The second meeting of the Financial Services Council’s “Fund Settlement System Working Group” was held on Thursday, October 17, 2024. As is customary, the secretariat provided explanatory materials on the working group’s background, issues, reference materials, etc. .
In addition, the meeting materials also include a detailed explanation of the custodian trust provided by Japan Securities Finance Trust Bank (JSF) and written opinions from external experts.
The Secretariat’s briefing provides an overview of the proposed amendments to Japan’s Payment Services Act, with a particular focus on two key aspects.
1.1 Asset protection regulations for remittance providers
Background: The law currently requires Japanese money transfer operators to protect all user funds received through escrow, bank guarantees, or trusts. In the case of bankruptcy, the government initiates the refund process through escrow, which takes approximately 170 days. The system prioritizes protecting users while minimizing social and economic impact, especially considering the prevalence of small-value transactions. Proposed amendment: In order to improve convenience for users and speed up refund procedures, the Financial Services Agency is proposing to allow direct refunds from trust companies and banks in addition to existing methods. However, this raises concerns about potential disadvantages compared to current systems and the need for safeguards such as escrow orders to protect users’ interests.
discussion points
The feasibility of allowing trust companies and banks to directly refund user funds while maintaining the escrow system and escrow orders. Addressing potential shortcomings of new refund methods compared to existing systems, particularly with regard to user protection. Specifying the applicability of direct refunds to prepaid payment instrument issuers Most financial products do not have user identification requirements and there are practical challenges in identifying beneficiaries.
1.2 Review of storage restrictions for first-class money transfer companies
Background: Type 1 businesses that handle high-value transfers operate under strict retention limits. Currently, funds cannot be accepted without a specific transfer order and funds cannot be held for longer than necessary for operational and technical requirements. This is intended to minimize the impact on users and society in the event of bankruptcy.
Existing challenges and needs: Current limitations create challenges such as:
Inter-company remittances: A separate deposit is required for each large-value remittance to a business partner, which is a heavy burden. Overseas remittances: The exchange rate requires a “remittance date” to be determined in advance, which hinders services that allow timely remittances. Uncertainty regarding processing times at correspondent banks further complicates the determination of advance remittance dates. Reverse foreign exchange/bill collection services: The nature of these services makes them impractical as the exact date of receipt from the payer and subsequent remittance to the payee cannot be determined. Simultaneous operation of Type 1 and Type 2 businesses: Under current regulations, funds received through Type 2 services (lower amounts) cannot be used for Type 1 remittances, and users are subject to the Type 2 limit. Transfers exceeding this amount will require separate payment.
Revision proposal
Extension of the permissible period for storing funds: In order to reduce the burden on users, the Financial Services Agency has proposed allowing a storage period of “about one month” for necessary investment purposes, taking into consideration general business practices. I am. This extension is limited to companies that have adopted new asset preservation methods (such as direct refunds) that enable faster refunds for users in the event of bankruptcy. Relaxing transfer order specificity requirements: Recognizing that the exact “funds transfer date” is not always earlier. The FSA proposes to allow some flexibility within the permissible retention period for determining the timing of funds transfers. Permission to transfer funds between type 1 and type 2 businesses: To streamline the operations of businesses that provide both types of services, the FSA will now cover type 1 and type 2 transfers. We propose to allow the transfer of funds received through our services. However, this will require strict measures to prevent evasion of high value transfer limits and ensure that Type 2 funds are not misused for high value transfers.
Issues regarding revisions to retention limits
The appropriateness of allowing a one-month retention period for Type 1 businesses that introduce new asset preservation methods. Possibility to allow the designation of a “funds transfer deadline” alongside or instead of a specific “funds transfer date” while ensuring legal compliance. Effectiveness of proposals. Measures to prevent the misuse of Type 2 funds for Type 1 transfers when allowing funds to be transferred between companies that provide both types of services.
The Japan Securities Finance Trust Bank (JSF) document focuses on procedures and practical considerations when the trust settlor (usually a financial services provider) faces bankruptcy, It provides a detailed overview. This document leverages JSF’s experience and highlights its track record in managing such situations and ensuring the return of customer assets.
2.1 What is a custodial trust?
A custodian trust is a type of trust mechanism commonly used in Japan to protect customer assets, especially in industries such as financial services and crowdfunding, where companies hold large amounts of customer funds. This is a system in which a financial service provider (trustor) entrusts a customer’s assets to a trust bank (trustee). Trust banks hold and manage these assets separately from their own assets, ensuring that they are protected even if the trustor runs into financial difficulties.
