Recent Developments of Islamic Finance in Japan

For a number of years, the utilisation of Islamic financing methods and practices has been discussed as one of the next significant trends in the Japanese financial market. This has yet to be the case unfortunately, largely because of the prolonged downturn in Japan's economy following the global financial crisis.

Although Islamic finance has not taken hold in Japan as previously anticipated, there have been, however, notable advancements. In fact, due to several recent developments (and proposed reforms) in laws and regulations, as well as actual transactions by Japanese market participants, Islamic finance in Japan looks to be moving steadily towards a breakthrough. This article aims to give an overview of some of those recent developments.


The issuance of sukuk by Nomura Holdings was no doubt one of 2010's hottest topics regarding Islamic finance in Japan. While there have been previous Japan-related sukuk issuances, such as the launch of the CP/MTN programs by Aeon Credit Service and Toyota Financial Services Corporation, respectively, these issuances were implemented by such companies' Malaysian subsidiaries.

The Nomura-issued sukuk is considered to be the first sukuk issued by a Japanese issuer and is a major significant event in the history of Islamic finance in Japan.

In countries with established Islamic finance practices, it is widely accepted that the tax treatment of dividends from sukuk should be equivalent to that on interest from bonds/notes so as to create a level playing field for both products, which is normally achieved through tax reform.

In this regard, the Financial Service Agency of Japan (FSA) has proposed tax reforms on various Islamic finance-related issues in its proposal on tax reform for 2011 (the 2011 Tax Reform Proposal).

FSA requested in the 2011 Tax Reform Proposal, among others, that –

  1. the tax treatment on sukuk dividends should be the same as bonds'/notes' interest, and
  2. tax on the repurchase of the underlying asset in sukuk transactions be exempted.

These reforms, if implemented, are expected to stimulate the incentive of prospective issuers by removing major obstacles that have long plagued sukuk issuances in Japan.

Another major legal issue concerning sukuk was with regard to its legal form. While no one questioned that sukuk is to be treated as a 'security' under the Financial Instruments and Exchange Act, there was some ambiguity on which category of securities it falls under.

The 2011 Tax Reform Proposal may have provided an answer to this question as well, as it refers to sukuk as a 'quasi bond trust beneficiary interest' issued by a specified purpose trust.

This should provide greater clarity to market participants, in particular, issuers, securities brokers and investors, with respect to (i) which disclosure requirements will be imposed on the issue of sukuk, and (ii) the legal nature of the product they issue/sell/invest in.

Now that two major issues have been or plan to be resolved (such as those related to taxation and legal form), it is expected that more Japanese issuers will consider the issuance of sukuk. There is a need, however, for further support from government.

In certain other countries that have more advanced Islamic finance practices, the government has issued sovereign sukuk to encourage sukuk issuance by the private sector.

Sovereign sukuk would work as a benchmark for sukuk of Japanese issuers and assist in the establishment of the infrastructure necessary for large-scale sukuk issuances.

Regulatory Reform on Banking Business

The amendments to the Ordinance for Enforcement of the Banking Law/Insurance Business Law in 2009 may also be a significant legal reform from an Islamic finance perspective. Such regulatory reform allows Japanese banks and insurance companies to provide a certain range of Islamic finance services through their subsidiaries. Following this reform, it was reported that The Bank of Tokyo-Mitsubishi UFJ obtained a license for Islamic windows from the Malaysia International Islamic Financial Center and started providing wholesale Islamic finance services through its Malaysian subsidiary.

This reform, however, does not act to allow Japanese banks/insurance companies to perform a full range of Islamic finance business. Rather, it provides that the Islamic finance business permitted to be conducted by their subsidiaries must relate to transactions that are regarded as equivalent to money lending.

In its response to public comments on such regulatory reform, the FSA made it clear that the transactions in the form of capital contribution would not be included; therefore, transactions such as mudarabah and musharakah will be excluded from the scope of permitted business.

