(1)Introduction
Efficiency and fairness are the two most important elements in
a marketplace where transactions take place. It was generally
thought that efficiency and fairness can be best achieved by screening
the firms that are allowed access to the market to raise funds,
and then requiring transactions to take place at a centralized
exchange or other similar venues. However, progress in electronics
and communications as well as financial technology has opened
up the possibility of alternative transaction methods. Also, in
order to encourage new business, access to the capital market
should be made available to a wider range of firms. It is worth
noting that systems can now be constructed that ensure fairness
of transactions without requiring them to take place at exchanges.
One should also take into account that , with the globalization
of the market, restrictions at home could drive transactions overseas,
resulting in a hollowing out of the market, under which circumstance
efficiency and fairness may not be achieved.
It is important that different markets compete under a common
set of fair transaction rules and other investor protection rules,
so that transactions can be more liberally undertaken. This is
in accordance with the basic philosophy underlying this reform.
More specifically, the following measures should be taken:
(2) Creating diverse and outstanding markets
In order to respond to varied transaction needs of investors,
a. For stock exchanges, in addition to efforts to review and improve
the transaction system within exchanges, the requirement of consolidation
of order-flow for listed securities should be abolished, and off-exchange
transactions permitted .
b. For the registered OTC (JASDAQ) market, its characterization
as one that compliments the stock exchange market should be rectified,
and measures should be taken to strengthen its function by improving
its secondary market capacities.
c. For unlisted and unregistered securities, securities companies
should be allowed to trade and intermediate these share actively,
after appropriate rules are put into place to ensure fairness
of transactions.
In addition, in terms of market infrastructure, measures that
include the following should be undertaken:
d. Broaden access to transaction and quote information.
e. Improve the clearing and settlement system for securities.
f. Improve the share lending market.
Together, these steps will widen the choice of markets available
to investors and issuers. Through competition among markets, the
efficiency and functioning of the securities market system as
a whole should improve.
(3)Enhancement of market efficiency and the issue of cross-holdings
of shares Strengthening the competitive environment of the market
is aimed not only at improving the quality of services available
to the users, but also at improving the efficiency of price formation.
Efficient price formation helps to bring together the varied views
of investors concerning a firm's future profitability and other
aspects, reflecting them in bond and share prices. These prices
in turn drive the funding and investment decisions, and results
in efficient allocation of resources based on market principles.
Moreover, the share price acts as the market's judgment on the
ability of the firm's management, and thereby exerts pressure
on the management to realize a more efficient use of capital and
to improve the competitiveness of the firm.
An important issue in this context is the widespread cross holding
of shares that are aimed at consolidating inter-corporate business
and securing stability of corporate management. Cross-holdings
are often cited as a peculiarity of the Japanese stock market
that inhibits the functioning of the market.
On this point, there are views that holdings motivated by non-financial
objectives need not be rejected, and that the effect of such decisions
on prices should not be seen to be distorting, and that in any
event, economically irrational cross-holdings are dissolving on
its own accord.
These views notwithstanding, there are those who hold that share
holders in mutual holdings situations may not exercise shareholder
rights in full and thereby tend to weaken corporate governance,
and also that cross-holdings introduce investment decisions that
are strategic in nature, and thereby discourages the willingness
to invest of investors who focus solely on financial returns,
thus hindering the operation of market mechanism.
The most important point of view that needs to be kept in mind
in this debate, is that cross holdings of shares should not inhibit
market mechanism, as that will be to the detriment of optimal
allocation of resources and efficient use of capital. From this
standpoint, even for cross-held shares, shareholders should constantly
reevaluate the return on investment and exercise governance checks
on the management of firms.
(4)Active participation of individual investors
The role of investors in providing critical judgment on the risk
and return of a financial instrument is of paramount importance
for market mechanism to work well. Without in any way lightening
the responsibility of intermediaries in their dealings with customers
such as those embodies in the suitability principle, individual
investors should also be encouraged to exercise their own judgment
in the management of their assets.
