Appendix II Concerns of U.S. Financial Instititions in Japan The Tokyo Stock Japan has gradually liberalized its financial system in recent years, and U.S. and other foreign financial institutions believe that in some areas they generally receive national treatment, that is, equal opportunities to compete in the Japanese financial markets. However, officials from U.S. financial institutions told us in October 1987 that in some market areas, they still find barriers to competition and have been frustrated by their lack of access to certain Japanese market sectors. In particular, these institutions have been frustrated by (1) the lack of access to the Tokyo Stock Exchange (TSE), (2) the small role U.S. firms maintain in the Japanese government bond market, (3) the difficulties associated with introducing some types of new financial products in Japan, such as futures and options, and (4) the fact that higher capital requirements are imposed on U.S. banks by U.S. regulators than are imposed on Japanese banks by Japan's regulators, which gives Japanese banks a competitive advantage in commercial lending. The Japanese have recently taken steps to address some of these concerns by, among other actions, expanding the membership of the TSE; increasing foreign firms' share of 10-year government bond issues, the most heavily traded bond in that market; and introducing higher capital requirements for Japanese banks. The increase in the TSE membership may be sufficient to provide membership to the most interested major foreign firms and appears to have addressed a major concern of the foreign community. In contrast, the actions taken to increase the foreign firms' share of the government bond market appear to have had little effect in increasing their share and alleviating their concerns-U.S. firms are still relegated to a minor role in Japan's primary market for government securities. When implemented, new capital standards may help remove a major source of competitive inequality in pricing loans arising from differences in Japan's and U.S. banks' capital requirements. Some problems remain in introducing new products, however, as trading in futures and options is not expected to begin before the end of 1988. A long-standing national treatment concern of U.S. firms has been access to the TSE. Some U.S. firms complained that they had been unfairly discriminated against by being denied membership on the exchange. In October 1987, exchange officials announced a second expansion of foreign membership, after the first expansion in 1985 allowed six foreign firms to become exchange members. This expansion should accommodate most major firms currently seeking membership. An increasing number of foreign firms are attracted to the Tokyo stock market because of its increasing size and importance.' Foreign firms regard membership in the TSE as a status symbol necessary to expand their share in the Japanese financial market. The financial advantage of membership is also important because member firms do not have to pay stock commissions to securities houses for executing trades as nonmembers do. The exchange, founded on April 1, 1949, opened up membership to foreign firms in April 1982 by deleting constitutional provisions against foreign membership. In November 1985, six foreign firms, of which four were U.S.-owned, gained membership to the TSE.2 These six firms received permission to begin actual exchange trading in 1986. However, several additional foreign applicants with extensive equities market experience were denied membership and believed that they were unfairly excluded from the exchange. According to TSE officials, the lack of floor space prevented any additional membership at that time. These officials said that because the exchange's auction system of stock trading requires its members to be physically present on the trading floor rather than linked electronically to the exchange, the lack of space was a valid reason for not increasing exchange membership. Recently, as a result of continued pressure from the foreign community to expand foreign membership, the exchange computerized between 50 and 100 of the its 250 most actively traded stocks, removing the need for floor traders in these stocks. This computerization, along with the building of additional facilities, opened up space for additional members on the exchange. In October 1987, TSE officials announced that 22 additional firms would be added to the membership. The 22 new members were selected in December 1987 and included 16 foreign firms, 6 of which were U.S. firms.3 Exchange officials told us they award membership to foreign firms using such criteria as the applicant's financial 'The TSE's aggregate current market value surpassed that of the New York and London stock exchanges in April 1987. The market value is obtained by multiplying the number of issued shares of listed companies by share price. These firms were Goldman Sachs, Merrill Lynch, Morgan Stanley, and Citicorp's London-based affiliate, Vickers da Costa Ltd. The TSE announced that it had received membership applications from 20 foreign and 20 domestic securities firms prior to the November 17, 1987, deadline. The 6 US. firms selected for membership in December 1987 were Salomon Brothers, First Boston, Shearson Lehman Brothers, Kidder Peabody, Smith Barney, and Prudential Bache. Appendix II Concerns of U.S. Financial Instititions Table II.1: Cest of Membership on standing, past business performance, and experience in the Japanese