FSA Newsletter November 2005

In order to add a method that uses the Public Certification Service for Individuals to the methods of customer identity verification that are specified by the Law on Customer Identification and Retention of Records by Financial Institutions, and Prevention of Fraudulent Use of Deposit Accounts (to be referred to as the ''Customer Identification Law''), the enforcement regulations for the law were revised and implemented on October 11.

Reason for the Revision

Under the Public Certification Service for Individuals, personal identity verification services that are required for online filing and other procedures are offered by providing electronic verification services by using electronic certificates that are issued by prefectural governors in accordance with the Law Concerning Certification Services for Electronic Signatures by Local authorities (to be referred to as the ''Law of the Public Certification Service for Individuals''). Preventive measures are incorporated in electronic certificates (to be referred to as ''JPKI Electronic Certification'') that are used in such services so as to keep them from falsified as the result of the use of electronic signatures based on the Law of the Public Certification Service for Individuals. Certificates are also verified for effectiveness. The certificates are thus assured to have the reliability comparable with that of customer identification verification documents that are used by financial institutions in the verification of their customers' identities as required by the Customer identification Law.
Electronic verification services that use such electronic certificates in accordance with the Law of the Public Certification Service for Individuals are similar to electronic verification services based on the ''Law Concerning Electronic Signatures and Certification Services: (to be referred to as the ''e-signature Law''), which have already been approved as a method of customer identity verification for the purposes of the Customer Identification Law. There are therefore no specific obstacles to adding these services as a method of customer identification for the purposes of the Customer identification Law. Consequently, the Enforcement Regulations for the Law on Customer Identification and Retention of Records by Financial Institutions, and Prevention of Fraudulent Deposit Accounts (to be referred to as the ''Enforcement Regulations for the Customer Identification Law'') have been partially revised to add the method of customer identification that uses the Public Certification Service for Individuals.

(Note) In connection with this subject, the IT Policy Package 2005 - Toward the Realization of the World's Most Advanced IT Nation - (approved by the IT Strategy Headquarters in February 2005) advocates for the ''promotion of use of the Public Certification Service for Individuals and the Basic Residential Registers Network System'' as one of the administrative services items that should be promoted. The current revision corresponds to one of the specific steps mentioned in the package as a way to achieve this goal. Specifically, the package states that ''a conclusion should be drawn at the earliest possible time but before the end of the 2005 fiscal year on such tasks as the introduction of electronic certificates by the Public Certification Service for Individuals for use as documents for customer identification for opening accounts, etc. by financial institutions, etc. that provide specified verification services. (The Ministry of Internal Affairs and Communications, the FSA and other relevant ministries)''

Outline of the Revision

The following method, which uses the Public Certification Service for Individuals, has now been added to the methods of customer identification by financial institutions, etc. that are permitted under Article 3 of the Enforcement Regulations for the Customer Identification Law:

(1)

The method of receiving from a customer (i) a government-issued electronic certificate that is issued by a prefectural governor, and (ii) information concerning a transaction, such as execution of a depository saving agreement, that uses an electronic signature that is verified by the electronic certificate, simultaneously with (iii) the receipt of information concerning an application for issue of an electronic certificate that is issued by a financial institution, etc. that is a signature verifier as specified in Paragraph 4, Article 17 of the Law of the Public Certification Service for Individuals.
When the financial institution, etc. is an administrative organization, etc. that is specified in Paragraph 1, Article 17 of the Law of the Public Certification Service for Individuals (i.e., Japan Post or Shokou Chukin Bank), the receipt of (i) and (ii) suffices.
Financial institutions, etc. refer to financial institutions, etc. as specified in Article 2 of the Customer Identification Law.

(2)

The method of receiving from a customer (i) an electronic certificate that is issued by a private certification service provider and used for specified certification services that are provided by said private certification service provider (to be referred to as a ''privately-issued electronic certificate''), and (ii) information concerning a transaction, such as execution of a depository saving agreement, that uses an electronic signature that is verified by the privately-issued electronic certificate.
A private verification service provider is a person who is appointed by the Minister of Internal Affairs and Communication in accordance with the provisions of Paragraph 1, Article 17 of the Law of the Public Certification Service for Individuals and authorized to issue a privately-issued electronic certificate described in (i) above at the request of a customer, etc.
Specified verification services refer to specified verification services stipulated in Paragraph 3, Article 2 of the e-signature Law.
Privately-issued electronic certificates of (i) above that can be used as customer identification documents for the purposes of the Customer Identification Law are limited to those that are issued by a method that is specified in Article 5 of the enforcement regulations for the Law concerning JPKI Electronic Certificate or Electronic Signatures and Certification Services.

