IFLR: What regulatory changes are needed in Japan to stimulate the economy?
Philip Quirk, managing director and head of the law division, Morgan Stanley, Japan: One of the obvious stimulants required is the implementation of an effective government plan to help Japanese banks dispose of their distressed debts. This is necessary to ensure that banks recover the capability to provide capital to healthy companies that require funding to expand.
The continued disposal of cross shareholdings would also be a positive step in the process of restructuring companies and banks in Japan. New mark-to-market rules introduced last year helped accelerate the pace of disposals. Exchangeable bond issues are a proven way of unwinding cross-shareholdings, but a number of barriers still exist in Japan that prevent their extensive use domestically. For example, the lack of a true sale treatment for the underlying shares until conversion occurs does not meet the timetable of many issuers - especially banks. Similarly a review of the limited exemptions to public offering requirements could stimulate increased private placement activity.
Tomoaki Ikenaga, director and general counsel, Deutsche Securities Limited, Japan: While Japan has taken a number of steps to stimulate the economy, there are still gaps between Japanese regulations and global market practices in certain areas. For example, the recent amendments to short sale regulations, which removed exemptions from flag requirements and the down tick rule for margin sales, initially supported prices on the Tokyo Stock Exchange. But [the amendments] led to a fall in transaction volumes because they added to the concerns of market participants. This was a short-term solution to maintain stock prices, but did not serve the long-term development needs of the market.
Japan needs to adopt best practices to foster trust in the markets by individual investors. The following steps should be made towards that goal:
the development and enforcement of more open accounting and reporting standards;
the review and modernization of banking, securities, insurance and tax laws to reflect a flexible and modern approach to financial markets; and
the modernization of bankruptcy law and the related commercial code to yield a more effective approach to freeing up distressed assets and resolving non-performing loans.
Senior counsel at a leading investment bank in Tokyo (preferred to remain anonymous): There are and will continue to be various individual changes that need to be implemented, including bringing private placement rules - particularly with respect to debt securities - up-to-date with the paperless or clearing system-based securities system.
But the key change that should be implemented is transparency and expediency on the part of regulatory agencies. Because of the lack of transparency, market participants are uncertain whether or not a certain product or service may be provided in Japan. This results in a chilling effect that impedes bringing in new products, services or initiating new activities that may contribute to the stimulation of the economy. The introduction of the no-action letter system is a step forward but the results to date, based on the experience of the market participants who have tried to use this system, have been disappointing.
With respect to expediency, the Japanese government should address requests for clarity, transparency or regulatory change. This becomes an issue when the regulatory change that needs to be effected will be either subject to approval by more than one government ministry/agency, or when the regulatory change will affect tax revenue. While each government ministry or agency may be extremely capable of protecting the interests that it is responsible for, there is a lack of strong leadership overall. So when the issue touches multiple government agencies, the default option often becomes a solution that takes into account the interests of every ministry or agency concerned, resulting in the worst common denominator.
When regulatory changes affect tax revenue, the lack of strong leadership will lead to the revenue authorities (including the Liberal Democratic Party, which has strong decision making powers with respect to tax policy) opposing any measure that reduces tax revenue in the short term. This impedes regulatory changes that need to be implemented.
IFLR: What are the main compliance challenges that you face and how do you overcome these?
Philip Quirk: A key challenge for foreign-based investment banks is that global products and risk management policies need an additional level of scrutiny before they can be introduced into the domestic market. This is particularly true in Japan. It is therefore critical that institutions develop an open relationship with the regulators and retain experienced compliance personnel to maintain this relationship.
Given the current economic climate there is increasing pressure on clients to find effective solutions for their financial needs. To maintain the highest standards of regulatory compliance firms must develop robust internal controls to assess new products and transactions. In this process it is as important to operate in accordance with the spirit as much as the letter of the local regulations. It is therefore essential to maintain a two-way dialogue with the regulators to ensure that standards are maintained as the regulatory environment evolves.
Senior counsel: The main compliance challenge is to better understand your regulatory authorities. This requires constant dialogue with the regulators as well as reading the political trends, because regulatory action can often be influenced by the political and economic trends of the times. Market participants will need to meet this challenge by increasing communication with the regulators and paying careful attention to politics by bringing in experienced government relations professionals. In the case of Japan, because there is a dearth of such professionals also experienced in the private sector, it may be necessary to develop such professionals.
