Discussion Papers

Findings from research and studies conducted at the Financial Research Center (FSA Institute) are organized and published as Discussion Papers to stimulate further discussion and comment.

The views expressed in the papers are those of the authors and do not necessarily reflect the views of the Financial Services Agency or the FSA Institute.

Discussion Papers (FY 2014)

No.	Title/Author(s)
DP2014-12 (March 2015)	REGULATORY REFORMS IN CONSUMER CREDIT -REVIEWING THE UK’S FINANCIAL SERVICES ACT OF 2012- Mamiko Yokoi-Arai Abstract | Full text (PDF:1,844KB) (Full text is available only in Japanese.)
DP2014-11 (March 2015)	Effects of Leverage Ratio Requirement on Bank Behavior Yuki Teranishi Abstract | Full text (PDF:818KB) (Full text is available only in Japanese.)
DP2014-10 (March 2015)	Assessment Methodologies of Systemic Risks: Global Trends and Implication for Japan Yuki Masujima Abstract | Full text (PDF:1,935KB) (Full text is available only in Japanese.)
DP2014-9 (February 2015)	An Investigation of the Financial System and Regulatory Reforms in the Tokyo Market: A Comparative Approach to International Financial Centers Hideaki Sakawa Abstract | Full text (PDF:973KB) (Full text is available only in Japanese.)
DP2014-8 (October 2014)	Possibility of Introducing an Electronically Recorded Monetary Claims System in Asian Countries and Related Challenges: Research for introduction in Indonesia and Vietnam Nobuhiko Sugiura Abstract | Full text (PDF:1,624KB) (Full text is available only in Japanese.)
DP2014-7 (September 2014)	Acts concerning Regulation and Structural Reform of Banks in the U.S., U.K., EU, Germany and France Ryoji Kitami Abstract | Full text (PDF:3,359KB) (Full text is available only in Japanese.)
DP2014-6 (August 2014)	Research on early detection of financial statement fraud Naoto Oshiro Abstract | Full text (PDF:1,873KB) (Full text is available only in Japanese.)
DP2014-5 (July 2014)	Corporate Governance in Japan: Developments in Listed Companies and Roles of Institutional Investors Ryoko Ueda Abstract | Full text (PDF:3,044KB) (Full text is available only in Japanese.)
DP2014-4 (July 2014)	An empirical study on strategic behavior of high frequency traders during the market pre-opening period Jun Uno Abstract | Full text (PDF:1,966KB) (Full text is available only in Japanese.)
DP2014-3 (July 2014)	Relationship between proxy voting and fiduciary duty of institutional investors Shunsuke Kasuga Abstract | Full text (PDF:1,629KB) (Full text is available only in Japanese.)
DP2014-2 (June 2014)	Non-Performing Loan Reduction with Regulatory Transition A Japanese Experience, 1998–2013 Masaki NakabayashiToshiki Kawashima Abstract | Full text (PDF:658KB)
DP2014-1 (April 2014)	Progress in the European Banking Union: Integration of banking supervision and resolution systems in the Euro area Takeshi Inoue Abstract | Full text (PDF:2,757KB) (Full text is available only in Japanese.)

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Abstracts

DP2014-12
''REGULATORY REFORMS IN CONSUMER CREDIT
-REVIEWING THE UK’S FINANCIAL SERVICES ACT OF 2012-''

Mamiko Yokoi-Arai, Special Research Fellow, Financial Research Center
(FSA Institute)

Consumer credit is becoming an increasingly large part of personal credit, with a number of financial authorities expressing concern over the manner in which consumers accumulate debt as well as the limited avenues with which they may rectify the issue. The UK carried out an overhaul of its financial regulatory structure in the aftermath of the financial crisis, establishing the Financial Conduct Authority to take overthe regulatory and supervisory responsibility for consumer credit. This working paper looks at the rationale of the UK’s reform, and how the supervision and regulation of consumer credit is being strengthened.

The paper compares international consumer credit data to illustrate how the debt burden on consumers may be disproportionately accumulating, and how regulatory reforms in different countries are trying to limit the exposure of consumers. In particular, the UK and Japanese consumer credit markets are compared in terms of their respective size.

