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EXPLOSIVE GROWTH OF JAPANESE
“REPO MARKET” CONTINUES, BUT...
Prepared by Technical Data
Division of Thomson Financial Networks
The Japanese “repo market” continued to grow during the first quarter of the new fiscal year, and all indications point to sustained rapid growth–at least during the immediate future. The market, which involves the lending of bonds using money as collateral, is used for both short-term financing (general transactions, which do not specify the issue) and the lending of bonds (special transactions involving specified issues).
The inception of Japan's version of bond repos in April 1996 was the result the actions of two people in very different circumstances. The first person was Nick Leeson, whose bankrupting of Barings Securities helped to reveal the precarious position in which many Japanese bond lenders had placed themselves. The Japanese market has the dubious distinction of being the only market allowing uncollateralized bond lending on a significant scale, and many Japanese financials lent JGBs to Barings. Although intervention from the ING Group averted losses, the near-miss brought to the forefront the need for collateralized bond lending in Japan.
The second person whose actions have made the Japanese repo market possible has been Prime Minister Ryutaro Hashimoto–primarily thanks to his efforts to modernize Japan's financial system as part of wide-ranging reforms. Although both the intentional and unintentional actions of these two people helped to bring about the Japanese repo market, other factors are driving the continued expansion of the market.
An increasing number and wider range of financial entities are starting to participate in the repo market, which is helping to enlarge and deepen the market. Repos were originally dominated–and to a certain extent still are–by the big four Japanese securities houses and a few foreign investment banks. Recently, Japanese city banks and trust banks have become active players, and in the future other financial institutions are expected to follow suit. Moreover, the market may even expand to include non-financials. The original stumbling block to the establishment of the repo market in Japan was the withholding tax. Special legislation was enacted to relieve financials from paying the withholding tax during repo transactions, which made the repo market viable for financials. There is currently a movement underfoot to extend this tax exemption to corporates, which would result in an open market and augment the volume of transactions due to a wider range of participants.
Also helping to fuel the growth of the repo market have been efforts by Japanese banks to meet BIS capital adequacy ratio requirements. Bruised by international reaction–both the Japan Premium and general selling of bank shares and convertibles–Japanese banks have been watching their capital ratios more carefully. Uncollateralized bond lending carries a risk weighting of 100% and has become more and more unacceptable to banks; consequently they have moved into repos. The simplicity of use and the little paperwork required of repos has been an additional bonus.
Another factor in repo market growth has been the drive by Japanese financial institutions to conform to global customs. There has been a gradual move toward international settlement standards, which are shorter and consequently lessen the risk of default. The move to shorter settlement times has meant that players with a short position have to come up with the bonds more quickly, forcing them to turn to the repo market. When the trading of repos started, settlement was based on the Japanese five-ten system but since then has moved to a rolling settlement of T+7 and finally the international standard of T+3. Additionally, adherence to international standards has boosted confidence in the trustworthiness of the market.
Although all the preceding factors point to the continued expansion of the Japanese repo market, the possibility remains that if the current securities transaction tax were repealed the market could disappear overnight. In this not unthinkable case, the current activity in the repo market would likely flow into the gensaki market. Since the gensaki market is more similar to the repo market in the Western sense, it would be extremely competitive in the absence of the tax.
Is the abolition of the securities transaction tax likely? The Ministry of Finance remains firmly opposed to this move but only because of the loss of revenue it would represent. If alternative sources of revenue were found, MoF resistance would disappear. As the financial industry continues to lobby vociferously against the tax, politicians are starting to warm up to the industry's viewpoint. So the end of the tax may only be a matter of time. The vast majority of participants at a recent Government Tax Commission hearing felt that the abolition of the tax is essential to Prime Minister Hashimoto's financial reforms. However, with current plans centering on reduction and not the abolition of the tax, the Japanese repo market remains safe in the short term.
September 22, 1997 James Sullivan
Technical data
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Copyright 1997, by Consensus Inc. All American and Pan American rights Reserved. editor@consensus-inc.com
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