would be

calculated as follows:

A) Where there is no existing share position (no committed securities):

The security deposit would be JPY6 million. If that entire amount is substituted with securities (assume listed share certificates with a cash conversion ratio (daiyo kakeme) of 80%), the minimum market price necessary for the share certificates would be computed as follows:

Thus, the security deposit required under this contract would be JPY6 million in cash or JPY7.5 million in securities (listed share certificates).

One can also calculate the total possible position(Note) using assets on hand.

(Note) In this section, this refers to a buy position or a sell position in margin transactions.

For example, if one has cash on hand of JPY4 million and listed share certificates with a market price of JPY10 million:a. Cash conversion value of listed share certificates:

b. The amount able to be allotted to margin:

Contract Amount × Security Deposit Ratio = Minimum Maintenance(JPY20 million) (30%) (JPY6 million)

Minimum Share Maintenance ÷

Cash Conversion Ratio of Listed Share Certificates =

Minimum Market Price ofShare Certificates

(JPY6 million) (80 %) (JPY7.5 million)

Market Price of Listed of Share Certificates on Hand ×

Cash Conversion Ratio of Listed Share Certificates =

Cash Conversion ValueMargin Securities

(80 %) (JPY8 million) (JPY10 million)

Cash in Hand + Cash Conversion Value of Margin Securities

(JPY8 million) (JPY4 million) (JPY12 million)

= Security Deposit



c. Calculation of the total stock position that is possible from this security deposit:

Therefore, the total share position that is possible is JPY40 million.

B) Where there is an existing share position (securities committed):a. Cases where the security deposit received is insufficient to cover the existing position

When the security deposit received is insufficient to cover the existing position, the minimum maintenance can be computed using the formula described above (contract amount ×ratio of security deposit collected). That is:

As in A) above, the security deposit would equal JPY6 million.b. Cases where the security deposit exceeds the amount necessary to cover the existing share

positionEven in cases where the security deposit is in excess of the amount needed to cover the

existing position, the minimum maintenance can be computed using the basic formula described above (contract amount × ratio of security deposit collected).

Provided, however, that the excess security deposit may be allocated to the margin on a new position (this is often used in practice), and in such a case the amount to be collected is the amount after deducting the excess security deposit from the minimum maintenance:

Now, the new total possible position can be calculated from this excess security deposit as follows:

Security Deposit ÷ Ratio of Security Deposit Collected = Total Possible Position (JPY12 million) (30%) (JPY40 million)

Contract Amount Ratio of Security Deposit Collected Minimum Maintenance=(JPY20 million) (30%) (JPY6 million)

×

Current Security Deposit (Note 1) –

Valuation Loss (Note 2) –

Margin Transaction Advances (Note 3) =

(JPY9 million)

Security DepositReceived

(JPY7.8 million) (JPY200,000)(JPY1 million)

Security Deposit–

Contract Amount of Existing Position (Note 4) ×

Security Deposit=

Excess Security

(JPY7.8 million) (JPY2.4 million)(30 %)(JPY18 million)Received Ratio Deposit

Minimum Maintenance – Excess Security Deposit(JPY6 million) (JPY2.4 million) (JPY3.6 million)

= Amount to be Collected

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The new possible share position is JPY8 million.

(Notes) 1. Where margin securities are deposited, the current margin is the cash conversion value computed by multiplying their respective cash conversion ratios (daiyo kakeme) by the market value as of the day immediately preceding the day on which such computation is made.

2. The valuation loss is computed by subtracting the market value as of the day immediately preceding the day on which such computation is made from the contract amount for the existing share position. However, if there are valuation gains on the other shares in the account, the valuation loss will be the amount net of such gains, and the total amount of any commissions, interest, broker loan rate, etc., other amounts charged to the customer. In the case of a net valuation gain, such amount cannot be added.

3. Amounts which remain unpaid after settlement concerning a margin transaction, etc.

4. Contract amount for existing share position obtained through an offsetting settlement (whose settlement date has not arrived) is excluded.

(iv) Variation MarginWhen the total amount of security deposit received from a customer for a margin

transaction declines in value to below 20% of the contract amount of all securities involved in the margin transactions conducted by the customer, a financial instruments business operator must require the customer to deposit an additional security deposit sufficient to maintain the said total amount of security deposit, by a date and time designated by the financial instruments business operator no later than the noon on the third business day” counting from the day on which such loss amount is incurred (TSE Brokerage Agreement Standards, art. 48, para. 1). Such security deposit to be additionally deposited is referred to as variation margin, or generally a “margin call.” The 20% in this case is called the minimum maintenance of the margin.

In cases where a customer files a request for settlement of an unsettled account subject to such computed loss by a date and time designated by the financial instruments business operator no later than the noon on the third business day” counting from the day on which the implicit loss occurred (in cases of settlement by any method other than offsetting transactions, limited to cases where the financial instruments business operator received money or securities necessary for settlement from the customer), the financial instruments business operator may subtract an amount equivalent to 20% of the contract amount of

(30 %)Excess Security Deposit ÷ Ratio of Security Deposit Collected = Total Possible New Position

(JPY2.4 million) (JPY8 million)



securities for which such request for settlement was filed from the security deposit that must be additionally deposited (TSE Brokerage Agreement Standards, art. 48, para. 2).

In cases where a financial instruments business operator received from a customer of a margin of an amount equivalent to (i) losses from offsetting transactions pertaining to an unsettled account subject to the computed loss, and (ii) the amount to be borne by the customer pertaining to such unsettled account, by a date and time designated by the financial instruments business operator no later than the noon on the third business day counting from the day on which the implicit loss occurred, the financial instruments business operator may subtract these amounts from the security deposit that must be additionally deposited during the period before the settlement of such offsetting transactions (TSE Brokerage Agreement Standards, art. 48, para. 3).

Where any computed loss arises, a financial instruments business operator may require that the customer deposit an additional security deposit corresponding to that loss even if the total amount of security deposit received does not fall below the 20% minimum maintenance level (TSE Brokerage Agreement Standards, art. 47).

The formula for calculating the variation margin deposit is as follows:

Security Deposit Received − (Valuation Loss + Advances Coincidental to the Margin Transaction) = Security Deposit Received Balance (A)Contract Amount × Security Deposit Minimum Maintenance of 20% = Security Deposit in cases of a 20% Minimum Maintenance (B)Cases where a variation margin is required = (A) < (B)Security deposit to be collected additionally (margin call) = (B) − (A)

(Sample Question) Customer A purchased on margin 10,000 shares of Company B at JPY1,000 per share, and submitted an initial cash margin of JPY3 million. Thereafter, a valuation loss of JPY2 million arose with respect to the Company B shares due to market fluctuations. What is the amount of variation margin Customer A must submit?

Security Deposit Received – Valuation Loss = Security Deposit Received Balance(JPY3 million)

Contract Amount 20% = Security Deposit Required for Minimum Maintenance(JPY10 million) (JPY2 million)

Security Deposit Required for Minimum Maintenance – Security Deposit Received Balance(JPY2 million)

= Variation Margin Amount(JPY1 million)

(JPY1 million)(JPY2 million)

(JPY1 million)

×






(JPY1 million)

×






(JPY1 million)

×

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Answer: Variation Margin Amount = JPY1 million

(v) Withdrawal, Etc. of MarginA security deposit not only functions as the collateral for an extension of credit, but also

as security against any loss amounts, and as such, in the past, the money or securities deposited as margin could not, in principle, be withdrawn or used as a security deposit to new margin transactions before the settlement day of the open stock position.(Note) However, following the revision to the Security Deposit Ordinance and the TSE Brokerage Agreement Standards, it is now possible to withdraw a security deposit before the settlement day. This dramatic change has greatly increased efficiency in raising funds for margin transactions.

Specifically, with regard to money or securities which have been received from a customer as a security deposit pertaining to a margin transaction, a financial instruments business operator is now able to allow the customer to withdraw money or securities up to the amount obtained by subtracting (A) an “amount equivalent to 30% of the contract amount of all securities pertaining to the margin transactions of the customer (or JPY300,000 if such amount is less than JPY300,000)” from (B) the “total amount of security deposit received pertaining to the margin transaction of the customer” (Security Deposit Ordinance, art. 7, para. 1; TSE Brokerage Agreement Standards, art. 44, para. 1).

With regard to money or securities which have been received from a customer as a security deposit pertaining to a margin transaction, a financial instruments business operator may allow the customer to withdraw such money or securities only in the following cases (Security Deposit Ordinance, art. 7, para. 2; TSE Brokerage Agreement Standards, art. 44, para. 2):

a. In cases of partial settlement pertaining to an unsettled account (limited to cases of withdrawing an amount equivalent to the amount obtained by subtracting B) from A) as mentioned above);

b. In cases of partial settlement of unsettled accounts (excluding settlement by offsetting purchase or sale), subject to deposit of all securities purchased, or all money equivalent to the sales proceeds of securities sold, via the margin transaction pertaining to such unsettled accounts to be settled, as a security deposit pertaining to a margin transaction (limited to cases where B) is equal to or larger than A));

c. In cases of settling all unsettled accounts; ord. In cases of replacing such money or securities in whole or in part.Furthermore, when a financial instruments business operator conducts a new margin

transaction for its customer, it may allocate money or securities that have already been deposited from the customer as a security deposit pertaining to a margin transaction, to the amount of money or securities which should be deposited as a security deposit pertaining to such new margin transaction, up to the following amount obtained by subtracting (Security Deposit Ordinance, art. 7, para. 3; TSE Brokerage Agreement Standards, art. 44, para. 3)






(JPY1 million)

×



A) an amount equivalent to 30% of the contract amount of all securities pertaining to the margin transactions of the customer; and B) if the amount of security deposit that should be deposited is less than JPY300,000 (the amount mentioned in A)), the difference between this amount and JPY300,000); from: C) the total amount of security deposit received pertaining to the margin transaction of the customer.

Accordingly, it is now possible to conduct margin transactions many times during one day by depositing only a single security deposit. Thus, investors, especially those called day traders, can leverage their limited amount of money and enjoy more opportunities and convenience in relation to their investment.

It is prohibited to withdraw money or securities in an amount equivalent to a computed profit arising due to market fluctuations or use the amount of such computed profit as a margin for other open stock positions (Security Deposit Ordinance, art. 9; TSE Brokerage Agreement Standards, art. 46).

(Note) This is the number of contracts that are unsettled in margin transactions, which is referred to as an open position. This consists of buy positions, otherwise known as open buy positions, which are unsettled purchases in margin transactions, and sell positions, otherwise known as open sell positions, which are unsettled sales in margin transactions.

(3) Loans and Interest in Margin Transactions(i) Extension of Credit (Loans)

Following a customer application, the actual extension of credit by a financial instruments business operator takes place on the settlement (delivery) date, the second business day following the date the trade was concluded. Thus, on the settlement date for the transaction, share certificates or their purchase price are loaned to the customer. The loan is not made based on the net amount of the contract price minus the security deposit submitted to the financial instruments business operator by the customer, but on the contract price for the transaction or the said securities sold (TSE Brokerage Agreement Standards, art. 41, para. 1).

Also, the loaned share certificates or the purchase price are not physically handed over to the customer; instead, the financial instruments business operator stands in place of the customer and advances the share certificates or purchase price on the delivery date for the transaction, and makes delivery via (the JSCC which is the financial instruments clearing center that is designated by) the stock exchange (TSE Clearing and Settlement Regulations, art. 3 and art. 4).

When a customer is a buyer in the delivery settlement (borrows the purchase price), he or she receives the purchased share certificates, and where a customer is a seller (borrows share certificates), he or she receives the proceeds from their sale. Again, however, these are not directly delivered to the customer, but the financial instruments business operator holds

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the loaned moneys or shares as collateral. This means that the loan between the customer and the financial instruments business operator is secured by both the security deposit initially deposited and the purchased share certificates or sales proceeds (TSE Written Agreement for Establishment of a Margin Transaction Account, art. 4 (Handling of Purchased Securities and Sales Proceeds)).(ii) Margin Interest, Margin Share Lending Premium and Broker Loan Rates

In cases where a customer receives an extension of credit from a financial instruments business operator (conducts a margin transaction), he or she receives/pays the interest rate or margin share lending premium calculated at the rate determined by the financial instruments business operator (TSE Document Delivered Prior to Conclusion of a Contract for Margin Transaction (sample form)). Also, when a securities finance company has a shortage of issues for loans for margin transactions (a condition where its loaned shares exceed its borrowed shares in its loan transaction balances), and procures those share certificates with an interest expense, the customer will receive/pay the interest at the broker loan rate (TSE Margin/Loan Trading Regulations, art. 8; TSE Brokerage Agreement Standards, art. 41, para. 2).

a) InterestA customer who purchases shares on margin (buyer) will pay interest to the

financial instruments business operator on the loan of the purchase price, and a customer who sells shares on margin (seller) will receive interest from the financial instruments business operator on the sales proceeds. The interest for standardized margin transactions was uniformly prescribed on the exchange, but starting in 1999, interest rates on margin loans have been totally deregulated, and like negotiable margin transactions, the financial instruments business operator and the customer are free to determine the interest rate upon agreement.b) Margin Share Lending Premium

Margin share lending premium was introduced in May 2002 for the purpose of maintaining a fair distribution of premiums between sellers and buyers. A margin share lending premium is a payment from a seller to a financial instruments business operator representing the expense incurred in connection with borrowing shares, and not to a buyer unlike the broker loan rate. Under the rules of the JSF, this is referred to as “interest on loans for loan transactions” (JSF Loan Transaction Lending Regulations, art. 23, para. 3).c) Broker Loan Rate (Premium)

In a loan transaction between a financial instruments business operator and securities finance company, an issue in which the number of shares loaned (open sell position) is greater than the number of shares on which funds are borrowed (open buy position) is called an excess lending issue (on financial instruments exchange markets established by the TSE and at PTSs, an “excess lending issue” is an issue in which the total number of shares loaned as calculated by aggregating the number of shares loaned on each financial instruments market is greater than the total number of shares on which funds are borrowed as calculated by aggregating the number of shares borrowed on each



financial instruments market). The securities finance company will endeavor to rectify this situation with respect to the excess lending issue (hereinafter referred to as the “shortage”) by having the financial instruments business operator make additional borrowing, or by receiving the repayment of shares loaned, etc. However, if the shortage still cannot be rectified, the securities finance company will procure the shares by paying the broker loan rate to a third party to complete the loan. This broker loan rate is generally called the “per diem premium” (gyakuhibu).

The broker loan rate is calculated in terms of sen (1/100 of JPY1) per share, collected from the seller (open sell position) and paid to not only the party from whom the shares were procured, but also the buyer (open buy position).

The receipt/payment of the broker loan rate arising from the loan transaction, and also with respect to the margin position, is collected from the customer who borrowed shares (open sell position) at a rate equal to the broker loan rate, and paid to the customer who borrowed the purchase price (open buy position) (TSE Margin/Loan Trading Regulations, art. 8; TSE Brokerage Agreement Standards, art. 41, para. 2; JSF Loan Transaction Lending Regulations, art. 23, para. 5).

In a negotiable margin transaction, the broker loan rate can be determined freely between the financial instruments business operator and the customer.d) Procedures for Determining the Broker Loan Rate

The broker loan rate is determined on the day following the date of the loan transaction application, and the required procedures (performed the day following the date of the loan transaction application) are described below (in the case of JSF).

With regard to an excess lending issue, JSF will announce the number of excess shares of stock (on financial instruments exchange markets established by the TSE and at PTSs, the “number of excess shares of stock” is the number of shares by which the total number of shares loaned as calculated by aggregating the number of shares loaned on each financial instruments market is greater than the total number of shares on which funds are borrowed as calculated by aggregating the number of shares borrowed on each financial instruments market) by the start of the morning session on the exchange on the day following the date of the application (JSF Loan Transaction Lending Regulations, art. 14, para. 2 and para. 4, JSF Handling of Excess Lending Issues in Loan Transactions).

With respect to an excess lending issue, financial instruments business operators can make an additional application for return of the borrowed shares or make an additional application for financing from 8:30AM to 10:00AM on the following day (JSF Handling of Excess Lending Issues in Loan Transactions). In this case, a broker loan application for financial instruments exchange markets established by the TSE and PTSs should be made concurrently along with those additional applications. If the shortage is rectified by this additional application, the phrase “full amount” (a condition where the number of shares loaned is the same as the number of shares on which funds

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are borrowed) will be displayed.Broker loan applications are accepted at a broker loan rate which does not exceed

the maximum rate specified in the “Maximum Rate Table” shown below (per share; hereinafter the same except for the “broker loan rate (per investment unit)” in the below table). However, in the bidding of share loan applications for issues for which a notice of caution has been issued or for which loan applications have been restricted or suspended, as well as for share loan applications placed after 9:30AM, the premium charge shall be JPY5 or more per share (for issues whose trading unit (meaning the trading unit designated by the TSE; hereinafter the same) is not one share, the premium charge should be set no higher than the value calculated by dividing JPY5 by the trading unit, and if this value is less than 5 sen, the premium charge should be 5 sen).

The broker loan rate should be JPY5 per share (for issues whose trading unit is not one share, the premium charge should be set no higher than the value calculated by dividing JPY5 by the trading unit, and if this value is less than 5 sen, the premium charge should be 5 sen).

Broker loan applications and additional applications shall be allocated to the excess lending shares in the following order:

(i) Additional applications for repayment of loaned shares and additional applications for loans―Appropriations are made in the order of application.

(ii) Applications for broker loans―Those with the lowest premium charges should be appropriated first. Where the premium charges are the same, then the appropriations are made in the order of application. If the applications have been made at the same time, then the order of application is made by drawing lots and all orders accepted prior to 9:30AM are considered to have been made at 9:30AM.

Where the number of shares needed to fill the broker loan applications for an issue has been met at a broker loan rate of not more than JPY50 per share (and in the event of issues that have a trading unit of other than one share, this shall be the amount obtained by dividing by the trading unit, and if this amount is 50 sen or less it shall be 50 sen), the highest of the broker loan rates assigned to the applications becomes the broker loan rate for that issue.

Where the necessary shares cannot be procured by broker loan applications, the closing time for applications is extended until 10:30AM, and a premium charge of more than JPY50 per share shall be collected. If the necessary shares are successfully procured by broker loan applications, the highest of the broker loan rates assigned to the applications becomes the broker loan rate for that issue.

If it is still not possible to procure the necessary shares, or if it is believed to be appropriate to procure some or all of the necessary shares without using the methods mentioned above, the broker loan rate in connection with the relevant shares will be set at the highest rate set forth below (for details, see “(Ref.) Issues that Increase Magnification of the Maximum Rate” below). In this event, JSF will in connection with



the quantity of the shortfall in the necessary shares procure the share certificates using separate negotiations with voluntary transaction counterparties, or another method, while working in close cooperation with the exchange, etc.

If it is still impossible to procure the necessary share certificates, even by taking these measures, JSF may extend the deadline for an application for broker loans and that for an application for the repayment of loaned shares (JSF Handling of Excess Lending Issues in Loan Transactions).

[Maximum Rate Table]I. ShareCertificates,PreferredEquityInvestmentCertificates,J-REITs,Infrastructure

Funds,ForeignShareCertificates,CountryFunds,DepositoryReceiptsofShares,Etc.

Investment Unit (Loan Price×Trading Unit)

Not More Than JPY50,000 Over JPY50,000

Maximum Broker Loan Rate (per investment unit) JPY100 JPY100 plus JPY20 for each complete

multiple of JPY10,000 over JPY50,000

The rate that is the maximum broker loan rate on the investment unit in the table above divided by the trading unit shall be the maximum of the broker loan rate per share (the maximum lending rate). If the maximum broker loan rate is JPY1.00 or less, the said rate shall be JPY1.00, and if the calculated maximum broker loan rate is over JPY1.00, the said rate shall be rounded up to an integral multiple of JPY0.1.

II. ETFs, Etc. (Excluding Infrastructure Funds)

Investment Unit Not More Than JPY10,000

More Than JPY10,000 and Not More Than JPY50,000 Over JPY50,000

Maximum Broker Loan Rate (per investment unit)

JPY60JPY60 plus JPY10 for each complete multiple of JPY10,000 over JPY10,000

JPY100 plus JPY20 for each complete multiple of JPY10,000 over JPY50,000

The rate that is the maximum broker loan rate on the investment unit in the table above divided by the trading unit will be the maximum lending rate. If the maximum broker loan rate is JPY0.6 or less, the maximum lending rate will be JPY0.6, and if the calculated maximum broker loan rate is over JPY0.6, the maximum lending rate will be rounded up to an integral multiple of JPY0.1.

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(Ref.) Issues that Increase Magnification of the Maximum Rate

Applicable Conditions Applicable Magnification Applicable Period

(i) Issues for which a date of ex-dividends or ex-rights has been determined, or issues that JASDEC(Note 1) has given notice to all shareholders pursuant to the Act Concerning Book-Entry Transfer of Bonds, Shares, Etc. in connection with share certificates that will be handled in the book-entry transfer services.

I, II2

Loan request portion that is made from 6 business days through 2 business days prior to the applicable date(Note 2).

I, II4

Loan request portion that is made on the business day immediately preceding the applicable date(Note 2).

(ii) Issues for which a notice to beneficial shareholders of foreign share certificates, etc. has been made pursuant to the “Regulations Concerning Custody and Book-entry Settlement of Foreign Share Certificates, Etc.” of JASDEC in connection with foreign share certificates or deposited securities handled by JASDEC in its services with respect to custody and book-entry settlement of foreign share certificates, etc. (excluding (i))

I, II2

Loan request portion that is made from 6 business days through 2 business days prior to the applicable date(Note 3).

I, II4

Loan request portion that is made on the business day immediately preceding the applicable date(Note 3).

(iii) Issues for which a caution has been issued in connection with the use of loan shares, etc.

I, II2

The loan request portion from the day following the notice date to the date on which such caution is revoked.

(iv) Issues for which a restriction or suspension of offer of loan transactions has been made.

I, II2

The loan request portion from the effective date through the day before the day on which the restriction or suspension is lifted

Issues which meet the conditions under (i) or (ii), and (iii) or (iv).

2 of (i) or (ii) The period of (i) or (ii) plus the relevant period of (iii) or (iv).

Where there is a risk that the difficulty in procuring loaned share certificates could interfere with the delivery settlement.

I, II10

The period of the emergency action.

Where due to extreme fluctuation in market conditions of shares or sudden shortages of shares, there are excess lending issues with highly excessive share loans, or where there is such a risk.

I, II4


Excess lending issues with extremely excessive share loans, or where there is such a risk.

I, II10


(Notes) 1. Japan Securities Depository Center, Inc. 2. Meaning the date of becoming ex-dividends or ex-rights, or the business day preceding

the date relevant for the purpose of determining the shareholders in connection with the notice to all shareholders.

3. Meaning the business day preceding the date relevant for the purpose of determining the beneficial shareholders of foreign share certificates, etc.



e) Calculation Period for Interest, Margin Share Lending Premium and the Broker Loan RateThe calculation period for interest, margin share lending premium and the broker

loan rate is: a) in the case of interest and margin share lending premium, the computation is made for the period from the delivery date that is the second business day following the date on which a new transaction is effected, through the delivery date that is the second business day following the date on which a transaction for repayment is effected, including the first and last days; b) in the case of broker loans, the computation is made for the accumulated broker loan rates during the period from the delivery date that is the second business day following the date on which a new transaction is effected, to the day preceding the delivery date that is the second business day following the date on which a transaction for repayment is effected (TSE Brokerage Agreement Standards, art. 42; JSF Loan Transaction Lending Regulations, art. 23).

The computation method of the interest and broker loan rate is as follows:

(4) Term and Settlement of Margin Transactions(i) Deferral of Open Share Position in Margin Transactions

The repayment date for a loan of share certificates sold or the purchase price in a margin transaction is the day following the day of lending (meaning the delivery date that is the third business day counting from the contract date), and if the customer does not give notice for repayment to the financial instruments business operator two business days prior to such date (the day following the contract date), the repayment date will be deferred for each day (except for non-business days of the exchange) for which such notice is not given.

Provided, however, that in the case of standardized margin transactions, the repayment date cannot be deferred beyond the second business day following the corresponding day in the sixth month from the date the underlying transaction was concluded. When there is no such corresponding day, the last day of the month, or in the case of a holiday, the previous business day shall be the repayment date (TSE Brokerage

Interest Rate =

Contract Amount × Number of Days × Annual Rate (Fractions less than JPY1 are

rounded off)365

Margin Share Lending Premium =

Contract Amount × Number of Days × Annual Rate (Fractions less than JPY1 are

rounded off)365

Broker Loan Rate =Accumulated Broker Loan Rates

During the Calculation Period × Number of Shares

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Agreement Standards, art. 43).Finally, in the case of a negotiable margin transaction, the customer and financial

instruments business operator can freely set the repayment date, without regard to the six-month limitation used for standardized margin transactions.(ii) Repayment (Settlement) Methods in Margin Transactions

Customers may repay their open sell positions or open buy positions in margin transactions through offsetting settlement (net cash settlement) or delivery settlements (delivery of equivalent shares borrowed or delivery of cash on hand).

a) OffsettingSettlementThis is a method whereby a customer repays using share certificates by

repurchasing share certificates sold for an open sell position (new sale) (as discussed in a. below), or repays using cash acquired through the resale of shares purchased for an open buy position (new buy) (as discussed in b. below), and the difference is paid or received.b) Methods Using Delivery Settlement

This is a method whereby a customer delivers actual shares (genwatashi, delivery of equivalent share certificates on hand) for an open sell position (new sale) (as discussed in c. below) and receives their sales proceeds collateralized, or pays equivalent cash (genbiki, delivery of cash on hand) for an open buy position (new buy) (as discussed in d. below) and receives share certificates collateralized.

Furthermore, when repayment is performed, the liquidation amounts will be computed in the following manner, with delivery taking place on the second business day following the date of notice of repayment:

a. Where shares for the short position are repurchased Gain/Loss − Brokerage Commission (including an amount equal to the

Consumption Tax) + Interest − Margin Securities Lending Premium − Broker Loan Rate = Net Amount Received/Paid

b. Where shares for the long position are resold Gain/Loss − Brokerage Commission (including an amount equal to the

Consumption Tax) − Interest + Broker Loan Rate = Net Amount Received/Paidc. When shares for the short position are repaid through delivery of equivalent

shares borrowed Sale Price − Brokerage Commission (including an amount equal to the

Consumption Tax) + Interest − Margin Securities Lending Premium − Broker Loan Rate = Net Amount Received

d. Where shares for the long position are repaid through delivery of cash on hand Purchase Price + Brokerage Commission (including an amount equal to the Consumption Tax) + Interest − Broker Loan Rate = Net Amount Paid

In addition to the above, a management fee (margin transaction management fee or



administrative fee) is incurred separately, for handling both open buy and open sell positions, every month from the new contract date, which is to be paid upon total settlement. The amount of this fee ranges from JPY110 to JPY1,100 (inclusive of consumption tax at 10%), but there is no need to pay it if the transaction is settled within one month from the contract date.

(5) Financial Instruments Business Operators and Securities Finance Companies(i) Functions of Securities Finance Companies

In order for margin transactions to realize their full potential, ample funds and share certificate reserves are necessary, but since financial instruments business operators cannot fully satisfy this demand with their own funds and share certificates on hand, they must borrow either funds or share certificates.

As a result, securities finance companies were established as specialist institutions to efficiently supply financial instruments business operators with the necessary funds and share certificates for margin transactions.(ii) DefinitionofaSecuritiesFinanceCompany

A securities finance company is a special financial institution under the FIEA, licensed by the Prime Minister to engage in the business of lending financial instruments business operators funds or share certificates necessary to settle margin transactions, through the settlement mechanism built in the exchange (FIEA, art. 156-24).

A notification must be filed with the Prime Minister if determination or amendment of the conditions of loans for funds or securities is desired (FIEA, art. 156-28, para. 2). Moreover, the Prime Minister shall order an amendment thereto in a case such as when it is recognized that these terms have become inadequate in view of general economic conditions (FIEA, art. 156-29), and a notification system for concurrent businesses has also been implemented (FIEA, art. 156-27, para. 1 and para. 2).(iii) Loans of Securities Finance Companies (Loan Transactions)

Loans to financial instruments business operators from a securities finance company in standardized margin transactions are called loan transactions.

The firms that can utilize the loans in relation to standardized margin transactions from JSF, which is a securities finance company, are limited to the following: financial instruments business operators that are trading participants or members of the exchange (hereinafter referred to as “financial instruments business operators”); customers of financial instruments business operators approved to operate PTSs; financial instruments business operators entrusted by non-clearing participants to conduct financial instruments market transactions through brokerage for clearing of securities, etc.; and registered financial institutions entrusted by non-clearing participants to conduct financial instruments market transactions through brokerage for clearing of securities, etc. (JSF Loan Transaction Lending Regulations, art. 1). When financial instruments business operators transact with JSF, they must submit a written agreement in advance. A person who has submitted a written agreement is referred to as a loan trading participant. Among loan trading participants,

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financial instruments business operators and registered financial institutions: both of which are entrusted by non-clearing participants to conduct financial instruments market transactions through brokerage for clearing of securities, etc. must submit to the JSF in advance a “written agreement on loan transactions, etc. through brokerage for clearing” provided separately (JSF Loan Transaction Lending Regulations, art. 2).

In order to receive a loan, financial instruments business operators must apply to JSF for the issue, number of shares, and other requisite matters by the prescribed time on a day at least two business days prior to the day on which they intend to receive the loan (JSF Loan Transaction Lending Regulations, art. 7). As a general rule, applications are made online (entry of the requisite items).

The loan price is determined based on the closing price on the application date (the day two business days prior to the lending date) (JSF Loan Transaction Lending Regulations, art. 15; JSF, Criteria for Determining the Loan Price). Credit amounts and loan share substitution amounts (the amount equivalent to the market price of the share certificates to be received in a broker loan) are computed by multiplying this price for lending/borrowing by the number of shares in the loan application (JSF Loan Transaction Lending Regulations, art. 19).

Finally, if a financial instruments business operator intends to repay cash or share certificates, etc. that it has been loaned in a loan transaction, an application for the issue, the number of shares of the relevant issue, and other requisite matters must be submitted to JSF by the prescribed deadline on the repayment application date (the day two business days prior to the repayment date) (JSF Loan Transaction Lending Regulations, art. 8).(iv) Loan Collateral

Financial instruments business operators must submit the loan collateral computed by multiplying a certain percentage (30% as of October 2019) by the amount of the lending securities or loan amounts by noon on the date of the loan (JSF Loan Transaction Lending Regulations, art. 18, para. 1). Margin securities may be used in lieu of loan collateral (JSF Loan Transaction Lending Regulations, art. 18, para. 2).

Furthermore, since the loan collateral and the security deposit by the customer with the financial instruments business operators are similar in nature, if the stock exchange amends the minimum maintenance or cash conversion ratio (daiyo kakeme) as a restrictive measure for margin transactions, JSF will implement similar restrictive measures for loan transactions (collection of an increased loan collateral, restriction or suspension of loans, or a request for repayment of cash or share certificates, etc. that have been loaned) (JSF Loan Transaction Lending Regulations, art. 4 and art. 18, para. 4).

Money or share certificates loaned are not directly exchanged between the financial instruments business operators and JSF, all transactions are conducted coincidental to settlement of regular transactions through the clearing organization on the exchange, and the loan is executed on the delivery date (JSF Loan Transaction Lending Regulations, art. 16).

Loan trading participants (financial instruments business operators) who receive a loan of cash provide share certificates, etc. equivalent to the amount being lent (loan collateral share certificates, etc.), and loan trading participants who receive a loan of share certificates



provide an amount of money equal to the price of the share certificates being lent (proceeds of lending shares, etc.), together with the loan collateral, to JSF, which holds them (JSF Loan Transaction Lending Regulations, art. 19, para. 1).

JSF may at its discretion lend the loan collateral share certificates, etc. that have been deposited, or provide the same as collateral, or may exercise the rights stated on the share certificates, etc. (JSF Loan Transaction Lending Regulations, art. 19, para. 2).

A loan transaction with a loan trading participant is based on the loan price on the application date, and since the day following the loan date is fixed as the loan transaction repayment date, if the loan trading participant does not apply for the repayment, it is processed automatically as if the loan trading participant had applied for repayment and simultaneously been granted a new loan. Therefore, even if no loan application is made, if the loan price changes, the net difference (updated difference or updated difference on broker loan) will still be exchanged with the loan trading participant (JSF Loan Transaction Lending Regulations, art. 17). This daily modification of the cash and lending securities at the loan price, and the exchange of the net difference, is referred to as a “mark to market.”

In other words, when the loan price increases, financial instruments business operators that received a cash loan (buyers) will be delivered the difference over the loan price multiplied by the number of shares (amount equivalent to the price increase gain) as a loan increase, and money equal to the difference between the loan price multiplied by the number of shares (amount equivalent to the price increase loss) will be collected as additional proceeds of lending shares, etc. from the financial instruments business operators that received a loan of lending securities (sellers). Conversely, when the loan price is decreased, the reverse operation is performed for all loan transactions.

The intent of the mark to market is to prevent losses due to settlement default in addition to do away with burdensome computations by settling computational gains and losses on a daily basis.

(6) Processing of Rights in Margin TransactionsDuring the loan relationship in margin transactions between financial instruments business

operators and customers, or between financial instruments business operators and JSF, the share price may occasionally drop due to (i) ex-dividends, or (ii) the grant to the shareholder of rights to receive shares, etc. through a share split, etc. or rights in share options, etc. (hereinafter collectively referred to as the “right to receive shares through a share split, etc.”); however, since this decrease is due to special factors, the gain or loss of a seller and buyer should be adjusted accordingly through appropriate processing.

(i) Ex-DividendsWhere shares in a customer’s open sell position (sell side) or open buy position (buy

side) go ex-dividend before the position is settled (when a new share position has been created but not settled), the financial instruments business operator will collect the amount equal to the after-tax dividend amount as the ex-dividends adjustment amount from the sell side (margin selling customer) after the dividend (a dividend from retained earnings) to

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be paid by the issuing company is fixed, and pay it to the buy side (margin buying customer) (TSE Rules for Treatment of Rights Pertaining to Standardized Margin Transactions, art. 2, para. 1). The reason for this payment is that the customer (sell side) would have received the dividends on those shares if they had not been loaned by the financial instruments business operators, and when the customer later physically delivers those shares or returns share certificates acquired through an offsetting transaction, the shares will decline in value by the dividend amount, requiring the sell side to compensate that portion.

The buy side receives the ex-dividends adjustment amount because even though it submitted the purchased share certificates to the financial instruments business operators as collateral, it has the right to receive dividends paid on the shares. Later, at the time of repayment, the sell side will have a gain due to the decline in value by an amount corresponding to the dividend payment, and the buy side will have a loss of the difference due to the ex-dividends, resulting in an offset of loss and gain between the parties.

This relationship is similar to the one between JSF and loan trading participants under Loan Regulations: the rights attached to the share certificates purchased through a loan belong to the loan trading participant who received financing, and the loan trading participant that borrowed the shares is obligated to present such rights to JSF. However, such rights may be treated as otherwise provided based on an agreement with the exchange, etc. (JSF Loan Transaction Lending Regulations, art. 20).(ii) Right to Receive Shares Through a Share Split, Etc.

In cases where a financial instruments business operator continues to loan money or share certificates in a standardized margin transaction to a customer, and the securities have attached the right to receive shares through a share split, etc. (or in cases where shares for the customer’s open sell position or open buy position go ex-rights before settlement), in principle the financial instruments business operator shall pay to the customer purchasing on margin, as of the allocation date of the right to receive shares as a result of a share split, etc. in the issues, cash in the amount equivalent to the value of the right to receive the shares from a share split, etc. as prescribed by the exchange (hereinafter referred to as the “value of processing rights”), and collect the same from the customer selling on margin. This cash amount shall be in accordance with the amount of the value of processing rights deducted from the contract price (the value of processing rights will be delivered by deducting the value of the processing rights from the purchase proceeds lent in connection with the standardized margin transaction for the customer purchasing on margin, and such value will be collected by deducting the value of the processing rights from the sale proceeds that are the collateral for the standardized margin transaction for the customer selling on margin) (TSE Rules for Treatment of Rights Pertaining to Standardized Margin Transactions, art. 4).

Also, if the repayment date for securities under a standardized margin transaction with the attached right to receive shares through a share split, etc. falls after the allotment date for the said right to receive shares through a share split, etc., the receipt/delivery of share certificates is carried out with ex-rights share certificates (TSE Brokerage Agreement Standards, art. 49 and art. 50). If new shares are added in an integer multiple of the trading



unit, the quantity of shares offered for sale or purchase will increase in accordance with the allocation ratio, and the contract price will decline.

If an allocation of new shares is made that is not in an integer multiple of the trading unit, the processing method will be handled as below:

a) Processing of Shares for the Open Sell PositionIf shares for the open sell position go ex-rights before they are settled, a customer

will be deemed to have paid an amount equal to the new share premium by subtracting the value of processing rights from the contract price, and instead, the customer does not have to make repayment of the right to receive shares through a share split, etc. attached to the borrowed shares. However, the customer cannot deliver the new shares received in a capital increase in kind and receive the value of processing rights with shares for the open sell position.b) Processing of Shares for the Open Buy Position

If shares for the open buy position go ex-rights before they are settled, there are two methods for adjusting the loan: the “subscription to new shares, etc.” and “cash settlement.”

a. Subscription to New Shares, Etc.“Subscription to new shares, etc.” can be said to be an application to receive

rights in kind (receipt of the actual securities) when a customer wishes to acquire the right, etc. to receive shares of stock by way of a share split, etc. that is allocated to purchased shares of stock that have been deposited with the financial instruments business operators. Stated differently, the customer pays an amount of money equal to the value of the processing rights (repayment) correspondingly reducing the purchase price (borrowed funds) in exchange for acquiring the rights.

The buy side customer who desires to subscribe to new shares, etc. may apply to the financial instruments business operators for new shares up to the number of shares in the open buy position. The financial instruments business operators must then apply to JSF by the prescribed deadline on the final day of trades with the rights (the deadline for applications from customers of financial instruments business operators may be accelerated by the time needed for the financial instruments business operators to complete procedures for the application to JSF).

When the number of shares applied for exceeds the new share issue, the number of shares allotted will be prorated in accordance with the number of shares applied for, and although new shares may not be allotted due to the transactional structure (the status of the buy side and sell side including the respective volumes and ratios of their outstanding balances), customers cannot raise an objection in such cases. If the shares to be allotted to the shares in the position (including share positions allotted on a pro rata basis) are odd-lot shares, new share certificates will not be issued, and, consequently, the new share certificates cannot be subscribed.

Accordingly, in some cases, the subscription to new share rights, etc. and cash settlement methods may occur simultaneously for the same share positions. When

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the rights are allotted, the customer must pay to the trading participant the price of new share subscription rights (value of processing rights × number of old shares) on the second business day after the ex-rights date. Where the “subscription to rights” method is not used, the transaction will be processed entirely through cash settlement (TSE Rules Concerning the Processing of Rights Pertaining to Standardized Margin Transactions; JSF Guidelines for Processing Rights to Receive Shares through Share Split, etc. in Loan Trading).b. Cash Settlement

Cash settlement means that a customer orders the sale of the right to receive shares through a share split, etc. allotted to the purchased shares, and uses the sales price (value of processing rights) to repay part of the purchase price (borrowed funds).

While the customer cannot acquire the right to receive shares through a share split, etc., the customer is able to have the amount of the loan reduced accordingly (the amount equal to the new share premium).

c) ProcessingatJSFProcessing at JSF is provided for in the “Guidelines for Processing Rights to

Receive Shares through Share Split, etc. in Loan Trading.”The foregoing relationship is similar to the one between loan trading participants

and JSF. JSF will accept applications from loan trading participants that borrowed shares to accept the new shares up to the number of borrowed shares until the final cum rights date for the new shares delivered to JSF by the issuing company with respect to its lending excess. When the number of shares applied for exceeds the number of the shares delivered, JSF makes a prorating in accordance with the number of shares applied for.

Similar to what occurs between financial instruments business operators and the customers, if new shares to be allotted to the borrowed shares are odd-lot shares, applications to subscribe for the new shares will not be accepted. If the number of shares applied for is fewer than the number of shares to be allotted, JSF conducts an auction for the remaining shares.

The payment or receipt of the price for the preemptive subscription rights is conducted at the same time as the exchange of the updated difference of the loan price on the ex-rights date.

With regard to complimentary tickets for shareholders and other benefits conferred to shareholders, JSF provides in its Guidelines that voting rights at a shareholders meeting, shareholder’s right to inspect account books, complimentary ticket for shareholders, and any other benefits accompanying securities involved in loan transactions shall not be treated as rights of shareholders.

(7) Regulations on Margin TransactionsThe margin transaction system aims to create supply and demand for securities through a



loan of either the purchase price or share certificates necessary to settle a trade, thereby contributing to improving market functions such as smooth stock circulation and fair price formulation. Although the structure is set as a simple lending and borrowing transaction, it results in the creation of credit through the system of crossing orders, and combined with the loan repayment term and the long and short interests in the market and speculation on the prepayment trends, it can strongly influence share prices. For this reason the exchanges carry out the following administration in order to promote the sound operation of the margin transaction system.

(i) Establishment and Operation of Guidelines (Daily Quotation Standards)In order to prevent excessive usage, etc. of margin transactions, daily quotation

standards are established. The exchange designates those issues which it determines as being covered by the standards to be “daily quotation issues” and announces these together with the margin transaction balance. The exchange has established the “Guidelines Concerning Measure to Raise the Security Deposit Ratio, etc.” and implements the measure to raise the security deposit ratio, etc. for an issue when it deems that there is excessive margin transaction in the issue.

a) StandardFor details, see the “Guideline For Designating Certain Issues As “Daily Quotation

Issues”.b) Announcement of Margin Transaction Balance

Issues that meet the standards set forth in the guidelines shall be publicly announced on a daily basis.

Guideline For Designating Certain Issues As “Daily Quotation Issues” (Effective date: February 1, 2017)In order to prevent individual issues from being subjected to excess use of

margin transactions in advance, Tokyo Stock Exchange, Inc. (hereinafter referred to as the “Exchange”) has established the following guidelines with respect to a designation of “Daily Quotation Issues.” If certain issues meet the standards set forth below, such issues shall be designated as “Daily Quotation Issues” and the margin transaction balance of such issues shall be publicly announced on a daily basis.I. Designation Standards

Issues that meet one of the standards set forth in 1. through 4. below shall be designated as “Daily Quotation Issues.”

1. Balance StandardIssues that are covered by either of the following:a) In the event the ratio of the sales balance to number of listed shares

is 10% or more and the ratio of the sale balance to the purchase balance is 60% or more; or

b) In the event the ratio of the purchase balance to the number of listed shares is 20% or more.

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2. Trading Ratio Standard for Margin TransactionsFor a period of three consecutive business days, if the disparity between

the share price for each business day and the 25-day moving average share price on each such business day is 30% or more, and either of the following criteria apply (limited to a daily trading volume of 1,000 units or more):

a) The ratio of new sales in margin transactions over three consecutive business days is 20% or more (limited to cases where the share price for each business day falls below the 25-day moving average share price on each such business day); or

b) The ratio of new purchases in margin transactions over three consecutive business days is 40% or more (limited to cases where the share price for each business day exceeds the 25-day moving average share price on each such business day).

3. Turnover Ratio StandardIf the disparity between the share price for a given business day and the

25-day moving average share price on that business day is 40% or more, and either of the following criteria apply:

a) The trading volume on the said business day is not less than the number of listed shares, and the ratio of new sales in margin transactions on the said business day is 30% or more (limited to cases where the share price for the said business day falls below the 25-day moving average share price on each such business day); or

b) The trading volume on the said business day is not less than the number of listed shares, and the ratio of new sales in margin transactions on the said business day is 60% or more (limited to cases where the share price for the said business day exceeds the 25-day moving average share price on each such business day).

4. Special StandardIssues may still be designated as “Daily Quotation Issues” if the

Exchange deems such designation is necessary based on the use of margin transactions or characteristics peculiar to certain issues, even though none of the standards in 1. through 3. above are applicable.

(Notes) 1. With respect to 1. above, even if issues are covered by the standards, the Exchange may decide that it is necessary to observe fluctuations in the balance. In such cases, the designation may not be made until the following business day after confirming the fact that the standards are still applicable.

2. With respect to 1. above, even if issues are not covered by the standards, the Exchange may determine that, in view of the use of margin transactions, the balance is likely to rise



significantly over the standard level on the following business day. In such cases, the standards may be applied.

3. With respect to 2. a) above, even where the trading volume or the ratio of new sales of the issue does not meet the respective standards, if (i) the trade is concluded at the lower-limit price only at the end of the afternoon trading session or (ii) the trade is not concluded and the lower-limit price is indicated as the closing special quotation, the standards may be applied by replacing the term “trading volume” with “volume of sell orders” and the term “ratio of new sales in margin transactions” with “ratio of new sell orders in margin transactions.”

4. With respect to 2. b) above, even where the trading volume or the ratio of new purchases of the issue does not meet the respective standards, if (i) the trade is concluded at the upper-limit price only at the end of the afternoon trading session or (ii) the trade is not concluded and the upper-limit price is indicated as the closing special quotation, the standard may be applied by replacing the term “trading volume” with “volume of purchase orders” and the term “ratio of new purchases in margin transactions” with “ratio of new purchase orders in margin transactions.”

5. With respect to 3. above, during the period from the business day following the day on which the initial contract price is determined until the 24th business day counting from the initial listing date, the standards may be applied by replacing the term “25-day moving average share price on that business day” with “share price on the day of determination of the initial contract price” (the share price on that business day must be the lower-limit price in the case of 3. a) or the upper-limit price in the case of 3. b)).

II. Cancellation StandardsIf an issue meets all of the standards in 1. and 2. below, its designation as a

“Daily Quotation Issue” shall be cancelled:1. Balance Standard

If an issue meets all of the criteria in a) and b) below:a) The ratio of the sales balance over five consecutive business days to

the number of listed shares is less than 8%; andb) The ratio of the purchase balance over five consecutive business

days to the number of listed shares is less than 16%.

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2. Share Price StandardFor the period of five consecutive business days, the disparity between

share price for each business day and the 25-day moving average share price on each such business day is less than 15%.3. Special Standard

Even if all of the standards of 1. and 2. are met, the Exchange may decide not to cancel the designation during the period that it determines necessary, in consideration of the conditions of use of margin transactions and characteristics peculiar to the issue.

(Notes) 1. With regard to the application of the share price standard as part of the cancellation standards in the case where the issue meets the designation standard involving the disparity from the 25-day moving average share price, the disparity is deemed to be less than 15%, irrespective of the actual disparity, if:

(1) the share price as of the day on which the issue met the designation standard exceeded the 25-day moving average share price, and the share price as of each business day falls below the 25-day moving average share price; or

(2) the share price as of the day on which the issue met the designation standard fell below the 25-day moving average share price, and the share price as of each business day exceeds the 25-day moving average share price.

2. With regard to the application of the share price standard as part of the cancellation standards in the case where the issue meets the designation standard involving the disparity from the share price as of the day on which the initial contract price was determined, during the period from the 10th business day to the 24th business day counting from the listing date, the term “25-day moving average share price” is replaced with “moving average share price since listing,” and the disparity is deemed to be less than 15%, irrespective of the actual disparity, if:

(1) the share price as of the day on which the issue met the designation standard exceeded the share price as of the day on which the initial contract price was determined, and the share price as of each business day falls below the moving average share price since listing; or

(2) the share price as of the day on which the issue met the designation standard fell below the share price as of the day on which the initial contract price was determined, and the



share price as of each business day exceeds the moving average share price since listing.

3. If issues are determined to be delisted, their designation as daily quotation issues may be cancelled.

III. Other・�Listed securities other than share certificates shall be treated as share

certificates.・�“Share price” means the latest closing price (if the latest quote is displayed,

such figure shall be used).・�“Trading volume” means the trading volume during the trading hours of the

TSE.・�“25-day moving average share price” means the average share price

(rounded off to one decimal place) for the period of 25 business days ending on the business day in question; provided, however, that appropriate adjustments may be made in case of a share split, etc.

・�“Moving average share price since listing” means the average share price (rounded off to one decimal place) for the period from the listing date until the business day in question; provided, however, that appropriate adjustments may be made in case of a share split, etc.

・�The “ratio of new sales in margin transactions” and the “ratio of new purchases in margin transactions” respectively refer to the ratio of the volume of new sales in margin transactions and the volume of new purchases in margin transactions during trading hours (limited to sales and purchases concluded), to the trading volume during trading hours.

・�The “volume of sell orders” and the “volume of purchase orders” respectively refer to the volume of offers (including market orders) at the lower-limit price, and the volume of bids (including market orders) at the upper-limit price, at the end of the afternoon trading session (both limited to the volumes during trading hours).

・�The “ratio of new sell orders in margin transactions” and the “ratio of new purchase orders in margin transactions” respectively refer to the ratio of the volume of new offers (including market orders) at the lower-limit price in margin transactions to the volume of offers, and the ratio of the volume of new bids (including market orders) at the upper-limit price in margin transactions to the volume of bids, at the end of the afternoon trading session (both limited to the ratios during trading hours).

・�The ratio of new sales in margin transactions and ratio of new purchases in margin transactions, the volume of sell orders and volume of purchase orders, and the ratio of new sell orders in margin transactions and ratio of new purchase orders in margin transactions are calculated from the

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aggregated figures declared by securities firms that are trading participants, and in the case where a trading participant revises the declared figures, those revisions are not taken into consideration.

End

(ii) Issue under Trade Monitoring System and Daily Announcement of Margin Transaction BalanceTogether with entry into force of the “System of Disclosure of Large Volume Holding

of Share Certificates, Etc.” (the so-called 5% rule) (FIEA, art. 27-23), the TSE implemented the issue under trade monitoring system, and where an issue is designated through this system (hereinafter referred to as “issues under trading monitoring”) and can be used for margin transactions, the margin transaction balance for such issue is announced daily (TSE Rules Concerning an Issue under Trade Monitoring, art. 2, and art. 4, para. 2).(iii) Regulations on Margin Transactions

When there are abnormal situations, such as radical fluctuations in share price due to excessive use of margin transactions, correctional measures, such as an increase in the security deposit ratio or increased collateral requirements, are taken. In addition, measures may be taken to flexibly restrict or suspend margin transaction sales or purchases depending on the situation.

These regulations are imposed by the TSE’s regulatory measures (TSE Business Regulations, art. 65; Rules on Regulatory Measures Concerning Securities Trading, etc. or Its Brokerage) and the “Guidelines Concerning Measure to Raise the Security Deposit Ratio, etc.”:

a) Raising the Security Deposit Ratio or Restrictions on the Substitution of SecuritiesThis involves raising the security deposit ratio for all issues or a particular issue,

and collecting an additional security deposit. Alternatively, financial instruments business operators may be required to collect all or part of the security deposit in cash (referred to by terms such as cash collateral, cash deposit, or collateral cash deposit, hereinafter referred to as the “cash collateral”).

There are four stages of measures to raise the security deposit ratio. The primary measure is to raise the ratio by the following values, and the secondary and subsequent measures are to further raise the ratios by the same values (TSE Guidelines Concerning Measure to Raise the Security Deposit Ratio, etc.):

Security deposit ratio: 20%Of which, cash collateral: 20%

b) Lowering the Cash Conversion Ratio of Margin SecuritiesThis involves modifying the cash conversion ratio (daiyo kakeme) of margin

securities.c) Deposit of Cash Collateral

This involves trading participants making a deposit to the TSE in cash in the amount equivalent to some or all of the cash collateral if restrictions have been imposed



on substituting securities for a security deposit.d) Restriction or Prohibition on Selling or Purchasing through Margin Transactions

This involves the outright restriction or prohibition on margin transactions (TSE Business Regulations, art. 65; Rules on Regulatory Measures Concerning Securities Trading, etc. or Its Brokerage, art. 1).Also, with regard to loan transactions, this involves restrictive measures such as

restricting or suspending the lending of funds or securities by securities finance companies, which has the same effect as the direct restriction of margin transactions (JSF Loan Transaction Lending Regulations, art. 4).(iv) Self-RestraintinSolicitationforRestrictedIssues

Financial instruments business operators must refrain from soliciting with issues that are restricted or prohibited for margin transactions by the exchanges or an Approved Member, and issues with respect to which securities finance companies have restricted or refused lending securities applications (Investment Solicitation Rules, art. 12, para. 2).

(8) Measures in the Case of Breach of Margin Transaction ContractsAfter a financial instruments business operator executes an order for a margin transaction

entrusted from a customer, if the customer (i) does not deposit the security deposit by the specified date; (ii) does not deposit any additional margin; or (iii) does not repay the loaned cash or securities relating to the margin transaction, the financial instruments business operator may, at its discretion, close out the customer’s position (TSE Brokerage Agreement Standards, art. 53. [Actions in the Case of Nonperformance of Settlement by a Customer]).

Similarly, between loan trading participants and JSF, where the loan trading participant does not (i) pay the net difference on an updated loan price; (ii) make payment of the interest or broker loan rate; (iii) repay loaned cash or securities; or (iv) replace defective collateral securities (purchased securities), JSF can appropriate the sales proceeds on a disposition of the collateral or collateral securities to the repayment of the loan trading participant’s debt (JSF Loan Transaction Lending Regulations, art. 22). In this case, if the debt cannot be satisfied even after the disposition, repayment will be received from the settlement funds of its clearing participant in accordance with the business rules of the clearing organization (JSCC).

(9) PTS Margin TransactionsFollowing the introduction of margin transactions at PTSs on July 19, 2019, the definitions

of the terms related to PTS Margin Transaction have been established.(i) PTS Margin Transaction

PTS Margin Transaction is a margin transaction in which a Regular Member extends credit to a customer for off-exchange sale and purchase through the approved business*1 conducted by Approved Members*2 (Off-Market Trading Rules, art. 2, item. 10).

*1 Approved business: The proprietary trading system operation business conducted by a Regular Member who obtains approval of proprietary trading system

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operation business (Off-Market Trading Rules, art. 2, item. 6).*2 Approved Member: Regular Member who obtains approval (of the Prime Minister)

for proprietary trading system operation business for the listed share certificates, etc. (Off-Market Trading Rules, art. 2, item. 5).

(ii) PTS Standardized Margin TransactionPTS Standardized Margin Transaction is a margin transaction at PTS that is conducted

according to the following rules in terms of the broker loan rate and the limit for extension of the return/repayment deadline (Off-Market Trading Rules, art. 2, item. 11):

a. Broker loan rate: The uniform rate designated by the TSE for each issue applies;b. Limit for extension of the return/repayment deadline: The return/repayment

deadline shall be a day following the day of lending by the Regular Member, and if such return/repayment is not notified within two business days before the deadline, it shall be extended to the next day sequentially; provided, however, that the deadline may not be extended beyond the second business day following the corresponding day that is six months after the day on which a sale or a purchase was effected in the margin transaction at the PTS.

(iii) PTS Negotiable Margin TransactionPTS Negotiable Margin Transaction is a margin transaction at PTS that is conducted

according to an agreement between the Regular Member and the customer in terms of the broker loan rate and the limit for extension of the return/repayment deadline (Off-Market Trading Rules, art. 2, item. 12).

(10) Operational Rules for PTS Margin TransactionsWhen an Approved Member handles PTS Margin Transactions, it must prepare Operational

Rules for PTS Margin Transactions which provide for the scope of Participating Members who may handle PTS Margin Transactions, the hours when PTS Margin Transactions are available, and the criteria for selection of issues for PTS Standardized Margin Transactions and issues for loan transactions at PTSs, and have its Participating Members comply with such rules (Off-Market Trading Rules, art. 6-7, para. 1).

11 Foreign Securities Transactions

The investing public have been allowed to invest (excluding investments to participate in management) in select foreign securities listed on overseas markets since July 1971, and thereafter, restrictions concerning foreign securities investments have gradually been removed, through listing foreign securities on the TSE (December 1973) to improve the efficiency of foreign securities investment, and piecemeal expansion of the number of overseas market investment targets. Also, beginning December 20, 1991, the foreign investment securities (a



“country fund”―a corporate-type, closed-end investment trusts whose purpose is to invest in securities in a certain country or region, in other words investment company shares) was listed on the OSE.

Following the integration of the cash equity markets of the OSE into those of the TSE as of July 16, 2013, the country fund market of the OSE was also integrated into that of the TSE, which was newly established.

11 1 Establishment of a Foreign Securities Transaction Account

When a financial instruments business operator accepts an order (including dealing in public offerings or secondary distributions or dealing in private placements) from a customer for a foreign securities (in this context, foreign share certificates, foreign investment securities, foreign ETFs, and foreign depositary receipts, etc.) transaction, upon executing an agreement concerning transactions in foreign securities, the financial instruments business operator must first deliver an “Agreement on Foreign Securities Trading Account” (hereinafter referred to as the “Account Agreement”) to the customer (except for a professional investor in the case that the investor will acquire foreign securities through dealing in private placement) in a format established by each financial instruments business operator respectively (a format that meets requirements specified in JSDA rules as well as financial instruments exchanges’ brokerage agreement standards) (the financial instruments business operator shall not be required to deliver the Account Agreement to a customer if it has already delivered the Account Agreement to the customer and the customer does not request the additional delivery of the Account Agreement), and receive an application from the customer to establish a trading account pursuant to this Account Agreement. In this case, the financial instruments business operator must ensure that the fact that it has received an application from the customer can be confirmed by receiving an application form from the customer stating that the customer wishes to establish a trading account pursuant to the Account Agreement or by any other method specified by the Association Member (Foreign Securities Rules, art. 3, para. 2 and para. 3). In accordance with the TSE Brokerage Agreement Standards, it is a principle that a trading participant must receive an application form from a customer for establishing a foreign securities trading account, and under certain conditions, it may receive an application by electromagnetic means, instead of receiving an application form (TSE Brokerage Agreement Standards, Rule 3-2. para. 1 and para. 4).

Since April 1, 2005, the “Account Agreement” form as respectively prepared by each financial instruments business operator has come to be used instead of the form prepared by the JSDA and the financial instruments exchanges. Consequently, of the following, items that correspond to the above are typical treatments.

Financial instruments business operators process the execution of foreign securities trading, etc. based on customer orders, settle the trading price, and act as the custodian, etc. of the said foreign securities as prescribed in the Account Agreement or the Agreement to Sell Foreign

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Section 11. Foreign Securities Transactions


Shares in a Tender Offer (Foreign Securities Transaction Account) (Foreign Securities Rules, art. 4, TSE Brokerage Agreement Standards, art. 28-3).

When receiving an order for a transaction in foreign securities (other than those which make disclosures based on the FIEA of Japan), financial instruments business operators must explain to the customer the fact that said foreign securities are not subject to the disclosure obligations under the FIEA. The method of explanation may be by statement in the Account Agreement or the document to be delivered prior to conclusion of a contract (Foreign Securities Rules, art. 6, para. 4).

The above mentioned delivery of an Account Agreement and collection of an application form for establishing a trading account may be made, e.g., by a method using an electronic data processing system, such as the Internet, instead of in paper form (Foreign Securities Rules, art. 32, para. 1, item 1 and para. 2, item 1; Electromagnetic Document Delivery Rules; TSE Brokerage Agreement Standards, art. 3-2, para. 3 and para. 4).

11 2 Modes of Foreign Securities Transactions

Foreign securities transactions conducted by general investors can be classified into domestic entrustment transactions, foreign transactions and domestic over-the-counter transactions, depending on the mode of the transaction.

A domestic entrustment transaction involves foreign shares of stock, etc. that are listed on a domestic exchange, and are prescribed in, e.g., the Business Regulations and the Brokerage Agreement Standards of the exchange. Foreign transactions and domestic over-the-counter transactions involve transactions in foreign securities except for those that are traded on a domestic financial instruments exchange market. These are consequently prescribed by the JSDA “Rules Concerning Sale and Purchase of Foreign Securities.”

(1) Domestic Entrustment TransactionsA domestic entrustment transaction means a transaction in foreign securities listed on a

domestic exchange.The trading, etc. of foreign securities on the exchange is executed similarly to domestic

securities transactions in accordance with the Exchange Business Regulations. However, some of the major differences between foreign securities and domestic securities are listed below:

(i) Types of TradesThere are only two types of trades for foreign securities: a) same-day settlement

transactions; and b) regular transactions (TSE Business Regulations, art. 9, para. 1, item 2).The delivery date in a sale and purchase of foreign securities is the second business day

following the contract date except for cases where a different treatment is separately agreed on with the customers (Foreign Securities Rules, art. 3, para. 6, item 2).(ii) Trading Units

Trading units are based on share price, and units of 1,000 shares, 500 shares, 100 shares,



50 shares, 10 shares or one share are used in accordance with the rules adopted on the securities exchange (TSE Rules Regarding Trading Units of Foreign Stocks, art. 2, para. 1; Business Regulations, art. 15, item 1(b)). The trading units of foreign ETFs and foreign ETNs are set at 100 units, 10 units and 1 unit (TSE Rules Regarding Trading Units of Foreign Stocks, art. 2, para. 2).

Chart 1-4 Structure of Domestic Entrustment Transactions for Foreign Share Certificates

(iii) through (vii) below describe an outline of the “Business Regulations Relating to the Depository and Book-Entry Transfers of Foreign Share Certificates, etc.” established by the JASDEC in accordance with the Act Concerning Book-Entry Transfer of Bonds, Shares, Etc., Article 9 Paragraph 1, proviso, and the Order for Supervision of General Book-Entry Transfer Institutions, Article 6, Paragraph 2, Item 3, focusing on the provisions regarding the JASDEC’s custody services for foreign share certificates.(iii) Settlement

Settlement is conducted in the same manner as domestic share certificates. Foreign share certificates traded on the exchange are deposited with the offshore custodian of the issuing company under title of the JASDEC; financial instruments business operators (account management institutions for foreign share certificates, etc.) make settlement by account transfer using their accounts established with the JASDEC.

Therefore, settlement of the foreign share certificates traded on exchanges is processed through the clearing procedure at the JSCC and then booked through the instructions from the exchange to the JASDEC as a transfer from the JASDEC account of the financial

(Source) JASDEC website

Beneficial shareholders, etc. of foreign sharecertificates, etc.

Account management institution for foreign share certificates, etc.

Offshore deposit return

Settlement verification

system

Request forbook-entry

transferBalance

reportBeneficial shareholder

report

Participant registration

New record deletion

Offshore deposit return

Dailybalance

Account transfer systemShareholder

notification system

Participant information

system

Beneficial shareholder

reportGeneral book-entry

transfer DVPRequest for DVP

book-entry transfer Batch processing

Offshore custodian

SWIFTJapan Securities

Clearing Corporation

JASDEC DVP Clearing

Corporation

Transfer agent (trust bank)

New book-entry transfer system

Schematic of the depository and book-entry transfer system of foreign share certificates, etc., using the new book-entry transfer system

Foreign share

certificate system (current system)

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instruments business operators that handled the sell order to the JASDEC account of the financial instruments business operator that handled the buy order.(iv) Processing of Dividends, Etc.

In cases where the rights for dividends, etc. are granted, a financial instruments business operator must submit a list of the names and addresses, etc. of its customers to the JASDEC, and the JASDEC will notify the transfer agent (trust bank) for the said issue.

In the case of a cash dividend, an offshore custodian of the JASDEC initially receives the cash dividend, and the dividend is paid in yen to the customer (the beneficial shareholder of foreign share certificate, etc.) through the Japanese bank handling the dividend payments.

In the cases of a share dividend, if a customer is to pay the amount equivalent to the withholding tax on the said share certificates, an offshore custodian of JASDEC initially receives the share dividend and transfers it into the foreign securities transaction account of the customer through a financial instruments business operator. However, in the case of fractional shares where a customer is not responsible for withholding tax, the offshore custodian of JASDEC will sell those securities and pay the sales proceeds to the customer through a transfer agent.(v) Processing of Share Options and Other Rights

In cases where share options are granted and Japanese shareholders are also able to exercise the rights under the share options, an offshore custodian of the JASDEC receives the share options and a customer exercises the rights under the share options through a financial instruments business operator.

Shares received in a share split, bonus issues, etc. are also transferred into the customer’s foreign securities transaction account, but fractional shares will be disposed of by sale.(vi) ChangeofCustody(Transfer)ofShareCertificates

Where a customer sells share certificates purchased in a domestic entrustment transaction (deposited with the offshore custodian of the JASDEC) on a foreign securities market, or where the said shares are returned, the financial instruments business operator will first change (transfer) the custody of the said share certificates from the offshore custodian of JASDEC to which the financial instruments business operator uses, and then sell or return them to the customer.(vii) Other

Documents concerning the shareholders’ general meeting, business reports, etc. and other miscellaneous notices from the issuing company are sent to the reported addresses of customers from the transfer agent. The JASDEC will exercise voting rights at the shareholders’ general meeting if the customer so instructs. However, in the absence of an instruction, the JASDEC will not exercise voting rights. For some issues, the detailed information of the shareholders meeting is disclosed on the exchange’s website and it may not be delivered to the beneficial shareholders in the form of a document.



(2) Foreign TransactionsA foreign transaction refers to a transaction to execute a trading order in foreign securities

(excluding foreign investment trust securities) by means of intermediary, brokerage or agency services towards a financial instruments market of a foreign country (including an over-the-counter market) as well as a commission transaction of a sale of foreign share certificates, etc., foreign share option certificates, foreign investment equity subscription right certificates or foreign bonds to a tender offer (Foreign Securities Rules, art. 2, para. 1, item 18).

If a financial instruments business operator brokers a sale by a customer in response to a tender offer of foreign securities, the financial instruments business operator must obtain an Agreement to Sell Foreign Shares in a Tender Offer (Foreign Securities Rules, art. 3, para. 9). Moreover, matters such as the execution of trades, etc. in foreign securities pursuant to an order by a customer, the settlement of the proceeds of the trade and the custody of the foreign securities must be handled in accordance with the Account Agreement or Agreement to Sell Foreign Shares in a Tender Offer (Foreign Securities Rules Article 4).

(i) Issues for Which a Financial Instruments Business Operator Is Able to Make Solicitations to CustomersForeign securities for which a financial instruments business operator is able to solicit

customers (excluding qualified institutional investors and certain types of business corporations) include foreign securities which are traded on or are expected to be traded on a qualified foreign financial instruments market, and which satisfy certain requirements. The term “qualified foreign financial instruments market” means a foreign financial instruments exchange market or foreign over-the-counter market which a financial instruments business operator has determined to have satisfied the requirements set forth in (ii) and to not present a problem from the perspective of protecting investors (Foreign Securities Rules, art. 7, para. 1, para. 2 and para. 3).(ii) RequirementsofQualifiedForeignFinancialInstrumentsMarkets

A qualified foreign financial instruments market must satisfy the following requirements. Securities for which transactions are conducted on a foreign financial instruments exchange market or foreign over-the-counter market and for which a financial instruments business operator conducts foreign transactions are referred to as “traded securities” (Foreign Securities Rules, art. 7, para. 4):

a) The trading price of the traded securities can be obtained;b) The financial statements or other financial information for the issuer of the traded

securities can be obtained;c) There is a supervisory governmental agency or similar institution that supervises

the financial instruments exchange market of the foreign country or over-the-counter market of the said foreign country;

d) It is possible to receive/remit the purchase price, the sales price, returns, etc. of the traded securities; and

e) There is an institution which conducts custody functions for the traded securities.

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(iii) Transactions in PracticeWhile customers are supposed to give instructions to financial instruments business

operators regarding the type of trade and the manner and location to execute the buy/sell, because the order is placed with an overseas market, the date/time of the order may differ from the contract date/time due to time differences, etc. Therefore, the contract date is fixed as the day when the financial instruments business operator confirms the execution of the buy/sell order at the place of execution (if such day is a non-business day, the first business day following the said day).

Generally, settlement for foreign transactions takes place on the third business day counting from the contract date, which is the same as settlement for domestic transactions. The exchange of money pertaining to the contract is conducted in yen or a foreign currency designated by the customer, to the extent the financial instruments business operator can meet the request. Conversion between foreign currency and yen is in principle made using the exchange rate determined by the financial instruments business operator on the contract date (Foreign Securities Rules, art. 3, para. 6, item 1, item 2, item 13 and item 14).

Financial instruments business operators must establish internal rules concerning handling charges and endeavor to put in place an internal control framework that includes internal inspections and auditing, as well as to engage in appropriate conduct of business in order to secure the transparency and fairness of foreign securities (Foreign Securities Rules, art. 9).(iv) CustodyofShareCertificatesandProcessingofRights

Share certificates purchased by customers are deposited under the name of a financial instruments business operator with the offshore custodian designated by the financial instruments business operator.

The financial instruments business operator first receives dividends, etc. on securities in custody on behalf of the customer and then pays them to the customer. If share options are granted, these are generally disposed of through a sale and the sales proceeds are paid to the customer.

Yen conversion of foreign currency amounts received by the customer is made using the rate determined by the financial instruments business operator on the date the financial instruments business operator confirms the receipt of the full amount (Foreign Securities Rules, art. 3, para. 6, item 3, item 6, item 7, item 13 and item 14).

A financial instruments business operator shall notify a customer of the following facts that may significantly impact the position of the customer: (a) notification of facts that may significantly impact the position of shareholders, etc. such as issuance of shares for subscription, a share split or a consolidation of shares; (b) notification of dividends, etc.; and (c) notification in connection with important items on the agendas of general meetings of shareholders, such as proposed mergers (Foreign Securities Rules, art. 3, para. 6, item 9).(v) Other

A financial instruments business operator must preserve notices from an issuing company and other materials, etc. for three years (one year with respect to foreign CDs and



foreign CPs) and make them available for inspection, and must deliver the materials, etc. upon request by a customer (Foreign Securities Rules, art. 6, para. 1, para. 2, and para. 3).

(3) DomesticOver-the-CounterTransactionsA domestic over-the-counter transaction means an over-the-counter transaction in Japan of

foreign securities (excluding foreign investment trust certificates) (Foreign Securities Rules, art. 2, para. 1, item 19), i.e., a transaction in foreign securities in which a financial instruments business operator trades as a principal with an investor.

The foreign securities for which a financial instruments business operator is permitted to solicit customers are the same as those for foreign transactions.

(i) Securing Transactional FairnessFinancial instruments business operators must, when conducting a domestic over-the-

counter transaction for foreign share certificates, etc. (other than issues that are listed on a domestic securities market) with a customer, conduct the transaction at a fair price, computed in a reasonable manner and based on the market price (internal market price) and must ensure the fairness of such transaction (Foreign Securities Rules, art. 11, para. 1). Also, where a customer so requests, a summary explanation of the method, etc. of calculating the trading price shall be provided orally or in writing (Foreign Securities Rules, art. 11, para. 4).

Moreover, in order to achieve transparency and fairness in domestic over-the-counter transactions, a financial instruments business operator must set forth in its internal regulations stipulations concerning appropriate contract management, etc. of domestic over-the-counter transactions and endeavor to put in place an internal administration framework that includes internal inspections and auditing, as well as to engage in appropriate conduct of business (Foreign Securities Rules, art. 9).(ii) Settlement, Etc.

Settlement for domestic over-the-counter share certificates is conducted through an account transfer (Foreign Securities Rules, art. 10), and share certificates in custody are processed in a manner similar to foreign transactions. Also, yen conversion and rights processing, etc. follow the same methods used for foreign transactions.

12 Securities Investment Computations

12 1 Stock Yield

Stock yield, also referred to as dividend yield, means a percentage of the amount of the annual received dividend divided by the amount invested (the acquisition cost of shares).

Dividends are distributions of retained earnings to the shareholders of a joint stock company,

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Section 12. Securities Investment Computations


or the retained earnings so distributed.Since dividends are paid to those persons who are shareholders as of the settlement date

(record date), the share price is the ex-dividend market price on the business day preceding the settlement date (two business days before in cases where the settlement date is a holiday).

Ordinarily, dividends are paid at a certain amount per share.The stock yield is given by the following formula:

If the share price is calculated based on expected yield using Formula <1>, it is possible to know the price to pay for the shares in order to obtain the expected yield. This share price is called the break-even price:

(Sample Question) Prospective annual dividend per share is JPY10 and the market price of the share is JPY500. What is the dividend yield of this share?

(Sample Question) I would like to purchase shares with a prospective annual dividend of JPY4 so that I earn an annual yield of 2.5%. What would the limit price on the share be?

Formula <1>

Stock Yield = Annual Dividend per Share 100

Share Price×

Formula <2>

Annual Dividend per ShareBreak-Even Price =

Desired Yield

Based on Formula <1> JPY10 100 = 2%

JPY500×

Based on Formula <2> JPY4

= JPY1600.025



12 2 Cum Rights, Ex-Rights Market Prices

Chart 1-5 gives the format for capital increases at corporations.

Chart 1-5 The Format for Capital Increases

Of the capital increases, in the case of the share split and shareholder-allocated onerous capital increase, the old shares are traded at a price that includes the right to the new share allotment up to the second business day prior to the date when the new shares are allocated (the third business day prior to the date in cases where the allotment date falls on a holiday). This is called the cum rights market price.

Thereafter, from the first business day prior to the new share allotment date (the second business day prior to the date in cases where the allotment date falls on a holiday), the share no longer has the right to the new share allotment. The price, therefore, decreases by the value of the right, and is called the ex-rights market price.

The formula for calculating the prospective ex-rights market price is as follows:

As shown in Formula <3>, in order to calculate the prospective ex-rights market price of the shares subject to the capital increase under certain conditions, it is enough to know three variables, i.e., the current cum rights market price, the paid-up amount for the new shares and the allotment ratio. The paid-up amount for the new shares means the amount to be paid per share in order for the new share to be allocated and the allotment ratio means how many new shares are allotted to each outstanding share.

Cum rights market price means the current value of the company per share. Multiplication of the paid-up amount for new shares by the allotment ratio shows how much will be newly paid into the company per current share. In other words, the numerator of Formula <3> is the value of a

Payment at Market Value (Capital increaseby issue at market value)(Allocated to third parties

other than shareholders)

(New shareholders subscribe, from the broad public)

Capital Increase by ThirdParty Allotment

Capital Increase by PublicOffering

CapitalIncrease

Shareholder-AllottedOnerous Capital Increase

Share split

(Onerous allotment of new shares to shareholders.)

Existing stocks are divided, resulting in a larger number of stock units. A share split is different from a capital increase, but a limited split is often called a free capital increase.

Formula <3>

Ex-Rights Market Price =

Cum Rights Market Price +(Paid-up Amount for New Shares × Allotment Ratio)

1 + Allotment Ratio

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current share after the capital increase.The denominator is the number of shares by which the current number of shares will increase

after the capital increase. That is, the right side of Formula <3> is the per-share value of the company after the capital increase divided by the number of shares after the capital increase.

The formula for calculating the ex-rights market price in the case of a share split would be as follows:

In addition, combining and transposing Formula <3> and Formula <4> can provide a formula for calculating the cum rights market price from the ex-rights market price under certain conditions.

(Sample Question) A share with a market price of JPY1,200 will be split 1 : 1.2 What would be the prospective ex-rights market price?

Using Formula <4>,

(Sample Question) The cum rights market price of a certain share prior to a 1 : 1.5 split was JPY1,500. If the ex-rights market price was JPY1,100, how much did the price increase over the cum rights market price of JPY1,500?

Using Formula <6>, JPY1,100 × 1.5 = JPY1,650 (cum rights market price calculated

from the ex-rights market price) JPY1,650 − JPY1,500 = JPY150

Formula <4>

Ex-Rights Market Price = Cum Rights Market Price

Split Ratio

Formula <5>

Cum Rights Market Price = Ex-Rights Market Price (1+ Allotment Ratio)– (Paid-up Amount for New Shares Allotment Ratio)

××

Formula <6>Cum Rights Market Price = Ex-Rights Market Price × Split Ratio

JPY1,200 = JPY1,000 1.2



12 3 Price/Earnings Ratio (PER)

The net profit per share for the current term is an index by which the profitability of companies is measured.

In a “consolidated profit and loss statement” and “consolidated statement of comprehensive income” to be prepared for a consolidated fiscal year starting on April 1, 2015, and thereafter, the revised presentation method applies with regard to a “net profit for the current term”: “net profit for the current term before minority shareholder profit or loss adjustment” is now presented as “net profit for the current term,” and “net profit for the current term” under the previous standards is now presented as “amount of net profit for the current term attributable to owners of a parent” (Consolidated Financial Statements Ordinance, art. 65, para. 4). In the case of non-consolidated financial statements, there is no change in the presentation method and the term “amount of net profit for the current term” is maintained (Financial Statements Ordinance, art. 95-5, para. 2).

The Consolidated Financial Statements Ordinance provides: “The amount obtained by adjusting the amount of net profit for the current term or the amount of net loss for the current term by adding or subtracting the amount that represents non-controlling interests in the amount of net profit for the current term or the amount of net loss for the current term must be stated as the amount of net profit for the current term attributable to owners of a parent or the amount of net loss for the current term attributable to owners of a parent” (Consolidated Financial Statements Ordinance, art. 65, para. 4).

Where details of the account settlement for a business year, a quarterly cumulative period, a consolidated accounting year, or a consolidated quarterly cumulative period are settled, a listed company must disclose such details immediately using the “Earnings Report (Summary)” or “Quarterly Earnings Report (Summary).” The format of disclosure by means of an earnings report may be chosen from among the four types of formats, i.e. the Japanese standards (consolidated), Japanese standards (non-consolidated), International Financial Reporting Standards (IFRS; consolidated) and US standards (consolidated), depending on the accounting standards adopted by the listed company and also from between the table style and the free description style. The definition of the term “net profit for the current term” differs among these four types of disclosure formats. In the section below, “net profit for the current term attributable to owners of a parent” in consolidated financial statements is used to explain what is usually called “net profit for the current term.”

This is also called EPS (Earnings Per Share). The higher the EPS, the higher the profitability

Formula <7>

Net Profit per Share for the Current Term = Current Term Net Profit (After Tax)Total Number of Outstanding Shares

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of the company.The Price/Earnings Ratio (P/E Ratio or PER) is an index for the price of shares being traded

relative to the net profit per share for the current term.The P/E Ratio is given by the following formula:

For example, if the net profit per share for the current term of Company A is JPY20 and the share price is JPY400, the P/E Ratio, according to Formula <8>, would be 20 times.

If the share price of Company B in the same industry is also JPY400, but the net profit per share for the current term is JPY25, the P/E Ratio is 16 times. Judging from the P/E Ratio, Company B is a better buy than Company A.

Also, in general, the P/E Ratio tends to be higher for a company with a higher rate of growth in company profits; however, whether the P/E Ratio for an individual issue is high or low depends on the industry and how the market perceives growth potential and profitability. For this reason, one method for evaluating the share price, and for deciding if the P/E Ratio of a certain issue is high or not, is to compare the current P/E Ratio with the trend for that specific issue for the past several years, and to determine where the current P/E Ratio fits into the trend. If it is positioned closer to the upper limit considering the trend, this would be a warning sign. On the other hand, if it is closer to the lower limit and there is potential for improvement in performance, then, it would be a good buy.

(Sample Question) If a company has capital of JPY20 billion (outstanding number of shares: 400 million shares), its net profit for the current term (after tax) is JPY12 billion and the share price of the company is JPY900, what is the net profit per share for the current term and the Price/Earnings Ratio (P/E Ratio)?

Formula <8>

Price/Earnings Ratio (PER) = Share Price

Net Profit per Share for the Current Term (times)

Using Formula <7>,

Net Profit per Share for the Current Term = JPY12 billion

= JPY30400 million shares

Using Formula <8>,

P/E Ratio = JPY900

= 30 timesJPY30



12 4 Price/Cash-Flow Ratio (PCFR)

The price of a share divided by the cash flow per share is called the “Price/Cash-Flow Ratio” (PCFR).

Cash flow normally means the flow of money over a certain period, as is implied in the term, and is defined by Cabinet Office Ordinance as “the increase or decrease in funds (cash(Note 1) or cash equivalents(Note 2))” (Financial Statements Ordinance, art. 8, para. 18, and para. 19; Consolidated Financial Statements Ordinance, art. 2, item 13 and item 14)

(Notes) 1. The cash here includes current accounts, ordinary deposits and other deposits that the depositor may withdraw without waiting a certain period of time.

2. Cash equivalents mean short term investments that can easily be converted to cash and for which there is little risk of fluctuation in value.

Nevertheless, the cash flow that is used in the PCFR normally uses the monetary amount of net profit plus depreciation costs.

An indicator consisting of the share price and the aforementioned EPS (net profit per share for the current term), i.e., the Price/Earnings Ratio (P/E Ratio), is generally used to determine the level of a share price in investment analysis. Since current net profit is easily influenced by differences in depreciation methods, it is not possible to evaluate whether it is supported by cash flow, i.e., the “profit quality.”

The PCFR has attracted attention as an investment analysis indicator using cash flow which is also emphasized in diversified international investment.

The fundamental theory of PCFR is the same as PER: the higher the PCFR, the more expensive the share; the lower the PCFR, the more the share is selling at a bargain. The difference with the PER is that since PCFR is calculated using cash flow determined by adding back depreciation expenses to the after-tax profit, it is more useful in making judgments about the growth potential, etc. of the company.

For example, suppose that a company establishes a new division to develop a new technology with a large future potential. In this case, it looks like a good investment, but if the development requires a large amount of expenses, profits would shrink. If you looked at the PER in this case, it would show that the share is somewhat pricey. However, looking at the PCFR reflected by the investment amount, the resulting figure would show that the share is not that expensive. In such cases, one is able to incorporate the growth potential into the calculation.

Assume that “Cash flow = Current Net Profit (after tax) + Depreciation Expenses.”

Formula <9>

Price/Cash-Flow Ratio = Share Price

Cash Flow per Share

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(Sample Question) What is the Price/Cash-Flow Ratio (PCFR) for a company (one closing per year) with capital of JPY20 billion (400 million issued and outstanding shares), current net profit (after taxes) of JPY12 billion, depreciation expenses of JPY2 billion, and a share price of JPY1,470?

<Reference>A “cash flow statement” is one of the basic financial statements, and must state the condition

of cash flow divided into the categories of, e.g., (1) cash flow from business activities, (2) cash flow from investment activities, and (3) cash flow from financial activities (Financial Statements Ordinance, art. 112; Consolidated Financial Statements Ordinance, art. 83).

The sum of (1) and (2) is referred to as “free cash flow.” It is the amount of money that a company earns from activities such as manufacturing and sales, minus the company’s expenditures for investment such as plant and equipment, and is also referred to as “net cash revenue.” This free cash flow can be used, e.g., to pay interest bearing debt, or as funds for increased distributions.

