Japan FSA announces tightening of crypto lending and IEO regulations

Japan's Financial Services Agency (FSA) has unveiled plans to strengthen regulations governing crypto lending businesses and Initial Exchange Offerings (IEOs). The move, announced during the fifth meeting of the Financial System Council's Working Group on Cryptocurrency Systems, aims to enhance investor protection by mandating better risk disclosures and secure custody practices.

New Classification for Crypto Lending Under Consideration

The FSA proposed that crypto lending businesses be governed by the Financial Instruments and Exchange Act, which imposes stricter requirements compared to the current Payment Services Act. A notable concern raised by the agency is a loophole that allows unregistered crypto businesses to operate under the guise of lending activities, thereby sidestepping existing regulations for crypto exchanges.

The agency noted that under current rules, operators are not consistently required to maintain cold wallets or manage segregated funds, exposing users to "price fluctuation and credit risks." To address this, the FSA emphasized the need for crypto businesses to implement stronger risk management measures for sub-lending parties and staking contractors, as well as to improve custody controls and clearly communicate risks to customers.

Tighter Regulations for IEOs Proposed

The FSA also suggested new measures for IEOs, including setting caps on investment amounts to prevent overinvestment. Under the proposal, investment amounts exceeding 500,000 Yen would be limited to 5% of an investor's revenue or net assets, with a maximum threshold set at 2 million Yen. The agency revealed that nearly 90% of past domestic IEO cases involved purchase amounts of 500,000 Yen or less, highlighting the potential for overinvestment if left unchecked.

However, the committee acknowledged the challenges of enforcing such caps, particularly given the nature of crypto markets. One member pointed out that "additional secondary market purchases can easily exceed the limit" and that investors might use multiple accounts on offshore platforms to bypass restrictions. The member also emphasized the importance of educating investors about risk management and diversification as a potentially more effective long-term strategy.

Concerns Over Market Dynamics and Technological Growth

The FSA highlighted specific cases where lending operators offered high annual interest rates of up to 10% or limited repayments to specific loan periods, raising questions about risk management. Additionally, some operators were found to lack safeguards against risks such as asset confiscation by lending contractors or defaults by sub-lending recipients.

Despite these proposals, several committee members expressed skepticism about the practicality of regulating certain activities. For example, the inclusion of off-chain exchanges under the new framework raised questions about alignment with market realities, as "staking is inherently an on-chain activity."

While the FSA aims to protect investors and prevent market manipulation, the agency stressed the need to balance regulatory measures with market growth and technological progress. "While investment caps and lending rules may appear to address immediate concerns, their effectiveness in the long run remains uncertain", the agency noted.

Looking Ahead

The FSA plans to finalize its regulatory framework by 2026, shifting crypto assets from their current classification under the Payment Services Act to a more stringent classification under the Financial Instruments and Exchange Act. This reclassification underscores Japan's broader efforts to enhance legal and tax regimes surrounding crypto businesses.

With these proposals, the FSA seeks to address immediate risks in the crypto sector while navigating the complexities of a rapidly evolving market. Whether these tighter regulations will achieve their intended goals remains to be seen.

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