[Green Sheet]

The ''Green Sheet'' system is a system started in July 1997 by the Japan Securities Dealers Association (JSDA) for the purpose of trading stock certificates etc. of unlisted companies, under which it is made possible to buy and sell unlisted stock certificates etc. issued in Japan by Japanese companies if a securities company registers such stock certificates etc. with JSDA and shows their asking prices and bids on a continuous basis (Green Sheet issues).

In Japan, many small- and medium-sized enterprises traditionally did not have their shares listed due to, among other reasons, excessive costs for the development of internal structures required for disclosure or for disclosure itself that would be required as a result of going public. In turn, unlisted stock certificates etc. for which no disclosure was available also contained a problem of difficulty in any attempt to distribute them, because investors had access to little information that they could base their investment decisions on.
Although JSDA rules previously prohibited securities companies from conducting any investment solicitation regarding unlisted securities, JSDA amended the rules in consideration of the problems described above and created the ''Green Sheet'' system, under which it is made possible to buy and sell stock certificates etc. of unlisted companies on the condition that a certain degree of disclosure should be implemented.
While, even after the creation of such a system, there remained no provisions in the Securities and Exchange Law applicable specifically to Green Sheet issues, Green Sheet issues are now defined under the Securities and Exchange Law as ''tradable securities (toriatsukai yukashoken)'' as a result of the April 2005 amendment, which was made for the purpose of boosting their trading and facilitating capital-raising by SMEs by having the Green Sheet system recognized more and augmenting their reliability through the application of rules against unfair trading, such as insider trading regulations.
Under the Securities and Exchange Law, ''tradable securities'' are subject to the insider trading regulations, with other legislative measures also taken in the form of statutes for, for example, the obligation to make the trading value etc. public, with a view to giving them more recognition and ensuring their reliability.
In consideration of the problem of cost burdens on issuers as described above, no provisions have been created to impose disclosure requirements specifically with respect to Green Sheet issues; under the current setup, it suffices to disclose a certain group of information pursuant to JSDA rules.
It is hoped that as a result of such measures taken in the Securities and Exchange Law and in other forms, the Green Sheet system will be recognized broadly, and they will be traded briskly in the future.

[Tier 1 and Tier 2]

The capital adequacy requirements were established to maintain financial system stability and protect depositors by ensuring that banks remain sound and do not become bankrupt by requiring them to maintain a minimum level of equity capital that is commensurate with the risks that they hold.

Equity capital is the numerator of the formula in the capital adequacy requirements. In the event that a financial institution suffers a loss, equity capital serves as a cushion (risk buffer) to absorb the loss. High quality components of equity capital are classified as Tier 1, and the rest as Tier 2. For example, capital stock, legal reserves, and surpluses are included in Tier 1. Subordinated loans and subordinated debts have the basic characteristics of liabilities. But they also have an equity-like character in that their repayment can occur only after other general liabilities are paid in the event that the issuer becomes insolvent. For this reason, financial institutions are permitted to include subordinated loans and subordinated debts in Tier 2 in the calculation of their capital adequacy ratios. Similarly, unrealized gains of marketable securities can serve as risk buffers. Banks that meet international standards are therefore permitted to include 45% of such gains in Tier 2. However, the amount that can be placed in Tier 2 is capped by the Tier 1 amount.
The denominator, on the other hand, is the sum of individual classes of assets, multiplied by their respective risk weights. Risk weights are 0% for cash and government bonds, 20% for claims on financial institutions, 50% for loans secured by mortgage on residential property and 100% for claims on the private sector.
A capital adequacy ratio is computed by dividing the numerator by the denominator, both of which are computed in accordance with the above-described calculations. The capital adequacy requirements require that financial institutions that have overseas business offices and operate internationally maintain their capital adequacy ratios at or above 8 percent, which is the international standard, and that domestic financial institutions that do not have any overseas offices maintain their capital adequacy ratios at or above the domestic standard of 4 percent.
The FSA is currently in the process of re-examining the ministerial notification of the capital adequacy ratio, based on the new capital adequacy framework (Basel II) that was released by the Basel Committee on Banking Supervision at the end of June 2004.
Formula for the Capital Adequacy Requirements (International Standards: Financial Institutions with Overseas Offices)

[Formula]

A:		I am aware that there are various news reports on the said case. However, as it relates to an individual case, I will refrain from commenting on it. The Financial Services Agency (FSA) collects information broadly on a daily basis in regards to the situation surrounding audits by Certified Public Accountants (CPAs). If any infringement of legislations is found in the process, FSA will take proper action as necessary according to legislation. In general, in regards to the false statements just mentioned, the members of top management who prepared fraudulent financial statements are required to assume criminal, civil and administrative liability. In addition, auditors who certified the fraudulent financial statements as being free of false statements, intentionally or negligently, are also required to assume criminal, civil and administrative liability. Therefore, we will take proper action according to legislation if there is any infringement in this regard. Auditors--or CPAs and auditing firms--have a serious mission, so their involvement in making false statements will heavily affect and grossly undermine their trustworthiness. It goes without saying that interested parties should strive to prevent such incidents from happening. It is also extremely important to steadily develop a system to prevent such incidents from occurring. As the trustworthiness of auditors, CPAs and auditing firms is currently at stake, they are urged to make utmost efforts to perform their duties properly based on their respective missions.
(from the press conference following a cabinet meeting on Tuesday, September 13, 2005)

