Provisional translation

Transcript of Press Conference by Former FSA Commissioner Hirofumi Gomi and New FSA Commissioner Takafumi Sato

(Tuesday, July 10, 2007, from 5:00 pm to 5:42 pm, at: FSA Press conference room )

[Comments by New and Former Commissioners]

Mr. Gomi:    Effective today, I resigned from my post as the Commissioner of the Financial Services Agency (FSA). My successor is Mr. Takafumi Sato, promoted from Director-General of the Supervisory Bureau. Your ongoing support would be highly appreciated.

Mr. Sato:    I am Takafumi Sato, appointed to the position of FSA Commissioner today. I am committed to doing my very best, so I would appreciate your support in the days ahead.

[Q&A]

Q.    Let me first ask a question to Mr. Gomi. Having served at the FSA and its previous incarnation -- the Financial Supervisory Agency--for a decade since the summer of 1997, and as the FSA Commissioner for the last three years, what is your assessment of the years you have served as Commissioner in light of those ten years at the FSA? What are your thoughts upon your resignation from your post as the FSA Commissioner, and the events that stand out in your memory?

Mr. Gomi:    The Financial Supervisory Agency was founded at a time when the situation was tough due to financial uncertainty. Even after various measures were taken to resolve this uncertainty, we had to dedicate enormous amounts of energy to solving the non-performing loan (NPL) problem. But the following three years in which I served as Commissioner was characterized by a change in the policy focus, from directing all its efforts in stabilizing the financial sector to aiming to realize a financial sector desirable for the future, following the resolution of the NPL problem. I am extremely grateful for having been able to gain such a rare experience as building the policy framework focused on customers of financial institutions. There are no special events that stand out in my memory. Having said that, allow me to use this opportunity to say that it was an extremely precious experience to have served under four prominent Ministers in three years. When I first became Commissioner, I served under Mr. Heizo Takenaka, who presented a roadmap to solve the NPL problem which was in dire straits. I was then able to serve under Mr. Tatsuya Ito, who formulated the Program for Further Financial Reform, which presented a state of the financial sector desirable for the future, following Mr. Takenaka's roadmap; it was a valuable experience for me to have been able to take various measures to fulfill this program under his instructions. I then served under Mr. Kaoru Yosano, who played a leading role and guided us in passing the bill for two major paradigm-shifting laws for financial regulation as you already know, namely, the Financial Instruments and Exchange Law and the Moneylending Control Law. He also made ambitious suggestions on measures to make market functions work properly, especially with respect to the reform of the Tokyo Stock Exchange (TSE), in view of the problems that occurred at TSE. Finally, up until yesterday, I was able to serve under Mr. Yuji Yamamoto, who presented ambitious ideas and proposals from a broad perspective against this backdrop. He not only oversees the domestic financial sector but also is aiming at bringing Japan's capital, securities and financial markets up to world-class. My most memorable experience during my three-year tenure as Commissioner was that I had been able to serve under these four Ministers and learn various things. That is my response to your question.

Q.    Let me now ask a question to Mr. Sato. You worked hand in hand with Mr. Gomi over the past ten years since the days of the Financial Supervisory Agency. Now that you are assuming the position of Commissioner, please elaborate once again on the future challenges facing financial regulation, your resolve and how you feel about the new appointment.

Mr. Sato:    As Mr. Gomi has just stated, when we look back exactly a decade ago, it was a time when there were concerns over the Japanese financial system as a whole, as major financial institutions went bankrupt. After somehow overcoming this crisis, we were then faced by the heavy burden of the NPL problem, a bitter legacy of the bubble economy era, which we had to tackle intensively. After a while, we saw a surge in the number of cases in which financial institutions lacked customer protection in their business operations, so we took action against these problems as well. We also saw a surge in the number of cases that undermined the operations of the securities market, as well as its fairness and transparency. We addressed this issue as well at legislative and practical levels. Having been through these stages, we are currently in a stage where we are seeing improvements in the actual situation, as we have made substantial progress in developing frameworks and measures at institutional and practical levels. Mr. Gomi has played a key role in various aspects over the past ten years.

