Chapter 1
Introduction

We made our review from September 1987 through January 1988 in

accordance with generally accepted government auditing standards.

Chapter 2

Views of U.S. Financial Institutions on National Treatment in Japan

U.S. financial institutions in Japan believe that in some areas they generally receive national treatment, but they still find Japan a difficult market in which to compete and have been frustrated by their lack of access to certain financial sectors. Despite the numerous steps taken to further open Japan's financial markets to foreign firms, foreign banks still have only a small share of the market and foreign securities firms continue to confront competitive barriers.

While U.S. financial institutions believe that they are generally accorded national treatment in Japan, they cited the following two problems: the first is a national treatment issue, while the second concerns market access.'

⚫ U.S. and other foreign firms play a small role in the Japanese government bond market. The Japanese have taken steps recently to address this concern by increasing foreign firms' share of 10-year government bond issues, the most heavily traded bond in that market. However, these actions appear to have added little to foreign firms' share of the government bond market.

U.S. firms have difficulty in introducing some types of new financial products in Japan, such as futures and options. Although the Japanese government has introduced legislation in the parliament establishing a domestic futures market to allow comprehensive futures trading in currencies, interest rates, bonds, and stocks, some of the difficulties associated with introducing new financial products are likely to remain for the near future.

A very important past concern of foreign financial firms, access to the Tokyo Stock Exchange, appears to have been addressed to the satisfaction of most of the foreign financial firms seeking membership.'

'These issues are discussed in more detail in our report, Market Access Concerns of U.S. Financial Institutions in Japan (GAO/NSIAD-88-108BR) March 1988

2Futures are contracts for future delivery of a commodity or a security. Options are contracts that give the holder the right to buy or sell a specified amount of securities at a predetermined price over a certain period of time.

Tokyo Stock Exchange officials in December 1987 selected 16 additional foreign firms for member ship. In 1985, 6 foreign firms had been admitted to the Exchange. The increased membership should accommodate most major foreign firms interested in and able to take advantage of membership with the exception of one qualified US firm whose membership application was recently rejected.

Chapter 2

Views of US. Financial Institutions on
National Treatment in Japan

Liberalization of
Markets

The success of foreign financial firms in Japan depends, to a certain
extent, on the degree of openness and deregulation of Japan's financial
markets. Since the late 1970s, the Japanese government has gradually
liberalized Japanese financial markets, doing so with increasing speed in
the past few years. The 1984 benchmark agreement commonly known
as the Yen/Dollar agreement has helped to accelerate this process by
promoting the (1) development of a Euroyen market, (2) liberalization of
Japan's domestic capital markets, and (3) removal of barriers to foreign
entry into the domestic financial services industry. Progress in liberaliz-
ing Japan's financial markets has been more successful in the interna-
tional than in the domestic market, in part because domestic
deregulation can be politically controversial.

The rigidities of Japan's regulated domestic markets affect U.S. firms'
abilities to compete in Japan. For example, many Japanese banks, in
contrast to foreign banks, have access to regulated, low-cost domestic
Japanese deposits through their large established retail networks."
Thus, foreign banks must rely on relatively high-cost money brokers for
their funding in Japan; this difficulty is compounded by Japan's lack of
a true interbank yen market where banking institutions borrow and lend
funds among themselves.

Some U.S. banks believe they are at a competitive disadvantage because Japanese regulators impose less stringent capital requirements on Japanese banks than U.S. regulators impose on U.S. banks. The Japanese have recently taken steps to bring their capital standards more in line with those of other major industrialized countries. In 1986, Japanese bank regulators raised the minimum capital guidelines for Japanese banks and in December 1987 announced that Japanese banks would be subject to the new risk-adjusted capital standards developed by the Basle Committee and the Bank of International Settlements.

'The Yen/Dollar agreement was developed by a working group from the US. Department of the Treasury and the Japanese Ministry of Finance in 1984. See our report, Implementation of the Yen Dollar Agreement (GAO/NSIAD-86-107) June 1986.

Low-cost deposits are partly the result of interest-rate controls which still affect 60 percent of bank time deposits in Japan.

"US banks do not view the retail networks per se as a national treatment issue or as a sigruficant barrier, since they are not planning to enter the retail banking sector in Japan.

The Basle Committee. formally the Committee on Banking Regulations and Supervisory Practices, is the principle forum for international coordination among national banking supervisors and regulators.

