(1) Introduction
Innovation in the market is ultimately driven by intermediaries.
As the environment becomes more conducive to innovation, the
role of intermediaries becomes even more important. In particular,
a framework must be built, wherein intermediaries that respond
to client needs and develop products and services with high value
added will flourish. As securities market reform proceeds, competition
between intermediaries, including new entrants, will become the
key to providing better services for the users of the market.
(2) Allowing diverse business by intermediaries
<1>Abolishing the legal restriction on side business
In order to provide more varied services, a legal framework that
allows securities companies the freedom to combine or uncouple
services, or to deliver securities transaction services together
with those services that do not fall into the traditional category
of securities business will become necessary. It is difficult
to envisage beforehand what services might provide synergy for
the delivery of securities related services, so that unless there
is a clear case for prohibiting a certain non-securities related
activity, securities companies should be allowed to engage in
any activity. To this end, current regulation that requires security
companies to engage solely in securities business needs to be
abolished.
<2>Employing holding company structure
As a result of this regulatory change, security companies will
gain the freedom to conduct varied business, either by themselves
or through subsidiaries. Repeal of holding company prohibition
will provide additional options to securities companies to carry
out diverse activities and improve management efficiency. By using
the holding company structure with appropriate risk separation
safeguards, securities companies should be allowed to branch into
areas that could not be carried out effectively by themselves
or by subsidiaries. To ensure effective supervision of securities
business, security supervisors may need to be given the powers
to require reporting from and conduct inspection of holding companies
and affiliated non-securities companies.
(3) Deregulation of Brokerage Commissions
<1>Total deregulation of brokerage commissions
To encourage the supply of differentiated services, an incentive
structure is also needed in addition to a legal framework permitting
such activity. Together with allowing securities firms freedom
in business strategy, brokerage commissions should be liberalized
fully. This would allow customers to choose between different
combinations of price and services, and would increase the welfare
of investors.
<2>Implementing deregulation
Freeing of brokerage commissions has profound implications, not
only on brokerage firms, but also on investors and other market
participants. It therefore needs to be considered within the overall
framework of securities market reform. It is also important to
note that deregulation of brokerage commissions is linked closely
with measures such as abolition of order-flow consolidation rules
and the introduction of wrap account services. The effects of
the implementation of the revised Foreign Exchange Law in April
1998 in a globalized market also need to be considered.
Bearing these factors in mind, the liberalization
of brokerage commissions should be introduced following the schedule
indicated below.
<3>Deregulation Schedule
First, in April 1998, commissions that apply to transaction value
in excess of Y50 million should be liberalized. After necessary
measures have been put into place to diversify lines of business
and to introduce new products, and necessary computer system investment
has been undertaken, completely liberalized commissions should
be in place by end-1999. Adjustments to the computer system will
necessarily require certain time, but since it is in the interest
of market users as well as the market, for complete deregulation
to take place as soon as feasible efforts by those involved in
the market to accelerate the process will be most welcome.
(4) Strengthening asset management services
<1>Asset management firms
In a new market environment, intermediaries will be required to
provide, asset management services that reflect the individual
circumstances of each investor for investors, and an optimization
of their financial structure that makes full use of various vehicles
for issuers. In asset management services, it is important that
intermediaries such as investment trust management companies and
investment advisory companies strengthen their asset management
capabilities, so that they may fulfill the expectation that investors
hold towards professional fund managers.
In addition, measures should be introduced that will increase
the efficiency of fund management, such as:
a. allowing investment trust management companies to outsource
a part of fund management.
b. Introduce the so-called private placement of investment trusts
c. Allow the inclusion of non-listed and non-registered securities
in investment trust's portfolio.
<2> Asset management services by securities companies
Securities companies should also build up the asset management
side of their business. In particular, wrap accounts which are
widely used in the United States, is of merit to investors as
they reduce the risk of excessive short-term trading aimed at
securing brokerage commissions. For securities companies, wrap
accounts provide a new line of business that could become the
core of high value-added services once brokerage commissions are
liberalized. Therefore, while the considerations that led to the
ban on discretionary accounts should be taken into account, it
is appropriate to introduce wrap accounts services, together with
the necessary rules to prevent illegal practice and to ameliorate
conflict of interest.
<3>Market information intermediaries
Intermediaries of market information, such as rating agencies,
performance evaluation firms, analysts and financial planners,
have important role to play in providing investment information
to individual as well as other investors. They are urged to further
strengthen their specialized skills while maintaining independence
and neutrality of opinion.
(5)Entry regulations and supervision of intermediaries
<1>General principles
In order to encourage creative and innovative activity, supervision
of financial intermediaries should employ as few regulation as
possible that limits freedom of business activity. The approval
system for business operations procedure(gyoumu-houhoushyo) should
be abolished. To strengthen financial intermediation, it is also
necessary for new entrants to bring in new ideas, technology and
vitality into the securities market.
<2>Reforming entry regulations (from licensing to registration for securities companies)
It would be difficult to maintain dynamism of
the securities market, if those that are capable and willing,
find it difficult to enter the securities industry. Securities
industry is expected, above all, to be innovative and provide
varied and attractive services to clients. Regulations governing
entry into securities business should be as liberal as possible.