Cash Flow per Share = JPY12 billion + JPY2 billion = JPY35400 million shares

Accordingly, under Formula <9>:

Price/Cash-Flow Ratio = JPY1,470

= 42 timesJPY35



■Concerning Net Assets, Equity and Shareholders’ Equity■(Example of Relevant Portion of

Non-Consolidated Balance Sheet)(Example of Relevant Portion of

Consolidated Balance Sheet)NET ASSETS NET ASSETSI. Shareholders’ Equity I. Shareholders’ Equity 1. Paid-in Capital 2. Capital Surplus

1. Paid-in Capital 2. Capital Surplus

(1) Capital reserve (2) Other capital surplus

Total Capital Surplus 3. Profit Surplus 3. Profit Surplus (1) Profit reserve (2) Other profit surplus XX Reserves Profit Surplus Carried Forward

Total Profit Surplus 4. Treasury shares 4. Treasury shares

Total Shareholders’ Equity Total Shareholders’ EquityII. Valuation, Conversion Difference Amount, Etc. II. Other Accumulated Comprehensive Income 1. Other valuation differential on securities 2. Deferred hedging gain or loss 3. Differential on revaluation of land

1. Other valuation differential on securities 2. Deferred hedging gain or loss 3. Differential on revaluation of land 4. Account for conversion adjustment on

foreign exchange 5. Cumulative amount for adjustment of

retirement benefitTotal of Valuation, Conversion Difference

Amount, Etc.Total of Other Accumulated Comprehensive

IncomeIII. Share Options III. Share Options

IV. Non-controlling shareholder interestsTOTAL NET ASSETS TOTAL NET ASSETS

In the past, net assets (“jun shisan”) were referred to as equity or shareholders’ equity, but the meanings of these terms have come to differ with, inter alia, the New Accounting Standards (announced on August 10, 2005) and the Companies Act (which came into force and effect on May 1, 2006) and other regulations. The item “non-controlling shareholder interests,” which was previously referred to as “minority shareholder interests,” represents a portion of a consolidated subsidiary company’s capital which is not equity of the company submitting consolidated financial statements (Consolidated Financial Statements Ordinance, art. 2, item 12). The item “other accumulated comprehensive income” in the consolidated financial statements (Consolidated Financial Statements Ordinance, art. 43-2) is equivalent to “valuation and translation adjustments, etc.” in non-consolidated financial statements (Financial Statements Ordinance, art. 67).

Equity refers to net assets minus the amount of share options and non-controlling shareholder interests (only in the case of consolidated financial statements) (Cabinet Office Ordinance

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Concerning Disclosure of Corporate Matters, Etc.; Form 2). Shareholders’ equity equals the paid in capital plus the surpluses.

This can be expressed as an inequality as follows: Net assets ≥ Equity ≥ Shareholders’ equity

Chart 1-6 Figure for a Company with Non-Controlling Shareholders’ Interests

12 5 Price/Book-Value Ratio (PBR)

While current net earnings per share are an indicator of the profitability of the company, net assets per share (BPS: Book-Value Per Share) is used as an index to observe the stability of the company. Net assets can be obtained by subtracting liabilities such as debts and corporate bonds from the total assets.

The value of net assets per share is called the Book-Value Per Share, which expresses the value of the company’s assets. It is said that the larger the PBR, the more stable the company.

In contrast, the Price/Book-Value Ratio (PBR) shows by how many multiples of BPS the share is being purchased.

Formula <10>

If the PBR is 1, it means the share price of the company is at the same level as the value of the assets (liquidation value).

Shareholders of Parent Company

Majority of Shares

Subsidiary Company

Non-ControllingInterests

Third Party Shareholders

Parent Company

Price/Book-Value Ratio = Share Price

(times)Book-Value per Share



(Sample Question) What is the Price/Book-Value Ratio (PBR) for a company (one closing per year) with total assets of JPY50 billion, total liabilities of JPY20 billion, 50 million shares of issued and outstanding stock where the price of its share is JPY600?

Since Net Assets = Total Assets − Total Liabilities = (JPY50 billion − JPY20 billion) = JPY30 billion, The Net Assets per share = JPY30 billion/50 million shares =

JPY600 Accordingly, using Formula <10>:

12 6 Return on Equity (ROE)

ROE (Return on Equity) illustrates, from the viewpoint of the shareholder, the performance and how the funds invested in the company are managed. If this rate is lower than the general level of the interest rate, shareholders do not have any incentive to invest in the company because it reflects the company’s profitability.

Companies initially are established with capital to purchase the necessary equipment and materials to conduct business and produce a profit. The shareholders’ ownership in a company includes not only the initial start-up capital, but also shareholders’ equity such as legal reserves and retained earnings, etc. accumulated thereafter. Therefore, a company with a steadily improving ROE would attract an increase in capital or an enrichment of the internal reserves.

ROE is calculated by starting with net profit for the current term and dividing by the net assets less the amount of share options and non-controlling shareholder interests (only in the case of consolidated balance sheets) (Cabinet Office Ordinance Concerning the Disclosure of Corporate Matters, Etc.; Form 2).

(Note) A profit/loss statement represents the process through which a company has earned profit within a certain period of time. Accordingly, in the financial analysis of P/L

Price/Book-Value Ratio = Share Price

= JPY600

= 1 timesJPY600BPS

Formula <11>

Return on Equity = Net Profit for the Current Term (Annualized)

× 100 (%) Equity* (Average of the Beg./End Period)

*Equity = Net Assets – (Share Options + Non-Controlling Shareholder Interests)

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items, an average is taken for the amount of capital employed within such period, and the average of the beginning/end period is generally used as a simplified method.

In the past, ROE, or return on equity, was called “return on shareholders’ equity” but with the coming into force of the Companies Act on May 1, 2006, “shareholders’ equity,” “equity” and “net assets” have come to indicate different content, with “shareholders’ equity” not equaling all net assets but being a more limited portion.(Note)

(Note) If the “return on shareholders’ equity” were to continue to be used, the standard for ROE would be switched, presenting the risk of a lost in continuity. For this reason, the ROE is to be calculated on the basis of equity.

Although the Cabinet Office Ordinance refers to this as the ROE, the TSE refers to this as the “ratio of net return to equity for the current term.” Following the amendment to the Consolidated Financial Statements Ordinance, the TSE has revised the calculation formula for the ratio of net return to equity for the current term as follows in order to maintain the continuity of consolidated financial statements: “net profit for the current term attributable to owners of a parent/equity (average between the beginning and end of the term)” (TSE, Aggregation of Earnings for the Term Ending March 2016, Overview of the aggregation method; Guidelines for Preparation of Earnings Reports and Quarterly Earnings Reports, March 2015). There has been no revision to the format under Item 2 of the Cabinet Office Ordinance on Disclosure of Corporate Affairs.

The “shareholders’ equity ratio” has been replaced with the “equity to total assets ratio” under the Cabinet Office Ordinance.

(Sample Question) What is the ROE of a company (one closing per year) at the end of the current period if its “equity (end of period)” and “net profit (after taxes)” were as shown below?

(Unit: JPY1 million)Equity (End of

Period)Current Net Profit

(After Tax)Current Period 2,800 300Previous Period 2,000 100

Since the equity as of the end of the previous period becomes the equity in the beginning of the current period, the average of the beginning period/end period = (JPY 2,000 million + JPY 2,800 million)/2 = JPY2,400 million.

Equity to Total Assets Ratio = Equity

100 (%)Total Assets ×



12 7 Return on Assets (ROA)

As with ROE, ROA (Return on Asset(s)) is one of the indicators of the profitability of a company used to gauge the company’s business activities. This is also referred to as “return on total capital.”

It is an indicator to measure how much profit has been produced against total assets (total capital) invested by the company in its business activities on an annual basis.

Formula <12>

(Sample Question) What is the return on assets (ROA) of a company (one closing per year) having total assets of JPY40 billion (no change between the previous term and the current term), sales of JPY36 billion, and net profit for the current term (after tax) of JPY1.8 billion?

(Note) As investor relations information, some listed companies disclose the ROA on the basis of their business income rather than net profit.

Accordingly, under Formula <11>:

Return on Equity = JPY300 million

100 = 12.5%JPY2,400 million

×

)revonruTtessAlatoT()selaSnonigraMtiforP(

Return on Assets = Net Profit for the Current Term Sales

100 (%)Sales Total Assets (Ave. of

the Beg./End Period)

= Net Profit for the Current Term

100 (%) Total Assets (Ave. of the Beg./End Period)

× ×

×

From Formula <12>:

Return on Assets = JPY1.8 billion100 = 4.5%JPY36 billion

JPY36 billionJPY40 billion ××

Business Income on Assets = Business Income*

100 (%)Total Assets (Average of the Beg./End Period)

* Business income = operating income + interest income + dividends income

×

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12 8 Earnings-Price Ratio

The earnings-price ratio is the inverse of the price-earnings ratio (PER) (i.e., the profit per share divided by the share price), and expresses the after tax profit as a percentage of the share price.

The dividend yield is determined by dividing the amount of the dividends per share by the share price; however, the payment of dividends is subject to the company’s dividend policy. Therefore, the earnings price ratio is founded on the concept that using profit instead of dividends in the numerator provides a more accurate picture of the company’s financial position, and represents business earnings per share.

12 9 Yield Spread (Difference in Yield)

This is an indicator to compare the earnings-price ratio and long-term interest rates on long-term government bonds, etc. The narrower the yield spread becomes, the more undervalued the share price may seem.

Formula <14>Yield Spread = Yields of Long-Term Bonds − Earnings Price Ratio

12 10 The EV/EBITDA Multiple

EBITDA (pronounced “ee-bitt dee-ay” or “ee-bitt-da”) stands for Earnings Before Interest, Taxes, Depreciation and Amortization, and is a profit indicator devised to compare the profitability of companies on an international scale. “EBITDA” is a measure of profit that reduces to the extent possible international differences in interest levels, tax rates and accounting standards for items such as depreciation methods. Recently EBITDA has become one of the most often used tools in enterprise valuation, and stands on par with Profit/Loss Statement profit.

Formula <13>

Earnings-Price Ratio = Current Term Net Profit per Share

100 (%)Share Price

×



Formula <15>EBITDA = Pre-Tax Profits + Interest Payable + Depreciation/Amortization Expenses

In valuing a particular share, analysts use the enterprise multiple EV/EBITDA, which looks at Enterprise Value (or “EV (Enterprise Value),” which equals market capitalization + interest-bearing debt − cash and deposits − short-term securities) as a multiple of EBITDA.

Formula <16>

The enterprise multiple is used for transnational comparisons of companies in the same industry. The lower the multiple, the greater the possibility that the share is undervalued; conversely, the higher the multiple, the more likely that the share is overvalued. For example, if American Company A has an EV/EBITDA multiple of nine, and Japanese Company B has a multiple of eight, the share in American Company A can be said to be overvalued in relation to Japanese Company B.

(Sample Question) What is the EV/EBITDA multiple of a company that has capital of JPY90 billion, a market capitalization of JPY850 billion, profit surplus of JPY40 billion, cash and deposits on hand (including short-term securities) of JPY50 billion, interest-bearing debt of JPY650 billion, and EBITDA of JPY170 billion?

(Note) Fractions of more than two digits are rounded off.

EV = JPY850 billion (Total Current Market Value) + JPY650 billion (Interest-Bearing Debt) − JPY50 billion (Cash and Deposits + Short-Term Securities) = JPY1,450 billion

EV/EBITDA Multiple = EV

EBITDA

Accordingly, under Formula<16>:

EV/EBITDA Multiple = JPY1,450 billion

= 8.5 timesJPY170 billion

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12 11 Average Share Price and Share Indexes

(1) Simple Average (Simple Average Share Price)The simple average is the aggregate share price of the issues covered divided by the

aggregate number of issues. For example, the simple average of all the issues listed on the First Section of the TSE would be computed as follows:

It is simple to calculate, and convenient as a measure of the increase and decrease of the share price in general. However, share prices decrease every time there is an ex-rights issue for capital increases. Since this is not based on fluctuations in market conditions, the share price loses continuity and therefore, there is the disadvantage of not being able to form comparisons with past prices. The Nikkei Stock Average is designed and calculated to compensate for this disadvantage, and to maintain share-price continuity.

(2) Nikkei Stock Average (Nikkei Average, Nikkei 225)The Nikkei Stock Average is calculated by averaging the share price of the 225 most

representative and liquid shares selected from among shares listed on the First Section of TSE Market and also, to maintain continuity, adjusting for the ex-rights price for capital increases, etc. The Nikkei Stock Average has a long history and it is used as the most general index for share prices.

For example, assuming the share prices of Company A, Company B and Company C are JPY300, JPY200 and JPY100 respectively, the simple average of these prices would be computed as follows:

If Company A performs a 1 : 2 share split, the share price of Company A, i.e. its ex-rights market price will be JPY150 regardless of the fluctuation in market conditions. A simple average in this case would be:

In order to maintain continuity to the share price, the denominator needs to be changed:

X = 2.25, in other words, the denominator becomes 2.25.

Therefore, the answer is derived by multiplying the simple average after ex-rights by 3/2.25

Simple Average = Total Closing Price of All Issues Listed on the First Section of the TSE Market

Total Number of All Issues Listed on the First Section of the TSE Market

JPY300 + JPY200 + JPY100= JPY200

3

JPY150 + JPY200 + JPY100 = JPY1503

JPY300 + JPY200 + JPY100 = JPY150 + JPY200 + JPY100 X3



or by a multiplier of approximately 1.33. In this respect, the Nikkei Stock Average is calculated with an adjusted denominator in order to maintain its continuity. When the capital increase goes ex-rights, the initial denominator (225) is adjusted downward; as a result, the current denominator is a 27.760, and the multiplier is 8.105 (as of October 16, 2019). Since this method for calculating the Nikkei Stock Average was developed by the Dow Jones Corporation, US, it is often called the “Dow Average” or “Dow.” Also, since the 225 composite issues in the Nikkei Stock Average are revised periodically, when certain issues are replaced, the denominator is revised as described above.

(Problems with the Nikkei Stock Average)(i) Since its first use on May 16, 1949, the multiplier has become larger as capital increases

have occurred, and the current multiplier is approximately 8. This means if the simple average increases by JPY8, the Nikkei Stock Average increases by approximately JPY9, therefore, it may be perceived as having separated from the actual trend of share prices.

(ii) As of October 16, 2019, approximately 2,155 issues of shares (including one issue of preferred shares and one issue of foreign company shares) were listed on the First Section of the TSE Market. Two hundred and twenty five of these shares represent a small ratio, so there are questions as to whether the Nikkei Stock Average correctly reflects the movement of the market as a whole. Also, adapting to change in an industrial structure is difficult (therefore, the Nikkei 500 Average is being introduced).

(iii) The Nikkei Stock Average changes regardless of the size of capital. In other words, if only small-cap shares move, the Nikkei Stock Average still fluctuates widely, and may not reflect the real sentiment of investors.

In light of these considerations, the Tokyo Stock Price Index (TOPIX) was introduced on July 1, 1969 by the TSE.

(3) Tokyo Stock Price Index (TOPIX)The amount of the increase or decrease of the total market value on the First Section of the

TSE Market compared to the total market value at a base date, serves to indicate the movement of the price of all shares in the market. In other words, by looking at changes to the asset value of the overall stock market, changes to share prices can be seen.

In terms of calculation methodology, TOPIX uses January 4, 1968 (closing price) as a base calculation date, on which the base of the index was set at 100, and the index is calculated for all subsequent dates.

Historically, TOPIX has been used as an index calculated through a comparison of the sum of share prices multiplied by the number of shares for all issues listed on the First Section of the TSE Market; that is, the total market value at the time of calculation (share price × number of shares) compared to the base market value (aggregate market value on the base date (January 4, 1968)). This calculation of TOPIX includes so-called “fixed shares” which are shares viewed as being, as a practical matter, unavailable for trades in the market, and it was anticipated that this might cause unbalanced supply and demand in the formation of prices for those issues constituting TOPIX. In October 2005, a free-floating share index was introduced to improve this situation, and

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in July 2006 the migration was completed.

* “Fixed shares” refer to those shares held by a section of shareholders for which the possibility of being traded in the market is considered low due to a business strategy.

* “Free-floating shares” refer to listed shares excluding fixed shares, or shares for which there is a possibility of being traded in the stock market.

(Note) Basis for the number of shares ・�Number of shares for the TOPIX = all listed shares × free-floating share ratio * The free-floating share ratio = 1 − fixed share ratio (fixed shares/number of shares)

Periodic review at every financial period and extraordinary review will be made.

(4) TOPIX 100TOPIX 100 is a market value-weighted index obtained by dividing TOPIX constituents into

seven groups based on their size and according to certain standards. TOPIX 100 is composed of 100 issues from those listed on the First Section of the TSE; i.e., TOPIX Core 30 with highest market capitalization and liquidity, and TOPIX Large 70 with the second highest market capitalization and liquidity.

It is calculated by assuming the level as of April 1, 1998, as 1,000 points. TOPIX 100 constituents account for about 60% of the market capitalization of all issues on the First Section of the TSE.

(5) TOPIX High Dividend Yield 40TOPIX High Dividend Yield 40 Index is composed of the latest 40 issues with actual

dividend yields being relatively high among the TOPIX 100 issues.These constituents are selected based on the actual dividends of each issue and on the stock

prices on the periodic selection base dates. The TOPIX High Dividend Yield 40 Index is calculated by assuming the level as of August 25, 2017, as being 1,000 points. Its constituents are regularly replaced once a year (which is on the last business day in June).

(6) Nikkei 300 Stock Average (Nikkei 300)The Nikkei 300 is a market value-weighted index, as with TOPIX, of the most representative

300 issues selected from among the shares listed on the First Section of the TSE Market. Most are selected from among issues with large market capitalization in their respective industries, with liquidity and corporate performance also being important selection factors.

The Nikkei 300 is the percentage of the total market capitalization, which is the sum of the

Tokyo Stock Price Index = Total Current Market Value at the Time of Index Calculation(Note)

100Base Market Capitalization ×



amount for each constituent calculated by multiplying the share price by the number of issued and outstanding shares (excluding preferred shares and the portion of shares held by the government, etc.) to the market capitalization at the base date (October 1, 1982).

In cases where the constituents are replaced, an onerous capital increase goes ex-rights, or in cases of a public offering, merger, etc., the market capitalization at the base date is revised.

Finally, in cases where the number of shares fluctuates without an accompanying payment, such as in a share split, or consolidation of shares, since the total market capitalization does not change, the base market capitalization is not modified.

(7) Nikkei 500 Stock AverageThe Nikkei 500 Stock Average is calculated using the prices of 500 issues listed on the First

Section of the TSE Market, and like the Nikkei Stock Average, is calculated using the “Dow Method.” Based on 500 constituent issues, by using the Nikkei industry classification system (36 categories), the Nikkei Stock Average by industry is also calculated and disclosed.

1. Special quote or sequential trade quote2. Current price (closing price)3. Base priceThe rules for selecting the share price to be used for this calculation are basically the same as

those for the Nikkei Stock Average. When using the closing price, the last trading price of the day of each constituent applies as the closing price. If trading in the daytime session was closed with a special quote (or sequential trade quote), the final special quote (or final sequential trade quote) is used instead of the closing price. The base price is used if there is no such price that is regarded as 1. or 2. The base price is the price selected in priority order of the theoretical ex-rights price, the previous days’ special quote or the sequential trade quote, or the previous closing price. Since the start of calculation (January 4, 1982 (calculated as far back to January 4, 1972)) the denominator has been 500, the same as the number of issues in the index. In addition, the Nikkei Stock Average by industry is the value obtained by dividing the total share prices for each industry by the denominator for that industry.

Nikkei 300 Index = Total Market Capitalization at the Time of the Index Calculation

× 100Base Market Capitalization

Revised Base Market Capitalization

=Base Market

Capitalization Before Revision

×Market Capitalization on the Day Prior to Revision

+ Revised AmountMarket Capitalization on the Day Prior to Revision

Nikkei 500 Stock Average = Total Share Price of Selected Shares

Denominator

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The causes for and the manner of the adjustment are the same as those for the Nikkei Stock Average. The denominator for the Nikkei Stock Average by industry is also modified for industries when constituent industries in the denominator change.

(8) NikkeiJapan1000This is an index that is calculated based on the top 1,000 shares in market capitalization after

adjustment of floating shares, from among all shares listed on domestic exchanges. Since the index consists of the issues that have the largest market valuation in view of the actual situation of investment possibility regardless of the listing market (the exchange), it accurately represents market neutral investment. The 1,000 issues that constitute the index account for more than 90% of the total market value of all issues on the market (on an adjusted floating share basis of aggregate value).

Under the issue replacement rule, issues in the index are replaced if necessary. The basic principle of the rule is that of “periodic replacement of issues” and “un-periodic exclusion and inclusion of issues.” As much as possible the number and frequency of replacements of issues are kept to a minimum and the index is designed to reduce tasks such as rebalancing by persons who make ongoing use of the index, while at the same time preserving the original meaning of the index as one that maintains and continues the nature of the constituents as being representative of the market.

(9) Nikkei Stock Average Dividend Point Index (Nikkei Dividend Index)This is an index calculated by accumulating dividends receivable when the Nikkei 225

composite issues are held for one year on a calendar year basis, using the calculation formula for the Nikkei Stock Average.

In accordance with the recently growing attention paid to the dividend point index on a global basis, the Nikkei Dividend Index started to be released in April 2010.

Specifically, this index is calculated by inserting each actual dividend per share every time each dividend value is fixed into the formula of the Nikkei Stock Average as a substitute for the share price and accumulating such dividend for one year. Annual calculation is a unique point of this index.

(10)JPX-NikkeiIndex400(JPX-Nikkei400)JPX-Nikkei Index 400 is a new index composed of issues of 400 companies that meet

requirements of global investment standards, such as efficient use of capital and investor-focused management perspectives and high appeal for investors. It is calculated as a market value-weighted index.

The calculation started on January 6, 2014, assuming the level as of August 30, 2013 (the base date) as 10,000 points.

JPX-Nikkei Index 400 constituents are selected from issues listed on the TSE First Section, the TSE Second Section, Mothers and JASDAQ. This index is a new type in that high-achieving companies measured by performance indicators, such as ROE (return on equity) and operating



earnings, are mainly selected as its constituents. Specifically, constituents are selected through screening (screening by eligibility criteria and screening by market liquidity indicator), scoring based on quantitative indicators, and scoring based on qualitative indicators.

A review for issue replacement is conducted on the last business day of August each year with the last business day of June as the base date.

JPX-Nikkei Index 400 is delivered in real time, per second, via the TSE’s Market Information System.

(11) Other Share IndexesIndexes of shares listed on the NSE include the Nagoya Stock Price Index (composite and

Nagoya issues respectively for both the 1st Section and the 2nd Section).Indexes for the JASDAQ Market of the TSE include the J-Stock Index, JASDAQ INDEX,

JASDAQ INDEX (Standard), JASDAQ INDEX (Growth), JASDAQ-TOP20, and Nikkei JASDAQ Index. In addition, the Mothers Index exists as an index for emerging shares.

12 12 Delivery Amount for Share Trading

When a sale or purchase contract for shares is concluded, the settlement (delivery) takes place on the second business day following the contract date. This payment is calculated by adding a brokerage commission (it is subtracted in the case of a sale), which should be paid to the financial instruments business operator that conducted the trade of securities, to the contract price (share price × number of shares).

The brokerage commission on trades in shares was completely deregulated in October 1999, and is determined by each financial instruments business operator.

(Sample Question) When placing a market order to purchase 7,000 shares of Company A, a contract for 5,000 shares at JPY1,000 and a contract for 2,000 shares at JPY1,010 are concluded on the same day. What is the delivery amount in this case?

* Assume that the brokerage commission is calculated in accordance with the following table. Further assume that even if more than one contract is concluded for the same issue in a single day, the brokerage commission is to be calculated on the total

JPX-Nikkei Index 400 = Total Market Capitalization for the Index at the Time of Calculation

× BasePointBase Market Capitalization

* Second decimal place (rounding off to second decimal place)

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amount of the values for the various contracts with these being treated as one order.

Contract Amount Brokerage Commission≤JPY1 million

>JPY1 million≤JPY5 million>JPY5 million≤JPY10 million>JPY10 million≤JPY30 million>JPY30 million≤JPY50 million

Total contract amount×1.150%Total contract amount×0.900%+JPY2,500Total contract amount×0.700%+JPY12,500Total contract amount×0.575%+JPY25,000Total contract amount×0.375%+JPY85,000

(Note) ・Amounts less than one whole yen are rounded off. ・An amount corresponding to the consumption tax is added.

Contract Price for the Company A Share: (JPY1,000 × 5,000 shares) + (JPY1,010 × 2,000 shares) = JPY7,020,000 Brokerage Commission: JPY7,020,000 × 0.700% + JPY12,500 +

Amount Equivalent to Consumption Tax = JPY61,640 + (JPY61,640 × 10%) ≈ JPY67,804

Delivery Amount: JPY7,020,000 + JPY67,804 = JPY7,087,804

(Sample Question) 10,000 shares of Company B share were purchased at JPY600 per share. What is the delivery amount in this case?

* Assume that the brokerage commission is to be calculated as 0.5% of the trading price.

Contract Price for Company B Share: JPY600 × 10,000 shares = JPY6,000,000

Commission: JPY6,000,000 × 0.5% + Amount Equivalent to Consumption Tax = JPY30,000 + (JPY30,000 × 10%) = JPY33,000 Delivery Amount: JPY6,000,000 + JPY33,000 = JPY6,033,000

(Sample Question) What is the delivery amount when 50,000 shares of Company C Share are sold for JPY200 per share?

* Assume that the brokerage commission is to be calculated as a flat JPY50,000 per order irrespective of trading price.

Contract Price for Company C Share: JPY200 × 50,000 shares =



JPY10,000,000 Brokerage Commission: JPY50,000 + Amount Equivalent to Consumption Tax = JPY50,000 + (JPY50,000 × 10%) = JPY55,000 Delivery Amount: JPY10,000,000 – JPY55,000 = JPY9,945,000

* Tax on capital gain of listed shares, etc. is not considered.

(Note) In principle, the gain on sale of listed shares, etc. (sales profit, capital gain) made by an individual is taxed through separate return taxation (i.e., reported on the final return but separately from other income). Nevertheless, it is possible to choose to be exempted from the reporting requirement by choosing the withholding specified account (meaning a specified account in which the holder elects to have withholding tax withheld).

The applicable tax rate is 20% (income tax is 15% and the inhabitant’s tax is 5%). Until December 31, 2037, the additional special income tax for reconstruction is imposed at 0.315%.

Meanwhile, under the NISA program (the tax exemption program for small-amount investments), no tax is imposed on capital gain from the listed shares, etc. that were acquired via the non-exempt account (up to JPY1,200,000 under the general-type NISA, JPY400,000 under the Dollar-Cost Averaging NISA, and JPY800,000 under the Junior NISA) and sold during the period eligible for tax exemption (see Volume 3, Chapter 4, “Taxation of Securities Transactions” for details).

12 13 Margin Transactions and Security Deposit/Minimum Maintenance

(Sample Question) I want to purchase 10,000 shares at their market price of JPY1,200

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on margin transaction. If I am going to substitute share certificates listed on a stock exchange for the security deposit, what must the minimum market price for this share be (assume the security deposit ratio is 30% and the cash conversion ratio (daiyo kakeme) for this share is 80%)?

Contract Amount: JPY1,200 × 10,000 shares = JPY12,000,000 Required Margin: JPY12,000,000 × 30% = JPY3,600,000 JPY3,600,000÷80% = JPY4,500,000

(Sample Question) I purchased on margin transaction 10,000 shares of Company A share for JPY1,000 per share, and contributed Company B share with a market price at the time of JPY7.5 million with margin securities for cash margin. If the value of the Company B share used as security deposit thereafter falls to JPY5 million, how much will the Company A share purchased have to decline in value until it drops below the minimum maintenance, requiring a margin call (assume the cash conversion ratio (daiyo kakeme) for share is 80%)?

The minimum maintenance derives from the calculation, Security Deposit Amount − Valuation Loss on Position = Contract Amount 20%, and if we substitute X for the Valuation Loss on Position, we can solve the equation for X as below:

JPY5,000,000 × 80% − X = JPY10,000,000 × 20% JPY4,000,000 − X = JPY2,000,000 ∴X = JPY2,000,000

If the Valuation Loss on Position exceeds JPY2 million, it will drop below the minimum maintenance level. So,

JPY10,000,000 − JPY2,000,000 = JPY8,000,000 JPY8,000,000 ÷ 10,000 shares = JPY800

Therefore, if the share price of Company A falls below JPY800, a margin call will be necessary.



Chapter 2 Bond Business

Section 1. Basic Knowledge Concerning Bonds ∙∙∙∙∙∙∙∙ 1711.1 Bonds and Their Features ∙∙∙∙∙∙∙∙ 1711.2 Types of Bonds ∙∙∙∙∙∙∙∙ 1741.3 Terms of Bond ∙∙∙∙∙∙∙∙ 189

Section 2. Outline of the Primary Markets ∙∙∙∙∙∙∙∙ 1922.1 Definition of the Bond Primary Market ∙∙∙∙∙∙∙∙ 1922.2 Current Status of the Bond Primary Market ∙∙∙∙∙∙∙∙ 1942.3 Primary Market for Government Bonds ∙∙∙∙∙∙∙∙ 1952.4 Primary Markets for Corporate Bonds ∙∙∙∙∙∙∙∙ 199

Section 3. Outline of the Secondary Market ∙∙∙∙∙∙∙∙ 2003.1 Characteristics of the Secondary Market ∙∙∙∙∙∙∙∙ 2003.2 Transactions on Exchanges and Executed Prices ∙∙∙∙∙∙∙∙ 2053.3 Over-the-Counter Transactions and the Related Systems ∙∙∙∙∙∙∙∙ 2073.4 Bond Borrowing and Lending Transactions ∙∙∙∙∙∙∙∙ 216

Section 4. Bond Market Conditions and Volatility Factors ∙∙∙∙∙∙∙∙ 2194.1 Volatility in Bond Market Conditions ∙∙∙∙∙∙∙∙ 2194.2 Factors Affecting Volatility ∙∙∙∙∙∙∙∙ 219

Section 5. Bond Trading Methods ∙∙∙∙∙∙∙∙ 2255.1 Outright Sales and Outright Purchases ∙∙∙∙∙∙∙∙ 2255.2 Bond-Switching ∙∙∙∙∙∙∙∙ 2255.3 Gensaki Transactions ∙∙∙∙∙∙∙∙ 2275.4 Delayed Delivery Transactions ∙∙∙∙∙∙∙∙ 2285.5 Transactions of Bonds with Options ∙∙∙∙∙∙∙∙ 2295.6 Other Transaction Methods, Etc. ∙∙∙∙∙∙∙∙ 231

Section 6. The Secondary Market for Convertible-Type Bonds with Share Options (Convertible Bonds) ∙∙∙∙∙∙∙∙ 2326.1 Definition of Share Options ∙∙∙∙∙∙∙∙ 2326.2 Change of Name ∙∙∙∙∙∙∙∙ 2326.3 Issuance of Share Options ∙∙∙∙∙∙∙∙ 2336.4 Product Characteristics of Bonds with Share Options ∙∙∙∙∙∙∙∙ 2346.5 Definition of Convertible-Type Bonds with Share Options ∙∙∙∙∙∙∙∙ 2346.6 Listing Rules for Convertible Bonds ∙∙∙∙∙∙∙∙ 2366.7 Amendment of the Companies Act and Bonds with Share Options

∙∙∙∙∙∙∙∙ 2376.8 Trading Rules for Convertible Bonds ∙∙∙∙∙∙∙∙ 2386.9 Fundamental Valuation Methods for Convertible Bonds ∙∙∙∙∙∙∙∙ 241

6.10 Price Volatility Factors of Convertible Bonds ∙∙∙∙∙∙∙∙ 2436.11 Convertible Bond Market Trends ∙∙∙∙∙∙∙∙ 245

Section 7. Bond Investment Calculations ∙∙∙∙∙∙∙∙ 2467.1 Coupon (Interest-Bearing) Bonds ∙∙∙∙∙∙∙∙ 2467.2 Discount Bonds ∙∙∙∙∙∙∙∙ 2557.3 Gensaki Transactions ∙∙∙∙∙∙∙∙ 2577.4 Convertible-Type Bonds with Share Options ∙∙∙∙∙∙∙∙ 258

1 Basic Knowledge Concerning Bonds

1 1 Bonds and Their Features

(1) DefinitionofBondsBonds are certificates issued by a national government, local government, government

sponsored entities, corporations, financial institutions or other organizations which procure a large amount of funds at one time from the investing public at large. Such certificates are in exchange for the funds in order to clarify the terms and conditions of the financing, such as the repayment of principal and the payment of interest.

Bond issuance is exemplified by the usual relationship between a borrower and a lender of funds: the issuer is the debtor (borrower) while the investors (bondholders) are the creditors (lenders), and the bond is equivalent to an IOU.

However, bond issuance generally has the following features that distinguish them from the usual money loan for individuals:

(i) A large number of investors invest under a uniform set of conditions;(ii) The issuer can procure a large amount of funds at one time; and(iii) Bonds are standardized as securities, which give the right to claim repayment of the

principal as well as the right to claim the payment of interest, and which allow holders to transfer to a third party their status as creditor by the sale of such securities at any time.

Whereas bonds are a means for procuring funds from the standpoint of the issuer, they are an investment target from the standpoint of the investor who purchases bonds. Therefore, the characteristics of bonds must, of course, be evaluated from both sides.

Moreover, while bonds are traditionally issued as certificates in the form of physical pieces of paper, paperless processing has increasingly come into use thanks to recent advances in information and communication technology, which makes it possible to digitally record the monetary amount of bonds held by investors as well as conditions such as repayment of principal and payment of interest to the ledger in which the rights belong to the investors, instead of issuing certificates that indicate these matters on the face.

This kind of paperless processing does not, however, change the nature of “bonds,” which represent securities by which the entity raising the funds is committed to redeeming a large number of investors’ bonds under a uniform set of conditions. Moreover, the fact that the rights an investor holds in connection with a bond can be transferred by sale to another investor is also conducted only in the form of processing by entering an increase or decrease in the amount retained on the ledger.

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Section 1. Basic Knowledge Concerning Bonds


(2) BondsasaMeansofProcuringFundsJust as different issuers, such as national governments, local governments, government

sponsored entities, corporations, and financial institutions have different characteristics, simply stating that “bonds are a means of procuring funds” belies the differences in the reasons why various entities seek out funds through bond issuance. In general, bonds have the following features:

(i) Funds procured by bond issues are most often for medium to long-term use;(ii) Borrowing from a financial institution is another way to raise a large amount of long-

term funding at one time; however, a bond issuance is often preferable due to the relative flexibility allowed in terms of the amount and use of funds. This is a function of the nature of bonds, which is comprised of multiple creditors, and the free transferability of rights; and

(iii) In addition to issuing bonds, a private corporation can raise long-term stable funds through issuing new shares with capital increase. In contrast to capital increase, where the funds obtained can be used semi-permanently, bonds must be redeemed (that is, funds must be repaid) upon maturity.

(3) BondsasInvestmentsThe important thing in selecting bonds or any other investment, such as bank deposits, loan

trusts, investment trusts, shares or land, etc., is to meticulously test the investment product from three perspectives: profitability, safety, and convertibility into cash.

(i) ProfitabilityNormally, bonds pay a specific rate of interest throughout the entire period from the

issuance to the redemption of the bond. Bonds with interest accrued at a rate that is promised upon their issuance are called “fixed rate bond.” The interest rate for fixed rate bonds does not change despite changes in the financial market environment or the issuer’s business performance.

It is this feature that fundamentally differentiates bonds from other investment products such as land, buildings, or shares, whose future expected return is uncertain. In summary, as a means of systematic fund management, fixed rate bonds are unsurpassed.

Fixed rate bonds are often said to be resilient when interest rates are falling; this is because the bondholders are promised a long-term fixed rate of interest, and thus, are able to benefit from capital appreciation in the bonds in addition to interest income under a decreasing interest rate environment. Conversely, however, bonds are vulnerable to the financial environment such as rising interest rates or inflation.

On the other hand, bonds for which interest rates fluctuate depending on the economic situations or interest rate environment are called “floating rate bonds.” Interest accrued on these bonds increases when the interest rate goes up, and decreases when the interest rate goes down. Therefore, the forecast for the future trends in interest rates is an important factor

Chapter 2. Bond Business


when examining profitability of floating rate bonds.It may depend on whether it is a fixed rate bond or a floating rate bond, or the interest

rate trends, but comprehensively speaking, bond investments are more advantageous than savings deposits in terms of the earning potential, i.e., level of return that is expected from them. The reason being that first, bonds can pay a relatively high interest amount since they enable the issuer to procure long-term stable funds. Second, bonds can omit the margins for intermediaries since bonds are a direct investment between the bond issuer and the investors.(ii) Safety

Ordinarily, bonds have a maturity date, and the issuer covenants to repay the principal when that date arrives. Regardless of how the financial market environment or the bond market prices change during the interim, bondholders ordinarily can recoup the bond principal in full simply by waiting for the maturity date to arrive.

However, if the issuer falls into financial distress or its operating results deteriorate, interest payments on the bonds can be delayed, and in some cases the issuer cannot redeem the bond principal. These types of circumstances are referred to as a default on bonds. In fact, during 2001, defaults on the Argentine government bonds, as well as bonds issued by Mycal and bonds issued by Enron in the U.S. caused major problems. Moreover, the defaults occurred one after another in the unprecedented financial crisis since 2008, causing attention to come to focus on the credit risk of the issuer.

Therefore, to prepare for the worst scenarios, some types and issues of bonds come with the following kinds of guarantees or security interests in order to ensure that bond interest and principal payments will be made on schedule:

A. Government Guarantee: These are bonds for which the government guarantees the payment of principal and interest.

B. General Collateral: These are bonds secured by a type of general lien that allows the holder to receive preferential repayment from all the issuer’s assets that takes priority over other creditors. These include the government sponsored entity bonds (agency bonds) issued by public agencies, electric company bonds issued by electrical power companies, telegraph and telephone bonds issued by NTT, etc.

C. Secured Mortgage: These are bonds secured by a mortgage (managed by a mortgage trustee company) on specific assets such as property, factories, and ships owned by the issuer

On the other hand, most general corporate bonds, etc. issued in public offerings are unsecured bonds.(iii) ConvertibilityintoCash

Bonds can be cashed in prior to maturity by selling them. The convertibility of a bond

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into cash can be referred to as liquidity.As a rule, pre-maturity conversion of bonds into cash shall be made at the

market value that changes from hour to hour. Therefore, the principal amount collectable prior to maturity could fall or rise, depending on the financial conditions at that time or the supply and demand of the bonds themselves. However, such market fluctuations are relatively stable, due to the assurance that the interest rate will not change from issuance to maturity, and the assurance that principal can be collected in full upon maturity.

For the conversion of bonds into cash prior to maturity, the existence of a subsequent investor who will purchase such bonds to be sold by the current investor is indispensable. It is generally said that the more creditworthy and well-known a bond is, the larger the issue amount and the broader the investor base holding the bond, the more liquidity that bond will have.

Chart 2-1 Criteria for Selecting Financial Products (The Most Important Factors)

(Unit: % of households)

Profitability Safety LiquidityBecause

Products are Easily

UnderstandableOtherBecause

of High Yield

Because of Future Capital

Appreciation Potential

Because of Guaranteed

Principal

Because Distributors as Financial Institutions

are Trustworthy and Reliable

Because Conversion for Cash is

Easy

Because of Freedom to

Make Deposits

and Withdrawals,

Even in Small

Amounts

2009 16.6 13.8 2.8 44.9 30.1 14.8 30.9 5.3 25.7 2.0 4.32010 15.8 13.2 2.6 48.4 29.8 18.6 28.5 4.5 24.0 1.8 4.42011 18.7 13.8 4.9 48.0 30.3 17.6 23.7 4.6 19.0 2.2 5.42012 16.9 12.1 4.9 46.7 28.7 18.0 24.7 5.3 19.4 2.5 6.72013 14.7 9.8 4.9 47.0 29.6 17.4 25.0 5.9 19.1 2.5 8.52014 16.7 11.7 4.9 45.7 29.5 16.3 25.1 6.0 19.1 3.1 7.92015 17.6 11.9 5.6 46.1 29.3 16.8 23.1 6.0 17.2 3.2 8.42016 17.5 12.1 5.4 45.7 29.9 15.8 24.7 6.7 18.0 2.4 7.92017 18.7 12.9 5.9 46.6 30.1 16.5 21.0 5.5 15.5 3.2 9.12018 17.6 11.3 6.2 41.8 27.8 14.0 25.8 5.7 20.1 2.2 9.9

(Note) Prepared based on “Public Opinion Survey on Financial Behavior of Household Account” in 2018 conducted by the Central Council for Financial Services Information.

1 2 Types of Bonds

There are various standards for categorizing bonds. These include, for example, differences in the issuer’s type of business, method of offering, whether the bond is secured or unsecured, interest-bearing or discounted, length until maturity, and so on.

It might be considered fundamental and practical to categorize bonds based mainly on the issuer’s type of business, with additional factors considered as needed. Basically, there are public bonds issued by the national government and local governments, etc.; private bonds issued by



private companies; and foreign bonds issued by foreign governments or foreign corporations, etc. Public bonds are composed of Japanese government bonds, issued by the national government; municipal bonds (also referred to as “local government bonds”), issued by local governments; government sponsored entity bonds (agency bonds), issued by incorporated administrative agencies or governmental special companies under enabling legislation; local public corporation bonds, issued by public corporations established by a local government. Private bonds are composed of: bank debentures, issued by financial institutions under special enabling legislation such as the Long-Term Credit Bank of Japan Act, etc.; corporate bonds, issued by private corporations; specified bonds, issued by specific purpose companies; and investment corporation bonds, issued by investment corporations (See Chart 2-2).

Chart 2-2 Major Types of Bonds

Super-long-term government bonds (20 years, 30 years and 40 years)

Floating-rate government bonds (15 years)

Long-term government bonds (10 years)

Inflation-indexed government bonds (10 years)

Medium-term government bonds (2 years and 5 years)

Short-term treasury securities (2 months, 3 months, 6 months and 1 year)

Government bonds for individual investors (3 years, 5 years and 10 years)

STRIPS

Nationwide market-based publicly-offered municipal bonds

Citizen participation-type market-based publicly-offered municipal bonds (3-7 years)

Non-publicly-offered local government bonds (Municipal bonds subscribed by banks, etc.)

Government guaranteed bonds

Fiscal Investment Loan and Program Agency Bonds (FILP agency bonds)

Non-publicly-offered special bonds

Interest-bearing bank debentures (1 – 10 years)

Corporate bonds (straight bonds)

Specified bonds

Bonds with share options

Investment corporation bonds

Exchangeable bonds

Yen-denominated foreign bonds (Samurai bonds)

Euro-yen bonds

Foreign currency-denominated foreign bonds

Telegraph and telephone bonds

Electric company bonds

Bank bonds

General corporate bonds

Government Bond

MunicipalBonds

Corporate BondsEtc.

Bank Debentures

Local Public Corporation Bonds

Government Sponsored Entity Bonds (Agency Bonds)

Public Bonds

Private Bonds

Foreign Bonds

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By checking the amount of bonds outstanding, one can see the scale of the bond market and its breakdown into these categories.

As of the end of FY2018, almost 90% of the approximately JPY1,188 trillion in bonds outstanding were public bonds. In particular, Japanese government bonds represented over 80% of the entire bond market (see Chart 2-3 and Chart 2-4).

(1) GovernmentBondsJust as the name indicates, Japanese government bonds are bonds issued by the national

government, and are considered to have the highest credit rating of all types of bonds.Major government bonds that are publicly issued include super-long-term government

bonds, floating-rate government bonds, long-term government bonds, inflation-

Chart 2-3 Issued Amounts and Outstanding Amounts by Bond Type

Amount Issued During FY2018

Outstanding Amount at End of FY2018

JPY100 million (%) JPY100 million (%)

Government Bonds

Open Market Issues

Super-long-term interest-bearing government bonds 316,858 17.6 3,990,246 33.6

10-year interest-bearing government bonds 332,752 18.5 3,143,233 26.5

10-year inflation-indexed government bonds 17,227 1.0 95,488 0.8

Medium-term interest-bearing government bonds 532,235 29.6 2,027,556 17.1

Short-term treasury securities 216,000 12.0 216,000 1.8Interest-bearing government bonds for individual investors 46,926 2.6 126,906 1.1

(Sub-total) 1,461,999 81.4 9,599,430 80.8BOJ Underwriting (BOJ subscription, etc.) 24,960 1.4 61,947 0.5(Sub-total) 1,486,960 82.8 9,661,378 81.4

Municipal Bonds

Publicly-Offered Local Government Bonds 62,785 3.5 612,985 5.2Underwritten by Banks, Etc. (As securities) 19,928 1.1 120,068 1.0(Sub-total) 82,713 4.6 733,053 6.2

Government Sponsored Bonds, Etc.

Government-Guaranteed Bonds 31,041 1.7 304,049 2.6FILP Agency Bonds, etc. 50,204 2.8 376,245 3.2(Sub-total) 81,245 4.5 680,295 5.8

Bank Debentures 14,462 0.8 80,386 0.7Corporate Bonds (Straight Bonds) 104,516 5.8 621,843 5.2Specified Bonds, Etc. (Asset-Backed Bonds) 2,700 0.2 4,497 0.0Convertible-Type Bonds with Share Options 160 0.0 2,585 0.0Yen-Denominated Bonds of Nonresidents 23,671 1.3 85,126 0.7

Total 1,796,377 100.0 11,869,165 100.0

(Notes) 1. Excluding short-term government securities (“financing bills”) within short-term treasury securities. Super-long-term interest-bearing bonds include 15-year floating-rate government bonds. Publicly-

offered local government bonds include joint-issue bonds and citizen publicly-offered bonds. 2. The figures indicated in the total column may not be consistent with the actual totals due to

rounding down to the nearest billion for amounts or to one decimal place for percentages.(Source) Prepared based on the “Issuing, Redemption and Outstanding Amounts of Bonds” compiled by the

JSDA and “Public Offering and Underwritten by Banks, Etc. Local Government Bonds Issuance, Redemption, and Outstanding Amount” in the “Japan Local Government Bond Association Report” compiled by the Japan Local Government Bond Association.



indexed government bonds, medium-term government bonds, short-term treasury securities, and government bonds for individual investors. In addition, there are government compensation bonds, issued by the national government in lieu of cash payments for liabilities assumed by the national government under a specific statute in order to fulfill a specific national policy objective. These are, in most cases, characterized by being subject to a restriction on transfer and thus, having a low degree of liquidity.

(i) Super-Long-TermGovernmentBonds(20, 30 and 40-Year Interest-Bearing Government Bonds)These are super-long-term government bonds issued with a maturity of 20, 30 or 40

years. Those with a maturity of 20 or 30 years are issued under a public auction method by a price competitive auction, while those with a maturity of 40 years are issued under a public auction method by a competitive yield auction.

From FY2007, the auction method for 30-year interest-bearing government was changed to a price competitive auction from the competitive yield auction that had been in place until that time.

40-year interest-bearing government bonds were first issued in November 2007.(ii) Floating-RateGovernmentBonds

Floating-rate government bonds are bonds with a maturity of 15 years, two interest payment dates per year, and a coupon that changes in accordance with market conditions. Specifically, the interest rate is calculated by deducting a value of α that is determined in advance by the Ministry of Finance, from the standard interest that is calculated on the basis of the average auction price of 10-year interest-bearing government bonds, at the auction that is held immediately prior to determining the interest rate of the floating-rate government bonds. The value of α remains unchanged through to maturity even if the coupon is modified.

Interest-bearing government bonds for individual investors: 126,906

Convertible-Type Bondswith Share Options: 2,585

Specified Bonds, etc. (Asset-backed bonds): 4,497

Corporate Bonds (Straightbonds): 621,843

Bank Debentures: 80,386

Government Sponsored Entity Bonds, etc.: 680,295

Local Government Bonds: 733,053

GovernmentBonds:9,661,378

Yen-denominated Bonds ofNonresidents: 85,126

Super-long-term interest-bearinggovernment bonds: 3,990,246

10-year interest-bearinggovernment bonds: 3,143,233

10-year inflation-indexedgovernment bonds: 95,488

Medium-term interest-bearinggovernment bonds: 2,027,556

Short-term treasury securities 216,000

BOJ Underwriting(BOJ subscription, etc.) : 61,947

Chart 2-4 Outstanding Amount at End of FY2018 (Unit: JPY100 million)

(Source) Prepared based on the “Issuing, Redemption and Outstanding Amounts of Bonds” compiled by the JSDA and “Public Offering and Underwritten by Banks, Etc., Local Government Bonds Issuance, Redemption, and Outstanding Amount” in the “Monthly Local Government Bond Report” compiled by the Japan Local Government Bond Association.

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(iii) Long-TermGovernmentBonds (10-Year Interest-Bearing Government Bonds)This is the core issue of bond markets in Japan, in both the primary and secondary

markets. The issuance terms and secondary market yield of these bonds form a benchmark for government bonds with different maturities and for other domestic bonds. Today, the public auction method by price competitive auction is used for issues.(iv) Medium-TermGovernmentBonds(2-Year and 5-Year Interest-Bearing Government

Bonds)These are issued under a public auction method by a price competitive auction.

Currently, there are two types being issued, 2-year and 5-year maturities.(v) Short-TermTreasurySecurities(Treasury Discount Bills, or TDB)

Previously, discount short-term government bonds and short-term government securities were issued. However, beginning in February 2009, these securities have been combined into short-term treasury securities. These are issued according to a discount formula determined by public auction in order to even out the redemption of government bonds and to facilitate the rolling over of borrowing, and to provide support funds for temporary shortfalls in cash within the general account and the various special accounts of the national government. The maturity periods are two months, three months, six months and one year. Since January 2016, not only corporations, but also individuals have become eligible to own these securities.

Any of the government bonds described in (i) through (v) above that are issued under a public auction method by a price competitive auction can also be partially issued in small amounts by noncompetitive auction.(vi) GovernmentBondsforIndividualInvestors

Government bonds for individual investors are government bonds that limit purchasers to individuals. Floating interest rate type government bonds with a maturity of 10 years have been issued from March 2003, and fixed interest rate type government bonds with a maturity of 5 years have been issued from January 2006, while fixed interest rate type government bonds with a maturity of 3 years have been issued from July 2010. At present, these bonds are offered monthly in the purchase unit of JPY10,000 starting from a face value of JPY10,000. From December 2011 until May 2013, these three types of government bonds offered to individuals had been issued as reconstruction government bonds offered to individuals. In addition, from April 2012 until January 2013, floating interest rate type reconstruction support government bonds with a maturity of 10 years offered to individuals had also been issued.

Floating interest rate type government bonds with a maturity of 10 years make payments at a floating interest rate two times annually, and for those issued in July 2011 and afterwards, the interest rate level is the base rate (the compound interest yield calculated based on the average contract price of 10-year fixed rate bonds at the last auction that took place in the month preceding the month in which the calculation period of the interest rate starts)(Note) multiplied by 0.66 (the minimum interest rate is 0.05%). (With regard to the reconstruction support government bonds mentioned above, which have characteristics of



floating interest rate type bonds with a maturity of 10 years, the minimum interest rate (0.05%) shall apply for the initial three years from the issuance irrespective of the market climates, and the bondholders were conferred commemorative coins three years after the issuance, in proportion to the outstanding balance of bonds they hold.)

(Note) However, for the interest on the first payment date, this shall be the auction that took place immediately before commencement of the offering period.

Fixed interest rate type bonds with a maturity of 5 years make payments at a fixed interest rate two times annually, and the interest rate is the base rate (projected yield on 5-year fixed interest rate government bonds calculated based on the market interest rate two business days prior to commencement of the offering period (the date of the auction of

Chart 2-5Comparison of Government Bonds for Individual Investors (“Fixed Interest 3-Year,” “Fixed Interest 5-Year,” and “Floating Interest 10-Year”) and Government Bonds Sold by the New Teller-Window Sales Method

Fixed Interest 3-Year Government Bonds for Individual

Investors

Fixed Interest 5-Year Government Bonds for Individual

Investors

Floating Interest 10-Year

Government Bonds for Individual

Investors

Government Bonds Sold by the New Teller-window Sales Method

Purchasers, etc.Limited to individuals; offer price is JPY100 per JPY100 of face value amount; minimum face value amount is JPY10,000, in units of JPY10,000.

No limit of purchasers; offer price is from JPY 50,000, in units of JPY 50,000

Maturity 3 years 5 years 10 years 2 years/5 years/10 years

Redemption amount JPY100 for JPY100 of the face value amount (same if redemption before maturity)

JPY100 for JPY100 of the face value amount

Interest Fixed interest [paid twice per year (semi-annually)]

Floating interest [paid twice per year

(semi-annually)]

Fixed interest [paid twice per year (semi-annually)]

Interest rate level Base rate – 0.03% Base rate – 0.05% Base rate ×0.66Decided by the Ministry of Finance based on the market interest rate trend upon each issuance

Minimum interest rate 0.05% No guarantee for minimum interest rate

Redemption before maturity

Redemption before maturity is possible at any time if it is after the second interest payment date (1 year after issue).

Salable on the market at any time (generating profit or loss)

Exception to limitations on

redemption before maturity

Redemption before maturity is possible even if it is before each of the interest payment dates set forth above if the holder has died or where the holder has suffered a major natural disaster.

Redemption amount if redeemed before

maturity

Face value amount + amount of accrued interest – already paid interest corresponding to the two most recent interest payments (before deducting tax) × 0.79685(In the case of issues with no adjustment for the first interest payment at the time of purchase)(Excluding redemptions before maturity in accordance with the exception to the limitations on redemption before maturity)

Market price. If the market interest rate rises after the purchase, the market value could decline and result in generating a loss upon the sale before maturity. If the market interest rate declines, the market value could rise and result in generating a profit upon the sale before maturity.

Frequency of Issue Monthly

(Note) It is possible that there will be no bond offerings at times such as when the interest rate declines.(Source) Prepared based on the Ministry of Finance’s website.

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10-year fixed interest rate government bonds)) minus 0.05 percent. The fixed interest type bonds with a maturity of 3 years make payments at a fixed interest rate two times annually, and the interest rate is the base rate (projected yield on 3-year fixed interest rate government bonds calculated based on the market interest rate two business days prior to the commencement of the offering period (the date of the auction of 10-year fixed interest rate government bonds)) minus 0.03 percent. For both types, the minimum interest rate is set at 0.05 percent.

There is a restriction on redemption before maturity for government bonds for individual investors. These bonds cannot be redeemed for one year after issuance. While the national government will repurchase the government bonds at face value upon redemption before maturity, an amount corresponding to a certain amount of interest will be deducted. The characteristics of government bonds have been improved as of April 2012.

In addition to government bonds offered directly to individual investors, individual investors can also purchase the same interest-bearing government bonds as those traded on the market. These government bonds are sold by a new teller-window sales method.

In the case of the new teller-window sales method, government bonds are offered at prices designated by the Ministry of Finance, as in the case of the offering handling method, but the solicitation handling institutions are not required to purchase unsold bonds. Government bonds sold by this new teller-window sales method are referred to as “new teller-window-sold government bonds.”

The chart shows the comparison between government bonds offered for individual investors and government bonds sold by the new teller-window sales method.(vii)Inflation-IndexedGovernmentBonds

With a typical fixed-rate interest-bearing government bond, the amount of principal at the time of issuance remains unchanged until redemption, and the interest rate, too, is constant for all interest payments. The amount of each interest payment is therefore equal, and the final interest payment and the original principal amount (par value) are paid upon redemption.

In contrast, the principal amount of an inflation-indexed government bond varies with trends in the consumer price index (CPI). In other words, if the CPI rises after the issue of an inflation-indexed government bond, then the principal amount of the said bond will rise commensurate with the rate of increase in the CPI (we hereinafter refer to the post-increase or post-decrease principal amount as the “inflation-adjusted principal amount”).

The amount paid to the bondholder upon redemption is the inflation-adjusted principal amount. Interest payments are made biannually, and the amount of each interest payment is calculated by multiplying the inflation-adjusted principal amount at the time of the interest payment by the coupon rate. The coupon rate, which is set at the time of issuance, remains constant for all interest payments. An increase in the inflation-adjusted principal amount due to an increase in the CPI will, therefore, result in an increase in the amount of the interest payment.

Due to the impact of the collapse of Lehman Brothers in 2008, the market environment



became extremely tough and the issuance of inflation-indexed government bonds was suspended. From October 2013, the issuance of a new type of inflation-indexed government bonds with a guarantee of principal (deflation floor) and with revised product characteristics has begun.

Ownership was limited to corporations, etc. such as qualified institutional investors, etc. From January 2015, individual investors are also allowed to own these bonds, which will reach maturity in January 2016 and thereafter.

The government bonds mentioned in (i) through (vii) above are issued in order to supplement the national budget and are categorized as follows, depending on the law governing their issuance:

(a) Public Finance Act (art. 4, para. 1, proviso)Construction government bonds (bonds that are issued in order to be allotted to sources

of capital for public projects, capital contributions and loans which will take the form of national assets).(b) Special Laws for Each Year

Special deficit financing government bonds (so-called “deficit bonds” that are government bonds which are issued under a special law in order to obtain funds to use in expenditures other than public projects, etc., where a revenue shortfall is expected despite the tax revenues, non-tax revenues, etc. as well as funds raised by the construction bonds).(c) Act Concerning Special Accounts (art. 46, para. 1 and art. 47)

Refund bonds (government bonds that are issued in order to secure the funds necessary to finance refunds for the consolidation or redemption of government bonds for each fiscal year).(d) Act Concerning Special Accounts (art. 62, para. 1)

Fiscal investment and lending special account government bonds (so-called “zaito bonds” that are issued for allocation to financial sources for the purpose of managing the fiscal loan funds program).(e) Act on Special Measures for Securing Financial Resources Necessary for Implementing

Measures for Reconstruction in Response to the Great East Japan Earthquake (art. 69, para. 1 and para. 4)Reconstruction bonds (government bonds issued for the purpose of securing the

financial resources necessary for reconstruction in response to the Great East Japan Earthquake).

Actual government bonds are not sold according to the classification of the law governing their issuance, and their creditworthiness or characteristics do not change depending on the difference in the governing law.(viii) STRIPS

Securities companies, etc. can separately sell the principal and interest portions of some of the interest-bearing government bonds that were issued after January of 2003. Corporations such as institutional investors are the major purchasers for both the principal and interest portions. Since January 2016, individuals have become eligible to buy these

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bonds.

(2) MunicipalBonds(LocalGovernmentBonds)Municipal bonds are bonds that are issued by local governments such as prefectures, cities,

towns and villages, and municipal bonds and national government bonds are collectively referred to as public bonds. Categorizing municipal bonds further, there are: “nationwide market-based publicly-offered municipal bonds” that are publicly offered broadly to ordinary investors through security companies or banks etc.; “municipal bonds underwritten by banks, etc.” that are directly underwritten by a few parties such as particular private financial institutions; “citizen participation-type market-based publicly-offered municipal bonds” issued by some local governments mainly for purchase by individuals; and “municipal compensation bonds” that are issued as an alternative to cash to owners of land that must be purchased for the projects to be conducted by local governments.

Borrowings other than those cast in the form of bonds, such as borrowings from government funds, the Japan Finance Organization for Municipalities or particular private financial institutions are sometimes referred to as municipal bonds. Most funds procurement in the open market is made in the form of bonds.

Among municipal bonds, nationwide market-based publicly-offered municipal bonds are best known. They are held widely, and thus have a high degree of liquidity. As of the end of March 2019, the 55 entities listed below, consisting of some prefectures and all Cabinet Order-designated cities, are qualified to issue nationwide market-based publicly-offered municipal bonds.

Prefectures (35)

Hokkaido, Miyagi, Akita, Fukushima, Ibaraki, Tochigi, Gunma, Saitama, Chiba, Tokyo, Kanagawa, Niigata, Fukui, Yamanashi, Nagano, Gifu, Shizuoka, Aichi, Mie, Shiga, Kyoto, Osaka, Hyogo, Nara, Shimane, Okayama, Hiroshima, Tokushima, Kochi, Fukuoka, Saga, Nagasaki, Kumamoto, Oita, Kagoshima

Cabinet Order Designated Cities

(20)

Sapporo, Sendai, Saitama, Chiba, Yokohama, Kawasaki, Sagamihara, Niigata, Shizuoka, Hamamatsu, Nagoya, Kyoto, Osaka, Sakai, Kobe, Okayama, Hiroshima, Kitakyushu, Fukuoka, Kumamoto

In addition, “joint-issue market publicly-offered municipal bonds,” which are bonds issued jointly by bodies eligible to issue publicly-offered municipal bonds, began being issued in April 2003.

As of the end of March 2019, the following 36 bodies participate in this type of joint issuance:

Prefectures (24)Hokkaido, Miyagi, Fukushima, Ibaraki, Saitama, Chiba, Kanagawa, Niigata, Fukui, Nagano, Gifu, Shizuoka, Aichi, Mie, Kyoto, Osaka, Hyogo, Nara, Okayama, Hiroshima, Tokushima, Kumamoto, Oita, Kagoshima

Cabinet Order Designated Cities

(12)

Sapporo, Sendai, Chiba, Kawasaki, Niigata, Shizuoka, Kyoto, Osaka, Kobe, Hiroshima, Kitakyushu, Fukuoka

Municipal bonds underwritten by banks, etc. are issued by a large number of issuers because



even cities and wards are eligible to issue the bonds. However, most of the municipal bonds underwritten by banks, etc., are issued in small amounts. Also, the municipal bonds underwritten by banks, etc. have a lower degree of recognition than nationwide market-based publicly-offered municipal bonds. In addition, the municipal bonds underwritten by banks, etc. tend to be held by certain specified bondholders. Therefore, municipal bonds underwritten by banks, etc. are less liquid than nationwide market-based publicly-offered municipal bonds.

Citizen participation-type small-market-based publicly-offered municipal bonds, which have been issued since FY2002, are being broadly sold even to investors who previously had little interest in municipal bonds, and the attractiveness of municipal bonds is being widely reappraised.

(3) GovernmentSponsoredEntityBonds(AgencyBonds)These are bonds issued under special legislation by incorporated administrative agencies

such as the Japan Expressway Holding and Debt Repayment Agency, local joint companies like the Japan Finance Organization for Municipalities, as well as governmental special companies, including the Japan Finance Corporation.

The issuers of government sponsored entity bonds are public institutions that are closely related to the government, and the funds procured through such government sponsored entity bonds are appropriated to public investment such as railways, roads, and housing construction.

Chart 2-6 Outstanding Government Guaranteed Bonds (Domestic Bonds, Publicly Marketed)

(Unit: JPY100 million)Outstanding as of the End of FY2018

Japan Finance Corporation 8,000Japan Expressway Holding and Debt Repayment Agency (Incorporated Administrative Agency) 171,046

New Kansai International Airport Co., Ltd. 3,300Hanshin Expressway Company Limited ―Development Bank of Japan Inc. 17,900Deposit Insurance Corporation of Japan 17,000Banks’ Shareholdings Purchase Corporation 8,500Nuclear Damage Compensation and Decommissioning Facilitation Corporation 8,000

Corporation for Revitalizing Earthquake-Affected Business 200Private Finance Initiative Promotion Corporation of Japan 180Japan Overseas Infrastructure Investment Corporation for Transport & Urban Development ―

Fund Corporation for the Overseas Development of Japan’s ICT and Postal Services Inc. ―

Organization for Promoting Urban Development (Incorporated Foundation) 388Central Japan International Airport Company Limited 1,444Japan Finance Organization for Municipalities 68,092

Total 304,050

(Notes) 1. Because figures have been rounded off, the total does not agree with the individual sums. 2. Calculated on face value basis.(Source) Prepared based on the Ministry of Finance’s “Debt Management Report 2019.”

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Of the types of government sponsored entity bonds, there are: “government guaranteed bonds” for which the government guarantees the payment of principal and interest, “non-publicly-offered special bonds” that are directly underwritten by designated financial institutions which have a connection with the issuer, and “fiscal investment and loan program agency bonds” that are not guaranteed by the government, but are issued through a public offering.

Government guaranteed bonds have a high degree of recognition and strong creditworthiness, a large size of individual issues, and are widely held due to public offering. Accordingly, their liquidity is high, and the trading volume of government guaranteed bonds actually exceeds that of non-government guaranteed bonds. Against the backdrop of the reform of the fiscal investment and loan program under which the fund of postal savings commenced its own funds management and government sponsored entities came to need to undertake their own procurement, issuance of fiscal investment and loan program agency bonds began in FY2001. Since then there have been a variety of product issuances, such as bonds with sinking fund provisions or floating-rate bonds, monthly pass-through securities backed by Japan Housing Finance Agency-sponsored home loans (RMBS), etc.

(4) LocalPublicCorporationBondsThese are bonds issued by a public corporation established by a local government (local

housing supply public corporations, local highway public corporations, and land development public corporations).

Under the “Securities Settlement System Reform Act” that came into effect on January 6, 2003, the bonds issued by local public corporations are now included within the definition of securities under the SEL (the present Financial Instruments and Exchange Act (FIEA)), thus, improving their liquidity. Furthermore, whereas previously local public corporation bonds were primarily underwritten by financial institutions in private placements, public offerings have also been adopted.

(5) BankDebenturesBank debentures are the bonds issued by the Norinchukin Bank, Shoko Chukin Bank, and the

Shinkin Central Bank pursuant to their respective enabling legislation (Long-Term Credit Bank Law, etc.).

Bank debentures are interest-bearing bank debentures with a tenor of 1 year or longer (bank debentures issued on a periodic basis usually have a 5-year tenor and the bank debentures issued on a spot basis have various types of tenors).

There are two methods of issuance: primary offerings and secondary offerings. Primary offerings are mainly for corporations, while secondary offerings are for individuals. For either primary offerings or secondary offerings, even where the subscribed amount does not meet the initially scheduled issuance amount, such subscribed amount will be the amount of the debentures. This rule is prescribed under the laws and regulations.



(6) CorporateBonds(StraightBonds)Corporate bonds (straight bonds) are bonds issued by private corporations, and are sub-

categorized into telegraph and telephone bonds, utility bonds, general corporate bonds, and bank bonds, etc.

Formerly, bonds issued by the Nippon Telegraph and Telephone Corporation (NTT), the various Japan Railways (JR) companies and Japan Tobacco Inc. (JT) were classified as agency bonds (presently called government-sponsored entity bonds), but they have been reclassified as corporate bonds accompanying the privatization of the former Nippon Telegraph and Telephone Public Corporation, Japan National Railways and the Japanese Monopoly Bureau.

Utility bonds are bonds issued by 10 electric power companies nationwide, such as the Tokyo Electric Power Company, and funds procured through the bond issue are appropriated to capital investments that benefit the public, such as dams and thermoelectric power stations.

General corporate bonds are bonds issued by private corporations in certain industries such as gas, steel, chemical, and railway, except for NTT, JR, JT and the electric power companies.

More recently, issuances of bank bonds that are issued by banks have been increasing (the prohibition on banks issuing straight bonds was abolished in October 1999). Among financial institutions which are able to issue bank debentures, there are some that choose to issue bonds under the corporation bond category, and this market is expected to expand.

(7) SpecifiedBonds“Specified bonds” as defined in the “Act on Securitization of Assets” are bonds issued by a

specific purpose company as defined in the said Act. A specific purpose company acquires a variety of assets such as receivables, real estate, etc. from the party procuring the funds, and issues specified bonds backed by those assets, which are called asset-backed securities (See Chart 2-7).

In a traditional financing, the party procuring the funds would be the issuer, and issue

Chart 2-7 Asset-Backed Securities Conceptual Diagram (as an example)

Assets

General loans receivables Automobile loans Housing loans Lease receivable Accounts receivable Real estatesShares

・・・・・

Liabilities

Capital

Traditional Financing:• Loans from banks• Bonds• CP• Shares, etc.

Procuring funds backed by the creditworthiness and earnings capacity of the issuer as a company

Procuring funds backedby the creditworthiness and cash flow of assets

Asset-Backed Securities: • Bonds• CP• Trust beneficiary interests,

etc.

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securities as pure debt; in contrast, in the asset-backed securities, the party procures the funds based on the creditworthiness or the cash flow of its own assets and the securities do not constitute the direct debt of the party.

(8) InvestmentCorporationBondsInvestment Corporation Bonds are bonds issued by an investment corporation pursuant to the

“Act on Investment Trusts and Investment Corporations.”

(9) ForeignBondsBroadly, foreign bonds are defined as bonds for which the issuer, the issue market, or the

currency is non-Japanese (foreign). They are classified into yen-denominated foreign bonds (Samurai bonds), Euroyen bonds, and foreign currency-denominated bonds (“foreign bonds” in its narrow meaning).

Issuer Issue Market Currency

Foreign bonds as broadly defined

Yen-denominated foreign bonds (Samurai bonds)

Non-Japanese (Foreign) Japanese market Japanese yen

Euroyen bonds Japanese/Foreign Foreign market(Euromarket) Japanese yen

Foreign currency-denominated bonds (“foreign bonds” in its narrow meaning) (the followings are examples)

Domestic bonds of foreign countries Foreign Domestic markets of

foreign countries Foreign currency

Eurobonds Japanese/Foreign Euromarket Foreign currencyYankee bonds Non-US US domestic market US dollar

Kangaroo bonds Non-Australian Australian domestic market Australian dollar

Maple bonds Non-Canadian Canadian domestic market Canadian dollar

(Note) The term “Euromarket” refers to markets across the world on which various transactions in Euro money (the local currency of any country held on deposits with financial institutions of other counties or held by non-residents) are conducted. Bonds issued on the Euromarket are generally referred to with a name consisting of the term “Euro” followed by the name of each issuing currency (for example, Euroyen bonds for yen-denominated bonds, and Eurodollar bonds for dollar-denominated bonds). On the Euromarket, where restrictions on trade practice and taxation rules are less strict than on the domestic market and therefore bonds can be issued more freely, it is now a major practice to issue bonds flexibly under the Euro Medium-Term Note (MTN) Program.

(i) Yen-DenominatedForeignBondsYen-denominated foreign bonds (Samurai bonds) are bonds issued in the Japanese

market by international agencies, national or local governments of foreign countries or



foreign business corporations (non-residents) that are denominated in yen.The amount of Samurai bonds issued has remained stable over the last few years. The

Japanese market has been established as a place to raise funds. Most bonds are issued by financial institutions.

Recently, the issuance of Samurai bonds by developing countries, which are guaranteed by the Japan Bank for International Cooperation (JBIC) under the Guarantee and Acquisition toward Tokyo market Enhancement (GATE), has become popular. Thus, fund-raising methods are becoming more diversified.(ii) EuroyenBonds

Euroyen bonds are yen-denominated bonds issued outside of Japan (Euromarket). In the past, a variety of restrictions were imposed on the issuance of Euroyen bonds, and few organizations were eligible to issue them, partly because of the tremendous influence these bonds could have on Japan’s domestic fiscal policies and financial system. However, deregulation progressed incrementally and it has become possible to issue bonds more flexibly and freely in terms of the types of bonds to be issued on the Euromarket. Currently, Euroyen bonds are issued by a large number of issuers, mainly business corporations (non-Japanese resident entities).(iii) ForeignCurrency-DenominatedBonds

Since July 1971, ordinary investors in Japan have been permitted to invest in foreign currency-denominated bonds.

Foreign currency-denominated bonds can be categorized according to the markets in which those bonds are issued as follows:

A. Domestic bonds of foreign countries (U.S. Treasury securities, German government bonds, bonds issued by U.S. and European financial institutions, etc.);

B. Bonds issued on the Euromarket (a.k.a., Eurobonds); andC. Bonds denominated in a foreign currency and issued in a country by a nonresident

issuer (a.k.a. Yankee Bonds, Kangaroo Bonds, Maple Bonds, etc.).

Investment in foreign currency-denominated bonds involves foreign exchange risks when converted into yen. There are also advantages, however, such as the investor can exploit international interest rate differentials and achieve global portfolio diversification.

Among the investments in foreign currency-denominated bond markets, the U.S. Treasury securities (denominated in U.S. dollars) are the largest in terms of scale. In addition, investments are further increasing in high interest rate bonds denominated in currencies of developed countries, such as Euro-denominated bonds and Australian Dollar-denominated bonds. In recent years, investment has also been made in bonds denominated in currencies of emerging countries, including Brazilian Real, Turkish Lira and Chinese Yuan.

On the foreign-currency denominated bond markets, foreign-currency denominated bonds (Eurobonds) offered in Japan targeting Japanese individual investors (“uridashi”) have been issued continuously, not only by highly-rated issuers such as international organizations

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or G-7 government-affiliated financial institutions, etc. but also by private entities such as financial institutions and business corporations. In recent years, in addition to bonds denominated in major currencies, such as the US Dollar and Australian Dollar, those denominated in currencies of emerging countries have also been issued. Thus, the size of this market has been expanding to the extent that even the word “uridashi” itself is gaining acceptance in the overseas securities market.

(10)OtherFinancialProducts(i) CommercialPaper(CP)

Commercial paper (domestic CP) is an unsecured, short-term and discounted security issued by a blue chip company to meet its operating capital requirements, and CP also has promissory note-like characteristics. CP is mainly sold to institutional investors who are well versed in the trends of the financial markets.

In January of 2003, the “Act on Book-Entry Transfer of Corporate Bonds, Etc.” (the name of the law at that time) came into effect, and transactions of electronic, paperless CP (defined in that law as “short-term corporate bonds”) commenced in March of the same year.(ii) NegotiableCertificatesofDeposit(CD)

Negotiable certificates of deposit (CDs) are transferable certificates of deposit issued by financial institutions, and are one of the non-regulated interest rate products. However, since the FIEA does not define CDs issued in Japan (domestic CD) as “securities,” securities firms handling domestic CDs are treated as being engaged in operations other than the financial instruments business.(iii) ForeignCommercialPaper,ForeignLoanReceivablesTrustBeneficiary

Certificates,andForeignCDForeign commercial paper (foreign CP) is, among foreign securities prescribed in

Article 2, Paragraph 1, Item 1 of the “Rules Concerning Foreign Securities Transactions” (hereinafter referred to as the “Foreign Securities Transaction Rules”; such securities shall be referred to as “foreign securities”), the securities prescribed in Article 2, Paragraph 1, Item 15 of the FIEA or the securities or certificates issued by a foreign person that have the nature of the relevant securities as prescribed in Item 17 of the said Paragraph (Article 2, Paragraph 1, Item 12 of the Foreign Securities Transaction Rules).

“Foreign loan receivables trust beneficiary certificates” are beneficiary certificates defined by Article 1, Item 4-4 of the Cabinet Office Ordinance Concerning the Disclosure of Information, Etc. Relating to Specified Securities, and asset finance products based on a trust funded by the loan receivables originated by an overseas financial institution (for example, CARDs) fall within this category.

Foreign certificates of deposit (foreign CDs) are transferable certificates of deposit issued by foreign financial institutions. They are foreign securities that fall within the category of securities prescribed in Article 1, Item 1 of the Order for Enforcement of the Financial Instruments and Exchange Act (Article 2, Paragraph 1, Item 11 of the Foreign Securities Transaction Rules). Unlike domestic CDs, foreign CDs fall within the category of



securities under the FIEA.

1 3 Terms of Bond

Bonds, which are fixed-interest-bearing securities, include several commitments by the issuer to the investor regarding the terms and conditions of issue, such as the timing and amount of interest and principal payments. Furthermore, conditions that are added later, such as the unit price of trading and yield can oftentimes come into play.

Therefore, simply stating “terms” belies the complexity in bond terms, all of which can have a subtle effect on the bond’s value.

(1) FaceValue(UnitsofBook-EntryTransfers)In the case of “paperless” bonds (book-entry transfer bonds, etc.), a certificate does not exist

as an actual piece of paper, and consequently the amount is not displayed on the face. Nevertheless, the amount set as the “monetary amount of each bond” in written documents listing the conditions of the security delivered to investors by the issuer could be thought of as the “face value” as traditionally conceived. When traded, trades are made using integer multiples of such monetary amount of each bond.

(2) BondPriceThe price of a bond is customarily expressed as a price per par value of JPY100, which

constitutes the unit price of a bond. The price may be exactly JPY100 (called “par”), or it may be more than JPY100 (called “over par”) or less than JPY100 (called “under par”). In many cases, ordinary bonds are issued at JPY100 or under par but very close to JPY100, but for government bonds whose terms of issue are decided by auction, issuance at over par is not unheard of.

The difference that arises when a bond that was purchased under par is redeemed is referred to as the redemption gain, while the difference that occurs when a bond purchased over par is redeemed is called the redemption loss.

(3) InterestRatesThe interest rate of a bond is expressed as an annual percentage of interest divided by the

face value. The majority of Japanese bonds make interest payments twice per year, in semi-annual installments, and coupons entitling the bondholder to each interest payment are attached to the face of each bond certificate. The bondholder can receive interest payments in exchange for the coupon. For this reason, the interest rate is sometimes referred to as the coupon rate, or simply the coupon. No tangible coupon is used in handling book-entry transfer bonds.

Bonds with coupons are called interest-bearing bonds, whereas bonds with no coupons are called discount bonds. The issue price of discount bonds is set under par, and offers bondholders a gain on redemption in lieu of interest payments. At present, short-term treasury

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securities are handled as discount bonds in Japan.If the issue date or redemption date of interest-bearing bonds does not correspond to the

coupon payment date, fractional interest is added on a per diem basis. Fractional interest consists of initial interest and final interest. The method of calculating fractional interest varies slightly depending on the type of bond.

When an already-issued bond is purchased or sold in the market, interest must be allocated to the purchaser and seller based on the amount of time each held the bond. This is accomplished by having the purchaser pay the seller the accrued interest based on the period from the day following the last interest payment date until the delivery date.

Although the purchaser of a bond is required to pay accrued interest to the seller at the time of purchase, the purchaser will receive the entire amount of the coupon at the next interest payment date; as a result, the interest income received by the purchaser effectively corresponds to his/her holding period.

(4) RedemptionThere are two types of redemption for bonds: final redemption and early redemption. The

date for final redemption is called maturity, and the period from the date of issuance to maturity is called the term, or maturity years. Newly issued bonds are called new issues, bonds after their issue date are called outstanding bonds, and the period until maturity for each is called the time to maturity. In principle, the redemption price upon final redemption is the face value of the bonds.

The partial redemption of bonds prior to maturity is called early redemption and is done to level the issuer’s funding burden at redemption. Early redemption includes scheduled redemption whereby the timing and price for early redemption is determined at the time of issuance, and optional redemption that is conducted at the issuer’s discretion. Scheduled redemption is made by a method of reducing the total balance of bonds of all holders of the relevant bond issue at an equal rate (called the factor method).

(5) YieldWhereas the coupon is the percentage of interest to face value, the percentage return on

invested capital is called yield. Yield usually refers to the simple yield to maturity, which is the ratio of the sum of the annual interest and yearly portion of redemption gain/loss to invested principal if the investor holds the bond until maturity. If the bonds are a new issue, this yield is called the subscriber yield. (For details, see “Section 7. Bond Investment Calculations”.)

Simple yield to maturity is the most fundamental indicator of the profitability of bonds. When the bond price of the bond goes up, the yield goes down, whereas when the bond price goes down, the yield goes up. In the secondary market, if yields fall, this can only lead to a rise in bond prices, signaling an upturn in the market. On the other hand increasing yields mean a downturn in the market.

Among several bond issues with the same yield and same maturity, issues with a higher interest rate have a higher price, whereas issues with a lower interest rate have a lower price.

From the issuer’s perspective, the costs of floating a bond include not only the interest and



redemption gain or loss, but underwriting fees, bond management commission, and fees applicable to interest and principal payments. To assist issuers, a ratio was devised that sums up all of these annual expenses and compares them with the net total amount raised by the bond issue. This ratio is called the Issuer Yield, and expresses the costs of the bond financing.

Chart 2-8 Bond Price and Yields

(6) OfferingPeriodSoliciting subscriptions from a large number of unspecified investors for a new bond issue is

called an offering. The period during which solicitation is made and applications for subscription are accepted is called the offering period. After the close of the offering period, the purchase price for the bonds is paid in lump-sum to the issuer on the payment date. In the case of bonds, the payment date is the same as the date the bonds were issued.

(7) ContractDateandDeliveryDateIn the secondary market where outstanding bonds are traded, each trade has a contract date

and a delivery date. The contract date is the day that the trade is arranged, and the delivery date is the day the trade is settled.

The delivery date for ordinary bond transactions is the third business day after the contract date. With regard to Japanese government bond transactions contracted as of May 1, 2018 and afterwards (excluding over-the-counter retail transactions and transactions with nonresidents, etc.), the delivery date is the first business day after the contract date. For retail transactions in government bonds and transactions in general bonds, from July 13, 2020 (on a trade date basis), the delivery date will be the second business day after the contract date.

(8) BearerBonds,Book-EntryTransferBonds,andRegisteredBondsAt present, under the “Act on Book-Entry Transfer of Bonds and Shares, Etc.,” all

government bonds issued on or after January 2003 will be book-entry transfer bonds. In contrast, general bonds other than government bonds, up to now, were issued in either registered bond or bearer bond form, however, since January 2006, due to the launching of the general bond book-entry transfer system, general bonds may now also be issued in book-entry transfer form similarly to government bonds.

These book-entry transfer bonds are not accompanied by a physical issuance of a certificate.

Unit price (yen) Unit price (yen)In case of 10-yearmaturity (with differences in interest rate)

Interest rate 3%Interest rate 2%

In case of 3% coupon rate (with differences in maturity)

Maturity: 5 yearsMaturity: 10 years

YieldYield

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Rather, trades (i.e., transfer of rights) are made by recording the value in an account opened by the holder in a financial institution and making adjustments to the said value, thereby making these bonds “paperless” bonds.

Furthermore, the “Corporate Bonds, Etc. Registration Act,” was repealed on January 4, 2008, and thereafter, new issues of general bonds in registered form are no longer issued (already issued registered bonds may continue to be under the registration system).

2 Outline of the Primary Markets

2 1 Definition of the Bond Primary Market

While different procedures may be followed depending on the type of bond issued, the fundamental steps in the bond issuance process are: (i) determining the date of issue, issue amount and the terms and conditions of the issuance, etc., upon considering the purposes of the funds procurement, the conditions in the bond market, etc.; and (ii) soliciting investor subscriptions, collecting the purchase price for the bonds from subscribing investors, and duly issuing the bonds. These procedures take place in the so-called bond primary market.

The bond primary market in Japan has traditionally been driven by the following four players: (i) issuers who procure funds by issuing bonds; (ii) investors who manage their assets by investing in bonds; (iii) underwriting companies (securities firms and banks, provided, however, that banks deal with public bonds only); and (iv) bond managers (banks, trust banks, etc.).

(1) UnderwritingCompaniesWhen securities are issued, an “underwriting company” is a company that acquires all or part

of the securities from the issuer for the purpose of selling them (a so-called “firm commitment” or “bought deal”), or a company that acquires any securities that remain unsold after the issuance (a so-called “standby underwriting” or “standby agreement”). Interposing an underwriting company between the issuer and purchasers enables the issuer to offer the subscription to a large number of unspecified investors and to simultaneously raise a large amount of funds.

Ordinarily, in order to spread the responsibilities associated with underwriting, several underwriting companies will gather together and form an underwriting syndicate to jointly handle the underwriting business. The underwriting syndicates for municipal bonds and government-guaranteed bonds are comprised of financial institutions such as banks, etc. and securities firms. On the other hand, underwriting syndicates for corporate bonds, etc. are comprised solely of securities firms. This is in line with Article 33 of the FIEA, which provides for the separation of the securities business and the banking business.



(2) BondManagersThe Companies Act requires a company issuing corporate bonds to install a bond manager. A

bond manager is a company that possesses all necessary authority to conduct functions such as receiving payments on behalf of the bondholders, etc. The entities eligible to become bond managers are limited to banks, trust banks or companies licensed under the Secured Bond Trust Act, and persons specified by the Order for Enforcement of the Companies Act.