Having been appointed to the position of FSA Commissioner, I am aware that one of the major challenges will be the qualitative improvement of financial regulation. In English, this corresponds to ''better regulation'' I have consulted with Financial Service Minister Mr. Yamamoto with respect to this agenda, and I intend to make this the FSA's major challenge for the near future. The need to tackle this agenda can be strongly acknowledged broadly from two angles. Firstly, of course, this need arises from Japan's major policy priorities at present, which is to stimulate its financial and capital markets and enhance their international competitiveness. We are, of course, aware that the quality of financial regulation is a principal determinant of the competitiveness of the markets subject to that regulation. Secondly, as I have briefly stated before, the Japanese financial sector is shifting from one stage to another, and regulation is shifting likewise in conjunction with this. As explained earlier, we have taken action against various incidents that have arisen over the past ten years in each of the three major objectives of financial regulation, namely, the stability of the financial system, customer protection, and the establishment of fair and transparent markets. Consequently, progress has been made in developing the regulatory framework, and the situation has improved somewhat. What we need to do in the future is to crystallize what we have learnt from our past experience and further consolidate it. At this juncture, the critical factors are self-help efforts and self-responsibility on the part of each financial institution. Accordingly, regulation must change and evolve into frameworks that respect these self-help efforts. Various changes are also taking place in the environment surrounding the financial sector. Financial transactions on the whole are becoming increasingly globalized. Financial instruments and sales channels are becoming more diversified. Management styles are also becoming more diverse. Furthermore, conglomeration is becoming increasingly common, while the existence of large funds, which have been making news lately, is playing a major role in the markets. To adapt to these new developments, ''better regulation'' is required.

In my view, there are four major pillars of ''better regulation.'' These may be regarded as our mindset or our approach to the evolution of our supervision methods. A first pillar involves seeking the optimal combination of rule-based supervision and principle-based supervision. As you may know, principle-based supervision consists of a framework to encourage financial institutions' voluntary efforts by explicitly stating several key principles. An advantage of this approach lies in ensuring freedom of management. On the other hand, rule-based supervision involves establishing detailed rules and applying them to individual cases, and its advantage lies in ensuring the predictability for financial institutions. Another advantage is also acknowledged, which is the elimination of administrative arbitrariness. In regards to the relationship between the two, I believe rule-based supervision and principle-based supervision are mutually complementary rather than a matter of ''either-or'' choice. Rule-based supervision is effective in cases where unfavorable action is taken under regulatory authority and in areas where common rules need to be applied to market participants consisting of a large number of unspecified parties. I think rule-based supervision will be required in such areas. On the other hand, principle-based supervision is effective in cases where financial institutions are encouraged to develop appropriate systems for governance, risk management and compliance. Also, for example, if new financial instruments are developed one after another, or if a new sales method is invented, it would be impossible to cover all of them by rules. In these cases, principle-based supervision is expected to play the role of filling in the gaps between the rules. In any case, the first pillar of ''better regulation'' involves ensuring the effectiveness of the entire financial regulation based on the optimal combination of rule-based and principle-based supervision.

A second pillar is about effectively dealing with priority issues. As our regulatory resources are extremely limited, we are critically aware of how they should be effectively allocated and invested into highly significant, high-priority issues. This is referred to as ''risk-focused'' and ''forward-looking'' approach at the Financial Services Authority of the United Kingdom (UKFSA). This approach involves investing regulatory resources into the areas that are of high significance by predicting and recognizing, as soon as possible, areas where there is a high level of risks and where huge risks might materialize in the future.

A third pillar involves placing greater emphasis on incentives, or paying attention to self-help efforts made by financial institutions. Taking inspections as an example, this is already incorporated in the Financial Inspection Rating System (FIRST). Basel II, which sets forth capital adequacy requirements for banks, also introduces extremely strong incentives. The ''relationship banking'' framework for regional banks has also been modified into a new permanent framework, beginning this financial year, to respect the initiatives of each financial institution. As such, policies that focus on incentives and respect self-help efforts have already been incorporated to a great extent. We are critically aware of how we could make this richer in content in view of the aforementioned change in stage.

Lastly, a fourth pillar is about enhancing the transparency and predictability of supervisory responses. Our recent responses include the revision of the No Action Letter System and presentation of FSA's views through dialogues with supervised financial institutions in the form of Q&As (FAQs). While we have already taken measures to clarify our inspection and supervision policies for each operational year, we will examine whether there is any room for further improvement.

Based on these four major pillars that define our mindset, one of our initiatives for the near future will be the enhancement of dialogues with financial institutions. This is extremely important in view of the need to share the aforementioned principles between financial institutions and the FSA. From the viewpoint of financial institutions, it has the effect of improving the predictability of FSA's responses, whereas from FSA's point of view, it will serve as an extremely important channel for identifying market trends on a real time basis. Our second initiative will be the enhancement of information sources. We are critically aware that the FSA could disseminate more information by using various platforms, in light of the nature of the suggestions made so far. Our third initiative is to enhance cooperation with foreign authorities. As financial transactions have become so globalized, it is indispensable to check the consistency among the regulatory authorities of different jurisdictions. It is also indispensable to cooperation with foreign authorities in dealing with cross-border transactions in individual cases. Our fourth initiative is the enhancement of market research abilities and functions that would enable us to identify market trends as accurately as possible in a timely manner, as I have already mentioned briefly. In tackling priority issues effectively, we would miss the point unless we have the ability to properly identify at all times what the priority issues are, in view of the actual state of the markets. Lastly, our fifth initiative is the improvement in the quality and skills of FSA staff. As you may be aware, the financial sector is an area in which an extremely high level of specialization is required. We must therefore look into possible measures including improving the expertise of the staff. These are our mindset and initiatives for tackling the issue of how to achieve qualitative improvement in financial regulation.

