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Japanese FSA Produces Reform Blueprint, Bank of Japan’s Shirakawa Talks up Risk Management

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The Japanese Financial Services Agency (FSA) has released its blueprint for an overhaul of the country’s financial services regulatory framework, including forcing more transparency in the OTC derivatives markets, new trade reporting requirements and risk management provisions. Last week, the governor of the Bank of Japan, Masaaki Shirakawa, also spoke about the importance of Japanese flavoured risk management and regulation at a Bank for International Settlements (BIS) summit in Kuala Lumpur.

The FSA is currently engaged in a detailed examination of the issues that Japan should address within the financial markets in preparation for government discussions early next year. Based on a survey of market participants conducted in July, the regulator has duly produced a “Draft Blueprint for the Development of Institutional Frameworks Pertaining to Financial and Capital Markets” (available to download below).

The regulator is advocating the use of central clearing counterparties (CCPs) for the derivatives markets, much like the rest of the world, and for market participants to provide a greater level of granular data around the trading of these instruments. Rather than using a global CCP, the Japanese regulator is keen for clearing to be passed by a domestic CCP or, if a foreign entrant is keen to establish a domestic presence, then minimum standards must be set for entry.

“From the perspective of ensuring the overall transparency of markets and enabling authorities to gain an adequate understanding of the actual conditions of OTC derivative transactions, information on OTC derivative transactions should be submitted to the authority from trade repositories and from CCPs,” states the regulator. This will likely require a data repository to be established and maintained by the regulator to update and manage this data, similar to the repositories being discussed in the US and Europe. Given that the FSA is looking at a domestic level data challenge, this should theoretically prove easier to implement than a global initiative.

The regulator is keen for securities firms to take a holistic approach to their compliance and risk supervision, which the FSA has identified as lacking within the current market order. The regulator will also adopt a consolidated regulatory and supervisory approach towards large or systemically important firms: “Consolidated regulation and supervision of the entire group, including the parent company, should be conducted with regard to securities companies whose operations and risk profile require monitoring on the entire group basis.”

This will involve an investment in counterparty data tracking to be able to ascertain risk exposure for a firm and its subsidiaries across the market. The Japanese FSA is therefore likely to be closely monitoring any progress made towards establishing international business entity identifiers over the next year or so (Swift take note).

Hedge funds will not get off lightly next year, as the regulator is keen for hedge fund registration. Much like the proposals coming from the rest of the world to this end, Japanese hedge funds will be compelled to invest in their IT infrastructures in order to operate in a more transparent and joined up manner and avoid the scrutiny of the regulator.

Strengthening transparency of the markets in general will also mean the requirement for more data around areas such as pricing and valuations, thus spurring further traction for data vendors in the Japanese market.

The Bank of Japan’s Shirakawa cautioned last week, however, that the Japanese market must come up with its own domestically focused regulatory approach rather than simply following the rest of the world. He pointed out the relative stability of the Asian markets during the financial crisis as a result of firms’ cautious and risk aware approach towards complex products. He also explained that the heterogeneous nature of the region’s markets means that a one size fits all approach is not suitable in terms of regulation.

He cautioned, in particular, that uniform liquidity risk regulation could harm the country’s economy: “A minimum set of common rules is needed to be applied to internationally active financial institutions. At the same time, however, it is also important to leave a certain amount of room for local regulators and supervisors to adapt to the local situation. For example, the appropriate method of liquidity management can differ according to the business model of a particular financial institution. When considering liquidity regulation, the first item that comes to many people’s mind as qualified liquid assets would be government bonds. However, in some Asian jurisdictions, outstanding amounts of government bonds issued are small, as a result of fiscal discipline. For such jurisdictions, a uniform liquidity regulation could even be harmful.”

These discussions and the FSA research should go some way to kicking off the government debates at the start of 2010. Next year should inspire the Japanese regulator to get closer to producing a comprehensive reform package and it is likely that data management will prove to be a significant area for investment as a result.

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