No. 6 — February 16, 1996


Weekly Review

--- by Jon Choy

A second follow-up meeting between Washington and Tokyo to review the implementation of a January 1995 bilateral financial services pact gave Ministry of Finance officials a chance to showcase their continuing program of financial market reform and deregulation. At the February 6 get-together in Tokyo Finance Ministry representatives announced plans to revise regulations by the end of March to allow corporations to sell asset-backed securities. American investment banks and investment advisory firms have been pushing for this relaxation. The Japanese officials also explained in detail proposed changes in rules covering the management of public and private pension funds; the changes are expected to increase business opportunities for foreign investment advisory firms. Combined with other announcements of rule changes, Tokyo could say that progress has been made in all four of the areas outlined in the 1995 pact.

Last year's financial services agreement was one result of the talks held under the umbrella of the U.S.-Japan Framework for a New Economic Partnership. Washington hoped that reforms sketched out in four areas — asset management rules, corporate securities, cross-border financial transactions and administrative transparency — would improve the climate of Japan's financial markets for foreign firms seeking to do business there (see JEI Report No. 2B, January 20, 1995). An initial review last May in Washington came too soon after the pact was signed to show substantial progress; that qualifier did not apply to the second review session.

Even though Japanese financial authorities and analysts have been preoccupied with resolving the nonperforming loan situation and related financial scandals (see JEI Report No. 4B, February 2, 1996), reforming and restructuring domestic financial markets remain high on policymakers' lists. Last March, for example, Tokyo removed the remaining restrictions that had prevented foreign firms from bidding to manage the estimated ¥20 trillion ($200 billion at ¥100=$1.00) pool of public pension funds and reduced licensing requirements for foreign investment advisory firms (see JEI Report No. 21A, June 9, 1995). Pension funds under foreign management increased 33 percent through the first half of FY 1995 (April 1-September 30), according to MOF officials; foreign firms, however, still manage less than 5 percent of all Japanese pension monies.

Observers expect MOF's latest moves in the pension fund area to shake up the market even more. Officials announced February 8 that the ministry would end regulations that detail public pension fund portfolio investment ratios and that limit the types of firms that can be tapped as investment managers. The so-called 5:3:3:2 rule, expected to be dropped by the end of this March, sets ceilings on the portion of each pension fund that can be invested in domestic fixed-income securities (50 percent), foreign equities and other financial instruments (30 percent), Japanese equities (30 percent) and real estate (20 percent). Interim changes also will impact rules that have forced pension funds to limit to one-third the share of any one fund that is managed by an investment advisory firm; the remaining two-thirds has to be managed by insurance firms or trust banks. MOF has proposed that, as of April 1, as much as 50 percent of any single fund can be managed by investment advisory firms, and that the ceiling would be lifted entirely three years later. This would open foreign access to the estimated ¥38 trillion ($380 billion) worth of private pension funds in Japan as well as the publicly sponsored ones.

Driving the changes are two factors: retired citizens' share of the population is growing, and traditional Japanese pension fund managers have achieved skimpy returns on their portfolios. Social Insurance Agency statistics indicate that the number of persons receiving a government-sponsored pension pierced the 30 million mark by the end of FY 1994, climbing about 5 percent to 30.4 million retirees and their spouses. Accordingly, public pension funds paid out a total of ¥29.6 trillion ($296 billion), 10 percent more than in FY 1993. The number of public pension fund contributors, however, rose only 0.4 percent that same fiscal year to 69.6 million. Japanese life insurance firms, which control a large portion of pension funds, announced in early February that they will be forced to cut their guaranteed annual return from 4.5 percent to 2.5 percent effective April 1. (From 1966, when insurers began managing pension funds, until 1994 they had guaranteed a 5.5 percent return, but poor market conditions forced the cut to 4.5 percent.) It is clear to analysts inside and outside the government that the combination of rising pension demands and falling returns is a recipe for future insolvency. By liberalizing the rules on how fund assets are allocated and who can manage this money, Tokyo clearly is hoping to keep the system in sound financial health for Japan's rising number of retirees.

With regard to corporate securities, MOF officials explained to their American counterparts at the early February meeting a rule change that would allow domestic and foreign firms to issue asset-backed securities in Japan beginning April 1. Also on that date MOF plans to allow the flotation of exchangeable and dual-currency bonds. Foreign investment banks and advisers have honed their skills in managing the sale of asset-backed securities into a competitive weapon that they hope will help them penetrate the Japanese market. Several categories of Japanese firms, including leasing companies and real estate firms, also anticipate that the rule change will make it easier for them to turn their illiquid assets into cash.

As for cross-border transactions, MOF announced February 8 another round of changes. Last August the ministry lifted restrictions preventing insurance firms from making loans overseas denominated in a foreign currency. The latest changes include: raising the limit on overseas foreign currency deposits made by corporations for investment purposes from ¥100 million ($1 million) to ¥200 million ($2 million); requiring companies to report quarterly such deposits when they exceed ¥50 million ($500,000) rather than ¥5 million ($50,000); allowing securities houses to broaden their services by making yen-interest rate swap agreements with foreign investors that buy yen-denominated bonds; permitting stock brokerages to settle trades of foreign currency-denominated securities with Japanese investors via their overseas foreign currency deposit accounts; and eliminating a requirement that the overseas subsidiaries of Japanese banks obtain MOF approval when they extend loans with terms of more than one year to foreign firms. The changes have two intended effects. They will ease the way for Japanese investors to make overseas loans and investments, which should help boost the trading of yen for other currencies. They also should foster competition by pressuring domestic financial services providers to lower fees to remain competitive with overseas counterparts.

In the area of administrative transparency MOF claimed that it had eased its procedures and rules to make much easier the introduction of new financial instruments in Japan. Officials also pointed out that the ministry had lowered rating requirements for corporate bond issues, an area of heightened activity in light of record-low Japanese interest rates.

American officials participating in the Tokyo review meeting were upbeat but cautious about the results achieved to date. In a statement after the session Deputy Secretary of the Treasury Lawrence Summers said, "We are seeing some encouraging signs of progress on the ground and in terms of new business for financial institutions. " Other Treasury officials warned, however, that the changes made to date were not revolutionary and that more time is needed before assessing their real impact. Private analysts for the most part said developments were going in the right direction. Washington still is seeking progress in other areas, however, such as insurance market access and deregulation. Outside observers are hoping that the bad-loan crisis will put more pressure on MOF to reform and liberalize Japan's financial markets to make them more flexible and innovative — as well as more open to foreign participation.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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