In May 2005, the Japanese ‘Law Concerning Investment Trusts and Investment Companies’ (link in Japanese – the ‘投資信託及び投資法人に関する法律’ or ‘toushi shintaku oyobi toushi houjin ni kan suru houritsu’, referred to below as the ‘ITL’) was revised to allow entities covered by the law to invest in real estate.
The law also introduced a new entity, the ‘Japanese Investment Company’ (in Japanese ‘投資法人’ or ‘toushi houjin’ abbreviated below as ‘JIC’) in addition to revising regulations related to existing ‘Japanese Investment Trusts’ (in Japanese, ‘投資信託’ or ‘toushi shintaku’ abbreviated below as ‘JIT’) governed by the law.
This revised ITL helped spur the development of the Japanese real estate investment trust market – the ‘JREIT’ market – which has grew rapidly in recent years prior to the inevitable pause as a result of the financial crisis.
Information on the JREIT market
For persons interested in this market a private body, the STB Research Institute, provides extensive English language analysis of the JREIT market on their website here, as does the site of the Japanese Association for Real Estate Securitization on their website, including maintaining a JREIT index here.
Japanese websites such as japan-reit.com (link in Japanese) also provide extensive Japanese language reporting and analysis of the market.
The website of Tokyu REIT also has an extensive English language investor disclosure section, so provides a useful reference example for investors interested in the JREIT market.
Introduction to the Investment Trust Law and entities regulated under the law
Article 1 of the ITL states the objective of the law, being the regulation of JITs and JIC’s (below collectively the ‘Entities’) established to allow the pooling of investor funds that can be managed by third parties other than the investors while protecting the rights of those investors in the Entities or of investors in securities issued by the Entities concerned. In other words, the ITL is concerned with the regulation of a typical collective investment scheme.
This article introduces some of the definitions in the ITL along with looking in more detail at some of the related regulations of the law.
Specified Assets and Investment Trusts
Article 2 of the ITL defines ‘Specified Assets’ (in Japanese ‘特定資産’ or ‘tokutei shisan’), being the assets regulated by the ITL in which the Entities invest. These assets include Marketable Securities (defined in paragraph 5 of article 2 of the ITL by reference to the Japanese ‘Financial Products and Transactions Law’ or below ‘FTPL’), real estate or other assets as determined by cabinet order.
Paragraph 3 of the article 2 defines Japanese Investment Trusts while paragraph 4 defines ‘Securities Investment Trusts’, being a subset of Japanese Investment Trusts which invest mainly in Marketable Securities (and which are not discussed further in this article).
Japanese Investment Companies
In contrast the Japanese Investment Trust, the Japanese Investment Company is recognized as having corporate character under the ITL article 61. Under ITL article 63 the address of the JIC is the location of its head office and under article 64 a JIC is not allowed to establish an office other than its main office, nor employ other persons. The JIC is also not permitted to undertake activities other than investment as regulated under the ITL.
Given the restrictions in article 64, the operations of the investment company, the management and custody of its assets, investment decisions and other activities are all entrusted by the JIC to outside specialists.
Application of the Japanese Corporate Law
Article 65 of the ITL notes how the Japanese corporate law should be interpreted in its application to Japanese Investment Companies.
The article explains how a number of terms introduced in the ITL correspond to terms in the Japanese Corporate Law. In particular, the term in the ITL ‘Investment Account’ (in Japanese ‘投資口’ or ‘toushi kou’) corresponds to ‘Shares’ (in Japanese ‘kabushiki’) in the Japanese Corporate Law; Investment Holder (in Japanese ‘投資主’ or ‘toushi nushi’), corresponds to Shareholder (in Japanese ‘’ or ‘kabu nushi’); Rules (in Japanese ‘規約’ or ‘kiyaku’) under the ITL are equivalent to Articles of Association (in Japanese ‘定款’ or ‘tei kan’) for ordinary Japanese corporations and Investment Stock (in Japanese‘投資証券’ or ‘toushi shouken’) corresponds to Stock (in Japanese ‘株券’ or ‘kabu ken’) under the Japanese Corporate Law.
One of the advantages of the corporate character of the Japanese Investment Company is that the entity can raise funds through the issue of Investment Stock to investors. In contrast to the position for a JIT, a JIC therefore can increase its leverage by borrowing funds or issuing Investment Stock.
Also, unlike in typical JIT, investors themselves can participate in the management of the investment company through the exercise of the voting rights which accrue to them through their ownership of Investment Account.
Also, while Japanese Investment Trusts are formed further to contract law and hence there is greater flexibility in determining the governance structure of the entity, Japanese Investment Companies have a more clearly defined governance structure under the ITL resembling that of ordinary corporations.