However, if the amount of each bond (minimum trading unit) is JPY100 million or more, establishment of a bond manager is not necessary. In this case, generally a fiscal agent (a financial institution that handles the repayment of principal and interest, etc. on behalf of the issuer) is installed.

The Secured Bond Trust Act also mandates that companies issuing secured bonds establish a trustee company. A trustee company defined under the Secured Bond Trust Act refers to a company that pursuant to the trust agreement with the issuer, manages the collateral on behalf of the bondholders and also conducts the bond management functions. If a default occurs, a trustee company may dispose of the collateral on behalf of the bondholders and use the proceeds to repay principal and interest. There is no trustee company, however, for bonds that are not backed by secured mortgage. The entities eligible to become trustee companies are limited to banks, trust banks or companies licensed under the Secured Bond Trust Act.

(3) MethodofIssuingBondsThere are two methods of issuing bonds: public offering, by which bonds are offered to a

number of unspecified investors; and non-public offering, by which bonds are offered to specified investors. Bond issuing methods are also divided into direct issuance, which means an issuer itself offers bonds, and indirect issuance, which means a third party acts as a broker. Of these, indirect issuance is used as common practice, taking advantage of the offering and credit capability of securities firms, etc.

Indirect issuance through a public offering is carried out by a brokered offering, underwritten offering, or total-amount underwriting.

Brokered offering is a method by which the issuer entrusts another company to make a public offering of its bonds. Since the entrusted party is not responsible for making up for the shortage even when the total amount subscribed falls short of the total amount of bonds to be issued, there is a risk of failure of issuance of bonds. Because of this, most bonds are issued by underwritten offering.

In the case of underwritten offering, the issuer enters into an agreement with an underwriter under which the underwriter is to deal in a public offering and underwrite the bonds unsold, as entrusted by the issuer. If the total amount subscribed falls short of the total amount to be issued, the underwriter is to underwrite the bonds unsold, thereby achieving the issuance of bonds. This method is employed when public bonds are issued and underwritten by syndicates.

Total-amount underwriting means the method by which underwriting syndicates purchase the total amount of bonds to be issued in bulk and then offer these bonds to investors.

Issuance of corporate bonds is subject to the principle that even when not all bonds to be

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Section 2. Outline of the Primary Markets


issued are subscribed, bond issuance is valid for those subscribed. To avoid a situation where bond issuance will become valid only with regard to the amount of bonds subscribed, it should be prescribed at the time of issuance that the bond issuance will become valid only when all offers are subscribed.

(4) UnderwritingMethodandAuctionMethodThe Japanese primary market has become increasingly deregulated in recent years; even

looking at government bonds issuances, for example, one can see changes to the traditional paradigm. Whereas previously government bonds were sold using an underwriting method, in which underwriters would commit to accept a fixed share of bonds in return for underwriting fees, now an auction method is employed.

Under the auction method, securities firms and other financial institutions can freely decide their desired purchase price and amount, but in return forfeit their ordinary fees.

2 2 Current Status of the Bond Primary Market

(1) PublicBondsThe most notable change in the public bond primary markets is the switch from the

underwriting method to the auction method for government bond issues.Previously, government bonds, guaranteed government bonds, and publicly-offered

municipal bonds were underwritten by a fixed share by a syndicate comprised of financial institutions and securities firms, but the super-long-term, medium-term, and short-term government bonds (short-term government bonds are currently known as short-term treasury securities) have gradually moved to a public auction method since around 1980, and now long-term government bonds are issued through the public auction method as well starting with April 2006 bonds, as the syndicate underwriting method was abolished at the end of FY2005.

Through the expansion of the auction method, firms with a strong customer base are able to purchase larger volumes of bonds.

In addition, the following can be raised as recent trends in the primary market: the amount of issues of public bonds overall is increasing because of the decrease in tax revenue due to the worsening domestic economy as well as the increase in public works; issue volume for short-term government bonds (currently short-term treasury securities) and 5-year medium-term government bonds which have been issued since February 2000, surpassing the level of long-term government bonds which are a major type of government bonds; finally, the maturities and product design schemes of bonds are becoming more diversified, as exemplified by the issue of, in addition to 5-year medium-term government bonds, 30-year and 40-year super-long-term government bonds, 15-year floating rate government bonds, inflation-indexed government bonds, and government bonds for individual investors, etc.

Further, from October 2007 a new type of teller-window sales of government bonds began.



This allows private financial institutions other than post offices to conduct the offering and sale of government bonds at prices designated by the Ministry of Finance that formerly were conducted only at post offices. It is intended to prepare an environment in which it is easy to purchase government bonds and to promote further ownership of government bonds by individual investors. Currently 2, 5, and 10-year fixed interest bonds are sold using the new system.

(2) PrivateBondsFund procurement by Japanese corporations through bonds can be largely divided into

straight bonds and bonds with share options. Convertible bonds and bonds with subscription rights (currently “bonds with share options”; hereinafter the same) were issued in large quantity in recent years after the interest rate decline and the rise in share prices. The amount of bonds with share options issued outside of Japan, in particular, has grown as a result of simpler issuance procedures compared with those for domestic issues, and lower funding costs compared with domestic issuance even after avoiding exchange rate risk through foreign exchange forward contracts.

In FY1997 and FY1998, sluggish share prices had the effect of causing a plunge in issues of convertible bonds and bonds with share options while increasing financing with straight bonds. The reason for the trend is the measures taken to lower issue costs such as the deregulation of the bond market and simplified issuance procedures, etc., including various measures such as the introduction of the proposal method by which a lead manager is selected based on the conditions of issuance and other terms proposed by several securities firms, the shelf registration system (described below), the uniform price sales method, and various fee reductions.

In addition, exchangeable bonds (also referred to as EB; those bonds that entitle the bondholder, upon request, to have its bonds redeemed with the share certificates of a specified company other than the issuer) were issued and listed on the Tokyo Stock Exchange in April of 2000.

2 3 Primary Market for Government Bonds

(1) IssuanceMethodsforGovernmentBondsThe issuance methods for government bonds are broadly divided into the open market

issuance method, the issuance directed towards individual investors method, and the public sector issuance method.

(i) OpenMarketIssuanceMethodUpon the open market issuance of government bonds, conditions are set that reflect the

prevailing market on the basis of public auctions (the method of having a bid participant bid on the issue terms desired as well as the amount of desired acquisition, and determining the issue terms and the issue amount on the basis of these bid results) and the price (yield) competitive auction, noncompetitive auction, non-price-competitive auction I, and non-price-

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competitive auction II are being adopted.(a) Price (Yield) Competitive Auction

A price (yield) competitive auction is an auction method that determines the issue price and issue amount based on bids by auction participants for the desired auction price (or yield) and desired auction amount that are made in response to issue terms (planned issue amount, maturity, coupon rate, etc.) presented by the Ministry of Finance.

In a price (yield) competitive auction, in principle, bids are successful in order starting from the highest price (or lowest yield) until the planned issue amount is reached. In Japan, the conventional method, in which the bid price (or yield) of each individual successful bidder becomes the issue terms, and the Dutch method, in which the issue terms (allotment minimum price / allotment maximum yield) are uniform regardless of the bid price (or yield) of each individual successful bidder, are used depending on the type of government bond to be issued.

Currently, 40-year bonds are issued through a yield competitive auction and the Dutch method, while inflation-indexed government bonds are issued through a price competitive auction and the Dutch method. Other types of government bonds are issued through a price competitive auction and the conventional method.

Further, from March 2001, the instantaneous issue amalgamation (instant reopen) system was introduced with the purpose of increasing the liquidity of government bonds, etc. Under this system a new issue of a bond is treated as being the same issue as outstanding bonds from the time the new government bond is issued, if it is decided to make an additional issuance (reopen) of a government bond that is the same as outstanding bonds, since the principal and interest payment dates, as well as the coupon rate of the government bond that is to be newly issued are the same as that of government bonds that have already been issued. Following upon the introduction of the instant reopen system, accrued interest is generated in regard to the government bonds that are newly issued as well.

Moreover, liquidity supply auctions were introduced from April 2006. This is a system of additional issuances of issues that lack liquidity with the purpose of striving to maintain and increase the liquidity of government bond secondary markets.(b) Non-Competitive Auction

Non-competitive auctions are conducted for 2-year, 5-year and 10-year fixed-interest government bonds, taking into consideration small and medium-size auction participants who tend towards smaller bid amounts. A non-competitive auction is an auction where subscriptions take place concurrently with a price competitive auction and the issue price is the weighted average price in the price competitive auction. Bidders may subscribe in only one of either the price competitive auction or the non-competitive auction. The maximum issue amount is 10 percent of the planned issue amount, and the maximum subscription amount is one billion yen per each auction participant (excluding Shinkin Central Bank, Shinkumi Federation Bank, Rokinren



Bank, and Norinchukin Bank).(c) Non-Price-Competitive Auction I, and Non-Price-Competitive Auction II

A non-price-competitive auction I is an auction where subscriptions are conducted concurrently with a price competitive auction and the issue price is the weighted average price in the price competitive auction, with the maximum issuance amount being 20 percent of the planned issue amount. Only government bond market special participants are eligible to participate, and offers and accepted bids may be made up to the offer limit amount for each participant that is decided depending on its successful bid record for the most recent two fiscal quarters.

A non-price-competitive auction II is conducted after publication of the results of a price (yield) competitive auction, and the issue price is the weighted average price under the conventional method (or the issue price in the case of the Dutch method). Only government bond market special participants are eligible to participate, and offers and accepted bids may be made up to the maximum offer amount for each participant that is decided depending on its offer record for the most recent two fiscal quarters (however, such maximum amount does not exceed the amount corresponding to 15 percent of the total successful bid amount for the relevant participant in price (yield) competitive auctions and non-price-competitive auctions I).

(ii) IssuanceDirectedTowardsIndividualInvestorsMethod(a) Government Bonds for Individual Investors

Government bonds for individual investors are sold through the handling of subscriptions by financial institutions. In this method, the financial institution solicits ordinary investors for applications to acquire government bonds for individual investors and sells them under commission from the government.(b) New Teller-Window Sales Method for Marketable Government Bonds

In addition to government bonds for individual investors, from October 2007 a new teller-window sales method for ordinary interest-bearing government bonds was introduced in order to broaden opportunities for individual investors to purchase government bonds.

This new teller-window sales method allows teller-window sales of government bonds by the handling of subscription sales method, which up to that time had been conducted only at post offices, to be conducted at ordinary private financial institutions, and this allows investors to easily and, in general, regularly purchase government bonds at a financial institution with which they are familiar. There are three types of government bonds that are subject to the new teller-window sales: 2-year, 5-year and 10-year fixed interest-bearing government bonds.

In the new teller-window sales method, as with government bonds for individual investors, while the Ministry of Finance commissions subscription handling institutions to carry out subscriptions and sales of government bonds, the Ministry of Finance pays a fee to the subscription handling institutions based on the volume of subscriptions handled. While the subscription handling institutions conduct subscriptions and sales of

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government bonds at the price set by the Ministry of Finance within a set period, they are not required to purchase unsold bonds.

(iii) PublicSectorIssuanceMethod・ Bank of Japan Switch (underwriting of refund bonds by the Bank of Japan)

While Article 5 of the Public Finance Act prohibits the Bank of Japan (the “BOJ”) from underwriting government bonds, a proviso to this Article provides an exception where there are special grounds within the scope of an amount authorized by the Diet. The BOJ’s underwriting of refund bonds within the limit of the redemption amount of the government bonds held by the BOJ (so-called “BOJ switch”) falls under this exception.

Through its financial market adjustments, the BOJ holds a large amount of government bonds, and if it redeems those holdings for cash, it is necessary for the issuing authority to issue refund bonds in the market to raise the redemption funds. However, supposing that a large amount of refund bonds were to be issued in the market, the result is that the private sector would lack funds, and in order to clear up this lack of funds, the necessity would arise for the BOJ to supply funds by purchasing a considerable amount of refund bonds from the private sector.

In order to avoid this roundabout route, switching is allowed up to the limit of the amount necessary to roll government bonds held by the BOJ.

(2) GovernmentBondMarketSpecialParticipantSystem(PrimaryDealerSystem)The number of countries, including the U.S. and countries in Europe, that are adopting the

primary dealer system—which provides designated primary dealers with benefits not enjoyed by other dealers, in exchange for the said primary dealers fulfilling certain obligations with respect to market making, etc. in the secondary market—is increasing.

Under such conditions, the JGB (Japanese Government Bond) Market Special Participants System was introduced in Japan in October 2004; the objective of this system is to foster the stable subscription of government bonds at the same time as sustaining and improving, etc. the liquidity, efficiency, competitiveness, transparency, and stability of the government bond market.

Government bond market special participants, as so-called primary dealers, perform an important role in the government bond market (primary and secondary markets). They cooperate in terms of the formulation and implementation of government bond management policy, and have special responsibilities and entitlements with respect to the government bond market. The Minister of Finance designates them as “JGB Market Special Participants (hereinafter referred to as “Special Participants”).

Specifically, those special participants that meet certain criteria and are designated by the Minister of Finance assume special responsibilities, including: 1) bidding and purchasing responsibilities with respect to primary market auctions; 2) secondary market responsibilities (providing liquidity); and 3) providing information, etc. to the Ministry of Finance.

Special participants are simultaneously entitled to: 1) participate in Meetings of JGB Special Market Participants; 2) participate in auctions for redemption by purchase (the method by which



the issuer makes purchases at the market price through the market from holders who agree to be bought out); 3) apply for the stripping and recombination of principal and interest for strippable book-entry government bonds (so-called “STRIPS government bonds”); 4) participate, etc. in the non-price competitive auction; 5) participate in liquidity supply auctions; and 6) become preferential counterparties in interest rate swap transactions.

2 4 Primary Markets for Corporate Bonds

(1) LiberalizationofBondIssuingMethodsFormerly, there were a number of different regulations on the issuance of bonds in Japan.

The issue terms were uniformly determined according to a set formula, and issue volumes were constrained as well. This rigid mechanism of floating was subsequently modified to allow issue terms and conditions to be determined in accordance with actual market conditions, in line with other deregulation measures.

(2) RecentBondIssuingMethodsEfforts to determine the issue terms after more precisely ascertaining actual market

conditions and the level of interest on the part of investors persist.For example, a technique known as “spread pricing” is adopted mainly by highly-rated

issuers. When assessing the market interest of investors, issuers will offer terms that, instead of specifying an actual interest rate, state an amount to be added to the interest rate for government bonds, etc. (the “spread”). By using spread pricing, not only can issuers adapt more quickly to changes in interest rates, but also get more detailed investor feedback.

In addition, efforts are being made to shorten the time it takes to determine the issue terms, by using the Internet, etc. (traditionally, the facsimile was used), when the members of an underwriting syndicate would report to the lead securities firm on the interest in the market.

(3) BondRatingsA rating expresses in a simple symbol (such as AAA, AA, A, or BBB) an opinion by a rating

company of the comprehensive capacity of an issuing company to perform its financial obligations as well as the probability that it will perform individual obligations, etc. as contracted (its creditworthiness). This communicates to investors in an easily understood form the creditworthiness of the issuing company and the individual bonds, and is used as information for decisions by investors.

Japan formerly employed a “designated rating agency system” that would use in financial policy a rating that had been assigned by a “designated rating agency” which the Commissioner of the Financial Services Agency had designated in consideration of factors such as rating performance. With the trends in revising and enhancing international rating regulations, however, the FIEA was amended in June 2009, and from April 2010 the “credit rating agency regulations”

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have been introduced and implemented in stages.Under the “credit rating agency regulations” the Commissioner of the Financial Services

Agency does not make a designation, but rather uses a “registration system” in which a rating company that satisfies requirements such as having in place a framework to make fair ratings may register as a “credit rating agency.” Nevertheless, rating companies that are not registered can also engage in the business of assigning ratings. In this case, obligations are imposed on a person providing rating information, such as that the person must explain certain matters to the investor.

(4) ShelfRegistrationSystemThe “shelf registration system” is a system whereby an issuing company which has filed in

advance a shelf registration statement which sets forth a scheduled issue amount of securities, etc. can issue securities within a certain period of time without having to file a registration statement for each issue at the time of the actual issuance and need file only a shelf registration supplementary statement that sets forth the terms and conditions of the issuance, and was introduced in October 1988.

Utilizing this system enables the issuer to simplify the issuance procedures for corporate bonds and shorten the period of time required from initial conception to actual floatation of a bond issue, thus, allowing for more flexible funds procurement.

Currently, most issuances of straight bonds make use of the shelf registration system.

3 Outline of the Secondary Market

3 1 Characteristics of the Secondary Market

(1) DefinitionoftheSecondaryMarketRarely will a single investor hold a particular bond from its original issuance until

redemption. Most bonds are sold by the fi rst investor to a second investor, then to a third investor, and so on, with the bond changing hands many times.

From the time a bond is newly issued until it is redeemed, the process, location of trading or trading system, the structure, the specifi c movements in the bond’s price, and general trends in the market as a whole concerning bond transactions among investors are collectively referred to as the secondary market.

(2) PlayersintheSecondaryMarketAs there are players in the primary bond market who assume various roles upon a new bond

issuance, the secondary market is also composed of many players, including those who participate in trading as well as intermediaries who help the trading process run smoothly.



3 Outline of the Secondary Market

3 1 Characteristics of the Secondary Market

(1) DefinitionoftheSecondaryMarketRarely will a single investor hold a particular bond from its original issuance until

redemption. Most bonds are sold by the fi rst investor to a second investor, then to a third investor, and so on, with the bond changing hands many times.

From the time a bond is newly issued until it is redeemed, the process, location of trading or trading system, the structure, the specifi c movements in the bond’s price, and general trends in the market as a whole concerning bond transactions among investors are collectively referred to as the secondary market.

(2) PlayersintheSecondaryMarketAs there are players in the primary bond market who assume various roles upon a new bond

issuance, the secondary market is also composed of many players, including those who participate in trading as well as intermediaries who help the trading process run smoothly.



As the fi nancial environment changed, so did the perception of bonds, and now bonds are viewed not as something to hold but as something to manage. The secondary market for bonds has been growing each year and becoming more active. Traditional participants in the secondary market include large-scale fi nancial institutions such as city banks, trust banks, life and non-life insurance companies, and agriculture and forestry cooperative-affi liated fi nancial institutions, but they have been joined in recent years, by business corporations, public corporations, mutual aid associations, investment trusts, local governments, individual investors, and foreign investors.

The secondary market can be said to operate effi ciently only when the diff erent buy/sell strategies of these diverse secondary market participants can be joined to consummate a trade. Securities fi rms and registered fi nancial institutions engaged in dealing activities are the chief players in the secondary market, and perform a vital intermediation role. These fi rms are called bond dealers.

It is important that the secondary markets realize the intentions of investors as soon and as often as possible, and it is also important that trades can be executed at fair and equitable prices. In this respect, bond dealers also play an important role in gathering a large quantity of investment and price information, and distributing this information to investors.

(3) ExchangeMarketsandOver-the-CounterMarketsBond transactions can be broadly divided into exchange market transactions and over-the-

counter market transactions.In transactions on the exchange, the investor will submit via a securities fi rm his buy or sell

order regarding an issue that is listed on one of the securities exchanges, and these trades are concluded in a concentrated manner on the exchange.

On the other hand, an over-the-counter market transaction is a negotiated trade between each investor and the bond dealer, or between two bond dealers, and essentially the buyer and seller are free to decide on transaction terms that best suit their various needs.

Shares are principally traded on an exchange; by contrast, currently over 99% of the total volume of bond trades take place over-the-counter.

This is because there are additional terms and conditions involved in every bond trade, such as the delivery date, the method of delivery (bearer bonds, registered bonds, book-entry transfer bonds) or taxes that must be taken into account when conducting a bond transaction. Bonds by their nature are ill-suited to exchange transactions, which are premised on standardized processing terms. On top of this, bond trades themselves are often complex deals, combining several diff erent series of bonds in a single transaction. In addition, the number of issues of outstanding bonds alone runs into the tens of thousands, and to try to list and centrally manage all of them on an exchange would be practically impossible.

Nevertheless, one advantage of exchange transactions is that the benchmark prices for representative issues are widely disclosed. Exchange transactions can thus be said to play an important role in the context of allowing investors equal access to market information (in Japan, trading prices in negotiated transactions on the over-the-counter market are not disclosed, except for certain types of transactions).

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Section 3. Outline of the Secondary Market


At the Japan Securities Dealers Association (hereinafter referred to as the “JSDA”), public and corporate bond over-the-counter trading reference statistics (hereinafter referred to as “trading reference statistics”) are announced every business day based on reports from Association Members that the JSDA designates. These are made for the purpose of reference for Association Members and customers at the time that an Association Member engages in over-the-counter trading in bonds with a customer (for details, see 3.3(3) below).

(4) BondBrokerTransactions in the over-the-counter market are negotiated trades. In almost all cases, a bond

dealer will act as counterparty in trading with investors in order to smoothly complete the negotiated transaction. Accordingly, a bond dealer, like a wholesaler, is expected to keep a certain level of inventory at all times.

However, since keeping an inventory involves price fl uctuation risks and a capital cost, there are limits on the volume of inventory any single bond dealer can hold. As a result, dealers may not always be able to accommodate the issues or volume desired by investors. In such cases, it becomes necessary to exchange certain issues or coordinate volume among bond dealers.

In order to meet these needs, a securities fi rm that specializes only in trades between bond dealers is called bond broker, and it serves the function of coordinating and unifying in one place the trades between bond dealers.

Chart 2-9 Over-The-Counter Trading Volume of Public and Corporate Bonds

(Unit: JPY100 million)Fiscal Year Trading Volume Government Bonds (%)

1975 556,986 12,445（ 2.2%）

1980 2,810,114 1,643,604（58.5%）

1985 25,146,531 24,042,582（95.6%）

1990 32,857,689 31,561,777（96.1%）

1995 39,351,791 37,741,479（95.9%）

2000 41,478,253 39,715,220（95.7%）

2005 72,237,910 69,006,266（95.5%）

2010 77,219,520 76,195,034（98.7%）

2014 105,044,103 103,915,659（98.9%）

2015 103,953,909 102,508,723（98.6%）

2016 92,839,302 92,102,710（99.2%）

2017 99,233,906 98,360,879（99.1%）

2018 158,628,806 157,813,606（99.5%）

(Source) Prepared based on the “Trading Volume of Over-the-Counter Bonds,” JSDA.

(5) ExpansioninTradingVolumeCenteredonGovernmentBondsThe total amount of outstanding bonds traded has grown tremendously from a mere JPY55

trillion or so in FY1975. Gensaki trading volume increased sharply with abolition of the securities



transaction tax and the start of public auctions for short-term government securities (Financing Bills, or “FB”) in April 1999, as well as the large increase in the outstanding FBs traded in the market, and as a result, over-the-counter trading volume reached JPY4,000 trillion in FY1999. Over-the-counter trading volume slightly declined in FY2001 and FY2002 owing to declines in trading volumes of discount short-term government bonds (Treasury Bills, or “TB”) and FBs, which in turn stemmed from the entrenchment of ultra-low interest rates. In FY2003, however, over-the-counter trading volume has surpassed JPY5,000 trillion for the fi rst time in 16 years since FY1987 (JPY5,094 trillion), with a sharp rise in gensaki transactions, which in turn was partly infl uenced by the Bank of Japan’s gensaki operations beginning in November 2002. When it comes to FY2007 the trade volume for the fi rst time broke above the JPY10,000 trillion level.

The growth in government bonds in particular is astounding. The share of government bonds among the total trading volume used to be only a few percentage points. However, their share of volume grew to close to 60% in FY1980 and was approximately 95% in FY1985.

The following are reasons given for the growth in over-the-counter trading volume:(a) The Rapid Increase in the Amount of Outstanding Bond Issues Centered on

Government BondsLarge-scale government bond issues in the decade beginning 1975 started the ball

rolling, and overall government bond issues, inclusive of government bonds for rolling over

Chart 2-10 Amount of Outstanding Bond Issues

(Unit: JPY100 million)At the End of Fiscal Year Outstanding Amount Government Bonds (%)

1975 589,989 149,731（25.4%）

1980 1,523,943 705,098（46.3%）

1985 2,614,843 1,344,315（51.4%）

1990 3,427,845 1,663,380（48.5%）

1995 4,697,535 2,251,848（47.9%）

2000 6,135,610 3,675,913（59.9%）

2005 9,042,481 6,662,842（73.7%）

2010 9,992,765 7,782,855（77.9%）

2014 10,936,223 8,729,855（79.8%）

2015 11,197,485 9,014,630（80.5%）

2016 11,441,625 9,267,751（81.0%）

2017 11,645,878 9,476,123（81.4%）

2018 11,875,181 9,661,378（81.4%）

(Source) Prepared based on the “Issuing, Redemption and Outstanding Amounts of Bonds,” which are statistics compiled by the JSDA; as well as the “Issues, Redemptions and Outstanding Amount of Local Government Bonds Off ered on the Public Market and Subscribed by Banks, Etc.” which are statistics listed in the Local Government Bond Monthly of the Japan Local Government Bond Association.

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maturing bonds (so-called “refund bonds”), reached JPY70 trillion in the FY 1998; in 2001, immediately following the issuance of fi scal investment and lending special account government bonds (so-called “Zaito bonds”), overall government bond issues surpassed JPY130 trillion; in 2005, total government bond issues increased substantially, to approximately JPY181 trillion, partly due to an increase in refund bonds. The amount of outstanding issues is thus expanding owing to these factors.(b) Increase in the Volume of FBs and TBs in Circulation and the Introduction of New

Gensaki TransactionsThe sales of FBs by the Bank of Japan in the open market began in May 1981, with

public auctions starting in April 1999. In addition, TB issues began in February 1986. FBs and TBs were consolidated and became short-term treasury securities (“TDB”) in February 2009. New gensaki transactions introduced in April 2001 are compatible with contracts in force in Europe and the U.S. Transactions are gradually shifting towards these and away from cash collateral bond borrowing and lending transactions, which were hitherto the core of the short-term fi nancial market, which contributes to an increase in government bond trading volume.(c) Changes in Funds Management Activities Involving Bonds

While on the one hand the assets held by fi nancial institutions and other investors are increasing, current conditions make it diffi cult to invest in risk assets due to BIS regulations and non-performing loan disposals, etc., and this has consequently focused the spotlight on bonds, chiefl y government bonds, as suitable investment targets.(d) Prolonged Low Interest Rate Environment

The economy remained in a slump at the same time as interest rate levels continued to fall since the period when the offi cial discount rate peaked at 6.0% in 1990, and the Bank of Japan, starting in February 1999, carried out a so-called “zero interest rate policy” by keeping the short-term market interest rate (unsecured overnight call rate) eff ectively close to nil. While the Bank of Japan temporarily abandoned this policy in August of the next year, it reverted to a zero interest rate policy in March 2001, and maintained this policy for a long time until fi nally abandoning it in July 2006 (raising the target level for the short-term market rate to 0.25%). Moreover, interest rates have once again been declining since the money markets fell into confusion as a result of the Lehman Shock of September 2008.

While previously, bond transactions centered on a specifi c issue from among 10-year government bonds which is referred to as the “benchmark government bond,” trading today encompasses bonds of wide-ranging maturities and varieties, and this is one factor, together with high levels of outstanding government bonds, behind high trading volumes.

Furthermore, from among the 10-year government bonds for which trading reference statistics are announced, currently the issue with the longest remaining time to maturity is used as the criterion for long-term interest rates.



3 2 Transactions on Exchanges and Executed Prices

(1) ListedIssuesAll bonds other than government bonds may be listed on the exchange by application of the

issuer. However, the exchanges have listing standards, and only those issues that satisfy these standards may be listed. As of the end of May 2019, there were 378 issues listed on the Tokyo Stock Exchange. Almost every issue of interest-bearing government bonds (2-year, 5-year, 10-year, 20-year, 30-year, and 40-year) issued in the open market and convertible-type bonds with share options off ered publicly domestically are listed. Apart from these, currently no bonds other than yen-denominated foreign bonds and foreign currency-denominated bonds are listed (refer to Chart 2-11).

Chart 2-11 Number of Bond Issues Listed on the Tokyo Stock Exchange

Government Bonds

Yen-Denominated Foreign Bonds

Foreign Currency-

Denominated Bonds

Convertible-Type Bonds with Share

Options

Corporate Bonds/ Bank Debentures/ Municipal Bonds/Special Bonds

Total

305 41 15 15 2 378

(Source) Prepared based on the “Monthly Statistics Report” posted on Japan Exchange Group’s website (as of the end of May 2019).

Because persons that can conduct trades on an exchange are limited to the transaction participant securities fi rms of that securities exchange, an investor who wishes to trade on the exchange must place his buy or sell order through a securities fi rm. The securities fi rm will broker the investor’s order and execute the trade on the exchange. A brokerage commission is collected from the investor at that time, and each securities fi rm is free to independently determine the amount of the brokerage commission.

Following the introduction of the professional market system through the amendments to the FIEA in 2008, “Tokyo Pro-Bond Market” was established as a bond market for professional investors in March 2012. This market is operated under the program listing scheme, which is a method of bond issue generally employed in foreign markets, and the disclosure rule that allows information disclosure to be submitted in English alone. Program listing is a scheme wherein the issuer which seeks to raise funds by issuing bonds registers in advance its program information such as the aggregated maximum limit of the value of bonds to be issued, as well as other basic and fi nancial information, and issues bonds when desired, up to such maximum limit. The market’s highly fl exible rules off er effi cient bond issuance procedures through simplifi ed disclosure documents, and simple formal requirements for listing eligibility for program information and individual bonds, such as acquiring a credit rating and securing a lead manager securities fi rm specifi ed by the Tokyo Stock Exchange.

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(2) DeliveryDateAs for the delivery date (i.e., the settlement date), settlement of government bond

transactions takes place on the fi rst business day after the contract date, and settlement of convertible-type bonds with share options takes place on the second business day after the contract date.

(3) TradingHoursTrading hours are from 9:00 until 11:30 in the morning session and from 12:30 until 15:00 in

the afternoon session for convertible-type bonds with share options. Trading hours for government bonds are 12:30 until 14:00 in the afternoon (refer to Chart 2-12).

(4) ExecutedPrice,QuotationsIn the exchange market, when a trade is completed, the price is immediately publicly

announced as the executed price. In the case of convertible-type bonds with share options, even when the trade is not completed, quotations for bid and ask prices are continuously announced, allowing investors to check the market price in real time.

Chart 2-12 Bond Trading Methods (Exchange Transactions)

Trading Hours Trading Unit NominalQuotation Unit

Sales Type andSettlement Date

Government bonds 12:30 – 14:00 JPY50,000 in face

valueJPY0.01 perJPY100 face value

RegulartransactionIn principle, the fi rst dayafter the contract day (T+1)

Convertible-type bondswith share options (*)

9:00 – 11:3012:30 – 15:00

JPY100,000, JPY500,000,JPY1 million,JPY2 million,JPY3 million,JPY4 million, orJPY5 million in face value

JPY0.05 perJPY100 face value

RegulartransactionSame-daysettlement trade

* This refers to a bond with share options for which there has been a resolution to the eff ect that it is deemed there was substitute payment by the corporate bond portion if there is a request to exercise share options, and moreover, that it is deemed there was a request for substitute payment if there was exercise of the share options.

(Source) Prepared based on the Japan Exchange Group’s website (as of October, 2019).



3 3 Over-the-Counter Transactions and the Related Systems

(1) FairPriceIn order to ensure transactional fairness, over-the-counter transactions must be conducted at a

fair price, based on the market value of the underlying security, computed under a reasonable formula.

(2) DeliveryDateThe delivery date for an over-the-counter transaction of bonds is generally predetermined but

may be determined freely by agreement between the parties. Formerly, the delivery dates for most of the bonds were lumped together on specifi ed days each month, such as the 10th day, 20th day and last day of the month (referred to as “gotoubi” settlement, meaning settlement date of the month that is a multiple of 5), which invited large settlement risks to accumulate over the relatively long period of time during which the trades remained unsettled.

Following the G-30 recommendations of 1989, it became important to constrain the balance of unsettled trades and reduce settlement risk by putting rolling settlement into practice and reducing the amount of time between contract and settlement. As a result, beginning in October 1996, delivery for government bonds shifted to a “rolling settlement (T + 7)” system, under which settlement occurs on the seventh business day after the contract date, and subsequently in April 1997 moved to the standard of settlement on the third business day (T + 3). From April, 2012, the standard date of settlement has been the second business day (T + 2). With the objective of mitigating settlement risks, improving liquidity, safety and effi ciency of government bond markets and short-term fi nancial markets, as well as maintaining and strengthening the international competitiveness of Japanese markets, the shorter settlement cycle, T + 1 has been introduced for transactions contracted on and after March 1, 2018.

Bonds other than government bonds moved to the “rolling settlement (T + 7)” system, under which settlement occurs on the seventh business day after the contract date, beginning in November 1997, and subsequently migrated to settlement on the fi fth business day (T + 5) from June 1998, and fi nally to settlement on the third business day (T + 3), starting in October 1999.

For retail transactions in government bonds and transactions in general bonds, from July 13, 2020 (on a trade date basis), the delivery date will be the second business day after the contract date (T+2).

(3) ReferenceStatisticalPrice[Yields]PublicationSystemAlthough the over-the-counter trading system is an eff ective means for completing large and

complex bond trades smoothly, there are defects in its system of publicly announcing prices.Since over-the-counter transactions are negotiated transactions between the seller and buyer,

third parties have no way of fi nding out the details of the transaction. Due to the fact that over-the-counter transactions comprise such a large share of the secondary market, however, it is important to publicly announce and make investors aware of trading prices and rates, not only to promote

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fair and equitable price formation in bond transactions, but also with a view to protect investors.In response to such needs, the JSDA has set up the following systems used to broadcast

reference information.(i) ReferenceStatisticalPrice[Yields]PublicationSystemforOTCBonds

TransactionsEach business day, the JSDA announces reference statistical prices [yields] for over-the-

counter bonds transactions based on the reports received from certain designated Association Member to serve as a reference to investors, securities fi rms and other parties conducting over-the-counter bond transactions.

Reference prices are announced for issues of publicly-off ered public and corporate bonds, etc. (bonds issued in Japan, but other than bonds with share options), the paid-up principal, interest and maturity payments of which are all denominated in yen and chosen by fi ve or more designated reporting members as issues (selected issues) to be reported to the JSDA.

“Reference statistical price [yields] for transactions” means the four quotations for “average price,” “median price,” “high price” and “low price” quotes reported by the designated reporting members (for bonds other than corporate bonds, etc., excluding certain ranges above and below the respective prices).

In addition to reference statistical price [yields] for transactions, information on corporate bond transactions (e.g. actual contract prices) has also been available since November 2, 2015, with the aim of revitalizing the bond market by improving the transparency of the bond price information and ensuring its reliability.

Chart 2-13Reference Statistical Price [Yields] Publication System for OTC Bonds Transactions

(Note) 1. “Corporate bonds, etc.” in this fi gure refer to corporate bonds, specifi ed bonds and yen-denominated foreign bonds.

2. “Other bonds” in this fi gure refer to government bonds, municipal bonds, government guaranteed bonds, fi scal investment and loan program agency bonds and bank debentures.

(Source) Based on the Japan Securities Dealers Association’s website.

DesignatedReporting Member

Calculation of price quotations

Japan Securities Dealers

Association

Calculation of reference statistical

price quotations

Internet Users

Securities Firms

Financial Institutions

News Agencies, etc.

【Other bonds】Reported by 4:30 PM

【Other bonds】Aim to announce by 5:30 PM

【Corporate bonds, etc.】

Reported by 5:45 PM

【Corporate bonds, etc.】

Aim to announce by 6:30 PM



(ii) RatingMatrixPublicationSystemStarting from April 1997, the JSDA began preparing and publishing a “Rating Matrix”

as a reference material. The “Rating Matrix” is a table including the ratings and compounded yields for each of the remaining years of bonds. It is prepared and published for each rating institution, in order to strive for the diff usion and awareness of ratings as well as the enhancement of investment information to be provided to investors, in view of, e.g., the increased importance of rating information among market participants, etc. on the bond markets since the abolishment in January 1996 of the issue eligibility standards.(iii) PublicationSystemofOver-the-Counter(OTC)QuotationofCorporateBonds,

Etc.forRetailCustomersIn April 2003, the JSDA began a campaign urging individual investors to actively

participate in the bond markets, as well as contributing to the sound development of the over-the-counter bond markets. To meet its goal, the JSDA currently has in place a “Publication System of OTC Quotation of Corporate Bonds, etc. for Retail Customers” which provides individual investors with transaction reference price information for each managing securities fi rm that deals in “bonds for individual investors,” etc. Generally, pricing information for bonds, etc. for individual investors is announced each business day.

Pursuant to this, it has become possible for individual investors to view on the JSDA website “reference price information for each fi rm” in the secondary market for the bonds, etc. that they themselves have purchased. Price and yield are reported and announced at the middle rate (middle rate between selling quotes and buying quotes).

Chart 2-14 Publicizing the OTC Quotation of Corporate Bonds, etc. for Retail Customers

(4) MarketMakingIn recent years, although bond trading has mushroomed, a breakdown will show that trading

(Source) Japan Securities Dealers Association: “Guidebook: ‘Bonds, etc. For Individual Investors OTC Quotation.’”

JSDA

http://www.jsda.or.jp/

Internet UsersDesired sales price

(offer)

Desired purchase price (bid)

High price

Low price

Middle rate

Reporting of quotes that are the basis for OTC transactions

Middle rateMiddle rate



Middle rateReporting Securities

FirmsCh

apte

r 1Ch

apte

r 3Ch

apte

r 5Ch

apte

r 2Ch

apte

r 4



has been concentrated in long-term government bonds, and then only a small number of issues among those. Compared to government bonds, government guaranteed bonds, municipal bonds, corporate bonds, yen-denominated foreign bonds, etc. are only issued in small amounts, making them less liquid.

Therefore, for those bonds, in order to (i) promote trading and provide a measure to improve liquidity; and (ii) further clarify the actual conditions of the market, “market making” commenced in June 1986 for yen-denominated foreign bonds, and in September 1986 for government guaranteed bonds, municipal bonds, and corporate bonds. Making a market means that certain designated securities fi rms and banks announce daily bid/ask quotes and stand ready to buy or sell at the price quoted when approached by an investor.

Also, in April 1988, for new issues of corporate bonds issued under the proposal method, market making during the off ering period was introduced. Currently this serves to charge underwriting securities fi rms with the responsibility for setting issuance conditions by making them present quotations to information vendors and other parties, and to stimulate the secondary market for regular bonds.

(5) TransactionsPriortotheAuctionandTransactionsPriortotheIssueDate(When-Issued,or“WI”Transactions)Amid vigorous institutional reforms, including diversifi cation of issuance methods and the

lowering of underwriting shares for government bond underwriting syndicates, etc., the “need to deliberate on the introduction of so-called WI (When Issued) transactions” was highlighted with the release in July 2002 of “The Vision for the Future of the Financial System and Policy” (the Offi cial Report of the Roundtable Committee on the Vision of the Japanese Financial System and Policies in the Future).

Against this background, from the perspective of endeavoring to make government bond auctions even smoother, the “Guideline for When-Issued Transactions of Japanese Government Bonds” was developed with the objective of establishing a favorable environment for the adoption of WI transactions (transactions that are engaged in from the time the Ministry of Finance announces and reveals certain terms pertaining to an upcoming issue, such as the expected auction date, the expected issue date, the expected issue amount, and the expected redemption date, up to the time of the announcement of the issue number and coupon rate, etc. on the auction date; which is also referred to as “transactions prior to the auction”), and came into force from February 2003.

Transactions prior to the issue date for government bonds are trades that, on the condition the issue takes place on the originally scheduled issue date for the said government bonds, are engaged in up to and including the day before the issue date, and conduct the delivery of government bonds, in accordance with the contents of the transaction contract, on or after the issue date of the said government bonds (the handling of subscriptions of government bonds, such as selling government bonds for individual investors, does not fall under transactions prior to the issue date).

A transaction prior to the auction is one form of transaction prior to the issue date, but in view of factors such as the transaction having to take place before the coupon rate is determined,



the aforementioned guideline prescribes market conventions, for example, that the method for determining the trade unit price pertaining to a transaction prior to the auction involving an interest-bearing government bond should be agreed by using the compounded yield or spread α, etc., and determining the trade unit price after the auction.

(6) SettlementSystemAlong with technological innovation and economic globalization in recent years, it has

become an important task to increase the effi ciency, stability and convenience of the settlement system. At present, payments and receipts in transactions of Japanese government bonds (JGBs) are settled by making entries in books under the JGB book-entry transfer system provided by the Bank of Japan (BOJ). In order to ensure the stable and effi cient settlement of JGB transactions, the BOJ operates a computer network system called BOJ Net. In addition, with a view to mitigating the risk of the failure of a single fi nancial institution causing an adverse eff ect on other fi nancial institutions and the settlement system and eventually on the fi nancial system as a whole, the settlement method has been changed from the traditional Deferred Net Settlement system that settles only the diff erence arising from a number of payments and receipts at a certain point in time during a day, to the real time gross settlement (RTGS) that settles each transaction individually (for details, see (7) below).

On the other hand, transactions of other bonds such as corporate bonds and municipal bonds are settled under the book-entry transfer system provided by the JASDEC. This system was introduced in January 2006 for the purpose of carrying out the management of transfer of bonds by means of electronic recording from the perspective of increasing effi ciency. It has speeded up the settlement procedure and reduced costs for management and delivery of bond certifi cates.

The JASDEC’s book-entry transfer system has the following features.(i) CompleteDematerialization

The entire bond management process from issuance to circulation and redemption is carried out by way of electronic information processing, achieving complete dematerialization and reducing the issuance costs and administrative costs.(ii) Book-EntryTransferSystembyBalanceManagement

Smooth circulation of bonds is achieved under the book-entry transfer system whereby the transfer of rights thereof is eff ected by electronically recording the increase and the decrease of the balance in the transfer account book.(iii) Multi-layerHoldingStructure

In order to facilitate various patterns of participation in the system, a multi-layer holding structure is adopted so that account management institutions (e.g., securities fi rms, fi nancial institutions, etc.) maintain a connection not only directly but also indirectly with the book-entry transfer institutions.(iv) DVP(DeliveryVersusPayment)Settlement

DVP settlement(Note 1) is made available at each phrase, i.e., upon issuance, circulation, and redemption, which is conducive to reducing credit risks.

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(v) STP(Straight-ThroughProcessing)With a view to increasing the effi ciency and reducing the risks in operations, the book-

entry transfer system is linked with the pre-settlement matching system (PSMS) completing the series of operations by way of electronic information processing, thus realizing straight-through processing (STP)(Note 2) for completing the entire process from trade matching to settlement.

Bonds that are eligible to be settled under the JASDEC’s book-entry transfer system are the following: (i) corporate bonds except for bonds with share options; (ii) municipal bonds; (iii) investment corporation bonds; (iv) specifi ed bonds issued by specifi ed purpose companies (SPCs): (v) special corporation bonds issued by fi scal investment and loan program agencies or local public corporation bonds; (vi) bonds issued by foreign governments or foreign corporations (Samurai bonds): (vii) corporate bonds issued by mutual companies under the Insurance Business Act; and (viii) corporate bond-like benefi cial interests in special purpose trusts (with some exceptions).

Bonds managed by fi nancial institutions such as securities fi rms and banks via book-entry transfer account registries are called book-entry transfer bonds. These bonds are handled electronically, and transactions of bonds (transfer of rights etc.) are eff ected when the bond holders enter the amount held and an increase or decrease thereof in their book-entry transfer accounts established with the fi nancial institution. Under the Act on Book-Entry Transfer of Bonds and Shares, etc., all Japanese government bonds newly issued on or after January 2003 are book-entry transfer bonds. The book entry transfer system was introduced with regard to bonds other than Japanese government bonds in January 2006, and these bonds can now also be issued as book-entry transfer bonds.

(Notes) 1. DVP Settlement Delivery versus payment (DVP) settlement service for non-exchange

transaction deliveries (NETDs) is a system designed to ensure settlement of funds and reduce capital risks related to securities settlement through linking the delivery of securities with the payment of the settlement amount for NETDs systematically. In order to provide the DVP settlement service for NETDs, the JASDEC DVP Clearing Corporation was founded in June 2003 as JASDEC’s wholly-owned subsidiary. JASDEC DVP Clearing Corporation started providing the DVP settlement service in May 2004.

2. Straight-through processing (STP) Straight-through processing (STP) means seamless, computerized

processing of the series of clerical procedures in securities transactions, from the contract to settlement.



(7) BankofJapanRTGSand“RulesConcerningResolutionofFailsinBonds,Etc.”(UniformBusinessPracticeRules)RTGS stands for “Real Time Gross Settlement,” and technically means “instantaneous gross

settlement.”The RTGS system was implemented by the Bank of Japan for settlement of current deposits

and government bond settlement in January 2001, on the heels of various movements by foreign countries to strengthen their markets against the risk to the settlement system caused by increasingly large fi nancial transactions (international standardization of RTGS). Under the traditional “Deferred Net Settlement” system, the Bank of Japan settles the diff erence between the gross amount of pay and receive “transfer orders” it receives from various fi nancial institutions that are stored in the system prior to the designated point in time for settlement; under the RTGS system, however, each “transfer order” is settled individually, without netting against another “transfer order,” immediately after it is received.

The traditional “Deferred Net Settlement” system has the possibility of throwing the settlement system into chaos upon the failure of a single fi nancial institution, and with the recent cases of Japanese fi nancial institution insolvencies, the shift to RTGS, which is the global standard in settlement systems, became a priority.

Nevertheless, the “Deferred Net Settlement” system allowed participants to settle only the net diff erence with the counterparty fi nancial institution at a certain point in time, whereas fi nancial institutions must have funds ready to make payment for each settlement concluded under the RTGS system. The burden of procuring the funds needed for gross settlement is a drawback for fi nancial institutions. To compensate for this, the Bank of Japan will provide “intra-day liquidity” on a secured basis for the primary and secondary markets.

In November 2005, with the objective of further enhancing the safety and effi ciency of large-value payment systems in Japan, the Bank of Japan announced a proposal on the Next-Generation RTGS (RTGS-XG) Project. In February 2006, following public consultation, the Bank of Japan launched a practical discussion and development process for the RTGS-XG Project in order to accomplish it.

Specifi cally, the RTGS-XG Project has the following pillars:(i) Introduce liquidity-saving features (LSF) into the RTGS mode of the BOJ-NET; and(ii) Modify BOJ-NET to incorporate large-value payments (all payments processed under

the Foreign Exchange Yen Clearing System (FXYCS) and large-value domestic exchange payments, i.e. at least 100 million yen per payment) currently handled by Deferred Net Settlement (DNS) systems through private-sector settlement system into the RTGS mode of the BOJ-NET.

Of these, the Bank of Japan implemented Phase 1 of the project (introduction of LSF and complete shift to RTGS for foreign exchange yen payments) in October 2008 and confi rmed that yen payments were processed smoothly. Subsequently, in November 2011, the Bank of Japan implemented Phase 2 of the project (shift to RTGS for large-value domestic exchange payments, i.e. at least 100 million yen per payment), further increasing the stability of payments. The volume of payments handled on the BOJ-NET increased signifi cantly as expected, and payments have

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been processed smoothly, including those at the end of March when the number and volume of large-value domestic exchange payments hit a peak. As for small-value domestic exchange payments, i.e. less than 100 million yen per payment, payment risk has been considerably reduced due to the signifi cant decrease in the value of payments handled on the DNS systems. As a result of the implementation of Phase 2, Japan has achieved the international stability standards for large-value payments at a high level.

The JSDA developed and published the “Japanese Government Securities Guidelines for Real Time Gross Settlement” in August 2000 laying out the practices, etc. that market participants must follow to carry out a smooth shift to RTGS. This was on the basis of their observance of the RTGS-related rules of the BOJ-NET, to reduce settlement risks in the environment for settlements after RTGS for settlements of JGBs has implemented, and to ensure smooth settlements. Thereafter, the JSDA has been appropriately updating the Guidelines. One such market practice is a “fail” practice — even in the event of a “fail” (a situation where a receiving participant is unable to receive securities to be delivered by a delivering participant although an initially scheduled settlement date has passed), this situation alone does not cause the delivering participant to fall into a default (or the contract shall not be canceled despite such failure of delivery). The JSDA’s “Japanese Government Securities Guidelines for Real Time Gross Settlement” and “Rules Concerning Resolution of Fails in Bonds, etc.” provide for basic matters concerning how to handle cases in which a “fail” occurs and resolve a prolonged “fail.”

In the process of review of the “Japanese Government Securities Guidelines for Real Time Gross Settlement” in June 2010, when the JSDA introduced a fail charge (a certain monetary burden imposed on the delivering participant who has caused a “fail”), the JSDA established the “Practical Guidelines for Handling of Fails Charges” accordingly. The JSDA has also reviewed the conditions for applying the cut-off time (the “deadline for government bond settlements set before the end time of the BOJ-NET JGB services,” as prescribed among market participants for the purpose of recognizing fails, etc., with the aim of facilitating completion of daily settlements) and the “fail” practice. In December 2013, in order to respond to the 2nd phase operation of the new BOJ-NET, the JSDA made an overall revision to the Guidelines and put them into force as of October 13, 2015.

(8) JapanSecuritiesClearingCorporationThe Japan Securities Clearing Corporation (JSCC) was founded as the fi rst securities clearing

organization under the Securities and Exchange Law (currently the “fi nancial instruments clearing organization”) in Japan, with a license to provide the service of assuming obligations arising from trading securities (currently the “fi nancial instruments obligation assumption service”), and it started operation on January 14, 2003. This led the move for clearing and settlement services for spot transactions, which had been handled independently by the respective securities exchanges (including JASDAQ), to be integrated under the JSCC, which provides inter-market securities clearing infrastructure. On February 2, 2004, the JSCC was designated by the Tokyo Stock Exchange (TSE) as its securities clearing organization for futures and options transactions. Starting from that date, the JSCC has been engaged in the fi nancial instruments obligation



assumption service for futures and options transactions conducted on the TSE. On October 1, 2013, the JSCC merged with the Japan Government Bond Clearing Corporation (JGBCC). Before that, the JSCC and the JGBCC had worked on reinforcing their partnership through their business alliance, capital participation, human resources exchanges, etc. The recent merger has further enhanced the control environment for settlement, including effi ciency in clearing operations and systems.

On securities markets, multiple market participants conduct sale and purchase transactions continuously. If they actually settle payments with the other party, it would be extremely ineffi cient, and moreover, they would have to execute transactions while taking into account the risk of the other party. To avoid this, there was a call for a mechanism where all transactions between market participants are replaced with transactions between market participants and the clearing organization in the phase of delivering and receiving securities and funds, so as to guarantee the execution of the settlement of transactions. Specifi cally, a clearing organization assumes an obligation of a party to a transaction (to deliver securities or pay funds), and at the same time, acquires a claim corresponding thereto (to receive securities or funds), and thus the clearing organization, on behalf of the other party to the underlying transaction, delivers or receives the securities or funds to or from the participant, thereby guaranteeing the execution of the settlement of the transaction. This is a fundamental function of a clearing organization. The clearing organization is called a central counterparty (CCP) as it settles transactions as the other party to multiple market participants. The clearing organization conducts netting (complete settlement of the calculated diff erence between the selling and buying volume, as well as the calculated diff erence of the corresponding payment amount between two parties, as if by off setting each other’s mutual obligations) for ensuring effi cient delivery and receipt of securities and funds, and instructs settlement facilities to settle transactions.

As the uniform clearing organization, the JSCC plays the following roles in providing clearing and settlement services:

(i) ImprovingEfficiencyThe points of access that market participants (e.g., securities fi rms) previously had for

each fi nancial instruments exchange market have been centralized at the JSCC. This enables market participants to standardize administrative work and reduce costs for back-offi ce tasks, as well as considerably off setting the settlement volume by conducting netting that covers multiple markets, thereby contributing to increasing the effi ciency in carrying out administrative work and handling securities and funds.(ii) ImprovingSafety

The clearing function is now available for transactions conducted on markets where it had not been available. As a result, it is theoretically possible to conduct transactions without needing to take into account the credit risk of individual participants. Furthermore, the introduction of DVP settlement has also made it possible to eliminate the risk of losing the principal upon delivery. In addition, the JSCC’s integrated settlement guarantee scheme as described in its business rules is now provided for fi nancial instruments exchange markets nationwide, thereby contributing to increasing the safety of these markets as a whole.

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3 4 Bond Borrowing and Lending Transactions

(1) DefinitionofBondBorrowingandLendingTransactionsAccompanying the diversifi cation of secondary markets, in May of 1989 the “bond

borrowing and lending (or loan) transaction market” was established, primarily for the purpose of ensuring the liquidity of government bonds.

The bond borrowing and lending transaction market is the place where bond borrowing and lending transactions are conducted. When a person sells bonds short (short sale = the sale of outstanding bonds that are not actually held by the seller on the contract date) and does not repurchase the bonds before the delivery date, that person enters into a bond borrowing and lending transaction in order to borrow bonds to use for delivery. In other words, a bond borrowing and lending transaction is a transaction under which borrowed bonds are used to make delivery, and on the repayment date of the borrowing and lending, the borrower returns to the lender bonds of the same type and volume (loan contracts).

Short selling and borrowing and lending transactions for bonds were in strong demand for a long time by market-related parties, who consider them instrumental in conducting spot/futures arbitrage trading and nimble spot bond trades, etc.

Initially, the expansion in the market for bond borrowing and lending transactions centered mainly on unsecured trades. However, an investment bank in the U.K. collapsed in February 1995 and similar events exposed the risks involved in unsecured transactions. Additionally, in light of the determination to implement rolling settlement, the issue became how to stimulate these transactions while providing increased security. The answer was “cash collateral bond borrowing and lending transactions (commonly referred to as loan-repo transactions, or cash collateralized repo transactions),” which became possible starting in March of 1996.

Not only did this allow securities fi rms to engage in much more active inventory fi nancing, but also encouraged the participation of trust banks, etc. and other asset management entities in this new market. In November 1997, the Bank of Japan began using repurchase transactions of government bonds as part of its open-market operations as a method of fi ne-tuning of the money supply, and these transactions have become a central element of the money markets. Also there are no special restrictions on transaction participants that are engaged in these bond borrowing and lending transactions, transactions between fi nancial institutions are most frequent.

(2) OutlineofBondBorrowingandLendingTransactionsPrior to commencing a bond borrowing and lending transaction, the parties must execute an

agreement between themselves.Bond borrowing and lending transactions can be divided into the following three types, based

on whether or not they are collateralized:(a) UncollateralizedBondBorrowingandLendingTransactions

This is the case where the lender lends bonds to the borrower without requiring the borrower to post collateral. The borrower pays the lending fees at the same time it returns the



bonds on the settlement date.(i) Transaction Execution Date (Start Date)

LenderBonds

Borrower

(ii) Transaction Settlement Date (End Date)

LenderBonds

Borrower

Lending Fees

Uncollateralized transactions had been widely used by participants due to the simplifi ed administrative work fl ow; however, the balance of uncollateralized transactions has withered because participants are shifting from no collateral to cash collateral as loan-repo transactions became more widespread, especially due to the industry-wide reexamination of credit management sparked by the 1997 fi nancial crisis. Although there is still continuing demand for uncollateralized transactions due to the fact that it is possible to procure low-cost fi nancing by combining them with loan-repo transactions or gensaki transactions and that it is possible to procure bonds for collateral without any funding burden, the market volume of these deals is gradually waning.(b) BondBorrowingandLendingTransactionsCollateralizedbyMarginSecurities

(i) Transaction Execution Date (Start Date)

LenderBonds

BorrowerCollateral (Margin

Securities)

Simultaneously upon lending the bonds, the lender accepts the collateral securities. Conversely, the borrower will submit the collateral securities simultaneously upon borrowing the bonds from the lender.(ii) Transaction Settlement Date (End Date)

Lender

Bonds

BorrowerLending Fees

Collateral (Margin Securities)

The lender will return the collateral securities simultaneously upon receiving the return of the bonds; conversely, the borrower will collect the collateral securities simultaneously upon returning the bonds to the lender. Lending fees are paid on the underlying bonds.

Users of these transactions are relatively limited, due to the fact that management of the collateral securities is burdensome, and the conversion ratio (kakeme) used for the collateral securities makes them less favorable when compared to cash collateral.

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(c) CashCollateralBondBorrowingandLendingTransactions(Loan-RepoTransactions)(i) Transaction Execution Date (Start Date)

LenderBonds

BorrowerCollateral (Cash)

Simultaneously upon lending the bonds, the lender (recipient of funds) accepts the cash collateral. Conversely, the borrower (provider of funds) will submit the cash collateral simultaneously upon borrowing the bonds from the lender.(ii) Transaction Settlement Date (End Date)

Lender

Bonds

BorrowerLending Fees

Collateral (Cash)

Interest

The lender (recipient of funds) will return the cash collateral simultaneously upon receiving the return of the bonds; conversely, the borrower (provider of funds) will collect the cash collateral simultaneously upon returning the bonds to the lender. Lending fees are paid on the underlying bonds, and interest is paid on the cash collateral.

The economic eff ect of this type of transaction is almost exactly the same as a gensaki transaction; legally, however, cash collateral bond borrowing and lending transactions are treated as loans, while gensaki transactions are treated as sales. The fact that provisions concerning the treatment of counterparty default (collective clearing clause) and a risk management structure (haircut, margin calls) were introduced in 1996 for cash collateral bond borrowing and lending transactions also sets them apart from gensaki transactions at the time.

Backed by the start of repo operations by the BOJ following the fi nancial crisis in 1997, cash collateral bond borrowing and lending balances expanded rapidly in the market, and now, they are a central feature of the money market, surpassing even call loans.

(3) CurrentSituationoftheBondBorrowingandLendingTransactionMarketCurrent Japanese loan-repo transactions have been criticized due to the fact that (i) they are

not compatible with “repo transactions” in force in Europe and the U.S.; and also because (ii) transactions with non-residents may result in withholding taxes being imposed on the non-resident with respect to interest earned on their cash collateral, thus, practically making cross-border transactions impossible.

In order to tear down these barriers and allow a broad base of non-residents to trade in Japanese government bonds, “gensaki transactions” (new gensaki transactions) that utilize a



contractual framework and transaction method based on the global standard were introduced in April 2001, and the Bank of Japan began gensaki operations (open market operations to supply liquidity to the fi nancial markets) in November 2002.

In addition, a tax-exempt system with respect to interest received on funds loaned under a gensaki transaction with a non-resident, etc. that meets certain criteria, has also been introduced.

4 Bond Market Conditions and Volatility Factors

4 1 Volatility in Bond Market Conditions

“Conditions in the bond market” refers to the overall state of volatility of the individual issues in the secondary markets, and “market conditions” (or market prices) is said to be “good” or “bad” depending on price movements or trading volume.

There are many complex factors that aff ect bond market conditions, including the direction and speed of interest rate movements, and the specifi c gravity of each factor will change depending on the general state of the economy at the time.

4 2 Factors Aff ecting Volatility

The basic factors infl uencing volatility are as follows:

(1) GeneralEconomicTrendsOut of all the various phenomena that can infl uence conditions in the bond market, generally

the most direct is a change in interest rate movements accompanying a change in the demand for funds.

In periods of a rising economy, corporations’ production, inventory fi nancing and capital investment become more active, increasing the demand for investment funds. Businesses cannot meet their needs through their own working capital, leading to an increase in fund borrowings. When the demand for borrowings increases and businesses start competing for loans, the funds available to lenders such as fi nancial institutions are insuffi cient, and loan interest rates naturally increase. Accordingly, short-term interest rates in the call money and bill markets, as well as the certifi cates of deposit market where fi nancial institutions procure their own funds, also increase.

In contrast, in a declining economy or periods of stagnation, business demand for funds wanes, creating an excess balance in the loaning funds of fi nancial institutions. Eventually, the interest rate on loans goes down, as do interest rates in the money market. To this point, we have

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Section 4. Bond Market Conditions and Volatility Factors


been discussing the general pattern.Bond market prices are closely tied to movements in the interest rate, and always maintain a

certain balance with various interest rates. In other words, when the general interest rate is higher, the yield on bonds also rises (bond price declines), but when the general interest rate is low, the yield on bonds also goes down (bond price rises).

A second factor aff ecting volatility is infl ation (rise in the price of goods and services), which is interrelated with economic movements. When the economy is expanding, the demand for “goods” exceeds the supply of goods, and the increase in wages exceeds the increase in productivity. As a result, prices are infl ated. As more “goods” are sold, interest rates will gradually rise, because the number of fi rms that decide to raise funds in order to invest in plant and equipment will increase, even if interest rates are high. Thus, generally the infl ation phase will be linked to a rise in interest rates. This is the relation of the expansion of the economy → infl ation → the rise of interest rate → the rise in yields on bonds (fall in bond prices). Meanwhile, events such as a hike in the international goods market or yen depreciation, even if they occur during a sluggish economy, tend to cause infl ation, which is a negative factor for the bond market.

Oppositely, when defl ation (fall in the price of goods and services) exists, the value of money will increase in relative terms because of falling prices, and the need to compensate for lost value with interest will disappear. Thus, interest rates will also decline during a defl ationary phase (or stagnation), or when defl ationary worries are strong.

If it were a question simply of “the relationship between the economy and interest rates,” the

Chart 2-15 Domestic Economy and Market Interest Rates

Bank of Japan’s monetary restraint policy

Tightening of supply and demand in the financial market

Restraint measures to slow down growth

Interest rate hike

The upward economy

Tightening of supply and demand for capital goods and consumption goods

Increase in need for funds among businesses

If the pace of economic growth is considered to be too rapid, there is a tendency for the government and the Bank of Japan to favor the retention of a steady growth over to a temporary economic boom

Concerns for inflation

Vitalization of procurement of funds

Interest rate decline

Business stimulating measures through monetary easing policy

Relaxation of supply and demand in the financial market

Bank of Japan’s monetary easing policy

Stagnation in procurement of funds

Concerns for deflation

Measures to stimulate the economy monetarilyare important.

Decrease in need for funds among businesses

Relaxation of supply and demand for capital goods and consumption goods

The downward economy



answer would be fairly simple, i.e., in general “when the economy improves, interest rates go up, when the economy worsens, the interest rates go down.”

(2) MonetaryPolicyAs described above, interest rates fl uctuate according to economic conditions as well as

fi nancial conditions. Also, there are certain instances where policymaking authorities manipulate interest rates through political measures taken for the good of the economy and prices. In Japan, the Bank of Japan is the central bank in charge of this monetary policy.

The methods available to the Bank of Japan to eff ectuate monetary policy are raising or lowering the interest level (the basic discount rate and basic loan rate (previously called the “offi cial discount rate”), hereafter referred to as “basic loan rate”) for the loans the Bank of Japan makes to other banks, and increasing/decreasing (through operations) the volume of currency in circulation (capital).

It is said that the infl uence of the former, basic loan rate manipulation has waned.The latter, on the other hand, open market operations have become the primary tool used by

the Bank of Japan to adjust the money supply.The Bank of Japan’s open market operations can be divided into operations where the Bank

of Japan buys government bonds or notes, or borrows government bonds and posts cash collateral (in order to supply liquidity), and operations where the Bank of Japan sells government bonds or notes (in order to absorb funds).

The Bank of Japan’s policy, such as cutting the basic loan rate and increasing the supply of funds, is called easy money, which results in a decline in interest rates. This is a positive factor for the bond market. The opposite of this policy is tight money (dear money), which works as a negative factor in the bond market.

Chart 2-16 Monetary Policy Interest Rate and Market Interest Rates

(3) ForeignExchangeandOverseasInterestRatesIn Japan, foreign exchange transactions were subject to strict regulations for much of the

post-war period. However, with the onset of the period of high economic growth, and its rise in international status, the change to a favorable balance of international payments and ballooning of foreign currency reserves, a policy of liberalization was gradually implemented from 1970

[The Bank of Japan’s short-term money market operation]

Decrease of a bank’s funding cost The Bank of Japan’s attitude of easy money

Decrease of short-term interest rates in general such as 3-month CDs

Expectation of a lower interest rate

Influence on long-term interest rate

Lower interest rate

◎Inducing the decrease of the short-term interest rate (overnight unsecured call rate)

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onward. With the amendment of the Foreign Exchange Act in 1980, transactions were liberalized, in principle, and inbound and outbound capital transactions were eff ectively deregulated. Furthermore, the entry into force of the 1998 revisions to the Foreign Exchange Act, which was touted as the frontrunner of Japan’s Big Bang, led to even further coordination of the transactional environment.

International capital transactions in recent years actively seek out all types of investment opportunities with no regard for national borders. Whether one focuses on the size of the amounts, the speed of capital movements, or the breadth of investment opportunities, all exert a heavy infl uence on the market. The demand for corporate funds has become more varied in response to increasing international joint ventures and capital alliances, as well as international business expansion. Both the primary and secondary markets have seen international capital shifts. In this environment, the impact of exchange rate and movements in foreign interest rates on domestic bond markets has steadily increased.

When the yen appreciates (strong yen), it leads to: decline in the price of imported goods → restraint of infl ation → decline in interest rates, and bond prices go up (yields go down). Also, in response to a sharp yen appreciation, the Bank of Japan may carry out dollar buying operations or induce lower short-term interest rates designed to stabilize the currency, which works as a positive factor for the domestic bond market.

In addition, a strong yen leads to increased investments in Japanese securities by non-resident investors seeking foreign exchange gains, which strains the supply and demand for bonds. On the other hand, a weak yen (depreciation of the yen), works as a negative factor for the domestic bond market, due to the possibility that the Bank of Japan will adopt a tight money policy in apprehension of rising prices.

Next, let us look at the infl uences that overseas interest rates may have on the domestic bond market. For instance, when the interest rate in the U.S. is higher than the interest rate in Japan, the interest rate diff erential will widen as the U.S. interest rate increases, which makes investment in dollars relatively more advantageous. Accordingly, funds fl ow to investments in the U.S., and the dollar will rise against the yen. This has a negative impact on the domestic bond market. Moreover, when the U.S. clearly indicates a tightening monetary policy by raising the basic loan rate, the market will anticipate the eff ect on the domestic monetary policy and the domestic bond market declines. When the interest rate abroad is lowered, it has the opposite eff ect.

Moreover, an increase in an interest rate diff erential (domestic interest rates < foreign interest rates) between domestic and foreign interest rates can be said to signal a strong yen (a strong yen in the future) on a forward exchange basis (since in a forward exchange there is no exchange rate risk, the risk of domestic and foreign investments is the same; that is, the exchange rate fl uctuates in a manner such that the return will be the same for a high-yield foreign-currency denominated investment when converted into yen as the return on an investment in yen currency).



<OverseasTrendsandMarketInterestRates>Since the U.S. has a large impact on the Japanese economy, the following explanation

will focus on the United States:

<ForeignExchangeandMarketInterestRates>This segment focuses on an explanation of the dollar-yen exchange market:

(4) SupplyandDemandforBondsLike other products, the price of bonds is determined by the relationship between supply

(sellers) and demand (buyers). The supply and demand relationship in bonds is the relationship between fi nancial assets that enable new purchases of bonds and the volume of new bond issues. Furthermore, the relationship between the selling and buying volumes of bonds by investors on the secondary market also infl uences the bond prices.

During the last few years since the announcement of a sizable increase in government bond issues in FY1999 against the backdrop of a worsening government balance of payments situation due to the prolonged recession, we have seen a repeated cycle of a relationship between the supply and demand for Japanese government bonds in which the supply/demand balance eases during phases in which concerns are raised about a worsening equilibrium owing to fi scal deterioration, and when defl ationary concerns recede, and in which the supply/demand balance tightens during phases when defl ationary concerns spread or hints are made of an anticipated continuing of the monetary easing policy.

In terms of secondary market trading patterns by type of participant, major investors such as fi nancial institutions for agriculture and forestry, trust banks, life and non-life insurers, investment trusts, and foreigners, etc. have by and large become net buyers over the past several years, and are underpinning the bond market. Basically, bond prices will remain fi rm as long as investors with large amounts of long-term funds continue to buy on actual demand.

In addition, bond-buying operations are sometimes carried out by the Bank of Japan as a measure to supply liquidity, and this has a short-term impact on the bond market.

None of the major factors infl uencing bond-market fl uctuations mentioned above act alone, and all of these factors are closely interrelated.

Increase in U.S. interest rates

The interest ratedifference between theU.S. and Japan widens.

Resurgence in investments in dollars

Strong dollar, Weak yen

Increase of Japanese domestic interest rates

In this example as well, the decline of U.S. interest rates leads to the opposite effect from what is described (the decline of theJapanese domestic interest rate).

The yen is relatively unpopular compared to the dollar

Flow of the sell-off of yen-based bonds and the purchase of dollar-based bonds Increase in

interest ratesStrong dollar, Weak yen

Increase in prices of imported goods

Inflation

The opposite of the above, a strong yen/weakdollar, is a factor for falling interest rates.

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Chart 2-17 Net Trading Volume by Principal Investors

(Unit: JPY10 billion)

Fiscal Year City Banks Regional Banks

Trust Banks

Financial Institutions

for Agriculture

and Forestry

Life and Non-Life Insurance

Companies

Investment Trusts

Business Corporations Individuals Foreigners

1993 ▲382 ▲65 477 342 490 365 94 47 ―1998 ▲871 32 517 629 253 241 120 86 3,2392003 5,643 842 3,446 1,133 507 2,063 632 72 2,4582008 2,553 1,002 3,976 1,336 1,234 1,498 886 32 8,1842013 ▲2,836 482 5,478 779 1,387 3,165 1,104 ▲19 16,3002014 ▲2,629 303 1,297 486 908 3,044 630 ▲38 20,1032015 ▲973 51 560 232 507 2,284 256 ▲37 21,5752016 1,063 ▲80 299 239 403 416 40 ▲37 21,8132017 2,209 ▲60 516 325 371 240 75 ▲23 21,2082018 352 16 373 230 407 406 93 ▲18 24,486

(Notes) 1. Triangles (▲) indicate net sellers, and no mark indicates net buyers. 2. In this table, beginning in FY2003, the total for city banks includes the portion of the

long-term credit bank, etc. 3. Rounded off to the nearest unit.(Source) Prepared based on “Trading Volume of Over-the-Counter (OTC) Bonds”, JSDA.

(5) CreditSpreadsChanges in a bond issuer’s creditworthiness are another factor aff ecting bond prices.Ordinarily, government bonds are deemed to involve no credit risk since the issuer of the

bonds is a nation (national government), and therefore, both the principal and interest are expected to be paid. Credit spread generally refers to the yield diff erential between a certain government bond and another corporate bond, etc. that have equivalent remaining terms to maturity, and bond prices vary as a result of fl uctuations in credit spreads. Concretely speaking, improvement in an issuer’s creditworthiness will cause the upgrade of the rating, etc., which lead to the reduction of credit spread. As a result the bond price will rise.

On the other hand, deterioration in an issuer’s creditworthiness increases the uncertainty regarding its ability to make principal and interest payments, and will cause the downgrade of the rating, etc., which leads to the expansion of the credit spread. As a result, the bond price will decrease.



5 Bond Trading Methods

5 1 Outright Sales and Outright Purchases

The most fundamental means to eff ectuate an actual bond trade is the simple outright sale or purchase. The transaction may involve only a single issue, but fi nancial institutions and corporate investors often trade combinations of multiple issues.

Trades are consummated by having each party to the trade present his desired terms and conditions. The most fundamental term is the simple yield to maturity, which is ordinarily called the trading rate. Additionally, each party will use the other major terms of the bond, such as the number of years to maturity, the coupon rate, the type of bonds, interest payment months, number of interest payments per year, delivery date, issuer’s credit, etc. in determining the value of the bond.

Some of the reasons why investors engage in outright purchases or sales of bonds include the necessity to invest surplus funds (outright purchases), the necessity to liquidate positions (outright sales), or market perception.

5 2 Bond-Switching

(1) DefinitionofBond-SwitchingBond-switching is a trading method involving a contract to simultaneously sell and purchase,

as in a contract where the same investor sells one issue while purchasing another issue. Oftentimes, bond-switching involves not one issue traded with one issue, but issues traded on a multiple basis.

Corporate investors, such as fi nancial institutions, conduct bond-switching in order to rationalize the management of their bond portfolios, which can include a large number of diff erent issues, and to improve the composition of their portfolios in line with their funding objectives.

(2) ObjectivesThe most representative purposes of bond-switching are as discussed below:(i) Bond-SwitchingBasedonMarketOutlook:

If one is bullish on the market and thinks that interest rates will fall in the future, a switching from short and medium-term bonds to medium and long-term bonds, which have greater price movements, would be advantageous. On the other hand, where one expects a rise in interest rates, a switching into short-term bonds will shrink price movement risks. (In this case, it is necessary to be content with investments whose return will temporarily be

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Section 5. Bond Trading Methods


depressed.)For instance, if one forecasts that the current interest rates are at their peaks, and will

decline in the future, the switching should be mainly for long-term bonds, even if the short-term interest rate is currently higher than the long-term interest rate. On the contrary, if the interest rate level is judged to have hit bottom, the switching should be into short-term bonds, and one would have to wait for the interest rate to increase, even if the interest rate on short-term bonds is lower than the interest rate on long-term bonds.(ii) AddedLiquidityBond-Switching:

In consideration of the need to liquidate bonds in the future, a portion of the bond portfolio is switched into highly liquid issues, such as government bonds with a lower price volatility risk.(iii) AddedCurrentYieldBond-Switching:

Some corporate investors place an emphasis on the earnings in each accounting period through current yield. To increase current yield, one can simply switch into bonds with a higher coupon rate. However, unless the number of years to maturity is changed, it will be diffi cult to avoid lowering the simple yield to maturity without assuming the credit risk of the issuer.(iv) AddedSimpleYieldtoMaturityBond-Switching:

To increase the simple yield to maturity, as long as the ordinary long-term interest rate stays higher than the short-term interest rate, one can simply switch into long-term issues with the highest possible yield. In return for a lower coupon rate and a slight decrease in liquidity, the holder can expect to increase the simple yield to maturity more eff ectively.(v) YieldSpreadManagement(SpreadTransactions):

Yield spreads generated by the high or low coupon rates, diff erent maturity lengths, and status as listed or unlisted move within a certain band or trend in the medium-long or long term as long as interest rates do not change signifi cantly. Even so, with such a variety of issue types, it is common for spreads to temporarily widen or tighten. Swiftly taking advantage of these opportunities by bond-switching enables one to increase the effi ciency of investments.(vi) FixedPortfolioManagement:

The balance of redemptions in a portfolio can be maintained at a fi xed level by an investment method involving mechanically conducted bond-switching. The maturity ladder-type portfolio and the dumbbell-type (barbell-type) portfolio are two typical examples.

The maturity ladder-type is a portfolio that holds bonds from short-term to long-term in equal weights for every single year maintaining the same composition of maturities each year. The dumbbell-type (barbell-type) is a portfolio that holds only short-term bonds to ensure liquidity and long-term bonds for profi tability. Either type is an investment system that intends to secure liquidity to a certain extent and at the same time seeks relatively steady profi ts by leveling off market volatility risk.



Chart 2-18 Ladder-Type and Dumbbell-Type

5 3 Gensaki Transactions

Gensaki transactions, also called “conditional transactions of bonds, etc.,” are bond transactions where the parties agree at the time of trading to execute off setting trades of the same type and volume of bonds at a predetermined date and price. In gensaki transactions, there are “brokered gensaki” in which a fi nancial instruments business operator acts as broker between a seller that wants to raise funds and a purchaser that wants to invest funds, and there are “dealer gensaki” in which the fi nancial instruments business operator itself becomes the seller or the purchaser. Normally, purchases conditioned on their sellback are called “kai gensaki” and sales conditioned on their buyback are called “uri gensaki.”

Gensaki transactions are bond transactions in which the seller and purchaser mutually agree to fi x the yield for the period in a way that is completely unrelated to market fl uctuations. While they assume the form of bond trades, gensaki are actually a system to fi x the yield for a certain period through a combination of interest and the diff erence between the initial trading price and the off setting trading price. Gensaki transactions also possess the characteristics of fi nancing transactions with bonds as collateral.

Also, in April 2001 a new transaction framework (also referred to as new gensaki transactions) was introduced, and the size of these transactions is expected to grow in the future, replacing bond borrowing and lending transactions and loan-repo transactions (for details, see “3.4 Bond Borrowing and Lending Transactions”).

The following are the main features of current gensaki transactions as compared to traditional gensaki transactions:

(i) Transactions are premised on global standards;(ii) New risk control provisions that were impossible with traditional gensaki transactions

have been established; and(iii) Contractual procedures exist to deal with unforeseen events such as the occurrence of a

default.Concerning gensaki transactions, JSDA has provided rules as follows for matters such as the

conclusion of trading agreements and the scope of the bonds, etc. that are subject to the transaction (Rules Concerning Handling of Conditional Sale and Purchase of Bonds, Etc.).

Ladder-type Dumbbell (barbell) type

Amount held (example) Amount held (example)

Year 1

Year 2

Year 3

Year 4

Short-term bond

Long-term bond

Remaining period Remaining period

···

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Chart 2-19 Mechanism of Gensaki Transactions

(i) Prior to commencing gensaki trading, an agreement must be executed with the customer, and such agreement must be fi led and held in safe keeping;

(ii) In principle, a terms sheet must be delivered to the customer for each trade;(iii) Eligible customers for gensaki transactions are limited to listed companies or

corporations equivalent thereto, which possess economic and social credibility;(iv) Bonds eligible for gensaki transactions are government bonds, municipal bonds,

government sponsored entity bonds, corporate bonds, specifi ed bonds, and investment corporation bonds, as well as yen-denominated foreign bonds and foreign currency-denominated bonds. However, bonds with share options are excluded;

(v) In conducting a gensaki transaction, the parties must be aware of the rights connected with the bonds to be traded and fully consider the liquidity and price movement of such issues;

(vi) In principle, bonds registered under another person’s name cannot be traded;(vii) In conducting a brokered gensaki transaction, generally the selling date and the

purchase date for the initial trade must be the same, and the repurchase date and the resale date for the off setting trade must also be the same; and

(viii) The balance of gensaki transactions must be monitored to avoid excessive transactions in light of each JSDA member’s fi nancial position. Also gensaki transactions must not be overly concentrated into transactions with a single counterparty.

5 4 Delayed Delivery Transactions

A delayed delivery transaction is a contract in which both parties agree to the delivery of bonds at a predetermined date and under certain conditions, where delivery is scheduled at least one month later than the contract date (after the anniversary date in the following month).

However, setting a delivery date that far in the future involves credit risks; moreover, under certain circumstances, it has the nuance of being a speculative transaction. For instance, the

Seller(1) Initial sale

(4) Repurchase after a specified period

Dealer gensakiDealer gensaki

Purchaser

Brokered gensaki

Financial InstrumentsBusiness Operator

(2) Initial purchase

(3) Resale after a specifiedperiod



variety of risks would include whether or not the seller can securely arrange the actual bonds and whether or not the buyer can securely arrange the funds at the time of the contract; whether or not the bonds and funds will be kept available until the delivery date; whether the agreement could potentially be broken if a major market fl uctuation occurred before the delivery date; and whether trouble could arise because the agreement between the parties was merely an oral agreement.

As a result, JSDA has set forth the following requirements with regard to matters concerning delayed delivery transactions, including concluding a transaction agreement, the scope of the bonds etc. subject to the transaction, and the transaction procedure (Rules Concerning Handling of Sale and Purchase of Bonds, etc. with Delayed Settlement.):

(i) A delayed delivery transaction is defi ned as a transaction with a period of at least 1 month from the trade date to the delivery date;

(ii) When executing a delayed delivery transaction, an Agreement Concerning Delayed Delivery Transaction must be executed with the customer for each transaction, and a copy of the said agreement shall be fi led and preserved;

(iii) Eligible customers for delayed delivery transactions are to be limited to listed companies or corporations equivalent thereto, which possess economic and social credibility;

(iv) The bonds eligible for delayed delivery transactions are government bonds, municipal bonds, government sponsored entity bonds, corporate bonds, specifi ed bonds, and investment corporation bonds, as well as yen-denominated foreign bonds and foreign currency-denominated bonds. However, bonds with share options are excluded;

(v) The period between the trade date and the delivery date (the delay period) must not exceed six months; and

(vi) The balance of delayed delivery transactions must be monitored to avoid excessive transactions in light of each JSDA member’s fi nancial position. Also, transactions must not be overly concentrated into transactions with a single counterparty.

5 5 Transactions of Bonds with Options

(1) WhatIsaTransactionofaBondwithanOption(anOver-the-CounterTransactionofaBondOption)?A transaction of a bond with an option, which is also referred to as an over-the-counter

transaction of a bond option, is a transaction of a bond wherein either of the parties has the right (option) to designate the delivery date, and if the delivery date is not designated within the exercise period, the agreement for the transaction is cancelled. The JSDA specifi es matters necessary for transactions of bonds with options conducted by Association Members over the counter, such as the publication of quotations of option price, conclusion of a sale and purchase agreement, and method of transaction (Rules Concerning Handling of Sale and Purchase of Bonds with Options).

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This type of transaction is characterized by the following two points: the details of an option can be customized: and the bonds sold and purchased are actually delivered.

For the fi rst point, particular types of options can be tailored, such as an option subject to a condition precedent (an option expires when the price of the bond to be traded reaches a predetermined level), an average option (the average price of the bond to be traded during a period is set as exercise price), and a look-back option (an option is exercised at the highest or lowest price during a period), etc.

For the second point, an actual securities portfolio can be directly involved in transactions. This feature greatly contributes to diversifi cation of cash bond transactions.

(2) TradingSystem(i) Tradingperiod

For a transaction of a bond with an option, the period from the contract date to the delivery date of the bond shall not exceed one year and three months. Within this range, a period for exercising an option can be determined freely by agreement between the parties for each transaction.

In practice, long-term transactions with an exercise period of more than three months are rarely seen. Most transactions are conducted on a shorter term from one week to about one month.(ii) Tradingunit

The minimum face value for a transaction is 100 million yen (or the value equivalent to 100 million yen for foreign currency-denominated bonds).(iii) Tradingprice(exerciseprice)

As in the case of the exercise period, the trading price or exercise price can also be determined freely by agreement between the parties.(iv) Methodofexercisingtheoption

An option shall be exercised during the exercise period according to the procedure for the delivery of the bond as prescribed in an individual transaction agreement beforehand. An option holder (buyer), when exercising the option, shall notify an option writer (seller) of the date of delivery of the subject bond. The option shall expire if it is not exercised during the exercise period.(v) Offsetting

Resale is prohibited for transactions of bonds with options. The outstanding portion of the option contract yet to be exercised may be liquidated by being off set with another option contract if (a) a seller under a former contract is a buyer under a latter contract, (b) except for this diff erence, all the other details are the same (e.g., underlying bonds, face value, exercise period, exercise price, etc.), and (c) a new contract is concluded with the same counterparty. In off setting the two option contracts, option prices are paid and received separately for these contracts, and net settlement is prohibited.(vi) TradingMargin

In transactions of bonds with options, an option holder should require a trading margin



from the option writer, except where an option writer is a professional investor. The amount of the margin should be not less than “the option price + 5% of the face value,” and should be paid to the option holder by noon of the second business day following the contract date. An additional margin may also be demanded when the option writer incurs a loss due to the fl uctuation of the market or other reasons.

