The first meeting of the Financial System Council’s “Working Group on Fund Settlement Systems”

The first meeting of the Financial System Council’s “Working Group on Fund Settlement Systems” will be held on Wednesday, September 25, 2024. As is customary, the secretariat has provided explanatory materials which outline the background, discussion points, and reference materials for the working group. It addresses the evolving landscape of payment and credit services in Japan, highlighting the emergence of new financial services, expanding user bases, and the need for regulatory adjustments to ensure a sound financial system.

I. Background and Matters for Consultation

The document begins by acknowledging the significant advancements in payment and credit services, particularly in the realm of cashless payments. Driven by technological innovation and increased participation from tech companies, certain payment services have become crucial components of daily life in Japan. This section emphasizes the importance of adapting financial regulations to accommodate these changes and foster continued growth within the sector.

II. Current Situation and Challenges in Payment, Settlement, and Credit Services

This section delves into the specifics of four key areas: Fund Transfers, Cryptocurrency Exchanges, Stablecoins, and Syndicate Loan Participation by Foreign Financial Institutions.

1. Fund Transfer Business

Cashless Payment Trends: The increasing popularity of cashless payments is highlighted, with the total transaction value reaching trillions of yen. This trend underscores the growing reliance on these services and the need for robust regulatory frameworks.

Current Regulations (Asset Protection): The document explains the existing regulations under the Payment Services Act, which mandate fund transfer businesses to safeguard customer funds through methods such as deposit, bank guarantee, or trust. In the event of bankruptcy, these protected funds are returned to users through a government-managed process. However, this process can take a minimum of 170 days, prompting discussions on faster alternatives.

Challenges and Considerations

Expediting User Fund Refunds: The existing 170-day refund process is deemed lengthy, necessitating the exploration of more efficient procedures. One suggestion is to allow direct refunds from banks or trust companies to users, bypassing the current government-managed process.

Cross-Border Fund Transfer Services: The emergence of new cross-border fund transfer services, operating outside the traditional fund transfer business framework, is acknowledged. These services, often categorized as “payment aggregators,” pose unique challenges:

• Regulatory Arbitrage: Some of these services operate without registering as fund transfer businesses, potentially creating an uneven playing field and raising concerns about consumer protection.
• Risks Associated with Cross-Border Transactions: Cross-border transactions inherently carry greater risks compared to domestic ones. These risks include potential delays due to reliance on foreign payment systems and difficulties in ensuring user protection across different jurisdictions.
• Need for Regulatory Clarity: The report calls for discussions on whether to extend existing regulations on fund transfer services to these new cross-border services, considering the balance between promoting innovation and ensuring financial stability and consumer protection.

2. Cryptocurrency Exchange Business:

Current Market Situation: The document provides an overview of the cryptocurrency market in Japan:

• Market Size and Growth: It highlights the significant growth in the domestic cryptocurrency market, with the trading volume reaching trillions of yen. This growth is accompanied by a continuous increase in the number of user accounts and registered cryptocurrency exchange businesses.
• Volatility and Notable Events: It acknowledges the inherent price volatility in the cryptocurrency market, referencing the fluctuation of Bitcoin’s price. The document also touches upon the impact of the FTX Trading Limited collapse, a major global cryptocurrency exchange, on its Japanese subsidiary, FTX Japan.

Challenges and Considerations

Protecting Domestic Assets in Bankruptcy: The FTX Japan case revealed a regulatory gap in the Payment Services Act. While the Financial Instruments and Exchange Act allows authorities to issue a domestic asset preservation order to protect customer assets in case of a brokerage firm’s failure, the Payment Services Act lacks this provision for cryptocurrency exchange businesses. This gap poses a risk of customer asset outflow, particularly for businesses dealing only in spot trading of cryptocurrencies. Therefore, the report urges discussions on regulatory measures to safeguard domestic user assets in case of bankruptcy of a cryptocurrency exchange business, especially considering the increasing number of firms engaged solely in spot trading.

