Strengthening the Competitiveness of Japan's Financial and Capital Markets

Takafumi Sato
Commissioner, Financial Services Agency

Third Japan CFO Roundtable
Tokyo, Japan
20 February 2008

I am very honoured to have this opportunity to address the Third Japan CFO Roundtable. As you can imagine from the title of my speech today, the Financial Services Agency (FSA) is striving to strengthen the international competitiveness of Japan's financial and capital markets. In this context, I am also delighted that this Roundtable is being held in Japan. Certainly, this event will contribute to stimulating our nation's financial and capital markets by providing a valuable forum for the exchange of views among the CFOs of Japanese and foreign companies and those in the financial services industry. I would like to express my thanks to Economist Conferences for hosting this Roundtable and for providing me with this opportunity to speak before you.

I. Competitiveness of Japan's Financial Markets--Why Does It Matter Today?

As a financial centre, Japan has many attractive aspects. Japan's economy is the second largest in the world, and the financial assets of its household sector exceed US$14 trillion. Its manufacturing sector includes many companies that boast the world's most advanced technologies. In a world increasingly concerned with the impact of global warming and climate change, Japanese companies are well-positioned to utilise their outstanding technologies in the fields of environment and energy conservation. Our country also enjoys the advantage of geographic proximity to the emerging market economies of Asia, the region expected to maintain the highest rate of economic growth in the world.

In addition, Japan has a well-developed infrastructure for supporting these economic advantages. We have a stable legal framework; we enjoy good public safety; our public transportation systems are highly developed; and we have a well educated labour force. Moreover, Tokyo offers many of the attractions expected of a global city. I think it is fair to say that Tokyo offers entertainment and dining that is among the best in the world. Tokyo used to be notorious for its high prices in the past, but that has certainly changed. Today, it is often more affordable than other major world cities. In addition to this excellent living environment, we can enjoy here a beautiful expression of each of the four seasons of the year. I can think of few countries in the world that are fortunate enough to have such seasonal beauty.

On the other hand, Japan's financial markets do also have a number of shortcomings. In recent surveys comparing the competitiveness of financial centres throughout the world, Tokyo not only trailed behind such global centres as London and New York, but was also lagging behind such regional rivals as Hong Kong and Singapore. The reasons for this are probably better known to the members of the audience who are actually engaged in business. A frequently heard comment is that Tokyo has a shortage of human resources in such areas as financial engineering, law and accounting. Another criticism is that, while English is the international language of finance, Japan has a shortage of people with strengths in both English proficiency and professional competence in finance and other related fields. Furthermore, the proportion of funds that flow through indirect channels such as bank deposits remains high in Japan. As a result, our capital markets remain relatively underdeveloped and lack depth. The number of foreign companies listed on Japanese exchanges is still limited.

We are aware of these weaknesses, and we are not standing idly by. For Japan to sustain economic growth with its declining and rapidly ageing population, we believe there is an urgent need to strengthen the competitiveness of our financial and capital markets. Japan's financial services industry needs to provide high quality services to its customers and contribute to the country's future economic growth. For many years since the 1990s, Japan's financial sector was overwhelmed by the collapse of the bubble economy and the nonperforming loan problem. During that period, Japan found itself left behind as international competition among financial centres intensified. Fortunately, those years of difficulties are over for Japan's financial sector, and we have entered a new stage. The negative impact of the ongoing global market turmoil on our financial system has been relatively limited. Now is an excellent time for the nation to close the gap with the global frontrunners.

II. Plan for Strengthening the Competitiveness of Japan's Financial and Capital Markets

Against this background, one of the top policy priorities for the current government is to strengthen the competitiveness of Japan's financial and capital markets. A concrete policy package has been put together for the realisation of this ambitious goal. We, the Japan FSA, announced this package in December last year, titled the “Plan for Strengthening the Competitiveness of Japan's Financial and Capital Markets”. This Plan contains the following four pillars.

The first pillar is creating a reliable marketplace where vibrant transactions take place. While ensuring fairness and transparency of the markets, we will enhance the markets' capability to respond to the diverse needs of domestic and international investors and issuers.

The second pillar is putting in place a business environment that vitalises the financial services industry and promotes competition. Deregulatory measures in this pillar are aimed at enabling banks and other financial services providers to make their business operations more efficient and to better serve the needs of their customers.

The third pillar is improving the regulatory environment so that it is consistent with the first and second pillars. Since I took office as Commissioner last summer, the FSA has been endeavouring to improve the quality of regulation under the overarching theme of “better regulation.” We will further promote this process.

The fourth pillar relates to improving the broader environment surrounding our markets. This includes development of a pool of talent in such areas as finance, law, and accounting, as well as improvement of urban infrastructure for the financial business.

The Plan contains as many as fifty specific measures. I wish to explain here some of the measures that I believe are of special interest to CFOs and other members of the audience, corresponding to each of the four pillars.