These trading margins may be substituted by securities in the full amount.(vii)Fees

In transactions of bonds with options, the option price (premium) is all that is to be paid and received, and in this sense, it could be considered that all fees and costs are included in the premium off ered to investors.

5 6 Other Transaction Methods, Etc.

(1) RollForwardsA roll forward is a bond-switching in which the delivery date for the selling contract and the

delivery date for the buying contract are staggered, such as when sales are made in February and purchases are made in April. The transaction can be considered a combination of a simple sale with a delayed delivery purchase transaction. Roll forwards facilitate both (i) portfolio improvements through bond-switching, as well as (ii) short term capital turnovers.

(2) AccumulationandAmortizationWhen the book value of a bond is signifi cantly lower than its face value (under par), the

holder will accrue a single large gain upon maturity. On the other hand, if the book value of a bond is signifi cantly higher than its face value (over par), the holder will realize a loss when the bonds are redeemed at maturity.

Financial institutions in particular may attempt to stabilize their earnings by evenly distributing profi ts and losses from redemption for all of their fi scal periods over the whole maturity period for a bond, and not concentrating such profi ts and losses on only one fi scal period at maturity. Under the Companies Act, the book value can be adjusted by a certain amount in each fi scal period if the book value is diff erent from the face value.

The adjustment to increase the value is referred to as accumulation, while the adjustment to decrease the value is referred to as amortization.

(3) BasisTransactionsA basis transaction is a type of transaction that focuses on the spread between spot prices and

future prices and seeks to take a margin.The spread between spot prices and future prices theoretically should converge toward a

certain standard range through active arbitrage transactions. In reality, however, since both the spot prices and the future prices change according to the supply and demand balance in their

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respective markets, the spread may widen or contract.If the spread widens abnormally, the position with the comparatively higher price is sold and

the one with the comparatively lower price is purchased, with the expectation that the spread will contract again in the future. If the spread tightens abnormally, the opposite would hold. If the spread widens and contracts as expected, margins can be earned by conducting reverse transactions.

Basis is a spread between a spot price and a future price, and is usually calculated as “spot price - future price × CF (conversion factor).”

For instance, when large volumes of new bonds are issued, sparking short hedging transactions originating from their purchasers, futures prices sometimes become extremely low and thus the basis widens. Also, during the period when leading contract month are replaced, there is a tendency to cover (repurchase) short hedges on nearby futures contracts (futures contracts with the closest settlement due date) and newly hedge with more distant futures contracts. Accordingly, with nearby futures contracts, the basis can shrink rapidly, whereas with other more distant futures contracts the basis widens rapidly.

(4) TradingMethodsUtilizingOptionsThese include, as broad examples, “target buying,” in which put options are sold to buy a

given bond at a desired level, and “covered calls,” in which call options are sold for a premium to improve yields during the period to maturity of a given bond held.

In addition, volatility trades are widely used, focusing not on the bond prices but the volatility of the prices.

6 The Secondary Market for Convertible-Type Bonds with Share Options (Convertible Bonds)

6 1 Defi nition of Share Options

Share options entitle the holder to purchase a specifi ed number of shares of the issuer company at a predetermined price if the request is made within a specifi ed period of time.

Correspondingly, the issuer company must issue new shares, or deliver treasury shares in lieu of issuing new shares, to the holder of the rights when those rights are exercised.

6 2 Change of Name

Accompanying the creation of share options in the amendments to the Commercial Code that



became eff ective in April 2002, the names of the following instruments were changed, as shown below:

Chart 2-20 Name Changes in Association With Amendments to the Commercial Code

Old Commercial Code 2002 Amended Commercial Code/Current Companies Act

Convertible bondsBonds with non-detachable subscription rights (warrant bonds)

Bonds with share options

Bonds with detachable subscription rights (warrant bonds)

Simultaneous off ering and allotment of share options and bonds

Treasury shares style stock options*Preemptive subscription right style stock options*

Combined under share options

* Stock optionsStock options are the rights granted to the directors or employees of a company that

entitle the grantee the right to purchase company shares at a predetermined price. If the price of the company’s shares goes up, the person holding the right can purchase the shares at the predetermined price, and sell the shares at their market price, making a gain on the diff erence. Companies were permitted to roll out stock options under the Commercial Code amendments that came into force in June 1997.

As a result, the term “convertible bonds” is no longer used in the language of laws and regulations. However, in practice, the term continues to be used to refer to bonds with share options that have the product characteristics of the former convertible bonds.

6 3 Issuance of Share Options

Under the old Commercial Code, preemptive subscription rights (shinkabu hikiuke ken), which entitle the holder to demand the issuance of new shares at a predetermined price, had to be issued in combination with corporate bonds (as a convertible bond or bond with subscription rights), except when granted to directors or employees as stock options. Pursuant to the Commercial Code amendment that came into eff ect in April 2002, however, issuance of stand-alone share options became permissible.

In addition, under the share option system, there are no restrictions on who may be granted rights, the number of shares granted or the exercise period, and restrictions were eased with respect to such matters as the ability to issue these instruments by board of directors’ resolutions.

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Section 6. The Secondary Market for Convertible-Type Bonds with Share Options (Convertible Bonds)


6 4 Product Characteristics of Bonds with Share Options

Under the old Commercial Code (up to the 2002 amendment), convertible bonds were a product that had a lower interest rate than straight bonds, but in return off ered the bondholder the right to convert a portion of its holdings into the shares of the issuer. The bond and the conversion right were seen as inseparable and were always priced as a single unit at the time of issuance and when circulating in the secondary market, and a separate value for the conversion rights portion was not recognized.

Similarly, the current Companies Act does not allow share options embedded in bonds with share options to be stripped from the bonds and sold separately (the value of the share options are embedded in the value of the bonds). Under the Companies Act, it is possible to provide that the issue price of the bond and the paid-up amount when exercising the share options must be the same amount; furthermore, when the bondholder exercises the share options, the bond is always redeemed and the redemption proceeds are allotted to the paid-up amount for the share options.

In other words, if the share option portion of a bond with share options were to be deemed to have a separate value when the bond with share options is issued, the instrument would possess features diff erent than those of traditional convertible bonds. In order to issue bonds with share options with the same product characteristics as conventional convertible bonds, the share option portion must be deemed to have zero value.

6 5 Defi nition of Convertible-Type Bonds with Share Options

“Convertible-type bonds with share options” (hereinafter referred to as “convertible bonds” or by the acronym “CB”) are bonds with attached share options, which cannot be detached or sold independently from the bonds. Additionally, when the share option is exercised, the bondholder is deemed to pay the paid-up amount for the share option in lieu of redeeming the entire amount of the bond, and the issue price of the bond and the paid-up amount upon the exercise of the share option must be the same.

Thus, similar to traditional convertible bonds, the investor can participate in the appreciation of the issuer’s shares. Furthermore, if the investor holds the bond without exercising the share option, he/she can still enjoy the bond as a fi xed-income security, and receive the bond’s face value upon maturity (there is also a type of convertible bond with no interest payment (zero-coupon)).

Convertible bonds are sometimes referred to as latent equity, because in spite of their outward appearance as bonds they can be converted to shares. As an investment product, CBs are unique fi nancial instruments combining the profi tability of shares with the safety of bonds.



(1) AttributesasCorporateBondsConvertible bonds feature all the usual terms and conditions of bonds, such as price, coupon

rate and term. Their characteristics are described below:

(i) Issue Price: In the past, the issue price was generally the face value (JPY100 payment for a JPY100 face value), but in recent years, it is frequently set higher than the unit price of the face value, such as JPY 102.50 payment for a JPY 100 face value.

(ii) Coupon Rate: Since these bonds have an advantage in that they can be converted into shares, the coupon rates are set lower than those for straight bonds, and the zero-rate type has become mainstream. The coupon rate is determined in reference to the conversion premium, ratings, maturity and the actual demand among investors, and based on the advice given by the lead manager securities fi rm.

(iii) Term: While there is a tremendous variety among bond terms for convertible bonds, most are plus or minus fi ve years.

(iv) Collateral: In the past, secured bonds were frequently encountered; recently, however, almost all issues are non-secured bonds.

(v) Series: For smooth trading on the exchanges, one series per issue. Most issues have denominations of JPY1 million.

(vi) Redemption: Most issues are redeemed as a bullet payment at maturity. However, there are cases where the issuing company will cancel the bonds by repurchasing its convertible bonds in circulation in the market. Also, there are some bonds with put option redemption of the bondholders, and with call option redemption of the issuing company. In addition, some bonds contain provisions allowing the issuer to redeem the issue before maturity if a resolution is approved that the issuer becomes the wholly-owned subsidiary of another company through a share exchange or share transfer, or if the share price maintains a certain percentage above the conversion price for a specifi ed period of time.

Furthermore, as convertible-type bonds with share options are regarded as having the same product characteristics as traditional convertible bonds, the issue price of the share option is deemed to be nil. Also, since the issue price of the share options is set at zero, depending on the exercise conditions, the bonds may fall within the defi nition of an “advantageous issue” under the Companies Act, requiring the issuer to obtain a special resolution by two-thirds majority vote of the shareholders general meeting to be able to issue the bonds.

(2) ConditionsofConversionintoSharesWith regard to the conversion of convertible bonds into shares, the conversion price, period

for requesting the exercise of share options, and the details of the shares to be issued upon

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conversion of the convertible-type bonds with share options into shares are set out in the terms sheet at the time of issuance.

・ Conversion Price (Exercise Price)The conversion price is the issue price per share upon conversion (upon exercise of

the share options). The conversion price is set at an amount higher than the closing price for the underlying shares at a certain date prior to the beginning of the off ering period for the convertible bonds (the percentage by which the conversion price, when determined, exceeds the market price of the shares is referred to as the “conversion premium”).

The bondholder can compute the number of shares he will acquire if he converts the convertible bond by dividing the total issue price of the bonds delivered when requesting the exercise by conversion price.

(Example) If the conversion price is JPY1,500, and the total issue price of the bonds delivered is JPY3 million:

6 6 Listing Rules for Convertible Bonds

(1) ListingExaminationThe listing examination for an issue of convertible bonds focuses on matters associated with

the aftermarket circulation of the bonds, such as the determination of the minimum issue amount, etc., with a view to ensuring the effi cient distribution of the bonds post-listing. (For details, see Volume 1, Chapter 5, “3. Securities Listing Regulations.”)

(2) ListingManagementSince share options are attached to convertible bonds, administering the exercise of these

share options similarly constitutes a major part of the listing management for convertible bond issues.

More specifi cally, upon conversion of the listed convertible bonds, a decrease in the total listed par value for the listed convertible bond and an increase in the number of listed shares occur simultaneously. Therefore, each month, the stock exchange requires issuers to report the details of any conversions and any changes to the total listed par value of the convertible bonds and number of listed shares.

In addition, when the listed convertible bonds are redeemed or cancelled by repurchase (the method by which the issuer makes purchases at the market price through the market from holders who agree to be bought out), or the conversion price is changed, the issuer must report to the stock

Number of Shares Acquired =

Total Issue Price of Bonds Delivered

= 3,000,000 = 2,000 sharesConversion Price 1,500



exchange regarding such matters.

(3) DelistingIf the exercise period expires, if the total listed par value falls below JPY300 million, or if

the shares of the issuing company become subject to the delisting criteria for shares, etc., the convertible bond will be delisted. If the convertible bonds are delisted by the time of the fi nal redemption date or the expiration of the period for requesting the exercise of share options, the delisting date shall be the third business day prior to the fi nal date of the period in which the intermediating of requests to exercise the share option can be made on the JASDEC.

Moreover, in the event that convertible bonds are handled in the clearing operations of JASDEC, the requirement for delisting shall be that they be excluded from being handled by these clearing operations.

6 7 Amendment of the Companies Act and Bonds with Share Options

The Companies Act was enacted on June 29, 2005, together with the “Act on Arrangement of Relevant Acts Incidental to Enforcement of the Companies Act” and came into eff ect on May 1, 2006.

Under the previous Commercial Code, bonds with share options were covered in their own separate volume (Commercial Code, art. 341-2 through art. 341-15). The Companies Act, however, does not classify these into a separate section, and defi nes them as “bonds with share options attached thereto” on the grounds that they can be handled through direct application of the provisions concerning share options or bonds (Companies Act, art. 2, item 22). Moreover, as bonds with share options are covered within the chapter concerning share options (Companies Act, art. 236, et seq.), their issue will follow the procedures for the issue of share options rather than the provisions for a bond off ering (Companies Act, art. 248).

One substantive amendment in connection with bonds with share options is the deletion of the clause stipulating that in a situation where the exercise price of bonds with share options is considered to be paid in exchange for the redemption of the bonds (this can occur either by conversion of bonds or substitute payment), the issue price of such bonds is deemed as the paid-in amount for the purposes of the exercise price of the share options (Commercial Code, art. 341-3, para. 2).

The substantive amendments that are being made in connection with share options involve a variety of issues, including an eff ort to achieve a balance with the regulations concerning shares, an attempt to simplify the system, and ad hoc amendments to correct insuffi ciencies that have become apparent in the implementation of the 2001 Commercial Code amendments.

The following is a list of the substantive revisions that have been made:・ A new system has been created for allocating share options free of charge to existing

shareholders in accordance with their shareholding ratio (Companies Act, art. 277).

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・ In the same manner as for a free allotment, persons who have received an allotment become “share option holders” on the allotment day, even in the event that the share options are issued for valuable consideration (Companies Act, art. 245, para. 1).

・ A new system has been created for share options with a buyback clause in which a company can require the acquisition of share options (Companies Act, art. 273, para. 1).

・ Explicit clarifi cation has been made that a company cannot exercise share options to its own shares (Companies Act, art. 280, para. 6).

・ Explicit clarifi cation has been made that share options can be acquired through succession not only in the event of an exchange of shares or transfer of shares, but also in the case of a merger or company split (Companies Act, art. 236, para. 1).

・ An amendment was added stating that odd-lot shares are to be redeemed in cash if fractions of less than a share occur as a result of the exercise of a share option, provided that odd-lot shares can be rounded down if this is explicitly stated in advance (Companies Act, art. 283).

・ The issuance of registered bonds with share options has become permitted (Companies Act, art. 236, para. 1).

・ The regulations on investment in kind will also extend to the exercise of share options (Companies Act, art. 284).

However, under the Companies Act, it is interpreted that the exercise of the share option as part of the convertible bonds is not subject to the regulation of the investment in kind, for the reason that it is a mere combination of the redemption of bonds and the payment of the exercise price by applying the redeemed amount.

6 8 Trading Rules for Convertible Bonds

Transactions of convertible bonds in the secondary market can be classifi ed into exchange transactions and off -exchange transactions. Exchange transactions can be further subdivided into “transactions during trading sessions” and “transactions other than those during trading sessions.”

Attention should be paid in this connection, as there are detailed rules regarding the matters to be observed in these transactions, such as the time window for trading, limits on price movements, etc. (although conceptually the rules are the same as the rules for transactions of shares).

(1) TransactionsDuringTradingSessions(SaleandPurchaseExecutedontheMarketDuringTradingSessions)Similar to transactions in shares, transactions are categorized as either principal (proprietary)

transactions or broker transactions. The detailed rules such as session hours, etc. are as set forth in the chart (in the case of the Tokyo Stock Exchange; see Chart 2-21).



Chart 2-21Summary Table of Transactions During Trading Sessions (ToSTNeT transactions)

Trading Session Hours 9:00 – 11:3012:30 – 15:00

Trading Unit Par value, JPY100,000, JPY500,000, JPY1,000,000, JPY2,000,000,JPY3,000,000, JPY4,000,000, or JPY5,000,000

Minimum Tick JPY0.05 per JPY100 par valueTypes of Quotations Limit price and market price

Price Limit Price limit on the underlying shares × Conversion ratio(must be at least JPY5)

Method of ExecutingTrading Contract Individual competitive sale and purchase (same as shares)

Conditional Trading On-open and IOC orders are allowed(On-close and Funari orders are not allowed)

Type of Trade andSettlement Date Regular/same day settlement transactions

Method of Settlement Book-entry Transfer at the Japan Securities Depository Center

(Source) Prepared based on the Japan Exchange Group’s website (as of October 1, 2019).

(2) TransactionsOtherThanThoseDuringTradingSessions(SaleandPurchaseontheMarketOtherThanThoseExecutedDuringTradingSessions)With the rise in the number of institutional customers, increasingly larger block orders and

basket trades, etc., transactions other than those during trading sessions was introduced in order to respond to the diversifi ed needs of investors, starting in November 1997.

The specifi c transaction rules such as the trading hours are set forth in the chart (In the case of the Tokyo Stock Exchange, where transactions other than those during trading sessions are called “ToSTNeT (Tokyo Stock Exchange Trading NeTwork System)” transactions; see Chart 2-22.).

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Chart 2-22 Summary Table of Transactions Other Than Those During Trading Sessions

Single Issue Transactions

BasketTransactions


Off -Auction Own Share Repurchase

VWAP Guarantee Transactions

/ VWAP Target Transactions

Eligible shares

Domestic shares, foreign shares, ETFs, REITs and CBs




Domestic shares, foreign shares, and REITs

Trading Hours 8:20 – 17:30

8:20 – 9:00 previous dayVWAP (VWAP Target Transactions are not possible)

8:20 – 17:30

8:20 – 8:4511:30 – 12:1515:00 – 16:00(Hours of order acceptance are 8:20 – 16:00)

8:45(Sell orders are accepted from 8:00 to 8:45)

11:30 – 12:30 morning session VWAP15:00 – 17:30 afternoon session and whole day VWAP

Trading Unit

Possible from the minimum trading unit


15 issues or more and total trading price of JPY100 million or more



Trading Price

Within ±7% of the most recent trading price of the auction market(*1)(*2)

(*1) Where there is a special quote or a sequential contract quote, the relevant special quote price or sequential contract quotation price(*2) Within the range of the last trading price + or - JPY5 without exception if 7% of the last trading price is less than JPY5.

VWAP Guarantee Transaction: Price obtained by adding/reducing the amount corresponding to commission to VWAP

VWAP Target Transaction: Weighted average price of the execution results in the auction market that targeted the VWAP (transactions are also possible at a price that refl ects the weighted average price as a result of execution plus the amount of commission)

Amount within ±5% of the base price calculated from the last trading price of the auction market for the composite issues

8:20 – 8:45Previous day’s closing price(including fi nal special quote price or fi nal sequential contract quote; where there is neither, that day’s base price; the same hereinafter),previous day’s whole day VWAP

11:30 –12:15Morning session’s closing price, morning sessionVWAP

15:00 –16:00Day’s closing price, afternoon session and whole day VWAP

Previous day’s closing price(including fi nal special quote price or fi nal sequential contract quote; where there is neither, that day’s base price)

(Source) Prepared based on the website of the Japan Exchange Group (as of October 1, 2019)



6 9 Fundamental Valuation Methods for Convertible Bonds

In valuing convertible bonds, the valuation of the bond portion is based on the bond’s yield, and it is computed in the same manner as straight bonds are calculated, as described above. Moreover, in valuing the equity portion, the parity value and the premium over parity are the standard methods used.

For the specifi c methods used to compute yield, please refer to the explanation for the bond portion.

(1) ParityValue(TheoreticalValueinTermsofSharePrice)Parity value measures the theoretical value of a convertible bond from the share price and the

conversion price. It is computed by dividing the share price by the conversion price, and expressed as the theoretical price per JPY100 face value of a convertible bond (it does not take into consideration accrued interest on the convertible bond, dividend payments on shares, or associated transaction costs, etc.).

A concrete illustration of an example calculation is as follows: where the conversion price is JPY1,200, and the share price of the convertible bond is JPY1,800, parity is JPY1,800 ÷ JPY1,200 × JPY100 = JPY150. In other words, in terms of the current share price, JPY150 is the appropriate value of this convertible bond.

Supposing that at that time the current market price for the convertible bond is JPY155, that convertible bond is being purchased at a value above the theoretical value. Conversely, if the market price is JPY145, it may be judged that it is being purchased at a low price.

(Note) Here we will assume the bonds have the same product attributes as traditional convertible bonds, and calculate the parity value based on the assumption that the price of the share option is zero. In English, parity has meanings such as “equal, equivalence, equilibrium value.”

(Example) The parity value of a convertible bond with share price as follows is shown below (the conversion price is JPY1,200):

Share Price (JPY) Parity Value (JPY)1,800 1501,200 100 600 50

Parity Value (JPY) = Share Price

Conversion Price100 ×

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(2) PremiumOverParityThe gap that arises between the market value of a convertible bond and its parity value is

called the Premium over Parity, and can also be expressed as a percentage.

(Note) Here, we will assume the bonds have the same product attributes as traditional convertible bonds, and calculate the premium over parity based on the assumption that the price of the share option is zero.

(Example) The Premium over Parity of a convertible bond where the share price, etc. is as follows is shown below (the conversion price is JPY1,200):

Share Price (JPY)

Parity Value (JPY)

Market Price of Convertible Bond

(JPY)

Premium Over Parity (%)

1,800 150 147 -21,200 100 115 15 600 50 95 90

(3) ConversiontoShares(ExerciseofShareOptions)inPractice(i) ApproachtoConversion

The decision to sell a convertible bond as a bond or to convert and sell the shares depends on the premium over parity. In general, when the premium is positive (parity value < convertible bond market price), it is more advantageous to sell the convertible bond, whereas if the premium is negative (parity value > convertible bond market price), it is more advantageous to convert the bonds to shares and sell the shares.

In practice, however, converting into shares necessitates taking into account the following points:

a. Transaction costs associated with the share sale (brokerage commissions, etc.); and

b. Accrued interest that can be received at the time of the sale of the convertible bond (in the case of requesting the exercise, accrued interest cannot be received).

Premium Over Parity (%) = Market Value of CB ‒ Parity Value

× 100Parity Value



(ii) ConversiontoSharesinPracticeIn practice, the following process is used when converting to shares:

InvestorJASDEC

participant (securities firm) JASDEC

Shareholder registry

administrator (trust bank, etc.)

Request for exercise

Increase in the shares in

deposit

Notice of request for

exercise

Notice of a new entry

Notice of request for

exercise

Notice of a new entry

* With some diff erences among securities fi rms, it generally takes about fi ve business days from the time when the investor makes a request for the exercise of the share option until the bonds are converted into shares.

* The investor bears the risk of any share price fl uctuation during the period from the exercise request until the delivery of the share certifi cates.

6 10 Price Volatility Factors of Convertible Bonds

If convertible bonds are generally thought of as a combination of bonds and shares, then the price of a convertible bond can be broken down into:

CB Price = (Price of a straight bond with the same bond terms as the CB) + (Price of an option with the same exercise price as the conversion price of the CB)

Accordingly, when analyzing the price volatility factors of convertible bonds, it is necessary to consider the following four factors:

(1) ApproachTowardsBondValuationThe valuation of the bond portion of a convertible bond is premised on the assumption that

the bond portion should have the same value as a straight bond with the same terms (same issuing entity, same rating, same remaining years to maturity, same coupon). Based on this assumption then, the following factors are the volatility factors of bond value:

(i) InterestRateFluctuationThe benchmark for this factor is generally an interest-rate swap for the same period as

the convertible bond.Thus, if the swap rate falls, the bond price will rise; conversely, if interest rates trend

upwards, the bond price will fall.(ii) FluctuationsinBondCreditSpread

The credit spread fl uctuates generally based on the fi nancial soundness of the issuing company. Theoretically, the spread is determined based on the company’s ratings announced by the ratings agencies.

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If the credit spread shrinks, bond price will rise; conversely, if the credit spread widens, the bond price will fall.

(2) ApproachTowardsOptionValueValuation of the option portion of the convertible bond is premised on the assumption that

theoretically, the value of the option will equal that of a call option on the underlying shares with the same terms (same issuing entity, same term to expiration, same conversion price). Based on this premise, the volatility factors are as follows:

(i) SharePriceFluctuationThe value of the call option fl uctuates based on movements in share price. The option value can be described simplistically as:

Option Value = Intrinsic Value + Time Value

Chart 2-23 Option Value and Payout

The option payout moves in parallel with movements in the share price, as shown in the chart. However, when the share price is lower than the conversion price, the option value becomes less sensitive to share price movements and the option value payout diagram shows a shallow curve. By contrast, when the share price is higher than the conversion price, the option value becomes more sensitive to share price movements and the option value payout diagram shows a steep curve and becomes closer to the intrinsic value.(ii) MovementsinVolatility

Volatility means the annualized daily percentage fl uctuation in share price or variability in the stock price. Generally as the volatility increases, the time value portion in the chart will increase, and the option value will also increase. Conversely, as the volatility declines, so will the option value.

Generally, the share price of a share with a high volatility is judged to have a stronger possibility of changing the price range in the future, causing the option value to rise.

Option Value Intrinsic Value

Time Value

Share PriceConversion Price

Option Value



(3) ConclusionIf the volatility factors of convertible bonds can be plugged into a matrix, as shown below:

Chart 2-24 Factors of Price Fluctuation in Convertible Bonds

Interest Rates Credit Spreads Share Prices VolatilityPrice Rises Fall Contract Rise IncreasesPrice Falls Rise Widen Fall Decreases

6 11 Convertible Bond Market Trends

Major changes in convertible bond markets are underway in recent years.In the past, investors in the market were mainly comprised of domestic institutional investors

and individuals; however, gradually more foreigners, particularly hedge funds, began to actively participate in the market. One can observe a similar trend in the primary market as well.

(1) OutstandingConvertibleBondBalancesVolumes of convertible bonds in the secondary market expanded in the latter half of the

1980s in response to the large increase in equity fi nance during those years, whereas in recent years this large volume has approached maturity, while new issues have declined. Other major factors for this decrease include the reduction in interest-bearing debt at the corporate level, and changes in attitudes towards capital costs.

Another recent feature is that while the market balance of convertible bonds issued domestically has withered, issues have shifted to the Euromarket. In particular, most large fi nancings of over JPY50 billion have been done in the Euromarket. As the demand for convertible bonds increasingly shifts from domestic to foreign markets, tapping the Euromarket allows issuers the ability to complete deals on more favorable terms than would be possible domestically.

Chart 2-25 Issue and Redemption of Convertible Bonds

(Unit: JPY100 million)Domestic Issues Domestic Redemptions

2014 440 1,3702015 1,600 9482016 720 6272017 130 3952018 160 189

(Source) Prepared based on “Issuing, Redemption and Outstanding Amounts of Bonds” by the JSDA

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However, as interest rates are low on a global basis, the advantage of convertible bonds as low-interest fi nancing means has somewhat declined, resulting in a decrease in issues of convertible bonds and a gradual decline in the outstanding balance.

(2) TrendsinTradingBalancebyInvestorCategoryWhen observing the recent trends in convertible bond trading balances for diff erent investor

categories, individual investors have been seen to be net sellers, which may be attributed to a fact that a relatively larger portion of new issues has been allotted to individual investors and then sold on the market. Meanwhile, foreign investors continued to purchase more than they sell (see Chart 2-26).

Foreign investors and corporations tend to use the market transactions other than those during trading sessions and the off -exchange trades more frequently in addition to the transactions during trading sessions.

Chart 2-26 Convertible Bond Trading Trends by Investment Category

(Unit: JPY100 million)

YearTotal Proprietary Broker

Details of Broker TradesCorporate Individual Foreigner

Sells Buys Net Sells Buys Net Sells Buys Net Sells Buys Net Sells Buys Net Sells Buys Net2014 517 516 -2 50 138 88 468 378 -89 119 128 8 303 26 -276 46 224 1792015 1,431 1,408 -22 137 323 186 1,293 1,085 -208 276 336 60 920 25 -895 98 724 6262016 944 938 -6 101 313 212 843 626 -218 197 235 38 595 15 -579 52 376 3242017 367 357 -10 63 125 62 304 232 -72 105 90 -15 184 7 -177 15 135 1202018 228 221 -7 38 73 36 190 147 -43 57 38 -19 119 10 -110 14 100 86

(Note) The survey targeted general trading participants capitalized at 3 billion yen or more.(Source) Prepared based on “Trading Volume by Type of Investor (Convertible Bond)” in the “Monthly Statistics

Report”, of the Japan Exchange Group.

7 Bond Investment Calculations

7 1 Coupon (Interest-Bearing) Bonds

(1) ProfitsofBondInvestmentsThe fundamental terms of a bond are the interest rate, the price and the number of years to

maturity. Profi ts from investments in bonds can be calculated using these three conditions.In addition, profi ts from bond investments can be divided into three components, as

described below:



(i) Coupon income ---Interest income (income gains)(ii) Redemption gain/loss ---Diff erence between redemption price and purchase price

(capital gain/loss)(iii) Reinvestment earnings of coupons ---Investment earnings from reinvestment of interest

payments received during the life of the bond

(2) YieldComputations(i) SimpleYieldtoMaturity

The simple yield to maturity is the yield if bonds are held from purchase until redemption. The simple yield to maturity computes how much interest income and redemption gain/loss was received on the bond each year as a percentage of the purchase price:

(Sample Question)What is the simple yield to maturity of a coupon bond with an annual coupon rate

of 2.0%, 10 years remaining until maturity, and a purchase price of JPY99.80?

(Note) Normally fi gures are rounded down after the fourth decimal place (hereinafter the same).

(Sample Question)What is the simple yield to maturity of a coupon bond with an annual coupon of

3.1%, 8 years remaining until maturity, and a purchase price is JPY109 (cases where a redemption loss is included)?

+

Formula <1>

Simple Yield to Maturity =

Interest Income per Year

Redemption Gain/Loss per Year

× 100 (%)Purchase Price

Coupon + (Redemption Price – Purchase Price) Number of Years to Maturity (years)

Purchase Price × 100 (%)=

Based on Formula <1>:

2.0 + (100 – 99.80)

1099.80 × 100 = 2.02

99.80 × 100 = 2.024048% ≈ 2.024% (Fractions are rounded down)

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Section 7. Bond Investment Calculations


(ii) SubscriberYieldThe simple yield to maturity in cases where a new bond issue is purchased is called the

subscriber yield:

(Sample Question)What is the subscriber yield for a long-term government bond with an annual

coupon of 2.0%, a maturity of 10 years, and an issue price of JPY100.63?

(iii) CurrentYieldCurrent yield is a measure of bond profi tability expressed as the annual interest on a

bond divided by the bond price. It is often used since calculation is relatively simple. Because current yield is a measure of interest income, it is an important index for investors who place an importance on constant and immediate profi ts:

(Sample Question)What is the current yield for a government bond with an annual coupon of 3.3%,

8.5 years remaining until maturity, and a purchase price of JPY110.80?

3.1 +(100 ‒ 109)

8 × 100 = 3.1 ‒ 1.125 × 100 = 1.8119266% ≈ 1.811%109109 (Fractions are rounded down)

Formula <2>

Subscriber Yield =Coupon +

(Redemption Price ‒ Issue Price) Number of Years to Maturity (years)

Issue Price× 100 (%)


2.0 + (100 ‒ 100.63)

10100.63 × 100 = × 100 = 1.9248732% ≈ 1.924%2.0 ‒ 0.063

100.63 (Fractions are rounded down)

Formula <3>

Current Yield = Coupon

× 100 (%) Purchase Price

Based on Formula <3>:3.3

× 100 = 2.9783393% ≈ 2.978% (Fractions are rounded down)110.80



(iv) YieldDuringtheHoldingPeriodWith actual bond investments, the bonds in the portfolio are not necessarily held until

the redemption date because of cashing or rolling over. Therefore, profi ts must be evaluated if sold prior to the redemption date.

A representative yet simple measure of the profi t during any holding period is the yield during the holding period. This can be derived by replacing the redemption price with the selling price, and the number of years to maturity with the period of ownership in the above-mentioned simple yield to maturity formula:

An increasing number of institutional investors are investing with the intention of collecting this yield based on the period of ownership.

(Sample Question)Two years after an investor purchased an interest-bearing government bond at

JPY99.80 with an annual coupon of 2.0% and a maturity of 10 years, it rose in price to 101.50, so the investor sold it. What is my yield during the holding period?

(3) BondUnitPriceCalculationIn bond trading, the unit price of the bond (purchase price) must in some cases be derived

from the desired yield:

Formula <4>

Coupon +(Selling Price ‒ Purchase Price)

Yield During Holding Period =Holding Period (years)

× 100 (%)Purchase Price


2.0 + (101.50 ‒ 99.80)2 × 100 = 2.85 × 100 = 2.8557114% ≈ 2.855%99.80 99.80 (Fractions are rounded down)

Formula <5>

Purchase Price =Redemption Price + (Coupon × No. of Years to Maturity)

1 + Yield × No. of Years to Maturity100

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(Sample Question) What must the purchase price be for an interest-bearing government bond with an annual coupon of 2.0%, and 5 years remaining until maturity, if the required simple yield to maturity is 1.4%?

(4) SimpleYieldandCompoundYieldAll of the yield computations so far used the simple yield method.With the simple yield method, the yield is expressed in terms of the ratio of profi ts relative to

the invested principal by simply dividing the total profi ts generated by the invested principal during the period of ownership by the number of years proportional to the holding period.

On the other hand, the compound yield method calculates the fi nal yield on the invested principal if the interest generating the yield is reinvested periodically.

The compound yield method is more detailed and more rational, and as the length of ownership increases, the diff erence between the simple yield method and compound yield method increase accordingly. Since the calculation is more complicated, in Japan, it was only used for some bonds such as discount government bonds, with a number of years to maturity in excess of one year, but currently, it is more widely used.

The following example evaluates the eff ect of reinvesting the interest.There are two bonds, bond A and bond B. Bond A has a coupon of 3.0%, 5 years remaining

until maturity, and a price of JPY92; bond B meanwhile has a coupon of 5.0%, 5 years remaining until maturity and a price of JPY100. The simple yield to maturity for both bonds is the same when the simple yield method is used, computed as follows:

Comparing this to a case in which the same amount (investment principal: JPY920,000) is invested, the receipt of profi ts would be timed as shown in the chart below.

The total profi t for the 5-year period is the same for both (meaning the same with the simple yield method), but bond A generates an annual interest income of JPY30,000 (a redemption gain of JPY80,000 obtained in 5 years), whereas bond B generates an annual income of JPY46,000. There is a diff erence of approximately JPY16,000 in annual interest received between the two.

Bond B would thus be considered more advantageous as an investment if the coupon

Based on Formula <5>:100 + (2.0 × 5) 1 + (0.014 × 5) = 1.07 =102.803738 ≈ JPY102.803 (Fractions are rounded down)

110

3.0 + (100 ‒ 92)

A: 5

× 100 = 5.0%92

5.0 + (100 ‒ 100)

B: 5

× 100 = 5.0%100



reinvestment income obtainable from investing the JPY16,000 is considered.

Chart 2-27 Timing of Earnings Receipts

(5) CalculationExampleforForeign-CurrencyDenominatedInterest-BearingBondsThe calculation method for foreign-currency denominated interest-bearing bonds is as

follows:,

(Sample Question)Compute the yen equivalent amount for the purchase of a U.S. treasury bond (T-bond

with a maturity date of November 15, 2025 with semi-annual interest payments on May 15 and November 15).

Coupon: 9.125%

80,000

30,000 30,000 30,000 30,000 30,000

year 1 year 2 year 3 year 4 year 5

46,000 46,000 46,000 46,000 46,000

year 1 year 2 year 3 year 4 year 5

(Redemption Gain)

Total Profit: JPY230,000

Total Profit: JPY230,000

Bond B: Face value of JPY920,000 is purchased for JPY920,000

Bond A: Face value of JPY1,000,000 is purchased for JPY920,000

Foreign Currency

Accrued Interest

Foreign Currency-denominated Purchase PriceForeign Currency-denominated Contract Price= Foreign Currency Face Value × Unit Price (Rounded to the nearest local currency unit) (1)

Foreign Currency-denominated Purchase Price = (1) + (2)Contract Price Converted into Yen = Foreign Currency-denominated Contract Price × Exchange Rate (Fractions less than one whole yen are rounded down*)

Accrued Interest Converted into Yen = Foreign Currency-denominated Accrued Interest × Exchange Rate (Fractions less than one whole yen are rounded down*)

Purchase Price Converted into Yen = (3) + (4)*In the case of selling by customers, fractions of less than one whole yen are rounded up.

*Please see (6)(ii) below regarding accrued interest.

ForeignCurrency

Face Value= ×

Coupon(Interest Rate)

(Rounded to the nearest local currency unit)

100×

Number of Days Elapsed(According to the market practice)

Number of Days per Year(According to the market practice)

(2)

(3)

(4)

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Face Value: USD1 millionUnit Price: 115-17 (= 115.53125)

* The number after the hyphen is referred to as a “tick,” where a tick means the fraction 1/32. The quotation “115-17,” expressed as a fraction, would thus be “115 17/32,” which in decimal form is “115.53125.”

Exchange Rate: JPY80 (= USD1)Delivery Date: April 14, 2018Days Elapsed: 150 days have elapsed from the last interest payment date.Days in a Year: 181 days × 2 = 362 days (Twice the number of days from the last

interest payment date (November 15) to the next interest payment date (May 15))

Foreign Currency-Denominated Purchase Price　= (i) + (ii) = USD1,155,313 + USD37,811 = USD1,193,124　(iii) Contract Price Converted Into Yen = USD1,155,313 × JPY80 = JPY92,425,040　(iv) Accrued Interest Converted Into Yen = USD37,811 × JPY80 = JPY3,024,880Purchase Price Converted Into Yen　= (iii) + (iv) = JPY92,425,040 + JPY3,024,880 = JPY95,449,920

* Note that the calculation method for the number of days elapsed for foreign-currency denominated interest-bearing bonds other than U.S. government bonds varies according to market practices (including the currency and issue).

(6) BondTradingBusinessPractices(i) Over-the-CounterTransactionsandExchangeTransactions

The secondary market for public and corporate bonds consists broadly of two markets, the over-the-counter market and the securities exchange markets. Share trading is concentrated mostly in the securities exchanges, while one of the major characteristics of the public and corporate bond transactions is that great majority of them are traded in the over-the-counter market. Any kind of bond can be traded in the over-the-counter market, but only listed bonds can be traded on the securities exchanges.

(i) Foreign Currency-Denominated Contract Price

= USD1 million × 115.53125 = USD1,155,313 100

(ii) Foreign Currency Accrued Interest

= USD1 million × ×9.125 150 days

= USD37,811100 362 days



The over-the-counter transactions are dealer transactions (principal transactions), and amounts equivalent to a commission are included in the bond price. There are instances where a separate brokerage commission is collected for transactions on the securities exchange, and such brokerage commission is to be determined independently by each securities fi rm.

(Sample Question)If a long-term government bond with a face value of JPY3 million and bond price

of JPY99 per unit is purchased, what is the total amount necessary (assuming a brokerage commission of JPY4,000 per face value of JPY 1 million, accrued interest of JPY2,000, and consumption tax at 10%)?

(Sample Question)If interest-bearing bonds with a face value of JPY2 million are sold at a bond price

of JPY101 per unit on the exchange, what is the delivery price (assuming a brokerage commission of JPY3,000 per face value of JPY1 million, accrued interest of JPY2,500, and consumption tax at 10%)?

Brokerage Commission = JPY2,000,000 ÷ JPY1,000,000 × JPY3,000 = JPY6,000Consumption Tax = JPY6,000 × 10% = JPY600

(ii) AccruedInterestAttention must be paid to the receipt and payment of accrued interest if interest-bearing

bonds are traded.Interest for most interest-bearing bonds is paid semi-annually on predetermined

payment dates. In other words, the interest is not paid on days other than the interest payment dates. So, a bondholder selling a bond between interest payment dates would not receive interest for the period from the last interest payment date to the date of sale. On the other hand, the bondholder buying the bond mid-period would receive the entire semiannual interest amount on the next interest payment date. In order to resolve this imbalance, the buyer pays to the seller, at the time of sale, the interest that accrued during the period from the day after the last interest payment date to the settlement date when the bond is traded.

As depicted in the chart below, if Mr. A sells an interest-bearing government bond for

Brokerage Commission = JPY3,000,000 ÷ JPY1,000,000 × JPY4,000 = JPY12,000

Consumption Tax = JPY12,000 × 10% = JPY1,200

Delivery Amount = JPY3,000,000 × 99 + JPY2,000 + (JPY12,000 + JPY1,200) 100= JPY2,985,200

Delivery Amount = JPY2,000,000 × 101 + JPY2,500 – (JPY6,000 + JPY600) 100

= JPY2,015,900

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face value JPY1 million with an annual interest rate of 2.0% on August 20, 20XX, Mr. A will receive the 61 days of interest accrued from the day after the last interest payment date, i.e., June 20, 20XX to the delivery (settlement) date (the date on which money is exchanged, not the date on which the trade is contracted), i.e., August 20, 20XX.

On the other hand, Mr. B, who purchased the government bond, must pay the purchase price of the bond plus accrued interest.

The JSDA has established a method for calculating the accrued interest for over-the-counter transactions.

The accrual days are counted from the day after the interest payment date to the delivery date (including only the day at the end of the period).

For example, suppose as set forth above, a trade for long-term government bonds is contracted on August 17, 20XX, where the most recent interest payment date was on June 20, 20XX. If delivery is set for August 20, 20XX, the number of days elapsed would be 61 days, from June 21, 20XX (the day after the most recent interest payment date) until August 20, 20XX (delivery date). Thereafter, the number of elapsed days is computed based on a 365 day year.

Specifi cally, the following formula is used for calculations:

* Previously, a withholding tax of 20% (20.315% on or after January 1, 2013) was deducted except in special cases. However, this treatment has been changed and withholding tax is not deducted for over-the-counter transactions in which the delivery is made on or after the fi rst day of the interest calculation period for the interest in domestic bonds which becomes due on or after January 1, 2016.

In relation to transactions at exchanges, the same calculation method applies to the interest accrued in transactions of interest-bearing bonds, etc. for which the fi rst interest payment date after the settlement date falls on January 1, 2016, or thereafter.

BABond holder

Interest payment

Date June 20, 20XX

Number ofDays Elapsed

(61 days)

Delivery Date

August 20, 20XX

Interest payment

DateDecember 20, 20XX

Formula <6>Accrued Interest (A) = Annual Interest per Face Value (JPY100) ×

Number of Days Elapsed365

(A)Total Face Value of Trade

= Accrued Interest for Total Face Value of Trade ×100



(Note) (A) is rounded down to the seventh decimal place from the eighth decimal place and beyond.

In the example above, Mr. A will receive accrued interest in the amount calculated as follows:

Also, for government bonds that are now subject to the instant reopen (instantaneous issue amalgamation) system, in some cases accrued interest will be generated even for a bond purchased on the issue date (because the fi rst interest payment for issues subject to the instant reopen system is regarded as uniform with all six-month portions regardless of the actual period of time from issuance until interest is paid).

7 2 Discount Bonds

Discount bonds are issued with the interest equivalent amount subtracted from the face value and a promise to redeem the bond at face value upon maturity. In Japan, the practice is to calculate the interest on a discount bond with more than one year to maturity using a compound annual interest rate. Therefore, the yields from a discount bond with one year or less to maturity and a discount bond with more than one year to maturity are calculated separately.

(1) CalculationofYieldsandUnitPricesofDiscountBondsRedeemedWithinOneYearThe simple yield to maturity for a discount bond redeemed within a year is calculated using

the simple yield method. The calculation formula is the same as the formula for the simple yield to maturity using the simple yield method for a coupon bond, but the interest rate is replaced by 0:

The formula for calculating the purchase price from the yield would be as follows:

Accrued Interest per Face Value (JPY100) = 2 × 61 = 0.3342465365

Accrued Interest for Total Face Value (JPY1 million in this case)

= 0.3342465 × JPY1,000,000

= JPY3,342100

Formula <7>

Simple Yield to Maturity (%) = Redemption Price – Purchase Price × 365 × 100Purchase Price Number of Days

not Elapsed

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The number of days that have not elapsed is calculated by including only the day at the end of the period.

(Sample Question)If the payment for a discount bond with one year until maturity is JPY99.30, what is the

yield?

(Sample Question)If a discount bond with a redemption date of January 31, 20XX+1 is purchased on

October 17, 20XX for JPY99.80, what is the simple yield to maturity? (The number of remaining days is: (10/17 - 1/31: counting only the last day) 106 days)

(Sample Question)If a discount bond with a redemption day of February 28, 20XX+1 is purchased on

September 30, 20XX for a yield of 1%, what is the purchase price?(The number of remaining days is: (9/30 - 2/28: counting only the last day) 151 days)

(2) YieldforDiscountBondswithOverOneYeartoMaturityFor the yield on long-term discount bonds with over one year to maturity, a formula based on

the compound yield method is used:

Formula <8>

Purchase Price (yen) = Redemption Price

1 + Annual Yield × No. of days Not Elapsed ÷ 365 100

Based on Formula <7>:100 – 99.30 × 100 = 0.704%99.30

Based on Formula <7>: 100 – 99.80 × 365 × 100 = 0.690%99.80 106

Based on Formula <8>:100 = JPY99.581 + 0.01 × 151 ÷ 365



The formula for calculating the purchase price from the yield would be as follows:

(Note) Calculating the compound yield based on the formula mentioned above is diffi cult to do by hand or with a regular calculator. For practical purposes, a table of yields for bonds based on the compound yield, or a programmed computer, is used.

7 3 Gensaki Transactions

The yield during the holding period for a gensaki transaction is usually calculated using the simple yield method and reinvestment of the interest received during the term is not considered. The calculation methods for gensaki, in principle, are the discount-bond method for bonds traded as discount bonds and the coupon bond method for bonds traded as interest-bearing bonds. Only the discount-bond method is explained here.

(1) ComputingPurchasePriceUsingtheDiscountBondMethod(Kai-Gensaki,Repurchase)Yield during the holding period is computed as follows:

To solve for the purchase price (start price):

Formula <9>

Compound Yield (%) = – 1 × 100Redemption Price

Purchase Price

No. of Yrs.To Mat.

No. of Yrs.

Formula <10>

Purchase Price = Redemption Price

1 + Compound Yield To Mat.

100

Yield During Holding Period (%) =Unit Selling Price – Unit Purchase Price 365

×100×Unit Purchase Price Period (days)

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(Sample Question)What is the unit purchase price (start price) for a gensaki (repo) with an annual rate of

1.00% and a term of 180 days? The trading unit is JPY100.

(2) ComputingUnitSellingPrice(Kai-Gensaki,ReverseRepurchase)

(Sample Question)What is the unit selling price of a government bond purchased for JPY97.80 and settled

in 98 days at an annual rate of 1.00%?

7 4 Convertible-Type Bonds with Share Options

(1) ConversionPriceThe conversion price is the price per share when convertible-type bonds with share options

(hereinafter referred to as “convertible bonds” or “CB” where appropriate) are converted into shares. For example, if the conversion price is JPY1,000, convertible bonds with a face value of

Formula <11>

Unit Purchase Price (yen) = Unit Selling Price

+1Yield During Holding Period Period (days)

001 365×


Unit Purchase Price = 100

= JPY99.50 1 + 1.00 180

100 365×

Formula <12>

Unit Selling Price = Unit Purchase Price ×Yield During Holding Period

100×

Period (days)1 +

365


Unit Selling Price = 97.80 × 1.00 = JPY98.061001 + × 98365



JPY1 million can be converted into1,000 shares in the company.The conversion price is often a price that is a several percentage to several dozen percentage

points more than the closing price of the shares on the day on which the issuance conditions are decided. If the value per share is diluted by the issuance of new shares during the period for requesting the exercise of share options, the conversion price is decreased to protect the rights of the convertible bondholders. Reductions in the conversion price are called “conversion price adjustments.”

The number of shares acquired when convertible bonds are converted to shares is derived with the following formula:

If fractional amounts result from the computation, the amount computed as:

Face Value – Conversion Price × Number of Shares (Portion of Integer)

is paid in cash.** Recently, odd-lot shares of less than one share are not paid in cash but are disregarded.

Whether or not such shares are paid in cash should be confi rmed with prospectus, etc. for each issue.

(Sample Question)If the convertible bonds of Company A (face value: JPY1 million) are converted into

shares at a conversion price of JPY670 (trading unit is 1,000 shares), what is the number of shares that are acquired?

The number of shares acquired is 1,492.Odd-lot shares (0.53 shares) may be disregarded or paid in cash [JPY360 (= 1,000,000

– 670 × 1,492)].

(2) Newly-IssuedBondsandOutstandingBondsNewly-issued convertible bonds are off ered by securities fi rms and basically listed on a

fi nancial instruments exchange on the following business day of the date of issuance.If the market value of convertible bonds is over JPY100, it is called “over par,” and if it is

lower than JPY100, it is called “under par.”

Formula <13>Total Value of the Issue Price of the

Number of Shares Acquired = Bonds Submitted by the Bondholder

Conversion Price

Using Formula <13>:1,000,000 1,492.53 (shares)

670≈

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A brokerage commission is charged when listed and already-issued convertible bonds are traded. Just as with shares and bonds, each securities fi rm is free to independently determine the brokerage commission it will charge.

At the time of sale, any profi ts from the convertible bond sale are taxed. The accrued interest is included in the delivery amount.

(3) PriceofConvertibleBond–ParityValueandPremiumOverParity–(i) DomesticConvertibleBonds

The price of a convertible bond is generally evaluated by its yield as a corporate bond when the share price is signifi cantly lower than the conversion price, however, the market price of convertible bonds parallels movements in the share price when the share price rises closer to the conversion price.

For example, if convertible bonds with a conversion price of JPY1,000 are held with a face value of JPY1 million and the price of shares in the company rises to JPY1,200, the parity value would be JPY120, and the bondholder is deemed to have the shares with value of JPY1.2 million:

However, the actual market price may be more or less than the parity value due to the fact that it is aff ected by the yield on convertible bonds and general trends in interest rates, the share market and the convertible bond market. The diff erence is called “premium over parity.” The higher the positive premium, the higher the convertible bond price is trading relative to the share price (there are cases where the premium over parity is a negative number, and this condition is called “discount to parity”):

(Sample Question)The convertible bonds of company A have an annual coupon of 4% and a

conversion price of JPY500. If the share price of company A becomes JPY700, what is the parity value of the convertible bond issued by company A? What is the premium over parity if the price of the convertible bond issued by company A is JPY150 or JPY135 at the time?

Formula <14>

Parity Value (JPY) = Share Price × 100Conversion price

Formula <15>

Premium Over Parity (%) = Convertible Bond Price – Parity Value

× 100 Parity Value



(ii) ForeignCurrency-DenominatedConvertibleBondsThe following is the calculation method used when investing in convertible bonds

denominated in foreign currencies such as US dollar, Swiss Franc, etc. When the foreign currency-denominated convertible bonds are issued, the conversion price is set and, at the same time, a fi xed exchange rate is determined for use when the bonds are converted to shares:

In other words, the number of shares described above will never change due to fl uctuations in the exchange rate.

The following formula is used to calculate the parity value:

Premium over parity calculations are the same as those for domestic bonds.

(Sample Question)If dollar-denominated convertible bonds of company B have an issue price that is

100% of the face value, an annual coupon of 2.5%, a conversion price of JPY600 and a fixed exchange rate of USD1 = JPY110, what is the parity value if the share price is JPY900 and the current exchange rate is USD1 = JPY100?

500


Parity Value = 700 × 100 = JPY140


Premium over Parity if the Conversion Price is JPY150 = 150 – 140 × 100 7.14%140

Premium over Parity if the Conversion Price is JPY135 = 135 – 140 × 100 – 140

(Discount to Parity)

≈

≈ 3.57%

Number of Shares after Conversion =Conversion Price

Total Value of the Issue Price of the Bonds Submitted by the

Bondholder Fixed Exchange

Rate×

Formula <16>

Parity Value =Share Price × Fixed Exchange Rate

× 100Conversion Price × Current Exchange Rate


900 × 110Parity Value = × 100 = JPY165600 × 100

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Recently, some convertible bonds are converted at a price denominated in foreign currencies rather than JPY, which has been used as the denominated currency.

In these cases, the number of shares after conversion and the parity value are calculated respectively by the following formulas in which the fi xed exchange rate does not apply:

Number of Shares after Conversion =

Total Value of the Issue Price of the Bonds Submitted by the Bondholder (Foreign currency)

Conversion Price (Foreign currency)

Parity Value = Share PriceConversion Price (Foreign currency) × Current Exchange Rate × 100



Chapter 3 Investment Trusts and Investment Corporations Business


Section 1. History of Investment Trusts ∙∙∙∙∙∙∙∙ 2661.1 Postwar Development of Investment Trusts ∙∙∙∙∙∙∙∙ 2661.2 Collapse of the Bubble and the Japanese Big Bang ∙∙∙∙∙∙∙∙ 2671.3 Investment Trusts After the Japanese Big Bang ∙∙∙∙∙∙∙∙ 268

Section 2. Concept of Investment Trusts∙∙∙∙∙∙∙∙ 2702.1 Definition of an Investment Trust ∙∙∙∙∙∙∙∙ 2702.2 Comparison Between Investment Trusts and Bank Deposits ∙∙∙∙∙∙∙∙ 2732.3 Terminology Found in (Contractual Type) Investment Trusts ∙∙∙∙∙∙∙∙ 277

Section 3. Types of Investment Trusts ∙∙∙∙∙∙∙∙ 2783.1 Publicly Offered Investment Trusts and Privately Placed Investment

Trusts ∙∙∙∙∙∙∙∙ 2793.2 Contractual Type (Investment Trust) and Corporate Type (Investment

Corporation) ∙∙∙∙∙∙∙∙ 2803.3 Investment Trusts Under Instructions from the Settlor and Without

Instructions from the Settlor ∙∙∙∙∙∙∙∙ 2813.4 Securities Investment Trusts (Securities Investment Corporations), Real

Estate Investment Trusts (Real Estate Investment Corporations), Investment Trusts Other Than Securities Investment Trusts, and Infrastructure Investment Trusts (Infrastructure Investment Corporations) ∙∙∙∙∙∙∙∙ 283

3.5 Stock Investment Trusts and Bond Investment Trusts ∙∙∙∙∙∙∙∙ 2853.6 Unit-Type (Tan’i Gata) and Additional Offering Type (Tsuika Gata)

∙∙∙∙∙∙∙∙ 2863.7 ETF ∙∙∙∙∙∙∙∙ 2873.8 Foreign Investment Trusts and Foreign Investment Corporations

∙∙∙∙∙∙∙∙ 2883.9 Closed-End Type and Open-End Type ∙∙∙∙∙∙∙∙ 2883.10 Others ∙∙∙∙∙∙∙∙ 2893.11 Product Classification and Classification of Attributes Stated in

Investment Trust Explanatory Document (Prospectus) ∙∙∙∙∙∙∙∙ 2913.12 Monthly-Paid Type, Currency-Selected Type, Leveraged Investment

Trusts, Complex Investment Trusts Similar to OTC Derivatives Transactions, and Knock-in Investment Trusts ∙∙∙∙∙∙∙∙ 293

Section 4. Structure of Securities Investment Trusts ∙∙∙∙∙∙∙∙ 2964.1 Investment Trust Contract ∙∙∙∙∙∙∙∙ 2964.2 Parties Involved in Securities Investment Trusts ∙∙∙∙∙∙∙∙ 299

Section 5. Management of Securities Investment Trusts ∙∙∙∙∙∙∙∙ 3025.1 Organization and Authority of Investment Trust Settlor Company

∙∙∙∙∙∙∙∙ 3025.2 Investing Techniques of Securities Investment Trusts ∙∙∙∙∙∙∙∙ 3055.3 Duties of Investment Trust Settlor Company ∙∙∙∙∙∙∙∙ 3075.4 Investment Targets and Investment Restrictions of Securities

Investment Trusts ∙∙∙∙∙∙∙∙ 3095.5 Transactions in Securities, Etc. in Securities Investment Trusts ∙∙∙∙∙∙∙∙ 3135.6 Execution of Instructions Regarding Voting Rights, Etc. ∙∙∙∙∙∙∙∙ 313

Section 6. Sale of Securities Investment Trusts ∙∙∙∙∙∙∙∙ 3156.1 Proliferation of Investment Trusts, and Basic Approach to Sales ∙∙∙∙∙∙∙∙ 3156.2 Regulations, Etc. Concerning Sales ∙∙∙∙∙∙∙∙ 3156.3 Unit-Type Investment Trusts ∙∙∙∙∙∙∙∙ 3236.4 Additional Offering Type Stock Investment Trusts ∙∙∙∙∙∙∙∙ 3246.5 Additional Offering Type Bond Investment Trusts ∙∙∙∙∙∙∙∙ 3286.6 ETF ∙∙∙∙∙∙∙∙ 3296.7 Handling of Foreign Investment Trusts ∙∙∙∙∙∙∙∙ 330

Section 7. Calculation of Base Value, Closing, Dividends, Cashing Out and Redemption of Securities Investment Trusts ∙∙∙∙∙∙∙∙ 3307.1 Calculation of Base Value ∙∙∙∙∙∙∙∙ 3307.2 Closing ∙∙∙∙∙∙∙∙ 3337.3 Dividends Distribution ∙∙∙∙∙∙∙∙ 3347.4 Cashing Out ∙∙∙∙∙∙∙∙ 3367.5 Redemption ∙∙∙∙∙∙∙∙ 3397.6 Taxation of Dividends, Cashing Out and Redemptions ∙∙∙∙∙∙∙∙ 3417.7 ETF ∙∙∙∙∙∙∙∙ 348

Section 8. Disclosure for Securities Investment Trusts ∙∙∙∙∙∙∙∙ 3498.1 Issuance Disclosure ∙∙∙∙∙∙∙∙ 3498.2 Continuous Disclosure ∙∙∙∙∙∙∙∙ 3518.3 Schedule for Preparation and Updating of Legally Required

Disclosure Materials ∙∙∙∙∙∙∙∙ 3538.4 Timely Disclosure ∙∙∙∙∙∙∙∙ 356

Section 9. Investment Corporations ∙∙∙∙∙∙∙∙ 3579.1 Establishment of Investment Corporations and Offering of

Investment Equity ∙∙∙∙∙∙∙∙ 3589.2 Organs of Investment Corporations ∙∙∙∙∙∙∙∙ 3619.3 Asset Investment of Investment Corporations ∙∙∙∙∙∙∙∙ 3639.4 Sales of Investment Equity of Real Estate Investment Corporations

∙∙∙∙∙∙∙∙ 3679.5 Custody of Assets, Accounting, Etc., Dividends, and Financing of Real

Estate Investment Corporations ∙∙∙∙∙∙∙∙ 3689.6 Disclosure by Real Estate Investment Corporations ∙∙∙∙∙∙∙∙ 373

IntroductionThe Act on Investment Trusts and Investment Corporations (hereinafter the “ITA” or “Act”)

states that its purpose is to contribute to the sound development of the national economy by establishing a system whereby persons other than investors collect investors’ funds and invest them mainly in securities, etc. by using investment trusts or investment corporations, and distribute the results thereof to the investors, and by ensuring appropriate management of funds by means of these vehicles, as well as taking measures to protect the purchaser, etc. of the securities issued under the system, in order to facilitate investors’ investments in securities, etc. (ITA, art. 1).

The ITA provides regulations to promote the sound development of the so-called market-oriented indirect financing mediated by professionals to serve this purpose by setting forth mechanism rules for sound financial products in asset management, thereby ensuring the adequate functioning of the capital market functions.

Abbreviations for laws and regulations used in this Chapter are as follows:

“FIEA”............................ Financial Instruments and Exchange Act (Act No. 25 of 1948)“FIEAEO” ................Order for Enforcement of the Financial Instruments and Exchange

Act (Cabinet Order No. 321 of 1965)“FIBCOO”...................... Cabinet Office Ordinance on Financial Instruments Business,

Etc. (Cabinet Office Ordinance No. 52 of 2007)“ITA”.............................. Act on Investment Trusts and Investment Corporations (Act

No. 198 of 1951)“ITA Enforcement Order”................................. Order for Enforcement of the Act on

Investment Trusts and Investment Corporations (Cabinet Order No. 480 of 2000)

“ITA Enforcement Ordinance”.......................... Ordinance for Enforcement of the Act on Investment Trusts and Investment Corporations (Prime Minister’s Office Ordinance No. 129 of 2000)

“ITCO”........................... Ordinance on Accounting of Investment Corporations (Prime Minister’s Office Ordinance No. 47 of 2006)

“JSDA Investment Solicitation Rules”….Japan Securities Dealers Association, “Rules Concerning Solicitation for Investments and Management of Customers, Etc. by Association Members”

“JSDA Advertising Rules” …. Japan Securities Dealers Association, “Rules Concerning Representation of Advertising, Etc. and Offer of Premiums”

“JSDA Foreign Securities Rules”…. Japan Securities Dealers Association, “Rules Concerning Foreign Securities Transactions”

“JITA Management Regulations”…The Investment Trusts Association, Japan, “Regulations Concerning Management of Investment Trusts, Etc.”

“JITA Detailed Rules for the Management Regulations”… The Investment Trusts Association, Japan, “Detailed Rules for the Regulations

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Introduction

Concerning Management of Investment Trusts, Etc.”“JITA MMF Management Regulations”… The Investment Trusts Association, Japan,

“Regulations Concerning Management of MMF”“JITA Detailed Rules for the Complex Investment Trust Regulations”… The Investment

Trusts Association, Japan, “Detailed Rules for the Regulations Concerning Complex Investment Trusts Similar to OTC Derivatives Transactions”

“JITA Real Estate Investment Corporations Regulations”… The Investment Trusts Association, Japan, “Regulations Concerning Real Estate Investment Trusts and Real Estate Investment Corporations”

“JITA Investment Management Report Regulations” ... The Investment Trusts Association, Japan, “Regulations Concerning Investment Management Reports, Etc. on Investment Trusts and Investment Corporations”

“JIDA Full Members’ Business Regulations”… The Investment Trusts Association, Japan, “Regulations Concerning Conduct of Business, Etc. by Full Members”

“JITA Investment Trust Accounting Regulations”… The Investment Trusts Association, Japan, “Regulations Concerning Evaluation and Accounting, Etc. of Investment Trust Property”

* The Prime Minister is the Minister who has administrative jurisdiction over the ITA. However, since much of this authority is delegated to the Commissioner of the Financial Services Agency (ITA, art. 225), the references in the remainder of this Chapter may be made to the Commissioner of the Financial Services Agency.

1 History of Investment Trusts

1 1 Postwar Development of Investment Trusts

After the end of World War II, the dismantlement of the zaibatsu conglomerates led to progress in the democratization of securities ownership so that they were made more accessible to ordinary citizens. The foundation for formulating real investment trusts that targeted general investors was solidified, and on June 4, 1951, the Securities Investment Trust Act was promulgated and enacted. Even prior to the war, there were a number of investment trusts and collective investment schemes, but the enactment of the Securities Investment Trust Act established these as a system that was secured by a special law.

Based on the enactment of this Securities Investment Trust Act, Japan’s investment trusts

Chapter 3. Investment Trusts and Investment Corporations Business


have basically increased their assets, although there have been various detours and ups and downs. Let us take a simple look back at that history.

After the enactment of the Securities Investment Trust Act, four major securities companies immediately registered as securities investment trust managers, each establishing unit-type investment trusts, and the investment trust system made its start under the new law. The next year, in 1952, additional offering type investment trusts appeared. Although it appeared that investment trusts were developing smoothly, in the following year of 1953, securities companies failed one after another, and in 1954, the Showa 29 Panic occurred. The environment surrounding investment trusts quickly deteriorated with investment trusts seeing a decrease in establishment amounts and an increase in cancellation amounts.

However, in 1956 when the share market revived on the Jinmu economic boom, investment trusts once again began to walk the path of development and became an engine of the share market’s growth. At the same time, voices calling into question the effect of investment trusts on the share market grew strong, and there was increased criticism of concurrent operation of a securities company and a trust company. Consequently, in 1959 the securities companies spun off and made their investment trust companies independent. During this period bond investment trusts also made their start in 1961.

From 1963 to 1964, the share market made weak progress, and finally in 1965 a securities crash occurred. The effect on investment trusts due to the crash was enormous, and the remaining principal of additional offering type stock investment trusts decreased by approximately one third.

While the securities and investment trust industries were turning to implementing reforms in order to regain trust, in October 1967 an amendment of the Securities Investment Trust Act came into force, providing for a fiduciary duty on the part of investment trust settlor companies. The various reforms were effective, and in the latter half of 1969, the number of stock investment trusts which until that time had been decreasing, turned to a net increase.

In 1970, among calls for the internationalization of capital, the inclusion of foreign securities in investment trusts began. Investment trusts overcame the first oil crisis in 1973, and together with stock investment trusts, bond investment trusts also expanded smoothly by riding the tailwind of the massive issuance of government bonds.

In 1980, medium-term government bond funds emerged and were a major hit product, and the competition between banks and securities companies became severe. Against the backdrop of the major expansion of Japan’s economy upon the 1985 Plaza Accord and the major rise in the share market, investment trusts, centered on unit-type investment trusts, also increased their balances, and at the end of 1989 the net asset balance of investment trusts had reached JPY58 trillion.

1 2 Collapse of the Bubble and the Japanese Big Bang

The bursting of the bubble in the 1990s had a profound effect on investment trusts and

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brought about severe investor flight. There was no means of stopping the long-term declining trend in the net asset balance of stock investment trusts from the JPY45 trillion level at the end of 1989, until the end of 1997 when the financial crisis became severe and such balance fell below JPY10 trillion.

Under these circumstances, the MMF (money management fund), which appeared in 1992, underpinned the total balance of investment trusts. It gained popularity for its convenience, attractive yield, and stable operation, and was an explosive hit product, exceeding JPY5 trillion in net assets eight months after establishment.

In 1994, having learned from the investor flight from stock investment trusts, the investment trust industry worked out thorough reforms focused on relaxing investment rules such as removing the ban on derivatives, improving disclosure, setting up performance evaluations in order to promote competition among settlor companies, and developing fair trade rules for improving the transparency of operations and sale.

While on the one hand this reform on the part of the investment trust industry went forward, the government also furthered efforts to counter the prolonged recession in the Japanese economy and the decline in the international competitiveness of the Japanese financial and securities markets, as well as to rejuvenate Japan’s financial capital markets. In 1998, the Financial System Reform Act was enacted and the so-called Japanese Big Bang was born. In this movement, investment trusts were positioned as the core channel for the more than JPY1,200 trillion (at that time) of personal financial assets in Japan to reach the market. The reform measures implemented in the Japanese Big Bang include the lifting of the ban on the handling of sale of investment trusts by financial institutions such as banks (sales at teller windows), which had been almost monopolized by securities companies.

1 3 Investment Trusts After the Japanese Big Bang

The 2000 amendments to the ITA expanded the scope of eligible investment targets to include real estate, etc. and made it possible to establish real estate investment corporations (J-REIT). In September 2001, the first J-REIT was listed on the Tokyo Stock Exchange. With the trend of protracted super-low interest rate, products whose nature aims to secure stable profitability became popular. Real estate investment corporations were newly established and listed in succession, thus showing solid growth.

The net asset balance of publicly offered securities investment trusts reached JPY58 trillion at the end of 1989, but after that it was unable to break this record due to the after-effects of the bursting of the bubble economy. However, with the expansion of MMFs as the engine, driven by the low interest rate environment and combined with the recovery of stock investment trusts that had at last emerged from the worst period after 1998, the net asset balance of publicly offered securities investment trusts exceeded the said record in June 2000 and reached JPY60 trillion.

Nevertheless, in addition to a rush of MMF cancellations due to the effect of some MMFs,



which included bonds from the U.S. company Enron which failed in 2001, having declined below the principal invested, the balances of bond investment trusts remained low due to the protracted super-low interest rate policy. Moreover, the downward trend of the domestic share market grew in strength following the collapse of the IT bubble which peaked in 2000, and the balances of publicly offered securities investment trusts did not experience growth either, following their peak in June 2000.

Thereafter, from around 2003, because of the comparison with domestic interest rates, balances in stock investment trusts have started to increase mainly in funds investing in foreign bonds. This movement was driven by the financial institutions such as banks, which could newly join in the sale of investment trusts due to the Japanese Big Bang. The financial institutions, in addition to the funds that included foreign bonds, focused on funds that invest in multiple assets such as domestic and foreign shares, bonds, and REITs, etc. and raised the balance of funds that they handled, and in August 2005 the banks’ net asset balance of publicly offered stock investment trusts classified by selling method exceeded 50%. It was the seventh year after the lifting of the ban on investment trust window sales. Furthermore, along with the increase in teller window sales, the percentage of monthly-closed and monthly-paid funds started to rise.

With this background, the balance of publicly offered stock investment trusts exceeded the bubble period peak of the end of 1989 in June of 2006, and the balance of all publicly offered securities investment trusts exceeded the peak for the June 2000 period in August of 2006. Thereafter the balance of publicly offered securities investment trusts reached JPY82 trillion in October 2007, supported by solid performance on the part of domestic and foreign denominated assets as a result of, for example, an increase in share prices on foreign and domestic share markets as well as a stable trend in the value of the yen.

This trend was upended by the global disruptions in the financial markets which occurred from around 2007, particularly in Europe and the U.S., that were sparked by the problem of delinquencies in subprime loans in the U.S. Funds seeking to avoid the confusion in the U.S. and Europe have flowed into Japan, driving up the value of the yen, while investment trusts that had invested in foreign currency denominated assets faced declines in their net assets. The impact of the failure of the U.S. securities firm Lehman Brothers in September 2008 has led to sharp declines in the share market worldwide.

With these changes the net assets in publicly offered securities investment trusts fell as of the end of January 2009 to a level that was below JPY50 trillion, which was 40 percent less than their peak. Thereafter, the financial markets calmed down again and the net assets in publicly offered securities investment trusts started to increase again, driven by currency-selected funds, and funds investing in REITs in the United States and other countries in the world. At the end of June 2014, the net assets surpassed the pre-Lehman peak and reached JPY116 trillion as of the end of September 2019.

In February 2016, following the action taken by the European Central Bank (ECB) in June 2014, the Bank of Japan introduced the negative interest rate policy. With the impact of this new policy spreading from short-term interest rates to long-term interest rates, early redemption of short-term financial instruments such as money management funds (MMF) were announced and

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implemented. In the age of super-low interest rates, there are schemes to promote the shift from savings to investment and support households in stable asset building. Specifically, tax exemption programs referred to as Nippon Individual Savings Account (NISA) have been introduced for small-amount investments (“general-type NISA”), investments by minors (“Junior NISA”), and installment investments (“Dollar-Cost Averaging NISA”). Under such circumstances, investment trusts are expected to play an increasingly prominent role.

2 Concept of Investment Trusts

2 1 Definition of an Investment Trust

(1) Essential Nature of the Investment Trust SystemThe essence of the investment trust system is found in a structure that aggregates capital

from multiple investors and is managed and administered by third party specialists. This type of structure is called a “Collective Investment Scheme.” The significance of the existence of collective investment schemes can be said to be found in their fulfilling the function of carrying out financial intermediation in order to invest private funds in the national economy and their contribution to the formation of household and corporate financial assets as well as the invigoration of financial and capital markets.

(2) Features of Investment Trusts(i) DiversifiedInvestmentIsPossiblewithaSmallAmountofFunds

It is a well-known fact that diversifying investments across a broad range of assets is less risky than investing in a single or small number of assets. However, for a single investor to be able to sufficiently diversify his/her investments, he/she would need a large amount of capital. Since investment trusts pool funds contributed by a large number of investors to form a fund (kikin), it becomes possible to enjoy the benefits of diversified investments even with a small investment amount.(ii) ProfessionalManagement

Accurate investment with analysis of general economic conditions, interest rates and companies requires a high degree of sophistication. Not only would it be difficult for individual investors to conduct this kind of analysis, but also they are forbidden from investing in certain assets, such as derivative financial instruments, etc. Investment trusts provide a scheme whereby general investors can benefit from professional investment management to which they would not otherwise have access.(iii) SuitableInvestorProtection

A fiduciary duty and a duty of care of a prudent manager (Note) are imposed on



asset management companies that manage investment trusts, and under the Financial Instruments and Exchange Act (FIEA), investment trusts must be subject to the government administrative supervision.

Also, investment trusts are obligated to make disclosures, etc. to investors through statutory documents including investment trust explanatory documents (prospectuses) and investment management reports as well as timely disclosures required under the regulations of the Investment Trusts Association, Japan, and it can be said that investment trusts are financial instruments that are based on a legal system that requires appropriate investor protections.(iv) AssistanceinChannelingFundstotheMarket

Investment trusts do not allow investors to invest directly in risk assets, such as shares or real estate, but rather, investment trusts are the core product in the so-called market-oriented indirect finance, under which financial service providers offer a broad range of products to investors.

Investment trusts can be said to perform a vital role in the national economy in “deepening the stratum of market participants, and thereby endeavoring to improve the efficient allocation of risk and the capacity to bear risk.”

(Note) For the fiduciary duty and the duty of care of a prudent manager, see 5-3 “(1) Fiduciary Duty, Duty of Care of a Prudent Manager.”

(3) MajorCostsThe major costs for investment trusts to be borne directly or indirectly by investors are listed

below.

Name of Costs WhenAccrued Description of Costs

Salescommissions

Uponpurchase

Cost to be paid to the distributor when purchasing an investment trust. Generally, such cost is a few percent of the offer price. There are cases where no sales commissions are required (no-load investment). The amount of sales commissions is determined by each distributor.

Management fee (trust fee)

While holding the trust

A fee for carrying out the investment and management of the investment trust property, which is to be received by the investment trust settlor company and the trustee company from the investment trust property.

The management fee (trust fee) is specified in the basic terms and conditions of an investment trust, and it is calculated at a fixed rate on a per diem basis and is deducted daily from the investment trust property.

Investment trust settlor companies pay part of their own fees to the distributors as commissions for acting as the investment trust settlor company’s agent in carrying out administrative work such as the distribution of profits and the payment of cancellation money (administrative agent commission).

In the case of a “fund of funds,” which is a fund that incorporates another fund (Note), the management fee accrues in relation to the underlying fund as well.

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Name of Costs WhenAccrued Description of Costs

LoadUpon cashing out and/or purchase

Where additional establishments are carried out in a fund or where there is a request to cash out, the fund will purchase assets that correspond to the additional funds or will comply with the investor’s request to cash out by selling the held assets. In addition to the costs generated by such transactions, where the liquidity of the included target assets is low, such transactions have an impact on the market and it is possible that the fund will end up bearing a large risk. In this type of fund, in order to maintain the fairness of the cost and risk burden between investors who have purchased additional establishments and beneficiaries who already hold the fund or between investors who cease being beneficiaries due to cashing out and the beneficiaries who continue to hold the fund, upon additional establishments or cashing out, the fund will use a system of collecting a load that is added to the trust assets, in which an additional sum is collected at the time of additional establishment or cashing out or to reduce the amount discharged from the fund.

Sales brokerage commission and expenses for futures trading or options trading

Upon sale andpurchase of shares, etc.

Expenses arising from futures or options trading upon selling or purchasing shares and bonds in which an investment trust invests. They are collected indirectly whenever accrued, and because it is an expense arising as a result of investment by the investment trust, the specific amount due cannot be presented in advance.

Audit fee, expenses for keeping assets in custody abroad, and other expenses

While holding the trust

A fee payable to a certified public accountant for an audit of a fund, and expenses arising from keeping assets in custody or trading them abroad (custody fee). Other expenses include expenses for establishing an underlying fund in the case of a fund of funds. (Note) The specific amount due cannot be presented in advance because actual costs will be deducted.

(Note) For details of a fund of funds, see 3-10 “(2) Fund of Funds.”

(4) TheTerms“InvestmentTrust”and“Fund”Although an investment trust is sometimes called a “fund,” there are cases in which the word

“fund” is used to refer to asset management type collective investment schemes in general.In principle, in this Chapter, the term “investment trust” or “fund” is used to refer to a

financial instrument that is set up and sold under the ITA. Nevertheless, caution is necessary because there are also “funds” that are not investment trusts.

Further, although the term “investment trust” was applied because under Japanese laws the investment trust system started by using trusts, i.e., a structure where a fund (kikin) is established based on a contract to have assets administered and managed by another person (trust), under the present ITA, the trust forms for contractual type investment trusts (Note) (i.e., investment trust) and corporate type investment trusts (i.e. investment corporations) coexist.

(Note) The law classifies contractual type investment trusts into those managed under instructions from the settlor and those managed without instructions from the settlor. For details, see “3-2 Contractual Type (Investment Trust) and Corporate Type



(Investment Corporation)” and “3-3 Investment Trusts Under Instructions from the Settlor and Without Instructions from the Settlor.”

2 2 Comparison Between Investment Trusts and Bank Deposits

In order to deepen our understanding of investment trusts, let us try to compare investment trusts with bank deposits (please be aware that this describes the most typical type of investment trusts in Japan; that is, the contractual type investment trusts under instructions from the settlor).

(1) CommonFunctionsasFinancialIntermediaryBroadly speaking, both bank deposits and investment trusts are one type of “financial

instrument,” and they are similar in that they possess financial intermediation functions, i.e., collecting funds and supplying such funds to entities that require funds, such as companies. Also, for both of them, individuals are in most cases the target from which funds are collected and companies are in most cases the entities that are supplied with such funds.

In this way, while there is no difference in the essential nature of the financial intermediation function, the method of intermediation differs. In the case of bank deposits the method of collecting funds takes the form of depositors making deposits with the bank, while in the case of investment trusts, collection takes the form of investors purchasing a share of rights concerning the investment trust property. Also, as for method of supplying funds, banks make loans to companies, while investment trusts supply funds by purchasing shares and bonds that are issued by companies.

(2) DifferencesinAccountsinWhichCollectedFundsArePlacedIn the case of an investment trust, the funds collected from depositors and investors only pass

through the distributor, such as a securities company or bank that is the liaison, and are maintained at the trust bank in segregated custody from the trust bank’s own assets, as opposed to a bank deposit where it is the liability of the bank at which the deposit is made.

For this reason, if a bank were to fail, there would be cases in which the bank deposits would not be preserved, while in the case of an investment trust, the structure which has been implemented would protect the assets even if the distributor, asset management company or the trust bank were to fail.

(3) DifferencesinAttributionofProfitsandLossesAs we saw in (2) above, in the case of bank deposits, the funds collected from depositors are

placed in the bank’s own account and then lent to businesses, etc. Regardless of the amount of interest obtained from lending or the amount of losses suffered due to bad loans, depositors

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receive their principal and the interest that was stipulated in advance. Even if the profit from the loans is higher than the interest received by depositors, the depositors cannot receive an amount of money that is greater than the interest, and even if the bank suffers a loss, so long as the bank does not fail, the principal and interest are guaranteed. The bank bears the risk for the funds loaned by the bank.

In contrast, the trust assets in an investment trust are in segregated custody and all profits and losses in the invested assets such as shares and bonds are attributed to the investors. Investors who purchase the investment trust bear the risks concerned with the funds being managed by the investment trust.

Because the assets invested in may fluctuate in price, the principal is not guaranteed. Thus, as with shares, the investment trust itself also fluctuates in price. The price of an investment trust is referred to as the “base value.” In the case of an investment trust, because the collected funds are in segregated custody, it is possible to calculate the total net asset value at the current point in time, which is the current value of the trust assets resulting from investments in shares and bonds, etc. The base value is the value (often expressed as the value per ten thousand units) that results from dividing the total net asset value by the number of shares of the collected funds (referred to as “number of units of beneficial interests”). In principle, the base value is calculated on a daily basis. When investors purchase and redeem an investment trust, it is done at this base value, in principle.

In investment trusts, there exists a price (market value) called the base value that does not exist in bank deposits. It is particularly necessary to fully understand this point in cases where investment trusts are sold by financial institutions, etc. which sell financial instruments with a guaranteed principal such as deposits.

Also, investment trusts have dividends, and this is different in character from interest on a bank deposit. (Note 1)

Dividends are paid to investors from one part of the segregated custody trust assets. Because the trust assets will be reduced precisely by the amount of dividends paid to investors, the base value falls by the amount of dividends paid (“dividend drop”).

In the case of bank deposits, the principal is fixed, the interest rate is expressed as a rate for a fixed amount of principal, and the profit obtained by the depositor can be calculated by only using the interest rate, but in the case of an investment trust, to calculate the profit obtained by the investment trust investor, it is necessary to take into consideration both the amount of dividends and fluctuations in the base value. (Note 2) Because the base value is always fluctuating, the dividend level does not represent the investment trust’s earning rate during the relevant term, and it is therefore not possible simply to compare interest (rate) and dividends (dividend rate).

For example, dividends may sometimes be paid beyond the amount of earnings generated during the term. In such case, the base value as of the closing date of the current term would be lower than that as of the closing date of the previous term (for details, see Chart 3-1).



(Notes) 1. For the regulations concerning the explanation on dividends that must be provided to customers when selling investment trusts, please check the description provided later (for details, see 6-2, “(4) Explanation on Expenses Payable by Customers and Dividends, and Measures to Confirm Customers’ Understanding of Currency-Selected Investment Trusts”).

2. Let us assume the following three cases.

Base value as of the end of the previous term Dividend Base value after the

dividend dropCase A JPY10,500 JPY100 JPY10,550Case B JPY10,500 JPY100 JPY10,450Case C JPY10,500 JPY100 JPY10,300

Among the three cases, while the base value as of the end of the previous term and the amount of dividend for the current term are the same, their profit and loss during the term differ as follows

Case A: Dividend [JPY100] + Change in basic value [JPY50] = Profit and loss [JPY150]

Case B: Dividend [JPY100] + Change in basic value [ −JPY50] = Profit and loss [JPY50]

Case C: Dividend [JPY100] + Change in basic value [ −JPY200] = Profit and loss [ −JPY100]

Thus, the profit and loss from an investment trust should be considered by taking into account the change in basic value in addition to the amount of dividend received.

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Chart 3-1 Points to Consider Regarding Dividends

(4) InvestmentTrustsHavingCombinedCharacteristicsofDirectFinanceandIndirectFinanceBank deposits, etc. are called “indirect finance” in the sense that the collected capital is

finance which is provided to businesses through the filter of bank accounts. On the other hand, the provision of capital to businesses, etc. through investors purchasing shares and bonds in the market (securities companies are only “liaisons”) is called “direct finance.” In the case of investment trusts, although the financing passes through the filter that is the management of the trust assets by specialists, the investors’ profit and loss is decided by the price set by the market.

(Notes) The amount available for distribution consists of: (1) dividends and other earnings minus the relevant expenses, (2) trading gains, including appraisal gains, minus the relevant expenses, (3) reserves for dividends, and (4) earning adjustments money.

Dividends are paid from the amount available for distribution in accordance with the distribution policy.

* Please note that this figure is a conceptual diagram and does not suggest the actual amount of dividends or base value.

JPY450 ((3)+(4))

The dividends which are paid may sometimes exceed the amount of earnings (dividends, other earnings and trading gains, including appraisal gains, minus the relevant expenses) generated during the accounting period. In such a case, the base value as of the closing date of the current period would be lower than that as of the closing date of the previous period.The amount of dividends does not always indicate the rate of earnings of the fund during the accounting period.

Where the base value increased from the level as of the closing date of the previous term

Closing date of the current periodBefore distribution*Reduction of JPY80

Closing date ofthe current periodAfter distribution

Unlike the interest accrued on savings and deposits, dividends from an investment trust are paid from the net assets of the investment trust. Therefore, if any amount is paid as dividends, the base value will decrease by the amount paid.

