Over the next few columns, Japan Asset Management Platform Group (JAMP) will identify potential snags for financial instruments business operators (FIBOs). First up, the duty to notify authorities when net assets fall below capital.

Regulations require investment managers (IMs) in Japan to maintain a minimum of JPY 50 million in capital, while IMs for Qualified Investors (QIs) must keep at least JPY 10 million in their capital account.  These capital requirements are deemed “necessary and appropriate for the public interest and investor protection”.  Consequently, most IMs make sure to maintain capital reserves above the statutory minimums.  Should net assets fall below the specified threshold, a notification to the regulator is triggered.

For example, an IM for QIs with capital at JPY 20 million whose net assets fall below JPY 20 million must notify the Prime Minister immediately, via the local financial bureau through which it initially registered.

It is not uncommon for net assets to dip below capital amount during the early stages of a company’s development as everyone who has tried to establish an IM business can attest.  Business is not yet firmly established; initial expenditures for personnel, office rents, and other expenses, which can be substantial, must be paid throughout the licensing process until the local authority deems various requirements including the human resource and business planning requirements for registration have been met.  The IM must also register with the Investment Trusts Association, Japan and/or Japan Investment Advisers Association, depending on  what business the company will engage in.*  

* IMs may register as: 1) investment trust, 2) discretionary account, 3) fund manager through kumiai scheme (similar to a partnership), and 4) Real Estate Investment Trust (REIT).

A FIBO’s corporate manager should anticipate and plan for potential shortfalls requiring notification by taking a few steps.  Prepare a liberal estimate of upfront costs during startup and make certain they are reflected in the business plan presented at registration.  Take specific measures to prevent the capital and net assets from falling below the statutory requirements.  One way would be setting the capital amount at the minimum IM requirement (JPY 50 million for full line IMs and JPY 10 million for IMs for QIs) and setting aside the remaining amount (not to exceed 1/2 of equity capital) as a capital reserve, as capital reserves are permitted up to 1/2 of the paid-in amount at the time of capital payment.  Increase capital and profit reserves until the amount stipulated by laws and regulations at which dividends are to be paid.  Net assets can be maintained above capital by covering anticipated expenses with the reserve while maintaining capital at the required minimum, borrowing from company founders, or an early capital increase if necessary, although that is not always easy.  For more specific and detailed process, consult legal and/or accounting specialists before taking actions. 

Finally, in the unlikely event that net assets fall below the capital threshold, the authorities must be notified.  To prevent an omission of the notification, managers should establish internal controls, for example, by clearly stating the items to be checked periodically in the internal rules, creating a control chart, and regularly verifying the value of net assets.