THIS MEMORANDUM IS FOR GENERAL INFORMATION purposes only. It does notconstitute legal advice; thus, it may not be relied upon regarding a specific legal issue orproblem
Re:

New Crypto Regulations of Japan

Author: So Saito, Tomoaki Katayama of So & Sato Law Offices
Date:

March 16, 2019Japan's Financial Services Agency (the “FSA”) imminently contemplates

reforming the crypto regulations to address the problems that arose after Phase 1 of thevirtual currency legislation, effected in April 2017. The FSA published a draft bill forthe amendment of the virtual currency regulation on March 15, 2019. Stated below isour current understanding of the amendment. Please note that as the national diets
will discuss the draft from now and the FSA will draft subordinated provisions of thelaws from now, there is still some uncertainty on the amendment, and our analysis isexpressly subject to changes in the future.
I

Background Information about Japanese Crypto Regulation

1

Existing crypto legislation and regulations
The Payment Services Act (the “PSA”) and the Act on Prevention of Transfer of

Criminal Proceeds (the “AML Act”), as amended together in April 2017, are the base of
the Phase 1 virtual currency legislation, as supplemented by the related ordinances,orders, and guidelines (most notably the Guidelines for Administrative processes
concerning virtual currency exchange service providers (FSA Guidelines)).
2

The Payment Service Act
The PSA (so amended in 2017) is an act which currently regulates a virtualcurrency exchange.

The PSA stipulates "Virtual Currency," "Virtual Currency

Exchange Service," and "Virtual Currency Exchange Service Provider" therein.

Itrequires registration of Virtual Currency Exchange Service Providers, and the FSAregulates and supervises them.
The PSA will be amended and involve more detailed regulation on crypto
exchanges and new regulation on crypto custody business.
3The Financial Instruments Exchange Acts (The “FIEA”)
The

FIEA

regulates

financial

instruments,

which

typically

includesecurities/derivatives, financial instruments, exchange business and operators thereof.
Currently, virtual currency does not fall under securities, in principle. Some
STO tokens fall under collective investment schemes (funds) that are securities (see item1

THIS MEMORANDUM IS FOR GENERAL INFORMATION purposes only. It does notconstitute legal advice; thus, it may not be relied upon regarding a specific legal issue orproblem
7 below).
Margin trading of virtual currencies (NDF, leveraged trades, physically settled
trades by loans in virtual currency) are currently non-regulated through FIEA.
4The AML Act
The Act on Prevention of Transfer of Criminal Proceeds (so amended in 2017)

has subjected VC exchanges to the AML/CTF regulations and imposed such duties ascustomer identity verification at the time of the transaction, etc.
5Self-Regulatory Organization
In April 2018, sixteen (16) registered VC exchanges joined to establish a self-

regulatory organization, the Japan Virtual Currency Exchange Association (the“JVCEA”). In October 2018, the JVCEA got certified by FSA as a Certified Association
for Payment Service Providers under PSA.
JVCEA established the self-regulation rules in furtherance of the existing
regulations that are based on, amongst others, PSA, AML Law and FSA Guidelines witha view to better protect users. Examples of self-regulation are as follows.
・Handling of virtual currency・User property management

・Management of system-risk and information security

・Contingency

・

AML/CFT・

Complaint processing and dispute processing

・

Solicitation and advertisement

・

User management

・

Order management system

・Prevention of illicit transactions

・Management system of virtual currency-related information

・

Financial management

6The status and prospect of pending Registration of Exchanges
Currently, to earn a VC exchange license is perceived to be staggeringly

burdensome for leanly staffed startups.

The screening standard now imposes aheightened level of internal control and security, so that no applicant may escape hiring
compliance officers, AML officers and internal auditors who are versed with the industry
and drafting of internal rules that are extensive and voluminous.
2

THIS MEMORANDUM IS FOR GENERAL INFORMATION purposes only. It does notconstitute legal advice; thus, it may not be relied upon regarding a specific legal issue orproblem
It is said that 190 companies have approached the FSA to take an exchangelicense, but no new exchanges were eventually approved through 2018.

In January

2019, Coincheck Inc. finally got registered, and it is rumored several others will get thelicense in 2019.
7

Current ICO /STO (Security Token Offering) regulation
Currently, the ICO is subject to the regulation of the PSA. For certain STOs,

the regulation of the PSA and the regulations of the FIEA are superimposed.
In December 2017, the FSA interpreted that ICO tokens may broadly be listed
as corresponding to "virtual currency.

" As a result, registering a "virtual currency

exchange business" and "notification of coin" has become required for the sale of ICOs inJapan. It is difficult to comply with these regulations, and no lawful ICOs have comeout in Japan since December 2017.
An STO is deemed to be a kind of ICO, and the same regulation applies. Inaddition to the PSA regulation, FIEA regulations are applied to tokens that are paid incash and pay dividends or principal redemption of 100% or more as collective investment
schemes.
II

Proposed Amendments to the Law

1General Information

1.1

Which laws will be amended?
The PSA and FIEA will be amended.

