Interim Report from the Working Group on Promoting Startup Investment

The “Digital Asset Co-creation Consortium” (abbreviated as DCC, with 266 member organizations) hosted by Progmat has released the “Interim Report” of the discussions conducted by the “Working Group on Promoting Startup Investment” established to contribute to the realization of the “Five-Year Plan for Nurturing Startups,” which aims to increase startup investment tenfold in five years.

In addition, to expand the range of assets subject to digital securitization, which broadens the options for individual asset formation, including the direction of regulatory reforms compiled in this Joint Study, DCC has established the “Working Group on Trust Accounting Rules” to comprehensively formulate the necessary rules for trust accounting across industries to achieve overall optimization.

Overview of the “Working Group on Promoting Startup Investment”

In December 2023, DCC established the “Working Group on Promoting Startup Investment” and has been conducting discussions under the observation of relevant authorities, involving 45 organizations such as venture capital firms (VCs), financial institutions, securities companies, secondary digital securities trading markets, law firms, accounting firms, and audit firms.

This Joint Study aims to design a framework that connects venture capital firms and individual investors by utilizing the digital securitization method, which allows for smaller investment units and the provision of necessary liquidity even for unlisted securities, as a means to expand the amount of funding for startups and diversify individual asset formation methods. The study will then lead to the development of specific product structures and the extraction of necessary regulatory reform requests.

Interim Results and Future Actions

In this Joint Study, DCC has clarified the significance of the endeavors for the participants in this product scheme and the product characteristics compared to similar products, refined the scheme from the perspective of regulations and investor protection, and documented the perspectives, premises, and rationales that should be shared as industry insights.

To address the necessary conditions for specific product structuring, such as revising the rules related to trust accounting, DCC will establish a separate “Working Group on Trust Accounting Rules” to comprehensively discuss the expansion of assets subject to digital securitization (including foreign assets and domestic movable properties), not limited to the product scheme discussed in this study.

Details

Significance/Product Characteristics of VC Fund STs

• By expanding the investor base for VC funds to new layers of investors, the supply of funds to the funds will stabilize, leading to a smooth supply and circulation of growth capital.
• Investing in startups will become a new option for individual investors’ asset formation. From the perspective of startups, they can raise funds without directly making unspecified individuals shareholders.
• Compared to similar products, VC Fund STs offer unique opportunities for both individual investors and VC funds.

Scheme of VC Fund STs

• For securitization purposes, a specific beneficiary securities trust (Tokutei JS) is envisioned as the legal vehicle (SPV) due to its advantages in terms of the stability of rights transfer and tax treatment.
• The securitized assets (trust property) are envisioned to be “VC fund LP equity interests” and “cash necessary for operations.”
• Additional investments in, replacements of, or redemptions from the VC funds within the trust period (i.e., management of the trust property itself) are not anticipated. Investment decisions in individual startups will be made by the VC fund.

Scheme Details of VC Fund STs (Regulations / Investor Protection)

• While the LP investor is a single “trust account” (trustee trust bank) that has received a trust transfer from the trustor (financial instruments business operator), the VC funds invested in by VC Fund STs are generally considered to fall under the special operations for qualified institutional investors, provided that certain conditions are met. (The final determination will depend on the actual circumstances of each case.)
• In addition to statutory disclosures, it is preferable to meet voluntary disclosure levels (such as the names of the VC fund’s portfolio companies, their allocation ratios, and some information from the LPS business reports) to the extent that is not overly burdensome for VCs and their unlisted portfolio companies.
• From an investor protection perspective, it is desirable for the industry to share a certain perspective (e.g., setting a transaction limit of around 5% or 10% of annual income or financial assets for investors other than specified investors) while each securities company establishes specific criteria for commencing transactions.
• When traded on a Proprietary Trading System (PTS), measures to prevent unfair trading practices will be necessary.

Scheme Details of VC Fund STs (Transaction Reasons / Scheme Participants)

• For the operation of VC Fund STs, funds required for mid-term management costs or responding to additional capital calls will be contributed in cash at the time of trust establishment, and various conditions will be clearly stated in the trust agreement.
• The trustor and residual beneficiary will be a qualified institutional investor/Type I financial instruments business operator (for the management of trust property, the trustor must either be registered for investment management business or outsource all asset management operations to a registered investment management company), not the GP of the VC fund.

Scheme Details of VC Fund STs (Accounting Treatment)

• For specific beneficiary securities trusts (Tokutei JS) to receive preferential tax treatment, there is a constraint that any income generated must be distributed in principle (with a retention ratio of 2.5% or less). However, if unrealized gains arise in the VC fund due to the fair value accounting of unlisted stocks, this would result in income in the Tokutei JS that is not accompanied by cash inflows (and therefore cannot be distributed).
• If a rule can be established to exclude such unrealized gains that are not accompanied by cash inflows from the calculation of the profit retention ratio for Tokutei JS, it is expected that this bottleneck would be resolved.

Actions Required for Implementation

• To discuss the rule-making for Tokutei JS without causing inconsistencies with existing products or the expansion of other securitized assets (such as foreign assets or domestic movable properties), the “Working Group on Trust Accounting Rules” will be newly established to comprehensively discuss trust accounting rules related to securitization, gathering trust banks and experts from across industries to achieve overall optimization.

Participating Organizations in the “Working Group on Promoting Startup Investment” (as of the Interim Report)

Venture Capital

1. Incubate Fund Corporation
2. WiL, LLC
3. SBI Investment
4. Global Brain Corporation
5. JAVCA Group

Banks/Trust Banks

1. Aozora Bank
2. Shinsei Trust Bank
3. Development Bank of Japan
4. Norinchukin Trust and Banking (and affiliated companies)
5. Mizuho Trust & Banking
6. Sumitomo Mitsui Trust Bank

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