Challenges and opportunities in Japan’s bank sector

Author: | Published: 1 Mar 2013
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Paul Hunter, secretary general of the International Bankers Association of Japan, shared his thoughts on Japan’s business environment, the newly-established Japan Financial Markets Council and global regulatory issues

Paul Hunter, secretary general of the International Bankers Association of Japan

What is the International Bankers Association of Japan (IBA) and what sort of business do foreign banks and securities companies undertake in Japan?

IBA Japan is a trade association representing 57 foreign banks and securities houses from 22 countries that have a presence in Japan. The organisation also has over 20 associate members including legal, accountancy and financial services consultants.

IBA Japan aims to promote and foster cooperation among foreign firms in Japan; promote the growth of banking and capital markets in Japan; as well as advance the common interests of its members.

Japan is the world's third largest economy and has a number of attractive characteristics for foreign banks. It is the most developed market in Asia with a per capita income nine times the size of China. It has a sound legal and business environment and unlike some other Asian markets, has no current or capital accounts or exchange rate controls. Japan also has a massive government bond market worth some $12 trillion; a large stock market with a market capitalisation of $3.5 trillion; the largest accumulation of personal wealth in the world (amounting to ¥1,510 trillion ($16.1 trillion); and also the largest pension funds ($3.3 trillion).

The size of the market therefore presents foreign firms with a number of opportunities, including: trading Japanese government bonds and equities; fundraising by international bond issuers who want to take advantage of the deep capital markets; and, equity investment by foreign institutional investors. Many Japanese firms are cash rich and are looking for opportunities to expand overseas, and foreign firms' advisory expertise and their global network can aid this process. Foreign banks are also active in the development and sale of derivatives, private wealth management and trade financing between their home country and Japan. To be considered a truly global bank, a firm needs to have a base in Japan.

What are the challenges of doing business in Japan?

Japan is a heavily banked market. There is a wide array of domestic firms often working on small profitability margins and competition can be tough. There are some parts of the market in which foreign firms, on the whole, do not get involved in – this includes mass market retail domestic banking services – as the opportunities for a profitable business are limited. Foreign banks therefore concentrate their efforts on areas where they can add value, for example leveraging off their expertise or global network, and where they can look to be profitable. Some firms have also taken opportunities to engage in formal tie-ups with Japanese companies to maximise their impact.

On the whole, from a regulatory perspective, foreign firms are not treated in an unequal manner compared with their domestic counterparts. For some foreign firms some of the practices in Japan may be different to the requirements in their home or other jurisdictions in which they operate. For example, in Japan there are firewall requirements about sharing information of a non-market sensitive nature between a firm's securities and banking business. This may mean there are less opportunities for cross-selling and also have implications for overarching management controls, but this is also true for domestic firms. The difference is that foreign financial groups may have to adapt some of their existing group practices which may cause challenges including integrating their Japanese operations or leveraging off their existing platforms.

Japan of course is also a costly market in which to do business, although as noted above, there are of course opportunities. Management needs to decide how to have the right control functions on shore and what makes sense to be outside the country.

The IBA is supportive of the Financial Services Agency's Better Regulation Initiative, as well as its goal of principle-based regulation. Japan wants to be a major financial centre and there is competition from within the region as well as globally. We look forward to working with the authorities in maximising the opportunities.

What are some of the Japan-specific issues that the IBA is focusing on this year?

Over the next year our members will want to see how the direction of the new Japanese government's three-pronged economic strategy will unfold. The three parts of the strategy are: monetary policy; fiscal stimulus; and, private sector-led growth and structural reforms to the economy. In the first few months of the administration we have seen the weakening of the yen and a corresponding rally in the Japanese stock market. But what will be key to the longer-term attractiveness of the Japanese market will be structural changes that may help boost the real economy.

Whether Japan joins the Trans-Pacific Partnership (TPP) negotiations and the progress on the EU-Japan Free Trade Agreement discussions will be important indicators (not just for the financial sector) about the Abe Administration's ability to secure wider structural change in domestic markets. The new management team at the Bank of Japan and the course of actions they choose will be another important feature in the coming year.

The wider global economic and business environment will also have an impact on Japan with firms wanting to optimise their operations and look for opportunities that fit into their global strategy.