A:		Looking back on the past year, various things happened in financial administration. Among them, the major challenge I had been faced with was to complete the task of financial revitalization, specifically, to fulfill the targets set forth in the Program for Financial Revival(PDF). I am deeply moved by the fact that the accomplishments have exceeded the targets in the Program for Financial Revival(PDF), as a result of implementing the measures set forth in the Program, and due to the tremendous efforts made by the parties concerned. Furthermore, we formulated and announced the Program for Further Financial Reform(PDF) as the financial administration guideline following the Program for Financial Revival(PDF), and then the work schedule(PDF). As I have been reappointed, I will make the utmost efforts to build a dynamic financial system from here on, by implementing the measures set forth in the Program for Further Financial Reform(PDF). As financial reform is an extremely important field in promoting structural reform, I hereby reaffirm my determination to do my very best to carry out financial reform.
(from the press conference following the first cabinet meeting on Wednesday, September 21, 2005)

A:		A crucial challenge that remained under the Program for Financial Revival was the issue of proper regulatory treatment of deferred tax assets, so it was addressed in the Program for Further Financial Reform and in the work schedule. As just mentioned, this has been a topic of heated debate since the formulation of the Program for Financial Revival. As one of the three major keys to realizing a sound financial system, we discussed the issue from various angles in the context of capital enhancement, followed by discussions at the Financial System Council, which led to the submission of the report. In response to fulfilling the target of halving the percentage of non-performing loans (NPLs) under the Program for Financial Revival, we conducted a thorough study in consideration of the gist of the report, and issued a public comment titled ''Draft Ministerial Notification on Proper Regulatory Treatment of Deferred Tax Assets under Capital Adequacy Regulations for Major Banks.'' We believe the latest measure will help further stabilize the Japanese financial system by making qualitative improvements in capital adequacy.
(from the press conference following the first cabinet meeting on Tuesday, September 27, 2005)

A:		It is truly regrettable that there proved to be many cases in which non-life insurance companies need to make additional payments of ancillary insurance claims such as extra expense claims. In response to this situation, the Financial Services Agency (FSA) has decided to order all non-life insurance companies today to report the number of cases in which such additional payments are needed, the progress of the payments, an analysis of the causes of such additional payments becoming necessary and measures to prevent the recurrence of such cases. As for the reasons, it is important that non-life insurance companies first strive to establish proper management functions for insurance claim payments of their own accord with respect to the case. While they have been voluntarily conducting verification, the FSA decided to order all non-life insurance companies to report at once, in order to ensure uniform and comprehensive efforts in dealing with this problem. We assume that the companies should submit the reports within two weeks or so, no later than October 14. As the companies are voluntarily conducting inspection and verification and publishing some of the results, we can receive the reports within about two weeks, by October 14. Then we plan to scrutinize the received reports and to publish them in some form. We assume that the period will be three years. Under the provisions of the current Commercial Code, a right of claim is valid for two years, so just to make sure policyholders will be protected, non-life insurance companies should conduct verification targeting a period of three years.
(from the press conference following the first cabinet meeting on Friday, September 30, 2005)

A:		As for the clarity of the criteria, it is difficult to set detailed standards beyond the existing ones stipulated by the relevant legislation, at this stage. And the authority will, upon application, make decisions on a case-to-case basis regarding approval for a major shareholder of a publicly-traded securities exchange. To be approved as a major shareholder, the authority will examine the appropriateness of the applicant in order to ensure fairness and other matters about the operation of the securities exchange, since major shareholders of the securities exchange will have substantial influence over its operations. In the present case, examination was carried out in accordance with the criteria stipulated in the Securities and Exchange Law. The authority, having gone through the hearing procedures under the Securities and Exchange Law, had decided not to approve the application on the ground that the authority could not ascertain that the criteria were met as the sound and proper operation of the securities exchange might be prejudiced by the applicant exercising its voting rights.
(from the press conference following a cabinet meeting on Friday, August 26, 2005)

A:		If I may answer to the question in general, an application for approval to become a major shareholder of a securities exchange will be considered on a case-to-case basis, and approval will be given if there is no risk of conflict of interest and the criteria in the relevant legislations are met.
(from the press conference following a cabinet meeting on Friday, August 26, 2005)