In addition, this paper focuses on issues posed by high-cost, short-term credit, also known as payday loans. This is a growing market in many countries, with consumers accessing it when they encounter serious financial difficulties. The UK has imposed cost ceilings to limit the cost burden on consumers, and how this ceiling was determined is reviewed in detail.

While the debt burden by consumer credit can be detrimental, it is the last resort of financing for SMEs and consumers in some situations. Their societal and economic roles need to be balanced with consumer protection considerations in policy discussions.

Keywords: consumer credit, financial regulation, financial supervision, payday loans

DP2014-11
''Effects of Leverage Ratio Requirement on Bank Behavior ''

Yuki Teranishi, Special Research Fellow, Financial Research Center
(FSA Institute)

This paper discusses concrete effects of two regulations, the leverage ratio requirement and risk-based capital requirement, on bank behavior using the theoretical model proposed by Kamada and Nasu (2010). The possible effects on bank behavior shown in the paper are as follows. First, banks are constrained to hold similar business portfolios. Second, banks are constrained to run high-risk high-return business models. Third, if banks cannot set up high-risk high-return businesses under the two regulations, they are forced to diminish the functions of financial intermediation. These effects are strengthened with other regulations and excessive evaluations on banks’ off-balance-sheet items with the leverage requirement. If bank behavior change in such manner, the risk resilience of the financial system against financial crises deteriorate. We need to carefully evaluate the outcomes of introducing the leverage ratio requirement.

Keywords: Leverage Regulation, Bank

DP2014-10
''Assessment Methodologies of Systemic Risks: Global Trends and Implication for Japan ''

Yuki Masujima, Special Research Fellow, Financial Research Center
(FSA Institute)

This paper is a survey and comparative analysis of the assessment methodologies of systemic risks and emerging risks, referring to the risk assessment approaches and methodologies of international organizations such as BIS, IMF and IOSCO, central banks, and financial regulators. It figures out the emerging risks related to the Japanese financial system, including the impact of global financial regulations, and describes what kind of risks could be triggered by an accumulated distortion in securities markets due to the wave of global monetary easing, in a situation where some advanced economies are changing their stance of monetary policy to tightening. This paper concludes that, without careful consideration of the rationale for regulation, introducing the same regulatory standards as those for the U.S. and European financial markets and institutions to Japan might dampen growth opportunities for Japan’s financial sector, particularly the non-bank financial sector, given the current sound conditions of the Japanese financial system. Moreover, international investment portfolios of Japanese investors are more fixed income-oriented than the average portfolio of global investors; the potential credit risk of bond funds in Japan appears to be increasing under the low interest rate environment. Thus, risk identification and assessment methodologies for systemic risks and emerging risks need to be improved further, focusing on Japan-specific factors.

Keywords: Systemic Risk, Emerging Risk, Risk Evaluation, IOSCO, International Financial Regulation

DP2014-9
'' An Investigation of the Financial System and Regulatory Reforms in the Tokyo Market: A Comparative Approach to International Financial Centers''

Hideaki Sakawa, Special Research Fellow, Financial Research Center
(FSA Institute)

This research analyzes two types of international financial center rankings and tries to reveal what tasks are important if the Tokyo market is to take the role of a leading international financial center in the near future. This research consists of two parts. The first part is the investigation of several financial center rankings and a Japanese survey of the Tokyo market. The second part is an empirical investigation of the relation between financial center rankings and features of listed firms in the financial center. The conclusions of this paper are summarized as follows. Firstly, the evaluation of the Tokyo market is high overall but is not high from the viewpoint of future growth and developments. Secondly, listed firms in higher ranking financial centers do not realize higher research and development intensity. Finally, there is a positive relation between financial center rankings of a financial center and corporate governance scores of listed firms in the financial center; financial centers that had more listed companies with strong corporate governance tended to achieve higher rankings. Such empirical evidence suggests that corporate governance reforms for listed firms in the Tokyo market might be effective for enhancing the Tokyo market’s role as a leading international financial center.