Conceptual diagram of payment of dividends

from an investment trust. Net assets of theinvestment trust

Dividends

Case where dividends are paid beyond the amount of earnings during the term

*Amount available for distribution JPY500

Earnings during the period

JPY50 ((1)+(2))

JPY50

JPY500 ((3)+(4))

Closing date of the current period Before distribution*Reduction of JPY50

Closing date of the current period After distribution

Where the base value decreased from the levelas of the closing date of the previous term


Dividends and other earnings

JPY20 (1)

Closing date of the previous term

Closing date of the previous term

JPY10,500

JPY10,550

JPY10,450

Dividends JPY100

JPY10,500

JPY500 ((3)+(4))

JPY80

JPY10,400

JPY420 ((3)+(4))

JPY10,300

Dividends JPY100





Thus, investment trusts are sometimes called “market-oriented indirect finance.”In the case of bank deposits that are indirect finance, because the act of depositing money can

be viewed as entering into a contract with the bank for payment of the principal and interest, the risk to which depositors must pay attention is the bank defaulting on that contract, i.e., it comes down to the issue of the bank’s credit risk. However, no matter how much profit the bank receives from its lending, this is solely the bank’s profit, and only the fixed interest is paid to depositors.

In the case of investment trusts that are market oriented indirect finance, however, the profit and loss from the fund management is attributed to the investors, and consequently, the risk that investment trust investors must pay attention to covers a wide range such as the price fluctuation risk and credit risk of the shares and bonds, etc. in which the trust assets are invested (for details, see 6-2 “(3) Duty to Explain Under the Financial Instruments Sales Act”). For this reason, in order to make it possible for the investor to be responsible for making his or her own investment decisions, the law requires detailed disclosures such as the investment trust explanatory document (prospectus) (Note) and investment management reports (for details, see “8. Disclosure for Securities Investment Trusts”).

When selling investment trusts, it is necessary to have prospective purchasers of investment trust products fully understand what kinds of risks are involved.

(Note) Although the document is legally referred to as “prospectus,” it is permitted to use an alternative name that may be easy for investors to understand (the FSA Guidelines for Disclosure of Corporate Affairs, 13-5) Accordingly, the Investment Trusts Association, Japan, designates the term “investment trust explanatory document” as such alternative name under the Regulations for Preparing Prospectuses Delivered Without Request. There are two types of prospectuses due to differences in the legal functions of prospectuses, namely, the “investment trust explanatory document (prospectus delivered without request)” and the “investment trust explanatory document (prospectus delivered upon request).”

2 3 Terminology Found in (Contractual Type) Investment Trusts

As under Japanese laws the investment trust system started in the form of a trust, i.e., a structure where a fund (kikin) is established based on a contract to have assets administered and managed by another person (trust), such trust law terminology has become part of the operational terminology for investment trusts under the ITA.

The asset management company of an investment trust under instructions from the settlor is called the “investment trust settlor company (settlor of an investment trust)” because it has a role as the trust’s settlor in the investment trust contract that is entered into with the trust bank.

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Also, under the ITA, investors that purchase and hold rights in an investment trust are called beneficiaries, while the certificate that identifies the investor’s share is called the beneficiary certificate (Note), and the rights that correspond to that share are called beneficial interests.

When an investor purchases an investment trust, the creation of an investment trust is carried out. This creation would include instances of an initial creation that establishes a trust based on an entirely new investor trust contract and an additional creation that adds trust money based on an investment trust contract that has already been concluded.

Conversely, among the methods available for an investor (beneficiary) to cash out an investment trust (for details, see “7-4 Cashing Out”), there is a redemption request to demand cancellation of part of the trust and a repurchase request by which the beneficiary certificate is repurchased by the distributor.

The remuneration (expense from the standpoint of an investor (beneficiary)) that the investment trust settlor company, distributor, and the trust bank, etc. receive for operating the investment trust is called management fees (trust fees). Aside from management fees (trust fees), it is necessary to be aware that the distributor often levies an offering (sales) commission on investors as compensation for selling the investment trust (there are also cases in which there is no offering commission).

(Note) Excluding certain funds such as mother funds (for details, see 3-10 “(1) Mother Funds”), contractual type investment trust beneficiary certificates have been made paperless (no certificate) from January 4, 2007 (January 2008 for listed investment trusts), and the creation, cancellation, and transfer of beneficial interests have been switched to a system of being performed by records kept in a computer system based account (book-entry transfer account). Nevertheless, beneficiary certificates that were obtained prior to the changeover in the system and that are held in hand by investors continue to be effective.

3 Types of Investment Trusts

Chart 3-2 is an overall picture of domestically registered investment trusts as of the end of September 2019 (additionally, there are also investments trusts that have been established abroad and sold in Japan (“foreign investment trusts”). There are numerous investment trusts in existence: slightly more than 12,000 in number and about JPY224 trillion in net assets.

Based upon the classification in Chart 3-2 below, let us look at the types of existing investment trusts.



Chart 3-2 Overall Picture of Investment Trusts (as of the end of September 2019)

3 1 Publicly Offered Investment Trusts and Privately Placed Investment Trusts

Investment trusts are generally targeted towards a large number of unspecified investors, but there are also investment trusts which are limited to certain investors (e.g., major institutional investors such as pension funds). The former are called publicly offered investment trusts, with the latter being referred to as privately placed investment trusts. “Public offering” and “private placement” are defined below.

(i) PublicOfferingUnder the ITA, a public offering is the solicitation of application for acquisition (including

those specified by Cabinet Office Ordinance as equivalent thereto) of newly issued beneficiary certificates made to many (fifty or more; ITA Enforcement Order, art. 7, para. 1) persons (ITA, art. 2, para. 8); provided, however, private placement with qualified institutional investor, etc. explained below is excluded. This is a concept equivalent to the “public offering of securities” under the FIEA.

Publicly offered investment trusts are subject to the information disclosure system under the FIEA (FIEA, art. 4 and below) and under certain investment restrictions (FIBCOO, art. 130, para. 1, items 8 and 8-2, and para. 2).

* Data for Real Estate Investment Corporations and Infrastructure Investment Corporations are as of the end of August 2019

Unit: million yenNumbers in parentheses are the number of trusts.

Investment TrustsTotal

224,208,229 (12,729)

Publicly Offered Investment Trusts 126,273,149 (6,120)

Privately Placed Investment Trusts97,935,080 (6,609)

Contractual Type Investment Trusts

116,207,632 (6,051)

Securities Investment Trusts

116,207,632 (6,051)

Investment Trusts Other Than Securities

Investment Trusts0 (0)

Securities Investment

Corp.0 (0)


Trusts

Investment Trusts Other

Than Securities

Investment Trusts

Stock Investment Trusts

104,258,740 (5,951)

Bond Investment Trusts

11,948,892 (100)

Cash Trust Beneficial Interests

Investment0 (0)

Investment Trusts Managed

Without Instructions

from the Settlor0 (0)

Stock Investment

Trusts92,041,008

(5,596)

Bond Investment

Trusts3,877,115

(979)

Unit-type Investment

Trusts795,922 (200)

Additional Offering Type

Investment Trusts

103,462,817(5,751)

Unit-type Investment

Trusts3,770 (12)

Additional Offering Type

Investment Trusts

11,945,122(88)

ETF39,911,885

(195)

Others63,550,933

(5,556)

MRF11,298,031

(12)

MMF0

(0)

Others647,092

(76)

Real Estate Investment

Corp.(*) Corp.(*)9,998,363 (63) 67,154 (6)


Corp.0 (0)

Real Estate Investment Corp. (*)

2,016,957 (34)

Investment Corp.10,065,517 (69)

Contractual Type Investment Trusts95,918,123 (6,575)

Investment Corp.2,016,957 (34)

InfrastructureInvestment

95,918,123(6,575)

(Source: Investment Trusts Association, Japan)

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Section 3. Types of Investment Trusts


(ii) PrivatePlacementwithQualifiedInstitutionalInvestors,Etc.Private placement with qualified institutional investors, etc. refers to the offering of

investment trust beneficiary certificates to professionals and are categorized into two types: solicitation of application for acquisition of newly issued beneficiary certificates to qualified institutional investors only (ITA, art. 2, para. 9, item 1) and solicitation of application for acquisition of newly issued beneficiary certificates to professional investors only (ITA, art. 2, para. 9, item 2).

Qualified institutional investors (FIEA, art. 2, para. 3, item 1) and professional investors (FIEA, art. 2, para. 31, art. 34-3, para. 4 and para. 6, etc.) are based on the concepts of the FIEA).

(iii) PrivatePlacementwithGeneralInvestorsSolicitation of application for acquisition of newly issued beneficiary certificates that do not

fall under any of (i) and (ii) are referred to as private placement with general investors (ITA, art. 2, para. 10).

Privately placed investment trusts are also established under the ITA, and their management is governed by regulations such as the Fair Trade Rules. However, privately placed investment trusts tend to have more “tailor made” features, and therefore, privately placed investment funds are not required to deliver prospectuses during the subscription period or have their books audited by a certified public accountant, etc. as is required for publicly offered investment trusts, and these differences show the more relaxed regulation of management and disclosure for privately placed investment funds than for publicly offered investment trusts.

3 2 Contractual Type (Investment Trust) and Corporate Type (Investment Corporation)

This classification is based on the difference in the statutory scheme that applies to the funds contributed by investors.

In a contractual type investment trust, the fund is established in the form of trust property pursuant to an investment trust contract entered into by the settlor (investment trust settlor company) and trustee (trust bank), and investors acquire the beneficial interests in the said trust. In contrast, a corporate type investment trust is established as a corporation for the purpose of managing the corporate assets, and investors acquire the securities issued by that corporation.

One can list the major differences between contractual type investment trusts and corporate type investment trusts as follows:

(1) JuridicalPersonalityIn the case of a contractual type investment trust, the trust property itself does not have a

juridical personality; however, in a corporate type investment trust, the asset management is undertaken by an investment corporation having a juridical personality.



(2) OrganizationContractual type investment trusts are governed by the investment trust contract entered into

by the settlor and the trustee, which sets forth the rights and obligations of the parties to the transaction; namely, the settlor, the trustee, and the beneficiaries. In contrast, corporate type investment trust structures are organized to correspond to the organization of a joint stock company.

Under the Japanese ITA, the terminology corresponding to the organization of a joint stock company is provided for as follows:

Company = Investment corporation, Shareholder = Investor, Shareholders meeting = Investors meeting, Articles of incorporation = Certificate of Incorporation, Share certificates = Investment securities, Shares = Investment equity, and Bonds = Investment corporation bonds

(3) InvestmentsUnder the ITA, there are no differences in the types of permitted investments for contractual

type and corporate type investment trusts. Nevertheless, because of the historical background whereby investment trusts mainly investing in securities have been created as contractual type investment trusts since the enactment of the “Securities Investment Trust Act” in 1951, while real estate investment trusts only became permitted with the amendment of the ITA in 2000, in most cases securities investment trusts take the form of a (contractual) investment trust, while real estate investment trusts take the form of an investment corporation (corporate type), as shown in Chart 3-2.

3 3 Investment Trusts Under Instructions from the Settlor and Without Instructions from the Settlor

Contractual type investment trusts are classified by law into investment trusts under instructions from the settlor and investment trusts without instructions from the settlor, based on the roles played by the parties that manage the investment trust. The investment trust without instructions from the settlor is a new form that was born from the 2000 revision of the ITA, but by the end of September 2019, there were no longer any balances in these trusts.

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Investment trust under instructions from the settlor

Investment trust without instructions from the settlor

Definition

The settlor gives instructions on investment to the trustee based on the trust contract entered into between the settlor and the trustee, and the beneficiaries acquire the divided beneficial interests in the trust (ITA, art. 2, para. 1)

The trustee concludes a trust contract with one or more settlors under a single set of basic terms and conditions of a trust, and manages the assets without relying on the instructions of the settlors (ITA, art. 2, para. 2)

Beneficiary Investor

Settlor Asset management company(investment trust settlor company) Investor (settlor and beneficiary)

Trustee Trust company, etc. (meaning a trust company or a financial institution engaged in the trust business)

Managed by Asset management company(investment trust settlor company)

Trust company, etc. (manager and trustee)

Distributor Financial instruments business operator, financial institution, etc.

Chart 3-3Structure of Investment Trust Under Instructions from the Settlor (Contractual Type)

Investor (Beneficiary)

Subscription payments

Dividend, redemption payments

Distributor(Financial Instruments

Business Operator, Financial Institution, Etc.)



Domestic/ Foreign Shares/

BondsInvestment

Earnings

Trust Bank (Trustee) Investment

instructions

Asset Management Company

(Investment Trust Settlor Company,

Settlor)

Conclusion of investment trust contract



Chart 3-4 Structure of Investment Trusts Without Instructions From the Settlor

3 4Securities Investment Trusts (Securities Investment Corporations), Real Estate Investment Trusts (Real Estate Investment Corporations), Investment Trusts Other Than Securities Investment Trusts, and Infrastructure Investment Trusts (Infrastructure Investment Corporations)

The principal targets of investment for investment trusts and investment corporations set forth in the ITA (specified assets) are listed in Article 3 of the ITA Enforcement Order, and can be categorized into five types of assets in accordance with the nature of the assets as follows:

(i) Securities and rights pertaining to securities-related derivatives transactions*;(ii) Real estate, rights associated with real estate and real estate-associated

products;(iii) Monetary claims, promissory notes, and interests in silent partnership, all of

which do not fall under the category of securities, and rights pertaining to derivatives transactions other than securities-related derivatives transactions*;

(iv) Commodities and rights relating to commodity investment transactions, etc.; and

(v) Infrastructure equipment (renewable energy power generation facilities, rights to operate public facilities, etc.).

* “Securities” shall exclude rights deemed as securities pursuant to Article 2, Paragraph 2 of the FIEA and listed in the items of the said Paragraph, and “securities-related derivatives transactions” shall mean securities-related derivatives transactions for securities other than such rights.

Among these five types, classification as a securities investment trust (securities investment corporation), real estate investment trust (real estate investment corporation), investment trust other than securities investment trust, or infrastructure investment trust (infrastructure investment corporation) depends on what the principal target of investment is.



Conclusion of investment trust

contract

Investment

Earnings



Investor (Settlor and Beneficiary)

Monetary Trust Beneficial

Interests, Etc.

Trust Company, Etc. (Trustee)

Distributor (Financial Instruments Business Operator, Financial

Institution, Etc.)

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(1) SecuritiesInvestmentTrust(SecuritiesInvestmentCorporation)The ITA defines a “securities investment trust” as an investment trust under instructions from

the settlor whose purpose is principally to make the investments (of an amount exceeding half of the total amount of investment trust property) as set out in (i) above (ITA, art. 2, para. 4). Also, the Investment Trusts Association, Japan, in the same manner as with a securities investment trust, defines a “securities investment corporation” as an investment corporation that invests an amount exceeding half of the total amount of the investment corporation’s assets in the investments set out in (i) above (JITA Management Regulations, art. 3 and art. 25). No investment trust without instructions from the settlor may be created for the principal purpose of investing in (i) above (ITA, art. 48).

With the exception of securities investment trusts, trusts including a declaration of trust that is to be created for the purpose of investing in securities are, in principle, prohibited (ITA, art. 7); however, trusts other than trusts that issue beneficiary certificates (Trust Act, art. 185) and that are not created for the purpose of dividing up beneficiary interest and having multiple persons acquire the same are permitted. This is to prevent unethical business operators from creating financial instruments similar to securities investment trusts, causing damages to investors and thereby distorting fair price formation in the capital market.

(2) RealEstateInvestmentTrusts(RealEstateInvestmentCorporations)Investment trusts or investment corporations that invest their assets principally in the

investments stated in (ii) above are called real estate investment trusts and real estate investment corporations (JITA Real Estate Investment Corporations Regulations, art. 3, para. 1).

While it is possible under the ITA to organize in the form of either an investment trust under or without instructions from the settlor (contractual type), as indicated in Chart 3-2, as of the end of August 2019 there are none in the form of investment trusts, and all are organized as investment corporations (corporate type).

Since real estate investment trusts in the United States are abbreviated as REITs, Japanese real estate investment trust corporations are also referred to as J-REITs.

Compared with securities investment trusts that invest in securities such as shares and bonds which are comparatively easy to liquidate, real estate investment corporations focus on real estate, an asset that has low liquidity (is not easily liquidated), and thus even if there is a cancellation request from a customer, it is difficult to flexibly sell the invested assets and respond to such requests.

Therefore, real estate investment corporations are normally established as closed-end funds which investors are not allowed to cancel but which provide investors with an opportunity to invest and liquidate investments by listing the real estate investment trust on the exchange.

Because real estate investment trust corporations can list investment securities that correspond to share certificates on an exchange in the same way as shares of a company, there are also many securities investment trusts that target real estate investment corporations for investment.

While the method of purchasing and cashing out of listed real estate investment trust



corporations is the same as for shares, because securities investment trusts that target real estate investment corporations for investment follow the methods for purchase and cashing out of securities investment trusts, it is necessary to take note of that classification.

(3) InvestmentTrustsOtherThanSecuritiesInvestmentTrustsInvestment trusts that target investments principally in (iii) and (iv) above are in this

category. A typical example of an investment trust falling within this category is one that invests in the beneficial interests of a money trust comprised of auto loans or other receivables.

As indicated in Chart 3-2, there is no such fund as of the end of September 2019. While legally it is also possible to establish this kind of trust in the form of an investment corporation, none have been established as of the end of September 2019.

(4) InfrastructureInvestmentTrusts(InfrastructureInvestmentCorporations)Following the ITA amendments as of December 1, 2014, infrastructure equipment

(renewable energy power generation facilities, rights to operate public facilities, etc. as mentioned in (v) above) has been included in the scope of specified assets. On April 30, 2015, an infrastructure fund market was opened at the Tokyo Stock Exchange. As of the end of August 2019, six issuances of this type of fund were listed on this new market. Since infrastructure equipment has low liquidity as in the case of real estate, these funds are organized as investment corporations (corporate type), rather than as contractual type investment trusts.

3 5 Stock Investment Trusts and Bond Investment Trusts

Securities investment trusts are broadly classified into stock investment trusts and bond investment trusts.

(1) StockInvestmentTrustsLegally, securities investment trusts that invest exclusively in Japanese government bonds,

local government bonds, corporate bonds, commercial paper, negotiable certificates of deposit issued by foreign corporations, government bond futures transactions, etc. are called bond investment trusts (ITA Enforcement Ordinance, art. 13, item 2(a)), and securities investment trusts other than bond investment trusts are defined as stock investment trusts (ITA Enforcement Ordinance, art. 6, para. 1, item 3).

Accordingly, the definition of a stock investment trust would naturally include a fund that focuses on shares, and would also include a fund that contains a certain percentage of both shares and bonds. Moreover, in practice many investment funds that focus on bonds are structured as stock investment trusts by adding shares as an investment target in the basic terms and conditions, even if the fund conducts investment without including any shares at all in its portfolio. Funds that focus on foreign bonds are often established as a stock investment trusts.

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The reasons that it is carried out in this way in actual practice are stated in “(2) Bond Investment Trusts” below.

(2) BondInvestmentTrustsAs stated in (1) above, bond investment trusts are limited to investing in Japanese

government bonds, local government bonds, corporate bonds, commercial paper, negotiable certificates of deposit issued by foreign corporations, government bond futures transactions, etc. Typical bond investment trusts are daily closing funds (funds that close daily) such as MMF (money management funds) and MRF (money reserve funds, cash management account funds) (for details, see “7. Calculation of Base Value, Closing, Dividends, Cashing Out and Redemption of Securities Investment Trusts”), and so-called long-term bond funds. As of the end of September 2019, there was no MMF on the market.

The characteristics of bond investment trusts are found in the facts that (i) the whole amount of the fund’s net assets that exceed the principal at each closing (every day if it is a daily closing fund) are distributed, (ii) they can be purchased (additionally established) only at the base value on the closing date, and (iii) in daily closing funds, when the base value is other than the principal’s price per unit (e.g., JPY10,000), it is not possible to make an additional establishment.

Thus, speaking about daily closing funds such as MMF and MRF, the investor’s purchase price is always the principal value per unit (e.g., JPY10,000), and this is always the same as the base value (e.g., JPY10,000) so long as there are no operational losses, and all profits on the trust assets become dividends.

Further, as for so-called long-term bond investment trusts, while the base value for one year closing funds fluctuates daily, if on the closing date the base value is over JPY10,000, all of that excess amount becomes dividends (on the contrary while it is possible to make an additional establishment even if the base value on the closing date is below JPY10,000, it is not possible to pay a dividend unless the base value in the following year exceeds JPY10,000, and the portion in excess of JPY10,000 must be distributed in its entirety).

Although the restrictions of (i) and (ii) above are limitations based on the tax system, it is believed that, as long as these kinds of restrictions exist, it is desirable from the perspective of the nature of a market-oriented financial instrument to use the structure of a stock investment trust, in which establishment and cancellation is possible and the base value fluctuates every day, for funds in which there is a strong likelihood that the base value will at times exceed the principal and at times be less than the principal, even if in practice the fund only invests in bonds. It is for this reason that many funds such as those that invest primarily in foreign bonds are established as stock investment trusts.

3 6 Unit-Type (Tan’i Gata) and Additional Offering Type (Tsuika Gata)

The classification for investment trusts as unit-type or additional offering type depends on



whether or not additional funds can be contributed to the fund after the fund is first established.A unit-type investment trust raises capital from investors during a fixed period of time, and

after the fund is established with the collected capital, it will not accept additional funds. While it is possible to calculate the base value, that is the basis on which an investor cashes out the fund and it is not possible to purchase at that base value.

There are two types of unit-type investment trusts, so-called family fund units (periodic and stylized investment trusts) under which identically structured unit trusts are established periodically on an ongoing basis, and so-called spot investment trusts, which are established in response to and formulated to fit the needs of investors, as well as market conditions such as the share market and the bond market, as they may be from time to time. At present, only spot investment trusts are being newly established, and no new family fund units are being established.

Additional offering type investment trusts (sometimes called open-type investment trusts) also raise capital from investors during a fixed period of time, and until the fund is established using the collected capital they are the same as unit-type investment trusts, but afterwards it is possible to raise additional capital. The base value does not mean only the base at which investors that already hold that investment trust can cash out the trust, but it also means the base for the purchase price for investors who intend to purchase the investment trust in the future.

3 7 ETF

ETF is an initialism for Exchange Traded Funds, and refers to investment trusts (Note 1) that are created so that their investment performance will be linked to a stock index such as TOPIX or the Nikkei average, or an indicator such as commodities prices, and which are listed on an exchange.

ETFs are bought and sold at a market price on an exchange in the same way as listed shares on an exchange. Unlike other securities investment trusts, they are not purchased and cashed out at a price based on the base value, but are characterized by being bought and sold at the market price. Tax treatment also differs from other securities investment trusts, and basically the same system applies as that for listed shares.(Note 2)

When the ETF system was initially established in 2001, only ETFs aimed at tracking specified Japanese share price indexes were allowed to be created. Subsequently, however, new types of ETFs have emerged, such as those tracking foreign share price indexes, commodity prices, and REIT index. In addition, foreign investment trusts (foreign investment corporations) have been listed on Japanese exchanges. Thus, the product types of ETFs have diversified in Japan.

(Notes) 1. There is a type of ETF which does not take the form of an investment trust in the legal meaning.

2. Some ETFs are subject to different taxation rules from those applicable to listed shares.

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3 8 Foreign Investment Trusts and Foreign Investment Corporations

“Foreign investment trust” means a trust established overseas in compliance with foreign laws that is similar to an investment trust (ITA, art. 2, para. 24), and “foreign investment corporation” means an incorporated organization established based on the laws of a foreign country or unincorporated organization that issues securities similar to investment securities, investment equity subscription right certificates or investment corporation bonds (ITA, art. 2, para. 25).

As stated at the start of this section, among the investment trusts that are offered in Japan, in addition to the domestic investment trusts indicated in Chart 3-2, there are also investment trusts that have been established abroad and brought to Japan.

In this case, in order to protect investors, the disclosure-related regulations of the FIEA (offerings using a securities registration statement and a prospectus) apply to foreign investment trusts (foreign investment corporations) that are publicly offered (excluding private placements) in Japan, and further, it is required under the ITA that the basic terms and conditions of an investment trust, the certificate of incorporation of the investment corporation or corresponding documents be attached and registered (ITA, art. 58 and art. 220).

In addition, it is necessary that the said foreign investment trusts (foreign investment corporation) be in conformance with the screening standards provided by the Japan Securities Dealers Association (JSDA Foreign Securities Rules, art. 16 and art. 17), and one of the Association Members of the JSDA, acting as a proxy Association Member under an agreement entered into with the foreign issuing party, etc., carries out duties such as delivery of prospectuses and settlement reports, etc. and the publication of the base value. The base value of foreign investment trusts is usually not described in yen but in a foreign currency. Upon the motion of the Commissioner of Financial Services Agency, a court may prohibit or suspend offerings of foreign investment trusts (foreign investment corporations) if the instructions on investment concerning the assets of a foreign investment trust (foreign investment corporation) are exceedingly inappropriate, and it is clear that the interests of investors will be harmed thereby (ITA, art. 60, para. 1 and art. 223, para. 1).

3 9 Closed-End Type and Open-End Type

Although the distinction between closed-end type and open-end type is not made in the statistics of Investment Trusts Association, Japan as shown in Chart 3-2, classification by this distinction is often done abroad, and because it is used to classify foreign investment trust (foreign investment corporation) products, we will take a look at it here.

The classification into unit-type (tan’i gata) or additional offering type (tsuika gata) is based on whether or not additional funding is made after the fund is initially established, but an open-



end type means a fund where the issuer can buy back the issued securities (the investor can cancel), and due to this, the fund (kikin) can be continually diminished. As opposed to this, closed-end type means a fund where, in principle, it is not possible to decrease the fund (kikin) by cancellation or buy-backs.

Although in Japan an additional offering type investment trust is sometimes called open, as discussed above, since, in principle, Japanese investment trusts allow investors to cancel freely (or in the case of a fund for which cancellation is prohibited for a certain period (the closed period), after the expiration of this period), even a unit-type investment trust would be included within the framework of an open-end type.

In closed-end trusts the scale of the fund is more stable than that of the open-end type, enabling the fund manager to concentrate solely on investing the fund without having to worry about this point. Also, because there is no necessity to be pressured to sell and liquidate the invested assets on the market to provide for diminishment in the fund, there is less of an aggravation factor on the market.

Nevertheless, the only way to cash out the beneficial interest in a closed-end type investment trust is to sell it on the market. The price will vary depending on the condition of the market, and will not always match the net asset value (base value) of the fund. Frequently, they can only be sold at a premium or a discount. Conversely, cashing out of an open-end type investment trust is conducted based on the net asset value (base value).

Furthermore, while the closed-end/open-end classification is not directly related to the underlying fund assets, in general, assets that are less liquid are more suited to the closed-end form. Because the manager must respond to investor repurchase or cancellation requests in the case of the open-ended type, it is sometimes necessary to sell or cash out the assets held by the fund in order to pay investors. Thus, it is easier for investment management purposes to organize a fund that incorporates a large percentage of assets that cannot be readily cashed out, such as real estate, as a closed-end investment trust.

For these reasons, investment trusts that target investments principally in real estate are normally organized as a closed-end corporate type investment trust (investment corporation) with the issued investment securities being listed on a financial instruments exchange and traded.

3 10 Others

The major categories of investment trusts are discussed in 3-1 through 3-8 above focusing on the overall image presented in Chart 3-2 presented at the start of this Section. In the following items we examine some of the other types of distinctive investment trusts.

(1) MotherFundsA mother fund is an investment trust in which the beneficial interests are acquired by another

investment trust (baby fund) to which the same investment trust settlor company gives

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instructions on the investment. In order to promote efficient investment management, several baby funds with varying structures are used to target the same underlying investment (family fund).

There are also structures that use several mother funds (e.g., a domestic stock mother fund and a foreign bonds mother fund) which each have the same single baby fund, so as to allow that baby fund to invest in different asset classes. Under these kinds of structures, the management of the various investment targets is left to the experts for each asset class at the mother fund, and the baby funds do not perform any management activities other than adjusting the mother fund inclusion. Family fund structures are used to enable a variety of different assets to be packaged into a single product offered to investors, while at the same time promoting the efficient management of the fund assets.

(2) FundofFundsFunds of funds are investment trusts (or investment corporations) that invest in investment

trusts (investment corporations) and foreign investment trusts (foreign investment corporations); provided, however, a fund that invests principally in a mother fund would fall within the “baby fund” type category of (1) above, and thus should not be included in funds of funds (JITA Management Regulations, art. 2, para. 3).

The fund of funds structure is designed to provide investors with new profit-earning opportunities by including a multitude of funds with differing risk characteristics and benefiting from the investment performance of funds managed by institutions with greater investment management expertise.

The Investment Trusts Association, Japan provides detailed regulations for funds of funds depending on distinctions such as whether they are publicly offered funds or privately placed funds, whether the funds invested in are domestic investment trusts or foreign investment trusts, which govern the conditions for fund inclusion, maximum inclusion ratios, etc. (JITA Management Regulations, art. 22, art. 23 and art. 24).

(3) FundsGearedTowardsDefinedContributionPensionFundsA defined contribution pension plan is a plan which mimics an American 401(k) plan, and is

a private pension in which the benefits vary depending on the performance of the investments. There are individual and corporate plans, and under a corporate plan, the employees can select where to invest their money from among a menu of investment products selected by the employer (bonds, shares, investment trusts, savings deposits, trusts, insurance products, etc.). Similarly, under an individual plan, subscribers select investment products from among those handled by the operational management institutions with which they have completed the subscription procedure. In 2017, the individual plan was reformed to include public employees and housemakers in the scope of eligible subscribers. At that time, the plan was given a pet name, “iDeCo,” with a view to making it more widely known and accepted as a scheme for supporting households through stable asset building.

A fund geared towards a defined contribution pension plan is a fund that is offered as one of the investment choices to the participants in the plan, and is often identified by the letters DC



(Defined Contribution) appearing in the fund’s name.

3 11 Product Classification and Classification of Attributes Stated in Investment Trust Explanatory Document (Prospectus)

In accordance with the “Guidelines for Product Classification” of the Investment Trusts Association, Japan, the product classification shown in Chart 3-5 “Product Classification” and the classification of attributes shown in Chart 3-6 “Classification of Attributes” are stated in the investment trust explanatory document (prospectus) of a publicly offered (contractual type) investment trust.

Among the items listed in Chart 3-5, the three items, i.e., “unit-type/additional offering type,” “investment target territory,” and “investment target assets (source of income),” will, in principle, be stated on the cover of an investment trust explanatory document (prospectus) for all funds. The other two items, i.e. “independent classification” and “supplemental classification,” are indicated only for funds that fall within these categories. In terms of the distinction between stock investment trusts and bond investment trusts described in 3-5 above, mainly for tax purposes, funds may be classified as stock investment trusts even though they do not actually invest in stocks. The product classification discussed here is designed to focus on the kind of assets that are the fund’s main source of investment income and to make clear the fund’s investment purpose and its risk characteristics.(Note 1)

Chart 3-5 Product Classification

Unit-Type/Additional

Offering Type

Investment Target Territory

Investment Target Assets

(Income Source)

IndependentClassification

Supplemental Classification

Unit-Type

Additional OfferingType

Domestic

Foreign

Domestic andForeign

Share

Bonds Real

EstateInvestment Trusts

Other Assets(　　　　　 )

Composite Assets

MMF

MRF

ETF

Index Type

Special Type

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Chart 3-6 Classification of Attributes

Investment Target Assets

Closing Frequency

Investment Target Territory

Investment Form

Exchange Rate Hedge＊

Target Index Special Type

Shares-Ordinary-Large-Small& Medium

Bonds-Ordinary-Public-Corporate-Other-Credit Attributes( )

Real Estate Investment Trusts

Other Assets( )Composite Assets( )-Fixed asset distribution type-Fluctuating asset distribution type

1 per year

2 per year

4 per year

6 per year (alternate month)

12 per year (monthly)

Daily

Other( )

Global

Japan

North America

Europe

Asia

Oceania

Central & South America

Africa

Middle and Near East

(Middle East)

Emerging

Family Fund

Fund of Funds

Yes( )

No

Nikkei225

TOPIX

Other( )

Bull/Bear Type

Conditional Investment

Type

Long-Short Type/Absolute Return Type

Other( )

＊The exchange rate is hedged against the yen.

Among the classification of attributes in Chart 3-6, “investment target assets” is to be stated by making a selection from among the listed assets. When the investment target assets are a composite portfolio of differing assets, a statement is to be made in parenthesis of the particulars, such as “shares and bonds.”

The accounting period for an investment trust is stated as “closing frequency” because the accounting period may be one year, six months, three months, two months (alternate month closing), one month (monthly closing), and one day (daily closing type (MMF and MRF)).

For “investment target territory,” multiple territories may be stated in some cases.Where the fund corresponds to a “family fund” or “fund of funds” as described in “3-10.



Others,” the appropriate selection is made under “investment form.”Where a fund invests in foreign currency denominated assets, the fund’s investment purpose

and the risk taken on by investors differs greatly depending on whether the exchange rate is hedged (taking as little exchange rate risk against the yen as possible) or not hedged (actively taking on exchange rate risk against the yen and aiming to enjoy a rise in the price of the foreign currency). This is indicated in the “exchange rate hedge” column, with the degree of exchange rate hedge being indicated in parentheses as “full hedge,” “partial hedge,” “timely hedge,” etc.

Where the fund is an index fund or a special type,(Note 2) the applicable type is stated.

(Notes) 1. As stated in 3-5, because systemically there is a large difference in the practical handling of stock investment trusts and bond investment trusts, this classification continues to be important (for details, see “6. Sale of Securities Investment Trusts” and “7. Calculation of Base Value, Closing, Dividends, Cashing Out and Redemption of Securities Investment Trusts”).

2. “Special type” refers to the following types of funds: “Bull/Bear Type” – used other than for hedging derivative products, aims to

invest actively together with linkage or reverse linkage to the various indexes (including linkage or reverse linkage index multiples).

“Conditional Investment Type” – by investing in structured bonds, etc., the investment outcome and maturity date, etc. are decided by the level of a market index (e.g., stock price index) in accordance with certain conditions.

“Long-Short Type/Absolute Return Type” – by selling short (shorting) issues and assets that are expected to fall in price and by purchasing issues and assets (buying long) that are expected to rise in price the fund aims to have zero substantive additions to portfolio holdings, and seeks returns that would not be affected by the entire movement of a particular market (e.g., Japan’s stock market).

3 12 Monthly-Paid Type, Currency-Selected Type, Leveraged Investment Trusts, Complex Investment Trusts Similar to OTC Derivatives Transactions, and Knock-in Investment Trusts

(1) Monthly-PaidTypeAs stated in 3-11 above, there is variety in the closing frequency of investment trusts, such as

once, twice, four times or six times a year, on a bimonthly, monthly, or daily basis. A monthly-paid type fund is a scheme wherein a closing is made and a dividend is paid on a monthly basis. Although most monthly-paid type funds are managed under the policy of ensuring stable payment of the dividend, it is necessary to fully understand matters such as that there may be cases where there is no dividend payment, whereas a dividend may sometimes be paid beyond the profit

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obtained by the fund, and that such a dividend payment would cause a decline in the base value, and that all or part of the dividends may be regarded as partial refund of principal.

(2) Currency-SelectedTypeA currency-selected type investment trust is designed to allow investors to select a currency

other than the yen as the subject of exchange trade, in addition to selecting the investment target assets such as bonds and shares. For example, if a fund aims to enable investors to receive the investment results in Australian Dollars using assets denominated in US Dollars, the fund carries out exchange trade by selling US Dollars and buying Australian Dollars, in addition to managing the investment target assets.

The sources of profit and loss arising in currency-selected type investment trusts are: (i) a rise or fall in the price of the investment target assets, and interest and dividend from such assets; (ii) income (premium) or expense equivalent to the difference in the interest rate between the currency in which the investment target assets are denominated and the selected currency, which arises from exchange transaction; and (iii) a rise or fall in the rate of the selected currency against the yen.

However, it should be noted that as a currency-selected fund is subject not only to the price fluctuation risk of the investment target assets but also the exchange fluctuation risk of the selected currency, a huge loss might occur in the event of a fall in the currency rate, and that profit from an exchange transaction does not always correspond to a difference between short-term interest rates but may possibly be far deviated from it. Those engaged in selling currency-selected type investment trusts should pay special attention to these points.(Note)

(Note) For the explanation of dividends that must be provided when selling investment trusts and the regulations, etc. concerning the sale of currency-selected type, check the description provided later (for details, see 6-2 “(4) Explanation on Expenses Payable by Customers and Dividends, and Measures to Confirm Customers’ Understanding of Currency-Selected Investment Trusts”).

(3) LeveragedInvestmentTrusts,ComplexInvestmentTrustsSimilartoOTCDerivativesTransactions,andKnock-inInvestmentTrustsLeveraged investment trusts and complex investment trusts similar to OTC derivatives

transactions (hereinafter referred to as “complex investment trusts”) are subject to tighter regulations than those for other types of funds in terms of investment solicitation and sales due to their special characteristics as financial products (for details, see 6-2 “Regulations, Etc. Concerning Sales”). Knock-in investment trusts are a type of complex investment trust, and in addition to regulations on investment solicitation and sales, tighter disclosure rules under special provisions are imposed than those imposed on other types of funds with regard to the disclosure in materials used for sales, etc., investment management reports, and websites of investment trust settlor companies, etc.



(i) LeveragedInvestmentTrusts“Leveraged investment trust” refers to an investment trust that is managed so that the

change rate of the base value is consistent with the value that is calculated by multiplying the change rate of a specific indicator or price by a predetermined factor (limited to two times or more or minus two times or less) (excluding listed investment trusts) (JSDA Investment Solicitation Rules, art. 2,item 9).(ii) ComplexInvestmentTrusts

“Complex investment trust” refers to an investment trust that will be of the same nature of a product or effect as that of a complex structured bond similar to OTC derivatives transactions (hereinafter referred to as a “complex structured bond”) by investing in such structured bond (JSDA Investment Solicitation Rules, art. 2,item 8).

“Complex structured bond” refers to a bond other than a Japanese government bond and a bond that has a structure to reflect the credit condition of a single entity, which falls under any of the following (JSDA Investment Solicitation Rules, art. 2,item 7):

(a) A bond for which the redemption price can be less than the face value (excluding those structured so that the change rate of the redemption price is consistent with the value that is calculated by multiplying the change rate of a specific indicator or price by a predetermined factor (limited to one time or minus one time);

(b) A bond subject to a condition that the redemption is made with other securities such as by the automatic exercise of rights in the derivatives transaction; or

(c) A bond which falls under any of the following, other than one structured so that the change rate of interest is consistent with the change rate of an interest indicator:a. Interest is not determined at the time of issuance, and the currency used for

redemption payment and that used for purchase payment are different;b. Interest is not determined at the time of issuance, and the currency used for

interest payment and that used for purchase payment are different; orc. Interest becomes zero or very close to zero depending on the conditions.

(iii) Knock-inInvestmentTrustsA knock-in investment trust is a type of complex investment trust, which has the

following features:(a) Derivatives transactions or structured bonds are used, and the target investment

results (e.g., redemption price, dividends, etc.) and the redemption date depend on a specific indicator or price;

(b) With the use of a knock-in option or any other similar economic effect, it has a product nature that could cause investors to incur a loss of principal or enjoy an unusual degree of profitability in cases such as when the specific indicator or price reaches a certain level during a certain period of time and the redemption price reflects such movements in the indicator or price; and

(c) A function or structure to secure principal (or to limit a loss) against movements in the indicator or price (excluding those relating to credits) under certain conditions is provided (JITA Detailed Rules for the Complex Investment Trust Regulations,

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art. 2).A typical example of a knock-in investment trust uses a stock index (Nikkei Stock

Average). For example, if the Nikkei Stock Average does not fall below a certain price level (knock-in price) at all during a certain period of time, profit can be secured (but only up to a certain amount however high the Nikkei Stock Average may be), whereas, if the Nikkei Stock Average falls below the knock-in price even once, the investment result is linked with such movements. In the course of soliciting investors to invest in knock-in investment trusts, it was often the case that while it was emphasized that investors can receive dividends at a rate above the deposit interest rate if the Nikkei Stock Average does not fall below the knock-in price, investors were not fully informed of the possibility of incurring a loss if the Nikkei Stock Average fell below a certain level just once during a certain period of time (e.g., a fall by 35% from the current stock price in five years). As a result, due to the lack of understanding of the nature of this product, there were cases such as investors incurring losses on a par with the fall in the Nikkei Stock Average. This led to the introduction of tighter disclosure rules for knock-in investment trusts under a special provision than those for other types of funds with regard to the disclosure in materials used for sales, etc., investment management reports, and websites of investment trust settlor companies. For example, the following statement must be clearly indicated on the cover or at the beginning of a prospectus, using 12-point or larger characters and be placed within a frame.

Please consider carefully upon application that this investment trust has a risk that a considerable loss could occur in principal when the base indicator (e.g., Nikkei Stock Average) reaches a certain predetermined level.

4 Structure of Securities Investment Trusts

Although the structure of a securities investment trust is described briefly in Chart 3-3, here we will take a more detailed look. In securities investment trusts under instructions from the settlor, the foundations for management are laid out in the basic terms and conditions. The parties involved in this type of investment trust are the asset management company (investment trust settlor company), the trustee (trust bank), the beneficiary (investor), and the distributor.

4 1 Investment Trust Contract

(1) ConclusionofanInvestmentTrustContractWhen an investment trust settlor company (i.e., settlor or asset management company)



proposes to enter into an investment trust contract with a trustee, the said basic terms and conditions of the investment trust must be filed with the Prime Minister (who, in practice, delegates its authority to the Commissioner of the Financial Services Agency) (ITA, art. 4, para. 1 and art. 225, para. 1). While the basic structure of investment trusts under instructions from the settlor is defined in the ITA, the detailed provisions governing their organization are set forth in the basic terms and conditions of an investment trust.

The main items included in an investment trust contract are as listed below (ITA, art. 4, para. 2).

(i) Trade names or names of the settlor and the trustee, and their business operations;

(ii) Types of the underlying assets and other matters concerning the management of the trust property;

(iii) Matters concerning the method, criteria and record date for the valuation of the investment trust property;

(iv) Matters concerning the redemption of trust principal and distributions of profit;

(v) Matters concerning the duration of the trust contract, extensions thereof, and early cancellation during the duration of the trust contract;

(vi) Matters concerning the accounting period of the trust;(vii) Matters concerning the method of calculating the trust fees and other fees

to be received by the trustee and the settlor(viii) Classification as to whether the investment trust is offered through a public

offering, private placement with qualified institutional investors, private placement with professional investors or private placement with general investors

(ix) Where the settlor entrusts another person with the authority to give instructions on investment, the trade name or name and other details of the person to whom the settlor entrusts such authority, and the costs of such entrustment;

(x) Matters concerning an amendment to the basic terms and conditions of the investment trust; and

(xi) Method of giving public notice to be used by the settlor.

The investment trust settlor company must provide any persons who are to acquire an investment trust with a written copy of the basic terms and conditions of the investment trust (ITA, art. 5, para. 1, main clause). However, this does not apply if (i) the basic terms and conditions of an investment trust are included in a prospectus, (ii) the investment trust is a privately placed investment trust to qualified institutional investors, (iii) in the case of private placement with general investors, the information on the content of the basic terms and conditions of the investment trust is provided or published as specified information on securities, etc., (iv) the desired investment trust property is the same as those of an already owned investment trust or (v)

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Section 4. Structure of Securities Investment Trusts


if an individual sharing the same household as the person to receive the said fund has already received the abovementioned document or it has been confirmed that the same will be received by such an individual and the said person agreed not to receive the said document (ITA, art. 5, para. 1, proviso; ITA Enforcement Ordinance, art. 10). Publicly offered investment trusts ordinarily include the contents of the basic terms and conditions of an investment trust in the prospectus, and thus, do not deliver a separate written document containing the same material.

(2) AmendmentstoanInvestmentTrustContractWhen the investment trust settlor company proposes to amend the basic terms and conditions

of an investment trust, it must file a notice with the Commissioner of the Financial Services Agency in advance of that fact with the content of the proposed amendment (ITA, art. 16, item 1). In this case, where the amendment is a material amendment, for a fund established prior to September 30, 2007 when the new Trust Act came into force (an Old Law Trust), the procedures in (i) below must be followed; and for a fund established after the enforcement of the new Trust Act (a New Law Trust), the procedures in (ii) below must be followed:

(i) MaterialAmendmentoftheBasicTermsandConditionsofanOldLawTrustWhere a material amendment of the basic terms and conditions of an Old Law Trust is

proposed, public notice of the fact of the amendment and the content thereof must be given in advance, and written notice stating these matters must be delivered to the beneficiaries (ITA prior to the September 30, 2007, amendment, art. 30). This public notice and written notice must include a statement to the effect that beneficiaries with an objection to the amendment may voice their objection within a certain period of time (which cannot be less than one month). If the number of units held by beneficiaries that state an objection within the specified period of time is greater than one-half of the total number of units held by all beneficiaries, no amendment is allowed.

On the other hand, where the number of such units is one-half or less, the amendment will take effect, but those beneficiaries who stated an objection within the fixed period of time may make a demand to the trustee that the portions of the fund owned by such beneficiaries be repurchased with the investment trust property at the fair value which they would have had if the amendment had not been made (ITA prior to the September 30, 2007, amendment, art. 30-2).(ii) MaterialAmendmentoftheBasicTermsandConditionsofaNewLawTrust

Where a material amendment of the basic terms and conditions of a New Law Trust is proposed, the amendment shall be made pursuant to the procedures for a written resolution of the beneficiaries.

In the case of a written resolution of the beneficiaries, the investment trust settlor company shall prepare a document stating the date of the said resolution, the contents of material amendments to the basic terms and conditions and reason thereof, matters to be stated on reference documents for written resolutions, deadline for exercise of voting rights and other matters, and dispatch the notice in writing to beneficiaries at least two weeks prior to the date of the resolution (if certain requirements are met, the notice may be made by



electromagnetic method) (ITA, art. 17, paras. 1 through 4). Written resolutions shall be adopted by a majority of two-thirds or more of the voting rights of all beneficiaries who may exercise voting rights (ITA, art. 17, para. 8). The basic terms and conditions may provide that a beneficiary shall be deemed to have approved the resolution if it does not exercise its voting right (such provision shall be stated on the notice sent to beneficiaries (ITA, art. 17, para. 7)). If all beneficiaries have manifested their intent to consent to the proposal of the investment trust settlor company in writing (or when certain requirements are met, by electromagnetic method), the procedures for a written resolution do not need to be taken (ITA, art. 17, para. 10; ITA Enforcement Ordinance, art. 31).

A beneficiary voting against the material amendments to basic terms and conditions may request that the fund which it owns be repurchased with the investment trust properties at a fair price (ITA, art. 18, para. 1). However, this provision on the dissenting beneficiaries’ right to request the purchase of their beneficial interest does not apply to an investment trust wherein a beneficiary’s request for the redemption of the fund which is filed during the trust contract period may be satisfied by the partial cancellation of the investment trust contract (e.g., a fund which allows cashing out every day except for holidays, etc. outside Japan) (ITA, art. 18, para. 2).

(3) CancellationofanInvestmentTrustContract(RedemptionoftheFund)When the investment trust settlor company intends to redeem the fund and cancel the

investment trust contract, it must notify the Prime Minister to that effect in advance (ITA, art. 19) (for details, see “7-5 Redemption”).

4 2 Parties Involved in Securities Investment Trusts

(1) InvestmentTrustSettlorCompanyOnly persons who are registered with the Commissioner of the Financial Services Agency

for engaging in investment management business may become an investment trust settlor company (FIEA, art. 2, para. 8, item 14, art. 28, para. 4, item 2, art. 29, and art. 194-7, para. 1).

The main types of business that the investment trust settlor company conducts are as follows:

(i) Conclusion of investment trust contract, and filing of notification of the basic terms and conditions of an investment trust and amendments thereof;

(ii) Establishment of the investment trust property;(iii) Giving instructions on management of the investment trust property (including

the exercise of voting rights by instructions);(iv) Calculation and publication of the base value of the fund;(v) Preparation of disclosure documents such as prospectus and management

report; and

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(vi) Cancellation of the investment trust contract (redemption of the fund).

Among the principal business operations of investment trust settlor company mentioned above, (iii) through (v) will be discussed later (for details, see “5. Management of Securities Investment Trusts,” “7. Calculation of Base Value, Closing, Dividends, Cashing Out and Redemption of Securities Investment Trusts” and “8. Disclosure for Securities Investment Trusts”).

For many funds, investment trust settlor companies outsource the management of investment trust property to investment management companies as provided for by law (for details, see the note indicated at the beginning of “5. Management of Securities Investment Trusts”).

There has also been an increase in investment trust settlor companies that outsource the calculation of the base value and the disclosure process.

It is necessary to be registered as a type II financial instruments business operator by the Commissioner of the Financial Services Agency where an investment trust settlor company conducts an offering of the beneficial interests in a fund which it issues itself (FIEA, art. 2, para. 8, item 7(a), art. 28, para. 2, item 1, and art. 29). In this case, the investment trust settlor company also performs the role of distributor, and thus the investment trust settlor company is said to be engaging in “direct sales functions.”

(2) TrusteeCompaniesTrustees must be trust companies, etc. (trust companies or financial institutions that conduct

trust businesses; hereinafter the same) (ITA, art. 3).The main businesses that trustee companies conduct are listed below:

(a) Administration of investment trust property;(b) Calculation of the base value of the fund (verification with the value calculated

by the investment trust settlor company); and(c) Approval/consent for the content of the basic terms and conditions of an

investment trust and for amendments thereof.

The trustee company becomes the titleholder of the investment trust property and administers it in its own name while keeping such property separate from its own assets. When incorporating foreign securities into investment trust property, the trustee must establish a custody contract with a local financial institution so that the local financial institution can take custody of the foreign securities. The trust company independently calculates the base value of the fund, which is then verified by the investment trust settlor company.

At present, the trustee business for investment trusts is being carried out by re-entrustment companies. This entrustment is designed to improve efficiency in business operations by separating the trustee business from other businesses of trust banks and having the trustee business centrally managed at a re-entrustment company, and by allowing the re-entrustment company to conduct the trustee business in cooperation with other trustee companies. In this way,



the role played by these re-entrustment companies in practice has taken on an increasing significance in the hierarchy of investment trust organization.

(3) BeneficiariesA beneficiary is a holder of a beneficial interest that possesses the right to receive the

earnings of the trust. Beneficial interests consist of the right to receive dividends and redemption proceeds, and to make fund requests for cashing out by cancellation or repurchase. Each beneficiary possesses an equal right, based on the number of units of beneficial interests held, to receive a contribution of the trust’s principal as well as any dividends (ITA, art. 6, para. 3)

(4) DistributorsExcept in the case of investment trust settlor companies that engage in direct sales functions,

investment trusts are usually offered and sold through “distributors” such as financial instruments business operators and registered financial institutions (this refers to financial institutions that have been registered in accordance with FIEA Article 33-2 concerning the business of investment trusts offerings, etc., hereinafter the same). Therefore, distributors play an important role in the actual administration of investment trusts, although they are not a direct party to the trust contract.

Pursuant to the basic terms and conditions of an investment trust, the investment trust settlor company may appoint a specific distributor (this is called a designated distributor) to sell the investment trust, and the designated distributor conducts the following business as an agent of the investment trust settlor company:

(a) Handling of the offering of the investment trust and trading;(b) Handling of distribution of profits and payments of redemption proceeds;(c) Requesting cancellation to the investment trust settlor company for funds

purchased from the beneficiary and relaying cancellation requests from the beneficiary; and

(d) Delivery of prospectuses and management reports to clients, and exchanging necessary information with the investment trust settlor company concerning offerings and sales (e.g., notifications from the designated distributor regarding the progress made in offering/sales, and notifications from the investment trust settlor company regarding the base value and other matters).

Distributors that are not designated distributors are usually called intermediary distributors, and they are required to interface with a designated distributor when conducting the abovementioned operations.

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5 Management of Securities Investment Trusts

One characteristic of investment trusts is that they are managed by professionals. In Japan, a person who may direct investment as the settlor of an investment trust under instructions from the settlor is a financial instruments business operator who is registered as an investment management business(Note) (FIEA, art. 2, para. 8, item 14, art. 28, para. 4, item 2, and art. 29).

We will take a brief look at practices in connection with the management of an investment trust. However, the statements below are made in connection with publicly offered securities investment trusts (investment trusts under instructions from the settlor). It is necessary to take note that different rules apply in regard to the investment of other investment trusts and there are also many areas that differ widely in practice, etc.

(Note) A financial instruments business operator who conducts an investment management business may delegate all or a portion of its management authority to another financial instruments business operator who conducts an investment management business or to a corporation established under foreign laws and regulations who conducts an investment management business overseas (FIEA, art. 42-3, para. 1, item 2; FIEA Enforcement Order, art. 16-12; ITA, art. 2, para. 1; ITA Enforcement Order, art. 2). Further, where management is conducted for investment only in assets other than rights related to securities or derivatives transactions, management may also be delegated to a trust company (ITA Enforcement Order, art. 2, item 2); provided, however, that the relevant investment trust settlor company cannot delegate out all of its authority to give instructions on investments concerning all of the investment trust property that it manages (ITA, art. 12, para. 1).

5 1 Organization and Authority of Investment Trust Settlor Company

The investment trust settlor company (management company) has the authority to perform the following investment functions with respect to the management of an investment trust: (1) research functions; (2) determination and implementation functions of the investment policy; (3) trading functions; (4) risk management functions; (5) performance evaluation functions; (6) compliance functions, etc. How these functions are embodied in an organizational structure and what kinds of processes are implemented differ depending on the management policies and investment philosophy of each management company. The differences in these matters are what distinguish each asset management company.



(1) ResearchFunctionsThese functions involve researching and analyzing the factors that could cause the price of

the assets to fluctuate such as economy, interest rates, and companies, etc. Experts such as economists, analysts(Note), or quants (quantitative analysis experts) are assigned to the division that heads the research function, and present the results of their analyses to the fund manager, etc. through meetings, etc. as described below.

(Note) Analysts at management companies are persons who conduct company research/analysis solely for the management of the investment trust. To distinguish them from the analysts at securities firms, etc. who conduct company research/analysis in order to provide information to customers (called “sell-side analysts”), these persons are sometimes referred to as “buy-side analysts” (similarly, analysts that work at institutional investors with investments in trust products or life insurance are also referred to as buy-side analysts).

(2) DeterminationandImplementationFunctionsoftheInvestmentPolicyIn the case of an investment trust, the major investment targets, investment methods,

investment restrictions and other matters are set forth for each fund in the basic terms and conditions of the investment trust. The functions involved at this stage are utilizing the analyses provided by the economists, analysts and quants to construct and manage a portfolio that will satisfy the fund’s goals while keeping with the matters stated in the basic terms and conditions of the investment trust, determining the investment policy and the specific types of securities, etc. transactions to use. In many cases, determination of the actual transactions to be implemented by the fund is left to the investment expert known as the fund manager. It would not be an overstatement to say that these functions have the largest influence over the fund performance.

The management company will often set up a committee known as the “investment policy board” or some other title to deliberate on the company’s fundamental investment policy, while the fund manager is given decision-making authority over the specific transactions to be conducted by each fund according to such a policy. However, the extent to which a policy applies company-wide, and the scope of the fund manager’s individual discretion varies with the management company or the fund. In addition, there are management companies and funds where the fund manager itself possesses the full assortment of research functions and the research organization is not independent. There are also management companies and funds where management is conducted not by an individual fund manager, but by a group of experts under a team management method.

(3) TradingFunctionsThese are functions to execute the securities, etc. transactions determined by the fund

manager, and an expert known as the trader is assigned. Although there are management companies where the fund manager concurrently serves as the trader, in most management

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Section 5. Management of Securities Investment Trusts


companies these posts are separated.In order to execute trades on terms that are favorable to the investors, the trader chooses the

counterparty and trading execution terms, accurately and properly executes the trade, and gives clear and appropriate instructions to the trust bank that is the trustee, which has the authority to manage and dispose of the investment trust property.

(4) RiskManagementFunctionsInvestment trusts are constantly exposed to a multitude of risks, such as (i) market risk

associated with the fluctuation of the price of the investment targets, interest rates, exchange rates, etc. (this includes the individual risks for the share or bond issues or industries that make up the portfolio); (ii) credit risk associated with changes in the creditworthiness of certain parties, such as the possibility of defaults by the issuer of the investment targets or the counterparty; (iii) liquidity risk that, due to a large volume of cancellation/monetization requests or turmoil in the markets, etc., it will not be possible to conduct transactions on the market or conduct transactions at economic terms.

The risk management function seeks to ascertain the various risks of each fund, and make the fund manager aware of the risks or insist on corrective measures in cases where the size of the risk grows larger than the level that is acceptable for the fund in light of its investment objectives. Because the expected return on the portfolio depends on how much risk is taken on, risk management functions play a vital role in fund performance.

Depending on the management company, the risk management functions could be housed in the same investment division as the fund manager, assigned to an independent management department, or both.

(5) PerformanceEvaluationFunctionsThese are functions that verify the investment trust’s performance after the fact. An analysis

is made of trends in the net asset value for each fund, the source of the trends, positive and negative factors, etc., and the results of this analysis are fed back to the investment desk. This partially overlaps with the risk management function described in (4) above, since the source of a fund’s performance depends largely on the level of risks to which the fund is exposed, and it is necessary to verify after the fact whether the fund was appropriately taking on the proper types of risks.

(6) ComplianceFunctionsThe FIEA charges the investment trust settlor company (management company) with a

fiduciary duty and duty of care of a prudent manager, and prescribes certain prohibited activities for the benefit of beneficiary protection (for details, see “5-3 Duties of Investment Trust Settlor Company”). Based on the spirit of the ITA, the Investment Trusts Association, Japan has also ratified detailed rules (various by-laws, etc.) which investment trust settlor companies must follow in complying with the ITA, the ITA Enforcement Order and ITA Enforcement Ordinance.

Additionally, the investment trust settlor company must establish various internal rules to



comply with the law and ordinances and the rules of the Investment Trusts Association, Japan. Naturally, the management company must conduct its investment activities in strict compliance with the law and regulations, the Investment Trusts Association, Japan rules, and its own internal rules.

Compliance functions involve providing guidance and training to the fund manager, etc. regarding these laws and ordinances, etc., monitoring the status of compliance with the laws and regulations, etc., stopping any violations of and correcting any actions that have a high likelihood of violating the law and ordinances, etc. Many management companies establish a compliance department separate from the divisions mentioned in (1) through (4) above, and in some cases even assign a compliance supervisor to each of those divisions. The hope is that greater internal control will be achieved in the investments and other business activities engaged in by the investment trust manager by having each division autonomously involved in compliance as well as an independent compliance division.

5 2 Investing Techniques of Securities Investment Trusts

(1) IndexInvesting(PassiveInvesting)andActiveInvestingIndex investing is an investing technique that tries to replicate as nearly as possible the

performance of a benchmark (Note) such as the Tokyo Stock Price Index or the Nikkei Stock Average. In order to more closely track the performance of the index, the fund mirrors the industry categories, interest rate risk (sensitivity to changes in interest rates), exchange risk (sensitivity to changes in foreign exchange rates), etc. of the benchmark, and tries to minimize specific risk through diversification.

In contrast, active management takes on a different risk than the benchmark based on the analysis of economic conditions, interest rates, and company research, etc. in an attempt to beat the performance of the benchmark.

(Note) “Benchmark” refers to the criterion upon which a fund’s investment goals and performance are judged. Stock indexes, bond indexes, etc. are used as benchmarks according to the major investment targets and the nature of the fund.

(2) Top-DownApproachandBottom-UpApproachActive investing is broadly classed into two methods on how to outperform the benchmark;

the top-down approach and the bottom-up approach.In the top-down approach to investing, the manager seeks to find sources of earnings that will

outperform the benchmark based on macroeconomic research and analysis, and constructs a portfolio of issues most likely to take advantage of these trends.

The opposite is the bottom-up approach to investing, which compiles a portfolio based on the

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results of painstaking research and analysis of individual companies, and seeks to outperform the benchmark.

(3) GrowthStockInvestingandValueStockInvestingActive investing in shares can be categorized into a number of “investment styles” depending

on how the sources of profits that surpass the benchmark are to be found. Growth stock investing and value stock investing are typical examples of such investment styles. In growth stock investing, the manager focuses on the future growth potential of the relevant company, whereas value investing involves comparing the value of the share with its price level, and organizing a portfolio of shares that are determined to be undervalued.

Growth stock investing and value stock investing are increasingly being researched as two different “investment styles,” and private economic research firms publish growth stock indexes and value stock indexes.

Other “investment styles,” in addition to the above, include large-cap investing and small-cap investing, etc., and by combining these with growth/value, investment styles can be further classified into “large-cap growth,” “large-cap value,” “small-cap growth,” and “small-cap value,” etc.

(4) BondFundManagementBond prices fluctuate mainly due to interest rate risk, credit risk, and liquidity risk. There is

also foreign exchange risk in cases where investment is made into foreign currency denominated bonds.

Therefore, in the management of a bond fund, interest risk is controlled on the basis of the duration of the portfolio.(Note) Attention is paid to the control credit risk of the issuer of the bonds that constitute the fund, while making changes to these bonds as necessary. Control is also put in place depending on the situation of foreign exchange exposure in the event of investing in foreign currency denominated bonds. Moreover, management is conducted by changing the maturity mix of the bonds in the fund, depending on whether the yield curve steepens or flattens.

(Note) The “duration” is the benchmark for the sensitivity of the bond price to changes in interest rates. In general, this increases in proportion to the maturity of bonds.

(5) RelationshipBetweentheInvestmentTechniqueandtheBasicTermsandConditionsof an Investment TrustThe basic terms and conditions for each fund set forth the major investment targets,

investment techniques, investment restrictions, etc. of the fund. There are cases where the investment techniques described in (1) through (4) above are clearly written in the basic terms and conditions, and cases where they are not. Since the purpose of an index fund is to track an index, usually this is clearly stated in the basic terms and conditions. However, in some cases the basic terms and conditions for an actively managed fund will clearly state only that the fund aims to



outperform a certain index, relegating to the fund manager the choice of investment approach and techniques, while in other cases the basic terms and conditions clearly describe the methodology of how the fund plans to beat the benchmark.

In addition, index funds that aim to track the performance of a growth stock or value stock index could be said to use passive investing techniques to manage an actively managed fund. Conversely, while so-called themed funds, which select issues that correspond to a certain theme (e.g., XX-related stock funds, etc.), are generally classified as actively managed funds, since their aim is to manage issues in the chosen theme and not a quantifiable benchmark, they could be seen as passive investment funds.

In any case, each investment professional needs to exert his best efforts to see that the investment trusts under his control accomplish their performance goals in line with the matters set forth in the basic terms and conditions.

5 3 Duties of Investment Trust Settlor Company

(1) FiduciaryDuty,DutyofCareofaPrudentManagerIn Paragraph 1 of Article 42, the FIEA prescribes a fiduciary duty on the part of an

investment trust settlor company, stating that “a financial instruments business operator, etc. shall engage in the investment management business faithfully on behalf of the holder of rights.” Paragraph 2 states the duty of care of a prudent manager which investment trust settlor companies are bound to uphold: “A financial instruments business operator, etc. shall carry out the investment management business with the care of prudent manager on behalf of the holder of rights.”

The fiduciary duty in Article 42, Paragraph 1, means that the investment trust settlor company must think solely of the welfare of the holder of rights, i.e., the beneficiaries, in performing its management activities. In general, this provision is construed to prohibit the following kinds of conduct:

(i) Any action that would put it its own interests in conflict with the interests of the beneficiaries;

(ii) Any action that conflicts with the interests of the beneficiaries; and(iii) Any action in furtherance of its own interests or the interests of a third party.

As stated in (2) below, the FIEA prescribes these prohibited acts as a concrete expression of the fiduciary duty.

The duty of care of a prudent manager laid down in Article 42, Paragraph 2, is the duty under which the investment trust settlor company must act as a professional. It can be understood that the ITA vests the investment trust settlor company with relatively unfettered discretion over the fund management, while at the same time requiring the investment trust settlor company to

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exercise a heightened degree of care as a professional.

(2) ProhibitedActsThe FIEA prohibits certain acts as a direct embodiment of the fiduciary duty. Below we take

a look at the most representative acts thereof (for details, see the FIEA, art. 42-2):

(i) Engaging in self-dealing;(ii) Entering into intra-transactions between the managed assets;(iii) Entering into so-called scalping transactions; (Note)

(iv) Entering into a transaction on terms differing from an ordinary transaction and detrimental to the interests of the beneficiaries;

(v) Entering into transactions for its own account using information related to transactions conducted as management;

(vi) Compensation for loss occurring in transactions (excluding cases of compensation for loss due to incidents) conducted as management or provision of special profits;

(vii) Entering into a transaction that is detrimental to the interests of the beneficiaries in order to further the interests of a third party, etc.;

(viii) Entering into unnecessary transactions in light of market conditions, etc. in order to further the interests of a third party, etc.;

(ix) Entering into transactions with the purpose of affecting the terms of primary offering of securities for which its parent corporation, etc. or subsidiary corporation, etc. is acting as lead manager, or acquisition of the so-called remains of offerings concerning securities which its parent corporation, etc. or a subsidiary corporation, etc. is underwriting, etc.; and

(x) Other prohibited acts.

(Note) An act of making an investment in investment trust property for the purpose of securing the interest of a party other than the beneficiary of the investment trust (including the investment trust company) by using fluctuations in the price indicator, etc. involved in the transaction managed based on the instructions on investment of securities, etc.

(3) ManagementinAccordancewiththeManagementPlanThe regulations of the Investment Trusts Association, Japan, require that management be

conducted by a method in accordance with the management plan, or by a method of putting in place a system for recording and reviewing matters such as the plan of management, the execution of management, and the reasons for the failure to execute management in accordance with the management plan in the event of such failure. In the case of conducting management in



accordance with the management plan initially referred to above, if any change in the management plan is to be made in the conduct of management, an explicit statement of the reason of change is required (JITA Management Regulations, art. 6; JITA Detailed Rules for the Management Regulations, art. 1-2).

5 4 Investment Targets and Investment Restrictions of Securities Investment Trusts

(1) InvestmentTargets(i) InvestmentTargetsSpecifiedintheITA

The main investment targets of investment trusts (“specified assets”) as specified in the ITA are the following types of investments: securities, rights pertaining to derivatives transactions, real property, real estate leasehold rights, superficies rights, promissory notes, monetary claims, silent partnership equity interests, commodities, rights pertaining to commodity investment transactions, renewable energy power generation facilities, and rights to operate public facilities, etc. (ITA, art. 2, para. 1; ITA Enforcement Order, art. 3). They also include real estate investment trusts and investment trusts other than securities investment trusts.

In the case of a securities investment trust, securities and rights to trading in securities-related derivatives transactions (“securities” shall exclude rights deemed as securities as provided for in Article 2, Paragraph 2 of the FIEA pursuant to the said Paragraph, and “securities-related derivatives transactions” shall mean securities-related derivatives transactions for securities other than such rights) must, in principle, comprise more than one-half of the investment trust property (ITA, art. 2, para. 4; JITA Management Regulations, art. 3).(ii) RulesoftheInvestmentTrustsAssociation,Japan

The provisions in the Investment Trusts Association, Japan rules regarding the investment targets of securities investment trusts are almost identical to the ITA provisions, except that shares are limited to listed shares or those that meet other prescribed requirements (JITA Management Regulations, art. 11; JITA Detailed Rules for the Management Regulations, art. 2). Regarding securitization-related products, only those products for which market values can be readily obtained are allowed to be included, in consideration of their liquidity (JITA Management Regulations, art. 13).

Furthermore, the rules of the Investment Trusts Association, Japan list the types of transactions in which an investment trust manager can engage (though certain limitations are imposed on the scope, etc. of each transaction type). The specified transaction types are:

A. Margin transactions; B. Share borrowing; C. Securities lending; D. Bond loan transactions, borrowing and short-selling; E. Repurchase transactions; F. Loans of money; G. Capital borrowing; H. Foreign exchange transactions; I. When-issued transactions (JITA Management Regulations, art. 15).

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(iii) InvestmentTargetsSpecifiedintheBasicTermsandConditionsofanInvestmentTrustThe basic terms and conditions of an investment trust list the investment targets of each

fund in accordance with its objectives and within the scope described in (i) and (ii) above. For example, the basic terms and conditions for a bond investment trust might state that the fund will not include shares, etc. in the securities that it will target.

(2) InvestmentRestrictionsIn order to secure the fiduciary duty regarding the underlying assets and to promote proper

risk management in line with the trust purposes of each fund, there are several restrictions on investments prescribed by the law and regulations, the Investment Trusts Association, Japan rules, and the basic terms and conditions of an investment trust. Below we examine the most representative of these various restrictions.

(i) RegulationsConcerningDiversifiedInvestmentsUnder the amended FIEA effective as of December 1, 2014, a management company is

prohibited from managing a fund, which is created on or after the said day, by a method contrary to a reasonable method for controlling credit risk properly that the management company has predetermined (FIBCOO, art. 130, para. 1, item 8-2).

Accordingly, the Investment Trusts Association, Japan, has established regulations concerning such “reasonable method” as referred to in Article 130, Paragraph 1, Item 8-2 of the FIBCOO (generally referred to as “regulations concerning diversified investments”). Under these regulations, the exposure in relation to the underlying assets or transactions is categorized into three categories, namely:

(a) Equity exposure;(b) Bond exposure; and(c) Derivatives exposure.The ratio of each exposure and the total ratio of these exposures in relation to the total

amount of net assets in the trust property for the same person are limited to 10% and 20%, respectively. If the ratio of any or the total of these exposures exceeds the respective limit due to the changes in the market conditions or an increase or decrease in the assets, an adjustment must be made within one month to keep the relevant exposure below the limit, and if it is difficult to make such an adjustment within one month by taking ordinary measures, the management company must make a necessary adjustment as soon as possible, while making such situation clear (JITA Management Regulations, art. 17-2, para. 1). In the calculation of an exposure in relation to a secured transaction, the value of the security may be deducted, while an exposure is zero in relation to Japanese government bonds, public bonds, international organization bonds, short-term financial instruments or forward exchange contracts, etc. (JITA Management Regulations, art. 17-2, para. 2 and para. 3). If any issue is or is highly likely to be dominant in the fund’s investment (accounting for a large percentage of the fund), certain measures must be taken, such as clearly indicating on the cover of a prospectus to be delivered a statement that the fund is specialized in a certain



issue, and the abovementioned 10% and 20% exposure limits may be changed to 35% (JITA Management Regulations, art. 17-3, para. 1, item 3).

The following funds are excluded from the prohibition under certain conditions (JITA Management Regulations, art. 17-3, para. 1, item 1, item 2, and item 4).

(a) MMF, MRF;(b) Index-linked funds (including those linked at a certain multiplying factor); and(c) Funds named after the name of the party subject to an exposure (excluding those

incorporating structured bonds).With regard to the application of the regulations concerning diversified investments to a

fund of funds, if an exposure of the underlying fund or the ceiling thereof can be ascertained, any part of such exposure or ceiling which belongs to the fund of funds may be regarded as an exposure of the fund of funds, and the abovementioned 10% and 20%-exposure limits may be applied. However, if an exposure of the underlying fund or the ceiling thereof cannot be ascertained, an exposure of the underlying fund is treated as an “equity exposure,” and the 10% exposure limit is applied (JITA Management Regulations, art. 17-2, para. 5 and art. 23, para. 2).(ii) RestrictionsonDerivativesTransactions

In cases where a fund employs derivatives transactions, thorough risk management is required. Therefore, the laws and ordinances provide that in cases where the amount corresponding to the risk that may arise due to fluctuations in the interest rate, price of currencies, prices in the financial instruments markets or other index or other causes calculated in a reasonable method prescribed by a financial instruments business operator, etc. in advance shall exceed the total amount of net assets of the fund, the derivatives transaction (including warrants, investment equity subscription right certificates, transactions concerning certificates or instruments representing options, and trades in bonds with options) must not be conducted or continued (FIBCOO, art. 130, para. 1, item 8).

Funds that use derivatives transactions, etc. for purposes other than hedging must clearly describe their investment stance in the basic terms and conditions (JITA Management Regulations, art. 18, para. 1).(iii) OtherInvestmentRestrictions

Under the ITA, the investment trust settlor company may not instruct the trust company to acquire shares issued by a single corporation if the total number of voting rights pertaining to the shares in a corporation held as part of the investment trust property of all investment trusts under instructions from the settlor managed by such settlor company exceeds 50% of the total number of issued shares of that corporation (ITA, art. 9; ITA Enforcement Ordinance, art. 20).

In order for dividends, cancellation gains or redemption gains on the stock investment trust to be subject to the dividends exemption under the tax system (for details, see “7. Calculation of Base Value, Closing, Dividends, Cashing Out and Redemption of Securities Investment Trusts”), the basic terms and conditions of an investment trust must include the restrictions on investments in assets other than shares and in foreign currency denominated

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assets, and funds that invest mainly in domestic shares, etc. provide for such restrictions in their basic terms and conditions of an investment trust.

(Notes) A sample provision in the basic terms and conditions of an investment trust concerning the restrictions on investments in assets other than shares:

・�Investments in assets other than shares shall generally be limited to 50% or less of the total trust property.

　�Sample provisions in the basic terms and conditions of an investment trust concerning the restrictions on investments in foreign currency denominated assets:

・No investment shall be made in foreign currency denominated assets. ・�The settlor shall not give instructions on investments that would cause the total

market value of the foreign currency denominated assets included in the trust property to exceed 50 percent of the total amount of the trust property.

The Investment Trusts Association, Japan only permits the inclusion of investment trust securities (referring to beneficiary certificates of investment trusts and foreign investment trusts, or investment securities of investment corporations and foreign investment corporations) where the said investment trust securities do not account for more than 5% of net assets, except those (a) which are listed or registered on a financial instruments exchange market or a foreign market, and which can be sold at any time; and (b) for which shares, etc. have been converted into investment trust securities (this restriction does not apply to a mother fund or a fund of funds). Also, the total amount that a single investment trust settlor company may invest in investment trust securities, to the extent that the investment trust settlor company has not entered into an agreement with the issuing fund of the said investment trust securities, cannot exceed 50% of the said fund’s total net assets.

Furthermore, in order to prevent conditions under which the overall expenses pertaining to the ultimate investment or fund cannot be ascertained, and in order to ensure the fair valuation of assets included in the fund portfolio, the Investment Trusts Association, Japan does not permit investment in fund of funds investment trust securities (unless the fund of funds is a mother fund or a listed investment trust), and prohibits reciprocal and circular holdings between or among investment trusts (JITA Management Regulations, art. 12).

The Investment Trusts Association, Japan imposes various restrictions with respect to MMF and MRF, such as requiring at least a certain rating for the assets, including public and corporate bonds, etc. in the fund or setting the upper limits for the average remaining term to maturity of the assets, in order to heighten the stability of these investments (JITA MMF Management Regulations).(iv) DutytoHaveAssetsAppraised,Etc.

When an investment trust settlor company conducts transactions in certain securities such as unlisted share certificates, etc.; transactions in real property, etc. (meaning real property, rights to lease real property and superficies rights); and over-the-counter derivatives



transactions using the investment trust property, the investment trust settlor company is required to have an uninterested lawyer, legal professional corporation, certified public accountant, auditing firm, or real estate appraiser that meets certain criteria appraise the value or investigate the other terms of the transaction (ITA, art. 11, para. 1; ITA Enforcement Order, art. 18).

These provisions do not impose restrictions on the assets for which an appraisal, etc. is necessary, but their practical effect is to make it harder to use the trust property to conduct over-the-counter derivative transactions, etc.

5 5 Transactions in Securities, Etc. in Securities Investment Trusts

When a transaction in securities in a securities investment trust is conducted, it is necessary to endeavor to conduct the transaction on terms that maximize the advantages to the fund in view of an overarching consideration that includes the market conditions and price at the time of making the transaction (i.e., “best execution”). In order to make this effective, it is necessary to clarify the record of relevant decisions made in connection with transactions requiring negotiations, such as those that are not conducted through an exchange (JITA Management Regulations, art. 4).

Moreover, most asset management companies separate the roles of fund manager (management division) and trader (division placing orders) (for details, see “5-1 Organization and Authority of Investment Trust Settlor Company”), so that the management division can issue order instructions to the division which places orders. In this event, order instructions involving multiple investment trusts can be combined when placing the order (i.e., pooled ordering). In order to ensure the best possible execution of pooled ordering, the Investment Trusts Association, Japan, determines the securities to be covered by pooled ordering, the transaction unit prices, and the method of allocation of contract results, and also requires an asset management company that conducts pooled ordering to put in place internal rules as well as control divisions such as a compliance division, and to monitor the condition of execution operations (JITA Management Regulations, art. 8-2).

5 6 Execution of Instructions Regarding Voting Rights, Etc.

The investment trust settlor company shall give instructions to the trustee company regarding the exercise of voting rights and other shareholder rights relating to the securities incorporated in the investment trust property (ITA, art. 10, para. 1; ITA Enforcement Order, art. 14; ITA Enforcement Ordinance, art. 21).

The investment trust settlor company exercises the voting rights in connection with shares

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held as investment trust property, by making an explicit statement to the trustee and instructing the trustee by making one of the following statements of intention for each of the items set forth on the agenda stated in the notice of a shareholders meeting (JITA Regulations Concerning Conduct of Business, Etc. by Full Members, art. 2, para. 1), by:

(a) Voting in favor of the agenda item;(b) Voting against the agenda item;(c) Giving a carte blanche proxy to the investment trust settlor company; or(d) Abstaining from voting.The exercise of voting rights relating to foreign shares shall be made according to the

prevailing local laws and customs of the domicile country of the said shares (JITA Regulations Concerning Conduct of Business, Etc. by Full-Members, art. 2, para. 3).

In addition, the Investment Trusts Association, Japan provides that each investment trust settlor company should prescribe internal rules regarding its fundamental approach concerning the exercise of voting rights to shares and the authority, etc. to declarations of intent (JITA Regulations Concerning Conduct of Business, Etc. by Full-Members, art. 2, para. 2). Some investment trust settlor companies post their fundamental approach concerning instructions for voting rights and the result of the exercise of voting rights of domestic stocks (the exercise result, in principle, in the shareholders meetings held in May and June) on their websites, etc.

On May 29, 2017, the Council of Experts on the Stewardship Code under the FSA publicized the revised version of the “Principles for Responsible Institutional Investors: Japan’s Stewardship Code” (Note). In this version, the Council requires institutional investors to publicly disclose the voting records for each investee company on an individual agenda item basis. Following this revision, investment trust settlor companies which have accepted the Code disclose company-specific voting in addition to aggregating the voting records for each agenda item.

(Note) Japan’s Stewardship Code was first formulated on February 26, 2014. Intended to promote the sustainable growth of companies, the Code presents the principles necessary to encourage a wide range of institutional investors to appropriately discharge their stewardship responsibilities through constructive dialogues with the investee companies. The Code, which consists of seven principles, is not legally binding. Institutional investors may decide whether to accept it, provided that they give a reason for not accepting it (“Comply or Explain” approach).



6 Sale of Securities Investment Trusts

6 1 Proliferation of Investment Trusts, and Basic Approach to Sales

Although investment trusts are designed to lower the risks involved with investment in securities, etc. to the greatest extent possible, the investment principal is not guaranteed and the dividends are not fixed. Some among the many types of investment trusts pursue returns while retaining an equal or even higher level of risk than for regular stock investments.

Pursuing higher returns always involves higher risks. Explaining these features accurately so that non-institutional investors can fully understand them is very important in order to promote the healthy spread of investment trusts. It is also important to have such investors understand the basic scheme of investment trusts, such as that when a dividend is paid, the base value will drop by an equivalent amount, and that all or part of the dividends may be regarded as a partial refund of principal. In addition, the product characteristics of investment trusts vary with each fund. Therefore, the distributor must provide sufficient information in order for investors to make independent investment decisions. These are the most important functions of the distributor.

Below, we will take a concrete look at the regulations and practices, etc. regarding the sale of investment trusts. However, the statements below are made in connection with publicly offered securities investment trusts (investment trusts under instructions from the settlor) (partially mentioning matters pertaining to foreign investment trusts), and it is necessary to take note that different rules apply in regard to the sale of other investment trusts and there are also many areas that differ widely in practice, etc.

6 2 Regulations, Etc. Concerning Sales

In the sale of investment trusts, in order to firmly establish the principle of investor self-responsibility, it is absolutely vital that investors are given a full explanation of the product characteristics of the investment trusts and make an informed decision to invest. Solicitations and advertisements must also be conducted in an appropriate manner. For this reason, the following regulations have been established with respect to the sale of investment trusts:

(1) Preparation of Investment Trust Explanatory Documents (Prospectuses)When selling an investment trust, the investment trust settlor company, which is the issuer of

the beneficiary certificates, must prepare a prospectus (FIEA, art. 13, para. 1; for details, see 8-1 “(1) Issuance Disclosure Under the FIEA”).

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Section 6. Sale of Securities Investment Trusts


(2) Delivery of the Investment Trust Explanatory Document (Prospectus) and Document to Be Delivered Prior to Conclusion of ContractThere are two types of investment trust explanatory documents (prospectuses); one that must

delivered in advance of, or at the time of, the purchase of units in an investment trust (investment trust explanatory document (delivery prospectus)) (FIEA, art. 15, para. 2), and one that must be delivered immediately if a demand is made at or before the time of purchase (investment trust explanatory document (demand prospectus)) (FIEA, art. 15, para. 3). If the advance consent of the investor is obtained, a document containing the said prospectus can be provided through methods employing a computer or other media provided for by Cabinet Office Ordinance in lieu of delivering a physical prospectus (Internet homepage, electronic mail, etc.). In this case, the said prospectus is deemed to have been delivered (FIEA, art. 27-30-9).

In addition, as the sale of investment trusts falls under the execution of a contract for a financial instruments transaction as provided for in the FIEA, the distributor shall prepare a document to be delivered prior to conclusion of a contract and deliver the document to be delivered prior to conclusion of a contract to an investor upon having such investor acquire investment trusts (FIEA, art. 37-3, para. 1, main clause); provided, however, that in practice, because the sale of investment trusts requires the delivery of a prospectus, the prospectus stating all or part of the matters to be stated in the document to be delivered prior to conclusion of a contract is delivered together with a supplementary document stating matters to be stated in the document to be delivered prior to conclusion of a contract that are not covered in the prospectus (FIEA, art. 37-3, para. 1, proviso; FIBCOO, art. 80, para. 1, item 3, and para. 5).

(3) Duty to Explain Under the Financial Instruments Sales ActThe Act on Sale, etc. of Financial Instruments (hereinafter the “Financial Instruments Sales

Act”) imposes on financial instruments distributors the duty to explain to customers material matters such as the risks, etc. pertaining to financial instruments, and the same law also applies to investment trusts (for details, see Volume 1, “Chapter 3, Laws Relating to Solicitation and Sales of Financial Instruments”).

The following are examples for reference of investment trust explanatory documents based on the Financial Instruments Sales Act.

˂Example of an investment trust with main investment targets ranging from shares to ordinary bonds, both on a yen basis and a foreign currency basis˃　・ This investment trust invests mainly in domestic and foreign shares and

bonds. Because the base value of this investment trust rises and falls depending on the effect of the price fluctuations of the included shares and bonds and exchange rate fluctuations, etc., it is possible that it will fall below the invested principal. Also, it is possible that it will fall below the invested principal due to changes in the management and financial circumstances of the issuers of the included shares and bonds and changes in external evaluations of these matters, etc.