securities market. The TSE may also, "when it deems necessary," consider the consolidated financial data of the applicant's parent firm. This loophole can give the exchange substantial flexibility in awarding seats because it allows the exchange to give greater consideration in awarding memberships to relatively new or small-sized foreign firms in the Japanese securities market. Despite its attractiveness, the cost of a seat on the TSE is high compared with other major stock markets (see table II.1). New memberships cost about 1.1 billion yen per seat (about $8.8 million at Yen 125/$1.00). In comparison, the cost for an equity seat on the New York Stock Exchange (NYSE) ranges from $625,000 to $1.2 million. In general, some membership costs on both exchanges can be recovered when a member leaves the exchange and sells the seat. Officials of the TSE contend that the costs for seats on the TSE and the NYSE are comparable because NYSE corporate members have many seats. Overall, however, the NYSE has 1,366 seats and about 650 public members, or about two seats per member. In addition, trading on the NYSE can be done by other methods without buying a full seat, such as through limited memberships." "For example, instead of acquiring a full equity seat on the NYSE, interested firms may (1) lease a As more foreign firms become members of the TSE, the concerns of the foreign financial community are shifting from gaining access to changing rules concerning how operations must be conducted on the exchange. Some firms have already expressed some of these concerns. Complaints range from the fact that all settlements must be concluded physically and in 3 days (that is, actual stock certificates must be delivered to the buyer) to the number of long and detailed reporting requirements, which add substantially to the cost of doing business on the exchange. Some of these problems may be eliminated when a new clearing system operated through the Japan Securities Depository Corporation opens in 1989. The new clearing system may allow more efficient settlement procedures to be introduced. Several foreign firms operating on the exchange have also complained about the manner in which brokerage commissions are being deregulated. These TSE members believe that foreign firms have been hurt the most by this action because commissions for the trades they specialize in, the large lot trades of over 10 million yen in size, have been reduced the most in the TSE's drive to deregulate commission rates. According to TSE officials, these commission cuts were not unfair because the large firms trading on the exchange are better able to absorb these cuts because of their size. The Japanese Japanese government bonds make up the largest portion of the bond market in Japan with the 10-year bond being the most important bond issue, especially in terms of secondary market trading. Despite recent measures to increase foreign participation in this issue, foreign firms are still relegated to a small role in the government bond issuance market.” *Commission rates have been deregulated on two occasions since 1986, most recently in October 1987, "Japanese government bonds are issued through an auction, an underwriting syndicate, and by direct Appendix II Concerns of U.S. Financial Instititions in Japan To improve foreign firms' share of the 10-year issue, the Japanese government (1) increased foreign firms' share of bonds allocated through the underwriting syndicate responsible for selling the 10-year issue and (2) introduced a limited "auction" for a portion of each 10-year issue. However, neither of these steps has satisfied the U.S. community, as discussed below. The underwriting syndicate consists of approximately 800 financial institutions. As of April 1987, 12 U.S. banks and 12 U.S. securities firms were members of the underwriting syndicate. Members of the syndicate are allocated bonds through a set formula. On April 1, 1987, the underwriting syndicate increased the allotment of 10-year bonds underwritten by foreign securities companies. Under the new formula, foreign securities firms increased their total share of the 10-year issue from 0.3 to 1.5 percent. As of November 1987, a limited "auction" had been introduced for about 20 percent of each 10-year bond issue. Under this process, firms bid on the volume of bonds desired without knowing the issue terms." This 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 increased their total share of the November 1987 10-year issues from the 1.5 percent share allocated under the previous formula to about 5 percent. Despite these changes, foreign firms have not been able to play a significant role in the primary market for government bonds in Japan. The U.S. Treasury and major foreign financial institutions in Japan have urged but have not succeeded in persuading the Japanese to adopt a full auction process for 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 government bond market, their primary objective is to maintain a smooth distribution system for all government bonds. These officials believe that a full auction process for government bonds would introduce an unacceptable level of uncertainty in the bond market, that is, there would be no assurance that purchasers would fully absorb all issues regardless of market conditions. Given this overriding The maximum bid per institution is one percent of the total 10-year bond issue for the month. Oversubscribed bonds are allocated to each bidder in proportion to each firm's bid. |