Proposed Legal and Regulatory Framework for Stablecoins

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On March 4, 2022, the Financial Services Agency of Japan (“FSA”) submitted a bill to amend the Payment Services Act (“PSA”) and other laws relating to electronic payments, to the Diet National of Japan. The provisions of this amendment bill include a new regulatory framework for stablecoins, aimed at responding to the significant growth in the issuance and distribution of stablecoins abroad, and associated issues such as the protection of users. If the bill passes the Diet, the new framework is expected to be introduced in 2023.

As part of this, stablecoins that are considered e-money (see section 1 below) will be regulated as monetary transfers and means of payment. Issuers will be limited to banks, remittance service providers and trust companies. In addition, a new “Electronic Payment Instrument Business” license (as defined in section 2. below) will be introduced for intermediaries who manage these stablecoins.

This article provides an overview of the proposed new legal and regulatory framework.

1. Electronic Payment Instrument

According to the FSA, stablecoins can be classified as follows:

(i) stablecoins that are issued at a price tied to the value of the fiat currency (e.g. 1 coin = 1 Japanese yen) allowing redemption of the issued price; and

(ii) stablecoins other than (i) above (for example, stablecoins that attempt to achieve price stability through algorithmic mechanisms).

The use of stablecoins described in item (i) above is intended to be similar to that of electronic money and the proposal is to regulate these stablecoins as “electronic payment instruments” (as defined in this section 1 below) as part of the PSA. The stablecoins described in point (ii) above are regulated as “crypto-assets” under the pre-existing PSA.

With respect to stablecoins regulated as electronic payment instruments (see (i) above), there are concerns about redemption rights in the context of issuer or intermediary bankruptcy . Therefore, it is proposed that the issuers of these stablecoins be limited to: (a) banks regulated under the banking law; (b) remittance service providers regulated by the PSA; and (c) trust companies governed by the Trust Business Act. It is currently understood that the respective bankruptcy protection regimes in cases (a) through (c) will be as follows:

a) The value of user assets (at the time of issue) is protected as deposit rights under the existing deposit insurance scheme.

(b) The value of the User’s Assets (at the time the Asset is issued) will be protected by deposit, bank guarantee or trust under the PSA.

(c) User’s assets will be kept away from bankruptcy as they are held in trust.

Under the proposed amendment to the PSL, “electronic payment instrument” means any of the following:

(i) the value of property (limited to assets denominated in foreign currencies which are recorded on an electronic device or any other object by electronic means, and, excluding transferable securities, electronically recorded monetary claims, instruments of prepaid payments and other similar items to be specified under the Cabinet Office Order) which may be used by unspecified persons to provide consideration for the purchase or rental of goods, or the rendering of services. This property value may also be bought and sold to unspecified persons acting as counterparties, and transferred by means of an electronic data processing system;

(ii) the asset value that can be mutually exchanged with the asset value described in the previous point, with unspecified persons acting as counterparties, and transferred by means of a data processing computer system;

(iii) specific beneficial interest; and

(iv) other items to be designated by order of the Cabinet Office.

“Specific Beneficial Interests” means beneficial interests in monetary trusts (limited to property values ​​that can be recorded and transferred electronically) where the entire amount of money entrusted under the Trust Agreement is managed as savings.

2. Introduction of “Electronic Payment Instruments Business” Registration

(1) Definition of “electronic payment instrument activity”

As part of the proposed new framework, the FSA will introduce a new registration system for intermediaries, in relation to regulated stablecoins as electronic payment instruments. Each of the following intermediaries’ business activities will fall within the scope of the Electronic Payment Instrument Business and, therefore, will be subject to the new registration system:

(i) the purchase and sale of an electronic payment instrument, or the exchange with another instrument of this type;

(ii) intermediary, brokerage or agency services in connection with the preceding article;

(iii) the management of Electronic Payment Instruments on behalf of others (except in cases of use to be specified by ministerial order); Where

(iv) on behalf of the remittance service provider, (a) transferring funds and reducing the value of a user’s claim against the provider by an amount equivalent to such transaction or (b) upon receipt of funds, by increasing the value of a User’s claims against the Provider, by an amount equivalent to such exchange transaction.

