Draft Report of the Working Group on Payment Services

On December 24, 2024, the 7th meeting of the Financial System Council's Working Group on Payment Services was held, reviewing a draft of the working group's report to be published in 2025.

As background, the "Grand Design and Action Plan for New Capitalism" (Cabinet Decision of June 14-21, 2024) aims to realize a decentralized digital society, while also taking into consideration user protection, and aims to utilize tokens related to Web 3.0 and facilitate payments.

At the general meeting of the Financial System Council on August 26, 2024, the Minister of Financial Services asked the Financial System Council to consider appropriate regulations while taking into consideration user protection, given the expansion of users and usage patterns of remittance, settlement, and credit services, and the emergence of new financial services.

In response to this request, the Financial System Council established the Working Group on Payment Services, and has held seven meetings since September to deliberate on the following issues:

• Diversification of methods for returning user funds in the event of the failure of a money transfer service provider
• Issues concerning remittance and settlement services, such as the regulation of collection agents
• Preventing the outflow of assets overseas in the event of the bankruptcy of cryptocurrency exchange operators
• Issues related to payment methods, application of money lending regulations to advance payment services, and other issues

The draft report details the findings of these discussions, summarized below, and followed by statements from the Japan Association for the New Economy (JANE) and the FinTech Association of Japan (FTAJ).

I. Core Themes and Context

• Fintech Integration: The report recognizes that Fintech is no longer a novelty but an integrated part of daily life.
• Evolving Financial Services: There is a proliferation of financial services beyond the traditional models, necessitating a review of regulations to ensure fairness, user protection, and alignment with the realities of new businesses.
• Web3.0 and Digitalization: The report notes the government's push for a decentralized digital society, emphasizing the need for balanced regulations that support innovation in Web3.0 technologies, such as token utilization and seamless payment solutions.
• Regulatory Review: The FSA established this Working Group to assess the adequacy of current regulations in light of these changes, focusing on user protection and appropriate regulatory frameworks for these evolving services.

II. Key Discussion Points and Recommendations

A. Remittance and Payment Services

Diversifying User Fund Return Methods for Fund Transfer

• Businesses Problem: Current regulations require funds held by fund transfer businesses to be returned via a slow process involving a deposit, taking a minimum of 170 days. This is particularly problematic for digital wage payments.
• Proposed Solution: Implement direct return methods, either through (1) guarantee institutions or (2) trustees, to expedite fund returns in the event of business failure.
• Considerations: Ensuring the soundness of guarantee institutions (e.g., only banks) and the appointment of qualified beneficiary agents (e.g., lawyers or CPAs).
• Note: This new method would be an optional addition to the existing deposit system to provide flexibility to businesses.

Relaxation of the Retention Restrictions for Type I Fund Transfer

• Businesses Problem: Strict restrictions on fund retention periods and specific instructions for fund transfers hinder user convenience and innovative services.
• Proposed Solution: Allow a limited fund retention period of up to two months, in line with commercial practices, under specific conditions.
• Accept deadlines for transfers instead of specific transfer dates.
• Allow Type II fund transfers to be used for Type I transfers under strict conditions to prevent regulatory loopholes.
• Conditions: Enhanced return mechanisms (direct return methods), management of user data, and reporting of any breaches.

Regulation of Cross-Border Collection Agency Services

• Business Problem: Cross-border collection agencies, particularly in areas like online casinos, fraud schemes, and overseas investments, pose risks like illegal activities, money laundering, and lack of protection for users.
• Proposed Solution: Apply the same "same activity, same risk" principle as seen in the FSB recommendations by bringing entities that function as remittance providers under existing remittance regulations.
• Specific Considerations: Exemptions: Exempt platformers and sellers involved in the transaction if the right to receive payment is properly granted to the collection agent and AML/CFT measures are in place.
• Escrow services: Further consideration is needed on the necessity of applying the same regulations to escrow services.
• Regulation Target: Collection agencies not involved in establishing the financial debt should be regulated under remittance laws. This includes services for online casinos, overseas investments, and general overseas e-commerce settlements.

