Jordan Murray and Erica Berthou are both lawyers in Debevoise & Plimpton's Investment Management Group. Murray can be reached at firstname.lastname@example.org and Berthou can be reached at email@example.com.
Marketing private equity funds in Japan or to Japanese investors has just gotten more complicated. New legislation significantly broadens the oversight authority of the Japanese regulator with respect to both boutique private equity firms and institutionally sponsored funds. However, potential fund sponsors should not be unduly concerned about marketing in Japan or of taking on Japanese investors. The goal for most private equity sponsors will be to limit their obligations in Japan to mere notification filings, rather than registration obligations, which are far more cumbersome under the new regime.
Under the new Japanese Financial Instruments and Exchange Law (the ?FIEL?), a general partner (rather than the sponsor) of a private equity fund structured as a limited partnership may be required to register with the Japanese regulator, both in connection with offering fund interests in Japan and serving as an ?investment manager? of a fund with Japanese investors. Registration is a document-intensive and time-consuming process, and once registered, the general partner will have considerable ongoing reporting obligations. In addition, if registration is required, the general partner will need to be organized as a corporation and meet certain other qualitative requirements.
The key to minimizing the impact of the new legislation is to satisfy certain statutory exemptions. If those statutory exemptions are met, the general partner will be exempt from registration and may be required to file only a simple notice, if anything, with the Japanese regulator. Failure to make a required registration or notification may lead to criminal and civil sanctions and/or fines for representatives of the general partner.
A key concept to the application of the registration exemptions is whether a fund's Japanese investors are ?Qualified Institutional Investors? (?QIIs?). The different categories of QIIs, which include Japanese banks and insurance companies, are listed in the FIEL. Investors that do not fall within a pre-approved category but satisfy certain minimum economic criteria may become QIIs by registering with the Japanese regulator. For this reason, a general partner should obtain written assurances from each of its Japanese fund investors regarding its QII status prior to admitting such investor to its fund and, particularly with respect to an investor that is required to renew its registration biennially to maintain its QII status, that the investor will continue to qualify as a QII for the duration of its investment in the fund.
First, the exemptions
A general partner will be exempt from registering with the Japanese regulator for purposes of offering and managing fund interests if it can comply with the ?QII-Targeted Exemption.? In order to qualify, (i) at least one investor in the fund must be a QII and (ii) there can be no more than 49 Japanese fund investors that are not QIIs. Note that qualifying for the QII-Targeted Exemption becomes extremely complicated if a fund has Japanese investors that are organized as certain types of special purpose vehicles, silent partnerships (tokumei kumiai) or other collective investment schemes that have investors that are not QIIs.
A second exemption from registration with respect to managing a fund with Japanese investors, but not with respect to offering fund interests in Japan, is the ?De Minimis QII Exemption.? In order to qualify, (i) the fund, directly or indirectly, may have no more than nine Japanese investors, all of which must be QIIs, and (ii) the aggregate capital contributions of such investors to the fund may not exceed one-third of the total capital contributions to the fund. Since the De Minimis QII Exemption exempts a general partner from the registration and notice filing requirements only with respect to the investment management of the fund, the general partner will still need to make a filing in respect of its offering activities in Japan unless either it has completed its offering of fund interests in Japan prior to September 30, 2007 (the ?Effective Date?) or it can rely on the Outsourcing Exemption (described immediately below).
Under the Outsourcing Exemption, if all marketing activities in Japan are carried out by a licensed placement agent in Japan (which could be an affiliate of a fund's general partner), the general partner generally will not need to register or file a notice in respect of such offering activities. However, if representatives of the general partner conduct any aspect of the offering in Japan, this exemption will not be available. Representatives of the general partner who are considering participating in meetings with prospective investors solely for informational purposes should proceed with caution in this regard, since there are no specific rules or guidelines concerning what constitutes prohibited offering activities in a joint visit. Japanese practitioners advise that the Japanese regulator is likely to interpret the Outsourcing Exemption strictly.
