Japan FSA: Towards function-based regulation
In a document published on September 27, 2018, the Study Group on the Financial System under the Financial System Council of the financial regulator, the Financial Services Agency (FSA), laid out the rationale for moving towards a function-based, cross-sectoral financial regulation.
Background
The necessity to consider this shift is based on
- The history of socio-economic conditions and financial regulation in Japan
- Changes in the circumstances surrounding the financial system
- The landscape of financial services a decade from now; and
- Features of current financial regulations
The strict postwar entity-based, sector-specific regulatory framework began to be relaxed in 1992 to allow entities (i.e., banking, securities and insurance sectors) to engage in services of other sectors through their group companies. A cross-sectoral, flexible regulatory framework was put in place for investment-type financial products with the Financial Instruments and Exchange Act in 2006.
The development of information technology has encouraged the unbundling and rebundling of services.
The adoption of cutting-edge technologies would bring about efficiency in fields such as payment and settlement, and changes in the structure of financial networks, thus leading to drastic change in the financial system, across financial services and in regards to financial institutions.
Currently, most financial regulations have been based on the type of the entity. If the sectors of the entities in question are different, applicable rules will be different even if the functions and risks associated with their activities are similar.
In light of the advancement of unbundling and rebundling driven by the development of information technology and endeavors to enhance user convenience, it is critical to incorporate function-based, cross-sectoral elements further into the regulatory framework and to apply the same rules to activities with the same funcitons and risks.
To promote innovation and enhance user convenience, players choose their business models and services in a flexible manner, with applicable rules being determined in accordance with their functions and risks. This also ensures protection for users and a level playing field, as players are not allowed to enjoy regulatory arbitrage.
In exploring the function-based, cross-sectoral financial regulations, it is necessary to consider the fact that the boundaries between financial services and non-financial services are being blurred.
Benefits
The regulation of each functions should be applied so that the following is ensured. Even when the benefits attained in each function are the same, the required level of attainment for each benefit will be different; a tailored approach for each function is required.
- Reliable provision of each function
- Provision of information to users
- Protection of user assets
- Protection of user information
- Anti-money laundering and combating the financing of terrorism
- Prevention of the realization of systemic risk
Entity-based regulation
Amid blurring boundaries between financial services and non-financial services, banks and banking groups are subject to strict entity-based regulations, i.e. regulations on scope of permissible business, prudential regulations, safety nets, etc.
- There is room to consider the focus placed on regulations on scope of permissible business of banks and banking groups
- Regulations on scope of permissible business should be reviewed so that groups with the top tier company being bank holding companies, banks and other business companies can compete on an equal footing basis, with attention to the differences in the effectiveness of avoiding risks in other businesses to the basic lines of business of banks
- Considering possible changes in the scope of business that conventional banking groups are expected to engage in, broad-ranging studies will be necessary to to update prudential regulations which accommodate risks of new types of business
- It will be necessary to consider whether objectives and coverage of safety nets may change, and effective methods will need to be considered accordingly
Products & services
Harmonization of rules for the process of providing products/services such as intermediary and agency services will be important so as not to hinder the cross-sector, cross-functional provision of products/services which meet user needs.
Considering possible changes in the structure of financial networks, it will be important to consider appropriate rules of platform providers, rather than regulating platform users, for effective implementation.
Future considerations
It will be necessary to devise a workable regulatory framework which encompasses ways to recognize and measure differences in the nature and risks of each service in each function and which adjusts rules accordingly.
Consistency should be considered within the mission of the financial regulator.
Attention should be paid to the creation of an environment in which players can properly utilize a wide range of information as well as proper protection of user information.
In deepening the discussions on the aforementioned issues, the following topics should also be considered:
- Ways to deal with global activities, achieving international harmonization and avoiding global regulatory arbitrage
- The right combination of laws and self-regulation
- Consistency with discussions from a private law perspective
- Adoption of cross-sectoral common fundamental concepts and rules in the financial field
A cross-sectoral authorization process in which requirements are adjusted in accordance with differences in the nature and risks of each function/service could be an issue to consider.
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