Use of Prepaid Payment Instruments for Donations

• Business Problem: Current regulations limit the use of prepaid payment instruments, but there is a growing need to use them for donations.
• Proposed Solution: Allow the use of prepaid instruments for donations to government bodies and recognized organizations but with limitations (e.g., capped at 10,000 to 20,000 yen per donation) in order to avoid AML/CFT abuse.
• Restrictions: The use of notification-type prepaid payment instruments should be prohibited, and verification of donation recipients is required to prevent fraud.

B. Crypto Assets and Electronic Payment Methods (Stablecoins)

Preventing Outflow of Assets During Crypto Asset Exchange Business Failures

• Business Problem: No domestic asset holding orders can be issued to crypto asset exchange businesses, which lack an equivalent regulation to the one applicable to securities firms.
• Proposed Solution: Introduce regulations allowing domestic asset holding orders for crypto exchange businesses during times of potential failure, mirroring those for securities firms.

Regulations Based on the Actual State of Crypto Asset Businesses

• Business Problem: Current regulations may be too burdensome for businesses acting as intermediaries for crypto asset sales and exchanges, as they don't handle or hold user assets, but are still subject to AML/CFT regulations.
• Proposed Solution: Introduce a new intermediary business category, akin to securities intermediary businesses, with no need for asset holding and more flexibility. This new type of intermediary will need to be affiliated with a registered exchange.
• Specific Considerations: Affiliation System: Adopt an affiliation system where intermediaries act on behalf of specific registered crypto exchanges.
• Financial requirements: No financial requirements for this new category.
• AML/CFT: No need to impose AML/CFT obligations on intermediaries when their registered exchanges already follow them.

Flexibility in Management and Operation of Funds for Specified Trust Beneficiary Rights (Type 3 Electronic Payment Instruments)

• Business Problem: Current rules mandate the management of 100% of stablecoin reserves as demand deposits at banks.
• Proposed Solution: Allow greater flexibility in asset management beyond demand deposits.
• Specific Considerations: Asset Types: Investments in low-risk assets such as short-term government bonds and time deposits, while setting limitations and caps on the ratios of these investments.
• Maturity and Residual Periods: Limiting the maturity and residual periods of government bonds to a maximum of three months.
• Risk Management: Implement requirements for additional trust funds by trust settlors if bond prices fall and the trust capital decreases.
• Ratio Limit: Impose a 50% limit on investments in bonds and time deposits.

Application of Travel Rule to Specified Trust Beneficiary Rights (Type 3 Electronic Payment Instruments)

• Business Problem: Current regulations do not apply the Travel Rule to specific trust beneficiary rights because they are typically issued as trust beneficiary rights in a beneficiary certificate issuing trust. However, new developments are emerging, which do not involve such trusts.
• Proposed Solution: Apply the travel rule to the transfer of specified trust beneficiary rights when these trust rights are not being issued via the previously planned trust systems to ensure information about senders and recipients can be identified.

Issuance of Type 1 Electronic Payment Instruments by Depository Financial Institutions

• Business Problem: Under current interpretation of the law, the issuance and redemption of electronic payment instruments qualifies as "exchange transactions" and is limited to only money transfer businesses and depository financial institutions. However, the FSA has been hesitant to allow banks to issue type 1 payment instruments.
• Proposed Solution: Given the novelty and risk profile of this activity, any discussion around allowing banks to issue type 1 instruments will be considered a medium to long-term project.
• Considerations: Any future potential authorization would be subject to further discussion concerning how best to ensure customer safety, financial stability and a smooth-functioning financial system.

C. Other Issues

Lending Status of "Stand-in Payment Services"

• Business Problem: "Stand-in payment services," where a business pays on behalf of a user and is later reimbursed, may be considered lending, bringing them under the purview of the Money Lending Business Act.
• Proposed Solution: Assess each service individually using established criteria, considering things such as: how much the business supplements the user's payment capacity, how much the user's credit score is considered and the overall economic effect.
• Considerations: Factors such as fee setting, stand-in periods, and user attributes will help guide the analysis of each service.

Regulation of Foreign Financial Institutions Participating in Syndicated Loans

• Business Problem: Foreign financial institutions participating in syndicated loans may need money lending registration. The existing framework makes it unnecessarily onerous.
• Proposed Solution: It is proposed that exemptions from registration may be considered for foreign financial institutions that only participate in syndicated loans.
• Considerations: It is also proposed that the potential risks of allowing this deregulation be carefully assessed and that measures are designed in order to address these risks.