Chapter 2

Views of US. Financial Institutions on
National Treatment in Japan

Japanese Government
Bond Market

Japanese government bonds make up the largest portion of the Japanese
bond market and are issued through one of three methods: an auction,
an underwriting syndicate, or direct placement with official accounts,
such as the Trust Fund Bureau and the Ministry of Posts and Telecom-
munication. In 1987, about 29 percent of these bonds were issued
through an auction, 37 percent through a syndicate, and 34 percent
were placed with official accounts. Seventy-eight percent of the bonds
issued by syndicate were 10-year government bonds. Changes made in
the government bond market in 1987 included issuing 20-year bonds
through an auction instead of through syndication and relaxing foreign
firms' eligibility criteria for participating in the 2, 3, and 4-year bond

markets.

The most important government bond issue is the 10-year bond issue, especially in terms of secondary market trading. While most other maturities are sold and priced through auctions, the Japanese government has maintained a consortium procedure for 10-year bonds.

To improve foreign firms' share of the 10-year issue, the Japanese government on April 1, 1987, increased foreign firms' share of the bonds allocated through the underwriting syndicate that is responsible for selling the 10-year issue from 0.3 to 1.5 percent and as of November 1987, introduced a limited "auction" for 20 percent of each 10-year issue. Under this process, foreign firms bid on a supplementary volume of bonds desired without knowing the issue terms. The maximum bid permitted per financial institution is one percent of the total issue; oversubscribed bonds are allocated to each bidder in proportion to its bid. This supplementary allocation system is not actually an auction, because the price of the bond is still set through negotiations between representatives of the underwriting syndicate and the Japanese government. Nevertheless, as a result of this new scheme, foreign securities dealers were able to increase their total share of a November 1987 10-year issue from the 1.5 percent share allocated under the previous formula to about 5 percent.

Despite this increase, foreign firms are still restricted to an insignificant role in the primary market for 10-year government bonds in Japan. The

"Underwriting is a process whereby an agent purchases a new issue of securities from an issuer and resells it. In an underwriting syndicate, portions of an issue are shared among participants. The underwriting syndicate for Japanese government bonds consists of approximately 800 financial institutions. As of April 1987, 12 US banks and 12 US. securities firms were members of this syndicate. "Secondary market trading refers to the buying and selling of previously issued securities.

Chapter 2

Views of US. Financial Institutions on
National Treatment in Japan

Introducing New
Products

U.S. Treasury and major foreign financial institutions in Japan have not succeeded in persuading the Japanese to adopt a full auction process for all government bonds in which issue terms are freely determined through open market competition. Although Ministry of Finance officials acknowledge that it is important to give foreign firms greater access to the full government bond market, their primary objective is to maintain a smooth distribution system and they believe that a full auction process would introduce an unacceptable level of uncertainty to the bond market, i.e., there would be no assurance that purchasers would fully absorb all issues regardless of market conditions. At this time, there are no plans to eliminate this syndicate allocation system.

Foreign firms in Japan sometimes have difficulties in providing the full range of products that they are able to offer in other markets, particularly new and innovative financial products such as futures and options. While not a national treatment issue, these difficulties result from existing regulations and policies governing approval of new products and the underdeveloped state of the futures and options markets in Japan. Under the Ministry of Finance's current policy, there is a general presumption of no entry for new products or services without prior Ministry approval.

A January 1988 Ministry of Finance report outlined the shape of a comprehensive financial futures market in Japan and called for broader Japanese access to overseas futures and securities options markets. The Japanese government has also submitted legislation to the parliament establishing a domestic futures market to allow comprehensive futures trading in currencies, interest rates, bonds, stocks, and various index products. However, it is not expected that a full-fledged financial futures and options market will begin before late 1988. The length of time it will take to develop a full-fledged futures market in Japan has led to complaints from some U.S. firms that new financial products are allowed to be used in Japan only after Japanese firms have mastered their use in overseas markets, leaving U.S. firms in Japan with little or no competitive edge.

U.S. financial institutions told us they also have had difficulty receiving permission to sell collateralized mortgage obligations, cash management

Index products reflect in a single number the market values of a list of selected securities. An equity stock index, for example, allows investors to profit from, or protect against, price movements in the stock market generally rather than in individual stocks.