Japanese funds model under threat

Asset managers are braced for a rise in the number of regulatory inspections and tighter rules around fund sales and insider trading in Japan.
Japanese funds model under threat

Fund houses in Japan are readying for a rise in the number of regulatory inspections and a tightening of laws, as a result of both the AIJ pensions scandal that broke in February and a crackdown on insider trading.

“The Japanese regulators will be seeking to tighten manager access to pension fund monies,” says Chris Wells, financial services partner in law firm White & Case’s Tokyo office.

“One shake-out from AIJ is that inspections of money managed offshore will focus increasingly on managers nominally trading from Hong Kong or Singapore but in fact directed through an advisory presence in Japan."

It is an open secret that many funds have a skeleton staff in Hong Kong or Singapore executing orders that are provided from Tokyo, note consultants. The aim is to avoid having to obtain a licence to manage assets in Japan.

“This is a very popular model, but it may not survive in its current form,” says Wells. “It appears to be under examination by regulators, and anyone taking a conservative compliance view will likely avoid this approach in favour of a structure where more management takes place in Japan.”

AIJ Investment Advisors is a Tokyo-based advisory firm under investigation for falsifying performance records on some ¥200 billion ($2.4 billion) in pension money. In June, AIJ president Kazuhiko Asakawa and three other employees were arrested by police for the illegal sale of pension funds, knowing their actual values had been hidden.

Before July, the hot issue in the press was the AIJ affair, notes Wells, but since then the focus has been on which will be “the next shoe to drop” in terms of insider-trading enforcement.

Tsotumo Okubo, a Diet member and chair of the Financial Affairs Committee of the Democratic Party of Japan, has been pushing for stricter rules. He has circulated a list of some 20 secondary public offering transactions over the past 24 months that his Committee suspects may have involved insider trading.

“Fund managers should be reviewing any trades that have been named to check whether they’ve done anything that may look anomalous or whether their staff may have had any questionable conversations,” says Wells.

Conversations that appeared relatively innocent at the time could appear suspect to a regulatory inspector not familiar with trader “market chat”, he adds.

Fund managers and other financial firms are concerned about this and are seeking advice on how to proceed, note consultants and law firms.

The investigation is unlikely to look back much beyond the Financial Instruments and Exchange Law, which came into force in October 2007, says Wells, “but you never know”.

Japan's insider-trading laws are likely to tighten up from next year, agrees Philippa Allen, Hong Kong-based CEO of consultancy ComplianceAsia. And she expects to see more actions being brought as a result of any changes.

“It’s been a very cosy club in Japan,” notes Allen, “but people may have forgotten that the Financial Services Agency can be quite an aggressive regulator.”

There may well be changes in the rules that will bring Japan closer to developments in other markets, agrees the chief operating officer of a Hong Kong-based hedge fund. He notes that thus far fines have been lighter than recent penalties administered in, say, the US.

“Insider-trading fines in Japan have until recently really often been limited to disgorgement of profits – not imprisonment à la Galleon [Management],” he says, referring to the case that saw Raj Rajaratnam sentenced to 11 years in a US prison in October 2011.

“That kind of disconnect will change," adds the COO, "and it is likely that you will see movement in Tokyo towards the harsher end of the spectrum.”

See also the Alternative Investment Services Special Report, which comes with the October 2012 issue of AsianInvestor magazine, for a feature on asset managers' regulatory concerns across Asian jurisdictions.

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