　・�This investment trust mainly targets domestic and foreign shares and bonds for investment. A loss may be incurred as a result of a decline in the base value due to the effect of price drops in the included shares and bonds (concerning foreign currency based securities, there will also be effects from fluctuations in exchange rates), and deterioration, etc. of the credit circumstances of the issuers of these shares and bonds (from the Investment Trusts Association, Japan’s “Guidelines Concerning Investment Trust Settler Companies’ Obligation to Explain in Accordance With the ‘Financial Instruments Sales Act’”).

If it is a fund with a closed period (no cash out period), in addition to the above, it is necessary to explain, “please note that during the closed period, it is not possible to cash out of the fund,” etc.

The Financial Instruments Sales Act states that regarding the timing of explanations of material matters, the explanation is to be made “during the period until the sale of the financial instruments is made,” and in the case of a sale of an investment trust it is appropriate to interpret this as meaning during the period until entering into the contract. It would appear that if a customer continues to make purchases into the fund after an explanation of material matters has been given, and the customer appears to continue to maintain an awareness of the material matters, it would not be necessary to make an explanation at the time of selling a fund for which the material matters to be explained to a customer are the same. Nevertheless, an explanation should be given if requested by that customer. Also, it is desirable that sales of funds that are not well known or that are thought to have a complicated and high-level structure be handled cautiously, and it is thought that consideration should be given to providing an explanation that corresponds to the nature of the product, such as by providing a more meticulous explanation.

(4) Explanation on Expenses Payable by Customers and Dividends, and Measures to Confirm Customers’ Understanding of Currency-Selected Investment TrustsGiven that investment trusts are instruments that are solicited and sold to a broad range of

customer groups, including ordinary customers who do not have sufficient expert knowledge and experience, it is important to conduct solicitation that is appropriate according to the customer’s knowledge, experience and investment intention. Therefore, distributors of investment trusts must pay particular attention to the following points (Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc., IV-3-1-2(4)):

(i) With respect to expenses payable by customers (excluding professional investors; the same applies in (ii) and (iii)) such as sales commissions, the distributors must explain the following matters in an easily understandable manner upon soliciting them to purchase investment trusts:(a) The rate of sales commissions for the investment trust for which

customers are solicited, and the amount of sales commissions in

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accordance with the purchase price (if such amount cannot be fixed at the time of the solicitation, an estimate thereof);

(b) The system wherein the rate of sales commissions payable per year by customers gradually declines as the period of their holding of the investment trust becomes longer (providing examples such as changes in the annual rate by period of holding (one year, three years, five years)); and

(c) Expenses payable by customers after purchasing the investment trust for which they are solicited (trust fees (in the case of an investment trust managed in the form of a fund of funds, the actual rate of expenses payable including the management costs for the underlying fund), the amount of a load, etc.).

(ii) With respect to dividends on investment trusts, the distributors must explain to customers, in an easily understandable manner, that all or part of the dividends may be regarded as a partial refund of principal.

(iii) Given that currency-selected investment trusts involve not only a risk that the price of the invested asset will fluctuate but also the complex risk of currency fluctuation, when entering into a contract with a customer who has no experience in investing in currency-selected investment trusts, the distributors must take measures, such as receiving a written confirmation from the customer to the effect that he/she has understood the product characteristics and risk profile and keeping such confirmation.

Chart 3-7Dividends Regarded as Partial Refund of Principal, and Dividends Not Regarded as Such

* ** When an investor of an additional offering type stock investment trust receives an amount as

partial refund of principal, the investor’s separate principal for the future will be as calculated by deducting such amount of partial refund from the investor’s previous separate principal (for details, see 7-6 “(1) Separate Principal, Ordinary Dividends, and Refund of Principal (Special Dividends) of Additional Offering Type Stock Investment Trusts”).

Dividends

Dividends part of which are regarded as partial refund of

principal

Dividends all of which are regarded as partial refund of

principal

Dividends none of which are regarded as partial refund of

principal

Base value before distribution

Principal acquired by the investor (separate principal)

Base value ex-dividend


Dividends


Principal acquired by the investor (separate principal)

Partial refund of principal

Partial refund of principal


Dividends

Principal acquired by the investor


(separate principal)

The dashed arrow represents the dividend drop.



When soliciting customers to invest using the NISA programs (the general-type NISA, Junior NISA, and Dollar-Cost Averaging NISA), it is necessary to provide an appropriate explanation in a timely manner where necessary regarding the fact that refunds of principal (special cash distributions), which are paid as dividends from investment trusts, are originally tax-exempt and do not stand to benefit from the NISA programs (Points of Attention upon the Opening of Account, Solicitation or Sale, etc. under the NISA Programs (Guideline)” (NISA Promotion and Liaison Association).

(5) Introduction of the System of Notification of the Total Return on Investment TrustsAs repeatedly mentioned earlier, because the base value is always fluctuating, the dividend

level does not represent the investment trust’s earning. When investors intend to ascertain the profit and loss they have gained or incurred from investments in investment trusts, they need information regarding the total return. The total return can be calculated by taking into account various factors such as the base value at the time of acquisition of investment trusts by the investors, the base value at the time of cashing out if the investment trusts are partially cashed out, the base value as of the base date for calculation of profit and loss, and the total amount of dividends received. From this standpoint, the Japan Securities Dealers Association decided to introduce a system whereby companies which are Association Members and sell investment trusts are required to notify their customers of the total return on the investment trusts they have purchased. This total return notification system was put into effect as of December 1, 2014, and has been applicable to publicly offered stock investment trusts (including foreign investment trusts and foreign investment corporations, with some exceptions) to be purchased by customers since the same day. The total return is indicated in terms of the amount of money, instead of the percentage. The notification should be made at least once each year on a base date as determined by the distributors.

(6) Duty to Explain upon Soliciting a Switching of FundsIn the event of soliciting offers to make acquisitions in a fund at the time of cashing out

another fund (excluding MMFs, MRFs, etc.) (soliciting a switching of funds), a financial instruments business operator, etc. must explain material matters pertaining to the said switching of funds (FIEA, art. 40, item 2; FIBCOO, art. 123, para. 1, item 9). Solicitation of short-term switching of investment trusts does not always help customers to build their assets stably and efficiently because such switching requires an additional payment of sales commissions, while it could lead to cashing out regarding a number of investment trusts within a short period of time, hindering efficient management and resulting in a decline in the investment results (Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, Etc., IV-3-1-2(5)).

A “switching of funds” here means to cancel in part, or withdraw or sell the investment equity of an investment trust that is currently held, or to order the same, etc., and also commit an act of soliciting a customer to acquire, purchase or order, the same, etc. in another investment trust, etc. Acts of soliciting the cashing out and acquisition as a combined set would constitute this

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type of activity.Examples of material matters that should be explained include: 1) the form and status of the

investment trusts; 2) the status of the investment trust to be canceled (profit/loss estimate, etc.); 3) costs for the switching of funds (cancellation fee, sales commission, etc.); and 4) matters concerning preferential treatment for switching (see 7.5 “Redemption”). It should be noted that among these matters, an explanation of costs for the switching of funds must cover the rates of the respective fees as well as the amounts of the fees in accordance with the amount of cashing out or the purchase price (if these amounts cannot be fixed at the time of solicitation for switching, an estimate thereof).

Using the NISA programs (the general-type NISA, Junior NISA, and Dollar-Cost Averaging NISA), income tax, etc. is not imposed on the dividend income, capital gains, etc. arising from listed shares, etc. purchased by investors within the tax exemption quota. However, the portion of the tax exemption quota already used for purchases of listed shares, etc. cannot be used again for subsequent purchases even after investors sell the purchased shares, etc. Therefore, users of the NISA programs may not be able to fully enjoy the benefits of the programs if they intend to employ investment techniques such as the switching of funds at short intervals. With this in mind, when soliciting customers to invest under the NISA programs, it is necessary to explain the investment scheme and propose appropriate financial instruments in light of the purpose of the programs (NISA Promotion and Liaison Association, “Points of Attention upon the Opening of Account, Solicitation or Sale, etc. under the NISA Programs (Guideline)”).

(7) Regulations on Solicitation and Sale of Leveraged Investment Trusts and Complex Investment TrustsThe meaning of the terms “leveraged investment trusts” and “complex investment trusts

(including knock-in investment trusts; hereinafter the same applies in (7))” are as defined in 3-12 “Monthly-Paid Type, Currency-Selected Type, Leveraged Investment Trusts, Complex Investment Trusts Similar to OTC Derivatives Transactions, and Knock-in Investment Trusts.”

Among these types of investment trusts, when soliciting sale of leveraged investment trusts to customers who are individuals, an Association Member must establish the solicitation commencement standards, and must not solicit customers who do not meet such standards (JSDA Investment Solicitation Rules, art. 5-2).

With regard to complex investment trusts, the following regulations are imposed in addition to regulations requiring the establishment and application of solicitation commencement standards that are the same as those relating to leveraged investment trusts (JSDA Investment Solicitation Rules, art. 6-2 and art. 8, para. 3):

(i) Delivery of an alert document (containing an alert to associated risks and information on the dispute resolution organization);

(ii) Provision of an explanation on the matters referred to in (i) in a manner and to an extent necessary to enable the customer to understand such matters in light of the knowledge, experience, and assets of the customer and the purpose of entering into the contract; and

(iii) Collection of a confirmation document from the customer.



Knock-in investment trusts, which are a type of complex investment trusts, are subject to tighter disclosure rules than those for other types of funds with regard to the disclosure in materials used for sales, etc., investment management reports, and websites of investment trust settlor companies, in addition to the regulations on solicitation and sale (for details, see 3-12 “Monthly-Paid Type, Currency-Selected Type, Leveraged Investment Trusts, Complex Investment Trusts Similar to OTC Derivatives Transactions, and Knock-in Investment Trusts”).

(8) Measures to Prevent Mistaking Investment Trusts for Savings Accounts, Etc.If financial institutions that handle savings accounts, etc. which guarantee the principal will

sell investment trusts, an explanation must be provided to the customer by delivering written materials and through other appropriate means based on the customer’s knowledge, experience, and assets, in order to prevent investment trusts being mistaken for savings accounts. Specifically, it is necessary to explain the following matters (JSDA Investment Solicitation Rules, art. 10, para. 1 and para. 2):

(i) An investment trust is not a savings account, etc. or an insurance policy;(ii) An investment trust is not subject to protection of the Deposit Insurance

Organization of Japan and the Non-Life Insurance Policyholders Protection Corporation;

(iii) Investment trusts (that are not purchased at a financial instruments business operator) are not covered by an investor protection fund;

(iv) Investment trusts do not guarantee return of principal;(v) Parties to the relevant contracts (i.e., the contracts under which the bank or

insurance company conducts a sale of the investment trust while the investment trust settlor conducts the establishment and management of the investment trust, and investment of the investment trust property, etc.); and

(vi) Other matters that may be deemed to be helpful in preventing mistaking investment funds for savings accounts, etc.

Furthermore, when handling investment trusts in its business outlet or office, the financial institution must display the matters set forth in (i) to (iv) above at a place where the customers who use the counter for investment trusts can easily see these displayed matters from that counter. However, such matters may be displayed at a place other than the place specified above if the financial institution provides the explanation mentioned above to the customer before handling the investment trusts and delivers or presents a document containing the explanation (including showing such document on the screen of a tablet or other device) by the time of executing the contract (JSDA Investment Solicitation Rules, art. 10, para. 3).

(9) Regulations Concerning AdvertisingA distributor or investment trust settlor company shall clearly and accurately represent the

following matters upon making advertisements or similar acts regarding investment trusts (FIEA,

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art. 37, para. 1; FIEA Enforcement Order, art. 16; FIBCOO, art. 72, art. 73, para. 1 and para. 2, and art. 76):

(i) Trade name or firm name of the distributor and/or investment trust settlor company;

(ii) Registration number of the distributor and/or investment trust settlor company;

(iii) Matters concerning fees, remuneration and other consideration;(iv) That the customer may suffer a loss of principal, the reason thereof and the

index as the cause thereof (to be represented in a size not extremely different from the letters or numbers of the largest size);

(v) Facts that are disadvantageous to customers with respect to material matters; and

(vi) That the distributor and/or investment trust settlor company are members of the financial instruments firms association (which is related to the content of the relevant business) and the name of the said association.

Premiums and other goods shall display the following or shall be offered together with other goods displaying the following (FIBCOO, art. 72, item 3):

(i) Name of the fund (ordinary name) or the type thereof;(ii) Trade name, firm name or ordinary name of the distributor and/or investment

trust settlor company (to be represented clearly and accurately);(iii) That the customer may suffer a loss of principal, the reason thereof and the

indicator as the cause thereof (to be represented clearly and accurately in a size not extremely different from the letters or numbers of the largest size); and

(iv) That the document to be delivered prior to conclusion of a contract or the prospectus (in cases a document is delivered together with the prospectus, the prospectus and such document) shall be read sufficiently (to be represented clearly and accurately).

In addition, the Japan Securities Dealers Association has established provisions stipulating conduct that is prohibited for Association Members who are distributors with respect to advertising, etc., and requires the mandatory appointment of an advertising examining officer when producing advertising, etc. with such officer being responsible for examining whether or not the said advertising in fact violates the prohibition provisions (JSDA Advertising Rules, art. 4, para. 1 and art. 5, para. 1).



6 3 Unit-Type Investment Trusts

(1) OfferingsUnit-type investment trusts raise funds for limited periods of time ranging from

approximately two weeks to one month. The distributor receives application money from investors during the offering period, and on the investment trust establishment date (fund establishment date), the collected funds are entrusted all together as investment trust property to the trustee company.

(2) Offering (Application) Price, Offering (Application) UnitWhile the principal price per unit (face value) is decided on a per fund basis, in the case of

unit-type investment trusts, it is generally JPY10,000 per unit. Acquisition applications are raised from investors at this principal price per unit. The offering (application) unit is, in principle, set by the distributor (thus, even if it is the same fund, if the distributor is different there are cases in which the offering unit is different; however, for funds that are exclusively for large-scale investors, there are cases where the offering unit is provided for in the basic terms and conditions of an investment trust). The offering unit is decided, for example, as being “in increments of one unit of at least 10 units” (if it is JPY10,000 per unit, the offering units would be in JPY10,000 units with the minimum being JPY100,000).

(3) Offering (Sales) CommissionsThe distributor determines the offering (sales) commission. (Even with respect to the same

fund, if the distributor differs, there are cases where the offering commission will differ.)(Note) In the case of funds where the primary investment target is shares, it is normal for the offering commission to be approximately JPY100 to JPY300 per each JPY10,000 of principal.

Collecting the offering commission can take the form of an inclusive or separate method.In the case of the separate method, if a two percent commission is levied on each JPY10,000

of principal, and then consumption tax, etc. (national and local consumption taxes; hereinafter the same; the consumption tax rate is set at 10% as a numerical example in this (3)) is added to the said offering commission, JPY220 per JPY10,000 of principal is paid by the investor aside from the investment amount.

In the case of the inclusive method, an amount that is the offering commission with consumption tax, etc. added is levied on the sales price. Although the distributor determines the offering commission, if the upper limit of the offering commission that is determined by each distributor is JPY330 per JPY10,000 of principal, JPY324 per JPY10,000 of principal, which corresponds to the said upper limit amount and the consumption tax, etc. on that amount, is deducted from the trust assets on the date that the trust is established and is paid to the distributor. Thus, the funds which are the basis of the investment are in this case JPY9,670 per JPY10,000.

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(Note) Concerning management fees (trust fees): It is necessary to note that fees on investment trusts, aside from offering (sales)

fees, include management fees (trust fees). Management fees (trust fees) are fees for carrying out the investment and management of the investment trust property, and are received by the investment trust settlor company and the trustee company from the investment trust property. From the point of view of the investor, they have the same economic effect as commissions.

The management fees (trust fees) are provided for in the basic terms and conditions of an investment trust, and they are calculated at a fixed rate on a per diem basis and are deducted daily from the investment trust property.

Investment trust settlor companies pay one part of their own fees to the distributors as commissions for acting as the investment trust settlor company’s agent in carrying out administrative work such as the distribution of earnings and the payment of cancellation money (administrative agent commission).

6 4 Additional Offering Type Stock Investment Trusts

(1) Initial Offering and Additional OfferingIn offerings for additional offering type stock investment trusts, there are initial offerings

and additional offerings (continuous offerings). The initial offering is an offering carried out in order to newly establish the fund, and as with unit-type investment trusts, funds are raised for a limited period of approximately two weeks to one month. The distributor receives application money from investors during the offering period, and on the investment trust establishment date (fund establishment date), the collected funds are entrusted all together as investment trust property to the trustee company. This point is also exactly the same as with unit-type investment trusts.

As opposed to this, additional offerings (continuous offerings) are offerings carried out in the form of adding capital to the fund after the fund is established, and after the fund’s establishment date, in principle, additional funds are raised every business day during the trust period (the continuing period of the fund). However, concerning funds that invest in foreign assets, etc., where the market on which most of the investment target assets are traded is closed, there are cases where applications for acquisition will not be accepted for the same date as the date on which the said market is closed.(Note) Also, there are funds that limit the additional offering period to a specific period of time (limited additional offering type).

Because the trust is added to by additional offerings and new beneficiary certificates are issued, legally it is an “offering,” but because it is easy to distinguish from the initial offering and because from the point of view of economic practice it is similar to the buying and selling of



shares on a secondary market, in practice, it is called “buying” or “purchase.” Likewise, a request to cash out by cancellation of the trust or a repurchase of the beneficiary certificates, in practice, is called “selling” or a “sale.”

(Note) This kind of day is provided for because even if additional establishments are accepted, there is the possibility that the investment purpose will not be achieved and that the blind system cannot be adequately maintained on the date the market is closed and it is not possible for the fund to purchase assets that reflect the value of the added capital (for details, see 6-4 “(7) Significance of the Blind System”).

(2) Offering (Application) Price, Offering (Application) UnitAlthough the principal price (face value) per one unit is decided on a per fund basis, in

additional offering type stock investment trusts, most are JPY1 per unit. In the case of additional offering type investment trust, although the initial offering raises funds at, for example, JPY10,000 per 10,000 units, because additional offerings are offered at the offering (application) price that is based on the base value, offering (application) units are determined by either:

(i) The investor specifying the number of units it will apply for;(ii) The investor specifying the amount of application money; or(iii) The investor specifying the application proceeds (the aggregate amount of the

application price, sales commission and consumption tax, etc. levied on the sales commission).

In principle, it is the distributor that determines offering units. (Thus, even if it is the same fund, if the distributor is different, there are cases in which the offering unit is different. However, for funds that are exclusively for large-scale investors, there are cases where the offering unit is set forth in the basic terms and conditions of an investment trust.) The offering unit is decided, for example, as being “in one unit increments of at least 100,000 units or in one yen increments from at least JPY100,000.”

(3) Offering (Application) Price for Additional OfferingsWhile the offering (application) price for additional offerings stock investment trusts is

normally the base value, for funds that collect a load upon additional establishments, it is the sales base value, which is the base value to which the amount of load is added.(Note) The previous day’s base value (for funds that collect a load at the time the additional offering is made, the sales base value) is published in the Nikkei’s morning edition.

In normal cases, the base value that is applicable to the offering price is the base value on the application date for funds that primarily target domestic assets for investments, and the base value on the business day that follows the application date for funds that include foreign assets it is the base value on the business day that follows after the application date (for details, see 6-4 “(7) Significance of the Blind System”). In the case of a fund of funds, the base value is determined as being that of two business days after the application date or thereafter. The computation date for

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the base value that is applicable to the offering price is sometimes called the base value application date.

(Note) Where additional establishments are carried out in a fund or where there is a request to cash out, the fund will purchase assets that correspond only to the additional funds or will comply with the investor’s request to cash out by selling held assets. In addition to the costs generated by such transactions, where the liquidity of the included target assets is low, such transactions have an impact on the market and it is possible that the fund will end up bearing a large risk. In this type of fund, in order to maintain the fairness of the cost and risk burden between investors who have purchased additional establishments and beneficiaries who already hold the fund or between investors who cease being beneficiaries due to withdrawal from the fund and the beneficiaries who continue to hold the fund, upon additional establishments or cashing out, the fund will use a system of collecting a load that is added to the trust assets, in which an additional sum is collected or the amount discharged from the fund is reduced at the time of additional establishment or cancellation.

(4) Offering (Sales) CommissionsThe offering (sales) commission is set by the distributor (even if it is the same fund, if there

are different distributors, there are cases where the offering commission will differ). For funds that mainly invest in shares, it is normal to levy approximately two to three percent of the offering price as the offering commission. However, recently, funds that do not charge any offering commissions (no-load funds) have been increasing. No load is a requirement of funds for Dollar-Cost Averaging NISA.

(5) Application Closing TimeIn an additional offering type stock investment trust, the investment trust settlor company

must require the distributor to comply with a closing of receiving customer application requests (buy orders), of no later than 3:00 p.m. The same is true for cancellations (including repurchases) (JITA Regulations Concerning Conduct of Business, Etc. by Full-Members, art. 8, item 1; for details, see 6-4 “(7) Significance of the Blind System”). The application closing time is set for each fund. For most funds it is the same time as the time that trading ends for the exchange’s trading session. However, it is necessary to note that some funds, which have a special structure such as the bull/bear type or funds that include assets that have low liquidity (i.e., that include assets that are difficult to turn into cash), have an even earlier acceptance closing time (e.g., by 2:00 PM). Applications that are made after the acceptance closing time has passed will be handled the next business day.

(6) Delivery of Additional OfferingsFor funds that include foreign assets, because the offering (application) price in an additional



offering is usually based on the base value for the day following the application date, it is not clear on the application date. Also, the offering price for funds that mainly target domestic assets for investment is not clear at the time of application. This is because, while the application closes on or before the end of trading for the securities exchange’s trading session, the offering price for such funds are based on the base value for the application date, which is calculated based on the closing prices of the exchange for that day. This system is called the blind system.

For this reason, in the case of additional establishments for a stock investment trust, when taking buy orders (applications for additional establishments), the application payment is received based on a rough estimate and the payment is adjusted on the delivery day. An example of how the application payment is calculated is described below. The delivery for funds that mainly target domestic assets for investment is often the third business day after the contract date, and for funds that include foreign assets it is often the fourth business day. In addition, in a case of a fund of funds, this is deferred by a further one or two business days.

Some distributors do not take an estimated payment from customers who have a certain amount of deposited assets. Some securities companies that handle money reserve fund accounts allocate MRF cancellation money to the acquisition application payment.

<Example of calculation of the acquisition application price>The case where there is an additional establishment of 50,000 units of an additional

offering type stock investment trust (without a load at the time of establishment) with a base value (per 10,000 units) of JPY12,000 (offering commission rate and consumption tax rate are respectively set at 2% and 10% as numerical examples):

Acquisition application amount = JPY12,000 × 50,000 units / 10,000 units = JPY60,000 Commission = acquisition application amount × commission rate = JPY60,000 × 2% = JPY1,200 Consumption tax, etc. = commission × consumption tax rate = JPY1,200 × 10% = JPY120 Acquisition application price = acquisition application amount + commission + consumption tax, etc. = JPY60,000 + JPY1,200 + JPY120 = JPY61,320

(7) Significance of the Blind SystemThe base value of an investment trust, for domestic assets, is calculated based on that day’s

domestic exchanges’ closing prices. Thus, for example, for an index fund that aims to link to a share price index for domestic shares, investors can calculate the approximate base value at the time when trading ends on the domestic exchanges. In such circumstances, suppose that applications for the acquisition of and cashing out of investment trusts were allowed even after the domestic exchanges close. It would then likely be impossible to purchase the share except by paying an elevated price, because participants in the share market would not be able to trade on the market until the morning of the next day. Nevertheless, by purchasing an index fund it would be possible to participate indirectly in the market at the base value calculated on the basis of the

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lower price that was available prior to the news becoming known, and then cashing out the fund at the higher base value on the following day to gain a profit. On the contrary, if it were bad news, although participants in the market would only be able to sell shares only at a share price that has fallen, holders of an index fund would be able to cash out the investment trust at the base value calculated on the basis of the higher price that was available prior to the news coming out.

Also, in calculating the base value of investment trusts, foreign assets are calculated based on the closing price of the previous day’s foreign markets. Thus, if the date used to apply the base value for funds that include foreign assets were to be the application date itself, this would enable investors to purchase investment trusts at the base value calculated on the basis of a lower price and cash out investment trusts at the base value calculated on the basis of a higher price than by participating in the market, since investors can calculate an approximate base value at the time of application.

The profit obtained through this kind of trading is called a free lunch (eating for free), and it harms the fairness of securities trading. Investment trusts have established systems such as base value application dates, application closing times, and the suspension of the acceptance of applications on days when foreign markets, etc. are closed, and the blind system was adopted in order to prevent this kind of trading and to maintain the fairness of trading on the securities and financial markets.

When selling investment trusts, it is necessary to fully understand these points and not to neglect consideration so that the fairness of trading is not harmed.

6 5 Additional Offering Type Bond Investment Trusts

Initial offerings of additional offering type bond investment trusts are also the same as unit-type investment trusts, so the following demonstrates the handling of additional offerings.

(1) Offering PeriodFor additional offering type bond investment trusts, additional establishments are accepted

only at the base value of the closing date (for details, see “3-5 Stock Investment Trusts and Bond Investment Trusts”). Unlike the case of additional type stock investment trusts, therefore, a specific offering period is established that ends on the closing date and funds are raised during that period in the same manner as with the original offering. The distributor receives subscription payments from investors during the offering period, and on the additional trust establishment date (the day after the closing date), the collected funds are entrusted all together as investment trust property to the trustee company.

However, in the case of funds that close on a daily basis (MMF and MRF), because closing is carried out every day, offerings are carried out continuously every business day. Although the business day following the day on which the acquisition application is received is the fund acquisition day in a normal case, for MMF and MRF, the fund acquisition day for acquisition



applications that were received before a specific time (e.g., noon) is the same as the day on which the application was received. As of the end of September 2019, there was no MMF on the market.

(2) Offering (Application) Price, Offering (Application) UnitThe principal price (face value) per unit of a bond investment trust is decided on a per fund

basis and in the normal case is JPY1 per unit.The offering (application) price is the base value on the closing date (the last day of the

offering period). For bond investment trusts, where the base value on the closing date exceeds JPY10,000, because all of the portion that exceeds JPY10,000 must be distributed, as long as the principal does not suffer a loss, the base value of JPY10,000 is the offering (application) price.

However, the offering (application) price for the daily closing type is the base value of the day before the acquisition day, but because closing is carried out every day and all proceeds are distributed, and moreover, because the separate principal system has not been introduced (for details, see “7-6 Taxation of Dividends, Cashing Out and Redemptions”), the result is that offering price will always be JPY10,000, and the offering cannot be made if the base value falls under 10,000.

The offering (application) units are normally determined separately for each fund. The offering unit is decided, for example, as being “increments of 10,000 units and a minimum of 10,000 units, or increments of JPY10,000 and a minimum of JPY10,000.” The offering unit for daily closing funds is one unit (yen) at a minimum of one unit (yen).

(3) Offering (Sales) CommissionsUntil now, there have been no funds that levy an offering (sales) commission. However, the

so-called long-term bond trusts that were launched in 1961 levy a cashing out commission at the time of cashing out.

6 6 ETF

The manner in which ordinary investors acquire ETFs (listed investment trusts) differs from that described up to here, and is done in the same manner as for listed shares. Purchase orders can be made as limit orders or market orders, and listed investment trusts can be bought on margin. The transaction unit is decided on a per fund basis, such as 10 units or one unit. Commissions are determined independently by each distributor.

In the case of in-kind contribution type ETFs, large investors such as securities firms and institutional investors can contribute a portfolio of physical shares to the fund selected so that the performance of the underlying shares of the ETF mirrors the relevant stock index in the case of an ETF that is linked to the stock index, and acquire (establish) beneficiary certificates.

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6 7 Handling of Foreign Investment Trusts

Foreign investment trusts are established and managed according to foreign laws and regulations. There are two types of foreign investment trusts: contractual type and corporate type. When a foreign investment trust is sold in Japan, it is governed by the FIEA and the ITA, and it is subject to the same restrictions and regulations as investment trusts established in Japan. Like Japanese investment trusts, the handling of primary and secondary offerings of foreign investment trusts must be accompanied by a prospectus.

When an order from an investor is first received to trade foreign investment trust securities, the agreement pertaining to foreign securities transaction accounts must be delivered, and an application to establish a transaction account must be received from the investor pursuant to the same (JSDA Foreign Securities Rules, art. 3, para. 2). The agreement pertaining to foreign securities transaction accounts shall set forth matters concerning the commissioned execution and processing of orders, custody of securities, and payment/receipt of monies, etc. (id., art. 3, para. 5).

Of course, at the solicitation, whether the investment matches the investor’s intention, investment experience, funds available, etc. must carefully be taken into account (id., art. 5). Like Japanese investment trusts, investment management reports must be delivered to investors at the end of each fiscal year for foreign investment trusts (ITA, art. 59).

7 Calculation of Base Value, Closing, Dividends, Cashing Out and Redemption of Securities Investment Trusts

Next, let us turn to the calculation of base values, closings, dividends, cashing out and redemptions of investment trusts. Please note that the following description concerns a publicly offered securities investment trust (investment trust under instructions from the settlor). Differing regulations apply to the calculations of the base value, closings, dividends, cashing out and redemptions of other investment trusts, and caution is necessary because there are many areas that are broadly different in practice, etc.

7 1 Calculation of Base Value

(1) What Is the Base Value?The base value is the value of the investment trust (for details, see “2 Concept of Investment

Trusts”), and, in principle, purchases of investment trusts and cashing out of investment trusts are conducted at the base value.

In principle, the shares and bonds, etc. that are included in the portfolio of the investment



trust are assessed at market value to obtain the total value of the assets. The total liabilities are then deducted from the total assets. This remainder is then divided by the number of units of beneficial interests (which in many cases is represented in units of 10,000), to obtain the base value. As a general rule, the base value is calculated on a daily basis.

The method of calculating the base value is stipulated specifically in JITA Investment Trust Accounting Regulations.

(2) Valuation of Assets in Portfolio(i) Principle Regarding Valuation of Assets in Portfolio

In principle, the assets in the portfolio are to be valued at market value. Market value here referred to means the price that can be recognized to have been formed in a fair manner based on the voluntary transaction or the intention of the transaction between a buyer and seller on an exchange or the over-the-counter market (JITA Investment Trust Accounting Regulations, art. 3, item 1). The method of valuing the assets is, in principle, to be conducted in a consistent manner (JITA Investment Trust Accounting Regulations, art. 3, item 2). Amendment of the method of valuing assets that seeks to a more favorable result is not permitted.

The most significant feature of investment trusts as a prominent product of market oriented indirect finance is that investors engage in transactions at a base value which has been calculated based on the market value that is determined in the market. For this reason, when evaluating the assets in a portfolio, the investment trust settlor company has a fiduciary duty to beneficiaries and is required to exercise the care of a prudent manager (JITA Investment Trust Accounting Regulations, art. 2).(ii) Valuation of Shares

In principle, domestic shares that are listed on a financial instruments exchange are evaluated at the closing price on that exchange on the calculation date of the base value. If there is no closing price on the calculation date, then, in principle, the evaluation will be made at the closing price on the date that is closest to the calculation date (provided that if the quotation price on the calculation date has fallen at least 10 percent when compared to the closing price on the most recent date, then the quotation price shall be used) (JITA Investment Trust Accounting Regulations, art. 6, para. 1, art. 8, para. 1 and para. 2).

Shares that are listed on a foreign exchange are, in principle, to be evaluated at the closing price on the most recent date for which it is possible to obtain knowledge on the calculation date of the base value on the relevant foreign exchange (JITA Investment Trust Accounting Regulations, art. 15).

Consequently, in the case of shares that have a continuous market price, in principle, for domestic shares the final price on the calculation date of the base value is to be reflected in the base value, while in the case of foreign shares the final price on the previous business day to the calculation date of the base value is to be reflected in the base value.(iii) Valuation of Bonds, Etc.

Bonds, etc. are to be valued at one of the prices of (a) the reference statistical prices for

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Section 7. Calculation of Base Value, Closing, Dividends, Cashing Out and Redemption of Securities Investment Trusts


trading (average values) that are published by the JSDA, (b) the price offered by a financial instruments business operator or a bank, etc. (excluding a sell quotation price), or (c) the price suggested by a price information company (JITA Investment Trust Accounting Regulations, art. 21, para. 1). Nevertheless, if a valuation amount cannot be obtained or if it is recognized that cause exists as a result of which the valuation amount obtained cannot be accepted as a market price, the investment trust settlor company shall make the evaluation at a valuation amount that it deems on the basis of reasonable grounds to be the market price, or shall consult with the trustee and make the evaluation at a valuation amount that both parties deem on the basis of reasonable grounds to be the market price (JITA Investment Trust Accounting Regulations, art. 21, para. 2).

Bonds, etc. that will be redeemed or will approach maturity within one year can be evaluated at the amortized cost method (accumulated amortization method) (JITA Investment Trust Accounting Regulations, art. 22, main text). In this event, if a discrepancy occurs between the market price and the price evaluated at the accumulated amortization method and if it is determined to be necessary in order to calculate an appropriate base value, the evaluation is to be promptly changed to the market price (JITA Investment Trust Accounting Regulations, art. 22, proviso).(iv) Foreign Exchange Rate Used in Converting Foreign Currency Denominated Assets

Into YenNormally, the base value of a Japanese investment trust is expressed in yen, and

consequently, in order to calculate the base value it is necessary to make a yen conversion of the valuation amount obtained pursuant to (i) or (ii) above, with respect to foreign currency denominated assets that are included in the portfolio. The foreign exchange rate that is used in this yen conversion is the rate that is calculated based on the mid-rate of the telegraphic transfer customer spot rate on the calculation date of the base value (JITA Investment Trust Accounting Regulations, art. 32, para. 1). In unavoidable situations such as if the customer rate is not announced, the rate will be determined using a valuation by the Self-Regulation Committee of the Investment Trusts Association (JITA Investment Trust Accounting Regulations, art. 32, para. 2). The customer rate is normally announced on the basis of the spot rate at 10:00 a.m., Japan time, but in cases in which there is substantial fluctuation in a single day the customer rate itself may ultimately be changed.

Consequently, in the case of foreign currency denominated shares and bonds that have a continuous market price, the final market price on the business day prior to the base value calculation date converted into yen at the customer rate on the base value calculation date is to be used in calculating the base value.(v) Valuation of Mother Fund and Cautions in the Case of a Fund of Funds

In the case of a family type fund, the valuation of a mother fund that includes a subsidiary fund (baby fund) is to be made at the base value on the base value calculation date (JITA Investment Trust Accounting Regulations, art. 25).

Funds that are included in the portfolio of a fund of funds are to be calculated using the same method as shares (only in the event that the component funds included are listed on an



exchange), or the base value that is announced by the asset management company, etc. of the relevant fund included in the portfolio, etc. (JITA Investment Trust Accounting Regulations, art. 24). For most funds of funds, the base value is calculated using the base value of the component funds on the business day preceding the base value calculation date. In this event, the base value of the fund of funds shall be the value that reflects the market price on the day which is two business days before the calculation date.

Thus, it is necessary to be aware that even in the case of funds that invest in the same investment targets, the market prices that are reflected in their base values, which are calculated on the same date, may differ in the time that these prices are included depending on whether the fund invests directly into shares or bonds, or through a mother fund, or through a component fund of a fund of funds.

7 2 Closing

The accounting period of an investment trust is prescribed for each fund in the basic terms and conditions of an investment trust. Accounting periods comprise various lengths, such as one year, six months, three months, two months (bi-monthly closing), one month (monthly closing), and one day (daily closing (MMFs and MRFs)). The investment trust settlor company closes the fund accounts on the last day of each closing period.

Similar to closing of the books for an ordinary company, fund account closing involves the preparation of a balance sheet, statements of income and retained profits, and accompanying notes (hereinafter the “financial statements”) for each fund as of the end of each accounting period, with the objective of clarifying the financial condition of the investment trust and the profit or loss for the term. In addition, funds that have a one year accounting period have an interim closing six months after the start of the period and must prepare the interim financial statements. Also, financial statements for funds with an accounting period of less than six months must be prepared every six months.

Based on the information contained in the financial statements, the investment trust settlor company then prepares an investment management report as required under the ITA (an investment management report must be prepared every six months for funds with an accounting period of less than six months).

The financial statements (or interim financial statements) prepared by the investment trust settlor company shall be audited by a certified public accountant or auditing corporation. The auditor will verify the market price of the securities as well as the fund’s securities transactions, interest income, dividends, etc. The audit will also focus on whether the investment trust settlor company’s internal control systems for all of its operations are functioning, and whether the fund is being managed in line with its objectives and investment policies.

The investment trust settlor company must submit its securities report together with these audited financial statements (or semi-annual securities report in the case of the interim financial

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statements) to the Director-General of the Local Finance Bureau within three months after the closing or interim closing is finished (for details, see “8. Disclosure for Securities Investment Trusts”).

7 3 Dividends Distribution

(1) Method of Determining DividendsThe maximum amount allowed for dividends is prescribed as follows in the rules of the

Investment Trusts Association, Japan (JITA Investment Trust Accounting Regulations, Book 5):(i) For a unit-type investment trust, at the end of an accounting period if the net asset

amount after subtracting expenses (hereinafter, the sum of management fees (trust fees) and other expenses) is equal to or larger than the principal, a dividend can be made up to the larger of the excess, or the amount of dividends, etc., and other income received during the term. If the net asset amount after expenses is less than the principal, dividends can be made up to the amount of dividends and other income received during the term.

(ii) For an additional offering type stock investment trust, the amount that may be distributed is the amount that is the sum of the total amount of dividends, etc. received after expenses plus the realized gains/losses during the term plus the valuation profit/loss at the end of the term minus expenses, and where a deficit has been carried forward from the preceding period, after compensating for the said deficit. In the case of an additional offering type stock investment trust, upon each additional establishment, an adjustment of gains/losses is carried out so as not to dilute the gains/losses per 1 unit.

(iii) In the case of an additional offering type bond investment trust, the entire amount of any excess over principal at the end of term is distributed.

Furthermore, in cases under (i) and (ii) above, the investment trust settlor company may determine the amount of any dividend, within the range of the distributable amount, in accordance with the fund’s dividend policy stated in the basic terms and conditions of an investment trust. When a distribution is made, the base value decreases by the dividend amount (dividend drop). In the case of government and corporate bond investment trusts, there are no distributions where the post-dividend drop base value results in a loss of principal. However, in the case of stock investment trusts (including those whose main placements are in government and corporate bonds), a cautious eye must be kept on distributions where the post-dividend drop base value may result in a decrease in principal (distributions that are equivalent to a repayment of principal).

(2) Payment of DividendsThe dividend amount is determined each closing date, and the investors receive this through

the distributor.The date on which dividend payments commence is normally stipulated in the basic terms



and conditions of an investment trust as a day designated by the investment trust settlor company within one month from the closing date, but payments are actually made four business days after the closing date, or thereafter. However, there are also many funds that allow investors to elect to reinvest their dividends, and in the case that an investor chooses to reinvest dividends, the distributor signs a cumulative investment contract with such investor. In this case, payment of the dividend is deemed to be the next business day, and after taxes are deducted from the said dividend, it is possible to reinvest by an additional entrustment at the base value of the day preceding payment (in other words, in principle, the closing date) (for details, see “7-6 Taxation of Dividends, Cashing Out and Redemptions”).

Finally, the statute of limitations for dividends is five years (ten years for redemption proceeds).

(3) Dividends and Fund Structure of Bond Investment TrustsAs mentioned above, in an additional offering type bond investment trust, all amounts

exceeding the base value on the closing date are distributed as dividends. Let us review this practice in relation to the structure of the fund.

In a long-term bond investment trust, new offerings are made once every month for the first year after initial inception, thereby creating twelve different funds. From the second year following establishment, monthly additions are made to each of the twelve funds. Additions are made on the day (generally the 20th day of each month) after the closing date of each month (generally the 19th day of each month). For each monthly closing, the full amount of income less expenses for the term is distributed, so that the base value immediately after closing will be the same as the initial principal, as long as there has not been a loss of principal. Thus, all subsequent additions can be made at the base value (JPY10,000), which is equal to the initial principal.

Next, let us look at MMFs and MRFs.The distinct feature of these funds is that they are closed every day (daily closing). With

daily closing, all daily gains such as interest from bonds in the portfolio and trading gains are distributed as the profit for the day, so that the base value following the closing will be equal to principal. This closing process is similar to that used for long-term bond investment trusts, except that it occurs daily and the fund can be offered each day at its principal amount. However, dividends are not paid to the beneficiaries daily. Instead, the dividend is accumulated as accrued dividends and is automatically re-invested at the end of each month. These funds invest mainly in medium-term bonds and short-term financial instruments in order to avoid the influences of market fluctuations as much as possible. As of the end of September 2019, there was no MMF on the market.

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7 4 Cashing Out

(1) Cancellation and RepurchaseThere are two methods by which an investor (beneficiary) who holds an investment trust may

cash out money from the fund during the trust period: cancellation and repurchase.Cancellation involves cashing out money by directly having trust assets liquidated for cash.

Repurchase involves having the distributor buy back the fund (the beneficiary transfers the beneficiary certificate to the distributor), and it is carried out once the investor makes a repurchase request.

(2) Cancellation Acceptance Date/Closed PeriodJapanese investment trusts accept cancellations every business day, in principle. However,

for funds that invest in foreign assets, etc., where the market on which most of the target investments are traded is closed, there are cases where an acquisition application dated the same day as the said market holiday will not be accepted.(Note 1)

Also, some investment trusts fix a closed period ahead of time in the basic terms and conditions of the investment trust, during which time cancellations are prohibited. The time during which cancellation is prohibited is called the closed period. Closed periods are intended to stabilize the invested funds.(Note 2) Examples of the length of closed periods are the first six months or one year following inception, or throughout the entire life of the trust, except at final closing.

(Notes) 1. This kind of day is stipulated because even if an attempt is made to sell the assets included in the fund in order to deal with investors’ requests for cashing out, if the market is closed and the assets cannot be sold, there is a possibility that a harmful effect on the fund’s assets will be unavoidable or it will not be possible to adequately maintain the blind system (for details, see 6-4 “(7) Significance of the Blind System”).

2. Even if it is a fund that provides for a closed period, basic terms and conditions of an investment trust will allow the beneficiaries to make cancellation or repurchase requests even during the closed period in certain circumstances. These circumstances include when the beneficiary dies, loses the greater part of its assets due to force majeure, becomes bankrupt, or becomes unable to maintain a livelihood due to illness. These basic terms and conditions of an investment trust also provide that the distributor will buyback the fund for reasons that correspond to the above.

(3) Limitations on Cashing Out, Deadlines for Accepting Requests to Cash OutWhere there are unavoidable factors such as a halt to trading on the financial instruments



exchange or a halt to foreign exchange trading, it is possible for investment trust settlor companies to suspend acceptance of cashing out (provisions in the basic terms and conditions of an investment trust and prospectus). This is because it would be impossible to handle an investor’s request to cash out when the market is halted, even if an attempt was to be made to sell assets that are included in the fund. In this sense, these limitations on cashing out seek to defend the fund when the market is in turmoil or other unforeseen events occur.

Requests to cash out sent to distributors of stock investment trusts shall not be accepted later than 3:00 p.m. (JITA Regulations Concerning Conduct of Business, Etc. by Full-Members, art. 8, item 1). This is for the purpose of maintaining the blind system (for details, see 6-4 “(7) Significance of the Blind System”).

Moreover, in many cases exposing investment trust property to a significant increase or decrease in net assets over a short period of time will affect the investment management and may cause adverse consequences to the remaining beneficiaries. From this perspective an investment trust settlor company is required to determine for each fund additional offering type investment trust a limit of the amount of cancellations that will be accepted at one time by a large subscriber as well as a certain amount that will require prior notice, in sufficient consideration of the size of the fund and its product characteristics, etc. With regard to a cancellation of a certain amount or more which requires a prior notice, such notice must be made to the distributor by 12:30 p.m. of the contract date (JITA Regulations Concerning Conduct of Business, Etc. by Full-Members, art. 9).

Since an MMF has product characteristics that make cash management even more important, the investment trust settlor company is required to engage in discussions with the distributor and endeavor to sell mainly to individual investors, as well as to provide a sufficient explanation concerning the importance of cash management at the time of sales. The investment trust settlor company is also required to discuss cashing out with the distributor, and to determine a limit on the amount of cancellations that will be accepted at one time from a customer as well to specify the amount for which prior notice will be required. With regard to a cancellation of a certain amount or more requiring a prior notice, the investment trust settlor company shall endeavor to have notice given by the distributor at least four days prior to the contract date (JITA MMF Management Regulations, art. 15). As of the end of September 2019, there was no MMF on the market.

(4) Cashing Out PriceIn the case of cashing out by cancellation request, in principle, the investment trust’s cashing

out price is the base value. However, for funds that levy a back-end load, the cashing out price will be the balance after deducting the load. Further, there are also funds that upon cashing out levy a performance fee (a management fee (trust fee) that is proportional to investment performance), and in this case, the said performance fee is also deducted. The price after these deductions is called the cancellation amount.

In the case of cashing out by repurchase request, for bond investment trusts it is the cancellation amount less the withholding tax. Although the situation is similar for stock investment trusts, an exemption from withholding at the source applies to stock investment trusts

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in normal circumstances (excluding cases such as when the distributor cannot immediately cancel the repurchased fund), and consequently, the cash value is the cancellation amount (for details, see “7-6 Taxation of Dividends, Cashing Out and Redemptions”).

The base value applicable to the cashing out price is usually the base value of the application date for funds that primarily invest in domestic assets, and for funds that primarily invest in foreign assets, it is the base value of the business day following the application date. In the case of a fund of funds, the base value is determined as of two business days after the application date or thereafter. As with offerings, the base value settlement date that is applied to the cashing out price is sometimes called the base value application date.

Regardless of the above, for funds that close daily (MMF and MRF), it is the base value of the day before the next business day after the date of receipt of the cashing out application (because closing is carried out also on holidays, the expression is not “the day of,” but “the day before the next business day”; this is the same in (5)) (provided that for some MRFs, when the cashing out is received in the morning, it is the previous day’s base value).

(5) Payment of the Cashing Out ProceedsFor funds that invest primarily in domestic assets, payment of the proceeds cashed out from

the fund by cancellation or repurchase normally occurs on the third business day after the date of receipt of the cashing out application. By contrast, for funds that include foreign assets, payment of the proceeds cashed out from the fund by cancellation or repurchase normally occurs on the fourth business day after the date of receipt of the cashing out application. However, in cases such as where the assets included in the fund cannot be easily liquidated, there are also funds that even further delay the payment period.

Regardless of the above, MMFs make payment from the following business day, and MRFs make payment on the day itself only in the case where the cancellation is accepted in the morning and the investor desires payment on that day (same day cancellation), but in all other cases payment is made from the following business day (provided, some MRFs make all payments on the following business day). For MMFs, simultaneously with the payment of cashing out proceeds, there is a payment of the dividends prior to re-investment that have been reported up to the day prior to the business day following the acceptance date of the request for cashing out.

Further, for MMFs and MRFs, “cashing” (meaning same day withdrawal) is allowed (depending on the distributor, there are also cases where cashing out is not handled). To cash out of MMFs, in order to make payment possible on the same day as the request to cash out, until payment of the cashing out proceeds is made on the following business day, it is possible for the distributor to lend an amount that corresponds to the cashing out proceeds (this is called a cashing out). Also, for MRFs, cashing out is possible with respect to requests for afternoon cashing out that will be paid the next business day (all requests to cash out MRFs that make all payments on the next business day). The upper limit for cashing out is JPY5,000,000 per fund (this may differ depending on the distributor) (the borrowing interest on cashing out is normally one day’s net distribution amount, and the cashing out proceeds are automatically allocated on repayment). As of the end of September 2019, there was no MMF on the market.



7 5 Redemption

Investment trusts are redeemed upon the expiration of the trust term prescribed in the basic terms and conditions of the investment trusts (redemption at maturity). However, it is also possible for the investment trust settlor company to renew the trust term at its discretion (extend the trust term).

Many investment trust funds, under the basic terms and conditions thereof allow redemption during the trust term when the investment trust property falls below a certain level (e.g., cases such as where the surviving number of units falls below 3 billion) (early redemption). Some funds allow early redemption after the fund management becomes stable subject to certain conditions (e.g., the base value exceeds JPY12,000 even once) (compulsory redemption).

When the investment trust settlor company proposes to cancel the investment trust contract, bringing redemption, it must notify the Commissioner of the Financial Services Agency in advance of such fact (ITA, art. 19). In the case of early redemption, it is necessary to carry out the procedures described in (i) below for Old Law Trusts, and the procedures described in (ii) below for New Law Trusts. However, where it is difficult to carry out the procedures below in the case that genuinely unavoidable circumstances arise, or where it is provided in advance in the basic terms and conditions of the investment trust that it will be redeemed in the case that certain conditions are met, this shall not apply where those certain conditions are met and redemption is carried out (ITA, art. 20, para. 2; ITA Enforcement Ordinance, art. 43; ITA prior to the amendment on September 30, 2007, art. 32, para. 3, proviso; ITA Enforcement Ordinance prior to the amendment on September 30, 2007, art. 51).

(i) Early Redemption of Trusts Under Old LawWhen early redemption of the fund of trust under old law is to take place, the

investment trust settlor company must give advance public notice of the fact that it will make such redemption, and deliver a written statement to that effect to the beneficiaries (ITA prior to the amendment on September 30, 2007, art. 32, para. 1). This public notice and written statement must note the fact that beneficiaries opposed to cancellation may voice any objections to the investment trust settlor company within a certain period of time (and such period cannot be less than one month). If the beneficial interests held by beneficiaries who stated an objection within the fixed period exceed one-half of the total beneficial interests, redemption is not possible. On the other hand, if they do not exceed one-half of the total beneficial interests, redemption is possible; provided, however, in this case, beneficiaries who stated an objection within the objection period may demand that the trustee repurchase the beneficiary certificates held by them, using the investment trust property, at the fair value the fund would have had if the redemption had not occurred (ITA prior to the amendment on September 30, 2007, art. 30, art. 30-2, and art. 32).(ii) Early Redemption of Trusts Under New Law

Where early redemption of the fund of trust under new law is to be carried out, it is done by the procedure of a written resolution of the beneficiaries.

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In the case of a written resolution of the beneficiaries, the investment trust settlor company prepares a document stating the date of the relevant written resolution, the reason for early redemption, the matters that should be stated in the written resolution reference materials, the time limit for exercise of voting rights, and other details, and notifies the known beneficiaries of this in writing no later than two weeks prior to the resolution date (where certain conditions are met, this may be done by electromagnetic means). A resolution in writing is passed by a majority of two-thirds or more voting rights of all beneficiaries who may exercise voting rights (ITA, art. 17, para. 8, applied mutatis mutandis through ITA, art. 20, para. 1). It is possible to set forth in the basic terms and conditions of the investment trust a provision to the effect that where a beneficiary does not vote it will be deemed to have voted in favor of the redemption (it is necessary to state that provision in the notification sent to the beneficiaries). Where all of the beneficiaries indicate their consent in writing to the investment trust settlor company’s proposal (where certain conditions are met, this may be done by electromagnetic means), the written resolution procedure is not required (ITA, art. 17 and art. 20, para. 1; ITA Enforcement Ordinance, art. 31).

Beneficiaries who were against early redemption may demand that the fund that they own themselves be repurchased at a fair price using investment trust property (ITA, art. 18 and art. 20, para. 1). However, this provision on the dissenting beneficiaries’ right to request the purchase of their beneficial interest does not apply to an investment trust wherein a beneficiary’s request for the redemption of the fund which is filed during the trust period may be satisfied by the partial cancellation of the investment trust contract (e.g., a fund which allows cashing out every day except for holidays, etc. outside Japan) (ITA, art. 18, para. 2 applied mutatis mutandis through ITA, art. 20, para. 1).

Payment of redemption proceeds commences within five business days from the date of redemption.

Regarding taxation of redemption proceeds, please check the description below (for details, see “7-6 Taxation of Dividends, Cashing Out and Redemptions”).

If the beneficiary decides to purchase another fund with the redemption proceeds, depending on the distributor, there may be preferential treatment for redemption switching or pre-redemption switching under certain circumstances.(Note)

(Note) Preferential treatment for switching refers to measures which allow an investor to move assets from one fund to another with no charge for or with a discount on the offering (sales) commission on the said fund purchase, if made within a certain period of time and with the redemption proceeds from another fund. Also, preferential treatment for pre-redemption switching means, where a different fund is purchased using the proceeds from cashing out of the fund within a certain period prior to redemption, there is no charge for or a discount on the offering (sales) commission on the said fund purchase.



7 6 Taxation of Dividends, Cashing Out and Redemptions

Readers should note that the treatment of the items described below is based on the system as of the end of November 2019, and it subsequently may have changed depending on tax law revisions, etc. Regarding the tax system for investment trusts other than publicly offered securities investment trusts, please check the description below (for details, see Volume 3, “Chapter 4, Taxation of Securities Transactions”).

(1) Separate Principal, Ordinary Dividends, and Refund of Principal (Special Dividends) of Additional Offering Type Stock Investment TrustsIn order to understand the taxation of the dividends, cashing out proceeds and redemption

proceeds for additional offering type stock investment trusts, it is necessary to understand the separate principal method and the distinction between regular dividends and refund of principal (special dividends).

Separate principal means each investor’s average acquired net asset value,(Note) which is the weighted average of the number of units acquired each time that investor acquires that fund, and is adjusted each time there is a dividend distribution.

The taxation of dividends depends on each investor’s separate principal and the relationship between the ex-dividend net asset value, and dividends are further broken down into ordinary dividends and refunds of principal (special dividends). Ordinary dividends are subject to taxation; however, special dividends are tax-free, as they are deemed to be a return of the investor’s separate principal, instead of taxable income:

(i) If the ex-dividend net asset value is equal to or greater than the investor’s separate principal, the entire amount of the dividend is classified as an ordinary dividend; and

(ii) If the ex-dividend net asset value is less than the investor’s separate principal, the portion of the dividend that corresponds to the shortage is classified as a refund of principal (special dividend), with the remaining amount being classified as an ordinary dividend.

Furthermore, when an investor receives the payment of a refund of principal (special dividend), the amount of his separate principal on the dividend date (closing date) minus the amount of the refund of principal (special dividend) becomes the investor’s separate principal going forward.

A specific example of the separate principal method is shown in Chart 3-8.

(Note) Additional offering type stock investment trusts shifted to the separate principal method on April 1, 2000. For investors who held a fund (additional offering type stock investment trust) at the time of the shift, the fund’s average trust money (the average purchase value of all of the fund’s investors) as of March 31, 2000, was treated as the separate principal of each investor.

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Dividends from a unit-type stock investment trust are subject to tax on the full amount of the dividend, without any distinction for ordinary dividends and refund of principal (special dividends).

Chart 3-8Structure of Taxation of Dividends from Additional Offering Type Stock Investment Trust (Sample)

Investor Separate Principal

B.V. Ex-Dividend

Separate Principal

Post-ClosingDividend Ordinary

Dividend

Special Dividend (refund of principal)

A JPY 0 JPY 9,000B JPY 500 JPY10,000

JPY10,300C

JPY 9,000

JPY10,500

JPY11,800

JPY10,000

JPY10,000

JPY10,000

JPY1,500

JPY1,500

JPY1,500

JPY1,500

JPY1,000

JPY 0 JPY1,500

Separate Principal

Post-Closing10,300

Separate Principal 11,800

Special Dividend

1,500

Investor CInvestor A Investor B

Separate Principal 10,500

Ordinary Dividend

1,000

SeparatePrincipal

Post-Closing 10,000

Special Dividend 500

Ordinary Dividend

1,500

Separate Principal

Post-Closing 9,000

Separate Principal

9,000

Dividend JPY1,500

B.V.Ex-Dividend JPY10,000

4. Calculation of Post-Closing Separate PrincipalThe investor’s separate principal after the closing (distribution) will be as calculated by deducting the amount of partial refund (special dividend) from the investor’s previous separate principal.

A JPY9,000－JPY0＝JPY9,000

3. Computation of the Ordinary Dividend and Special Dividend SeparateInvestor Principal

A JPY9,000 < JPY10,000 B.V. ex-dividend is higherthan the separate principal

B JPY10,500 > JPY10,000 B.V. ex-dividend is lowerthan the separate principal

C JPY11,800 > JPY10,000 B.V. ex-dividend is lowerthan the separate principal →Difference of JPY1,500 is a “Special

Dividend (refund of principal)”

11,80010,5009,000

Dividend drop

1,500

10,000

Investor A Investor B Investor C Closing→Distribution

Before distribution

11,500

1. Separate Principal of InvestorDate of Separate

Investor Acquisition PrincipalA June 20 JPY 9,000B Aug. 10 JPY10,500C Oct. 1 JPY11,800

2. Status on the Closing Date (Oct.15)Base Value (B.V.) JPY11,500Dividend JPY 1,500B.V. Ex-Dividend JPY10,000

→Difference of JPY500 is a “Special Dividend”(refund of principal)Remaining JPY1,000 is an “Ordinary Dividend”

→ Entire JPY1,500 is an “Ordinary Dividend”

C JPY11,800－JPY1,500＝JPY10,300B JPY10,500－JPY500＝JPY10,000



(2) Taxation of Dividends for Stock Investment TrustsDividends from a stock investment trust are treated as dividend income (Income Tax Act, art.

24, para. 1).(i) Individual Investors

Ordinary dividends from unit-type investment trusts and from additional offering type investment trusts, under the system that does not require the filing of a tax return, are subject to separate withholding tax at the rate of 20.315% (15% as income tax, 0.315% as special income tax for reconstruction, and 5% as inhabitant tax). An investor may also choose, however, to file a tax return for dividend income under the comprehensive taxation system or the separate self-assessment taxation system. In the case of some funds a tax credit on dividends is allowed if comprehensive taxation is selected(Note 1), while if separate self-assessment taxation is selected, the dividend income from taxable dividends can be netted against the capital gains or loss from sale of shares, etc.(Note 2)

It is possible to have dividend income on taxable dividends and the capital gains or loss from the sale of listed shares, etc. netted within the special account.

(Notes) 1. In order to eliminate double taxation with respect to individual beneficiaries receiving share dividends, which are subject to corporate taxes and income taxes, tax credits for dividends can be applied, allowing for the deduction of 10% of the dividend income amount from income tax, and 2.8% of the same amount from inhabitant tax (if total taxable income, including dividend income, exceeds JPY10 million, the tax credit rates applicable to the portion of dividend income equal to the amount of total taxable income that exceeds JPY10 million are 5% and 1.4%, respectively), but a dividend credit may also be applied to a part of the dividends of stock investment trusts that include domestic shares. For taxation purposes, however, 50% of stock investment trust dividends are deemed to be attributable to share dividends, and furthermore, tax credit rates for dividends decrease as per Chart 3-9 in line with increases in the non-stock ratio (the proportion of assets other than shares, as prescribed in the basic terms and conditions of an investment trust, within total trust assets,) or in the foreign currency denominated asset ratio (the proportion of foreign currency denominated assets, as prescribed in the basic terms and conditions of an investment trust, within total trust assets).

2. Where there is a loss that has arisen according to the calculation of capital gains, etc. for that year from listed shares, etc., or where there is a transfer loss for listed shares, etc. that has arisen in each year within the preceding three years (excluding that which was already deducted in the preceding years), the amount of these losses shall be deducted from the amount of dividend income from listed shares, etc. and other income.

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Chart 3-9 Ratios Regarding Dividend Tax Credits for Individual Investors

Non-stockratio

Foreign currency-denominated asset ratio

50% or less Over 50% up to and including 75% Over 75%

50% or less Half of sharesOver 50% up to and including 75% Quarter of shares

Over 75% Not applicable

(ii) Corporate InvestorsOrdinary dividends from unit-type stock investment trusts and from additional offering

type stock investment trusts are subject to having only income tax withheld at the source, and not inhabitant tax. Consequently, the tax rate is 15.315% (15% as income tax and 0.315% as special income tax for reconstruction). The taxation rule that excludes such dividends from the revenue of corporate investors does not apply to stock investment trusts in the business year that starts on April 1, 2015, and thereafter, except for specified stock investment trusts such as ETFs that invest in Japanese shares (Act on Special Measures Concerning Taxation, art. 3-2).

Furthermore, under the corporation tax, refund of principal (special dividends) is not subject to tax, and only amounts pertaining to such refund of principal (special dividends) are accounted for as reductions in book value. Also, corporations may deduct the full amount of any withholding taxes imposed on taxable dividends (provided, however, in cases where the corporation acquired its beneficiary certificates through purchase, the deduction is prorated for the corporation’s holding period during the year in which the purchase occurred).(iii) Foreign Tax Credit (Adjustment for Double Taxation)

In order to adjust double taxation, i.e. taxation in Japan and taxation in a foreign country, on distribution money to be received by taxpayers from investment in foreign assets using publicly offered investment trusts, a new foreign tax credit has been introduced for tax withholding from 2020. Securities companies, etc. which are in charge of handling payment of distribution money deduct the amount of foreign tax that has been paid by the investment trust in the foreign country for the relevant term from the amount of tax in Japan, up to the amount of income from distribution money (this tax credit does not apply to inhabitants tax). As a result, if the foreign tax credit is applied at the time of distribution, the amount of tax may differ from the amounts mentioned in (i) and (ii) above.

(3) Taxation of Cancellation Gains/Redemption Gains from Stock Investment Trusts(i) Individual Investors

Cashing out gains or redemption gains received from cancellation or repurchase of a stock investment trust, or received from the redemption of a stock investment trust will be treated as a capital gain, and the difference between the cashing out price or redemption price and the acquisition price (including the offering (sales) commissions and other expenses



required for the acquisition) will be subject to separate self-assessment taxation and taxed as a capital gain after being netted with the income or loss on sale of listed shares, etc. The tax rate is 20.315% (15% as income tax, 0.315% as special income tax for reconstruction, and 5% as inhabitant tax).

The special account for withholding at source may also be used for netting with the income or loss on sale of listed shares, etc.

˂Example calculation˃An individual investor has 200,000 units in a publicly offered stock investment trust

(back-end load upon cancellation equivalent to 0.2% of base value) for which its separate principal (10,000-unit basis) is JPY10,000 (2% commission at the time of purchase, 10% consumption tax thereof). Calculate the proceeds received and the capital gain/loss that arises in the cases where the investor cashes out its units, when the net asset value (10,000-unit basis) is JPY10,500.

Expenses for Acquisition = Base Value × (1 + Fee Rate × (1 + Consumption Tax Rate) × No. Units Purchased/10,000

= JPY10,000 × (1 + 0.02 × 1.10) × 200,000/10,000 = JPY 204,400Cashing out Price = Base Value − Back-end Load = JPY10,500 − JPY10,500 × 0.2% = JPY10,479Proceeds Received = Cashing out Price × No. Units Held/10,000 = JPY10,479 × 200,000 units/10,000 = JPY209,580Capital Gain/Loss = Income from Sale − Expenses for Acquisition =JPY209,580 − JPY204,400 =JPY5,180 (capital gain)

(ii) Taxation of Corporate InvestorsUnlike in the case of individual investors, the stock investment trust cancellation or

redemption gains received by corporate investors are treated as dividend income.Accordingly, for the amount that the cancellation price or redemption price exceeds the

investor’s separate principal, for stock investment trusts, the excess is subject to the withholding rate of 15.315% (15% as income tax and 0.315% as special income tax for reconstruction).

When a corporate investor cashes out from a stock investment trust through a repurchase request rather than cancellation, the net proceeds for the corporate investor will be the balance of the amount by which the repurchase price exceeds the separate principal, minus the amount equivalent to income tax withheld, giving rise to a capital gain or loss.

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(4) Taxation on Government and Corporate Bond Investment TrustsDividends from government and corporate bond investment trusts(Note) are treated as interest

income (Income Tax Act, art. 23, para. 1), and are subject to withholding tax at the rate of 20.315% on the full amount of the dividend (comprised of a 15% income tax, 0.315% special income tax for reconstruction and 5% inhabitant tax) if the investor is an individual (as in the case of dividends for stock investment trusts, such individual investors can complete the taxation procedure by paying withholding tax without filing a tax return or netting dividend income with the capital gains or losses on listed shares, etc. if they choose to file a tax return for dividends under the separate self-assessment taxation system). Cancellation or redemption gains from such trusts are treated as capital gains and subject to separate self-assessment taxation as in the case of stock investment trusts. They are netted with the trading profits and losses on listed shares, etc. and are subject to capital gains taxation at the rate of 20.315% (comprised of a 15% income tax, a 0.315% special income tax for reconstruction and a 5% inhabitant tax).

Where the investor is a corporation, the full amount of government and corporate bond investment trust dividends is counted as profits and are subject to corporation tax. Also, the withheld income tax, special income tax for reconstruction, and local income tax are deducted from the corporation tax.

(Note) As to additional offering type stock investment trusts, the separate principal method has also been applied to additional offering type bond investment trusts (excluding daily closing funds).In the case of additional offering type bond investment trusts, if the base value exceeds the price per unit of principal (usually JPY10,000; hereinafter referred to as JPY10,000), an amount equivalent to the whole of such excess must be paid as dividends, and additional establishment may be carried out only at the base value on the closing date. As a result, separate principal necessarily equals to or falls below JPY10,000, and because a distribution of earnings is not allowed if the base value before distribution falls below JPY10,000, there would be no dividend to be paid as refund of principal.

(5) Application of the Tax-Exempt SystemThe following are tax-exempt systems that are related to investment trusts:(i) Tax Exemption Programs for Small Investments (General-type NISA),

Investments by Minors (Junior NISA), and Installment Investments (Dollar-Cost Averaging NISA)Among investment trusts and investment corporations, publicly offered stock

investment trusts, ETFs, listed REITs, etc. are covered by the general-type NISA introduced on January 1, 2014, and Junior NISA introduced on April 1, 2016. Under these programs, income from dividends, capital gains from cancellations and redemptions from investment trusts invested via general-type NISA and Junior NISA accounts are exempt from taxation. Investment trusts held in taxable accounts may not be transferred to general-type NISA and



Junior NISA accounts.On January 1, 2018, a tax exemption program was introduced as a scheme to promote

installment investments and diversified investments in small amounts in order to support households in stable asset building. This program, called “Dollar-Cost Averaging NISA,” covers publicly offered stock investment trusts and ETFs that are suitable for long-term installment investments or diversified investments and satisfy the predetermined requirements (Note). Investors may set the investment quota either for the general-type NISA or Dollar-Cost Averaging NISA for each year; they are not allowed to use both programs in the same year.

(Note) The requirements for investment trusts covered by the Dollar-Cost Averaging NISA are prescribed in detail in the Order for Enforcement of the Act on Special Measures Concerning Taxation and the relevant public notice issued by the Cabinet Office. The major requirements are as indicated below.

(Common requirements)- The trust contract is valid for an indefinite period or for 20 years or more.- Dividends are not paid monthly.- The investment is not made through derivatives transactions, except for an investment

for hedging purposes.- A notification is made to the Prime Minister to report the products handled by the

investment trust.(Requirements for designated index investment trusts)- The investment trust is linked with any of the indexes designated by the public notice.- The shares are included in the major investment targets.- No sale commission, cancellation fee or account management fee is charged.- The trust fee does not exceed the designated level.(Requirements for investment trusts other than designated index investment trusts)- The investment trust has net assets of JPY5 billion or more.- At least five years have passed since the trust was created.- No sale commission, cancellation fee or account management fee is charged.- The trust fee does not exceed the designated level.- The shares are included in the major investment targets.(ETFs)- The ETF is linked with any of the indexes designated by the public notice.- The investment target assets are shares.- The trust fee does not exceed the designated level.- In the case of an ETF listed on a domestic market, it is designated by the exchange as

an ETF for which measures to ensure smooth distribution have been implemented.- In the case of an ETF listed on a foreign market, it has net assets of JPY1 trillion or

more.

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(ii) Defined Contribution Pension SystemInvestment trusts are used as a means of investing pension assets in the defined

contribution pension system, and income that arises due to the investment of pension assets is, in principle, tax-exempt under tax law (although it is subject to the special corporations tax, imposition of the special corporations tax (the tax rate is approximately 1% of the reserve funds) has been halted until March 31, 2020).

In a corporate-type defined contribution pension plan, the corporation contributes funds to the employee’s pension account, and since January 2012 it has become possible for the employee to contribute funds to his/her pension account as well (this is called “matching contributions”). The funds contributed by corporations are eligible for inclusion in deductible losses in the calculation of corporation tax, while the funds contributed by employees as matching contributions and the funds contributed by individuals in individual-type defined contribution pension plans are eligible to be used as income deductions (deductions for small-sized enterprise mutual aid premiums).

Also, although taxed at the payment stage, there is preferential treatment under the tax system, such as being exempted as retirement income when taken as a lump sum payment or being exempted as a public pension, etc. when taken as a pension.

(iii) Worker’s Asset Formation SystemSo-called long-term bond investment trusts and “asset formation stock funds” are

exempt from tax on their dividends (including amounts in excess of principal at the time of cancellation or redemption) under the asset formation pension savings or asset formation residential savings systems.(iv) Tax Exemption System for Interest Income, Etc. from Small Savings of Persons

with Disabilities, Etc. (so-called Maru Yu System for Disabilities, Etc.)The tax exemption under this system is granted for persons who meet certain

requirements, such as the wives who are eligible to receive survivor’s pensions and persons who have physical disability certificates, with regard to their interest income from government and corporate bond trusts, up to JPY3.5 million in combination with interest income from savings and other financial instruments covered by this system.

7 7 ETF

The methods of dividend distribution and cashing out by ordinary investors for ETFs differ from that mentioned up to this point, and are carried out in the same manner as with listed shares. In other words, cashing out from ETFs by ordinary investors is carried out by selling (transferring) at the market price on the exchange in the same way as with a listed share.

Also, income distributions are paid to beneficiaries who are recorded in the list of beneficiaries as of the closing date.

The tax treatment of a capital gain or loss on sale of an ETF, as well as distributions of



earnings, is handled essentially in the same manner as for listed shares, and there is no distinction between ordinary dividends and refund of principal (special dividends).

8 Disclosure for Securities Investment Trusts

It is vital to the sound development of the investment trust system that investors are provided with sufficient information and materials that will allow them to make an independent and informed decision regarding their investments. Based on this necessity, both the FIEA and the ITA contain disclosure systems that apply to investment trusts, and require investment trusts to provide material information concerning their operations.

The disclosure for investment trusts is comprised of issuance disclosure and continuous disclosure. In the remainder of this section, we will look at the rules and practice, etc. of disclosure for investment trusts.

The following statements concern publicly offered securities investment trusts (investment trusts under instructions from the settlor) (although in some cases statements are made concerning privately offered securities investment trusts (investment trusts under instructions from the settlor)). It is necessary to take note that different rules apply for disclosure of other investment trusts, and there are also many areas that widely differ in practice, etc.

8 1 Issuance Disclosure

Issuance disclosure refers to the disclosures that must be made to investors when they purport to acquire a new issue of securities; in the case of investment trusts, both the FIEA and the ITA prescribe the content of the disclosure.

(1) Issuance Disclosure Under the FIEAUpon an offering or sale of a publicly-offered investment trust, the investment trust settlor

company, which is the issuer, must file a securities registration statement with the Director-General of the Local Finance Bureau (FIEA, art. 4, para. 1). The filed securities registration statement is made available for public inspection (FIEA, art. 25, para. 1), thus being disclosed to investors.

When having an investor acquire an investment trust, an explanation on the investment trust (a prospectus) must be delivered in advance of or simultaneously (in the case of an investment trust explanatory document (delivery prospectus)) with having the investment trust purchased, or when a request for delivery is made on or before the time of having the investment trust acquired, immediately (in the case of an “investment trust explanatory document (request prospectus)”) at the request (for details, see “6. Sale of Securities Investment Trusts”), and consequently, the

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Section 8. Disclosure for Securities Investment Trusts


investment trust settlor company also prepares investment trust explanatory documents (prospectuses) as disclosure information, simultaneously with securities reports.

The main content of a delivery prospectus is as set forth below:

1. Cover Page, Etc. of a Delivery Prospectus (From the Cover Page Through the Statement of Matters in the Main Text):

(1) Statement to the effect of being a delivery prospectus; (2) Statement of being a prospectus under the FIEA; (3) The name of the fund and the product classification; (4) Information on the settlor company, etc.; (5) Information on the trustee company; (6) Method of obtaining detailed information; (7) Date of commencement of use; (8) Matters in connection with effect of notification; (9) Product classification and table of attribute categories; and (10) Other matters that are to be stated.2. Main Text of a Delivery Prospectus (in the Following Order): (1) Purposes and features of fund; (2) Investment risk; (3) Investment performance; and (4) Procedures and commissions, etc.3. Additional Information (If Necessary): (The above is from art. 2 through art. 4 of the “Regulations Concerning

Preparation of Delivery Prospectuses.”)

(2) Issuance Disclosure Under the ITAIn cases where the investment trust settlor company purports to execute an investment trust

contract, it must file the contents of the basic terms and conditions of an investment trust pertaining to the investment trust contract with the Commissioner of the Financial Services Agency (ITA, art. 4, para. 1), and must deliver written documents containing a description of the basic terms and conditions of an investment trust to those persons who wish to acquire the investment trust (ITA, art. 5, para. 1, main clause); provided, however, this does not apply when the investment trust explanatory document (prospectus) sets forth the contents of the basic terms and conditions of an investment trust (ITA, art. 5, para. 1, proviso). In the case of a publicly offered investment trust, ordinarily an investment trust explanatory document (prospectus) that includes a copy of the basic terms and conditions of an investment trust is delivered in lieu of these written documents.

Since no prospectus is prepared or delivered with respect to a privately placed investment trust, a document called a “Product Explanation” or other name is prepared, and includes the details of the basic terms and conditions of an investment trust.



8 2 Continuous Disclosure

Continuous disclosure is a system to provide investors with decision-making information by requiring a fund to make periodic disclosures to its investors after securities are issued. In addition to the continuous disclosure prescribed by the FIEA and ITA, there is also the periodic disclosure under the Investment Trusts Association, Japan Agreement (for details, see “8-4 Timely Disclosure”); however, here we will only look at disclosures that are required by law.

(1) Continuous Disclosure Under the FIEAThe investment trust settlor company must submit a securities report for each fund it

establishes to the Director-General of the relevant Local Finance Bureau within three months after the closing of the said fund for each of the relevant fund’s accounting periods (FIEA, art. 24, para. 1 and para. 5); provided, however, when the accounting period of the fund is less than six months, the securities report must be submitted every six months (Cabinet Office Ordinance on Disclosure of Information, etc. on Regulated Securities, art. 23, proviso).

Additionally, for a fund with a closing period of one year, an interim securities report (FIEA, art. 24-5, para. 3), or when a movement occurs in the fund’s related corporations, etc., an extraordinary report (FIEA, art. 24-5, para. 4) must also be submitted to the Director-General of the Local Finance Bureau. The securities report, the semi-annual report and the extraordinary report are likewise subject to public inspection (FIEA, art. 25).

The securities report must include the financial reports for the two most recent periods. These financial statements, as well as the annual and interim financial statements included in the securities registration statement, securities report, and interim report must be accompanied by the audit certification prepared by a certified public accountant or an auditing company that has no special interest in the issuer (FIEA, art. 193-2).

(2) Continuous Disclosure Under the ITAThe investment trust settlor company must prepare an investment management report

for each investment trust property at the end of each closing period (six months for funds in which the closing is less than six months) without delay and deliver the report to beneficiaries (ITA, art. 14, para. 1).

The system for disclosure via investment management reports has been reformed with regard to such reports to be prepared at the closing on or after December 1, 2014. The new system will require both the summary of an investment management report containing extremely important matters and the whole body of the investment management report to be prepared and delivered to beneficiaries. Under the new system, investment trust settlor companies must prepare such summarized versions of investment management reports and deliver them to known beneficiaries via the distributors (ITA, art. 14, para. 4). If investment trust settlor companies provide customers the whole body of the investment management report by electromagnetic means, as provided in the basic terms and conditions, they are deemed to have delivered the investment management

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report (ITA, art. 14, para. 2). However, even in such a case, they must deliver the whole body of the investment management report upon request of a beneficiary (ITA, art. 14, para. 3; JITA Investment Management Report Regulations, art. 10, para. 1).

An investment management report (the summary and the whole body thereof) is not required to be prepared or delivered in cases such as the following: (i) where funds are privately offered by qualified institutional investors and the investment trust contract prescribes that the delivery of investment management reports is unnecessary; (ii) where it is anticipated that an individual sharing the same residence as the beneficiary will receive the said report and the beneficiary has agreed by the report drafting date not to receive the same (excluding where a request for delivery was made by the report drafting date); and (iii) where the funds in question are MRFs or funds listed on a financial instruments exchange.

Matters that should be stated in investment management reports are prescribed in the ITA. Among these matters, the following are considered important and required to be included in the summary of an investment management reports to be delivered to customers (Ordinance on Accounting of Investment Trust Property, art. 58-2):

1. The investment policy for the investment trust property;2. Developments in the investment of the assets during the accounting period

for the investment trust property;3. Changes in the investment status;4. Remuneration, etc. for the investment trust settlor company and the trustee

company and other expenses borne by the beneficiaries in relation to the investment trust property during the accounting period for the investment trust property, as well as the details of the services for which such remuneration and expenses are paid;

5. The ratio of the total market value of each of the major issues of shares to the amount of net assets in the investment trust property, as of the end of the current term;

6. The ratio of the total market value of each of the major issues of public and corporate bonds to the amount of net assets in the investment trust property, as of the end of the current term;

7. The ratio of the total market value of each of the major issues of beneficiary certificates of investment trusts (excluding beneficiary certificates of the parent investment trust), beneficiary certificates of the parent investment trust, and investment securities of investment corporations to the amount of net assets in the investment trust property, as of the end of the current term;

8. The ratio of the appraised value of each of the major types of derivatives transactions to the amount of net assets in the investment trust property, as of the end of the current term;

9. The division that will receive inquiries from the beneficiaries and its telephone number;



10. In the case of an investment trust for which it is provided in the basic terms and conditions that the items of information to be contained in the whole body of an investment management report may be provided by electronic and magnetic means, a statement to that effect, and information necessary for inspecting such matters to be contained in the whole body of an investment management report; and

11. A statement to the effect that the whole body of an investment management report is delivered at the request of the beneficiary, and information necessary for making such request.

The matters enumerated above are those basically assumed for securities investment trusts.The matters that should be stated in investment management reports for real estate

investment trusts and infrastructure investment corporations are also prescribed.In addition, investment management reports are supposed to be prepared in such a way as to

make them easy for investors to understand (See Financial Services Agency, “Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, Etc.” VI-3-2-3(2)). Based on this, the Investment Trusts Association, Japan specifies, in its regulations, the matters to be set forth in an investment management report and the presentation order of these matters. In doing so, the Investment Trusts Association, Japan aims to standardize the format of disclosure through investment management reports.

8 3 Schedule for Preparation and Updating of Legally Required Disclosure Materials

In 8-1 and 8-2 above we looked at the contents of disclosures for publicly offered securities investment trusts under the FIEA and the ITA. Here, we will look at the schedule by which these legally required disclosure materials are prepared and updated in practice. Chart 3-10 provides an example of the schedule for preparing and updating legally required disclosure materials in connection with a publicly offered additional offering type investment trust that has closing on an annual basis.

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Chart 3-10Legally Required Disclosure Schedule in Connection with Publicly Offered Additional Offering Type Investment Trusts (Fund with annual closing, and where there are no extraordinary correction filings)

First, where the fund is to be established, it is necessary to raise funds with an initial offering. In that case, as already noted the investment trust settlor company that is the issuer must file a securities registration statement with the Director-General of Local Finance Bureau (FIEA, art. 4, para. 1), and because it takes effect from the 15th day after the filing is accepted (FIEA, art. 8, para. 1), the filing must be made 15 days or more before beginning the initial offering.

When the filing is accepted, it is possible to solicit applications for the new fund (provisional offering). However, it is not possible to accept acquisition applications unless 15 days have passed and the filing has taken effect.

On the other hand, under the ITA, when concluding an investment trust contract, the content of investment trust contract that pertains to the said basic terms and conditions of an investment trust must be filed in advance with the Commissioner of the Financial Services Agency (ITA, art. 5, para. 1), and because the investment trust contract is executed on the fund’s initial establishment day, the basic terms and conditions of an investment trust is to be filed by the day before the initial establishment day. It is also necessary to attach the basic terms and conditions of an investment trust to the securities registration statement, and normally, the content of the basic terms and conditions is stated in the investment trust explanatory document (prospectus) as well. In practice, therefore, the basic terms and conditions of an investment trust are also prepared at the time of the filing of the securities registration statement.

Once the initial offering period of approximately two weeks to one month is over, the trust agreement is executed and investment commences.

Once six months elapse after commencement of investment, the investment trust settlor company carries out an interim closing, prepares interim finance statements, and after an audit by

FIEA <Issuance Disclosure> Investment Trust Explanatory Document (Prospectus)

Securities Registration Statement

Corrected Statement

<Continuous Disclosure> Semi-Annual Report

Securities Report

Offering Start

Establishment (Conclusion of Trust Contract)

Filing

Filing to Financial Services Agency before Establishment

Commence Use

State contents

Submit 15 days or more before offering

Filing

Interim Closing

Updating

Reflecting corrected contents

Corrected filing

SubmissionWithin 3 months after

mid-term closing

Reprint or insert corrections

Reflecting closing contents, etc.

Closing Interim Closing

Normally, 2 to 3 weeks from closing

Preparation/Delivery

Updating

Reprint

Filing

Same settlement

contents

Reflect closing contents, etc. and file as new offering

Updating

Corrected filing

Submission

Within 3 monthsafter closing

Submission

Initial Offering

Continuous Offering

ITABasic Terms andConditions of anInvestment TrustInvestment Report(delivery to investor)



a certified public accountant or an auditing firm (FIEA, art. 193-2), an interim report must be submitted within three months from the date of the interim closing (FIEA, art. 24-5, para. 3). Because it is also necessary to have the securities registration statement reflect the contents, etc. of the interim closing that is included in the semi-annual report, a filing of an amended registration statement is made at the same time. Moreover, when an amendment is made to the content of a registration statement, the investment trust explanatory document (prospectus) must also be corrected, and is to be updated by a revised printing of the investment trust explanatory document (prospectus) that was initially used or by inserting documents on which the corrected matters are stated.

After six more months have passed, leading up to closing, the investment trust settlor company carries out closing processing, prepares the investment management report, and delivers it to the investors through the distributor. There is no legally stipulated time limit for delivery, but the normal practice is for delivery to be made to the investors within approximately two to three weeks from closing.