III. Comments - Japan Association for New Economy

1. Introduction

"Payments" in various transactions are becoming more convenient, efficient, secure, and low-cost through the ingenuity of many businesses involved in transactions and payments, while utilizing digital technology. They play an important role in supporting economic activities.

In both e-commerce and in-store payment fields, there are multiple parties involved, including merchants (sellers), payment service providers (PSPs/payment collection agencies), merchant acquirers, payment service providers, and payers (buyers). Even in a single sales contract, multiple B2B transactions exist between the merchant (seller) and the buyer. By streamlining and consolidating contract procedures, merchant reviews, and sales proceeds settlement while offsetting fees, etc., for each B2B transaction, sellers can meet diverse needs, buyers can choose from a variety of payment options, and payment service providers can achieve operational efficiency. The settlement of sales proceeds between each B2B is basically done through bank transfers based on contracts. This mechanism is fundamentally the same regardless of whether the seller and buyer are both domestic or one is overseas. It has been a rooted mechanism as a payment ecosystem for many years without causing major problems.

2. Lack of Basis and Actual/Impact Assessment to Justify the Need for Regulations

Under these circumstances, simply because either the seller or the buyer is located overseas, subjecting existing businesses within the EC payment and code payment ecosystem to the current law as "cross-border payment collection agencies" and imposing the obligations of the current "funds transfer business" law, which assumes a simple A-to-B remittance service, requires considerable legislative facts and concrete grounds. Compared to domestic payments operating under a similar framework, no specific risks have been presented for overseas EC payments or inbound code payments. The FSB document also states that proportionate regulations should be considered after conducting a risk assessment, not that existing regulations should be applied without even identifying or grasping the risks.

3. Opinions on the Sections Related to Cross-Border Payment Collection Agencies in the Draft Report

A hasty conclusion should be avoided. A thorough investigation of actual practices should be conducted, risks should be clarified based on actual occurrences, and then methods to address those risks should be considered. The impact on actual practices should be confirmed, and concrete discussions and considerations based on actual practices should be exhausted. At the current stage where the clarification of risks to be addressed, the investigation of actual situations, and the impact assessment are insufficient, and the definitions, specific practical considerations, and approaches are extremely vague, we strongly oppose the inclusion of the direction of regulating overseas EC payments and inbound code payments. We naturally also strongly oppose the approach of broadly deciding on the direction of regulation, amending the law first, and then deciding on the details later.

Classifying EC payments and code payments as regulated foreign exchange transactions and simply applying existing funds transfer business regulations that are completely incompatible with the reality of payments in EC and in-store transactions, attempting to crush sound businesses by ignoring the realities of economic activities, will have a significant impact on the Japanese economy without resolving any issues.

IV. Comments - FinTech Association of Japan

The association's key points are:

• Cross-border payment collection: They agree with identifying online casinos and investment fraud as risks but argue that the report doesn't adequately address other risks like double payments and payment delays. They believe the current regulations are sufficient for user information protection and question the proportionality of applying additional financial regulations. They also highlight the potential merits of payment collection, such as reducing non-payment risk and preventing fraud.
• Level playing field: They emphasize the importance of considering the "same activity, same risk, same regulation" principle, but also call for consideration of existing domestic payment collection regulations and the potential negative impact on Japanese businesses if regulations are too stringent.
• Scope of regulations: They argue against regulating inbound traveler payment collection using overseas QR codes in domestic stores, citing lack of evidence for increased risk and potential harm to the cashless society initiative. They propose excluding entities and activities already regulated under other laws, using credit card issuers/acquirers as an example, and suggest similar treatment for inbound traveler payment collection.
• Money transfer business regulations: They support diversifying user fund return methods in case of business failure but emphasize the need for detailed practical considerations. They also propose raising the annual donation limit for prepaid payment instruments. They support the case-by-case approach to regulating "Tatekae" (advance payment) services, advocating for balanced consideration of user protection and innovation.

In general, the Fintech Association supports the report's direction but urges careful consideration of the practical implications and potential negative impacts of overly broad regulations on businesses and innovation. They advocate for a balanced approach that addresses risks proportionately while supporting the growth of the fintech industry.

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