Perhaps as a result of a preference for greater transparency and certainty in corporate governance compared with flexibility, the only listed JREITS at the beginning of 2010 have been JICs.
Other important changes introduced by the ITL that helped promote the JREIT market included formulating requirements around qualifications for trustees of assets under management, introducing measures to prevent acts contrary or damaging to the interests of investors, clarifying fiduciary responsibilities towards investors and clarifying obligations to manage investments appropriately. Investor disclosure regulations were also updated.
In 2007 with the adoption of the FPTL, regulations concerning the management and activities of trustees under the ITL were incorporated into the new law.
There are a number of other ways in which Entities can be classified under the ITL, as follows:
Open-ended and closed entities
In an open-ended fund, investors can request repayment of invested money directly from the fund. In contrast, in a close-ended fund an investor must sell his investment to a third party in order to return his capital unless the fund is being wound up. Given the relative lack of liquidity in the underlying real estate investment, JREITS listed at the beginning of 2010 were all close-ended funds.
Publicly placed and privately offered funds
The distinction between publicly placed and privately offered securities in a JIC or offering of an investment in a JIT also depends on definitions in the FPTL. A publicly offered security is one where 50 or more unspecified investors were solicited to invest in the security concerned where the offer is also not treated as a private placing with defined qualified institutional investors. Privately placed offerings can be divided between offerings made only to qualified institutional investors and offerings made only to 49 or less general investors. There is no limitation to the number of investors in an offering made solely to qualified institutional investors.
Assets in which a Japanese Investment Company can invest
Given the importance of the Japanese Investment Company to the JREIT market the remainder of this article gives an overview of the assets in which JICs can invest and the organization of their capital structure. Following articles will look at the taxation of JREITS and in due course consider the JIC and JIT accounting and governance structure.
Article 193 of the ITL states that the investment activity of the Japanese Investment Company should be carried out in accordance with the company’s Rules and related asset investment guidelines. The article also notes that a JIC can transact in specified assets as follows.
The acquisition or disposal of marketable securities.
The lending of marketable securities.
The acquisition or disposal of real estate.
The lending of real estate.
The entrustment of the management or the direct management of real estate.
Other transactions as decided in cabinet orders.
Note however that under the ITL, provided the activities are in accordance with the JIC’s investment guidelines and Rules, the JIC can purchase, dispose or transact in other assets besides those listed above.
Purchase of shares in other companies
Article 194 of the ITL limits the ability of a JIC to acquire shares in another company. A registered JIC cannot acquire a majority of the shares representing the voting rights of another company.
Related party transactions
Article 195 of the ITL limits transactions of the JIC with certain related parties. In particular, a JIC cannot carry out the transactions referred to above in article 193 with either the Representative Director (in Japanese the ‘執行役員’ or ‘shikkou yakuin’), the Supervisory Director (in Japanese the ‘監督役員’ or ‘kantoku yakuin’), or with the Investment Management Company of the JIC itself. The roles of these parties will be outlined in future articles addressing the corporate governance structure of the JIC.
The website of Tokyu Reit gives an example of rules around transactions with related parties in English at this link.
Regulation by the Japanese Investment Trusts Association
The ITL itself does not have an explicit definition of the underlying assets in which a real estate JIC can invest. However, guidelines issued by the Japanese Investment Trusts Association (‘JITA’), whose website can be found here, do address this point. The regulations issued by JITA (the ‘JITA Regulations’) can be found at this link (link in Japanese).
According to the regulations relating to real estate investment funds and real estate investment companies which can be found here (link in Japanese) then under article 3, more than 50 per cent of the assets of an entity should be real estate in order for it to be treated as a Real Estate JIC.
Paragraph 2 of article 3 of the JITA Regulations defines real estate to include real estate itself, a lease right over real estate, a lease right over land in Japan or overseas, beneficiary rights in a trust over the previous 4 items, and an investment interest in a Japanese silent partnership with underlying real estate investment.
Paragraph 3 of articles 3 goes on to list a number of derivative assets whose value depends on real estate, including preferred investment securities issued by a Japanese TMK (as explained in this article) and including the Investment Account and Investment Stocks issued by JICs under the ITL. Assets recognized under foreign law corresponding to these assets are also permitted objects for JIC investment.
The ITL does not explicitly address whether an Entity can develop land or buildings. Having an entity be party to a contract with a developer to build property or develop land would seem to be covered by the acquisition of real estate under paragraph 3 article 193 of the ITL.
Also the ITL allows activities to be carried out by a JREIT provided they are specified in its Rules or investment plan.