After that, the investment trust settlor company must submit the annual securities report within three months after the closing date after receiving an audit of the closing by a certified public accountant or an auditing firm. The contents, etc. of the closing that are included in the annual securities report are also reflected in the securities registration statement, but as a different public offering from the previous public offering, this case differs from the interim closing in that it is not a corrected filing but a submission of a new securities registration statement. This is because the effective period is set at 16 months or less for the securities registration statement and the prospectus (one month initial offering + one year closing period + three months submission deadline for the annual securities report) (JITA Regulations Concerning Conduct of Business, Etc. by Full Members, art. 7), and subsequently a new securities registration statement is submitted each year.(Note)

Chart 3-10 describes a fund that has a one-year closing period, but the finance reports and investment management report preparation period is every six months for funds for which the closing period is not more than six months such as those with six months, three months, two months (every other month), one month (every month), and one day (daily closing types) closing periods, including monthly-paid funds. In the legally stipulated disclosure schedule for these types of funds with a closing period of not more than 6 months, the “interim closing” indicated in Chart 3-10 becomes the “(full year) closing” and the “interim report submission” becomes the “securities report submission,” and the preparation of investment management reports is done twice a year, every six months.

Also, where it is necessary to amend important matters that should be stated in the filings or correct other contents in order to protect the public interest or investors, the investor trust settlor company must submit an extraordinary corrected filing regardless of the closing period (FIEA, art. 7), and in such case, the investment trust explanatory document (prospectus) is updated (by reprinting or in the form of inserting documents stating the corrected matters in the already existing investment trust explanatory document (prospectus)).

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(Note) Where a new securities registration statement is submitted, in the same way as with the time of the initial offering, the legal principle is that it takes effect after 15 days have passed (FIEA, art. 8, para. 1). Thus, it is necessary to file for new offering periods at least 15 days before the offering period based on this principle. However, in consideration of the special characteristics of the continuing nature of offerings in the case of securities investment trusts, from the second year, as long as they meet certain conditions, filings take effect from the next day (published by the FSA, “Points to be Considered regarding Disclosure of Details, Etc. of Specified Securities” (Guideline for the Specified Securities Disclosure System), 8-1). Normally, in order to meet the relevant certain conditions, the normal business practice is carried out on the schedule indicated in Chart 3-10.

8 4 Timely Disclosure

To assist investors, the Investment Trusts Association, Japan has rules requiring investment trust settlor companies to provide timely disclosures to investors, in addition to the legally required disclosure documents, on their homepages (JITA Investment Management Report Regulations, Chapter 5).

Subject to these rules are privately placed investment trusts, ETFs, unit-type investment trusts that are in the closed period (for details, see 7-4 “(2) Cancellation Acceptance Date/Closed Period”) and all but a few of the funds managed according to the instructions given by investment trust settlor companies, and funds for which timely disclosure is not mandatory may, at the investment trust settlor company’s discretion, provide timely disclosure (Same regulations, art. 20). The frequency of disclosure is monthly or quarterly (as disclosure is usually made on a monthly basis, the disclosure materials generally go by the title “monthly report”), and the matters that must be disclosed are (i) an overview of the fund; (ii) disclosure concerning expenses; (iii) trends in dividends and yields; and (iv) the status of assets in the fund portfolio. This timely disclosure is now the disclosure means that is most familiar to investors because it is easy to access via the Internet, information is updated frequently, and investment trust settlor companies have devised various ways of disclosing the information in a compact manner that is more useful to investors.



9 Investment Corporations

In the investment corporation system, a special corporation similar to a stock company (Kabushiki Kaisha, K.K. or KK; an association established under the ITA for the purpose of investing assets mainly in specified assets) is established, and this corporation itself becomes the fund (kikin) in the same collective asset investment scheme as a (contractual type) investment trust. The pool of contributions (funds) gathered from investors is granted corporate status, and this corporation becomes subject to certain rights and obligations. The management resembles that of an ordinary corporation (self-governance structures), and the needs of investors (investor-owners who are granted legal status similar to that of shareholders of a corporation) are reflected in management through the decision-making process at the investors meeting, etc. As is clear from Chart 3-11, it is necessary for investment corporations to outsource all operations such as asset management, asset custody, management of investors meetings and board of officers meetings and calculations. An investment corporation must use the term “toshi hojin” (which means “investment corporation”) in its trade name (ITA, art. 64, para. 2).

In Japan, the investment corporation scheme is used primarily by real estate investment trust corporations (J-REIT). Funds for investing in infrastructure equipment (renewable energy power generation facilities, and rights to operate public facilities, etc.) have been introduced as a new type of investment target under the ITA upon its amendments as of December 1, 2014. In Japan, such funds were created by the investment corporation scheme. This scheme is considered to be suitable for creating a fund which includes assets such as real property with lower liquidity than the ordinary type of securities and for liquidating such assets by listing securities issued by the fund (investment securities).

Below we will take a look at the operations of an investment corporation, focusing on a real estate investment corporation as an example.

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Section 9. Investment Corporations


Chart 3-11 Structure of an Investment Corporation

9 1 Establishment of Investment Corporations and Offering of Investment Equity

(1) EstablishmentTo establish an investment corporation, the organizers first prepare the certificate of

incorporation and file a notification of establishment of an investment corporation with the Prime Minister, and upon completion of certain procedures and registering, the investment corporation will be formally established (ITA, art. 66 through art. 74).

The following is a summary of the establishment procedures:(i) The organizer must satisfy the statutory qualification requirements, such as that at least

one of the organizers must have experience in carrying out tasks for the management of the same kind of assets as the specified assets which are to be the main subject of investment of the investment corporation to be established (ITA, art. 66, para. 3 and para. 4 and art. 98, items 2 through 5; ITA Enforcement Order, art. 54).

(ii) The certificate of incorporation sets out the basic items of the investment corporation and is equivalent to the basic terms and conditions of an investment trust used in the contractual type investment trust, or the articles of incorporation of a stock company. The ITA stipulates the matters to be stated in the certificate of incorporation. The major matters are as follows (ITA, art. 67, para. 1 and para. 2, art. 86, para. 1, and art. 93, para. 1):

Accounting Auditor

Administrative Agent(Administrative mattersrelating to accounting,

etc.)

Administrative Agent(Administrative matters

relating to transfer ofownership, etc.)

Investors (Investor-Owners)

Purchase ofinvestmentsecurities

Financial InstrumentsBusiness Operators, Etc.

Application money Dividends

Conclusion of agreement outsourcing ordinary

administrative matters related to offering of investment units

Distributor(Underwriter)

Asset Custody Company(Trust Bank, etc.)

Asset custody

Real Estate RelatedAssets, Etc.

Rent income, etc.Investment

Conclusion ofagreement

outsourcing assetcustody

Financial InstrumentsExchange

Listing of investment securities

Accountingauditing

Investment Corporation

Investors’ Meeting Board of Officers Corporate Officers

Supervisory Officers

Selection of properties;Determination ofleasing strategy;

Asset sales

Conclusion ofasset managementagreement

Asset ManagementCompany (Investment

Trust Settlor Company)

Conclusion of generaladministrationoutsourcing agreement



(a) Whether an investor can have his/her investment equity in the company redeemed upon request (i.e., open-end) or not (i.e., closed-end);

(b) The total number of units of investment equity that the investment corporation is authorized to issue;

(c) Minimum net asset amount which must be maintained by the investment corporation at all times (cannot fall below JPY50 million (ITA, art. 67, para. 4));

(d) Asset management targets and strategy;(e) Policy for distribution of money(f) Amount of compensation which will be paid to the corporation’s corporate officers,

supervisory officers, and accounting auditors, or the standard used in deciding the said amounts;

(g) Amount of asset management fees which will be paid to the asset management company, or the standard used in determining the amount of the said asset management fees; and

(h) Name and address of the organizer(s).Under the ITA, the following matters can be prescribed in the certificate of

incorporation:(a) That under certain circumstances, redemption may be suspended in the case of

open-end type (ITA, art. 67, para. 2);(b) That investment securities will not be issued in the case of open-end type until

there is a request on the part of the investor (ITA, art. 86, para. 1); and(c) That the voting rights of all investors who do not attend the investors meeting and

who do not vote will be deemed affirmative (Deemed affirmative) (ITA, art. 93, para. 1).

The notification of establishment of an investment corporation that the organizers submit to the Prime Minister in advance must be accompanied by the certificate of incorporation and other necessary documents. The certificate of incorporation becomes effective when this notification is accepted by the Prime Minister (ITA, art. 69). An investment corporation is formed upon the registration of its establishment (ITA, art. 74).(iii) The total capital amount of the investment corporation at the time of establishment is

the total amount to be paid in for the investment equity issued upon establishment, which is set at an amount equal to or greater than JPY100 million by the ITA (ITA, art. 68; ITA Enforcement Order, art. 57). The organizer conducts an offering for subscription of investment equity to be issued at establishment. The organizer must, upon each solicitation of persons to subscribe for investment equity issued at establishment, prescribe the number of units of investment equity, the amount of money to be paid for the investment equity and the date or period for payment of money (ITA, art. 70-2), and notify persons who apply for subscription of the investment equity to be issued at establishment of the requisite matters (ITA, art. 71, para. 1). The candidates for the position of the corporate officer at establishment, the supervisory officer at

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establishment and accounting auditor at establishment listed on the investment equity application form are formally appointed when the allotment of the investment equity is completed (ITA, art. 72).

(2) Registration of Investment CorporationsAlthough a notification system is adopted with respect to the establishment of an investment

corporation (ITA, art. 69), a registration system is adopted with respect to its operations. Therefore, in order to engage in asset trading, an investment corporation must register with the Prime Minister in advance (ITA, art. 187). The ITA provides for the necessary procedures for such registration (ITA, art. 188 through art. 190).

The types of transactions in specified assets that a registered investment corporation may perform are: the acquisition and assignment of securities; borrowing and lending of securities; acquisition and assignment of real estate; leases of real estate; and entrustment of the administration of real estate. A registered investment corporation is not allowed to conduct transactions in which the corporation itself engages in land development or building construction, those in which the corporation itself engages in production, manufacture, or processing of commodities or any other acts specified by Cabinet Office Ordinance as being similar thereto, or those in which the corporation itself engages in manufacturing and installation of renewable energy power generation facilities or any other acts specified by Cabinet Office Ordinance as being similar thereto (ITA, art. 193, para. 1; ITA Enforcement Order , art. 116).

(3) Offering of Investment Equity for SubscriptionInvestment corporations may make an offering of investment equity for subscription up to

the total number of units of investment equity prescribed in the certificate of incorporation. However, as the operations concerning an investment corporation shall be delegated, the corporate officers of an investment corporation must not conduct administrative affairs concerning the offering, etc. of investment securities (ITA, art. 196, para. 1).

On each offering of investment equity for subscription, the board of officers must approve the number of units of investment equity for subscription, the amount to be paid for the investment equity for subscription or its calculation method and the date or period of payment of money (ITA, art. 82, para. 1).

The investment corporation must notify persons who apply for subscription of the investment equity for subscription of the matters referred to in (1) (ii) (a) through (h) (the main items included in the certificate of incorporation) and other requisite matters (ITA, art. 83, para. 1). The subscriber of the investment equity for subscription becomes an investor on the payment date or the date payment was made (ITA, art. 84, para. 1; Companies Act, art. 209).



9 2 Organs of Investment Corporations

An investment corporation has, as its organs, the investors meeting, corporate officers, supervisory officers, and the board of officers, which are equivalent to the shareholders meeting, directors, auditors, and the board of directors of a stock company, respectively.

(1) Investors MeetingThe items for resolution by the investors meeting are the matters prescribed by the ITA and

the matters prescribed by the certificate of incorporation (ITA, art. 89).The principal items for resolution by the investors meeting are as follows:(i) Election of corporate officers, supervisory officers, and accounting auditors (ITA, art.

96);(ii) Removal of corporate officers, supervisory officers, and accounting auditors (ITA, art.

104);(iii) Amendments of the certificate of incorporation (ITA, art. 140);(iv) Approval of asset management entrustment agreement (ITA, art. 198, para. 2);(v) Consolidation of units of investment equity (ITA, art. 81-2, para. 2);(vi) Approval of an absorption-type merger or a consolidation-type merger agreement (ITA,

art. 149-2, para. 1, art. 149-7, para. 1, and art. 149-12, para. 1); and(vii) Dissolution (ITA, art. 143).

Among the above, the election or removal of the corporate officers, supervisory officers, and the accounting auditor, and the approval of the asset management entrustment agreement must be determined through an ordinary resolution (the owners of a majority of the total number of units of issued investment equity attend the meeting, and decisions are made with the approval of a majority of the voting rights of those in attendance) (ITA, art. 93-2, para. 1; provided, however, where the certificate of incorporation provides for a percentage that is higher than a simple majority, for the removal of corporate officers and accounting auditors, that percentage applies (ITA, art. 106)). Also, changes to the certificate of incorporation, the consolidation of units of investment equity, the approval of merger agreements, and dissolution must be determined through a special resolution (the owners of a majority of the total number of units of issued investment equity must attend the meeting, and decisions are made with the approval of at least two thirds (where a percentage that is greater than two thirds is provided for in the certificate of incorporation, that percentage applies) of the voting rights of those in attendance) (ITA, art. 93-2, para. 2).

In principle, investors meetings are convened by the corporate officers (ITA, art. 90, para. 1). Because the term of office for corporate officers is no more than two years, meetings are held usually once every two years to appoint new officers. To convene an investors meeting, the company must make a public announcement of the meeting at least two months prior to the proposed dated of the meeting, and it must send all investors notice of the meeting at least two

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weeks before the meeting date, with investors meeting reference materials and voting rights attached (ITA, art. 91, para. 1 and para. 4).

Also, the certificate of incorporation may provide that the voting rights of all investors who do not attend the investors meeting and who do not exercise their voting rights shall be deemed to be affirmative votes for the resolutions proposed at the investors meeting (where multiple resolutions are proposed and from among those resolutions there are resolutions that conflict with each other, excluding any of the conflicting resolutions) (ITA, art. 93, para. 1).

At an investors meeting of an investment corporation, voting rights may be exercised by a document or electromagnetic means.

(2) Corporate Officers, Supervisory Officers, and the Board of OfficersThere are two types of officers in an investment corporation: corporate officers and

supervisory officers. The corporate officers execute the investment corporation’s business and act as representatives of the corporation (ITA, art. 109, para. 1). They are equivalent to the representative directors in an ordinary joint stock company. The supervisory officers supervise the corporate officers’ performance of their duties (ITA, art. 111, para. 1). Corporate officers and supervisory officers are elected by the investors meeting (ITA, art. 96), there must be at least one or two corporate officers, and the number of supervisory officers must be at least one greater than the number of the corporate officers (ITA, art. 95). The term of office for corporate officers may not exceed two years (ITA, art. 99). Although the term of office for supervisory officers is four years, it is possible to provide a shorter term by the certificate of incorporation or by a resolution of the investors meeting (ITA, art. 101, para. 1).

Because of the nature of their duties, supervisory officers must maintain their independence. Therefore, organizers, corporate officers, the officers and employees of a corporation that is an organizer or its subsidiaries, etc., corporate officers of an investment corporation, officers or employees of financial instruments business operators, etc. that handled the offering or its subsidiaries, etc., and other persons who may have a problem carrying out their duties as supervisory officers due to circumstances such as a conflict of interest with the organizers or corporate officers of the investment corporation may not become supervisory officers (ITA, art. 100).

In an investment corporation, a board of officers comprised of the supervisory officers and corporate officers is installed, and when a corporate officer wishes to conduct any important business function (conclusion or amendment of entrustment agreements concerning the investment and custody of assets, entrustment of general administrative matters, convocation of investors meetings, etc.), the executive officer must obtain the approval of the board of officers (ITA, art. 109, para. 2). Executive officers must also make a report on the state of the company’s business operations to the board of officers at least once every three months (ITA, art. 109, para. 3).



9 3 Asset Investment of Investment Corporations

An investment corporation only functions as a vehicle for asset management (also known as a “conduit”), and is required to outsource the actual asset management operations, asset custody operations and other general administrative affairs.

For the purpose of conducting asset investment, a registered investment corporation must enter into an agreement with an asset management company to entrust its asset investment business to that company (ITA, art. 198, art. 1). From the standpoint of self-execution obligations, asset management companies are prohibited from re-entrusting the whole of the authority concerning asset investment entrusted thereto, as in the case of securities investment trusts (ITA, art. 202, para. 1), but may be allowed to re-entrust a portion of such authority under the agreement with the investment corporation (FIEA, art. 42-3; ITA, art. 202, para. 2).

(1) Duty of Loyalty and Duty of Care of a Prudent Manager of the Management CompanyAsset management companies must be financial instruments business operators engaged in

the investment management business, and if the subject of investment includes real estate, the license/authorization under the Building Lots and Buildings Transactions Business Act is required (ITA, art. 199). Asset management companies which are financial instruments business operators engaged in the investment management business have the duty of loyalty and the duty of care of a prudent manager toward right holders (i.e., investment corporations), as in the case of management companies handling securities investment trusts (FIEA, art. 42, para. 1 and para. 2).

(2) Investment Targets of Real Estate Investment Corporations (J-REIT)Real estate investment corporations (J-REIT) invest principally in real estate, etc. and asset-

backed securities, etc. that primarily target investments in real estate, etc., and distribute rent proceeds, etc. and other investment management profits generated to investors.(Note) Each fund has its own management characteristics, such as concentrating on urban properties or diversified regional holdings, and such as focusing on industrial facilities, office buildings, residential buildings, logistic facilities, hotels, and healthcare facilities.

The management of real estate investment trusts is carried out by asset management companies that are experts in real estate management. The asset management company chooses and invests in the real estate, decides the leasing strategy, which is the conditions under which the real estate investments will be leased, and manages the real estate. Also, the asset management company draws up long-term repair plans necessary to maintain the value of the real estate and executes such plans in a timely manner.

Real estate investment corporations are listed on the financial instruments exchange, providing investors with a market upon which to trade their investments. Under the rules of the financial instruments exchange, listed real estate investment corporations must meet certain requirements, such as the requirement that at least 70% of the total assets under management consist of real estate, etc.

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(Note) Under the JITA Real Estate Investment Corporations Regulations, “real estate, etc.” and “asset-backed securities, etc. that primarily target investments in real estate, etc.” are defined as follows:

“Real estate, etc.” means (i) real property, (ii) real estate leasehold rights, (iii) superficies rights, (iv) assets (i) through (iii) under foreign laws and regulations, (v) beneficial interests of a trust in which assets (i) through (iv) are entrusted, (vi) beneficial interests in a money trust established for the purpose of managing investments in assets (i) through (iv), (vii) contribution shares in a silent partnership concerning real estate, (viii) beneficial interests in a money trust established for the purpose of managing investments mentioned in (vii) as the primary trust asset, and (ix) assets having the same characteristics as those of assets of (v) through (viii) that are formed based on foreign laws and regulations, and (x) shares or capital contributions issued by a foreign real property holding corporation.

“Asset-backed securities, etc. that primarily target investments in real estate, etc.” mean (i) preferred equity investment certificates, (ii) parent investment trust beneficiary certificates (an investment trust that is established for the purpose of causing acquisitions in other investment trusts, (iii) parent investment securities (investment securities of an investment corporation that is established for the purpose of causing acquisitions of other investment corporations), (iv) special purpose trust beneficiary certificates, (v) silent partnership contribution share certificates, and (vi) assets that have the same characteristics as those set forth in (i) through (iv) and which are formulated in accordance with the laws and regulations of a foreign country, for the purpose of investing more than one half of its assets in real estate, etc.

(3) Asset Investment According to the Asset Management Plan for Real Estate Investment Corporations (J-REIT)When carrying out asset investment for a real estate investment corporation, an asset

management company must prepare an asset management plan which specifies the following matters for each fund and try to carry out asset investment according to such plan (JITA Real Estate Investment Corporations Regulations, art. 9):

(i) Management period scheduled under the asset management plan;(ii) Investment policy of the real estate investment corporation;(iii) Attributes of the real property, etc. and asset-backed securities, etc. assumed as the

investment targets;(iv) Valuation method for the assets held;(v) Criteria for shuffling of the real property, etc. held and asset-backed securities, etc.

held;



(vi) Policy for formulating a long-term repair plan for the real property, etc. held, the total amount of reserve based on the long-term repair plan, etc. for the real property, etc. held as estimated for the accounting period concerned, and the amount of reserve planned for each accounting period; and

(vii) Policy for formulating a plan on borrowing and repayment of funds (including a plan on the issuance and redemption of investment corporation bonds (including book-entry transfer investment corporation bonds; the same applies hereinafter); the same applies hereinafter).

An immediate plan on borrowing and repayment of funds must also be included as reference information.

(viii) If any amendment is made to the asset management plan, the date of amendment and the specific reason for the amendment; and

(ix) Other matters as may be deemed necessary for the protection of investors.

(4) Investment Restrictions on Real Estate Investment Corporations and Requirements for Management SystemsSince real property, etc. is one of a kind of assets with greater individuality than securities,

etc., investment restrictions exist in accordance with the characteristics and types of real property, while asset management companies are required to have in place appropriate management systems.

(i) Investment Restrictions and Systems Required for Overseas Real Estate, Etc.When a real estate investment corporation (J-REIT) seeks to acquire overseas real

estate, etc., the country or region in which the relevant estate is located must meet the following conditions (JITA Real Estate Investment Corporations Regulations, art. 24-2):

(a) The country or region has in place a law and other systems necessary for properly securing rights to use, profit and dispose of real estate, etc.;

(b) The country or region has in place a registration system and other systems necessary for ensuring the perfection of rights concerning real estate, etc. against third parties;

(c) The country or region has in place a law and other systems necessary for ensuring the proper conclusion and performance of agreements for transactions involving real estate, etc.;

(d) The country or region properly publicizes exchange rates for the currency to be used in transactions and ensures that the currency can be converted into Japanese yen without delay when necessary;

(e) The country or region sets in place conditions for properly conducting payment settlements and transfers; and

(f) The country or region has in place a litigation system and other dispute resolution systems.

When an asset management company gives instructions regarding the acquisition of

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overseas real estate, etc., it must, from the perspective of investor protection, conduct an investigation and collect information to the same extent as when acquiring property located in Japan, and take the measures necessary to manage and recover the leased property, etc. appropriately (e.g., appointing a local agent depending on the situation in the country or region in question) (JITA Real Estate Investment Corporations Regulations, art. 24-3). An asset management company is also required to have in place an internal system which enables the company to perform the following duties appropriately when giving instructions regarding the acquisition of overseas real estate, etc. (JITA Real Estate Investment Corporations Regulations, art. 24-4).

(a) Disclosure of information concerning the overseas real estate, etc. and the country or region in which the relevant property is located;

(b) Retention of records, etc. in Japan regarding the communications with the local asset administration company, etc.;

(c) Acquisition of information from the country or region in question and timely and appropriate response based on such information; and

(d) Timely disclosure in the event of a disaster, etc.(ii) Systems Required for Healthcare Facilities

If a real estate investment corporation seeks to acquire a healthcare facility (e.g., a serviced residence for the elderly, fee-based home for the elderly, or a group home for the elderly with dementia), the asset management company must have in place an internal system which enables the company to perform the following duties appropriately according to the size and characteristics of the relevant services (JITA Real Estate Investment Corporations Regulations, art. 24-5):

(a) Proper response when obtaining the necessary information from the party operating the healthcare facility (hereinafter referred to as the “facility operator”) as needed in the course of investing in the healthcare facility, in light of the actual conditions, etc. of the facility operator;

(b) Provision of information, etc. to the facility users so as not to make the users feel insecure due to the fact that their facility becomes the investment target of the real estate investment corporation; and

(c) Disclosure to investors of the circumstances specific to the healthcare facility in addition to the general disclosure items.

(5) Investigation of the Value, Etc.When the acquisition or transfer of land or buildings, or rights or assets relating thereto has

been carried out with regard to an investment corporation for which the asset management company is managing assets, the asset management company must have a real estate appraiser who does not fall within the scope of interested persons, etc. appraise the real property pertaining to the relevant assets (ITA, the main clause of art. 201, para. 1). However, this shall not apply if the asset management company has such appraisal conducted prior to the acquisition or transfer (id., proviso).



When an OTC derivatives transaction has been conducted with regard to an investment corporation for which the asset management company is managing assets, the asset management company shall have an attorney, legal professional corporation, certified public accountant, audit corporation, or real estate appraiser that has no interest in that transaction and meets certain requirements investigate the value and other matters of the relevant assets (ITA, the main clause of art. 201, para. 2). However, this shall not apply if the asset management company has such investigation conducted prior to the said transaction (id., proviso).

(6) Transactions with Interested Persons, Etc.Where an asset management company invests assets of a registered investment corporation

under its entrustment, and the acquisition or assignment of securities, borrowing and lending of securities, acquisition or assignment of real estate or lease of real estate is to take place between the registered investment corporation and an interested person, etc. of the asset management company, the asset management company is required to obtain consent of the board of officers of the registered investment corporation in advance, in principle (ITA, art. 201-2).

An asset management company must deliver to the investment corporation statutory matters in writing at least once every three months (ITA, art. 203). At the time, the asset management company is required to clarify whether the asset management company has been trading for its own account in the same issues of securities or same types of commodities, etc. as the asset management of the investment corporation or whether the asset management company has conducted trades in real estate for its own account, etc. when the specified assets invested in by the investment corporation include real estate (ITA, art. 203, each item of para. 1; ITA Enforcement Order, art. 125, para. 3).

In addition, if specified assets are traded, etc. between the investment corporation managed by the asset management company and the asset management company or its directors or corporate officers, other investment corporations managed by the asset management company, interested parties, etc., the asset management company must deliver a document stating matters concerning the transaction to the said investment corporation and such other investment corporations, etc. (ITA, art. 203, para. 2; ITA Enforcement Order, art. 126; ITA Enforcement Ordinance, art. 248).

9 4 Sales of Investment Equity of Real Estate Investment Corporations

When general investors trade in units of investment equity of a listed real estate investment corporation, they must conduct such transactions on the exchange, similar to listed shares, via a securities firm that is a trading participant of the said financial instruments exchange. Limit orders and market orders are both possible. Commissions are independently determined by each distributor.

Because the following types of risks are associated with real estate investment corporations,

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it is necessary to have investors understand these types of issues:(i) It is not a product for which the principal is guaranteed. The trading price will fluctuate

on the market;(ii) Dividends will fluctuate depending on changes in income from the real estate, etc. The

amount of dividends predicted by the asset management company is no more than a prediction that is based on a specific set of premised conditions, and it is not guaranteed;

(iii) Due to the effects of various economic conditions such as the real estate leasing and sales markets and the interest rate environment, there is the possibility that dividends will decrease and the price will fall. For example, if the amount of rent from the owned real estate falls and there is a decrease in income or if interest rates rise and financing costs increase, it is possible that dividends will decrease;

(iv) If the investment target real estate is subject to an earthquake or fire, etc., it is possible that the dividends and price will fall due to such unpredictable situations; and

(v) If it conflicts with the standards set by the financial instruments exchange and is delisted, it is possible that trading in the fund will become extremely difficult.

9 5 Custody of Assets, Accounting, Etc., Dividends, and Financing of Real Estate Investment Corporations

(1) Custody of AssetsA registered investment corporation cannot place assets in its own custody and must entrust

the custody functions to an asset custody company (ITA, art. 2, para. 22) (ITA, art. 208, para. 1). Therefore, the investment corporation concludes an entrustment agreement for custody of assets with an asset custody company which is to carry out the custody services for the investment corporation’s assets. The asset custody company assumes the duty of loyalty and the duty of care of a prudent manager in relation to the investment corporation (ITA, art. 209, para. 1 and para. 2).

Since persons who may serve as an asset custody company are limited to persons such as trust companies, etc. or financial instruments business operators engaging in the securities, etc. management business (ITA, art. 208, para. 2; ITA Enforcement Ordinance, art. 252), trust banks usually provide the asset custody services as in the case of investment trusts.

(2) Entrustment of Administrative AffairsBecause of its required role of a “conduit” as mentioned above, an investment corporation

must outsource its asset investments to an asset management company, and the custody of its assets to the asset custody company. Furthermore, it must entrust its administrative affairs other than these to the administrative agent. The scope of administrative affairs that an investment corporation must entrust to another include: accounting; offering of investment equity and investment corporation bonds; preparation, etc. of the investors registry, investment equity subscription right registry and investment corporation bonds registry; and the operation of a board of officers meeting (ITA, items of art. 117). Accordingly, it is often the case that the trust bank



that serves as the asset custody company also assumes some of these administrative affairs, or that an accounting firm assumes accounting affairs.

An administrative agent also assumes the duty of loyalty and the duty of care of a prudent manager in relation to the investment corporation (ITA, art. 118, para. 1 and para. 2).

(3) Accounting, Etc.An investment corporation must prepare accurate accounting books in a timely manner and

preserve such accounting books and other important materials related to its business for ten years from the day of the closing of the accounting books (ITA, art. 128-2). An investment corporation must also prepare financial statements (a balance sheet, income statement, statement of changes in investors’ equity and explanatory notes), an asset management report, statement related to the distribution of money, and annexed detailed statements thereof, and submit these materials to an accounting auditor to have them audited (ITA, art. 129 and art. 130; ITCO, art. 34, para. 1).

Accounting of a real estate investment corporation must be processed in accordance with the Ordinance on Accounting of Investment Corporations, the Real Estate Investment Corporations Regulations and other regulations of the Investment Trusts Association, Japan, and business accounting standards generally accepted as fair and appropriate (JITA Real Estate Investment Corporations Regulations, art. 4). To comply with this, an asset management company must properly retain and manage the sales contracts and a third party’s appraisal reports with regard to the properties held by the real estate investment corporation in which management operation is entrusted, service contracts concluded with the service providers, and other documents necessary for carrying out the entrusted business properly (JITA Real Estate Investment Corporations Regulations, art. 4-2).

An investment corporation must also prepare books and documents related to its business and preserve them for ten years (ITA, art. 211; ITA Enforcement Ordinance, art. 254).

(4) Valuation of Properties, Etc. Held and Calculation of the Base ValueAs the valuation method to be used to calculate the fair value of the real property, rights of

lease to real property and superficies rights held by a real estate investment corporation, a method that is considered to be appropriate for each asset must be selected from the following and be prescribed in the certificate of incorporation, and valuation must be made by such method; provided, however, that this does not apply to a real estate investment corporation established through private placement (JITA Real Estate Investment Corporations Regulations, art. 5, para. 1):

(i) Valuation based on an appraisal by a real estate appraiser;(ii) Valuation based on the actual transactions of similar properties in the vicinity;(iii) Valuation as amended through reduction based on the price assumed for acquiring the

property in question again at the relevant time (limited to the valuation of buildings);(iv) Value calculated by the income approach (DCF method or direct capitalization

approach); or(v) A combination of (i) through (iv).In accordance with the principle of continuity, the valuation method prescribed in the

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certificate of incorporation shall, in principle, not be changed (JITA Real Estate Investment Corporations Regulations, the main clause of art. 5, para. 2).

Beneficial interests in trusts created by entrusting therein real property, rights of lease to real property and superficies rights (including these assets under foreign laws and regulations), beneficial interests in money trusts created for the purpose of investing in these assets, and contribution shares in a silent partnership shall basically be valued based on the price offered by the trust company of the assets or the operator or the final price quoted on the listed market (JITA Real Estate Investment Corporations Regulations, art. 6 and art. 7).

Assets other than real property that are held by a real estate investment corporation shall be valued by a method provided in the JITA Investment Trust Accounting Regulations and Regulations on Infrastructure Investment Trusts and Infrastructure Investment Corporations, and if this is difficult, valued according to the business accounting standards generally accepted as fair and appropriate (JITA Real Estate Investment Corporations Regulations, art. 8).

The amount of depreciation of real property held shall be calculated by the straight-line method in the case of buildings (excluding attached facilities) or by either the straight-line method or the declining balance method which is prescribed in the certificate of incorporation in the case of facilities, etc. (JITA Real Estate Investment Corporations Regulations, art. 12, para. 1). The calculation method applicable to facilities specified in the certificate of incorporation shall not be changed in principle (JITA Real Estate Investment Corporations Regulations, art. 12, para. 2).

A management company shall correct the book value of the real property, etc. held at the end of each accounting period by deducting the amount of depreciation calculated by the abovementioned method from the book value at the beginning of the relevant accounting period (JITA Real Estate Investment Corporations Regulations, art. 13). If there has been any capital expenditure during each accounting period with regard to the real property, etc. held (expenditure for extending the life of the asset or increasing the value of the asset), an amount equivalent to the expenses incurred as such capital expenditure shall be added to the book value at the beginning of the relevant accounting period (JITA Real Estate Investment Corporations Regulations, art. 23). With regard to trading securities held, a management company shall correct the book value thereof through fair value adjustments, and add any securities valuation profit to the securities trading profit, and any securities valuation loss to the securities trading loss, respectively (Real Estate Investment Corporations Regulations, art. 14, para. 1). A management company shall also calculate any adjustment in the value of other securities held and record it as fair value adjustment or record the balance as valuation and translation adjustments at the end of each accounting period (JITA Real Estate Investment Corporations Regulations, art. 14, para. 2).

The amount calculated by deducting the liabilities from the total amount of assets after such depreciation, capital expenditure adjustment, and fair value adjustment of securities, etc. and then dividing the result by the number of units of investment equity shall be publicized as the amount of net assets per unit (base value) (JITA Real Estate Investment Corporations Regulations, art. 26 applied mutatis mutandis through the same regulations, art. 41). This base value is used as a benchmark for the trading price on the exchange.



(5) Distribution of MoneyFor tax purposes, if investment corporations seek to include the amount paid as dividends in

the amount of deductible expenses, that is, to make their profit tax-exempt, they are generally required to pay out in excess of 90% of their distributable profit as dividends (Act on Special Measures Concerning Taxation, art. 67-15, para. 1, item (ii), (e)). Following this provision, the Investment Trusts Association, Japan (JITA) has a rule to allow real estate investment corporations to distribute the whole amount of profit they gained during the current period (JITA Real Estate Investment Corporations Regulations, art. 42). If the amount of profit calculated under the ITCO falls short of the amount of income under tax law (inconsistency between taxation and accounting), the real estate investment corporation may take either of the following measures in order to meet the requirements for exemption from corporation tax: distribute money in an amount equivalent to the amount of increase in an allowance for temporary difference adjustment (ITCO, art. 2, para. 2, item 30), or set up a voluntary reserve in an amount equivalent to a reserve for temporary difference adjustment (ITCO, art. 2, para. 2, item 31) (JITA Real Estate Investment Corporations Regulations, art. 42, para. 2). If the real estate investment corporation records an allowance for temporary difference adjustment or a reserve for temporary difference adjustment, it must, for subsequent periods, add an amount of reduction from the reserve for temporary difference adjustment to, or subtract an amount of reversal of the allowance for temporary difference adjustment from, the amount of unappropriated retained earnings which is part of the amount of profit (JITA Real Estate Investment Corporations Regulations, art. 43-2). Furthermore, the real estate investment corporation is required to state, in the notes to financial statements, matters such as the cause of the allowance, reversal, reserve or reduction, the assets generated from the allowance or reversal, the amount of allowance, reversal, reserve or reduction, and the specific methods for making a reversal or reduction (JITA Real Estate Investment Corporations Regulations, art. 43-3 and art. 43-3-2).

Investment corporations are also allowed to pay money to investors as a refund of contributions that constitutes a distribution accompanying a decrease in contributions, etc. under tax law, up to 60% of the amount that remains after deducting the total amount of accumulated depreciation recorded as of the last day of the preceding accounting period from the total amount of accumulated depreciation calculated as of the last day of the current accounting period (ITA, art. 137, para. 1; JITA Real Estate Investment Corporations Regulations, art. 43). When real estate investment corporations make a refund of contributions that constitutes a distribution accompanying a decrease in contributions, etc. under tax law, except in the case of making such refund of contributions continuously at every closing, they should give full consideration to matters such as the disclosure of distinction between a distribution of profit and a refund of contributions, the decision-making process, policy for making a refund of contributions, and matters that may have an impact on medium to long-term cash flow required for financing (e.g., long-term repair plan). They are also required to clearly state in an asset management report that the amount paid is not a payment of distribution of profits but a refund of contributions that constitutes a distribution accompanying a decrease in contributions, etc. under tax law, and put notes in the relevant parts of the report regarding the objective grounds or reasons for the validity

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of the amount of refund of contributions (JITA Real Estate Investment Corporations Regulations, art. 43-5).

If investment corporations make refunds of contributions that constitute distributions accompanying a decrease in contributions, etc. under tax law continuously at every closing, they must announce the refund and disclose the refund policy in their certificates of incorporation, securities registration statements, annual securities reports, prospectuses, websites and other media, and put notes in the relevant parts of asset management plans. In addition, when disclosing the refund policy and putting notes in asset management plans and reports, they must present objective grounds therefor based on reasonable data, etc. (JITA Real Estate Investment Corporations Regulations, art. 43-4).

(6) FinancingReal property was included in the scope of investment targets under the ITA through the

2000 amendments, and accordingly, financing by means of investment corporation bonds was also introduced as a new financing method (only in the case of closed-end investment corporations; ITA, 139-2, para. 1). This is to meet the need of flexible financing means such as borrowings available for investing in real property, which has greater individuality than securities.

In an offering of investment corporation bonds, the total amount of investment corporation bonds for subscription, the amount of money for each investment corporation bond, the interest rate, the method of redemption and due date for redemption, the method and due date for interest payments, etc. must be determined by the meeting of the board of officers (ITA, art. 139-3, para. 2).

The JITA Real Estate Investment Corporations Regulations provide that investment corporations are allowed to borrow funds only to the extent necessary for the purpose of asset management, etc. and they must give consideration to the soundness of their property when borrowing funds. The JITA’s Real Estate Investment Corporations Regulations further require management companies to state in their asset management reports such matters as the reason for each borrowing, the amount borrowed, the lender, security, the interest rate, and the repayment method and due date (JITA Real Estate Investment Corporations Regulations, art. 18).

The issuance of investment corporation bonds takes time, and borrowings require time for examination, etc. To solve these problems and ensure more prompt financing, the issuance of short-term investment corporation bonds (CPs) has been introduced in the 2007 amendments. The issuance of short-term investment corporation bonds is permitted under certain conditions such as that the investment corporation bonds are issued for the purpose of procuring the funds necessary to acquire certain specified assets, etc., and that the maximum issue amount thereof is fixed by the certificate of incorporation, etc. (ITA, art. 139-13). The amendment in 2014 introduced an investment equity subscription right system as a new financing and capital policy method for investment corporations. The new system now enables financing through allocation to the existing investors (rights offering).



9 6 Disclosure by Real Estate Investment Corporations

(1) Disclosure by Listed Real Estate Investment CorporationsListed real estate investment corporations (J-REIT), which are categorized as listed

companies, are subject to the disclosure regulations under the FIEA, including issuance disclosure (securities registration statements, prospectuses) and continuous disclosure (annual securities reports). They are also required to disclose the details of their investment management by way of asset management reports as referred to in the ITA. In addition, for each accounting period, the corporate officers of an investment corporation must prepare an asset management report (ITA, art. 129, para. 2), and have such report, as well as the balance sheet and other financial statements, audited by an accounting auditor. After these materials are approved by the board of officers, the investment corporation must notify the investors of such approval without delay.

(2) Main Items of Asset Management Reports of Real Estate Investment CorporationsThe following are the main items to be contained in an asset management report (ITCO, art.

71 through art. 75):(i) Process of asset investment during the business period;(ii) Changes of the business performance and status of property over the most recent three

business periods;(iii) Information on the real property, etc. held, including:

(a) Location, lot number, etc.;(b) Prices of each property at the end of the current accounting period (appraised price,

posted price, road price rating, published price for sale, etc.);(c) For each property with tenants, the occupancy rate and the total number of tenants

at the end of the current accounting period, as well as the total rent income during the business period; and

(d) Total sales during the business period;(iv) Issues that the investment corporation should cope with;(v) Material events that have occurred after the closing in relation to the status of the

investment corporation;(vi) Other matters necessary for clarifying the status of asset investment by the investment

corporation during the business period;(vii) Matters concerning officers, etc. of the investment corporation (e.g. name, position,

duty, and the total amount of remuneration for corporate officers, supervisory officers or accounting auditors); and

(viii) The names of the major investors (top ten investors), and the number of units they hold and their holding ratios.

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(3) Disclosure on Management of Real Estate Investment Corporations(i) Disclosure of Changes in the Valuation of the Real Property Held

The valuation method for the real property held by an investment corporation is prescribed in the certificate of incorporation, and in accordance with the principle of continuity, the method once adopted shall not be changed, except when it becomes no longer appropriate due to justifiable grounds and replacing it with another method is reasonably judged not to be detrimental to the protection of investors (JITA Real Estate Investment Corporations Regulations, art. 5, para. 2). When changing the valuation method, it is necessary to clearly state the reasons for the change, the value calculated by the former method and that calculated by the new method at the end of the accounting period when the change has taken place, etc. in the asset management report for the said period (JITA Real Estate Investment Corporations Regulations, art. 5, para. 3).(ii) Disclosure on Long-term Repair Plans, Etc.

An asset management company must state in an asset management report for five years or more the amount of reserve set aside at the end of each accounting period based on the long-term repair plan, etc. for the real property, etc. held (JITA Real Estate Investment Corporations Regulations, art. 11).(iii) Disclosure of Borrowings

If an asset management company borrows any funds for a real estate investment trust, etc., it must state in the asset management report for the relevant accounting period the reason for each borrowing, the amount borrowed, the lender, security, the interest rate, and the repayment method and due date, etc. (JITA Real Estate Investment Corporations Regulations, art. 18).(iv) Disclosure of Capital Expenditure

When an implementation plan for capital expenditure (excluding deductible capital expenditure such as a reserve for repair) has been determined, it is necessary to state the name and location of the subject real property, the purpose of the capital expenditure, the scheduled period and amount, and an estimated amount of increase in the book value of the real property in the asset management report and prospectus to be delivered to investors prior to the implementation of the capital expenditure (JITA Real Estate Investment Corporations Regulations, art. 24, para. 1). The same matters must be disclosed on the basis of the actual figures after the capital expenditure plan has been completed (JITA Real Estate Investment Corporations Regulations, art. 24, para. 3). If capital expenditure is necessary for any real property held due to a natural disaster or similar event, it is necessary to give public notice of this fact promptly by the method prescribed in the certificate of incorporation and state the same in the asset management report (JITA Real Estate Investment Corporations Regulations, art. 24, para. 2).(v) Disclosure of Distribution of Money as a Refund of Contributions That Constitutes

Distribution Accompanying Decrease in Contributions, Etc. Under the Tax LawInvestment corporations are allowed to pay money to investors as a refund of

contributions that constitutes a distribution accompanying a decrease in contributions, etc.



under tax law, up to 60% of the amount that remains after deducting the total amount of accumulated depreciation recorded as of the last day of the preceding accounting period from the total amount of accumulated depreciation calculated as of the last day of the current accounting period (ITA, art. 137, para. 1; JITA Real Estate Investment Corporations Regulations, art. 43). When real estate investment corporations make a refund of contributions that constitutes a distribution accompanying a decrease in contributions, etc. under tax law, except in the case of making such refund of contributions continuously at every closing, they should give full consideration to matters such as the disclosure of distinction between a distribution of profit and a refund of contributions, the decision-making process, policy for making a refund of contributions, and matters that may have an impact on medium to long-term cash flow required for financing (e.g., long-term repair plan). They are also required to clearly state in an asset management report that the amount paid is not a payment of distribution of profits but a refund of contributions that constitutes a distribution accompanying a decrease in contributions, etc. under tax law, and put notes, etc. in the relevant parts of the report regarding the objective grounds or reasons for the validity of the amount of refund of contributions (JITA Real Estate Investment Corporations Regulations, art. 43-5).

If investment corporations make refunds of contributions that constitute distributions accompanying decrease in contributions, etc. under tax law continuously at every closing, they must announce the refund and disclose the refund policy in their certificates of incorporation, securities registration statements, annual securities reports, prospectuses, websites and other media, and put notes, etc. in the relevant parts of asset management plans. In addition, when disclosing the refund policy and putting notes, etc. in asset management plans and reports, they must present objective grounds therefor based on reasonable data, etc. (JITA Real Estate Investment Corporations Regulations, art. 43-4).

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Chapter 4 Incidental Businesses

Section 1. Businesses Other Than Financial Instruments Business∙∙∙∙∙∙∙∙ 379

Section 2. Contents of Businesses Incidental to Financial Instruments Business ∙∙∙∙∙∙∙∙ 3812.1 Securities Borrowing and Lending, or Intermediary or Agency

Services Therefor ∙∙∙∙∙∙∙∙ 3812.2 Money Loan Incidental to Margin Transactions ∙∙∙∙∙∙∙∙ 3832.3 Money Loan Secured by Securities Deposited for Safe Custody from

Customers∙∙∙∙∙∙∙∙ 3852.4 Agency Service for Customers Concerning Securities ∙∙∙∙∙∙∙∙ 3862.5 Agency Service of the Business Pertaining to Payment of Earnings,

Redemption Money or Cancellation Money with Regard to the Beneficiary Certificates of an Investment Trust or Foreign Investment Trust or Delivery of Securities or Other Assets in the Trust Property Relevant to the Securities ∙∙∙∙∙∙∙∙ 390

2.6 Agency Service of the Business Pertaining to Distribution of Money, Distribution of Refunds or Residual Assets, or Payment of Interest or Redemption Money with Respect to the Securities (Investment Securities, Investment Equity Subscription Rights Certificates, Investment Corporation Bond Certificates, or Foreign Investment Securities) Issued by an Investment Corporation ∙∙∙∙∙∙∙∙ 390

2.7 Conclusion of the Cumulative Investment Contracts ∙∙∙∙∙∙∙∙ 3912.8 Provision of Information or Advice Related to Securities ∙∙∙∙∙∙∙∙ 3962.9 Agency Service of the Business of Any Counterparty Financial

Instruments Business Operator, Etc. ∙∙∙∙∙∙∙∙ 3962.10 Custody of Assets of a Registered Investment Corporation ∙∙∙∙∙∙∙∙ 3972.11 Other Incidental Businesses ∙∙∙∙∙∙∙∙ 398

1 Businesses Other Than Financial Instruments Business

Operators of Type I financial instruments business or investment management business (hereinafter referred to as the “financial instruments business operators”) are unable to realize their full potential by engaging solely in the financial instruments business.

Therefore, under the Financial Instruments and Exchange Act (the “FIEA”), businesses that are difficult to separate, or cannot be reasonably separated from the financial instruments business are permitted as businesses that financial instruments business operators may conduct as long as there is no damage to the interests of society overall or the protection of investors.

Businesses other than the financial instruments business can be divided broadly into the following three categories:

(1) Business activities that may be conducted without notifying or obtaining the approval of the Prime Minister, as activities incidental to the financial instruments business (incidental business; FIEA, art. 35, para. 1);

(2) Specified business activities such as the money lending business or the real estate (building lots and buildings) transaction business that may be conducted by notifying the Prime Minister (notified business; FIEA, art. 35, para. 2, each item thereof); and

(3) Business activities, other than the financial instruments business, incidental business, and notified business, that may be conducted by obtaining approval from the Prime Minister (approved business; FIEA, art. 35, para. 4).

(for details, see Volume 1, Chapter 2, 2.2 “(3) Business Other Than Financial Instruments Business”).

This Chapter discusses those business activities that are incidental to the financial instruments business (incidental business).

Article 35, Paragraph 1 of the FIEA presents a list of business activities that are incidental to the financial instruments business. These business activities include:

(1) Borrowing or lending of securities, or intermediary or agency services therefor;

(2) Money loan incidental to a margin transaction;(3) Money loan secured by securities that are deposited for safe custody from

customers (limited to those specified by Cabinet Office Ordinance);(4) Agency services for customers concerning securities;(5) Agency service of the business pertaining to payment of earnings, redemption

money or cancellation money with regard to the beneficiary certificates of an investment trust or foreign investment trust issued by an investment trust settlor company, or pertaining to delivery of the securities or other assets

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Section 1. Businesses Other Than Financial Instruments Business


included in the trust property involving the said securities;(6) Agency service of the business pertaining to distribution of money,

distribution of refunds or residual assets, or payment of interest or redemption money with regard to securities (investment securities, investment equity subscription rights certificates, investment corporation bond certificates, or foreign investment securities) issued by an investment corporation;

(7) Conclusion of a contract for cumulative investment (limited to those specified by Cabinet Office Ordinance);

(8) Provision of information or advice related to securities (excluding such advice provided under an investment advisory contract);

(9) Agency service of the business of financial instruments business operators, etc.;

(10) Custody of assets of registered investment corporations;(11) Consultation to any other business operator with regard to the business

transfer, merger, company split, share exchange or share transfer, or intermediation therefor;

(12) Consultation to any other business operator with regard to the management;(13) Sale and purchase of currencies and other assets (excluding crypto-assets; the

same applies in (15)*) prescribed by Cabinet Order as being related to derivative transactions (excluding transactions of securities-related derivatives), or intermediary, brokerage or agency service therefor;

(14) Sale and purchase of negotiable deposits and other monetary claims (excluding those that fall under the category of securities), or intermediary, brokerage or agency service therefor;

(15) Management of investment property as an investment in the following assets:(i) Specified assets as provided for in the Act on Investment Trusts and

Investment Corporations (excluding real estate and other assets specified by Cabinet Order); and

(ii) In addition to those provided for in (i) above, assets as prescribed by Cabinet Order; and

(16)* Provision of customer information acquired from the customer to a third party with the consent of the customer or any other provision of information held by the financial instruments business operator to a third party, which contributes to advancement of the financial instruments business that the financial instruments business operator conducts or to improvement of convenience for users of the financial instruments business operator (excluding an act that falls under (viii) above).

[* This provision will come into effect on the day specified by Cabinet Order within a period not exceeding one year from the date of promulgation (June 7, 2019).]

Chapter 4. Incidental Businesses


An agreement in connection with incidental business will not constitute a “contract for financial instruments transaction” (FIEA, art. 34), and consequently will not be covered by the duty of delivery of document prior to conclusion of a contract (FIEA, art. 37-3) or other duties.

2 Contents of Businesses Incidental to Financial Instruments Business

2 1 Securities Borrowing and Lending, or Intermediary or Agency Services Therefor

This business refers to conducting borrowing and lending transactions for consumption of securities wherein one party (lender) lends securities to the other party (borrower), and upon the expiration of an agreed period of time, the borrower returns to the lender securities of the same type, quality, and quantity as those borrowed, as well as providing the intermediary or agency services for such transactions. There are several types of borrowing and lending transactions for consumption of securities depending on the type of underlying securities, such as borrowing and lending transactions of share certificates, etc. and borrowing and lending transactions of bond certificates. Among them, the section below explains borrowing and lending transactions of share certificates, etc. These transactions are conducted, for example, in cases where a customer intends to sell share certificates, etc. in a standardized margin transaction and the financial instruments business operator needs to procure the share certificates, etc. from a securities finance company (for details, see Chapter 1, “10.1 Outline of Margin Transaction System”), or where a financial instruments business operator needs to procure share certificates, etc. from the existing shareholders for an additional secondary distribution by the over-allotment (for details, see Volume 1, Chapter 4, “4.5 Shares Related Matters”).

The following stipulations concerning borrowing and lending transactions of share certificates, etc. (e.g., share certificates, share option certificates, bonds with share options, equity investment certificates, preferred equity investment certificates, and listed beneficiary certificates of investment trust, etc.) are prescribed in the “Rules Concerning Handling for Borrowing and Lending Transactions of Share Certificates, Etc. , which is a Self-Regulatory Rule of the JSDA (hereinafter referred to as the “Rules”).

(1) ExplanationtoandConfirmationwithIndividualInvestors,Etc.(Rules,art.4)Prior to borrowing share certificates, etc. from an individual investor, etc., a financial

instruments business operator must explain the basic structure of the borrowing and lending transaction of share certificates, etc. and risks associated with such transaction, and must try to make the individual investors, etc. understand the risks involved in such transactions, and confirm that the individual investor, etc. will engage in such transactions based on its own judgment and at its own risk.

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Section 2. Contents of Businesses Incidental to Financial Instruments Business


(2) ConclusionofAgreements,Etc.(Rules,art.5)When conducting a borrowing and lending transaction of share certificates, etc., the financial

instruments business operator must in advance enter into a master agreement concerning borrowing and lending transactions of share certificates, etc., which sets forth matters concerning, inter alia, the method of entering into individual agreements on borrowing and lending transactions of share certificates, etc., the method of paying lending fees, and deposit of collateral money, etc., as well as keep organized and retain these agreements.

An “individual transaction statement,” must also be delivered, etc. to the customer at the time of an individual borrowing and lending transaction of share certificates, etc., setting forth matters such as the contract date, the name of the issue(s), the lending volume, the lender, the borrower, the lending period, the lending fees, etc.

(3) AcceptanceandSubstitutionofCollateralMoney,Etc.(Rules,art.6andart.7)Before conducting a lending transaction of share certificates, etc. as the lender, a financial

instruments business operator decides, by agreement with the customer (the borrower), whether the contract to be concluded is a lending transaction of share certificates, etc. with collateral in which the lender will receive collateral money or securities, etc. as the substitute for collateral money (hereinafter referred to as “securities substitute for collateral money”), or a lending transaction of share certificates, etc. without collateral in which the lender will not receive collateral in exchange for the delivery of the share certificates, etc.

(i) CasesWhereaFinancialInstrumentsBusinessOperatorLendsShareCertificates,Etc.A financial instruments business operator receives the collateral money or securities

substitute for collateral money according to its agreement with the customer.The financial instruments business operator may pay interest on the collateral money

deposited by the customer.If securities substitute for collateral money are deposited in lieu of collateral money,

their price cannot exceed the amount obtained by multiplying the previous day’s market price by a prescribed percentage.(ii) CasesWhereaFinancialInstrumentsBusinessOperatorBorrowsShare

Certificates,Etc.A financial instruments business operator must provide collateral money or securities

substitute for collateral money to the customer according to its agreement with the customer.Furthermore, if the said customer is an individual investor, etc., the financial

instruments business operator is required to deposit collateral (including collateral equivalents) except in cases where it receives prior or simultaneous written confirmation from the said individual investor, etc. that collateral does not need to be deposited.

In addition, whenever a financial instruments business operator engages in unsecured transactions, then regardless of the customer’s attributes, it must adequately explain to the customer the risk factors involved in the said unsecured transactions.



(4) Acceptance,Etc.ofAdditionalCollateralMoney,Etc.(Rules,art.8)When the financial instruments business operator lends share certificates, etc. to a customer,

the total market value of those share certificates, etc. is marked to market on a daily basis, compared to the total amount of the customer’s collateral money and securities substitute for collateral money (multiplied by the applicable haircut), and if a shortage or excess results, the financial instruments business operator will receive additional collateral or return the excess collateral to the customer, according to its agreement with the customer.

(5) ReturnofCollateralMoney,Etc.(Rules,art.10)Upon the expiration of the loan period, after the financial instruments business operator

receives the return of the loaned share certificates, etc., it must promptly return the collateral money, etc. deposited by the customer.

(6) ReceiptandPaymentofLendingFees(Rules,art.11)The lending fees that the financial instruments business operator receives from the customer

when it makes a loan of share certificates, etc., and the lending fees paid to the customer when the financial instruments business operator borrows share certificates, etc. are determined according to its agreement with the customer.

(7) ReconciliationofOutstandingAmountofLending,Etc.(Rules,art.12)When the financial instruments business operator engages in a borrowing and lending

transaction of share certificates, etc., it must reconcile the outstanding balance of the share certificates, etc. subject to lending, collateral money, etc. with the customer at least once every three months.

(8) EnhancementofInternalControlSystems(Rules,art.15andart.16)Prior to commencing borrowing and lending transactions of share certificates, etc., financial

instruments business operators must establish internal rules concerning borrowing and lending transactions of share certificates, etc. in order to ensure sound business management.

In addition, financial instruments business operators are required to have their internal administration supervisor periodically check under his/her responsibility whether borrowing and lending transactions of share certificates, etc. are being appropriately carried out in accordance with the internal rules.

2 2 Money Loan Incidental to Margin Transactions

This business refers to the business activity wherein a financial instruments business operator loans funds to a customer who will engage in margin transactions (for details, see Chapter 1, “10 Margin Transactions”).

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(1) ContentofOperationsA margin transaction shall mean a trade or other transaction in securities that is conducted

with a financial instruments business operator extending credit to a customer (FIEA, art. 156-24).A financial instruments business operator may itself provide the funds to be lent to the

customer who seeks to engage in margin transactions, or may use a loan transaction with a securities finance company to procure the same.

The monetary amount that the financial instruments business operator lends to the customer is not the difference between the margin deposit that the customer has deposited and the contract price, but rather is the total amount of the contract price (TSE Brokerage Agreement Standards, rule 41, para. 1). Cash equivalent to the total amount of the contract price is not delivered directly to the customer, but rather the financial instruments business operator delivers the contract price of the customer directly through Japan Securities Clearing Corporation, a financial instruments clearing organization designated by the financial instruments exchange (settlement), on the delivery date of the transaction, thereby making the loan (TSE Clearing and Settlement Regulations, arts. 3 and 4).

As a result of this settlement through delivery, the financial instruments business operator receives the share certificates, etc. that have been purchased, but does not deliver them to the customer. Rather they are retained by the financial instruments business operator to secure the proceeds on the loan (TSE Agreement for Setting up Margin Transaction Account, art. 4 “Treatment of Securities Purchased and Sales Proceeds”). Consequently, a margin transaction between a customer and a financial instruments business operator is secured by both the margin deposit and the share certificates, etc. of the purchase.

(2) CustomersEligibleforLoansSince the loan is incidental to a margin transaction, customers who have submitted the

“Margin Account Agreement” to a financial instruments business operator and have opened a “margin account” are eligible for loans.

(3) ClearStatementofLoanConditionsWhen providing money loan to a customer, a financial instruments business operator shall

appropriately present to the customer the terms and conditions of the loan, such as the loan interest rate, the term of the agreement or the loan and the repayment procedures.

(4) RepaymentProceduresCustomers repay the purchase price from the proceeds received by reselling the share

certificates, etc. that they have purchased in margin transactions, or they can simply hand over money equal to the purchase price that the customer borrowed to the relevant financial instruments business operator and receive the share certificates, etc. (delivery of cash on hand).

Margin deposits that a customer deposits with a financial instruments business operator are to be managed separately from the assets of the financial instruments business operator itself, but the share certificates, etc. purchased or the proceeds for share certificates, etc. sold (hereinafter



“unsettled balances”) are not held in separate custody from the financial instruments business operator’s own assets.

Thus, if the financial instruments business operator were to go bankrupt, the customer may not be able to repay the margin loan by such means as physical delivery of cash or shares. In such cases, the customer must settle the deal in cash using the share price, etc. published by a financial instruments exchange in lieu of the ordinary repayment methods for margin transactions.

In this case, the customer’s claim against the financial instruments business operator for the amount of money involved in the unsettled balances is not given any priority whatsoever, so even if a computational profit results from the transaction, there is a possibility that the customer will not be able to recover the same.

In addition, claims for payment of unsettled balances are not covered by the Investors Protection Fund.

2 3 Money Loan Secured by Securities Deposited for Safe Custody from Customers

This business consists of two types of business activities; the cashing business and the secured lending business (lending money to customers by accepting securities as collateral in order to meet their financing needs). The scope thereof is set forth in Article 65 of the Cabinet Office Ordinance Concerning Financial Instruments Business, Etc. (hereinafter referred to as “FIBCOO”). The section below explains the cashing business of a money reserve fund (MRF), which is major service in this business.

(1) CashingBusinessThe cashing business refers to the activity of lending money to a customer who has requested

cancellation of his/her beneficiary rights in an MRF, so that the customer will be paid the amount equal to the cancellation money on the date of cancellation request. Specifically, a money loan is provided to the customer in an amount equal to the cancellation money using the securities related to the cancellation request as collateral until cancellation money is paid on the day following the date of cancellation request.

(2) TermsandConditionsoftheLoan,Etc.(i) LendingLimits

This is the amount that each financial instruments business operator determines for the MRF based on whichever is less of the amount that can be returned that is calculated on the basis of the balance of each fund or JPY5 million (FIBCOO, art. 65).(ii) LoanInterest

The loan interest is the net dividends of the MRF made up until the cancellation date from the date of cancellation request.

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(iii) LoanTermThe term is the period from the day when the loan is made until the next business day.

(iv) CollateralThe collateral is the MRF subject to the cancellation request.

(v) MethodofRepaymentThe cancellation amount to be paid to the customer on the next business day following

the loan is appropriated to the repayment.(vi) ApplicationsforCashing

A written application is unnecessary. It is necessary, however, to confirm that the customer wishes to use the “cashing” system.

(3) Other(i) ClearStatementofLoanTermsandConditions,Etc.

When cashing is accepted, a document setting forth the loan limit and other lending conditions must be issued to the customer (if cashing via an ATM is used, it is also possible to divulge the loan terms and conditions, etc. on the ATM display screen, and make the agreement, etc. available to customers by placing copies near the ATM). The application can be accepted after confirming the customer’s intent. This can also be done through a comprehensive agreement concluded at the beginning of the transaction, etc. with the loan terms and conditions being clearly stated in the customer agreement, etc.

Additionally, the methods of lending and repayment and other major lending conditions must be posted in an appropriate location at the offices of the financial instruments business operator that handles such lending.(ii) PreparationofBooks,Etc.

Documents required for the cashing businesses such as books, etc. must be prepared, kept organized and retained.(iii) ComplianceMatters

When conducting cashing businesses, care is to be exercised with respect to the amount, the interest rate and the period in connection with lending and funding, in order to ensure the protection of customers, the credibility of the financial instruments business operator and the soundness of its operations, and there must be compliance with the various laws and regulations, etc. required from the perspective of protecting investors and the public interest.

2 4 Agency Service for Customers Concerning Securities

The agency service for customers concerning securities consists specifically of the following businesses: (1) acting as agent in receiving payments for and paying principal and interest on bonds; (2) introducing brokerage for share-related administrative tasks, (3) acting as the customer’s standing agent concerning securities; and (4) acting as agent, etc. in receiving various



payments to be made to customers. The section below explains the agency service regarding bonds and shares, etc. issued in Japan.

(1) ActingasAgentinReceivingPaymentsforandPayingPrincipalandInterestonBonds(i) ActingasAgentinReceivingPaymentsforBonds

This business refers to the activity wherein a financial instruments business operator will receive payments (the purchase price) for those bonds as a designated payment-handling institution pursuant to its agreement with the issuer of the bonds, and pay the amounts it receives to the designated location on the payment date.(ii) ActingasAgentinPayingPrincipalandInterestonBonds

This business refers to the activity of paying principal and interest on the bond on behalf of the bond issuer or the payment agent (banks, trust companies) upon the request of the bondholder, etc.

Overall, the payment of principal and interest is made in succession as follows:

Issuer → Payment Agent → Account Management Institution → Owner of the Bonds

To facilitate the chain above, the owner of the bonds delegates to the account management institution the authority to demand and receive the principal or interest and the account management institution further delegates the same to entities such as the JASDEC and the Bank of Japan.

The following is an explanation of the agency service for paying principal and interest on bonds under the General Bond Book-Entry Transfer System and the Government Bond Book-Entry Transfer Clearing System.

(a) GeneralBondBook-EntryTransferSystemThe general bond book-entry transfer system makes the transfer of rights in general

bonds, namely, corporate bonds, municipal bonds, public corporation bonds and yen-denominated foreign bonds, completely paperless, instead of having to issue bond certificates in paper form, pursuant to the “Act on Book-Entry Transfer of Corporate Bonds, Shares, Etc.” (hereinafter the “Book-Entry Transfer Act”).

Under this system, a newly issued bond shall be issued as a book-entry transfer bond of the Japan Securities Depository Center upon the issuer’s agreement to the issuance of the bond as a book-entry transfer bond.

The payment of principle and interest under this system (involving the Japan Securities Depository Center, Inc. (JASDEC)) is processed as follows.

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(b) GovernmentBondBook-EntryTransferSystem

The government bond book-entry transfer system is a system wherein the delivery (clearing) of government bonds traded via financial instruments business operators, banks, etc. (account management institution) is carried out through book-entry transfer, that is, by transferring those bonds on the transfer account books kept at the Bank of Japan (book-entry transfer institution).

Pursuant to the Book-Entry Transfer Act, no bond certificate is issued for Japanese government bonds, and consequently persons wishing to acquire a new issue of book-entry government bonds must open an account with an Account Management Institution prior to the purchase in order to process the book-entry transfer of the bonds.

Principal and interest payments for book-entry government bonds are paid from the Bank of Japan to the account management institutions and finally to the government bond holders.

The clearing for book-entry transfer government bonds is processed as follows.

(2) IntroducingBrokerageforShare-RelatedAdministrativeTasksThis business refers to the activity wherein a financial instruments business operator

introduces brokerage for the share-related administrative tasks listed below to the issuing company or the JASDEC at the request of a customer.

(i) Forwarding the request for purchase or additional purchase of odd-lot sharesA shareholder’s request filed with a financial instruments business

operator is forwarded to the JASDEC and then to the issuing company (the administrator of the shareholder registry).

(Notes) 1. “Account Management Institution” refers to financial instruments business operators, banks, etc. 2. “Payment Agent” refers to those designated by the Japan Securities Depository Center as a payment

agent (Ordinarily, this is a bank that has been entrusted by the corporate bond issuer with administrative functions such as managing the bond register)

Bank of Japan Payment Agent (Note 2)

Japan Securities Depository

Center (JASDEC)

Account Management

Institution (Note 1)

General Bond Holders (vi) Payment of

principal and interest

(v) Notice of deposit into current account

(iv) Payment request

(iii) Data on requests for payment of principal and interest

(iii) Data on requests for payment of principal and interest

(ii) Final notice of principal and interest

(i) Tax information declaration data

(Note) Account Management Institution: financial instruments business operators, banks, etc.

Book-Entry JGB

Holders (iii) Principal/interest payment

Account Management

Institution (Note) (ii) Transfer of payment funds

(i) JGB book-entry interest (or redemption) payment date specifications

Bank of Japan



(ii) Handling a request for notice to individual shareholders (for the exercise of the right of minority shareholders)

The right of minority shareholders covers the right to request inspection and copying of the articles of incorporation, share handling regulations, minutes of shareholders meeting and other documents, and the right to submit proposals for shareholders meetings.

(iii) Processing the exercise of share options (including bonds with share options, share options, etc.)

(iv) Acting as agent for filing a notification of change of address and conducting other share-related administrative tasks

(3) ActingastheCustomer’sStandingAgentConcerningSecuritiesThis business refers to conducting all or a portion of the administrative tasks enumerated

below as the agent or proxy of an investor residing outside of Japan (“foreign investors”) based on the contract of entrustment concluded with the investor. As companies issuing shares or bonds request that foreign investors appoint a standing agent or select a provisional address in Japan, foreign investors who make an investment in Japan appoint a standing agent who is a resident in Japan and entrust the agent with management of securities they acquired.

Also, the financial instruments business operator must collect a document from a customer evidencing the entrustment (power of attorney) when the business operator is entrusted by the customer with securities-related business concerning the standing agent functions (JSDA Rules Concerning Acceptance of Deposit, etc. of Securities, art. 7). Moreover, an entrusted financial instruments business operator may collect a standing agent fee from the customer in the amount determined by the financial instruments business operator.

The contents of the major operations include:

(i) Investor Account Management Required to Conduct Standing Agent Functions

(ii) Agent for Transferring Title to Securities and Receiving Deposits(iii) Agent for Receipt and Management of Dividends, Interest, Redemption

Money, Etc.(iv) Exercise of Rights to Share Options and Bonds with Share Options, Etc.(v) Execution of a Voting Right by Proxy(vi) Agent for Administrative Procedures Concerning the Acquisition,

Disposition or Transfer/Assignment of Securities Under the Laws Including the Foreign Exchange and Foreign Trade Act

(vii) Agent in Applying for Reduction of or Exemption from Withholding Tax Under a Tax Treaty

(viii) Agent in Repurchase Requests for Odd-Lot Shares(ix) Report

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(4) ActingasAgentinReceivingVariousPaymentstoBeMadetoCustomersThis business refers to the activity wherein a financial instruments business operator receives

money to be paid to a customer from the issuing company, etc. on behalf of the customer through the bank account held in the name of the financial instruments business operator, and then remits such money to the securities account held by the customer:

(i) Dividends on shares;(ii) Proceeds on repurchase associated with a repurchase request that is made in

connection with odd-lot shares;(iii) Adjustment payments in association with exercise of share options;(iv) Cash to be paid as a result of the consideration for a merger, etc., which

became permissible by relaxation of consideration regulation; and(v) Cash to be paid as consideration in a buyback request on shares with put

options, or as consideration in shares subject to call.

All of these activities are limited to receiving cash in connection with the portion of shares (and in connection with (iii) the portion involving share options) that a financial instruments business operator holds in safe custody on the account of the relevant customer.

2 5 Agency Service of the Business Pertaining to Payment of Earnings, Redemption Money or Cancellation Money with Regard to the Beneficiary Certificates of an Investment Trust or Foreign Investment Trust or Delivery of Securities or Other Assets in the Trust Property Relevant to the Securities

This service refers to cases where a financial instruments business operator, under an agreement concluded with the settlor (settlor company) for each issue of investment trust, receives payment of earnings, redemption money or cancellation money, or receives delivery of securities or any other assets in the trust property relevant to the investment trusts, and pays over these amounts or delivers these assets to the trading accounts of the customers, etc. (beneficiaries). The same applies to foreign investment trusts (for details, see Chapter 3, “3-3 Investment Trusts Under Instructions from the Settlor and Without Instructions from the Settlor”).

2 6 Agency Service of the Business Pertaining to Distribution of Money, Distribution of Refunds or Residual Assets, or Payment of Interest or Redemption Money with Respect to the Securities (Investment Securities, Investment Equity Subscription Rights Certificates, Investment Corporation Bond Certificates, or Foreign Investment Securities) Issued by an Investment Corporation

An investment corporation only functions as a vehicle for asset management, and is required to outsource the actual asset management operations, asset custody operations and other general administrative affairs.

This service refers to the activity wherein a financial instruments business operator conducts, with respect to the securities issued by an investment corporation, distribution of money, distribution of refunds or residual assets or payment of interest or redemption money to the



investors on behalf of the investment corporation (for details, see Chapter 3 “Investment Trusts and Investment Corporations Business”).

2 7 Conclusion of the Cumulative Investment Contracts

This business refers to concluding a cumulative investment contract wherein “a financial instruments business operator (limited to those engaged in the securities, etc. management business) receives deposit money from a customer, and in exchange of the said money, sells securities to the customer continuously on dates designated in advance” (FIEA, art. 5, para. 1, item 7) so as to have them acquired by the customer.

(1) StructureofaCumulativeInvestmentContractUnder a cumulative investment contract, a financial instruments business operator

temporarily purchases securities for the amount of money paid in by a customer or the returns or redemption money derived from the securities deposited by the customer (hereinafter referred to as the “amount paid in, etc.”), and then sells the securities thus purchased to the customer in proportion to the amount paid in, etc., thereby having the customer acquire the securities.

In the event of a joint purchase such as cumulative stock investment and in the case where the total amount paid in, etc. is less than the purchase price (or a whole integral multiple thereof; in the case of cumulative stock investment, the market value at the financial instruments exchange, multiplied by the share unit number) for the securities that are to be purchased by the customer, the purchase will be made with funds that are combined with payments made by other customers or those of the financial instruments business operator, and ownership of the securities will be shared with other customers, etc. (in the name of the financial instruments business operator).

In this event, if the quantity increases, the portion shared by the customer will also increase on each occasion. When the aggregate of the cumulative paid in amount reaches the purchase price of a trading unit of securities (or 100 shares in the case of cumulative stock investment), securities to be owned by the customer will be identified, and the customer shall have sole title thereto (in the name of the customer).

<<Example of purchase>>CumulativeInvestmentContractforPurchasingCompanyA’ssharesfor10,000Yen

EachMonth(i) A customer purchases 100 shares (share unit number) jointly with other customers,

etc., and (ii) when the number of shares allocated to the customer among the shares thus jointly purchased reaches the share unit number, the customer acquires sole ownership for those shares.

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Amount paid in

Company A’s share

price

Number of shares acquired

Number of shares in joint ownership

Number of shares

in sole ownership

1st month JPY10,000 JPY250 40 shares

The total number of shares acquired is 40 shares, which is less than the share unit number.→ All shares are in joint ownership

0 shares

2nd month JPY10,000 JPY200 50 shares

The total number of shares acquired is 90 shares (40 shares (acquired in the 1st month) + 50 shares), which is less than the share unit number.→ All shares are in joint ownership

0 shares

3rd month JPY10,000 JPY400 25 shares

The total number of shares acquired is 115 shares (90 shares (acquired by the 2nd month) + 25 shares), of which 100 shares constitute the share unit number and are allocated to sole ownership of the customer.The remainder (115 shares – 100 shares = 15 shares) is in joint ownership.

100 shares

4th month JPY10,000 JPY300 33.3 Shares

The total number of shares acquired is 48.3 shares (15 shares (acquired by the 3rd month) + 33.3 shares), which is less than the share unit number.→ All shares are in joint ownership

100 Shares

(Fees, etc. are disregarded)

(2) DetailsofaCumulativeInvestmentContractA cumulative investment contract must provide for the following matters.(i) EligibleSecurities

The types of securities that may be handled as part of the financial instruments business operator’s cumulative investment businesses include bonds such as government bonds and local government bonds, investment trust beneficial certificates such as unit-type and additional offering type investment trusts, foreign investment trust beneficiary certificates, investment securities, foreign investment securities, listed share certificates, listed investment trust beneficiary certificates (ETFs) and listed investment securities (J-REIT).(ii) MethodofPurchasingSecurities

The securities purchased are, in principle, limited to new issues (except for share certificates, listed investment trust beneficiary certificates and listed investment securities),



and the type of securities as well as how to allocate the customer’s deposit among the securities purchased must be determined in advance under the agreement.

Nevertheless, in cases where there is no new issue on the predetermined issue date under the agreement and another suitable new issue cannot be located, the financial instruments business operator may purchase securities of the same type that have already been issued, as set out in advance in the agreement.

The financial instruments business operator purchases the securities without delay once the amount paid in, etc. reaches the purchase price (or an integral multiple thereof) of the new securities to be purchased for the customer.

Customers can pay the whole or part of the purchase price at any time and cancel a purchase of securities at any time by so instructing the financial instruments business operator.

The purchase price is basically determined by the type of securities as follows:

(a) For bonds, the price for public offering or secondary distribution;(b) For investment trust beneficiary certificates, the price set forth below:

(i) for a unit-type investment trust, the price for public offering;(ii) for an additional offering type bond investment trust, the net asset

value as of the purchase date or the day immediately preceding the purchase date;

(iii) for an additional offering type investment trust other than those mentioned in (ii) above, the net asset value as of the day immediately preceding the purchase date (in the case of an additional offering type investment trust in which the partial redemption charge is collected at the time of purchase, the amount obtained by adding the said partial redemption charge to the net asset value); and

(c) For foreign investment trust beneficiary certificates, the net asset value on the date immediately preceding the purchase date;

(d) For investment securities or foreign investment securities, the price prescribed in the certificate of incorporation or any other document equivalent thereto; and

(e) For listed share certificates, listed investment trust beneficiary certificates or listed investment securities, the market price at the financial instruments exchange designated in advance in the contract (where there are several contract prices at the exchanges of the issue concerned, their weighted average price).

(iii) ManagementMethodforAmountsPaid-in,Etc.The amounts paid in, etc. shall be managed separately as cumulative investment

deposits, and no payment will be made to customers of interest or other gains on these deposits.

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(iv) TransferofOwnershipIn the case of joint purchases such as cumulative stock investment, when the serial

codes and numbers of the securities purchased by a customer are identified, these securities which have been jointly owned in the name the financial instruments business operator come under sole ownership of the customer (in the case of cumulative stock investment, these securities are held in the name of the customer).(v) MethodofCustody

Deposit balances, etc. for securities received under cumulative investment businesses must be held in custody separately from other securities. In this case, securities that are held jointly by the financial instruments business operator and customers must be further segregated.(vi) Cancellation

Under a cumulative investment contract, the customer may make a cancellation request at any time.

(3) CumulativeStockInvestmentsCumulative stock investment is a system whereby investors deposit funds with the financial

instruments business operator, and the financial instruments business operator uses that pool of funds in order to purchase a predetermined issue of shares, etc. on a certain date each month (cumulative investment through joint purchases).

The investor signs a cumulative stock investment contract, etc. with a financial instruments business operator and selects a share from the list of shares pre-selected by the financial instruments business operator. Using the amount paid in, etc. by each of the investors who selected the same issue, on a predetermined date every month, the financial instruments business operator will acquire the said shares, etc. in a joint purchase.

This enables investors to purchase shares, etc. periodically and continuously with a fixed amount of money (dollar-cost averaging method): even a relatively small amount. At the point at which the cumulative stocks purchased become a round-lot, the investor can become an ordinary shareholder by changing the cumulative stock investment account into a custodial account (for details, see Chapter 1 “7 Cumulative Stock Investments”).

(i) ExemptionfromtheInsiderTradingRegulationsIf a predetermined amount is paid periodically for the automatic purchase of a certain

shares under a cumulative stock investment program, this will be covered under the Cabinet Office Ordinance Concerning Restrictions on Transactions, Etc. in Securities, Article 59, Paragraph 1, Item 9, and the regulations concerning insider trading (FIEA, art. 166 and art. 167) will not apply (for details, see Volume 1, Chapter 2, “12.4 Insider Trading”).

Thus, even if a corporate insider who has knowledge of material facts (insider information) purchases shares before the information becomes publicly available, as long as the transaction is a part of the periodic purchases under a cumulative stock investment program entered into before the information became known to the party, the transaction will not violate the insider trading regulations.



Exemption is allowed only when the purchase of shares under the cumulative stock investment program satisfies all of the following conditions:

a. The purchase is made according to a predetermined plan;b. The purchase is not based on an individual investment decision;c. The purchase is part of a series of continuing purchases; andd. The customer’s total paid-up amount for a single issue is less than JPY1

million per month.

(ii) Non-ExemptedTransactionsAn exception to the rule would be “automated purchases” that are exempted from the

insider trading regulations.However, the following transactions are not exempted from the insider trading

regulations and thus need to be monitored diligently:

・ Sale of a customer’s shares in the said issue;・ Purchases made with irregular payments; and・ Conclusion or amendment of a cumulative stock investment contract

after learning of material facts, and making a purchase under the said contract before the facts are publicly announced.

(iii) CustomerPaymentAmountsOnly customer payments of less than JPY1 million per month for a single issue are

exempted from the insider trading regulations. When the said customer has cumulative stock investment contracts with multiple financial instruments business operators designating the same issue, the total of all payments made by the investor for the shares must be less than JPY1 million in order to be exempted from the insider trading regulations.

Because a financial instruments business operator cannot check the investor’s transactions with other financial instruments business operators, it must without fail notify the investor at the time of concluding the contract that “if the total amount of the amount paid in under the contract with the financial instruments business operator and the amount paid in, etc. under any other contracts with any other financial instruments business operators for the purchase of the same shares becomes JPY1 million or more, it will be subject to the insider trading regulations”.

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2 8 Provision of Information or Advice Related to Securities

This business covers the following activities in which a financial instruments business operator provides a customer with expertise and know-how in connection with securities. Providing advice, etc. under a contract for receiving remuneration by giving advice on the value of securities (investment advisory contract) constitutes the investment advisory business, and requires registration.

(1) ProvisionofInformation,Advice,Etc.RelatedtoBusinessPertainingtoSecuritiesorOtherFinancialInstrumentsBusinessesA business that offers, inter alia, information or advice on financial instruments businesses,

and provides information and know-how, etc., which specifically refers to information and advice on financial strategies, etc. and asset management, etc. that the financial instruments business operator has accumulated through its operations in the financial instruments business.

(2) ProvisionofInformationandAdvice,Etc.RegardingtheProceduresforApplicationstoVariousInstitutionsintheCaseoftheIssuanceofSecurities,Etc.Offering, inter alia, information and advice on various procedures for the issuance and

listing, etc. of securities (note that there is a potential conflict with the Administrative Scrivener Act if application documents are prepared for submission to administrative agencies on behalf of an issuer), specifically, offering information and advice on the issuance of new shares and public offerings, etc., and regarding other finance issues.

2 9 Agency Service of the Business of Any Counterparty Financial Instruments Business Operator, Etc.

This business refers to the agency services (excluding 2-5. above) for the financial instruments business and the incidental business (excluding the business activities involved in the agency service mentioned herein) of another financial instruments business operator, etc. (including the registered financial institution business conducted by a registered financial institution), which such principal financial instruments business operator is permitted to conduct.

For example, a financial instruments business operator may engage in the cumulative investment business as an agent of another financial instruments business operator, etc.

(1) AgencyServiceRelatingtoCumulativeInvestmentBusinessThis business refers to the brokerage service for introducing customers (the introduced

customer) to a financial instruments business operator that carries out a cumulative investment business (hereinafter a “delegating financial instruments business operator”), or carrying out administrative work on behalf of a delegating financial instruments business operator, such as



delivering purchase proceeds between the business operator and the introduced customer.The major agency services relating to cumulative investment business are as follows:

・ Receiving of applications for cumulative investment and other related documents;

・ Receiving applications to purchase securities;・ Receiving payments;・ Receiving applications to cancel cumulative investment contracts; and・ Returning securities or paying refunds in association with return sales of

securities.

Moreover, a financial instruments business operator that engages in agency activities relating to cumulative investment business must explicitly state to customers requesting a cumulative investment contract that the agreement will be entered into with the delegating financial instruments business operator, and obtain the customer’s consent to the same.

(2) RelationshipwithDelegatingFinancialInstrumentsDealerThe financial instruments business operator providing the agency services relating to the

cumulative investment business must enter into an agreement with the delegating financial instruments business operator which explicitly states that the agency services shall be limited to those involving intermediary activities and clarifies who has responsibility to the introduced customer.

A system must also be implemented in order to have delivery and receipt of money, etc. with the delegating financial instruments business operator conducted accurately and in a timely manner.

2 10 Custody of Assets of a Registered Investment Corporation

This business refers to the activity wherein a financial instruments business operator or a trust company, etc. acts as an asset custody company and keeps in custody the assets of a registered investment corporation which is restricted from retaining its own assets (Act on Investment Trusts and Investment Corporations, art. 208, para. 2).

Since the financial instruments business operators mentioned here are limited to those that carry out securities, etc. management business, this business can be said to constitute an incidental business concerned only with a Type I financial instruments business operator that carries out management business of securities, etc. (for details, see Chapter 3 “Investment Trusts and Investment Corporations Business”).

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2 11 Other Incidental Businesses

In addition to the above businesses, (i) advising in connection with an assignment of business, merger, company split, exchange of all shares with those in an existing holding company, transfer of all shares to a newly established holding company with shareholders receiving shares in the holding company in return, or intermediating in connection with the same (activities in connection with mergers and acquisitions, etc.); (ii) advice concerning the management of another business operator (management consultant activities, etc.); and (iii) trading in currency, etc. have been prescribed in the FIEA (FIEA, art. 35, para. 1).

Moreover, as well as these explicitly listed business activities, a financial instruments business operator can engage in other business incidental to the financial instruments business including(1) safe-deposit box business, and (2) agency business for receiving payment of public utility charges, etc., as “any other business incidental to financial instruments business,” as prescribed in the FIEA, the main paragraph of art. 35, para. 1 (discussed later).