1.2

Why crypto regulations are being reformed
Japan had massive cryptocurrency hacking incidents against two major

Japanese crypto exchanges in 2018—Coincheck in January and Zaif in September.
After the Coincheck hack, the FSA tightened its oversight of crypto exchanges,
including imposing stricter registration requirements and on-site inspections.

Ithanded out many business improvement orders and suspended a few exchanges.
In light of highly volatile cryptocurrency prices and explosive trading volumes
in 2017, a surge of ICOs in 2017, and hacking incidents in 2018, FSA created a Study
Group on Virtual Currency Exchange Services in March 2018 to discuss appropriate
crypto regulations. After eleven (11) sessions of discussion, the group published a final
report last December.

The FSA drafted bills based on this report and the nationalgovernment submitted the draft to the national diets in March 15, 2019.
3

THIS MEMORANDUM IS FOR GENERAL INFORMATION purposes only. It does notconstitute legal advice; thus, it may not be relied upon regarding a specific legal issue or
problem

1.3

When will the amendments be enacted?
The timeline still remains uncertain. Quite a few people seem empirically toinfer the schedule as follows.
(1)The national government submitted the amended bill to the national diets in
March 15, 2019, and the national diets will discuss them.

(2)

The national diets will approve the bill around this May.

(3)

The FSA will draft government ordinances and guidelines which aresubordinated rules of the amended law around the end of 2019. They will beon public comment procedure and be finalized around March 2020.

(4)

The amended law will be valid within one year after the enactment of the acts
(i.e.around April or May 2020).

(5)Some of the new regulations, such as regulation on custody and derivative,might have a six (6)-month transition period after the enactment.

1.4

Way of Calling of Virtual Currency will be changed to Crypto Asset
The way of calling of Virtual Currency will be altered to Crypto Asset with thePSA amendment.

In this memorandum, we will call virtual currency crypto assets

hereafter.
2

Exchange Business

2.1

Additional Duty Imposed on Exchanges
Exchanges will have the following requirements in addition to the current

requirements:
・to establish and publish policy on incidents of virtual currency thefts

・to hold virtual currencies that are not less than the value of the customer’s virtual
currencies in hot wallets (if any) as the exchange’s own assets

・to trust customers fiat into a trust company

・

to disclose financial statements publicly

・

to publish, when conducted, OTC deals with customers as well as bid prices, ask
prices, and bid-ask spreads for such OTC deals, etc.

・to refrain from making excessive advertisements, misrepresentations, conclusiveassessments, cold calls, inadequate solicitations in light of the customer’s
knowledge, etc. or advertisements and solicitations to induce speculative trading

4

THIS MEMORANDUM IS FOR GENERAL INFORMATION purposes only. It does notconstitute legal advice; thus, it may not be relied upon regarding a specific legal issue orproblem
・

to replace the current ex-post notification requirement of any change in tradable
virtual currencies with a prior notification requirement thereof in order to exclude
problematic virtual currencies
We believe that one of the most onerous burdens is the second one.

The

definitions of “hot wallet” and “cold wallet” are not stipulated in the law, and we believethat SRO will discuss it.
If an exchange holds 5% of users’ BTC in a hot wallet, such exchange needs tohave the same amount of BTC as its own asset. As there is little hedge market, anexchange should owe a volatility risk of crypto. An exchange shall consider how muchit holds in a hot wallet and how to manage the volatility risk of its own crypto in orderto do a healthy business.
2.2

Preferential Right of Customer
The amended PSA stipulates a new right of customers. Customers will havethe right to receive a preferential return of crypt assets they deposited with an exchange
and the exchange segregated upon its insolvency.
2.3

Regulation on Unfair Trading
The amended FIEA will regulate unfair trading. The regulation applies not

only exchanges but every person, including customers.
Prohibition of unfair trading includes following but does not include prohibitionof insider trading:・

prohibition of unfair trading・

prohibition of fraudulent acts, spreading rumors, using fraudulent means orintimidation

・

prohibition of market manipulation

3

Custody Business

3.1

Currently, custody business is not regulated.
The current PSA regulates virtual currency exchange businesses and does notinclude businesses that just provide a custody service.

