Marsh issued a warning to UK companies from its London office that their “subsidiaries and affiliates of Japanese firms,” face some new risks in association with “new Japanese legislation relating to internal controls and financial reporting, which comes into effect today. Failure to comply may have significant penalties for senior management in Japan, including fines and imprisonment.”
Marsh explained: “Part of Japan’s Financial Instruments and Exchange Law, or J-SOX, as it is informally known, is modelled on the US’ Sarbanes-Oxley Act and aims to improve the transparency and accountability in business processes for all Japanese listed companies. Approximately 3,800 Japanese listed companies, including their significant subsidiaries and affiliates, fall under the J-SOX requirements.
“To assist with the implementation of J-SOX, the Japanese Financial Services Agency issued the Standard and Practice Standards for Implementation Guidance for Management Assessment and Audit earlier this year.
“The Standard recommends a risk-based, top-down approach to J-SOX implementation across the entire group, including overseas subsidiaries. This approach implies that when management assesses the effectiveness of internal controls, it shall first assess company-level controls on a consolidated basis, and then consider the result of these assessments, assess the process-level controls to the extent necessary and focus on the risks that could create material misstatements in financial reporting.”
Abigail Simpson, a Senior Consultant in Marsh’s Risk Consulting Practice, commented: “The requirement for all listed companies to review how well risk is managed, both at company level and at process level, in the context of financial statements is a new concept for many Japanese organisations. As a result, this requirement has proved challenging and has been fuelled by the limited number of accountants, auditors and consultants to assist with the implementation of the regulations.”
Other challenges include:
— Limited experience with establishing and evaluating internal controls
— Lack of standard business processes between many Japanese companies and their subsidiaries
— Time constraints to effectively implement internal control systems.
Marsh repeated that the “requirements of J-SOX extend to ‘significant subsidiaries and affiliates’, which implies that business locations and units that have an impact on the accounts, determined by sales, accounts receivable and inventory, for example, should be included in the scope of the legislation. As such, a considerable number of UK, as well as other international subsidiaries of Japanese listed companies, are therefore required to document and evaluate internal control processes in line with their parent companies.”
Simpson added, “A systematic approach to risk management will help firms more accurately evaluate internal controls in line with their J-SOX requirements. But the benefits are more than just for compliance. Robust internal controls, through a risk management framework, allow businesses to take more risk. Decision making can thus take greater consideration of risk in the capital budgeting and strategic planning processes, which in turn can provide a competitive advantage.”
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