That a JIC can carry out Ltd development activities is also implied from the comprehensive supervisory guidelines for participants in a securities business under the FPTL issued by the Japanese Financial Services Agency where these guidelines can be found at this link (in Japanese). However, these guidelines also make clear that development activities that could adversely impact the investment cash flows or investment objectives of regulated company would not be appropriate.
Registration and establishment of a Japanese Investment Company
Article 187 of the ITL is a requirement for a JIC to register in order to carry out the investment activities regulated by the ITL.
Article 66 of the ITL also introduces rules around the knowledge and qualifications of persons who can act as promoters in establishing a JIC . This page of the Japanese Egov website gives allows such a person to make an application for registration of a JIC. The page includes a list of the materials required for JIC application (in Japanese).
Japanese Investment Company Rules.
As previously noted, the rules of a JIC are equivalent to the articles of association of a company. Below is a list of the items that must be included in a JIC’s Rules and a Japanese example of a JREITs Rules can be found at this link (link in Japanese) at the website of Tokyu REIT. The items are:
The objective of the JIC
The commercial registration number of the JIC.
Whether or not the entity is open-ended or close-ended.
The total number of Investment Account units that can be issued (equivalent to shares for an ordinary company).
The amount of monies invested at the time of establishment of the JIC.
The minimum amount of net assets that will always be maintained by the JIC
The investments and investment plan of the JIC.
In relation to assets of the JIC, their investment valuation method, valuation standard and the time when the standard is applied.
The JIC’s guidelines for making monetary distributions.
The accounting period of the JIC.
The address of the main office of the JIC.
The amount of compensation for the CEO, Supervisory Director, Statutory Auditor or the method by which such compensation will be determined.
The amount of compensation paid to the investment company for its, investment services or the standard by which such compensation will be calculated.
The main address and outline of contractual terms intended for the parties entrusted with general operations of the JIC and the custodian of JIC assets at the time of its establishment.
The maximum amount of borrowings or securities issued by the JIC.
The name and address of the persons establishing the company and the compensation received by persons establishing the company.
Whether persons establishing the company will receive any profit from its establishment and if so the amount of such profit.
Whether or not there are any costs associated with establishing the company to be borne by it and if so the nature and amount of those costs.
The article also notes at that if a limitation is going to be put on the ability of the company to redeem units as an open-ended fund, such limitation should also be stated in JIC Rules. An upper or lower limit can also be noted for the amount invested in the entity at the time of its establishment. The minimum amount of net assets must be at least JPY50m. Modifications or additional rules on matters not regulated under the ITL can also be included in the JIC Rules.
Investment Account and Investment Stock
Investment Account is equivalent to equity and Investment Stocks equivalent to debt for a Japanese Investment Company. Below are some of the regulations relating to these securities under the ITL
Article 76 of the ITL notes that Investment Account has no specified face value.
Limitation of liability
Article 77 of the ITL defines the extent of liability of an Investment Account holder, which is limited to the amount paid for the Investment Account. The holder is also entitled to a distribution of monies, a distribution of residual assets and to vote at a general meeting of the Investment Holders.
Article 78 notes that it is possible for Investment Holders to transfer their interests in an Investment Account. Paragraph 2 of the article notes that, in contrast to the position for ordinary Japanese companies, requirements for the board of directors to approve transfer of Investment Accounts or other limitations on transfer cannot be established.
Purchase of own capital
Article 80 of the ITL notes that a JIC cannot purchase its own Investment Account, nor receive such an asset as a collateral pledge. However the article notes there are some circumstances where this limitation does not apply, including the succession of assets from a ceasing company in a merger that include the company’s Investment Account.
Also as regulated by the ITL, the JIC can purchase its Investment Account for the purposes of, for example, disposing of such account on a redemption. Article 81 also includes a prohibition on the purchase of Investment Account a parent company of the JIC. Under articles 81, 82 and 83 an investment company also cannot split or consolidate Investment Account. Article 129 of the ITL Enforcement Order also outlines other circumstances under which a JIC can acquire its own Investment Account. This include purchase for new consideration, when received as a distribution of surplus or as a dividend out of surplus from another company in which the company has invested, or when received further to a corporate reorganization, merger, or share exchange including similar transactions recognized under foreign law.
Finally a company can purchase an interest in its own Investment Account when it is necessary or unavoidable to complete such a purchase for the purposes of exercising related rights.
Under article 124 of the ITL an open-ended investment company is required to redeem its Investment Account upon the demand of the Investment Holders. Redemptions may not to be made when the JIC has entered liquidation, when its net assets fall below the minimum level specified in the JIC Rules or when circumstances originally specified in the JIC Rules apply,
Investment and other activities of the investment company
The activities of/and investment company limited by the scope decided in the company’s investment plan and in its Rules as discussed previously.p