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JAPANESE NEW RISK RETENTION RULESFOR SECURITIZATIONSATSUMI & SAKAITOKYO | LONDON | FRANKFURT
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March 2019

ATSUMI & SAKAITOKYO | LONDON | FRANKFURT
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March 2019
No. A&S (EN)_005

Japanese New Risk Retention Rules for Securitizations
On March 15, 2019, the Financial Services Agency of Japan (“FSA”) published the partial
amendments to notices on the capital ratio requirements (Pillar I, Pillar III) etc. and the results ofthe public comments 1. These amendments include the new risk retention rules which will be
introduced from March 31, 2019. The new risk retention rules require banks and certain otherfinancial institutions (collectively, “Affected Financial Institutions”) 2 which make investments ininterests in securitizations to apply higher risk weighting to a securitization exposure unless such
Affected Financial Institutions satisfy certain risk retention requirements. In this newsletter,
we outline the new risk retention rules.
1.

What’s Risk Retention?
Risk retention means, in the context of securitization transactions, an originator and otherrelevant parties retain some portions of risks in original assets being securitized.
In cases where an originator transfers its assets to a securitization vehicle for the purpose ofobtaining funding, the originator may pass credit risks in the original assets to investors
without carefully analyzing the quality of such assets. The risk retention rules are designed
to increase the originator’s incentive to form appropriate assets being securitized bymandating that the originator retains some portions of risks in the original assets.

2.

Comprehensive Guidelines for Supervision of Major Banks, etc.
After 2009, based on the international financial crisis triggered by the subprime loan
problem in the United States, the risk retention rules have been globally discussed, which
includes the Declaration of the G20 London Summit (2009) 3 and Recommendation toStrengthen Oversight and Regulation of Shadow Banking published by the Financial Stability
Board (FSB) (2011) 4 . In November 2012, the International Organization of Securities
Commissions (IOSCO) issued a final report entitled “Global Developments in Securitisation
Regulation” 5 and recommended that regulators and policy makers implement risk retention
regulations. On April 30, 2015, based on the recommendation, the FSA introduced the1

FSA , “Regarding the publication of the partial amendments to notices on the capital ratio requirements(Pillar I, Pillar III) etc. and the results of the public comments”（https://www.fsa.go.jp/news/30/ginkou/20190315-1.html）
2
The Financial Institutions subject to the new risk retention rules include banks and other depositary
institutions, bank holding companies, ultimate parent companies of large securities companies designated by
the FSA.
3
G20 London Summit, April 2, 2009, “Declaration on Strengthening the Financial System”(https://www.mofa.go.jp/policy/economy/g20_summit/2009-1/annex2.html)
4
FSB, “Recommendations to Strengthen Oversight and Regulation of Shadow Banking”(http://www.fsb.org/2011/10/financial-stability-board-publishes-recommendations-to-strengthen-oversight-an
d-regulation-of-shadow-banking/)
5
https://www.iosco.org/library/pubdocs/pdf/IOSCOPD394.pdf

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March 2019
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current risk retention rules by amending the supervisory guidelines 6 applicable to banks,
insurance companies, securities companies (“Supervisory Guidelines for Financial
Institutions”).
The Supervisory Guidelines for Financial Institutions require banks and other certain
financial institutions to do the following actions when they make investments in interests insecuritization products 7:-

to check if an originator continuously retains parts of risks in the related securitization
product; and-in cases where the originator doesn’t retain such risks, to deeply analyze theoriginator’s involvement in the formation of original assets and the quality of theoriginal assets.

Under the current rules, the originator does not have any direct obligation to retain thecredit risks in the relevant securitization. Therefore, in this regulatory regime, it can beallowed that the originator form the origination of the original assets and that investors
make investments in securitization products, even though the originator does not holdsome portions of risks in the relevant securitization transactions.
3.

The Partial Amendments to the FSA Notices on the Capital Ratio Requirements (Pillar I)(1) Outline of the New Risk Retention Rules
The FSA introduces the new risk retention rules by amending the FSA Notices on the Capital
Ratio Requirements (Pillar I) 8. Under the new rules, the Affected Financial Institutions
must:(i) confirm if the originator of the related securitization transaction retains a securitization
exposure equal to not less than 5% of the total of original assets being securitized; and(ii) as a general rule, apply triple risk weighting (capped at 1,250%) to the related
securitization exposure in cases where the Affected Financial Institutions cannot
confirm the compliance of the 5% risk retention requirements 9.