Issuers such as banks and remittance service providers are not required to register to transact electronic payment instruments, but they must comply with some of the rules applicable to commercial operators of instruments electronic payment.

(2) Conditions of registration

An applicant will either need to be incorporated as a joint-stock company (kabushiki kaisha) in Japan or, in the case of a commercial operator of foreign electronic payment instruments, have a business office and a representative domiciled in Japan. The candidate will also be required to meet certain financial requirements which will be specified by order of the Cabinet Office and have effective and reliable business systems as specified and required by all applicable laws.

(3) Requirements of commercial operators of electronic payment instruments

(i) Information security management measures must be taken.

(ii) Provision of information regarding the terms and conditions of contracts relating to the activities of electronic payment instruments and implementation of the measures necessary to protect users and carry out these commercial activities in an appropriate manner.

(iii) The receipt of deposits of money or other property from users in connection with commercial activities related to electronic payment instruments is prohibited.

(iv) Users’ electronic payment instruments must be managed separately from the operator’s own assets and regularly audited by a chartered accountant or auditing company.

(v) The Electronic Payment Instrument Business Operator and the issuer must enter into a contract including provisions relating to the sharing of liability between the Electronic Payment Instrument Business Operator and the issuer.

(4) Monitoring

The proposed amendment to the PSA includes provisions regarding the preparation of books and reports, submission of relevant reports as well as audit reports from chartered accountants or audit firms, on-site inspections, issuance and compliance with business improvement orders, etc.

(5) Self-regulatory body

A general incorporated association should be established by stakeholders, such as commercial operators of electronic payment instruments, to provide guidance to members on compliance with the provisions of the PSA and other laws, regulations and rules . The FSA is expected to certify the association, provided it meets certain requirements, such as providing adequate oversight of the electronic payment instrument trading industry in Japan.

3. Foreign commercial operator of electronic payment instruments

Proposed changes to the PSA prohibit foreign commercial operators of electronic payment instruments from soliciting residents of Japan unless they are registered with the FSA and comply with all relevant requirements of the legislation Japanese. Therefore, intermediaries, such as crypto exchanges and wallet service providers, who provide services to residents of Japan related to stablecoins classified as electronic payment instruments, will likely be required to register with the FSA, the same way. In addition, foreign issuers of these stablecoins are required to obtain a banking license or register as remittance service providers so that their stablecoins can be issued and used by residents in Japan.

4. Electronic payment service operator

Similar to the concept of an electronic payment instruments business under the PSA, an intermediary will be considered an “electronic payment service” and will be subject to the new system of registration, under proposed amendments to the banks, if this intermediary carries out the following operations: Activities:

(i) on behalf of the bank, (a) transfer funds from the bank account, thereby reducing the value of a user’s bank deposit, or (b) increase the value of a user’s bank deposit, equivalent to the amount of funds received through a foreign exchange transaction; and

(ii) within the framework of the previous article, the conclusion of a contract as an intermediary for the acceptance of deposits on behalf of the bank.

The registration requirements, restrictions, supervision and self-regulatory body for operators of electronic payment services are similar to those for commercial operators of electronic payment instruments.

As mentioned above, bank deposits are protected by the existing deposit insurance system. The Deposit Insurance Corporation may require an electronic payment service operator to report and submit documents, and has the authority to conduct on-site inspections.

5. AML/CFT

Under proposed amendments to the Prevention of Transfer of Proceeds of Crime Act, commercial operators of electronic payment instruments and operators of electronic payment services will be required to exercise customer due diligence (CDD). If an Electronic Payment Instruments business operator enters into a contract with an offshore Electronic Payment Instruments business operator, for continuous or repeated transfers of Electronic Payment Instruments, confirmation that the counterparty located at the foreigner has established a sufficient system to perform the CDD will be required. In addition, when an Electronic Payment Instruments Company Operator makes transfers of Electronic Payment Instruments at the request of customers, it must submit the customer’s identification information to the beneficiary institutions.

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