By Stanley Howard, Teneo Partners – Effective capital raising is generally a key, if not the primary objective of global fund managers when considering whether to establish a presence in Japan. Despite the Covid-19 induced acceleration of conducting business within virtual meeting environments, the positive impact of having a physical presence in Japan should not be minimised.
More than in other countries and regions, the importance of personal communication and relationship building in the Japanese culture is vital to sustained success. But how asset managers manage to achieve that objective in a cost-efficient way is a critical issue.
There are two principal approaches to raising capital in Japan. The first is the securities distribution approach whereby funds are placed directly with investors by distributors. The second is the asset management approach whereby a manager offers funds based on a contractual investment management mandate with an investor. The approach that an asset manager takes in respect to capital raising will depend on their strategy, which will in turn determine the licenses that are required, and the structure used for the business.
Securities distribution in Japan can only be conducted by an entity that is registered with the Financial Services Agency (“FSA”) as a Financial Instruments Business Operator (“FIBO”), comparable to a fully licensed broker-dealer in the US. If marketing shares of a corporate type fund or units of a trust type fund, the FIBO will need what is referred to as a Type-1 license. If on the other hand, the FIBO is placing partnership interests, it will need a Type-2 license. In either case, an asset manager that decides to rely on the securities distribution approach will need to decide whether to incorporate a company in Japan and apply for their own FIBO license or to work with an established FIBO as their outsourced placement agent. This can be a difficult choice since the first option that offers complete control of the branding and marketing process is both expensive and time consuming. The other more economical option leads to the delegation of the sales and marketing strategy to a third party that may not execute in a manner that is satisfactory to the asset manager.
The asset management approach also comes down to a choice of incorporating locally and subsequently applying for a Discretionary Fund Management (“DIM”) license or working through an established local entity already holding a DIM license. The fundamental difference between the two approaches is that in the case of the asset management approach, the manager cannot sell funds. Rather, placements are made by executing a discretionary mandate agreement with each separate investor. Establishing its own company with the requisite fund management license enables an asset manager to enter into those direct agreements with allocators such as pension funds. But the set-up and approval process is slow and the regulatory requirements high. Working as a sub-contractor to an existing domestic DIM is a faster and less expensive alternative but the downside is that the asset manager will have a difficult time in developing any meaningful relationships with the pension funds. Before asset managers despair the difficulty in acquiring a foothold in Japan, they should be encouraged by the effort that the FSA and the Government of Tokyo have undertaken to make the licensing effort of the asset management approach a bit easier. This is a relative statement however because although the DIM application process may now be easier, the requirements for qualifying and the subsequent oversight by the regulator are not. Asset managers should be further encouraged by the advancement and sophistication of the overall infrastructure and ecosystem of the industry. Firms such as Gordian Capital have come into the Japanese market to provide the kind of fund management platform services to global asset managers that has been so successfully employed in Singapore. Because of that development and the solutions that the new entrants have provided, the decision to build or outsource is no longer a binary one.
As a capital raising strategy, the asset management approach is used primarily for targeting pension funds. But before taking that step, an offshore manager should bear in mind that the pension fund market in Japan is a particularly insular and highly competitive one, so breaking into it is exceedingly difficult. Success by offshore managers has generally been limited to only those asset management subsidiaries of the largest global investment banks. Consequently, if the principal goal for maintaining a presence in Japan is to capital raise across a broad base of investors, then we suggest the securities distribution as the best approach.
The securities distribution approach can be applied not only to pension funds and corporate investors but to all types of financial institutions. There is no safe harbour for asset managers to self-market any funds the fall under the Paragraph 1 securities definition of the Financial Instruments and Exchange Act. For the purposes of funds, this would be any structure that issues shares or units. Consequently, any sales activity for those types of funds can only be conducted by a so-called Type-1 FIBO. This drives the requirement for an asset manager to either incorporate an entity in Japan and obtain its own license or to work through a local distributor. We should also note that prior to marketing these types of Paragraph 1 securities, the fund must submit a private placement notification with the appropriate local finance bureau of the FSA. A GP of a fund that issues partnership interests may self-market under the Article 63 exemption as those interests fall under the Paragraph 2 securities definition. We are finding however that increasingly more GPs are opting out of the self-marketing safe harbour to avoid the annual filing that is required under Article 63. In those cases, they are required to use a Type-2 licensed FIBO for the marketing and distribution of their fund. Fortunately for GPs, there is no requirement for a private placement notification with the FSA for their Paragraph 2 securities.
The positive news for asset managers is that there are placement agents such as Teneo Partners that provide creative sponsorship solutions which break the dichotomy between maintaining control of the marketing process and outsourcing all to a licensed third party.
Founder & CEO, Teneo Partners
Stanley Howard is founder and CEO of Teneo Partners Japan Limited. Employed by the Japanese trading company ItoChu after graduating from the University of Michigan, he later completed his MBA studies at Northwestern University. After graduate school, he held various positions with Smith Barney Harris Upham, Morgan Stanley, and Investor Select Advisors prior to founding Teneo Partners. Stan was born and raised in rural Japan, giving him a level of understanding of the culture that few foreigners have.