Q.    What did the Minister say upon your resignation, Mr. Gomi, and upon your appointment, Mr. Sato?

Mr. Gomi:    The official announcement itself is ceremonial, so there were no special comments made at that occasion. However, when I discussed my resignation with the Minister, he asked for my assistance in internationalizing both Japan's regulation and its financial and capital markets based on my broad experience at the FSA, even after my resignation, whatever position I may be in at the time.

Mr. Sato:    I have also exchanged opinions with the Minister several times since he gave me an informal notice of the appointment last week. During the exchange, he instructed me to exert my efforts in tackling the issue of stimulating the Japanese financial and capital markets and boosting their international competitiveness more than anything else. In that context, he gave me specific instructions, for example, to improve dialogues with financial institutions and enhance cooperation with foreign authorities, for the purpose of improving the quality of financial regulation as a whole as I explained earlier.

Q.    This is a question to Mr. Gomi. Mr. Sato just talked about the challenge for the future, namely, supervision that respects the self-help efforts of financial institutions. Have you ever thought that self-help efforts were respected but not fulfilled?

Mr. Gomi:    The idea of encouraging self-help efforts by giving various incentives at the regulatory level came up at the time of formulating the Program for Further Financial Reform in 2004, that is, in the process of making the transition to financial regulation in ordinary times. In terms of output, the development of a framework to give incentives as projected under the Program for Further Financial Reform was completed in two years as scheduled by the Program. However, it is an issue for the future whether, in terms of outcome, it would actually function and how effective it would be in improving the self-help efforts of financial institutions and fulfilling high-quality internal controls. That is how I summarize the situation.

Q.    Mr. Gomi, some critics have pointed out that the FSA has estranged itself from financial institutions following the NPL problem and the advent of such problems as the non-payment of fringe insurance claims. What is your view on this, looking back at the past three years?

Mr. Gomi:    Over the last three years, we have of course exchanged views with financial institutions in various situations. However, communication between troubled financial institutions and the FSA somewhat differs qualitatively from ongoing dialogues with financial institutions seeking to establish better internal controls through communication with the FSA, in which financial institutions identify the hurdles set by the FSA, the FSA's current focus and its view on where risks are. We have engaged in dialogues with countless troubled financial institutions over the past three years, and in hindsight, it would have been more desirable if there had been more opportunities to engage in dialogues with financial institutions while they were not in trouble. I believe there will be such opportunities in the future.

Q.    Mr. Sato, do you have any ideas for mechanisms of dialogues with private financial institutions just mentioned by Mr. Gomi?

Mr. Sato:    Firstly, if each and every FSA official is prepared for it and has a solid sense of purpose for dialogues, more fruitful and necessary communication will follow in each situation, and at each juncture. Secondly, in regards to the way in which it is carried out, we will examine whether any shortcomings exist in terms of the frequency, format, and level of communication, as well as the issues to be discussed. And if we find that communication in some areas should be institutionalized to a certain extent, we will look into the possibility of doing so.

Q.    Mr. Sato, in regards to the rule-based and principle-based supervision approaches you just described, private financial institutions seem to understand rule-based supervision well but some of them are not sure about principle-based supervision. They are wondering whether there are concrete principles in Japan in the first place. In this context, do you intend to present examples of principles, or are you inclined to develop principles through dialogues with financial institutions to a certain extent? How do you intend to establish principle-based supervision?

Mr. Sato:    Basically, we will determine mutually-acceptable principles through dialogues with financial institutions, as you just stated. While the FSA will of course demonstrate its initiative in areas where it cannot give in, it is important to discuss with financial institutions to the extent possible, as to what kind of principles are important and what kind of principles are highly effective.

