The task of this Council is to propose how such a restructuring
of the Japanese market may be accomplished.
1. From gradual deregulation to structural market reform
Fundamental reforms in many markets around the world have left
the Japanese market lagging seriously behind the most advanced
markets. In order to recoup this delay, an urgent task is to introduce
those products and services that are commonplace in overseas markets
but have not yet been introduced in the Japanese market. However,
the Japanese market cannot become an international market rivaling
New York and London, if Japan only introduced products after they
had been developed in overseas markets. Not only will it be necessary
to close the gap with more advanced markets, but it should be
the aim of this reform to build a mechanism into the market by
which the market develops spontaneously.
In Japan, there has been a tendency to introduce new instruments
and services on a one-by-one basis: typically, an instrument or
a service that had been developed in overseas markets will be
identified; its domestic market potential and investor protection
measures studied; and after a consensus on desirability had been
reached, the new instrument or service will be introduced under
a common industry standard. Such a strategy was efficient in the
sense that it eliminated trial-and-error process by introducing
only those instruments and services with a proven track record.
However it not only limited the scope of options available to
investors and issuers, but may also have encouraged an imitative
attitude among financial intermediaries and discouraged creativity.
Similarly, an approach that placed emphasis on distancing investors
from risk rather than making risk known to investors, may paradoxically
have created the misperception that those areas where restrictions
had been lifted were safe areas with an official seal of approval,
thereby weakening the idea that each market participant is responsible
for his own judgment and must behave in the market with self-discipline.
If the Japanese market is to develop in step with the global market
in an age of rapid financial innovation, an approach whereby regulators
vet and approve each new instrument or service is not a viable
strategy. Rather, regulations that act to restrict new initiatives
should be reduced to the extent possible, and creativity be allowed
to flourish. To this end, preventive regulations limiting activity
and products should be repealed to the extent possible, and policies
should shift to one that builds up an environment in which market
discipline operates effectively. Investors and firms should be
given the freedom to choose from as wide a range of financial
instruments and services as possible, basing their decisions on
accurate disclosure of information. Through this process, those
instruments and services that best meet the needs of the users
will be born and will grow. Building a framework that encourages
such development of the market based on market forces is the key
to enhancing the quality and competitiveness of the Japanese securities
market, and, ultimately, in regenerating dynamism on the Japanese
economy, as well as ensuring a more efficient allocations of resources
worldwide.
The Council proposes to move from a regime that is based on a
single, unified system to one that encourages diverse competition.
It also asserts a shift in supervision policy from one that attempts
to regulate business activity to one that is centered on disciplinary
powers of the market. Similar ideas have underscored past market
reforms in the United States and in the United Kingdom, and is
most probably a natural response to the increased sophistication
of financial and communications technology, and globalization
of financial markets. It should be noted that the reforms in these
two countries have helped create employment and income growth
in the securities industry, and have enhanced the global position
of the New York and London markets.
The Japanese market has, underlying it, Y1200 trillion of household
financial assets, a huge real economy, and financial intermediaries
with high potential for innovation. The Japanese market, then,
has the ingredients to become a truly international market. By
creating an infrastructure that encourages innovation based on
market principles, and thereby transforming the market into one
where intermediaries with advanced financial technology and flexibility
to meet diverse needs can flourish, the Japanese market could
become an internationally recognized market that can be compared
to New York and London.
2. The Importance of Market Framework
(1)Building a fair and trusted market
A reorientation of regulatory philosophy towards one that emphasizes
freedom of activity will increase the importance of creating a
market that is fair and can be trusted. A free market should not
degenerate into a wild west where self-interest simply collide
with one another. Fair competition must prevail in order for the
market mechanism to function effectively. To this end, the market
must be such that ordinary investors, who are the holders of the
Y1200 trillion of financial assets and who are in a disadvantaged
position in terms of access to information and negotiating ability,
can participate in the market without the apprehension that he
may be treated unfairly. If this were not the case, then it would
be impossible to require investors to evaluate risk and form their
own investment decision. Moreover, in an internationally open
market, clear and transparent rules and their swift and effective
enforcement are necessary for transactions between professional
market participants.
A sense of trust that fair transaction rules are universally
observed is the most basic requirement for a market. Such a goal
cannot be achieved through the traditional approach of ensuring
the soundness of the market by regulating the business activity
of intermediaries, given that the proposed reform intends to create
a framework in which market mechanism is to drive market development.
A transition from preventive regulation to rule-based surveillance,
and in particular strengthening of disclosure, fair transaction
rules, and surveillance and enforcement mechanism are essential.
Although such a penalty based system provides an underpinning
for the market, it will not be enough to rely on criminal penalties
alone. A system of dispute settlement whereby compensation for
financial injuries from unlawful and unjust actions are quickly
and reliably recovered is also important. In addition to penal
and administrative penalties, the existence of such a civil procedure
will also be an effective deterrent to unfair market activity.
Nonetheless, market cannot exist solely on the basis of a system
of rules that can be ultimately be resolved through a judicial
or administrative process. Observing established rules is a minimum
requirement. As the scope of freedom widens, market participants
will be required to regulate themselves in a disciplined manner.
In the case of disclosure, for example, it is not enough simply
to disclose information required by law: issuers should actively
disclose information that may be of value in forming investment
decisions, and do so in an easily understood fashion. This is
important not only for the market, but it is ultimately in the
interest of the issuer himself, as those that do not disclose
sufficient information will eventually be shunned by investors.
Irresponsible actions will destroy the market, and in the long
run, is not in the interest of the participants that behave in
such a manner. Freedom requires a higher ethical standard. It
is an important challenge for the Japanese market to firmly establish
a high standard of ethics in the market. Those involved in the
securities market should make every effort to strengthen the Japanese
people's trust in the market.
(2) Developing Market Infrastructure
The other important role for the public sector, along with the
establishment of rules, is to improve market infrastructure such
as the settlement system.
Recent advances in technology mean that private supply of services
is feasible even in areas where it was taken for granted that
the service had to be provided by the public sector. It is appropriate
for the private sector to take the lead in areas where it is feasible
to do so.
It is also important for the public sector to complement private
initiatives, if leaving it entirely to the private sector could
result in an undersupply or inefficient supply of services. Care
must be taken, of course, so that official involvement does not
kill off the emergence of alternative sources of supply by constraining
the development of market infrastructure into a single mold.
Civil and Commercial Codes, as well as the Tax Code and the Accounting Standards are all important elements of market infrastructure and comprise what may be considered a system of basic software. As deregulation proceeds and improvements in the market's physical infrastructure such as the settlement system take place, the market will gradually converge towards a common global standard. In that process, the market-friendliness of such basic software is emerging as a factor that determines how user-friendly a market is. With globalization of financial markets, users can increasingly even select between different systems of basic rules, by choosing the market in which a transaction takes places. As a result, for financial transactions, there is now emerging a set of de-facto standard for Civil, Commercial and Tax Codes as well as Accounting Rules. A market whose rules differ significantly from such a standard risks being
bypassed by users, particularly professional ones.