(1) Creating Reliable and Vibrant Markets

The first pillar is creating reliable and vibrant markets. One of the key measures included in the first pillar is making transactions among professionals more vibrant. Markets under highly flexible regulatory frameworks geared toward professional investors, such as AIM (Alternative Investment Market) in the UK and the markets under Rule 144A of the US Securities and Exchange Commission (SEC), have been growing successfully in recent years. Drawing upon these experiences, we are contemplating introducing a highly flexible market designed for professional investors based on the principle of self-responsibility. I believe this will broaden opportunities for both Japanese and non-Japanese issuers to raise funds in our markets, and will also promote financial innovation through competition among professional players.

Under current securities regulations, private offerings limited to qualified institutional investors (tekikaku kikan toshika) are exempted from public disclosure requirements. Taking advantage of this existing exemption rule, a framework for transactions among professionals will be put in place by the end of this year. At the same time, we are working to introduce a new framework for an exchange market, whose participants will be expanded to include so-called specified investors (tokutei toshika), who are supposed to have better competence than ordinary retail investors. For this purpose, we will soon be submitting a bill for the amendment of current laws to the Diet.

We will also expand the scope of securities for which disclosure in English is permitted. Currently, disclosure in English is permitted only for foreign exchange-traded funds (ETFs). This will be revised to permit English disclosure for all types of securities issued by foreign issuers, including foreign governments and foreign funds. The necessary revisions to the existing rules will be completed around this spring. This measure is expected to greatly reduce the administrative burden on foreign issuers raising funds in Japanese markets.

Other measures in the first pillar include:

We expect these measures to improve the attractiveness and user-friendliness of Japan's financial and capital markets for investors and issuers, both domestic and abroad. At the same time, we will implement various measures to ensure greater market fairness and transparency as a means to bolster confidence in the markets.

(2) Putting in Place a Business Environment that Vitalises the Financial Services Industry and Promotes Competition

The second pillar of the Plan is vitalising the financial services industry and promoting competition. First among the measures in this pillar is the relaxing of firewall regulations. Specifically, the ban on interlocking officers and employees among banking, securities, and insurance businesses in a financial group will be lifted, and restrictions on the sharing of undisclosed corporate customer information between banking and securities businesses will be relaxed. These steps should enable financial groups to better serve their customers　by allowing them to propose a wide range of alternatives at a time, and will facilitate integrated risk management within a financial group. At the same time, financial firms will be required to put in place internal systems for controlling conflicts of interest.

In addition, the scope of businesses permitted to banking and insurance groups will be broadened. This is a policy response in light of the growing diversification, sophistication, and internationalisation of financial services. Specific measures include:

We expect these deregulations to help financial groups become more creative and provide financial services of higher quality to customers. A bill for legislative amendments required for these measures is being prepared for early submission to the Diet.

(3) Improving the Regulatory Environment

The third pillar is so-called better regulation. I believe that the quality of regulation is a crucial determinant of the competitiveness of the financial markets to which it is applied. In a better regulatory environment, financial institutions will be encouraged to develop creative ideas at their own initiative, and this we expect will lead to better financial services.

There are several areas we are currently focusing on for this purpose. First, we plan to put together key principles and share them with the industry. The principles are expected to play a guiding role for financial firms in exercising best practices and to serve as a basis for the interpretation of rules. Thus, more principles-based regulation will help to ensure maximum flexibility in business operations for financial firms. This will improve the effectiveness of our supervision by encouraging voluntary efforts by financial firms. To share principles, we will enhance our dialogue with the industry and relevant parties through various channels. In this context, I believe the opportunity that I have been given today at this Roundtable is a valuable one.

Second, we are striving to enhance transparency and predictability of our regulation and supervision. Last July, the FSA revised the No Action Letter system to facilitate the processing of letters of inquiry. In addition, responding to inquiries on the interpretation of rules often received from financial firms, we plan to put together our views in the form of FAQs (Frequently Asked Questions) and post them on our website. We are also accelerating our efforts in translating into English financial laws and rules and relevant policy documents and materials. The translation of major laws will hopefully be completed by June.

Other areas we are focusing on for better regulation include:

Combining these efforts, we hope that this will contribute to achieving our goal of strengthening the competitiveness of the Japanese markets.

(4) Improving the Broader Environment Surrounding the Markets

The fourth pillar of the Plan relates to improving the broader environment surrounding the markets. The measures we have in mind are: developing and accumulating internationally competitive human resources in the areas of finance, law, and accounting; and enhancing urban functions to levels suitable for an international financial centre. Tokyo scores well in terms of infrastructure in my opinion. But we need strategic and long-term efforts both in terms of infrastructure and in terms of human resources.

Putting this Plan into action is an urgent task for us. The FSA is committed to the speedy and steady implementation of the measures in the Plan. Of the measures outlined today, some will not require any revision of existing laws and the FSA can act on its own on these matters. In such areas, we intend to act immediately. Expansion of disclosure in English, and many of the measures for better regulation fall in this category.