Keywords: International Financial Center Ranking, Tokyo Market, Corporate Governance

DP2014-8
'' Possibility of Introducing an Electronically Recorded Monetary Claims System in Asian Countries and Related Challenges: Research for introduction in Indonesia and Vietnam''

Nobuhiko　Sugiura , Special Research Fellow, Financial Research Center
(FSA Institute)

“The Action Plan for the New Growth Strategy – Blueprint for Revitalizing Japan” published by the Financial Services Agency (FSA) on December 24, 2010, states as follows regarding projects that the FSA should tackle in the future: “...the FSA will conduct a survey on the current status of financial and capital markets in Asian countries ..., thereby making these frameworks (including ... the electronically recorded monetary claims system, etc.) widely available in Asia.”
As a part of those surveys, the FSA published “The Survey on Business-to-Business Transactions in Asia” in 2011 (hereafter, “the survey”) in order to grasp the situation in relation to the introduction of the electronically recorded monetary claims system. The survey reported basic information about the industrial structure, the financial system, local business practices and problems in financing. Thereafter, responding to the results of field research and the survey, the FSA published another survey titled “Possibility of the Diffusion of the Electronically Recorded Monetary Claims System among Asian countries and Future Tasks” in 2012.
In response to these surveys and additional newly ascertained facts found from the survey in 2013 and 2014, this paper analyzes more concrete aspects of the possibility of introducing an electronically recorded monetary claims system in Asian countries, particularly in Indonesia and Vietnam, and also reports the results of the introduction seminar held in these countries in March 2013.
In addition, this paper tries to find measures and policies for encouraging Asian countries to adopt the electronically recorded monetary claims system for innovation in their financial products.

Keywords: Electronically recorded monetary claims, Asian bond markets, Export system

DP2014-7
'' Acts concerning Regulation and Structural Reform of Banks in the U.S., U.K., EU, Germany and France ''

Ryoji Kitami , Special Research Fellow, Financial Research Center
(FSA Institute)

The financial crisis since 2008 has shown us many lessons, and one of which regarding the financial system is a shadow banking function carried out by investment banks. In major countries, with the U.S. having dynamic corporate culture and the EU facing increased competition under the unification of the EU market, banks tend to be high-risk-high-return oriented, which virtually means the widespread emergence of American-type investment banks.
In these circumstances, two remarkable trends have been noticed in the macro-prudential policies of major countries: one is the imposition of an additional capital requirement on systemically important financial institutions, so as to facilitate the resolution of failed or failing financial institutions without recourse to public sector funds; and the other is the introduction of the Volcker Rule (in the Dodd=Frank Act) as well as acts concerning the regulation and structural reform of banks in the UK, EU, Germany, and France, which provide regulations on businesses and the structure of systemically important financial institutions. The second trend reflects the idea that separating high risk activities from systemically important financial institutions could prevent the TBTF (too big to fail) problem and failures of such financial institutions.
With regard to the coverage and extent of regulation, acts concerning the regulation and structural reform of banks in major countries have their own characteristics, and the differences among them may influence market competition between major financial markets in the process of the enforcement of such acts. How the authorities of major countries might respond to adjust such differences and the degree to which they might look for convergences would be important policy issues.
In the meantime, banking businesses in Japan were separated from securities firms and securities businesses were separated from banks by Article 65 of the Securities Exchange Act of 1948, like the Glass Steagall Act of 1933 in the United States. In 1992, as part of financial deregulation, banks were permitted to engage in securities businesses and security firms to engage in bank businesses by way of establishing subsidiaries. Then, in 1997 such deregulation was expanded to permit business entry by way of establishing subsidiaries under holding companies. However, with regard to short-term propriety trading, registration for trading business is still required under Article 33 and 33-2 of the Financial Instruments and Exchange Act. On top of that, reflecting Japanese financial institutions’ different target models and the lack of related know-how as well as human resources, Japanese banks have not yet reached the point where they have transformed themselves into American-type investment banks.
For the time being, Japanese major banks search for business opportunities in Asian markets, which show high potential for economic growth, and they are likely to maintain a commercial bank model. Therefore, it is not likely that a wide emergence of investment banks will be seen in Japan, nor is it necessary to introduce acts concerning bank regulation and structural reform like those introduced in other major countries.

Keywords: investment bank, TBTF problems, Basel III, bank regulatory acts, structural reform acts.