Even so, securities companies must maintain the trust of their
clients, as securities companies' important role is to provide
access to the securities market. Obviously, one should not attempt
to encourage new entrants into securities business by merely lowering
the standards required for entry. Potential entrants must posses
a minimum level of financial and human resources required to execute
business in an honest and reliable manner. The standards that
are required would differ between different types of activity,
reflecting the degree of specialized skills and necessary risk
management levels.
In considering the most appropriate legal framework for achieving
these objectives, one should bear in mind that securities companies
will not be required to refrain from non-securities business,
and also that measures will be taken to clearly segregate customers'
asset from the securities companies own assets in the course of
this reform. Therefore, the Council believes that, provided a
mechanism for securities companies meeting and maintaining certain
minimum standards can be constructed, the current licensing regime
should be replaced in favor of a registration scheme. Within this
registration scheme, specific lines of business that require special
skills and a higher degree of risk control, such as OTC derivatives
business and underwriting business, may require explicit approval
from the regulator, so that the required standards may be met.
In asset management area, there is the need to ensure investor
protection while encouraging competition. Bearing in mind the
reform of the entry regulation regime for securities companies
and also taking into account the special characteristics of asset
management business, investment trust management and discretionary
investment management in investment advisory business should be
subject to regulatory approval upon entry.
<3>Securities business by banks
Mutual entry into banking, securities and trust business has been
conducted within the context of Financial System Reform initiated
in 1993. In this scheme, banks may engage, in principle, in securities
business not through the bank itself, but through a securities
subsidiary, in order to maintain the safety and soundness of the
banking institution and to guard against conflict of interest.
In addition, in order to ensure a smooth implementation of the
Financial System Reform, banks' entry into securities business
is to be conducted gradually and in stages, and, as a rule, banks
are required to set up new institutions whose line of business
is initially subject to certain limitations.
This limitation on line of business was reviewed within the context
of the Government's Deregulation Program announced at the end
of March. In this program, it was announced that
A. secondary market business for equity related bonds and transactions
related to stock index futures and options (but excluding those
that may require delivery of the underlying shares) will be allowed
from the second half of FY 1997, and
B. the review of remaining restrictions will be completed in the
context of the wider financial system reform now under consideration.
In this wider financial system reform currently being contemplated, competitive environment in the securities market will be strengthened through such measures as abolition of regulation prohibiting non-securities business by securities companies and allowing wider scope
of business. In the banking sector, measures that will lead to
greater freedom and diversity of products, businesses and corporate
structure are envisaged. Moreover, the use of holding company
structure that was previously prohibited by the Antimonopoly Law
will be freed, so that entry via this route will also become possible.
In view of these changes, the Council believes it appropriate
to lift the remaining restrictions on the business of bank's securities
subsidiaries during the second half of FY1999. Until then, in
the case where banks employ the holding company framework, affiliated
securities companies will be subject to the same restrictions
as current subsidiaries.
Once the above reform is put into place, there will be no need
to distinguish, from a financial system point of view, between
banks' securities subsidiaries established in the process of 1993
Financial System Reform, and ordinary domestic securities companies.
Firewalls between securities companies and banks designed to prevent
ill effects from conflicts of interest and to ensure a level
playing field, should be reviewed in the light of experience.
Also, in order to ensure that firewall regulations are observed
as the scope of business of bank-affiliated securities companies
widens, inspection and surveillance mechanism needs to be reconsidered.
In the context of banks' entry into the securities business, the
question of banks' influence over firms that emanate from the
banks' large holdings of shares has been a subject of intense
debate. There are those who advocate that banks no longer retain
such influence and that irrational cross holdings are in the process
of dissolution. Whatever the truth of such statement, it seems
clear that excessively large holdings of shares by banks is not
desirable, from the viewpoint of maintaining safety and soundness
of banks and in its effect on the stock market. The Council strongly
hopes that the introduction of holding company systems into this
country will act as a catalyst that triggers a rethinking of banks'
share holdings strategy, towards reducing or eliminating shareholding
by the bank itself.
(6) Ensuring the safety and soundness of securities companies and the framework for client protection
<1>Introduction
Investors and firms need to access the securities market through
securities companies, and even though preventive regulations such
as entry regulations are lightened or abolished, one must always
bear in mind that the functioning of the market will be severely
impaired if intermediaries, as a group, lose the trust of end-users.
It is necessary to construct a surveillance system that ensures
that intermediaries abide by the rules and do not misuse their
privileged position in the market. Intermediaries should be aware
of their role in supporting the market, and are encouraged to
set standards of conduct that rise over and above those required
by law.
Against the background of a more liberal regime
for entry and business operations, it is also important that exit
of intermediaries occur smoothly. Investors in the market should
not bear undue loss as a result of disorderly exit by intermediaries.
<2>Prudential and regulatory oversight
To secure financial and operational soundness of securities companies,
monitoring system must be reinforced. This would include revising
capital adequacy rules so that they reflect the risk run by securities
more precisely, as well as raising the standard of disclosure
by securities companies. Stiff sanctions should be imposed on
companies that falsify or hide information in the course of inspection
or in reporting, so that the monitoring system works effectively.
<3>Investor protection related to exits of intermediaries from the market
Institutional framework related to bankruptcy and other forms
of exit of securities companies must be developed, so that investors
will not incur undue loss in the event that a securities companies
are forced to close. To this end the following measures need to
be adopted:
A. Strict separation of client assets from the securities companies
own assets.
B. Enlarging the Securities Deposit Compensation Fund scheme