2.2 JSF’s experience with custodian trusts
JSF has extensive experience in managing custodial trusts and has handled a wide variety of trusts for a variety of clients including:
Financial products business operators: customer-separated money trusts, foreign exchange margin trusts, securities CFDs/overseas securities futures margin trusts, commodity CFDs/overseas commodity futures margin trusts, crypto asset exchange operators: crypto asset custody trusts, crypto asset derivative evidence Gold trust, fund transfer business Provider: Performance guaranteed money trust, Other businesses: Crowdfunding payment trust, Real estate specified joint venture investment trust
JSF has also been involved in a number of trust termination cases, primarily for the following reasons:
Exit: Exiting a business from a particular service or industry. This is often due to regulatory changes or market changes. Business Transfer: The transfer of business to another company, including a merger or acquisition. Voluntary liquidation: Closure of a business at the own option of the settlor. Regulatory Actions and Administrative Actions: Significant regulatory actions against the contractor, including revocation of operating license and significant administrative penalties.
Importantly, most trust terminations processed by JSF were not due to customer protection concerns, but were due to business decisions or regulatory actions.
2.3 Managing a Trustee’s Insolvency: Key Steps and Considerations
The JSF outlines a step-by-step process for dealing with situations where the settlor of a custodial trust faces insolvency.
Trigger events and information sharing
Certain events can trigger the process, such as a revocation of a business license, a bankruptcy filing, or a cease and desist order. The Trustee will immediately contact the beneficiary representatives and relevant authorities to gather information.
Evaluation of customer asset protection
The fiduciary will determine whether and to what extent there is a deficiency in customer assets. If protection of customer assets is deemed to be sufficient, the process could include a simpler transfer of assets based on an existing trust framework.
Transfer of authority and notification to customers
In the event of a potential asset shortfall, the trustee will work closely with the beneficiary representative (usually an attorney or similar professional appointed to represent the client’s interests). The trustee transfers the authority to manage the client’s assets to the beneficiary representative. Beneficiary Representatives work together to calculate individual customer claims in conjunction with the Trustee and notify customers of the situation and asset recovery process.
Distribution of customer assets
The beneficiary agent, with the support of the fiduciary, establishes a system for receiving and validating customer claims. After verification, the trustee will distribute the available assets to the customer according to the determined distribution rate.
2.4 Practical insights and lessons learned
JSF’s experience highlights several important aspects of managing the termination of a Safekeeper Trust.
Early preparation is key: Maintaining accurate and up-to-date customer data is essential for efficient asset allocation. Clear communication is key: Transparent and timely communication with customers throughout the process helps manage expectations and minimize anxiety. Collaboration is essential: Close collaboration between customers, trustees, beneficiary representatives, and relevant authorities ensures a smooth and effective process. Flexibility is key: Having clear contract terms is essential, but excessive rigidity can hinder your ability to adapt to unforeseen circumstances.
2.5 Dealing with practical challenges
JSF recognizes the particular challenges encountered during asset recovery.
Dormant Accounts: Identifying and verifying the rightful owner of a dormant account can take time. Data Accuracy: Inaccuracies in customer data provided by contractors can cause delays and complicate the verification process.
JSF highlights that its experience with the termination of the Safekeeper Trust, particularly in the context of funds transfer service providers, suggests that ‘dormant accounts’ are unlikely to be a major problem due to the nature of the business.
The third document from the meeting was a written opinion submitted by Keiko Ogawa, partner and certified public accountant at EY Strategy and Consulting, to the Financial Services Agency’s Working Group on Payment Services Act.
Important points:
Direct refunds by banks and trust companies: The letter raises concerns about the feasibility and cost of direct refunds from banks and trust companies to users. It emphasizes the need for a thorough analysis of additional costs and potential burdens on both financial institutions and customers. Review of fund storage regulations for Type 1 remittance providers:
– One month storage: The letter supports the proposal to allow funds to be stored for “approximately one month” if necessary for operational reasons, taking into account both user convenience and risk management. I’m doing it. To reduce the risks associated with long retention periods, it proposes setting limits based on factors such as the operator’s credit risk score.
・Funds transfer deadline: Considering the convenience of users and businesses, we agreed to establish a “funds transfer deadline” in addition to the “designated fund transfer date.” Type 1 Money Transfer Operators: The letter notes that allowing such transfers may violate existing law prohibiting Type 1 money transfer operators from holding funds. Emphasizes the need for measures to address potential risks to user asset protection, and clarifies the verification process for determining the use of retained funds exceeding the 1 million yen limit for Type 2 business. I’m looking for it.
Overall, the letter supports the proposed amendments and calls for a thorough consideration of the potential risks and burdens for both users and businesses, particularly regarding direct refunds and the handling of funds associated with various remittance operations. It emphasizes gender. Clear guidelines and practical solutions are needed to ensure smooth deployment and user protection.