6

FSA, “Regarding the publications of the partial amendments to the supervisory guidelines in relation to thesecuritization risk retention rules”（https://www.fsa.go.jp/news/26/20150430-5.html）. The supervisory
guidelines mean guidelines for administrative employees who are in charge of supervising financial institutions
such as banks.
7
With respect to banks, Comprehensive Guidelines for Supervision of Major Banks, etc. III-2-3-3-2(3)②二(https://www.fsa.go.jp/common/law/guide/city/03b.html)
8Partial Amendments of the FSA Notices on the Capital Ratio Requirements (Pillar I)（https://www.fsa.go.jp/news/30/ginkou/20190315-1.html）
9
With respect to banks, Chapter VIII, Section I, Article 248, paragraph 3 of the FSA Notice on “the Standards
for a Bank to Determine the Sufficiency of Equity Capital in Light of the Assets Etc. Held Pursuant to Article 14-2of the Bank Act (FSA Notice No.19, 2006) (“Notices on the Capital Ratio Requirements”)（https://www.fsa.go.jp/news/30/ginkou/20190315-1/09.pdf）

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March 2019
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As with the current rules, the new rules do not impose direct obligations on the originatorto comply with risk retention requirements. In addition, the new rules require theAffected Financial Institutions to secure an adequate level of capital in consideration of therisk retention status of the originator and any other relevant parties, though the current
rules do not set out the status and the adequate levels of credit risks held by the originator.
In this regard, the new rules are additional regulations to the current rules.
(2) The 5% Risk Retention Requirements
In the risk retention rules, it sets out four types as a method for the 5 % risk retentions heldby the originator 10.
(i) Vertical TypeThe credit risks can be held vertically, meaning that an equal potion of all tranches held, andthe total amount of the securitization exposure is 5% or more of the aggregate exposure of
the original assets for the related securitization transaction (See Example 1 in the Exhibit).
(ii) Horizontal TypeThe credit risks can be held horizontally, meaning that all or parts of the most junior tranche
held, which is 5% or more of the aggregate exposure of the original assets for the related
securitization transaction (See Example 2 in the Exhibit).
(iii) L-shaped TypeIf the most junior tranche is less than 5% of the aggregate exposure of the original assets,
the credit risks can be held as combination of vertical and horizontal, meaning that all of themost junior tranche together with an equal potion of other tranches held, and the total
amount of the securitization exposure is 5 % or more of the aggregate exposure of theoriginal assets for the related securitization transaction (See Example 3 in the Exhibit).
(iv) Other TypeThe credit risks can be held if they are considered to be equal to or not less than each of theforegoing items (i) through (iii). The status of the credit risks held by the originator mustbe judged specifically in each individual case. However, Q&A of the FSA Notices on the
Capital Ratio Requirements 11 provides the following cases as examples of this category 12.
(a) the originator holds 5% or more of each tranche (See Example 6 in the Exhibit);(b) the portion of the most junior tranche held or the aggregation of subordinated tranches
in order of subordination held is less than 5%, and the originator holds all these
10With respect to banks, Chapter VIII, Section I, Article 248, paragraph 3, item (i) through (iv) of the Notices on
the Capital Ratio Requirements,
11
FSA, “Q&A of the FSA Notices on the Capital Ratio Requirements” in relation to “Partial amendments to the
FSA Notice regarding Capital Ratio Requirements (Pillar I, Pillar III)” etc. (review of the capital charges
framework of securitization products) (“Q&A”)（https://www.fsa.go.jp/news/30/ginkou/20190315-1/42.pdf）
12
Q&A, <Standards for judging the status of credit risks held by the originator>, Article 248-Q4