On the other hand, such measures as the establishment of markets designated for professionals, the relaxing of firewall regulations, and the broadening of the scope of businesses permitted to financial institutions will require corresponding legislative revisions. In these areas, we are committed to promptly submitting the necessary amendment bill to the Diet. By taking these actions, it is our intention to enhance the attractiveness and quality of Japan's financial and capital markets, and thereby to attract and accumulate funds, information, and human resources to our markets from both domestic and international sources.

III. Ongoing Turmoil in Global Financial Markets and Its Impact on Japan's Financial System

I would like to focus the rest of my speech on the ongoing global market turmoil and its impact on the Japanese financial system.

The turmoil triggered by the subprime mortgage problem in the US has affected various markets around the world since last summer. Many major financial institutions in the US and Europe have been reporting massive losses. It would be inconceivable for the Japanese market alone to remain immune and unaffected. In fact, we have seen that Japanese stock prices are moving in tandem with the US and other markets, and sometimes falling more. However, the impact on the soundness of Japanese financial institutions has been limited. As far as the financial system is concerned, we can say at present that the global market turmoil has not had a serious impact on the Japanese financial system itself.

Last week, the FSA released data on the exposures of Japanese banks and other deposit-taking institutions to subprime-related products as of the end of last year. Aggregate exposures came to approximately $14 billion, while aggregate losses--the sum of valuation and realised losses from April to December last year--amounted to approximately $5.5 billion. These figures reflect holdings of any securitised products related to subprime loans, including ABSs (asset-backed securities) backed by subprime loans and CDOs (collateralised debt obligations) backed by such subprime-related ABSs.

These figures clearly show that the exposures and losses of Japanese banks are very limited in comparison with global figures. For instance, the total size of the subprime loan market in the United States is said to be about $1.3 trillion. Many major US and European financial institutions have announced losses on the order of billions of dollars per institution, or tens of billions of dollars in some cases. It is also fair to say that the size of the exposures and losses of Japanese banks on the whole should be well under control in light of their financial soundness. In aggregate, the Tier 1 capital of these institutions amounts to nearly $450 billion, and their net annual operating profits from banking businesses totalled about $60 billion in the last business year.

Needless to say, the market turmoil we are faced with is still ongoing on a global scale and has been spilling over to a broader range of financial products and markets. Therefore we must continue to be vigilant and carefully monitor developments in the financial markets and the business conditions of financial firms.

By the way, I believe that Japan is probably the only major country where the authorities have released these national aggregate exposure figures. Our first release back in November last year on figures as of end-September, and its update last week, reflect our position that the release of such information by the authorities can contribute to reducing uncertainties in the markets. In a broad sense, this constitutes part of our efforts toward better regulation.

While the US and European credit markets have been adversely affected by the turmoil, Japan's credit market has remained relatively stable. This may be a reflection of the stability of Japan's financial system. This is likely a matter of significance for CFOs in charge of financial management strategies. Corporate credit markets in the US and Europe have experienced a sharp widening of spreads since last summer. On the other hand, the increase in corporate bond spreads in Japan has been limited, and Japan has continued to provide a relatively stable marketplace to raise funds. As a result, the total value of corporate bonds issued in the Japanese market during 2007 was up 40 percent from the previous year, marking the highest level in nine years.

From the 1990s to early 2000s, we experienced serious and prolonged difficulties in the financial sector due to nonperforming loan problems. The issue faced by Japan's financial system at that time was the over-concentration of risks in the banking sector. We have eventually overcome these difficulties by taking effective policy actions and also efforts on the private sector. The policy actions included capital injection into weak banks using public money. Along with this process, our institutional framework to ensure the stability of the financial system has been upgraded and improved considerably.

The ongoing global turmoil, however, is of a new, different nature, in that it arises from financial markets and its impact can spill over instantly on a global scale. In this sense, it can be characterised as a “21st century-type crisis”. Thus, the problems we are currently faced with on a global scale are more complex and interdependent, and more challenging for authorities around the world.

IV. Concluding Remarks

It is fortunate for us that the impact of the global turmoil on Japan's financial system has been relatively limited, and that we are in a position to be able to envisage in a forward-looking manner how to develop Japan's financial markets in the future. The FSA is fully committed to promptly implementing the various measures envisaged in the Plan so that we can continue to contribute to making our markets more attractive to investors and issuers, both domestic and abroad.

It is the private sector, however, who is expected to play the leading role in our collective efforts to this end. By taking advantage of the policy measures implemented in accordance with the Plan, financial firms and exchanges will be able to further improve their products and services and better serve the needs of their customers. The role of invigorating the financial markets also falls in part on those who use the financial services and capital markets. We look forward to working with all of you, including corporate CFOs and those in the financial services industry, to make Japan's financial markets better and more attractive and to strengthen their international competitiveness.

Thank you.