(1) Safe-DepositBoxBusinessThis business refers to the business of providing customers of financial instruments business

operators with a safe and convenient place to store customers’ assets. Under the agreement of service, the prescribed fees are collected and safety-deposit boxes are lent out.

(2) AgencyServiceforReceivingPaymentofPublicUtilityCharges,Etc.This business refers to the business in which pursuant to the contracts of a financial

instruments business operator with a customer and a service provider company, the financial instruments business operator, on behalf of the service provider company, collects cash from the customer by means of automatic cancellation of MRF of a cash management account (shoken sogo koza) of the customer, or through physical receipt of cash at a counter for the purposes of payment of the public utilities charge or the credit card bill, etc. and then distributes the cash to the service provider company.



Chapter 5 Sales Operations


Section 1. The Task of a Sales Representative ∙∙∙∙∙∙∙∙ 4021.1 Description of the Task ∙∙∙∙∙∙∙∙ 4021.2 Stance for Proceeding with the Task ∙∙∙∙∙∙∙∙ 403

Section 2. Ethical Sense Required for Sales Representatives ∙∙∙∙∙∙∙∙ 4042.1 What Are Ethics? ∙∙∙∙∙∙∙∙ 4042.2 The Necessity of Possessing a Sense of Ethics ∙∙∙∙∙∙∙∙ 4042.3 Prohibition Against Wrongdoing and Self-Awareness as a Sales

Representative ∙∙∙∙∙∙∙∙ 4052.4 Points to Keep in Mind in Order to Continuously Maintain

Consciousness of Ethics ∙∙∙∙∙∙∙∙ 4062.5 Code of Ethics ∙∙∙∙∙∙∙∙ 407

Section 3. Compliance with Laws, Regulations and Rules ∙∙∙∙∙∙∙∙ 4123.1 What Is Compliance? ∙∙∙∙∙∙∙∙ 4123.2 Check List for Sales Representatives ∙∙∙∙∙∙∙∙ 414

Section 4. IOSCO International Conduct of Business Principles ∙∙∙∙∙∙∙∙ 428

Section 5. Principles in the Financial Services Industry and Principles Concerning Customer-Oriented Business Conduct ∙∙∙∙∙∙∙∙ 429

Section 6. Sales Representative’s Approach to Sales Activities ∙∙∙∙∙∙∙∙ 4336.1 Selecting the Business Targets ∙∙∙∙∙∙∙∙ 4346.2 Approaching the Selected Targets ∙∙∙∙∙∙∙∙ 4356.3 Creating Prospects ∙∙∙∙∙∙∙∙ 4366.4 Making Your Own Customers ∙∙∙∙∙∙∙∙ 4376.5 Building a Long-Term Relationship ∙∙∙∙∙∙∙∙ 4386.6 Assessing One’s Self-Conduct ∙∙∙∙∙∙∙∙ 439

Conclusion ∙∙∙∙∙∙∙∙ 440

IntroductionThe reform of the Japanese financial and capital markets (the Japanese version of the Big

Bang) began with the enactment of the Financial System Reform Law in 1998, under the three point slogan of FREE, FAIR and GLOBAL.

The “Vision for the Future of the Financial System and Policy” of 2002 pointed the way towards a multi-vectored reconfiguration of the financial system centering on market functions, and the series of sweeping measures began to take concrete form from a broad perspective in the “Program for Promoting Securities Markets Reform.”

A major revamping of securities taxation was also implemented in January 2003 in order to accelerate the shift “from savings to investment”, and to encourage active participation in the markets by individual investors.

Based on a report prepared by the Financial System Council in December 2003 entitled “Moving Toward a Financial System Centered on Market Functions”, which addressed the systemic changes needed to improve the stature of the financial markets, the restrictions on banks acting as intermediaries for financial instruments business operators, etc. in the sales of shares were lifted (the securities intermediary business) with the objective of making the markets more accessible to everyone.

In December 2004, the Financial Services Agency formulated a financial reform program and, as one of the fundamental aspects of the program, promoted the slogan of “Building a financial services nation”, which was to feature five perspectives, including “Emphasis on users’ needs and thorough implementation of user protection rules.” By way of concrete measures, a new law tentatively called the “Investment Services Law” was proposed as a policy with the aims of upgrading user protection rules so that they would match financial reality and formulating comprehensive, unified rules of trading in connection with financial products and services.

Then, in September 2007, with a view to building an overarching legal regime governing the sale and solicitation of financial instruments, the Financial Instruments and Exchange Act (hereinafter the “FIEA”) was enacted by way of amendment to the former Securities and Exchange Act, with the objectives of “thoroughly inculcating user protection rules and improving user convenience,” “ensuring the functioning of the market mechanism” and “addressing the internationalization of the financial and capital markets.”

In January 2014, the NISA program (a tax exemption program for small investments) was put into operation, and in April 2016, the Junior NISA program (a similar tax exemption for minors) was introduced. In January 2018, the Dollar-Cost Averaging NISA program was launched.

In this manner, policies have been enacted from a broad perspective, in order to create true depth in the markets by having a wide variety of investors participate, and to build a financial system that centers on market functions. In turn the trend towards financial deregulation and globalization is accelerating, together with factors such as the international strategies of Japanese corporations and participation by foreign affiliates.

Amid such developments, sales representatives have a very major role to play as a conduit

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Introduction

linking investors and the markets.The authority of sales representatives is stated in Article 64-3 of the FIEA as follows: “A

sales representative shall be deemed to have the authority to conduct any extra-judicial acts concerning acts listed in the items of Article 64, Paragraph 1 of the FIEA (sales and purchases as well as other transactions in securities) on behalf of the financial instruments business operator, etc. to which he/she belongs.” Thus, as is evident even from the text of the law itself, the acts of a sales representative are “acts that represent the financial instruments business operator, etc.,” creating a serious social responsibility.

To meet these high expectations and carry out their important responsibilities, sales representatives are expected to have at all times an individual professional awareness of the public role of financial instruments business operators, etc., and to approach their work with a high consciousness of legal compliance, professional ethics and self-discipline. Moreover, sales representatives must constantly devote energy to self-development so that they can appropriately analyze the diverse information of the ever-changing market, and based on that information, give effective advice to investors. It is only through these efforts that they will be able to earn the confidence of investors.

1 The Task of a Sales Representative

1 1 Description of the Task

Investor expectations for returns can vary. Some expect to realize a capital gain on the value of a company as it grows, and others are more concerned with interest and dividend income over the long term. There are also differences among investors in terms of investment experience, investment planning, assets, income and the degree of risk they are able to tolerate.

For example, if the investment plan is one that places priority on the safety of the principal, a suitable recommendation would be to invest in products that provide safety, such as government bonds, and are consistent with the amount of risk the investor can tolerate. On the other hand, investors who are concerned about the aging society might benefit by a recommendation to invest in a company that provides nursing care services.

Nevertheless, given the myriad of complicated factors that impact the market, it is no easy matter for one to locate the right investment that offers the appropriate balance between acceptable risk and expected returns among a host of financial services.

Also, while the future is uncertain and investment activity is always accompanied by anxieties, by being diligent in one’s efforts, it is possible to gain some insight about the future.

The task of the sales representative is to provide useful advice and information, within the framework of certain rules as discussed below, which assists investors in overcoming their

Chapter 5. Sales Operations


anxieties and reaching a final investment decision. This is accomplished by repeatedly selecting appropriate investment targets aimed at an uncertain future.

In other words, a sales representative must arrive at an accurate analysis and understanding of the needs of the investor, and further, he or she must also consider other factors such as the plan and objective of the investment as well as the assets and income of the investor, and offer valuable investment advice based on a sincere appraisal of the future and backed by a full knowledge of the available investment products. By providing valuable investment advice, a sales representative is able to receive a high degree of satisfaction and trust from the customer.

This will lead to greater participation in the markets by investors, and can also be said to make a contribution to the development of a market economy and greater happiness for society in the future.

1 2 Stance for Proceeding with the Task

Having a proper stance is critical for any line of professions, and for the sales representative, the following are required to be considered:

(1) Pay Careful Attention to Basic BehaviorSales representatives must pay careful attention to their basic professional behavior because

failure to do so will make it impossible to carry out their duties, no matter how much knowledge or ability they have. The following are examples of issues that sales representatives should keep in mind:

・ Listen carefully to the customer and learn the customer’s intentions;・ Make proposals that are consistent with the customer’s intentions;・ Respond to requests accurately to the fullest extent possible;・ Provide prompt and accurate reports to customers; and・ Keep confidentiality.

In addition to the above, sales representatives should also be mindful of such other issues and matters as they consider important, and pay careful attention to their basic behavior.

(2) Be Aware That a Sales Representative Is Selling TrustIt goes without saying that trust is an imperative for all sales activity, but particularly in the

field of securities what investors require is appropriate investment advice that meets the needs of the individual investor. Whether or not an investor will use this advice in making a final investment decision depends on the credibility of the financial instruments business operator, etc. and the sales representative. In this sense, it is imperative that sales representatives be aware that they “are selling trust itself.” Also, a sales representative must not act in a way that damages

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Section 1. The Task of a Sales Representative


customer trust, such as seeking to advance his/her own interests by using his/her position as a sales representative.

(3) Continually Striving for Professional Development by OneselfProviding advice tailored to the needs of investors is critical if one is to earn their trust. To

this end, it is essential that a sales representative continually stays abreast of a great deal of the most recent information and is prepared to provide products and services that are optimally suited to the needs of the investor.

Sales representatives must always have a full awareness of their capabilities as well as the investment environment, and endeavor to identify and to refine aspects of their skill set that will contribute to their own improvement, such as their professional knowledge and technical skills. By doing this, one will become able to develop a fine-tuned sense of the changes taking place in the world, analyze large volumes of information, and provide services that lead to investor satisfaction.

2 Ethical Sense Required for Sales Representatives

2 1 What Are Ethics?

As stated above, sales representatives must be highly conscious of professional ethics and legal compliance, etc. in the performance of their duties.

Sales representatives must understand that “just as with etiquette, having a high ethical sense is fundamental to being a professional.” Continuing to maintain a high ethical sense leads to maintaining trust in all respects.

2 2 The Necessity of Possessing a Sense of Ethics

As stated above, a sales representative is authorized to conduct, on behalf of members of the Association to which he/she belongs, any extra-judicial acts concerning trading or other transactions in securities. Therefore, sales representatives are required to have a high sense of ethics as professionals who are constantly engaged in the activities of financial instruments business operators.

For example, acts such as insider transactions or market manipulation conducted by a sales representative in his/her capacity as a professional are absolutely prohibited. This is not only simply to say that a sales representative should not act improperly or unfairly, but to say that a



professional is firmly expected to take the approach of actively taking action to eliminate risk or unfairness (for details, see Volume 1, Chapter 2, “12-3 Market Manipulation” and “12-4 Insider Trading”).

Also, business and ethics are not opposed to one another. Only business that is in accordance with legitimate rules should be considered to be socially permissible. One can say that just as a poor quality business does not pay, a business lacking in ethics will not pay.

Ethics means not simply stopping at observing the existing rules, but also means, for example, the necessity of taking a position where one does not act improperly, even if there is no applicable rule. Also, in order to foster an appropriate ethical sense, it is extremely important that the viewpoint of a third party is always kept in mind.

In order to be a good businessperson and a good member of society, it is necessary to take the position of always acting on the basis of conscience.

2 3 Prohibition Against Wrongdoing and Self-Awareness as a Sales Representative

Knowing the purpose of and background to the rules, sales representatives must aim to refrain from acting wrongly or inappropriately.

The purpose of the FIEA, which prescribes the sales representative system, is “to contribute to the protection of investors and thereby to maintain and increase trust in the financial instrument exchange markets by ensuring fairness in issuance of securities and transactions of financial instruments, etc.” The self-regulatory rules of the Japan Securities Dealers Association (hereinafter referred to as the “JSDA”) have the same purpose.

The acts of a sales representative are acts that represent the financial instruments business operator, etc. Taking into consideration the very large number of customers to which the financial instruments business operator, etc. targets its business and the role played by the financial instruments business operator in the national economy, a sales representatives’ acts involve serious social responsibility.

For example, the reason that the FIEA imposes a duty to explain and requires suitability when making solicitations is because there generally is a large information gap between financial instruments business operators, etc. and customers, and to rectify that, the customer should make investments based on the customer’s own judgment only after having obtained appropriate and adequate information.

It is inexcusable for a sales representative to act wrongfully or improperly, and it must always be kept in mind that such an act will bring about a loss not only on the part of the person who acted in such a way, but also could greatly damage trust in the firm to which the relevant sales representative belongs and the entire industry, as well as the capital markets.

Penalties for a sales representative who acts wrongfully or improperly can include revoking the sales representative’s qualification, or terminating the sales representative’s employment, and for a person who acts in such a way as to cause a considerable loss of trust, based on the JSDA

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Section 2. Ethical Sense Required for Sales Representatives


rules, there is also the severe penalty of denial of employment for a period of five years or permanently (i.e. Special Members of the JSDA must not allow the relevant person to engage in a registered financial institution business; also, Specified Business Members must not allow the relevant person to engage in the specified business).

In particular, severe criminal penalties are imposed as a result of criminal prosecution in respect of acts such as insider trading or market manipulation. In these cases, the responsibility of the company as a whole in addition to the relevant person will be brought into question, and if administrative sanctions or the like are imposed, the reputation of the company will also suffer, and it will inevitably incur major economic losses (for details, see Volume 1, Chapter 2, “12-3 Market Manipulation” and “12-4 Insider Trading”).

Further, permitting intervention by antisocial forces in financial instruments trading or the financial instruments markets, thereby enabling persons engaged in financial instruments trading to have relationships with antisocial forces, or permitting money laundering and terrorist financing, will not only damage the health of the financial instruments markets and financial instruments-related bodies, but will also result in the loss of trust of many investors.

In recent corporate scandals, there have also been an increasing number of examples that were triggered by whistle-blowing.

Just as there is the phrase “Heaven’s vengeance is slow but sure” (meaning that although the net spread by heaven is large and wide and appears to be loosely woven, evildoers will not be allowed to escape its mesh and will be caught; the just deserts for evil will come sooner or later), one must understand that if one acts in violation of laws or regulations, this will invariably be discovered and a severe penalty will be imposed.

It is necessary to beware that if one makes light of something, saying that it is a small violation, there is a risk that it will develop into an even larger incident, and concealment of wrongdoing can easily give rise to further wrongdoing.

As described above, it must be remembered that a wrongful act will damage trust in the capital markets and will unavoidably lead to harming even the essential functions of the capital markets, which are the smooth investment and procurement of funds.

This could cause a serious effect even on the national economy, and one must consider that if damage is once done to trust in the markets, that trust cannot easily be restored, and it will require a large amount of effort at great cost.

2 4 Points to Keep in Mind in Order to Continuously Maintain Consciousness of Ethics

As stated above, it is essential that each individual sales representative goes about his or her business with a rigorous professional and ethical consciousness. The following is a summary of points to keep in mind in order to continuously maintain a consciousness of ethics:

(i) It must be understood that a wrongdoing will invariably be found out. Also, the concealment of wrongdoing easily brings about further wrongdoing, and will cause a



considerable loss of trust;(ii) Things must not be taken lightly with the attitude that it is only a small violation.

The risk of something leading to an even larger incident must always be borne in mind;(iii) As a professional, the excuse, “I didn’t know the rules,” cannot be tolerated;(iv) It is necessary to avoid the easy perception, “since everyone around me also does

it, it probably is OK,” and to make responsible individual judgments. Decisions on these occasions must not be made on the basis of an individual’s assumptions, and in the event of any doubt, advice must be sought from the individual’s superiors or specialist sections such as the internal control section or the legal section;

(v) Do not pretend not to see mistakes around you. You must have the courage to correct these mistakes;

(vi) It is essential to avoid viewing cases of wrongdoing or inappropriate acts that occur at other companies as “someone else’s problem,” but to take the attitude of learning from those cases as “mistakes to learn by.” In that sense, since we believe that disciplinary actions against members or securities mediation cases, etc. will serve as a reference, it is necessary for one to pay daily attention to these;

(vii) Social consciousness is always changing, and it is necessary to be aware that a more thorough response is expected. The recent trend is for judicial decisions regarding corporate or professional wrongdoing to produce strict judgments; and

(viii) Strive to distance yourself from an environment that easily invites wrongdoing or temptation. Together with maintaining health in mind and body, it is essential to abstain from a lifestyle that involves taking on excessive debt, take care to act with dignity, and always draw a line between public and private life.

2 5 Code of Ethics

The JSDA calls upon its members to possess a Code of Ethics. The background to this includes the following:

(i) A series of liberalizations in financial regulations have encouraged competition and have led to diversification in securities products and services, but at the same time we have also seen acts on the part of certain securities companies that have the possibility of interfering with the fairness and soundness of the capital markets (e.g., conflicts of interest in proprietary trading or problems related to share underwriting); and

(ii) Along with strengthening of supervision, inspections, and monitoring as well as the preparation and enforcement of laws and regulations by the authorities, an independent approach by the securities industry has become necessary, and the JSDA was called upon to study the preparation of standards to increase the self-discipline of securities companies.

The following is an explanation of the general features and functions of a code of ethics, as

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well as points to keep in mind.A code of ethics consists of ethical standards that are stated systematically. Ethical standards

are standards for moral behavior in the activities of corporations and individuals, and in the case of profitmaking businesses, a code of ethics has the function of restraining, within socially tolerable levels between multiple interested parties, the seeking of profit that is the basic economic activity of businesses. A code of ethics holds a position as a more fundamental (having a higher ranking) standard than laws and regulations or self-regulatory rules, and the acts, etc. that it targets are broader in scope. Even if the question of whether the act, etc. in question is right or wrong cannot be judged under laws and regulations or self-regulatory rules, it is possible to make a judgment based on ethical standards, and in this sense, a code of ethics can be regarded as functioning as a complement to laws and regulations or self-regulatory rules.

As opposed to laws and regulations or self-regulatory rules, compliance with which is subject to external controls and impositions, compliance with a code of ethics is fundamentally due to self-discipline that is based on one’s conscience. Thus, if a strong volition to comply voluntarily is lacking, it becomes easy to make ethics disappear. Further, because unlike laws and regulations or self-regulatory rules, ethical standards are not always universal, the effort to call for appropriate and standard ethical criteria is indispensable. Each Association Member must ensure that its officers and employees understand the meaning of holding themselves to a code of ethics and that each one of them is prepared to comply with the code of ethics voluntarily and actively, so that the code of ethics will not exist only in name.

“Rules Concerning Maintenance of and Compliance with Ethical Code by Association Members”

(i) Aim of Enactment of the RulesIn the “Working Group on Maintaining and Improving Self-regulation at Securities

Companies” which was established in April 2007 under the “Securities Strategy Board and the Self-regulation Board,” the JSDA acted on the understanding that it was necessary, e.g., (a) to create a code of ethics (a standard model) to serve as a guideline for self-regulation by Association Members, (b) to formulate self-regulatory rules for the possession of and compliance with a code of ethics at each Association Member, and (c) to establish an organization to study and organize the behavior and customs that are desirable for persons working in the securities industry concerning matters not directly provided in laws and regulations or rules, etc.; and conducted concrete studies, based on the “Research Report Concerning Security Companies’ Codes of Ethics” (for details, see the notice issued by the JSDA to its members dated April 17, 2007, entitled “Sending the Research Report Concerning Security Companies’ Codes of Ethics” (JSDA Notice (ki) 2007 No. 4), and its website).

As a result, the “Rules Concerning Maintenance of and Compliance with Ethical Code by Association Members” were enacted in September 2007 as self-regulatory rules for the possession of and compliance with a code of ethics at each Association Member, based on the proposal for self-regulatory rules that was put together by that Working Group. These



rules came into effect in December 2007.(ii) Purpose

The purpose of these rules is to make each Association Member, as a pillar of the capital market, fully understand the importance of their duties as carrying out an intermediary function in the capital market that is entrusted by society, always maintain a sound social common sense and ethical sense for the purpose of obtaining the trust of the people, take measures that are necessary to establish the required professionalism and maintain the high sense of ethics among its officers and employees, and ensure that each Association Member endeavors to prevent any action that causes doubt or disbelief from society regarding the fair execution of business by an Association Member, thus developing trust in the capital market by maintaining and improving self-discipline in its social mission and the roles it assumes (art. 1).(iii) Maintenance and Submission of Code of Ethics

a. JSDA members are to maintain ethical standards that include the contents of the model code of ethics that is separately designated by the JSDA or rules that have the same purposes concerning the sale and purchase or other transactions of securities, etc. as prescribed in Article 3, Item 8 of the Articles of Association of the JSDA (hereinafter a “code of ethics”) (art. 2).b. JSDA members must submit the code of ethics that they possess by a method determined by the JSDA (art. 3, para. 1), and must also submit the code of ethics to the JSDA if its contents are amended (art. 3, para. 2).

(iv) Reporting and Explanation Obligations, Etc.a. A JSDA member is to voluntarily report to the JSDA regarding matters that the JSDA member determines inappropriate or that may develop to be inappropriate in light of the code of ethics even though these are not directly provided by laws, regulations, and rules. (art. 4, para. 1).b. When the JSDA is aware of the occurrence or existence of matters regarding actions or practices by a JSDA member, and the JSDA determines that the matters are inappropriate or that they may develop to be inappropriate in light of the code of ethics even though this is not directly provided by laws, regulations, and rules, the JSDA may request that the JSDA member concerned explain such matters (hereinafter referred to as “Material Matters”). (art. 4, para. 2).c. When a JSDA member is requested by the JSDA to explain the Material Matters pursuant to Article 4, Paragraph 2, the JSDA member must immediately explain such matters to the extent that this is not in violation of laws, regulations, and orders, etc. made by a competent administrative agency or other public agency (art. 4, para. 3).d. The JSDA shall request an entity which intends to join the JSDA to submit the code of ethics maintained by the said entity before giving approval for its participation, and also receive an explanation about the details of the code of ethics and the establishment of the internal systems from a person who is to be a representative (art. 5).

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(v) Establishment of Internal SystemsA JSDA member shall establish internal rules that are deemed necessary for the member

for the purpose of ensuring the effectiveness of the code of ethics, including the assignment of a person in charge of operation and control, providing education and training to officers and employees, and how to respond in case a violation is found (art. 6).

[MODEL CODE OF ETHICS]

September 18, 2007(Amended) February 2, 2009

JAPAN SECURITIES DEALERS ASSOCIATION

As an important contributor to capital markets (which provide a principal place for raising and investment of funds for the national economy), we should fully understand our responsibilities concerning carrying out an intermediary function in the capital market, which are entrusted to us by society and pursuant to “The Principles in the Financial Services Industry” published by the Financial Services Agency, we shall make every possible effort to always maintain sound social common sense and ethical sense for the purpose of obtaining the trust of the people and to attain the required professionalism.

As good citizens we must respect each other and eliminate or prevent discriminatory utterances and any kind of harassment based on nationality, race, sex, age, faith, religion, social status or handicap.

Accordingly, we have prepared ourselves to establish the Code of Ethics set forth below as our basic attitude for conducting our business and declare our intention to comply with the Code.

1. Compliance with Social Norms and with Laws and Regulations, Etc.We must correctly understand and strictly comply with all rules in relation to

financial instruments transactions, including laws and regulations for the purpose of protecting investors and achieving fairness in transactions. We shall also maintain and implement social mores and a sense of ethics that are consistent with social norms at large, and will supplement those areas that are not foreseen in laws, regulations, rules or the like.

2. AppropriateManagementofConflictsofInterestWe must manage conflicts of interest relating to our business appropriately.

Furthermore, we must not make any improper profits by using our position or authority, or any information, etc. obtained through our work.



3. CompliancewithConfidentialityObligationsandInformationManagementWe shall use the utmost care in the management of, and shall maintain the

confidentiality of, information of which we obtain knowledge in the course of business, with the exception of legally disclosed information and other information that we are permitted to disclose under the regulations concerning information disclosure.

4. Maintenance of Social Order and Contribution to SocietyAs a good corporate citizen, we shall positively participate in social activities, and

shall contribute to the stability and maintenance of social order. We shall deal resolutely with forces and organizations, etc. that engage in antisocial activities, and shall not conduct any transactions with such persons.

5. Conduct Emphasizing Customers’ InterestsIn our work we shall ascertain and act in accordance with the customer’s

knowledge, experience, assets and objectives concerning investment, and shall at all times take into account the best interests of the customer.

6. Carry Out Work Honestly and Fairly from the Point of View of the CustomerAs intermediaries, we shall carry out our work honestly and fairly and from the

point of view of the customer, and at all times shall emphasize the needs and interests of the customer.

We will not give favorable treatment to any particular customer by using our authority or position in the company, or comparatively superior usable information. We will also endeavor to uphold the principle of self-responsibility by proper solicitation of investments and by thoroughly carrying out transactions pursuant to the discretion of the customer.

Moreover, if a fiduciary responsibility arises pursuant to a contract into which we have entered with a customer, we will at all times act faithfully for the benefit of the client.

7. Giving Advice to CustomersWhen we give advice to customers, we should be neutral, clearly separate facts and

opinions and make full use of our professional capacity.In accordance with relevant laws and regulations, etc., we shall not give advice to

customers that is based on unpublished insider information that, it is anticipated, would have an effect on the value to be derived from the investment.

8. Conduct in the Capital MarketsEven where there is no provision of law or other rules, etc., the company’s Code of

Ethics should be consulted in making any judgment concerning conduct that is potentially doubtful having regard to commonly accepted social mores and what is

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expected of a market intermediary.In accordance with relevant laws and regulations, etc., we shall appropriately

manage unpublished insider information that, it is anticipated, would have a material effect on the value to be derived from the investment.

9. Consciousness of the Company’s Social Mission and Maintenance and Improvement of the Integrity and Trust in the Capital MarketsWe must have a correct understanding of the fairness and integrity of the capital

markets, and must do nothing to impede the sound development of the capital markets. We shall further act with the awareness of the social mission that we are carrying out through maintaining the integrity of capital markets.

We shall not engage in or participate in any inappropriate conduct that could damage proper disclosure of information, distort the formation of fair prices, impair public trust in the members, or otherwise damage the integrity of the capital markets.

3 Compliance with Laws, Regulations and Rules

Financial instruments business operators, etc. have the function of market intermediaries to connect the capital markets and customers, and bear a public role. They must conduct their business activities with a full appreciation of that fact.

3 1 What Is Compliance?

In the Japanese context, the word “compliance” primarily means “compliance with laws and ordinances.”

In the past, the meaning of this word has been somewhat unclear and there was not a high level of awareness of its intent. More recently, however, in the wake of a spate of corporate scandals, the term “compliance” has become more commonplace in general usage. The securities industry also suffered a loss of investor confidence following the demise of the bubble economy and has become stricter about compliance with the laws, regulations and rules designed to ensure investor protection with the intention of regaining investor trust.

Most products handled by financial instruments business operators, etc. are characterized by the risk of adverse price fluctuation and provide no guarantee with respect to the principal. To conduct solicitation of investment regarding such products to an unspecified but large number of investors, sales activity must be sincere, fair and thorough in terms of safeguarding the investor. Many laws, regulations and rules have been enacted in order to achieve this end, and compliance



with these is required.Consequently, sales representatives must naturally fully understand the applicable laws and

regulations that govern securities together with the rationale and background leading to their enactment, and must practice lawful and appropriate sales activities.

For this reason, sales representatives are required to act in compliance with the following fundamental ethical standards:

(i) Exercise Diligence in Meeting the Trust and Expectations of the InvestorsInvestors regard a financial instruments business operator, etc. as a professional worthy

of their confidence in matters relating to investments and expect their trades to be carried out in a fair and faithful manner. Therefore, sales representatives must be diligent in their professional development by acquiring the requisite knowledge and technical skill as well as performing sales activity in adherence to high ethical standards in order to meet the expectations and trust of investors.(ii) Respect the Investor as the Final Decision-Maker for the Investment

Although the sales representative must provide appropriate advice to investors, the final investment decision must at all times be made at the discretion and liability of the investor themselves.

Sales representatives are required to tell the investor clearly about the principle of individual responsibility by stating like “please be aware that it is the customer who is responsible for making the final decision regarding any investment,” or “please be aware that it is the investor who receives the benefit or burden of the outcome of any investment whether or not such investment is profitable.”(iii) Ensure That There Is a Correct and Reasonable Basis for Sales Activities

The principle of individual responsibility is predicated on the investor making the investment decision. However, the investment decision must be based on correct information and a sufficient understanding on the part of the investor.

When providing investment advice to an investor, the sales representative must also provide a full explanation with a rational basis. The content of such explanation and any accompanying materials must be accurate so as to avoid any misunderstanding by investors.(iv) Consider Factors Such as the Investor’s Plan and Investment Objectives When

Providing Investment AdviceWhen providing investment advice, sales representatives must endeavor to become

aware of the investment approach, investment objectives, investment experience, assets and other attributes of the customer, and must give investment advice that is consistent with the customer’s intentions. However, the responsibility of a sales representative does not end with simply following the customer’s wishes. If an investor is clearly engaging in investment activity that is unsuitable given the investor’s investment plan and objectives, available assets and level of income, the sales representative is required to give appropriate advice to the investor in order that such investor may reconsider.

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Section 3. Compliance with Laws, Regulations and Rules


3 2 Check List for Sales Representatives

There are many points that a sales representative should take note of when actually conducting financial instruments transactions with a customer.

(1) Points of Note upon Soliciting a CustomerA sales representative must take note of the following points when soliciting a customer:(i) Are the products presented to the investor suitable in light of the investor’s

knowledge, investment experience, available assets, investment plan, investment purposes and nature of capital (such as type of issues, volume, frequency, etc.)? For investors interested in margin transactions, futures transactions, options transactions and so forth, does the investor pass the trade initiation standards prescribed by the relevant firm?

(ii) In relation to the principle of suitability, do you understand the points to note when soliciting customers, especially elderly customers, to make investment?

A financial instruments business operator, etc. must conduct solicitation for investments in accordance with the principle of suitability.

Generally, elderly people are said to experience a decline in memory or ability to understand, in addition to waning of physical ability. Furthermore, elderly people have fewer opportunities to find a new source of income, and for many, the assets they currently hold may be the required to cover their future living costs. In some instances, customers with experience in investment and who appear to have a sufficient understanding of the investment targets at the time of solicitation may not remember the transactions they themselves executed a few days later. As a result, the customers or their families may lodge complaints, which may also result in mediation or litigation. To prevent such cases, the JSDA rules provide that when soliciting elderly customers to purchase securities, etc., an Association Member must establish internal rules that include, among other things, a definition of “elderly customers,” the scope of securities, etc. to be sold, the method of explanation, the method of taking orders, and strive to only make proper investment solicitations. Therefore, if you solicit elderly customers for investments, you should give due weight to the principle of suitability.

(iii) Do you understand the solicitation commencement standards? The solicitation commencement standards are standards which provide for the

scope of customers whom financial instruments business operators can solicit by visit or phone or at sales counters, among those who do not request the solicitation of the relevant transaction. Under the JSDA Rules, financial instruments business operators are required to establish such solicitation commencement standards with regard to complex structured bonds similar to OTC derivatives, investment trusts, and leveraged investment trusts, and solicit only those customers who meet the standards. Therefore, when you intend to solicit a customer, you should first confirm whether the customer



satisfies the standards. The JSDA Rules also provide that financial instruments business operators shall

fully understand the characteristics and risks of the securities, etc. that they intend to sell to customers, and shall not sell the securities, etc. if they cannot identify customers who are suitable for such securities, etc. (reasonable-basis suitability).

(iv) Was the customer provided with fair and truthful investment information that will not result in any misunderstandings?

(v) Is the solicitation free of any conclusive statements regarding future price increases or decreases?

The FIEA prohibits the provision of conclusive statements such as “Watch it for a month. The price will definitely rise,” or “A seven percent yield is a sure thing.”

(vi) Was the solicitation carried out at a time that the customer would feel to be annoying?

(vii) Is the trade free of any collaborative transaction with the customer, any pre-trade request or promise for compensation of losses (also known as a guaranteed trade), or any post-trade request or promise for compensation of losses (including any note or statement to a customer who has incurred a loss, indicating that the loss will be compensated)? Was there any post-trade loss compensation? Is the solicitation free of any promise for special profits?

For example, any expression to the effect that “Regardless of the circumstances, we will aim at an annual return of 10%. Should anything happen, we will discuss that with you separately. We will never cause you any harm” is prohibited under the FIEA because it is deemed as promising to offer a special benefit or offering and promising a loss guarantee or compensation. Such action will be subject to administrative action, and the financial instruments business operator, etc. and the sales representative may be punished with a criminal sanction, such as a fine or imprisonment. A customer who requests and obtains a promise for a guarantee or for compensation of their losses will also be punished. Therefore, these actions must be avoided at all costs.

For engaging in such loss guarantees or compensation, the sales representative may be punished by imprisonment for up to three years or a fine of up to JPY3 million, or both. The financial instruments business operator, etc. may be fined up to JPY300 million. A customer (an individual) who requests and obtains a promise for a guarantee or compensation of losses may be punished by imprisonment for up to one year or a fine of up to JPY1 million, or both. The amount received as a guarantee or compensation for losses will be confiscated or the value thereof will be forfeit.

(viii) When soliciting a transaction for switching investment trusts, has an explanation of the important matters in connection with switching been given for both the investment trust to be sold and the investment trust to be purchased?

The FSA’s Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc. enumerate the following as examples of important matters that should be explained at the time of soliciting a switch in investment trusts:

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(i) Form and status of investment trusts, etc.;(ii) Status (e.g., rough estimate of profit or loss) of investment trusts,

etc., to be cancelled;(iii) Expenses necessary for switching (e.g., cancellation fees, commission

on sales, etc.);(iv) Items regarding preferential treatment for redemption switching;

and(v) Other items that could affect customers’ investment decisions in light

of the characteristics of the relevant investment trust, etc., and the needs of the customers.

(ix) Do you understand the matters that should be explained to customers regarding the NISA program (a tax exemption program for small-amount investments) when soliciting and accepting applications for the opening of NISA accounts or after opening these accounts?

The NISA is a program that exempts revenues from dividends, capital gains, etc., on up to JPY1,200,000 of annual investment in listed stocks, etc., from income and inhabitants taxes for a maximum of five years from the year the initial investment was made. Upon soliciting and accepting application for the opening of NISA accounts and after opening these accounts, you should explain the following points to customers so that they have an accurate understanding:・ Each customer is allowed to open only one account at a single financial institution

(excluding cases where the customer has changed financial institutions, etc.);・ Once any of the listed shares, etc. held in the tax-exempt account are sold, the

customer is disqualified from using the same portion of right to tax exemption;・ The amount of investment proceeds yet to be used for tax exemption this year

cannot be rolled over to the next year;・ Losses incurred on a tax-exempt account cannot be used to offset capital gains or

dividends on other securities held in specific accounts or general accounts for tax calculation purposes;

・ Refunds of principal repayments (special dividend), a form of dividends on investment trusts, are themselves tax exempt and do not stand to benefit from the NISA program; and

・ Tax exemption is granted for dividends and similar items only if they are delivered to customers via financial institutions, etc. with which they hold NISA accounts.

Under the Junior NISA program (a tax exemption program for minors), investors under 20 years of age are eligible for exemption from income tax and inhabitants’ tax on their dividend income and capital gains from investment in listed shares, etc. up to JPY800,000 for five years from the year they made investment. The Junior NISA program differs from the NISA program mainly in the following points. Sales



representatives must explain these points to customers as necessary to avoid their misunderstanding.・ A Junior NISA account opened at a financial institution cannot be switched to a

different financial institution; and・ In principle, Junior NISA account holders cannot withdraw funds from their

accounts until December 31 of the year preceding the year when they are 18 years old as of March 31.

The Dollar-Cost Averaging NISA introduced in 2018 is a program available for investment based on a cumulative investment contract, under which dividend income, capital gains, etc. arising from investment in ETFs and stock investment trusts up to 400,000 yen per year are exempt from income tax and inhabitants tax for up to 20 years. Investors can only use either the general-type NISA or the Dollar-Cost Averaging NISA each year, but they can change the program on a yearly basis.

(2) Points of Note upon Receiving an Order, Etc.A sales representative must take note of the following points when receiving an order for

transaction from a customer:(i) Was the customer provided in advance with documents (documents delivered prior

to contract execution, etc.) including the following matters (there are exclusion provisions)?・ Trade name, firm name or name and address;・ A statement that the operator is a financial instruments business operator, etc. and

their registration number;・ Outline of contract;・ Outline of commission, remuneration, etc.;・ If there is “a risk of loss arising” or “a risk that the amount of loss could exceed the

amount of the customer’s security deposit,” a statement to this effect; and・ Other matters provided by law.

(ii) Was the investor provided with an explanation using the required methods, and to the degree required for the customer to understand the documents delivered prior to contract execution, etc. which were provided to the customer, in light of the customer’s knowledge, investment experience, financial standing and purposes for entering into the financial instruments trading contract?

(iii) Has a prospectus been provided to the customer prior to or at the time of a primary or secondary offering of shares, etc.? In the solicitation of a primary or secondary offering of shares, etc. are materials differing in contents from the prospectus being used?

(iv) Is the solicitation free of any sales attempt aimed at unspecified and numerous customers relating to the purchase or sale of a small number of specified securities and continuing for a certain period, simultaneously and excessively, such as would impair the formation of a fair market price? Is an order received from the customer with the

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knowledge that it could lead to market manipulation or other unfair trading, e.g., by using fluctuations in prices caused by such trading to make profits for oneself or for a third party other than the customer?

(v) Does the solicitation include the provision of any corporate information regarding the issuer of the securities? Or, is the trade conducted for the financial instruments business operator’s own account based on corporate information? Has the order for a trade been accepted with knowledge that the trade falls within the category of insider trading, or of the likelihood of that the order falls within that category of trade?

An example would be accepting an order based on a statement from the sales representative to the effect of “although this is off-the-record, the company is expecting a capital increase. If you buy now, the price will probably go up.” Another example of a trade that should be avoided at all costs would be a trade based on a statement from a customer to the effect that “I just heard from a general manager of XX Pharmaceuticals that it will announce a new medicine next month. I think we can make some money if we buy the shares now, so buy 10,000 shares.” A sales representative must always consider if, in any conversation with the customer, there is anything unnatural or suspicious in the request for the opening of an account or the trade order, etc. Therefore, knowing the employment of the customer, the motive for the investment and the reasons for selecting the particular securities are all important parts of the business.

(vi) Is the sales representative accepting an order for the trading of securities or any other transaction knowing that the customer is using a name other than his/her own name (i.e., an alias or dummy name)?

(vii) Was the trade approved by the customer? Is the sales representative making any transactions for the customer’s account without the consent of the customer?

(viii) Has an explanation been provided to the customer of the “important matters” provided in the Act on Sales of Financial Instruments, Etc. (“Financial Instruments Sales Act”) by the time of sale of financial products such as securities, etc.?

The three “important matters” provided in the Financial Instruments Sales Act are as follows:

<Market Risk> If there is a risk of loss of principal caused by a fluctuation in the markets for

interest rates, currencies, share prices or other indices, an explanation must be given that “loss of principal may occur,” as well as of “the relevant index that would be the direct cause of this occurring” and “the mechanism by which it may occur.” Furthermore, if “there is a risk that the loss incurred could exceed the amount of the initial principal,” an explanation must be given of this risk, as well as of “the relevant index that would be the direct cause of loss exceeding the initial amount of the principal” and “the mechanism by which the loss could exceed the initial amount of the principal.”

<Credit Risk> If there is a risk of loss of principal caused by a change in the credit situation of the

business or assets of a seller of financial products or a company that issues securities



such as bonds, an explanation must be given that “a loss on principal may occur,” as well as of “the relevant person who would be the direct cause of this occurring” and “the mechanism by which a loss on principal may occur.” Furthermore, if “there is a risk that the loss incurred could exceed the amount of the initial principal,” an explanation must be given of this risk, as well as of “the relevant person that would be the direct cause of loss exceeding the initial amount of the principal” and “the mechanism by which the loss could exceed the initial amount of the principal.”

<Restrictions on Period for Exercising Rights or Cancellation> If the product is subject to a period during which the rights can be exercised or

cancellation is not permitted, an explanation to that effect must be given.(ix) Has verification at the time of transaction been conducted at times such as

commencing trading or custodial service with a customer as prescribed in the “Act on Prevention of Transfer of Criminal Proceeds”?

(x) In relation to handling an order from a person other than an account holder, do you understand the requirements that a person who acts as an agent for an account holder must satisfy?

In principle, a financial instruments trading contract must be concluded with an account holder. If it is impossible to execute a transaction with an account holder, you may execute a transaction with the account holder’s agent.

If you execute a transaction with an agent of an account holder, the agent must have an authority to act as an agent for the account holder. A person has the authority to act as an agent of another: (1) if the person is granted the authority to act as an agent (voluntary representation); or (2) the authority to act as an agent is stipulated by law (statutory representation). If you engage in a transaction with a person other than an account holder, you must fully confirm that the person representing the account holder has the authority to execute the transaction on behalf of the account holder. Common ways to confirm the other person’s authority to act as an agent include requesting the submission of a document that proves the authority to act an agent (or a certificate of registered matters in the case of a statutory agent), or obtaining a notification required by each Association Member.

(xi) Do you understand what you should do if you make a clerical mistake? If you make a clerical mistake, such as inputting the wrong order data in the

computer, you should first report it to, and seek instruction from, the internal administrator. Subsequently, you should deal with the customer in a sincere manner concerning this incident. You must not conceal the mistake or personally ask the customer to accept the wrong order.

(xii) Is the final investment decision made by the investor based on the investor’s decisions and responsibilities?

Unless a discretionary investment management contract has been concluded, accepting an order of a trade of securities without having the investor’s explicit instructions on each of the criteria of “whether to buy or sell, the type of issue, volume

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or price” is prohibited. For example, a sales representative can never say anything in which he/she would appear to be making the final investment decision, such as that “Regarding XX shares, I’ll make sure to arrange an adequate buy price and volume. Leave it up to me” (except for accepting an order where, in accordance with the provisions of the FIEA, an adequate internal control system has been put in place).

(3) Product Characteristics and RisksA sales representative must take note of the following points when explaining to the

customer about the characteristics and risks of the product offered for sale:(i) Do you understand the product characteristics and risks of foreign shares? Similar to domestic shares, foreign shares have price fluctuation risk and credit

risk. Fluctuations in share prices are attributable to various factors, such as the issuing company’s business results and financial conditions, and market trends. In addition, when handling foreign shares you should take into consideration exchange fluctuation risk. Fluctuations in exchange rates are attributable to factors including the currency-issuing country’s financial conditions, political situations and interest policy. Exchange rates for some currencies fluctuate unexpectedly due to low liquidity or exchange intervention.

Furthermore, it is sometimes more difficult to obtain the information of the issuing companies of foreign shares than to obtain similar information for domestic shares. You should make sure to provide customers with sufficient information, such as how to obtain share price information.

(ii) Do you understand the product characteristics and risks of shares issued in emerging countries?

Similar to foreign shares generally, shares issued in emerging countries have share price fluctuation risk, credit risk and exchange fluctuation risk. In addition, low liquidity may be another risk because markets for shares issued in emerging countries have not matured sufficiently.

(iii) Do you understand the product characteristics and risks of standardized margin trading?

Margin trading is defined as the sale and purchase or other transactions in securities conducted by providing a loan or other advance of money or securities to the customer (extension of credit). If a customer is to conduct a margin transaction, the customer needs to submit a predetermined amount of money (or a certain percentage of the transaction amount) as a margin deposit (the customer may be requested to submit an additional margin (margin call)). Therefore, it is necessary to make the customer fully understand the structure of margin trading. Similar to spot trading (such as share trading), margin trading has price fluctuation risk and credit risk. A margin transaction could generate a loss that exceeds the deposited margin. Accordingly, financial instruments business operators should carefully select customers for margin transactions, and must establish standards for commencement of transactions under the



JSDA Rules.(iv) Do you understand the product characteristics and risks of complex structured

bonds similar to OTC derivatives? Complex structured bonds similar to OTC derivatives are structured bonds with

redemption or interest conditions that are determined by OTC derivatives, etc. Examples of these bonds include: (1) bonds with a redemption price that can be less than the face value; (2) bonds with interest that is not determined at the time of issuance, and for which the currency used for redemption payment and that used for purchase payment are different; and (3) bonds with interest that becomes zero or very close to zero depending on the conditions. Customers engaging in transactions of structured bonds could incur an unexpected loss due to the complexity of the structure. The Association Rules require that Association Members should establish standards for commencement of solicitation if soliciting customers (limited to individuals, excluding professional investors) who do not request solicitation for sale of these bonds. Therefore, before you solicit customers, you should first confirm whether your solicitation satisfies the solicitation commencement standards. Even if you deal with customers who meet the standards, you should carefully examine whether the customers are suitable for the transaction according to the principle of suitability.

(v) Do you understand the product characteristics and risks of foreign currency-denominated bonds?

As in the case of domestic currency-denominated bonds, foreign currency-denominated bonds have price fluctuation risk and credit risk. Fluctuations in prices are attributable to various factors, such as fluctuations in interest rates and the issuing company’s financial conditions. In addition, when handling foreign currency-denominated bonds, you should take into consideration exchange fluctuation risk. Fluctuations in exchange rates are attributable to factors including the currency-issuing country’s financial conditions, political situations and interest policy. In the case of bonds denominated in currencies of emerging countries, in particular, the spread for exchanging the Japanese yen and the foreign currency (the exchange fee) becomes large, which could reduce the amount received by customers using the Japanese yen more than they expected. Exchange rates could also show unpredicted fluctuations due to low liquidity or the currency-issuing country’s exchange intervention policy. Moreover, there is also a risk that prices could fluctuate due to changes in the political, economic, or social situations in the issuer’s country, leading to restrictions on trading or delivery of bonds.

While foreign currency-denominated bonds with high interest rates are often more attractive than domestic currency-denominated bonds, there are also risks behind them. Therefore, you should properly provide customers with necessary information so that they can understand such characteristics and risks.

(vi) Do you understand the product characteristics and risks of high-yield bonds? High-yield bonds generate a high rate of yield, as the name represents, due to the

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fact that they are sold at a high coupon rate corresponding to low credibility or that their unit price is declining. High yield is an attractive feature of this type of bond as an investment target. However, it also means high default risk and low liquidity. Therefore, if you solicit customers to buy these bonds, you should carefully examine the degree of their risk tolerance and ability to understand.

(vii) Do you understand that, at the time of selling an investment trust, you should explain to the customer that dividends may not be paid depending on the fund performance?

Dividends on an investment trust (fund) are paid from investment earnings, and the investment trust is managed with the aim of making a certain amount of payment for each accounting period. If there are no earnings, dividends may not be paid or the amount of dividends actually paid may be smaller than the amount anticipated.

The structure of dividends on an investment trust is difficult for ordinary investors to understand and can be misunderstood, so you should provide an explanation to customers reflective of the level of their understanding.

(viii) Do you understand that, at the time of selling an investment trust, you should explain to the customer that when dividends are paid, the base value of the fund declines by the amount paid?

Dividends on an investment trust are paid from the investment trust assets collected from investors. Therefore, if any amount is paid as dividends to the investors, the net assets decrease and the base value declines by the amount paid. This differs from interests on bonds or deposits. This structure is difficult for ordinary investors to understand, so you should provide an explanation to customers reflective of the level of their understanding.

(ix) Do you understand the product characteristics and risks of currency-selected funds?

Currency-selected funds are investment trusts under a scheme wherein the investment results obtained from underlying assets, which are the target of investment, can be received in a different currency than that in which the underlying assets are denominated, through exchange trading. Because of this scheme, these funds have exchange fluctuation risk in addition to price fluctuation risk of the underlying assets. Furthermore, investors should understand that premiums or expenses may arise due to a difference in the interest rate between the currency in which the underlying assets are denominated and the currency chosen for exchange trading. It should be noted that exchange fluctuation risk would increase with regard to some currencies for which exchange trading is conducted as a non-deliverable forward (NDF) transaction.

(x) Do you understand the product characteristics and risks of monthly-paid funds? A monthly-paid fund is an investment trust under a scheme wherein closing is

made and a dividend is paid on a monthly basis. As mentioned above, you should provide an explanation to customers so that they will understand that dividends may not always be paid, and if any amount is paid as dividends, the base value of the fund



declines by the amount paid. There are two types of dividends, ordinary dividends and special dividends

(refunds of principal), and they are subject to different taxation schemes. It should also be noted that if special dividends (refunds of principal) are paid, the individual principal decreases.

(xi) Do you understand the product characteristics and risks of funds in shares, etc. issued in emerging countries?

As in the case of the shares issued in emerging countries referred to in (ii), there are many risks such as price fluctuation risk, credit risk, exchange fluctuation risk, and low liquidity risk.

(xii) Do you understand the product characteristics and risks of complex investment trusts similar to OTC derivatives?

Complex investment trusts similar to OTC derivatives are investment trusts that will have the same product nature or effect as that of complex structured bonds similar to OTC derivatives as they are managed using structured bonds.

Similar to complex structured bonds similar to OTC derivatives, the Association Rules require that Association Members should establish standards for commencement of solicitation when soliciting customers (limited to individuals, excluding professional investors) who do not request solicitation for sale of complex investment trusts similar to OTC derivatives. Before you solicit customers, you should first confirm whether your solicitation satisfies the solicitation commencement standards. Even if you deal with customers who meet the standards, you should carefully examine whether the customers are suitable for the transaction according to the principle of suitability.

(xiii) Do you understand the product characteristics and risks of leveraged investment trusts?

Leveraged investment trusts are investment trusts managed in a manner that the change rate of net asset value per unit of the investment trust assets will match the value that is calculated by multiplying the change rate of the base indicator by a pre-defined factor (limited to two times or minus two times).

Similar to complex structured bonds or complex investment trusts similar to OTC derivatives, standards for commencement of transactions should be established with regard to leveraged investment trusts.

Investors may incur a large loss by investing in leveraged investment trusts because these trusts are designed to fluctuate in price to a greater extent than the price fluctuations in the investment target assets. Furthermore, most leveraged investment trusts are created as bull/bear type funds, which are premised on the desire to earn profit by switching funds. You must note that if you solicit customers to switch funds too frequently, you might be taken as attempting to gain more fees.

(xiv) Do you understand the product characteristics and risks of ETFs? ETFs (exchange traded funds) are investment trusts which are created so that their

investment performance will be linked to a share index or an indicator such as

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commodities prices, and which are listed on an exchange. As ETFs are tradable at the market price on an exchange, they have price fluctuation risk in the same way as listed shares. Furthermore, it should be noted that ETFs are linked to indicators, and indicator fluctuations do not always correspond to price fluctuations. The product types of ETFs on domestic markets have diversified, and currently, ETFs linked to foreign share indexes or commodity price indexes are available in addition to those linked to domestic share indexes. Before soliciting customers for investing in ETFs, you should understand the characteristics and risks of this product.

(xv) Do you understand the product characteristics and risks of real estate investment corporations (real estate investment trusts; J-REITs)?

Real estate investment corporations or real estate investment trusts (J-REITs) are listed on an exchange and can be traded in the same manner as share trading. J-REITs invest principally in real estate, etc. and asset-backed securities, etc. that primarily target investments in real estate, etc., and distribute rent proceeds, etc. to investors.

Like shares, J-REITs have price fluctuation risk. In addition, as dividends are paid from earnings from the invested real estate, etc., investors might incur unexpected losses if unpredictable events occur, such as if the management of the real estate does not go well or the real estate is subject to a natural disaster.

(xvi) Do you understand the product characteristics and risks of futures trading? Futures trading is a contract to conduct a sale and purchase on a predetermined

date in the future at a price determined today. The major financial futures currently listed on the exchanges in Japan include various share price index-related futures (e.g., TOPIX, REIT, Nikkei Average), bond futures and interest-rate futures. When conducting a futures transaction, customers are required to deposit a predetermined amount (or a certain percentage of the transaction amount) as a margin.

As futures trading is conducted on the promise of future payment and futures prices fluctuate to a greater extent than spot prices, investors could incur an unexpected loss. Furthermore, investors can trade multiple issues during the same contract period. However, if the trade cannot be settled when the contract expires, the exchange or securities firm will use the margin deposit at its own discretion to pay the obligations, without giving any notice or warning and without having to follow any legal procedures. It should also be noted that a loss could occur in excess of the margin deposit.

On the other hand, futures trading can provide a wider range of investment choices because it can transfer (hedge) price fluctuation risk.

(xvii) Do you understand the product characteristics and risks of options trading? Options trading is a transaction in which one purchases or sells the right to buy

(call option) or sell (put option) a specified financial product (underlying security) at a specified price (exercise price or strike price) by a specified future date, regardless of the market price of that underlying security at the time. The major options currently listed on exchanges in Japan are share index options, securities options (options for



which individual shares, individual REITs, and individual EFTs are the underlying securities), and JGB futures options. If conducting an options transaction, customers are required to deposit a predetermined amount (or a certain percentage of the transaction amount) as a margin.

As options have price fluctuation risk, a loss that exceeds the margin deposit could arise in options trading. It should also be noted that there is a time limit for the exercise of the option.

On the other hand, options trading can limit risk and create profit and loss patterns that are not found with underlying products.

(xviii) Do you understand the product characteristics and risks of OTC derivatives trading?

Unlike market derivatives trading, the conditions for OTC derivatives trading can be determined depending on the customer’s needs. Various types of assets can be the underlying assets for OTC derivatives, such as securities, interest rate, exchange rate, and commodity price index. OTC derivatives transactions can be roughly divided into three types: forward transactions, swap transactions, and options transactions. Complex derivatives transactions can be created by combining these types of transactions.

As OTC derivatives transactions are negotiated transactions, unlike market derivatives transactions, each party bears the risk of the other party falling into default (counterparty risk). Market prices of derivatives change along with the changes in the prices of the underlying assets and the passage of time. It should also be noted that investors could incur a loss depending on market liquidity.

(xix) Do you understand the product characteristics and risks of (domestic or overseas) trading in covered warrants?

Covered warrants are warrants or certificates which represent options based on individual shares or indexes. There is a time limit for the warrant holder’s exercise of the right. Furthermore, investors could lose the whole investment amount depending on the price fluctuations of the underlying assets, and prices can fluctuate significantly. Accordingly, Association Members are required by laws and regulations as well as the Association Rules to collect a written confirmation from customers when commencing trading in covered warrants.

When you explain this product to customers, you should pay attention to the following points:・ Unlike bonds, covered warrants become worthless upon the arrival of the exercise

date;・ While the price rise in covered warrants is larger than that in shares, the price fall

is also larger than that in shares;・ If the share price falls below the exercise price and there is no prospect for a price

rise in the future, the price will decline as the remaining period before maturity lessens; and

・ As the remaining period lessens, covered warrants are less likely to be quoted.

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(xx) Do you understand the product characteristics and risks of VWAP guarantee trading?

VWAP guarantee trading is sale and purchase of share certificates, etc. listed on an exchange at a price based on the VWAP (Volume Weighted Price Average). As the VWAP is a weighted price average, it is not always an advantageous price depending on the price movements on the relevant day.

(4) OthersIn addition to the points listed above, a sales representative must also take note of the

following points:(i) Are you aware that you must refrain from transactions that constitute a conflict of

interest? Refraining from transactions that constitute a conflict of interest is indispensable in

order to maintain trust in the fairness of transactions and services. Examples of conflicts of interest in services include clashes between your own interests, or the interests of a related party, and the firm’s interests or a customer’s interests, or the holding of positions that conflict with each other in the provision of services. This includes cases that give rise to the external appearance of a clash of interests.

In these cases, it is necessary to take appropriate measures to avoid the circumstances that would give rise to a conflict of interest, such as withdrawing from a position of an opposing interest or acting in accordance with the opinion of an independent third party. One example of this is the provision in the JSDA rules that prohibits, in principle, an analyst who is in charge of a company from personally trading and owning securities in that company.

(ii) Are you aware of any influence that an act that is in violation of laws or regulations would have?

As mentioned briefly in (1) Points of Note upon Soliciting a Customer, (viii) above, if there has been an act that is in violation of laws or regulations, there may be a criminal punishment or administrative action, and moreover, self-regulatory organs such as the JSDA may impose disciplinary actions, etc. (for details, see this Chapter, 2-3 “Prohibition Against Wrongdoing and Self-Awareness as a Sales Representative”).

The direct purpose of the administrative actions against sales representatives is to exclude unqualified persons from the scope of sales representatives, and the direct purpose of disciplinary actions, etc. by self-regulatory organs is to deter and prevent the reoccurrence of acts by the officers and employees of Association Members that are in violation of laws and regulations, and to exclude from the industry persons who have acted in a manner that causes a considerable loss of trust in the financial instruments business. Not only the relevant sales representative, but also the relevant Association Member will be subject to a disciplinary actions, etc. if it is recognized that an act by the sales representative that is in violation of laws and regulations stems from shortcomings, etc. in respect to the internal controls of the Association Member to



which the relevant sales representative belongs. The aim of administrative actions and of disciplinary actions, etc. by self-

regulatory organs is to strive to achieve through these actions the protection of investors by securing the fairness of securities trading and other transactions, and to contribute to the maintenance and improvement of trust in the financial instruments business and the financial instruments trading markets.

To go even further, in recent years business scandals such as accidents involving products, false labeling, and illicit transactions have been reported by the mass media. The companies covered by such news reporting receive criticism from society, and what is more, they may suffer a negative effect such as their trading partners suspending trading with them. This reaches not only the business that caused the problem, but it also has a negative effect on other companies in the same industry and is referred to as a reputation risk or damage due to rumor. As described above, a violation of a law or regulation, etc. has a far-reaching effect, and since it can be considered to be an extremely important risk, it is necessary not to neglect to exercise care on a daily basis to avoid causing a violation of laws and regulations.

(iii) Do you understand that you should make the customers well aware of the availability of the financial ADR system?

In 2009, an alternative dispute resolution system in the financial sector (financial ADR system) was established as a new means for dispute resolution in addition to civil litigation. Under the “Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc.,” financial instruments business operators, etc. are required to publicize the trade name or name and contact address of the ADR body (dispute resolution organization) and make customers well aware of the financial ADR system. Financial instruments business operators, etc. are also required to explain the financial ADR system to customers on or before delivering the document to be delivered prior to conclusion of contract. With regard to disputes between Association Members and their customers concerning sale and purchase and other transactions of securities or derivatives transaction, etc., the Financial Instruments Mediation Assistance Center (FINMAC) acts as an ADR body providing dispute resolution services.

(iv) Do you understand the duty of personal information management that financial instruments business operators, etc. must comply with?

Financial instruments business operators etc., are business operators that handle personal information and therefore must comply with the Act on the Protection of Personal Information and the Guidelines for Personal Information Protection in the Financial Field in order to protect personal information of customers.

You must acquire personal information of customers (including prospective customers) in a proper manner, and may not use the acquired information for purposes other than the predetermined purpose. If you cause any piece of the acquired information to be leaked, you will lose the customers’ trust, so you must be careful in the management of personal information.

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Under the Act on the Use of Numbers to Identify a Specific Individual in the Administrative Procedure, notifications of individual numbers began to be sent to residents in Japan in October 2015, and these numbers were put into use for administrative procedures in January 2016. Accordingly, in order to prepare statutory documents, financial institutions are required to ask customers to provide their individual numbers. Since individual numbers are special personal information subject to strict rules regarding their intended purpose for use and procedure for acquisition, special care is required for their management.

Sales representatives must conduct their sales activities with a full understanding of the matters described above.

4 IOSCO International Conduct of Business Principles

A basic approach for securities operations has been approved internationally as the code of conduct governing securities operations. In November 1990, IOSCO (the International Organization of Securities Commissions) adopted the International Conduct of Business Principles, which is described in (i) through (vii) below, in order to provide an international standard of conduct for securities business operators against a background of the rapid globalization of securities trading:

(i) Honesty and FairnessIn conducting its business activities, a firm should act honestly and fairly in the best

interests of its customers and the integrity of the market.(ii) Diligence

In conducting its business activities, a firm should act with due skill, care and diligence, in the best interests of its customers and the integrity of the market.(iii) Capabilities

A firm should have and employ effectively the resources and procedures which are needed for the proper performance of its business activities.(iv) Information About Customers

A firm should seek from its customer information about their financial situation, investment experience and investment objectives relevant to the services to be provided.(v) Information for Customers

A firm should make adequate disclosure of relevant material information in its dealings with customers.(vi) ConflictsofInterest

A firm should try to avoid conflicts of interest, and when they cannot be avoided, should ensure that its customers are fairly treated.(vii) Compliance



A firm should comply with all regulatory requirements applicable to the conduct of its business so as to promote the best interests of its customers and the integrity of the market.

The seven principles described above are all basic rules governing the conduct of the securities business. In June 1991, the Securities and Exchange Council proposed that these business principles should be applied in Japan and that the necessary legislation should be implemented for items which are appropriate to explicitly stipulate in laws or regulations. Since then, the required legislative amendments have been implemented.

Needless to say, an awareness of and unceasing efforts for compliance with the business principles of each person involved in the activities of financial instruments business operators, etc. is indispensable to ensuring that these rules of conduct function effectively.

5 Principles in the Financial Services Industry and Principles Concerning Customer-Oriented Business Conduct

In April 2008 the Financial Services Agency announced “The Principles in the Financial Services Industry.” The Principles are a set of key codes of conduct or general behavioral rules that underlie the basis of statutory rules such as laws and regulations, and should be respected when financial firms conduct their business as well as when the FSA takes supervisory actions. Sharing common views on the Principles among a wide range of relevant parties would bring about the following effects:

(i) Users of financial services will be able to know in advance what they can expect in terms of the behavior of financial firms as well as the quality of financial services they offer, and thus purchase financial services with a sense of security.

(ii) Financial firms that provide financial services will have a clear vision on the way they should act in cases where there are no applicable written rules or where the interpretation of existing rules may vary. They could refer to the Principles as guidelines in their voluntary efforts to improve their services as well as develop and provide new ones, in order to respond flexibly to changing circumstances.

In this sense, the principles will indicate the direction in which the financial firms should head in their efforts to improve their services and the foundation of best practices. They may also serve as the basis for interpreting existing rules.

(iii) For its part, the FSA can (i) ensure prompt and adequate supervisory responses based on the actual conditions of the firms concerned by complying with the basic ideas as outlined in the Principles when interpreting and applying rules at the time of on-site inspections and off-site supervision. Moreover, (ii) when conducting reviews of existing rules such as laws, regulations, and the FSA’s Supervisory Guidelines, efforts aimed at simplifying and clarifying rules in line with the Principles can contribute to putting in place a market and regulatory environment that does not impede innovation or free competition in the area of financial services.

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Section 5. Principles in the Financial Services Industry and Principles Concerning Customer-Oriented Business Conduct


Based on this, it is necessary for the relevant persons engaged in the activities of financial instruments business operators, etc. to fully take to heart the spirit of the Principles in the Financial Services Industry.

The Principles in the Financial Services Industry

Principles in the Financial Services Industry Practical Image

Financial service providers are expected to:1. Pursue greater customer benefits

and fulfill expected roles through voluntary efforts with creativity.

(i) Ceaseless efforts aimed at providing financial services to meet customer needs;

(ii) Proper relationship with diverse stakeholders;(iii) Conformity to expectations that Japan’s financial

services industry generate high value-added and contribute to sustainable growth of the national economy; and

(iv) Responses aimed at meeting social responsibilities.

2. Participate in the markets with the resolve to improve the functioning thereof as a whole and secure fairness and transparency therein.

(i) Compliance with laws and regulations as well as self-regulations;

(ii) Contribution to improving market functions, including market efficiency, through pursuit of best practices and improvement in self-regulations as needed; and

(iii) Contribution to securing market transparency and fairness, by strictly confronting malicious acts that may harm transparency and fairness of the markets.

3. Pay due regard to reasonable customer expectations and conduct business with integrity and professional prudence in order to meet their needs.

(i) Due consideration of customer needs to be reflected in provision of appropriate financial services and management of contracts thereafter, including follow-ups;

(ii) Maintenance of decency in transactions, including by preventing abuse of dominant positions;

(iii) Thorough protection of customer information; and(iv) Fair treatment among customers and compliance

with arm’s-length rules.4. Pay due regard so as to provide

customers with information and advice on a timely basis and in a clear and fair manner, thus enabling them to make economically rational judgments.

(i) Disclosure of information with accuracy and clarity for customer decision-making, thereby securing substantive fairness;

(ii) Conformity to the customer suitability rule; and(iii) Provision of truthful information to customers and

avoidance of misleading explanations.

5. Respond to customer consultations and inquiries with integrity and provide needed information and advice, while making efforts to disseminate financial knowledge.

(i) Commitment to gaining customers’ understanding and confidence to the extent possible;

(ii) Accumulation and analysis of cases of consultations, inquiries and complaints, thereby improving business operations, particularly in the area of customer explanation; and

(iii) Dissemination of correct financial knowledge.




6. Prevent abuse stemming from conflicts of interest between one’s self, including group firms, and the customers, or among different customers.

(i) Sufficient verification as to whether conflicts of interest and other business conflicts are being handled properly;

(ii) Implementation of appropriate control over conflicts of interest to avoid abuses; and

(iii) Performance of duties with integrity.

7. Manage customers’ assets in an appropriate manner, corresponding to the responsibilities assumed.

(i) Appropriate management of customer assets; and(ii) Fulfillment of obligations borne as asset managers.

(e.g., responsibilities to provide good managerial care, keep in separate custody and meet fiduciary requirements, depending on the context of contracts)

8. Establish appropriate mechanisms for corporate governance, including by way of making necessary personnel allocations, and achieve effective corporate governance, to ensure financial soundness and proper business operation.

(i) Establishment of effective and efficient corporate governance;

(ii) Appropriate allocation of executives and employees;(iii) Compliance with laws, regulations and other

business rules, and sound and proper conduct of business thereby; and

(iv) Appointment of directors qualified as being fit and proper.

9. Conduct appropriate information disclosure, considering the significance of both setting market discipline to work and enhancing transparency of corporate management.

(i) Timely and appropriate disclosure of information to the markets; and

(ii) Timely and appropriate disclosure of information to stakeholders at large.

10. Establish mechanisms so as to avoid being exploited by financial crimes, including by way of blocking antisocial parties’ access.

(i) Implementation of mechanisms aimed at preventing involvement in or exploitation by financial crimes, including blocking off anti-social parties’ access; and

(ii) Implementation of mechanisms for customer management and collaboration with relevant organizations.

11. Maintain sound financial basis corresponding to risk profile.

(i) Proper evaluation and assessment of the structure of assets, debts and capital in the light of the risk profiles of the firms in question; and

(ii) Maintenance of capital proportionate to the extent of risks.

12. Conduct appropriate risk management in accordance with the size and features of the business operation and inherent risk profile.

(i) Implementation of appropriate risk management mechanisms;

(ii) Comprehensive recognition and effective control of various risks that may adversely affect assets, debts and profits and losses; and

(iii) Establishment of sustainable profit structure.

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Section 5. Principles in the Financial Services Industry and Principles Concerning Customer-Oriented Business Conduct



13. Establish countermeasures against large-scale disasters and other contingencies in accordance with the role it fulfills in the markets.

(i) Prospects for market liquidity in times of market turmoil; and

(ii) Establishment of crisis management systems and coordination among the parties involved in the event of crises.

14. Provide accurate information with integrity upon reasonable requests from the FSA, and facilitate effective communication with the FSA, including by way of interactive dialogues.

(i) Prompt provision of sufficient and accurate information meeting the FSA’s needs, in response to reasonable requests; and

(ii) Effective communication between the FSA and financial service providers through enhanced interactive dialogue.

(Source: Financial Services Agency)

In March 2017, the Financial Services Agency published the “Principles Concerning Customer-Oriented Business Conduct,” which represent the principles the Financial Services Agency considers to be helpful for financial institutions, etc. (hereinafter referred to as “financial service providers” as in the Principles) to achieve best practices in realizing customer-oriented business conduct. In these Principles, the Financial Services Agency adopts a principles-based approach so that financial service providers can realize the customer-oriented business conduct not merely in form but in substance according to the respective situations they are in. Financial service providers are required to fully understand the purport and spirit of the Principles and make appropriate decisions regarding what they should do to put the Principles into practice.

If financial service providers decide to accept the Principles, they must develop a clear policy for realizing customer-oriented business conduct and operate their business according to the policy. Specifically, financial service providers accepting the Principles are required to develop and publish a clear policy for realizing customer-oriented business conduct, periodically disclose the implementation status of the policy, and periodically review the policy, as provided for in Principle I below. Furthermore, they should include their approach to the principles indicated in Principles II to VII below in the policy if they accept the Principles. If they do not accept the Principles, they should explain the reasons for the non-acceptance and their alternative measures in an easily understandable manner in the policy.

Principles Concerning Customer-Oriented Business Conduct

[Development and Publication of Policy Concerning Customer-Oriented Business Conduct]Principle I. Financial service providers should develop and publish a clear policy for realizing customer-oriented business conduct and periodically disclose the implementation status of the policy. The policy should be periodically reviewed in order to achieve improved business conduct.[Pursuit of Customers’ Best Interests]Principle II. Financial service providers should maintain a high level of expertise and



professional ethics, treat their customers faithfully and fairly and pursue the best interests of the customers. Financial service providers should make efforts to ensure such business conduct becomes established as a corporate culture.[Appropriate Management of Conflicts of Interest]Principle III. Financial service providers should accurately identify the possibility of conflicts of interest arising in relation to transactions with customers, and appropriately manage them when there is the possibility of any conflict of interest arising. Financial service providers should develop a corresponding policy for such purposes in advance.[Clarification of Fees and Expenses]Principle IV. Financial service providers should provide information in a manner that enables customers to understand the details of all fees and expenses, regardless of name, incurred by the customers, as well as what is a service corresponding to each of such fees and expenses.[Easily Understandable Provision of Important Information]Principle V. Financial service providers should provide important information on sales or recommendations of financial products and services, in addition to the matters indicated in Principle IV. above, in a manner understandable by customers based on the presumption that there exists an information asymmetry between customers and themselves.[Provision of Services Suited to Each Customer]Principle VI. Financial service providers should understand customers’ asset status, trading experience, knowledge, trading purpose and needs, and manufacture or sell or recommend financial products and services suited to each customer.[Frameworks for Motivating Employees Appropriately and Other Measures]Principle VII. Financial service providers should develop frameworks for motivating employees appropriately including remuneration and performance evaluation systems and employee training designed to encourage conduct such as actions to pursue customers’ best interests, fair treatment of customers, and appropriate management of conflicts of interest, and a framework for appropriately motivating employees through employee training and other means, as well as an appropriate governance system.

(Source) Financial Services Agency

From the perspective of promoting “visualization” of financial service providers’ practices, the Financial Services Agency discloses on its website a list of financial service providers that have developed a clear policy for realizing customer-oriented business conduct and the voluntary key performance indicators (KPI) published by financial service providers and recognized by the FSA as good examples.

6 Sales Representative’s Approach to Sales Activities

A sales representative’s work is not simply a matter of receiving instructions from someone

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Section 6. Sales Representative’s Approach to Sales Activities


else. Sales representatives must, by themselves, plan, execute and confirm their own work to develop their own methods for the securities business. When a certain goal is asked of a sales representative, if they have been constantly developing themselves, they can aggressively approach the goal by understanding the background of the goal. Gaining a full understanding of the meaning and substance of securities sales, and approaching their work by developing themselves, sales representatives can develop many ideas, experience the joy of achievement, and progress with their work effectively.

Here let us consider the planning, execution and confirmation stages in accordance with the sales representative’s operational procedure.

6 1 Selecting the Business Targets

There are many targets of the sales activities of the securities business, including individuals and institutions. The possibilities are almost limitless. However, details regarding such target investors, such as names and locations, are not given, and therefore, those who attempt sales at first may feel overwhelmed.

Yet at the same time, it is impossible to get things moving just by attempting to reduce “wasted sales activities,” since no one knows which activities are “wasted activities” until one actually contacts customers. This does not mean that indiscriminate sale is the solution. When making a sales approach, an effective approach must be taken if it is to see results. The first question is to decide who will be the subject of the approach. After some time, a sales representative will become able to select such subjects based on experience and knowledge.

Based on the above, specific methods of target selection may include the following.(i) Preparing General Documents

Examples are corporate credit registers that are sold on the market.* With the implementation of the Personal Information Protection Act, care is required

in connection with the handling of name lists, etc.(ii) Narrowing Down the Area

To improve the efficiency of sales activities, the target area may be narrowed. Keep a map of the area and enter the name of the subjects selected from various lists. During sales activities, add information seen, heard and obtained during visits to potential customers.(iii) Narrowing Down the Industry

One method is to concentrate on an industry by preparing documents and news that involves a certain industry. For example, it may be possible to enter a certain set of conditions using a search engine on the Internet and retrieve a list of industries that satisfy those conditions.



6 2 Approaching the Selected Targets

Once the targets have been selected, the next step is to approach them. Although it is difficult to start a conversation with someone you are not acquainted with, utilizing your strong points, communication can start when you think of what the target person wants. There are many things that you can learn through experience.

Good manners are a skill that everyone must have as the minimum requirement for communication. Manners are the expression of a courteous willingness to accept the other person and are a prerequisite for communication. However, merely being excessively deferential to the other person does not establish communication.

Good manners are the minimum necessity for communication. What are the points sales representatives should be cautious of?

First, communication must be interactive and cannot be established unilaterally. Good communication requires listening as well as talking. To listen, the other party must speak. Sales representatives have a tendency to show their presence or to just continue to talk on their own when explaining a product. However, that is neither good nor sufficient communication.

Foreign sales texts often state that sales are not a speech but a conversation. This statement is illustrated by the above discussion.

The same applies to the sales representative. Unilateral explanation of the product and its necessity is only a “speech.” If the other party does not pay attention, it is only a speech without an audience. The good communication discussed above means that the sales representative must attempt to make a “conversation” with customers rather than giving a speech to them.

Then, how can you establish a “conversation”? Usually, a question directs the other party to answer. At that point, the other party becomes a part of the conversation and bilateral communication with the customer is initiated.

Based on the above, let us consider points to note in more detail regarding communication.The first point is “choice of words.” During daily communication, we choose the words we

use and place them in an adequate order to express a thought. There are particular word choices as well as an appropriate order in which to organize one’s presentation that are appropriate for sales activities, and sales representative must be well educated in presentations with these word choices and order.

The second point is “tone of voice.” Sales activities are not written promotions or pamphlets but are carried out through the spoken word. Voice and intonation are part of the spoken word. No matter how well the words are selected, sales efforts will not be successful with inappropriate and blunt intonation.

The third point is the “demeanor and facial expression.” Communication can be categorized into verbal communication and non-verbal communication. Many people often think that something non-verbal is not communication. However, in reality, non-verbal communication conveys much more information than verbal communication. Demeanor and facial expressions are always detected through the other party’s eyes. Unlike communication by telephone or radio, the

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communication in this case is not a matter of listening alone.The three important factors of communication – choice of words, tone of voice, and

demeanor and facial expression – can and should be mastered by everyone (In addition, providing reader-friendly references is another important method of communication that should not be forgotten).

6 3 Creating Prospects

Next, the list of prospects should be selected from the initial targets based on contacts such as visits. Even if the initial contact did not lead directly to an immediate transaction, the contact may become a customer after ongoing appropriate advice. Prospects are investors who may become future customers.

Each sales representative must rely on his/her own perceptions and logic to determine who will become a prospect. During a visit, concentrate on the investor’s words rather than just listening without any particular purpose. Soon, different ideas regarding the future relationship and possible suggestions will develop through communication with the targets. Such ideas are based on each representative’s experiences and knowledge. People who have a lot of curiosity or people who diligently study practical fields have more ideas because they tend to have more experience and knowledge.

However, no matter how many ideas develop, the opposite party cannot become a prospect if he/she is not suited to investment. A sales representative must carefully inquire if the investor has both sufficient capital and the ability to manage his/her own economic activities (i.e., sufficient economic understanding). Sometimes a person who seems to have a reputable and affluent background is not suited for investments at all. For example, a famously wealthy man may have lost all his assets over time. Through the conscious accumulation of experiences, a sales representative should become able to judge an investor’s financial capacity and economic understanding. And with this, a sales representative should be able to meet prospective customers with economic capacity in unexpected settings.

Enter the prospect’s information in your database or prospect notebooks, including name, address, telephone number, occupation (position), date of birth, family members, estimated assets (income), the products which meet his/her preferences, his/her interests, clues regarding the best method of approach, etc. If the other party is a corporation, enter the points which the corporation would be interested in from the perspective of the industry, legal issues, financial issues, taxation issues, etc. Such accumulations of information become an irreplaceable asset for a sales representative. When there are an abundant number of prospects, new customers develop smoothly. A sales representative can build a relationship without rushing to do business and can expand the horizon of his/her relationships. As a result, the business approach can become less hasty and more substantial in its effectiveness and adequacy. Therefore, a sales representative who is just starting out may aim primarily at building a certain number of prospects until a certain time



goal is reached.

6 4 Making Your Own Customers

How can a sales representative convince more customers to select him/her from among many competitors and have them actually start the transaction? In this section, we would like to review a few factors that can make a prospect the customer of a particular sales representative.

First, the sales representative must be completely knowledgeable about the products he/she handles. The sales representative must understand the products well enough to be able to explain in easy-to-understand terms to customers how much return can be expected from each product. In addition, the sales representative must understand the expected return amount and the feasibility of such return (risk), at a level sufficient that they can explain these matters plainly to customers. To convey the concepts of risk and return plainly, the sales representative must be able to consider and describe in his/her own words precisely how the return is achieved (income gain or capital gain), the reasons why the return is expected, the circumstances in which return will be higher or lower than expected and the frequency of such circumstances.

To be able to do this, sales representatives must study. “Study” does not mean simply memorizing something, but rather training themselves for understanding of the risk and return associated with the product. Furthermore, studying alone does not enable the sales representative to make a presentation of the product. Sales representatives must gather diverse information and form a foundation for their opinions. There is an almost limitless amount of information that can be useful for this task, such as the actual price movements of the securities, interest rates and foreign exchange trends, analysis of information from a company’s research division, articles from newspapers and magazines, stories from co-workers and superiors, and information obtained from daily business operations. Through consistent efforts to train themselves, sales representatives will unleash unexpected potential within themselves.

Next, it is important to know the investment needs of the customer. It is important to note that investors do not simply “give out” important information about themselves, such as their investment needs, if a sales representative remains passive. A sales representative must aggressively search for communication opportunities and discover more information about customers. It is also necessary to recommend some type of products. After various approaches, the needs of the customers and the suitable investment products will become apparent.

Motives for investing are many and varied.(For example)・ Speculation;・ Stable growth of assets;・ Hedging against inflation;・ Purchasing the shares of one’s own employer through a share purchase plan;・ Purchasing related to commercial sales;

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・ Temporary investment of extra cash (assets); and・ Taking advantage of tax benefits, etc.Consider the information given by the customer logically and think flexibly; it is then that

ideas start to appear. It is very important not to draw any hasty conclusions about a customer.At times, the customers themselves do not know their own investment needs, or they have

multiple investment purposes. Therefore, it is very important to think from the customer’s point of view with regard to each individual case. Otherwise, the investment appropriate to the customer does not become apparent.

In order for an investor to become a customer, a transaction must be consummated. In other words, the sales representative must select products suitable for the customer’s investment needs and have the customer understand and purchase the products. There are products with high returns and high risks, and products with low returns and low risks. There is no right or wrong answer for the appropriate combination of risk and return. The final decision about the combination of the products has to be made by the customer. The sales representative must assist in the process by offering the most suitable products to the customer, judging from his/her communication with the customer. Although the process seems more time consuming, it leads to customer trust and a continuous long-term relationship with the customer.

When the customer has various investment needs, they may require several different combinations of risk and return to accommodate such needs. However, there is no need to worry, because as mentioned previously, there are many different types of securities in the market. Therefore, combining various products can accommodate investor needs. The use of derivatives such as futures and options widens the range of needs that the sales representative can accommodate.

Fundamentally, the markets are free markets in which, with agreement between the funding side and the investing side, almost infinite combinations of risk and return can be established. Therefore, the job of a sales representative has limitless potential. But first, each sales representative must do his/her best within their limit of wisdom to sustain a solid basis for future growth.

6 5 Building a Long-Term Relationship

Opening an account only for a single transaction is far from a complete business relationship. The business relationship becomes complete only when a continuous long-term relationship is established. After-sales service (customer service) is not the sole purpose of a long-term relationship. The next business opportunity lies in a long-term relationship.

A product that was initially suitable for the customer’s needs may not be as suitable over time because the financial and economic environments change constantly, as do securities prices. Under new circumstances, a product that is even more suitable to a customer’s needs may emerge. At times, the needs of a customer change. Nothing stays the same. In sales of securities, such



changes can lead to new business opportunities to reassess the investment depending on the situation surrounding the changes. Whether or not such business opportunities are taken advantage of depends on the sales representative’s sensitivity to changes in the environment, ability to understand change, adaptability and continuous relationship of trust with the customer. Sales representatives must never cease to improve their skills or make light of the relationship with the customer simply because they have succeeded in capturing a number of new customers.

6 6 Assessing One’s Self-Conduct

If sales representatives can carry out the above-mentioned activities in a well-planned manner, they are one step closer to success. In this section, let us consider in detail how well-planned progress is achieved.

First, it is important to establish goals that define what must be done within a certain limited time. Obviously, a person working in a well-planned manner toward a goal and a person working without a goal will have significantly different outcomes.

Next, it is very important to review, analyze and inspect past results and achievements. Such inspection can be done from many different perspectives. Efforts to detect investment needs based on the customer’s reactions to the sales representative’s suggestions, which we discussed above, are also part of this assessment process. Actual performance of investments can allow for an assessment of the quality of the original suggestions given to the investor. In more direct words, ask if sales activities are efficient, if the quality of the conversation with the customer is good and if the sales representative appears to be confident when recommending products. These questions can provide clues to check the representative’s sales abilities. It is also important to inspect one’s work in relation to corresponding business sections. Ask how past sales contributed to creating the customer’s assets or making profits for the financial instruments business operator to which the sales representative belongs and how much cost he/she incurred to earn the profits.

As a result of such introspection, more creative solutions may be added to daily operations, leading to overall progress. The virtuous circle of planning, action and introspection provides a desirable action pattern for a sales representative.

Creativity requires broad mental horizons and adequate judgment. For well-planned action, strong discipline and diligent self-management are necessary. Introspection regarding past actions requires a sharp analytical mind and the modesty to assess one’s own actions. Through the repetition of planning, action and introspection, a sales representative is gradually trained and will grow into a superior human resource with extensive personal capacities and knowledge. In the end, the process enables the customer to continuously trust the sales representative and improves the success of sales activities. It is hoped that every sales representative will learn good habits.

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ConclusionIn this section, the professional attitude and behavior of the sales representative have been

discussed, along with the work flow of its business. It is easier said than done to adhere to the standards discussed in this section, just as it takes much effort to become the best at anything. No one can be a superior sales representative from day one. At the same time, everyone has the potential to become a superior sales representative.

The capacity to be a superior representative is a natural byproduct of constant effort and attention to detail in one’s work.

For sales representatives, their level of work improves when they strive to be of use to the customer. A sales representative must not forget to be honest and sincere toward the customer in the course of the sales business. This is also for the purpose of one’s own growth. Cultivation of self-development and integrity should be made the indelible foundation of a sales representative in any era or generation.



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