DP2014-6
'' Research on early detection of financial statement fraud''

Naoto Oshiro, Special Research Fellow, Financial Research Center
(FSA Institute)

This report deals with recent developments in research on the area of early detection of financial statement fraud (FSF). First, summaries of academic research are provided from the viewpoints of determinant factors, motivations and incentives of fraudsters: “Hypothesis of meeting or beating a benchmark” and “Hypothesis of bonuses and incentives structure.” Some opportunities for committing fraud are factorized, including “composition of boards of directors and auditors committees,” “quality of audit” and “concentration of decision power.” Second, some typical schemes of FSF are summarized, such as revenue recognition, fictitious and inflated revenues, and improper capitalization of costs. Third, previous research on early detection of FSF are investigated and it is found that most of these models deal with only determinant factors of FSF, and only a limited number of models are more or less practically operational; M-Score of Beneish (1999b) and F-Score of Dechow et al. (2011), and the latter focus on the likelihood of restatements. Research on the early detection of FSF is still in a profound area, and further strenuous efforts and diverse approaches are indispensable.

Keywords: Financial Statement Fraud, Early Detection Model, Earnings Management

DP2014-5
'' Corporate Governance in Japan: Developments in Listed Companies and Roles of Institutional Investors''

Ryoko Ueda, Special Research Fellow, Financial Research Center
(FSA Institute)

This research analyzes the improvements in corporate governance of Japanese listed companies and the influence of institutional shareholders.

Firstly, in order to analyze the external factors, the report discusses the changes in circumstances of the Japanese market after the 1970’s. The main players before the 1990’s were banks who provided credit to companies and also served as shareholders. It was once suggested that corporate governance in Japan was characterized by the “main bank” system. However, since the burst of the “bubble economy” in the early 1990’s, institutional investors including domestic pension funds and foreign asset managers have had a greater presence than banks.

Secondly, this report analyzes developments in corporate governance at listed companies based on an experimental study. The study showed that corporate governance was considerably influenced by institutional shareholders through their proxy voting. This report also reviews the legislation and relevant rules on corporate governance including the reform of the Companies Act and Cabinet Office Ordinance on Disclosure of Corporate Information, etc.

Thirdly, this report examines the influence of institutional shareholders and analyzes their activities toward good corporate governance. In 2009, “Report by the Financial System Council’s Study Group on the Internationalization of Japanese Financial and Capital Markets” was published and asset managers such as investment trusts and investment advisory companies started to disclose the policy and the results of proxy voting. In 2014, pursuant to the recommendation of “Japan revitalization Plan 2013,” Japan’s Stewardship Code was published in February 2014 and it is expected that the institutional shareholders will play significant roles in improving corporate governance of the investee companies through engagement with them. Finally, the report analyzes the changes in the practices of shareholders meetings historically and examines how institutional shareholders have played their role and had an impact on the improvement of corporate governance at Japanese listed companies.

Keywords: corporate governance, stewardship, outside director, institutional investor, shareholder

DP2014-4
'' An empirical study on strategic behavior of high frequency traders during the market pre-opening period''

Jun Uno, Special Research Fellow, Financial Research Center
(FSA Institute)

The market opening is an important function of stock markets. The information accumulated overnight and the concentration of orders affects the price formation in anticipation of, and at, the market opening. A key question we ask in this research is whether high frequency quote revisions that occur during the pre-opening period amplify noise or lead to an improvement in the price formation.

The purpose of disseminating pre-opening quotes is to provide a good indication of the day’s opening price. However, the pre-opening quote information may still be noisy for several reasons. First, large orders that may have a significant impact on the opening price will not be entered until the very last moment (perhaps the last milli-second prior to the opening) because there is no advantage in entering them sooner. Indeed there are clear disadvantages: larger orders attract other participants and induce other investors to react quickly and cause deterioration in the execution price. Additionally, in most markets, there is no time priority applied to orders submitted during the pre-opening period.

Second, aggressive investors may enter noisy orders. The term “noisy” connotes a type of order that uses an aggressive limit price to send a signal to investors on the opposite side, to induce them to provide liquidity. Indeed, some investors may have an incentive to enter false orders with aggressive limit prices to elicit a favorable response from true orders from the opposite side. While this does not always work to the advantage of the aggressive investor, it may serve to add noise to pre-opening quotes.

The faster execution of trades helps delay their final action until very close to the market opening. Therefore, the noise effects may prevail up to the final seconds in the pre-opening period.