The definition of a virtual

currency exchange business is as follows, and does not include mere custody business.
(i)

Sale and purchase of VC (i.e., an exchange between VC and fiat currency) orexchange of a VC into another VC;(ii) An intermediary, brokerage, or agency service for the acts described above (i); and5

THIS MEMORANDUM IS FOR GENERAL INFORMATION purposes only. It does notconstitute legal advice; thus, it may not be relied upon regarding a specific legal issue orproblem(iii) Management (custody) of a fiat currency or VC on behalf of the users/recipientsin relation to the acts described above in (i) and (ii).
3.2

Custody businesses will be regulated
The amended PSA will regulate custody businesses. The definition of custodyis “to manage crypto assets for others except for the case such business is allowed inother laws). ” Custody businesses will not be able to do business to Japanese residents
without a license.
3.3What kind of custody businesses will be regulated?
As the definition of “custody business” is unclear, the types of custody businesses

that will be regulated are still uncertain.
Generally speaking, we believe that businesses that hold customers’ secret keys
and sends crypto for customers will be regulated. However, whether or not multi-sig
custody is regulated, a company that sets a node for the Lightning network and holds its
customers’ crypto is uncertain.
3.3

Will a software wallet service that does not hold customers’ secret keys beregulated?
We believe no.
3.4

Regulations a custody business operator should obey.
It is believed that the custody business operator should abide by similar

obligations to virtual currency exchange, such as those below.
・

the requirements of registration

・the establishment of an appropriate internal control system・the requirements ofsegregation of customers’ virtual currencies

・

external audit of customer audit, customer asset segregation, and financial
statements

・to establish and publish its policy on incidents of virtual currency thefts

・

to hold virtual currencies which are not less than the value of the customer’s
virtual currencies in hot wallets (if any) as its own assets

・

to give customers the right to receive a preferential return of the virtual
currencies they deposited with custody upon its insolvency [that takes precedence
over the right of general creditors]
6

THIS MEMORANDUM IS FOR GENERAL INFORMATION purposes only. It does notconstitute legal advice; thus, it may not be relied upon regarding a specific legal issue orproblem
・

not to handle virtual currencies recognized to be likely to hinder user protection
and/or appropriate and reliable performance of the virtual currency exchange
business・

the know-your-customer (KYC) requirements under the AML law

・suspicious activity reporting requirements under the AML law

4

Crypto Derivative

4.1

What is the current regulation on crypto derivatives?
As has been said in I.

derivatives right now.

3.

above, there is no regulation by law on crypto

The JVCEA, however, exerts control over crypto derivatives

through the provisions in its self-regulation rules.
4.2

Does FIEA regulate crypto derivative transactions? Will the FIEA regulate

crypto derivative transactions?
The FIEA regulates derivatives such as foreign exchange derivativetransactions(IR/FX-relatedderivatives),

equityderivatives

derivative transactions), and credit derivative transactions.

(securities-related
The regulations onderivatives only apply a stipulated derivative on FIEA, and the crypto derivative is not
stipulated in FIEA. We believe the amended FIEA will add a crypto derivative in theenumeration.
4.3

What kind of regulation will a crypto derivative dealer be required to obey?
Currently, a forex derivative dealer should register as a Type I Financial

Instruments Business Operator.

This means registration as a full-fledged security

company, and it is difficult to take the license.
4.4

What will be a maximum leverage ratio?
It is currently discussed that a maximum leverage ratio should be two (2) times.

4.5

Will there be any exemptions to a license?
Derivative dealers are currently exempted from taking a license if they only

trade with institutional investors such as banks, security companies, and corporations
that have more than JPY1 billion capital. We expect that a similar exemption applies
to a crypto derivative dealer.

7THIS MEMORANDUM IS FOR GENERAL INFORMATION purposes only. It does notconstitute legal advice; thus, it may not be relied upon regarding a specific legal issue orproblem
5Regulation of ICO and STO

5.1

The regulation of ICOs
As for the regulation of ICOs, no major changes are being made by thelegislative reform at this time.

To conduct/carry out ICOs, it is believed that theregistration of crypto assets exchanges plus the filing of the coins with the FSA will berequired. The registration requirement can be met by either the ICO issuer himself orby an ICO sales broker. The ICO coins that will be approved for sale in Japan are being
discussed by the FSA and JVCEA, and it is believed that the JVCEA will publish therules governing the self-regulation of ICOs in the near future.
5. 2

The regulation of STOs
FIEA now defines STOs independently of ICOs under this amendment. Since

an STO is clearly positioned as a Security, FIEA applies. A seller of an STO other thanthe issuer (such as an STO broker) must register as a Type I Financial Instrument
Operator.

If an issuer sells STOs directly, the issuer must register as a Type II

Financial Instrument Operator, which is less complicated. FIEA regulations such as
the duty to disclose information, the regulation of sales, and invitation will apply.
Currently, unlike ICOs, there are exemption provisions for the sale of securities,
such as Regulation D and Regulation S in the U. S. The sale of securities only toqualified institutional investors or selling securities to a small number of people are
exempt from some regulations. It seems that such exceptions will be applied to the saleof STOs, but the details of these exceptions will only be defined in future ordinances.
6

Other

6.1

ETF: I read an article that states that the Japanese government will allow

crypto ETF. Is it true?
We do not have any information that the Japanese government will allow crypto
ETF. The study group did not discuss crypto ETF, so we do not have any information.
EOD8