Recommendation 1 Recommendation 2 Recommendation 3 Recommendation 4

Recommendation 5 Recommendation 6 Recommendation 7 Recommendation 8

Market selection

Recommendation 8

Local laws and regulations should ensure that there is segregation of client assets from the principal assets of their custodian; and no possible claim on client assets in the event of custodian bankruptcy or a similar event. Regulators and markets, to further improve investor protection, should work:

• to ensure clarity on the applicable law on cross border transactions
• to seek international agreement on a legally enforceable definition of finality in a securities transaction
• to ensure that local law fully protects the rights of beneficial owners
• to strengthen securities laws both to secure the rights of the pledgee and the protection accorded to client assets held in Securities Systems.

1.	Under local rules and regulations, what are the segregation requirements for keeping client assets and custodian assets in the depository?	Deposited securities in JASDEC are not segregated in the vault as principal and customer securities. Such practice of keeping securities in fungible form is allowed under the law and JASDEC rule. However, the rule requires that JASDEC segregates customer securities from principal securities on the account of each participant. To keep the record of such segregation updated, JASDEC receives daily report on it from each participant. Therefore, JASDEC does not segregate physically customer securities from principal securities, but segregates them by recording on each participant account. In addition, the participant is required by the law to keep customer assets segregated from its own assets in a firm and orderly manner. Although there is no legal or regulatory requirement to do so, it is market practice for Japanese custodian banks to segregate their own proprietary assets from their customer’s assets. This is done not only in the custodian bank’s books but also in the manner in which the custodian bank maintains the physical segregation of the securities. This market practice is enforced through the due diligence, custodian selection, and custody agreement processes during which potential customers of Japanese custodian banks verify that this segregation is properly occurring. All Japanese custodian banks have the facilities required to segregate their proprietary assets from their customers' assets. However this segregation occurs at varying levels within the customers' assets, such as at the individual client level, investor level or fund level depending upon the custodian bank. In the JASDEC system (the Japanese corporate share depository system), it is a statutory requirement that the proprietary account of the custodian bank and the depository accounts of the custodian bank’s customers be kept segregated.
2.	How are clients' assets protected in the event of insolvency of a custodian or depository?	Because JASDEC maintain customer securities segregated from principal securities on each participant account kept by JASDEC, insolvency of a participant custodian does not affect the customer securities on the book. Deposited securities would be withdrawn and returned to customers when the instruction for withdrawal of customer assets is made by the insolvent custodian. In case of insolvency of a depository, the depository status would be cancelled according to provisions of the law. Creditors of the depository cannot claim to the securities deposited with the depository, because the depository has no ownership and any other interest in deposited securities. At the time of insolvency, the deposited securities will be returned to all participants based on the record of each participant account. In the case of certificated securities, both bearer form and non-bearer form, if these are held by the custodian bank as agent for the customer then they will be legally deemed to be held by the customer. Uncertificated registered securities will be considered to be held by the customer if they are properly registered in the customer’s name at the relevant registrar. With respect to bearer form securities, under Japanese law, the customer’s securities, or their interest in the ownership of the securities is protected from seizure by creditors or procedures undertaken by an insolvency administrator so long as these assets are properly segregated from the custodian banks' own proprietary assets. This segregation is only effective if it is readily apparent to third parties such as an insolvency administrator. That is, book segregation by itself is insufficient, there must be actual physical segregation of the proprietary and customer assets. In the JASDEC system, the custodian bank’s proprietary assets and customers’ assets are kept segregated. The insolvency of a custodian bank may lead to seizure or other procedures by a creditor or a court appointed insolvency administrator, but customer’s assets, so long as they are properly segregated from the custodian bank’s proprietary assets, will not be subject to the control of a creditor or the insolvency administrator. Cash deposits are unsecured obligations, similar to general bank deposits and may fall under the control of the insolvency administrator. However depositors are under the protection of the Deposit Insurance System, which is maintained by the Japanese Government.
3.	Does local law recognise the existence of beneficial owners who may differ from the legal owner of a security?	Local law does not generally recognise the existence of beneficial owners, unless covered by the Trust Law, and the Law concerning Central Depository and Book-Entry Transfer.
4.	Does local law clearly define the point of time when a settlement, both for the security and the cash involved, achieves finality and thus cannot be unwound?	The law defines that any person with his name entered into a ledger of Participant accounts or customer accounts shall be deemed as the possessor of stock certificates amounting to a number of shares entered into such a ledger. The entry made on the ledger of Participant accounts or customer accounts can be said as the point of finality and cannot to be unwound if the receiving participant or customer is a bona fide purchaser and acts without gross negligence.
5.	Does a pledgee have an absolute right to realise their security at all times?	A pledgee has an absolute right to realise its security following the procedures provided by the Civil Code and the Law of Civil Execution.
6.	Does the depository have loss sharing provisions in its rules, and how would these be applied?	If there is a deficiency between the record of a book and actual amount of deposited securities, the law says that the depository and participants with customer accounts should be jointly and severally responsible for compensating such a deficiency. Rules of JASDEC provide more about the process for compensation. When there is a deficiency of deposited securities, JASDEC promptly compensates such missing securities. In order to compensate, JASDEC enters into a property and casualty insurance contract and uses insurance money to compensate the deficiency. When it cannot compensate all of the deficiency of deposited securities with the insurance money, JASDEC compensates such deficiency by using its investing assets to the extent authorised by the board of directors. In case the deficiency still cannot be fulfilled by the above measures, participants who keep the ledger of customer accounts should compensate such deficiency jointly and severally with JASDEC. In such case, JASDEC and participants demand that the person responsible for the deficiency compensate the damages made.