(5)A fair and transparent framework for the market
<1>Appropriate investor protection for new products and services
Fairness and transparency in a market is a precondition for requiring
investors to bear the responsibility for their own investment
decisions. Against the background of emergence of new products
and services and increasing complexity of transactions, it is
important to build upon the existing fair trade rules to ensure
that the market remains a dependable one for investors. Rules
concerning conflict of interest, market manipulation, and insider
trading need to be broadened to cope with developments such as
wider scope of business conducted by securities firms, expansion
of electronic trading including that through the Internet, and
introduction of new transactions such as OTC derivatives.
<2>Strengthening the penalty for violation of rules
Furthermore, penalty for violating these rules should be reviewed,
and in particular, penalty for insider trading should be strengthened.
<3>Reinforcement of inspection, surveillance and enforcement system
To ensure that the rules are applied effectively, inspection,
surveillance and enforcement system should be reinforced, including
the strengthening of the Securities and Exchange Surveillance
Commission. Inspection and surveillance methods should also evolve
to meet the demands of an increasingly sophisticated market.
In order to ensure the effectiveness of inspection and surveillance
activities, penalty for false reporting to inspection and surveillance
authorities should be strengthened.
<4>The role of self regulatory organizations
In a rapidly changing and highly professional market, it is often
difficult to strike an appropriate balance between a regime that
permits freedom of innovation, and determining a set of rules
that guarantee a fair market. Other advanced markets employ legally
acknowledged self regulatory organizations to fill the gap between
penal and administrative system of inspection, surveillance and
enforcement, and the self imposed ethics of individual market
participants. Self regulatory organizations are formed by financial
intermediaries, but their main role is to establish an appropriate
code of conduct for intermediaries. As such, they are well placed
to increase the trust of users in the market and intermediaries,
and such efforts are, in the long run, in the interest of the
intermediaries themselves. Under a more liberal regime, the role
of self regulatory organizations in Japan will gain even more
importance.
<5>A system to cope with civil disputes
Civil disputes may also increase in the new environment, and it
is also important to expand and improve the mechanisms to settle
disputes by, inter alia, providing a legal basis for the arbitrating
functions of self regulatory organizations.
(6) Strengthening disclosure
<1>Introduction
It is important to provide sufficient information on the risk
and return associated with potential investment. This will help
strengthen the market mechanism and also contribute to reducing
disputes. A fair and transparent system of disclosure should be
reinforced.
<2>Review of Accounting Standards
A. Disclosure framework should move to one based on consolidated
accounting, in order to make more transparent the financial conditions
of companies, whose activities have become increasingly diverse
and global.
B. Accounting standards for financial instruments should also
be reviewed, including the use of mark-to-market methodology,
along with those for liabilities and assets associated with corporate
pension schemes. These are major accounting challenges as we enter
the 21st century.
Through these initiatives, a system of accounting standards and
disclosure particulars that are in line with international norms
should be put into place. The Corporate Accounting Council issued
on June 6 a proposal to revise the consolidated system of accounts.
Other issues will also be examined in due course.
<3>The role of certified public accountants
Efforts to secure the accuracy of disclosure information is required
to compliment these revisions in accounting and disclosure standards.
The quality of certified public accountants' auditing needs to
be raised, which will also contribute to better corporate governance.
The Certified Public Accountants Council issued on April 24 a
ten point proposal to improve the quality of audits, and it is
hoped that these proposals would be put into effect under the
auspices of the Japan Institute of CPA.
<4>Improving access to disclosure information
Disclosure information is useful in forming appropriate investment
decisions only if they are readily available to and understood
by the investor. The application of electronic technology in disclosure
and dissemination of disclosure information via the Internet will
improve access to disclosure information and will also help the
growth of market related information services. Currently, details
of an electronic based disclosure system is under consideration,
and the introduction of such a system at an early date is urged.
<5>Investor education
For individuals, investor education activity is valuable in that
it helps individuals to gain deeper understanding of disclosure
information and form their own investment decisions. Efforts in
this area should be strengthened. For example, self education
initiatives by individuals through such activity as investment
clubs need to be encouraged. The Council also hopes that those
involved in public education will also recognize the importance
of investor and consumer education, including knowledge of securities
markets, and enlarge educational effort in this area.