Japan, like many countries, is looking at how to ensure that financial stability is well rooted in the domestic system. Last year the Financial Systems Council commissioned a working group to look at a range of financial stability issues including the role of foreign banks in Japan. The IBA participated as an observer and has worked with the FSA secretariat. The working group's recommendations are now likely to form amendments to the Banking Act, the Financial Instruments and Exchange Act (FIEA) and other related laws in the current Diet session. The government is keen to ensure that foreign banks hold a minimum of ¥2 billion worth of assets in relatively safe domestic instruments and there will be arrangements to phase in this provision. There will also be a supervisory framework to look at risks related to the outflow of funds. Like other national regulators Japan will also be looking at having in place a robust framework, both for foreign and domestic financial institutions, to deal with the risks in dealing with failed institutions. We will be working with the regulatory authorities to ensure the smooth introduction of these measures.

A separate Financial Systems Council working group has also been looking into the area of insider trading. The IBA is in favour of open and transparent markets that help support a vibrant and well functioning market. We therefore are in favour of legislation that is likely to be introduced which will criminalise individual trading behaviour in the case of the disclosure of material and non-public information about issuers. We plan to work with the authorities over the coming year about how the regulations are actually implemented.

Another example of global change having an impact on the domestic agenda is whether Japanese clearing houses are in line with the Basel III Financial Market Instruments (FMI) principles. International firms want to treat their trade exposures to the clearing counterparty as a risk weighted asset requiring capital of two percent; this would be advantageous to many internationally focused Japanese and foreign firms.

How will the IBA work with the newly-established Japan Financial Markets Council (JFMC)? How does the JFMC plan to interface with other international financial organisations, such as the Asia Securities Industry & Financial Markets Association (ASIFMA) and the Global Financial Markets Association (GFMA)?

The JFMC was set up last year and includes five major Japanese capital markets firms (Bank of Tokyo-Mitsubishi UFJ, Daiwa Securities Group, Mizuho Securities Co, Nomura Holdings and SMBC Nikko Securities), and five foreign firms which are coordinated through the IBA. The co-chairs are currently from Morgan Stanley and Nomura. The Council's objective is to look at the impact of global regulatory initiatives and how they will impact on Japanese market participants.

The JFMC works in partnership, where appropriate, with the GFMA. This is an umbrella organisation for the three regional entities: the Securities Industry and Financial Markets Association (Sifma), Asifma – which excludes Japan – and the Association for Financial Markets in Europe (Afme). A memorandum of understanding (MoU) between GFMA and JFMC has been put in place and it sets a framework in which we agree we will cooperate and collaborate on a range of issues where appropriate.

Although the JFMC is a new entity, it has received a good level of initial support including from the Japanese regulatory authorities. Our activities have been focused on responding to major regulatory consultations that are of particular concern to Japanese market players. These have included: the joint Basel Committee on Banking Supervision (BCBS) and Iosco consultation on initial margins for non-centrally cleared derivatives; cross-territorial issues raised in the US Commodity Futures Trading Commission's (CFTC) proposed cross-border swap regulations; and the Financial Stability Board's (FSB) consultation on shadow banking risks for securities lending and repos.

The IBA Secretariat (which is made up of six people in total) also provides secretariat functions to the JFMC and we work closely in line with member firms. The Council therefore has limited resources and we have to set clear priorities on the issues on which we will focus.

What are the most pressing global regulatory issues for 2013, and how do you expect them to affect international banks in Japan?

Many of the regulatory issues that affect international financial institutions will also affect their entities in Japan either directly or indirectly. For example, large firms' capital requirements, liquidity plans or resolution schemes will need to take account of their Japanese operations. The Japanese authorities have also been introducing many of the global standards into domestic law (for example the Basel III capital requirement standards) and they have also taken leading roles in some of the international standard setting bodies including Iosco.

Extraterritoriality issues are likely to continue to be important. For example we believe it is important that the principle of substituted compliance – when rules that maybe are different but equivalent in nature and intention, across countries – is recognised by national and international regulators when developing new regulatory regimes. To do otherwise is likely to cause confusion, implementation problems and unintended consequences. The Japanese regulatory authorities have written and published letters to the US Commodity Futures Trading Commission on this issue and it was also the subject of a JFMC letter in relation to cross-border swap regulations.

The JFMC has highlighted some of the problems we foresee with the BCBS/IOSCO proposed rules on initial margins for non-cleared swapped derivatives including the impact it may have on liquidity levels and possible feedback on the real economy including in Japan. We are alive to the concern about possible regulatory arbitrage but we believe it is important that regulatory authorities also consider the varied practices in different jurisdictions when developing global standards and they should have regard for local business conditions and practices – which may differ in practice to those prevailing in Europe or North America – and which may include inbuilt mitigation procedures.

One of the key issues we believe will be important in the coming year is how the combination of new global regulatory standards will interact with each other. Both regulators and practitioners need to guard against introducing measures that may, in aggregate, have unintended and unfortunate consequences.

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