Our results concerning the Tokyo Stock Exchange (TSE) show a dramatic shift of order submission up to two seconds before the opening time. This affects the efficiency of pre-opening quotes as a predictor of opening price up to one seconds. As mentioned above, the purpose of disseminating pre-opening quotes is to provide a good indication of the day’s opening price. However, the results concerning TSE indicate that pre-opening quotes might mislead market participants. Finding better market rules and the effects of market competition may help market venues and regulatory bodies to improve institutional settings.

Keywords: market pre-opening period, pre-opening quotes, price efficiency, high frequency trading

DP2014-3
'' Relationship between proxy voting and fiduciary duty of institutional investors ''

Shunsuke Kasuga , Former Special Research Fellow, Financial Research Center
(FSA Institute)

The exercise of proxy voting in European and American pension funds changed after the financial crisis in 2008. For one, the UK government introduced the Stewardship Code in order to enhance engagement activities. On the other hand, the Dodd-Frank Act was enacted by the US government to strengthen the corporate governance of companies and financial institutions. In Japan, the interest in corporate governance activities increased in the early 2000s, against the background of the downturn in the stock market and the expansion of equity investments in pension funds. Since then, efforts such as improving the voting process and disclosure have been made mainly by asset managers.

The first part of this paper focuses on the relationship between proxy voting and fiduciary duty in pension investment. The second part discusses the recent trends of corporate governance activities in Japan, USA and the UK. In Japan, most pension funds are still somewhat reluctant to implement corporate governance activities despite asset managers’ efforts to improve disclosures of proxy voting. However, there is change seen on the part of Japanese institutional investors. Some pension funds have started investment from an environmental, social and governance (ESG) perspective in order to reduce downside risks. Other asset managers on the other hand have launched a Japanese equity engagement fund to increase corporate value from a long-term perspective.

Keywords: Fiduciary duty, institutional investor, pension investment, proxy voting, corporate governance, stewardship code

DP2014-2
'' Non-Performing Loan Reduction with Regulatory Transition ''
A Japanese Experience, 1998–2013

Masaki Nakabayashi , Special Research Fellow,
Financial Research Center (FSA Institute)

Toshiki Kawashima , Associate Research Fellow,
Financial Research Center (FSA Institute)

Japan experienced falling asset prices, reform of the financial market and massive reduction of non-performing loans from the late 1990s to the 2000s. This paper reflects non-performing loan reduction from 1998 to 2013 under the new regulatory regime and examines whether it was necessary to guide the banking sector to aggressive write-offs of non-performing loans in the early 2000s under the shadow of structural reform. Our results indicate that non-performing loan accumulation could have been cyclically reduced only by further extension of mortgage loans and, for Japan to avoid a housing-price bubble, the structural disposal in the early 2000s was justified.

Keywords: Non-performing loan reduction; structural reform; regulatory reform; mortgage loan; Japan.

DP2014-1
'' Progress in the European Banking Union: Integration of banking supervision and resolution systems in the Euro area ''

Takeshi Inoue, Special Research Fellow, Financial Research Center (FSA Institute)

As part of the European Banking Union in the Euro area, the European Central Bank (ECB) will directly supervise around 130 significant credit institutions under the Single Supervisory Mechanism starting from November 2014. The ECB is undergoing a comprehensive assessment prior to taking full responsibility for its supervision including a stress test which will be jointly carried out with the European Banking Authority. It attracts global attention and whether the comprehensive assessment restores the battered confidence in European banks’ balance sheets or not has been a key question among authorities and markets.

The European Parliament and the Council of the European Union have managed to agree on a compromised text for the Single Resolution Mechanism (SRM), another pillar of the European Banking Union (EBU), after clashing on the decision making process of bank resolutions and back stop systems on 20th March 2014. Both sides had to accept a few political concessions in order to pass the legislation before the general election of the European Parliament in May.

The EU-wide Bank Recovery and Resolution Directive, which the SRM is based on, has been agreed upon in December,2013 and will be implemented in 2015. A Bail-in tool, ensuring that unsecured creditors and shareholders rather than taxpayers get first in line to pay for bank failures will be introduced in 2016.

The European Banking Union will be the greatest step ever for the EU after the introduction of the common currency the euro. Pragmatic approaches to put the stability of the Eurozone first beyond political and interstate conflicts will be the key to success and prevent disorder and over anxiety during the transition period.

Keywords: Banking Union, Single Supervisory Mechanism,
Single Resolution Mechanism, Bail-in, Sovereign Debt Crisis