Principles in Japan are actually scattered about in existing laws and regulations, supervisory guidelines, inspection manuals and so forth. Our future agenda is to determine whether it is necessary to select principles from among those that are scattered about and turn them into a more systematic set of principles and, if it is deemed necessary to do so, determine the viewpoints to be adopted when putting them together. For example, the UKFSA has presented about 11 principles. Bearing this in mind, if I may mention the most typical principles that are scattered about in Japan, but purely as examples and without making any predictions, they would include the principle that financial institutions are required to perform effective governance, execute operations of high quality, carry out risk management properly and maintain financial soundness as a matter of course, in addition to putting in place a compliance system and fulfilling compliance with laws and regulations. In regards to customer protection and customer relations, financial institutions would be required to provide customers with information properly. This would include the principle of customer suitability as well. Fulfilling the fiduciary duty to customers and fair treatment of customers would also be indispensable. Significant principles may also include preventing transactions involving conflict of interest and preventing financial institutions from abusing their dominant position. Ensuring fairness in market transactions by the markets themselves may also become a significant principle. My understanding is that principles like these are currently scattered about in Japanese laws and regulations, supervisory guidelines, inspection manuals and so forth. Therefore, as I stated earlier, we will look into this matter, including what kind of principles should be developed in the future, and whether necessary it is to develop and compile such principles.

Q.    Mr. Sato, the balance between rule-based supervision and principle-based supervision varies from country to country, as exemplified in the United States and the United Kingdom. What kind of balance do you seek between them, based on your policy direction considering the Japanese model, the characteristics of Japan or the characteristics of the Japanese market?

Mr. Sato:    I do not have any predetermined policy direction in mind at this point. We will look into the most effective framework that best suits Japan's actual situation in the course of discussions. One instructive example is London's financial and capital markets, which have achieved outstanding success. It is distinctive in that the effectiveness of principle-based supervision is focused on the so-called wholesale sector, the world of professionals, and that it assumes the existence of peer pressure among expert groups according to their respective fields of specialization in the financial sector. In Japan, as I have stated earlier, we need to look for a framework that suits Japan in its entirety, including not only the wholesale sector, the world of professionals, but also the retail sector including small consumers and investors who are relatively disadvantaged in terms of the information they have.

Q.    With regards to the enhancement of timely and accurate market research functions, markets are diverse and vary. Which market requires the greatest enhancement to the FSA's market research function? Where is the attention directed at, for example, would that area be trends in hedge funds?

Mr. Sato:    This involves finding out what kind of transactions are currently being carried out in the marketplace and what kind of trends are there in all markets. Therefore, we have not limited our scope to any particular area at this point. Of course, such conventional markets as stock markets and bond markets are within our scope, but we should not rule out new areas such as alternative investments. With this in mind, as I stated briefly earlier, activities of funds have rapidly grown in terms of their market presence in recent years, and their activities are having a significant impact on the entire markets. We need to make efforts to understand the actual market situations, including fund activities, to the extent possible, and in a timely manner.

Q.    In explaining the developments at the FSA over the past few years, Mr. Sato stated that customer protection gathered pace after the appointment of Mr. Gomi as FSA Commissioner and now a paradigm-shift is finally occurring towards the quality of governance and the quality of financial regulation. Couldn't this issue be tackled without first strictly enforcing customer protection? We would like to hear opinions from both of you.

Mr. Sato:    The quality of governance is a major premise for the fulfillment of customer protection. Thus the need to improve the quality of governance has been here to stay, whether it is now or was some time ago. It is important that the management team, including top management, build a framework to properly identify what kind of services are being provided and what kind of sales approach is taken in practice at the operations floor of its own company. And if there are any problems, management should properly recognize them as facts, investigate the causes of the problems, formulate measures to prevent them from occurring again based on the investigation of the causes, make the measures known to the operations floor, and make them function in a sustainable manner even after the matter has been dealt with. In the field of customer protection, the Financial Instruments and Exchange Law will be fully in effect around September. Various legislative frameworks and rules have been developed for customer protection. In practice, we truly feel that financial institutions, particulalry many of those that faced supervisory action as problems came up to the surface, have improved their quality of governance considerably in the course of implementing their respective business improvement plans which they prepared following the business improvement order. We are naturally encouraged by these changes, and it is in this context that I believe a paradigm shift is taking place. Namely, the management team is now supposed to make such endeavors in a sustainable and continual manner based on self-help efforts and self-responsibility, taking into account signals from the regulator, rather than based on a framework in which management action to fix problems is triggered by supervisory responses.

Q.    Mr. Sato, there is a growing interest in you especially among financial institutions, as to what kind of person you are. Please explain your ideas on what you would like to do in dialogues with financial institutions.

Mr. Sato:    I would like to explore ways to exchange views with members of financial institutions as diversely as possible. While I headed the Supervisory Bureau, especially in the past year, we exchanged views with financial groups and financial institutions about their current self-assessment and business areas they were strategically investing their business resources in for the future. This differs from engaging in dialogues when some kind of supervisory action was required or taken, as explained earlier by Mr. Gomi. Typically, I would like to communicate with them as frankly and candidly as possible in everyday situations rather than at times when a pressing issue needs to be tackled. Needless to say, this is not just up to us and it will depend on what the financial institutions would prefer to do, so we will consult them about how to communicate with each other as well.