Even if an offering qualifies for the Outsourcing Exemption, if a fund admits a Japanese investor, its general partner will need to rely on another exemption in respect of the investment management of the fund since there are few scenarios in which a general partner would outsource all of its management responsibilities. The practical effect of the Outsourcing Exemption is that a general partner generally may wait to file its notification (if it needs to file one at all) until either a non-QII Japanese investor or a tenth QII is admitted to its fund.
Here are some basic guidelines that can help fund sponsors evaluate whether offerings in Japan and to Japanese investors will involve registration and/or notification requirements. The rules are complex and sponsors should consult Japanese counsel in specific cases. Here are a few actions required of the GP.
No Marketing in Japan After the Effective Date
A general partner of a fund that completes all of its marketing activities in Japan prior to the Effective Date is still subject to the FIEL requirements with respect to funds that have Japanese investors.
De Minimis QII Exemption. If a general partner can rely on this exemption, no further action is required.
QII-Targeted Exemption. If a general partner cannot rely on the De Minimis QII Exemption, but the QII-Targeted Exemption is available, the general partner will have to file a notice with the Japanese regulator by December 31, 2007.
Grandfathered Status. A general partner that cannot rely on any of the aforementioned exemptions may be exempt from registering by virtue of a grandfathered status, but will have to file a special notice with the Japanese regulator by December 31, 2007 to qualify for such status.
Investment Period. Even funds that have completed their active investment period are subject to these notification requirements.
Marketing in Japan both before and after the effective date
FIEL Exemptions. If a general partner commenced an offering in Japan prior to the Effective Date and it is eligible for one of the registration exemptions under the FIEL, but is relying on the QII-Targeted Exemption, it will still be required to make the appropriate notification to the Japanese regulator by the earlier of (i) December 31, 2007 and (ii) the admission of a Japanese investor after the Effective Date.
Grandfathered Status. If a general partner commenced an offering in Japan prior to the Effective Date, but cannot rely upon one of the registration exemptions under the FIEL, the general partner will not have to register as long as the marketing of the fund in Japan is complete by March 31, 2008. A filing notice with the Japanese regulator must nonetheless be made by December 31, 2007.
There is not clear guidance regarding the level of marketing required before the Effective Date in order for a general partner to be grandfathered under the FIEL as having ?commenced? an offering prior to the Effective Date. Japanese practitioners seem to be comfortable that the threshold will be crossed if a private placement memorandum has been delivered to a prospective Japanese investor prior to the Effective Date. However, a general partner cannot rely on this grandfathered status with respect to Japanese investors contacted after the Effective Date.
Marketing in Japan after the effective date
Unless the Outsourcing Exemption may be relied upon, a general partner commencing marketing activities in Japan after the Effective Date must file a notification (if an exemption from registration applies) or register under the FIEL prior to starting such activities. Unless a general partner relying on the Outsourcing Exemption may also rely on the De Minimis QII Exemption, it generally will have to file a notice (or register if the QII-Targeted Exemption is not available) with the Japanese regulator before admitting Japanese investors.
A general partner that is not required to register under the FIEL must enforce significant restrictions regarding transferring fund interests (and in fact such restrictions are specifically mandated by the FIEL for the QII-Targeted Exemption to apply). In addition, the FIEL requires that the relevant transfer restrictions be set forth in the applicable fund documentation.
The notices to be filed with the Japanese regulator are fairly simple, contain little sensitive information and may be made in English. However, it is not clear whether the information filed will be publicly available, so fund sponsors should assume it will be.
The enactment of the FIEL will add another layer of complexity to offering fund interests in Japan and admitting Japanese investors into private equity funds structured as limited partnerships. In most cases, however, the impact will largely be administrative and most general partners should be able to rely on the exemptions available from registration.
This article originally appeared in the Fall 2007 Private Equity Report from Debevoise & Plimpton.