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March 2019
No. A&S (EN)_005

tranches together with subordinated tranches to these tranches in order ofsubordination, and the sum of these tranches held is 5% or more of the total (SeeExample 5-1 and 5-2 in the Exhibit); and(c) the portion of the most junior tranche held or the aggregation of subordinated tranches
in order of subordination held is less than 5%, and the originator holds all thesetranches, and holds each of the tranches other than the foregoing tranches equally, etc.,
and the sum of these tranches held is 5% or more of the total (See Example 6 in the
Exhibit).
It should be noted that although the originator retains 5% and more securitization exposure,
it can be judged that the originator does not retain credit risks in effect in cases of hedging
such credit risks by a guarantee or purchasing CDS etc. 13. As a method to confirm whether
the originator has hedged credit risks etc. or not, it can be confirmed by requesting thearranger to disclose information or requesting the originator to submit a written
confirmation, etc.
(3) Timing and Method of Confirming the Status of Credit Risks Held by the Originator
As a rule, whether the 5 % risk retention requirements are satisfied needs to be judged on acontinuing basis, not only at the time of acquisition of securitization products but also eachtime of measurement of risk assets by establishing a system for due diligence 14.
Also, whether the 5 % risk retention requirements are satisfied can be confirmed byobtaining a written confirmation from the originator. In addition, if it is difficult to confirm
in writing, it would be permissible to confirm by any other reasonable means such as an oral
confirmation from the parties related to the originator, etc. instead of a written
confirmation 15.
(4) Exceptions of the 5 % Risk Retention Requirements
The Affected Financial Institutions do not have to apply higher risk weighting to asecuritization exposure in cases where it is judged that the original assets have not been
inappropriately formed based on various factors such as the status of the originator’s
involvement in the formation of the original assets, the quality of the original assets or any
other circumstances. What cases fall under the exceptions will be discussed in section 5 inthis newsletter.

13

Q&A, <Standards for judging the status of credit risks held by the originator>, Article 248-Q3
Q&A, <Timing and method of confirming the status of credit risks held by the originator >, Article 248-Q5
15
Q&A, <Timing and method of confirming the status of credit risks held by the originator >, Article 248-Q5,
and No. 26 of the FSA’s response to the public comments.
(https://www.fsa.go.jp/news/30/ginkou/20190315-1/02.pdf)
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ATSUMI & SAKAITOKYO | LONDON | FRANKFURT
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March 2019
No. A&S (EN)_005(5) Effective Date
The new risk retention rules will be effective on March 31, 2019 (“Effective Date”)16.
However, with respect to securitization products held by the Affected Financial Institutions
on the Effective Date, the rules are not applicable to such Affected Financial Institutions
which continuously hold such securitization products 17.
It should be noted that the new rules do apply to existing securitization products on the
Effective Date, meaning that the rules apply to securitization products which the Affected
Financial Institutions purchase after the Effective Date, even though such securitization
products are formed prior to the Effective Date.
4.

How to Deal with CLOs
While Japanese financial institutions invested significantly in U.S. CLOs most of which are
AAA Open Market CLOs, in early January overseas media alerted that the U.S. CLO market
may be at risk from the Japanese rule change as it could make it more difficult for suchinvestors to continue said investment. The Loan Syndications and Trading Association (LSTA)
had been discussed with the FSA regarding the treatment of Open Market CLOs andsubmitted their comment letter 18 under the public consultation process to the effect thatinvestors in Open Market CLOs should be excluded from higher capital charges.
However, we have not been aware of such a risk as the media reported as far as we havebeen involved in U.S. Open Market CLOs. In response to the comments to the effect that
Article 248, paragraph 3 should be removed 19, the FSA considered the dialogue withinvestors, etc. that have been conducted so far and is trying to clarify by Q&A the cases
where it can be judged that "the original assets have not been inappropriately formed " sothat it would avoid unintended excessive consequences that could be caused by the
introduction of this rules 20. As a practical matter, as is often the case with Open Market
CLOs the focus of discussion is now on how to conduct due diligence in order to judge thatthe original assets have not been inappropriately formed pursuant to Q&A.

5.

Cases Where It is Judged that " the original assets have not been inappropriately formed "Q&A 21 cites the following cases as examples of cases where the original assets have notbeen inappropriately formed:

16

The FSA Notice regarding Capital Ratio Requirements, Supplementary Provisions, Article 1
FSA Notice regarding Capital Ratio Requirements, Supplementary Provisions, Article 418https://www.lsta.org/news-and-resources/news/japanese-risk-retention-the-lsta-weighs-in
19
For the comments of Japan Bankers Association,
https://www.zenginkyo.or.jp/fileadmin/res/abstract/opinion/opinion310125.pdf
For the comments of Securitization Forum of Japan,
http://www.sfj.gr.jp/opinion/data/public/190128.pdf
20
No. 49 and No. 50 of the FSA’s response to the public comments.
21
Q&A, < Cases where it is judged that " the original assets have not been inappropriately formed " >, Article
248-Q2
17