3. Stablecoins

Global Landscape and Significance: The report recognizes the rapid global expansion of stablecoins, now representing a significant portion of the overall cryptocurrency market. It highlights the dominance of major stablecoins like Tether and USD Coin.

Regulatory Approaches in Other Countries: The document presents an overview of regulatory approaches towards stablecoin reserve assets in other jurisdictions:

• United States (New York State): Allows for the investment of stablecoin reserve assets in safe assets like short-term U.S. Treasury bonds.
• Europe: Requires a minimum of 30% of the reserve assets to be held as deposits with credit institutions, with the remainder allowed to be invested in highly liquid financial instruments.
• United Kingdom: Permits the use of short-term cash deposits and government bonds maturing within one year as reserve assets.
• Singapore: Allows for the use of cash, cash equivalents, or bonds maturing within three months as reserve assets, provided they are issued by specific government entities.

Challenges and Considerations

Management and Operation of Reserve Assets: Currently, Japanese regulations mandate the management of reserve assets for stablecoins issued as specific trust beneficiary rights entirely in the form of yen-denominated demand deposits. The document suggests exploring more flexible approaches to managing and utilizing these reserve assets, considering the practices adopted in other countries, while ensuring price stability, liquidity, and redemption certainty.

4. Foreign Financial Institution Participation in Syndicate Loans:

Background and Importance: The report highlights the significance of foreign currency-denominated syndicate loans as a viable financing option for Japanese companies expanding overseas. It acknowledges the existing regulatory limitations hindering the participation of foreign financial institutions in these loans.

Regulatory Constraints and Their Impact:

• Licensing Requirements: Currently, foreign financial institutions seeking to engage in banking business in Japan, including participation in syndicate loans, must obtain a banking license and establish a branch in the country.
• Money Lending Business Registration: Foreign financial institutions without a banking license can participate in syndicate loans by registering as money lending businesses. However, this requires establishing a physical presence in Japan, which is often impractical for entities with no other business activities in the country.
• Challenges and Considerations: The document recognizes the burden placed on foreign financial institutions by the requirement to establish a presence in Japan solely for participating in syndicate loans. It suggests revisiting the existing regulations to explore options for reducing this burden without compromising financial stability and consumer protection.

5. Points for Discussion

This section summarizes the key discussion points:

• Expediting the User Fund Refund Process for Fund Transfer Businesses: Discuss alternative methods to accelerate the refund process for users of bankrupt fund transfer businesses, potentially involving direct refunds from banks or trust companies.
• Regulatory Approach to Cross-Border Fund Transfer Services: Discuss whether to regulate cross-border fund transfer services under the existing framework for fund transfer businesses, considering the balance between innovation and consumer protection.
• Protection of Domestic User Assets in Cryptocurrency Exchange Bankruptcies: Discuss regulatory mechanisms to ensure the protection of domestic user assets in the event of a cryptocurrency exchange business bankruptcy, particularly for firms engaged solely in spot trading.
• Management and Operation of Stablecoin Reserve Assets: Discuss the potential for allowing more flexible management and utilization of reserve assets for stablecoins issued as specific trust beneficiary rights, drawing from practices in other jurisdictions while ensuring stability and user protection.
• Regulatory Framework for Substitute Services: Discuss the appropriate regulatory treatment of “substitute services,” which involve a third-party making a payment on a user’s behalf and later seeking reimbursement. This should consider the similarities and differences between these services and traditional lending and fund transfer services.
• Foreign Financial Institution Participation in Syndicate Loans: Discuss potential revisions to existing regulations to facilitate the participation of foreign financial institutions in foreign currency-denominated syndicate loans, considering the needs of Japanese companies expanding overseas while maintaining financial stability and consumer protection.

Overall, this document highlights the Japanese government’s proactive approach towards adapting financial regulations in the face of rapid technological advancement and evolving user needs in the digital age. It underscores the government’s commitment to fostering innovation and growth within the financial services sector while prioritizing consumer protection and maintaining the stability of the financial system.

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