The FSA also responded that finance lease transactions would generally be regarded as equivalent to money lending while operating leases would unlikely be regarded as such, which means some forms of Ijarah may fall outside of the scope of permitted business.

The provider of Islamic finance services is also restricted in that the reform only allows banks'/insurance companies' subsidiaries to deal with the permitted categories of Islamic finance business as stated. This means Islamic finance business by Japanese banks/insurance companies themselves and/or through their respective branch offices would still be prohibited.

Taking into account that companies establish a local business presence in a foreign country based on an examination of a number of factors including tax merits, banks and insurance companies would naturally want more flexibility in this regard.

While outstanding issues remain, this reform signifies that the Japanese government recognises and addresses the financial institutions' need of entering into Islamic finance business. While the provision of Islamic finance services in a foreign country by a subsidiary of a Japanese company would not directly promote Islamic finance transactions in Japan, it would still play an important role.

The knowledge and know-how obtained, as well as the entering into the network of players in the Islamic markets, by such Japanese financial institutions would surely be beneficial.

Also, as the finance for such business would better be obtained through Islamic financing method, their Islamic financing business in a foreign country may create further Islamic finance transactions involving Japanese parties. To facilitate more Japanese financial institutions carrying out Islamic finance business, further regulatory reform would be necessary.

Real Property Investment by Islamic Investors

The 2007 acquisition of three real properties in Tokyo by Boubyan Global Real Estate Fund (BGREF) is surely one of the milestones when considering Islamic finance in Japan. The transaction applied a novel structure using two SPVs connected by Ijarah, and is thought to be the first domestic transaction applying Islamic financing techniques. Unfortunately, there have been few (possibly no) other similar real estate transactions thereafter due to the serious downturn in the Japanese real estate market.

As the Japanese real property market gradually starts improving, presumably, there will be quite a few investment opportunities which might interest Islamic investors. To materialise such interests into actual deals, market players should consider various deal structures. While the two SPV structures used in the BGREF deal is one of the viable structures for Islamic investors' acquisition of real estate in Japan, it seems also true that it may expose lenders to a different risk profile from that regarding a common acquisition structure, such as a GK-TK or TMK and, as a result, it may take time for existing real estate non-recourse lenders including Japanese mega banks to accept such structure.

As is always the case, potential market participants must be flexible and innovative on structures, and other categories of lenders to take senior finance portions must also be considered. In this regard, taking senior financing from Islamic financial institutions via a preferred class of equity investment or Islamic finance transactions such as murabahah would also be worth evaluating as an option.

In conjunction with the support by governmental measures such as regulatory reforms, the innovations by market participants are critical in enhancing the utilisation of Islamic finance in Japan. The creative efforts of such market participants would surely help in increasing the investment of Islamic money in the Japanese real estate market.


The recent developments, as detailed above, have led to an increased recognition of Islamic finance practices in Japan. The taxation and banking reforms with respect to Islamic financing have left little doubt that the Japanese government sees such types of financial practices and instruments as material parts of the financial market in Japan. As well, Islamic financial transactions carried out recently, such as Nomura Sukuk, indicate that the private sector has also recognised the emerging importance of such practices.

The foregoing notwithstanding, it will take additional measures from both the government and private market participants to further enhance the standing of Islamic finance in Japan.

The government, undoubtedly, should recognise more Islamic financing methods through further regulatory reform and allow more Japanese financial institutions to conduct such activities.

The private sector should endeavour to engage in more transactions that use such practices and consider creative approaches in conducting transactions. Only through the continued efforts of both the government and market participants will Islamic finance truly break through in Japan.

Naoyuki Kabata was involved in Boubyan Global Real Estate Fund's acquisition of properties in Tokyo in 2007 as lender's counsel and advise a number of other clients, both domestic and international, on prospective Islamic financing transactions.

This article first appeared in Islamic Finance News (15 December 2010, Page 16). For more details, please visit