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March 2019
No. A&S (EN)_005(1) Examples of cases where it can be confirmed that the originator, etc. bears the credit
risks equivalent to or not less than those listed in Article 248, paragraph 3:
Even if it cannot be confirmed that the originator bears the credit risks in a manner thatsatisfies the conditions listed in Article 248, paragraph 3, the credit risks are borne by
any related party other than the originator such as the originator's parent company or
the so-called arranger deeply involved in the origination of the securitization product,and it can be confirmed that the total sum of such credit risks borne by these persons
and the originator is equal to or not less than the amount of credit risks listed in Article
248, paragraph 3;

Although the originator does not bear the risks by retaining securitization exposure, theoriginator has provided credit enhancement with respect to any subordinated portion,and it can be confirmed that such credit risks borne by these persons are equal to or
not less than the credit risks listed in Article 248, paragraph 3;

In a case where the receivables, etc. are randomly selected as the underlying assets
from the pool of assets containing a large number of claims, etc. (excluding
securitization products), it can be confirmed that the credit risks to be borne by theoriginator, etc. by continuously retaining all the receivables, etc. other than the original
assets that become the underlying assets contained in such pool of assets (or bycontinuously retaining the receivables, etc. randomly selected from the pool of assets
concurrently with the receivables that constitute the original assets), accounts for 5%
or more of the total exposure of such pool of assets; andIn a synthetic securitization transaction, it can be confirmed that the originator andinvestors share the losses incurred by the receivables that are the original assets andthat the originator bears the credit risks equivalent to or not less than those listed in
Article 248, paragraph 3.

(2) Example of cases where it is judged that the original assets have not been
inappropriately formed by performing in-depth analysis on the quality of the original
assets:

As with such securitization products of which the underlying assets are real estate(including trust beneficial interest in real estate) for which an appropriate appraisal
report or engineering report has been prepared, regardless of whether the originatorbears risks, it can be judged from objective documents, etc. that the original assets
have not been inappropriately formed;



Where the person who originates a securitization product does not originate the sameusing the assets held by it as the original assets but originates a securitization productby purchasing receivables from the market as the original assets, it can be judged fromobjective documents, etc. that the quality of such receivables procured from themarket is not inappropriate.

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Q&A elaborates methods of judging “the quality of the original assets” as follows:When making investment in a securitization product, it is particularly important toperform in-depth analysis on the quality of the original assets from the perspective ofcredit risks, etc. For this reason, as a method of judging the quality of the original
assets, it is considered insufficient to make a judgment only based on the externalrating of such securitization product and the transaction price of the original assets inthe market, or the short-term performance of the original assets (especially during aboom period).

In addition to the above, for example, if the original assets are loan receivables, then it
is required to confirm and verify from the perspective of whether the loan screening
criteria used by the originator are appropriate, whether the loan contract covenants
contribute to the protection of the rights of investors, whether the content and termsof the security for the loan receivables are appropriate, or whether there are any
problems with the ability of the originator or the servicer, etc. to collect receivables.

When making the foregoing confirmation and verification, it is necessary to actuallyconfirm and verify the loan receivables that are the original assets for the securitization
product. As a method thereof, if it is difficult for the financial institution itself to do so,
upon confirming whether the purpose and reasonable standards of acquisition andreplacement of the loan receivables by the securitization vehicle have been established(whether excessive discretion has not been given to the persons involved in theorigination of the securitization product with regard to selection of the original assets),
it is possible to confirm and verify in a timely manner that the receivables that will
become the original assets have been appropriately acquired and replaced inaccordance with said criteria (e.g., confirm and verity, as necessary, by conducting asample check of the original assets that have been actually acquired and replaced).

Other than the above, it is also considered desirable to conduct a risk analysis of the
securitization product as a whole by performing stress tests based on reasonable
scenarios and periods, etc.



Based on the results of the foregoing confirmation and verification, it is necessary thatit can be judged that the original assets have not been formed inappropriately in light of
the investment criteria provided by the financial institution.