IFLR: Should Japan adopt the US approach and create a truly independent securities regulator?
Philip Quirk: There may be a perceived benefit that a regulator, which is truly independent from government, would be more transparent and accountable in terms of legal redress. But the key issue is whether the regulator acts in an effective, efficient and transparent manner.
The UK Financial Services Authority is a non-governmental organization and the appointment process for commissioners of the US Securities and Exchange Commission is designed to be apolitical. The Japanese Financial Services Agency (FSA) is an external organ of the Cabinet Office that reports to the Cabinet and therefore remains a government organization.
The regulator is taking a very thorough approach to its on site inspections, as all investment banks that have been through the process would agree.
Tomoaki Ikenaga: Rather than modelling itself on any one country, Japan is developing its own approach to securities regulation. Regardless of the approach chosen, we agree that regulatory independence is an important quality in a well-functioning and fair market and support steps in that direction.
Further, the FSA's ability to provide transparent, clear, and consistent interpretation of rules and regulations to market participants will go a long way toward restoring confidence. We acknowledge that doing so will be a challenge within the current political and regulatory frameworks.
Senior counsel: I am a true supporter of a truly independent securities regulator though I cannot give an opinion on whether the US securities regulators are truly independent. In my view, a truly independent securities regulator will be free from the influence of politics, and will aim overall to balance an efficient market and the protection of investors, and to implement securities regulations in a fair and transparent manner.
IFLR: What are the biggest challenges you foresee for doing business in the future?
Philip Quirk: It is essential that foreign-based investment banks maintain an open dialogue with the regulator to ensure that global business practices and internal controls are always in accordance with the regulator's concept of what constitutes the highest regulatory and ethical standards.
To achieve this, institutions must act on an inclusive basis with the regulator. Frequent consultations and disclosure of information help the regulator perform its function and help the institution maintain high regulatory standards.
Tomoaki Ikenaga: Having discussed the importance of restructuring, there are still several challenges. Firstly, the size of the market is small and illiquid compared with other developed economies. Secondly, the level of sophistication in this market tends to be fairly limited compared with other international markets. Thirdly, the administration faces undue and, to date, insurmountable social resistance against necessary restructuring activities, such as bankruptcy, staff reductions, reorganizations, foreign buyouts and foreign management teams. In this environment, Japanese companies tend to postpone the difficult decision to tackle fundamental problems until these issues threaten their very survival.
All of these problems impede the natural role of supply and demand in bringing equilibrium to the capital markets.
Senior counsel: The challenges are to create a competitive edge in terms of innovative products and services - including restructuring ideas - and ensure regulatory compliance when implementing these.
| IFLR: What trends are emerging in the types of deals being done? Philip Quirk: There is an increasing acceptance of foreign investment and expertise. We believe that through restructuring, there will generally be a greater role for foreign investment banks to play in the rehabilitation of financial institutions and corporates. Japanese convertible bonds, particularly issued in the Euromarkets, are becoming increasingly popular to facilitate financial restructuring. The downside protection of convertible bonds combined with an option on the upside performance of the company over the medium term is particularly well suited to both the equity market environment and to the prevailing industry and business conditions many Japanese companies are experiencing. We also expect that more Japanese companies will continue to undertake share repurchase programmes when financial pressures on companies and their associated leverage concerns ease. Tomoaki Ikenaga: Clearly M&A and restructuring are critical forces in Japan, though the number and size of these transactions continue to lag behind those of other markets. However, advisory and restructuring businesses have continued to develop in recent years, and the use of advisers by Japanese corporations continues to grow. To a large extent, the M&A market is being driven by the necessity for Japanese companies to restructure and re-tool. The environment has also been affected by a series of changes to the Japanese commercial code - spin-off rules, revised bankruptcy procedures, and new accounting rules - all of which have accelerated corporate restructuring. There is also increased insterest in the privatization of government-related service agencies and industries. This is one of the main areas the Japanese administration wishes to advance. The establishment of a public corporation to operate the Postal Services Agency is one example. Another is Japan Highway Public Corporation, which is studying possible privatization options. These developments will accelerate as Japan sets about restructuring its economy. Senior counsel: M&A and restructuring transactions involving troubled financial institutions, companies and borrowers will continue to increase. The banks are unable to restructure themselves because of a lack of strong leadership that will make sacrifices, and a lack of financial and government support. |