(3) Example of cases where the requirements under Article 248, paragraph 3 cease to besatisfied due to changes in the situation after the acquisition of the securitization
product but it can be judged that the risks have been continuously retained:

The originator satisfies the conditions listed in Article 248, paragraph 3 at the time of
the acquisition of the securitization product and in spite of the fact that the originator
continues to hold such exposure, the total amount of exposure held by the originatorhas fallen below the requirements under Article 248, paragraph 3 due to a default of
the original assets.

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March 2019
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ExhibitExample 1

Example 2

Example 3

Most senior

Most senior

Most senior

Mezzanine

Mezzanine
Mezzanine

Most junior

Most junior

Most junior
*The
most
junior trancheby itself does
not reach 5% of
the total amountof exposure oftheoriginal
assets.

Example 4

Example 5-1

Example 5-2

Most senior

Most senior

Most senior

Mezzanine

Mezzanine 1

Mezzanine1

MostseniorMezzanine1

Most
juniorExample 6

Mezzanine 2
Mezzanine 2
Most junior
*The
most
juniorandmezzanine 2
tranchesbythemselves do
not reach 5%of the total
amountofexposureoftheoriginal
assets.

Most junior
*The
most
junior trancheby itself does
not reach 5%of the total
amountexposure oftheoriginal
assets.

8

Mezzanine 2
Most junior
*The
most
juniorandmezzanine 2
tranchesbythemselves do
not reach 5%of the total
amountofexposureoftheoriginal
assets.

ATSUMI & SAKAITOKYO | LONDON | FRANKFURT
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March 2019
No. A&S (EN)_005

For further information on these matters, please contact:
Yuri Suzuki
Attorney (Bengoshi), Japan
Partner, Atsumi & Sakai
E: yuri.suzuki@aplaw.jp

Fumiko Oikawa
Attorney (Bengoshi), Japan
Partner, Atsumi & Sakai
E: fumiko.oikawa@aplaw.jp

This memorandum was prepared by Japanese lawyers (Bengoshi) at Atsumi & Sakai and isprovided as a general guide only; it does not constitute, and should not be relied on as
constituting legal advice. Please see notice 2. below regarding any subsequent Japanese law
advice.

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March 2019
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Atsumi & Sakai
www.aplaw.jp/en/
Tokyo Office: Fukoku Seimei Bldg., 2-2-2 Uchisaiwaicho, Chiyoda-ku, Tokyo 100-0011, Japan
London Office: 4th Floor, 50 Mark Lane, London EC3R 7QR, United Kingdom
Frankfurt Office: Taunusanlage 21 60325 Frankfurt am Main Germany

NOTICES
1. ABOUT ATSUMI & SAKAIThe Firm's name is Atsumi Sakai Horitsu Jimusho Gaikokuho Kyodo Jigyo. We are organized as an integrated combination ofcertain foreign law joint enterprises as defined in the Act on Special Measures Concerning the Handling of Legal Services byForeign Lawyers. The members of our foreign law joint enterprises comprise a legal professional corporation by the nameof Atsumi Sakai Horitsu Jimusho Bengoshi Hojin, certain Registered Foreign Lawyers, lawyers of a Japanese Civil Codepartnership (represented by Yutaka Sakai, Attorney-at-Law), and Mr. Markus Janssen, qualified in the Federal Republic of
Germany and registered in Japan as a foreign lawyer for advising on the law of the Federal Republic of Germany, who heads
Janssen Foreign Law Office. In addition to lawyers admitted in Japan, our Firm includes Japanese lawyers and Registered
Foreign Lawyers qualified to advise on the laws of the US States of New York and California, England & Wales, the laws of
the Federal Republic of Germany, the People’s Republic of China, India, the States of Queensland and Victoria, Australia.
Registered Foreign Lawyers who are qualified to advise on State laws are also qualified to advise on Federal laws of theirrespective countries (each such law “Foreign Law”).
2. LEGAL ADVICE
Unless stated otherwise in any correspondence or document from A&S (together, “Documents”), any opinions or advice
given in any Document by A&S on any law is given under the supervision and authority of (i) in respect of Japanese law or
any law other than a Foreign Law, a specified lawyer at A&S who is a Bengoshi, or (ii) in respect of any Foreign Law, aspecified Japanese lawyer licensed in the relevant jurisdiction to advise on that law or a specified Registered Foreign Lawyer
at A&S permitted to advise on such law in Japan.

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