fima research center, university of hawai'i 1 further reforms of the jgb market for the...

FIMA Research Center, University of Hawai'i

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Further Reforms of the JGB Market for the Promotion of Regional Bond Markets

S. Ghon RheeS. Ghon RheeUniversity of HawaiUniversity of Hawai‘‘ii

ADBI WORKSHOP“Development of Domestic and Regional Capital Markets”

13-14 June 2001, Bangkok, Thailand


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Looking Back: The Asian Financial Crisis

Reversal of Capital Flows to Crisis-Reversal of Capital Flows to Crisis-Affected Economies: $105-$110 billion or Affected Economies: $105-$110 billion or 10% of the Pre-Crisis Combined GDP10% of the Pre-Crisis Combined GDP

Was the Reversal Too Large for the Asian Was the Reversal Too Large for the Asian Economies as a Group to Cushion Its Economies as a Group to Cushion Its Impact on Their Currency and Equity Impact on Their Currency and Equity Markets? Markets?


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Magnitude of Reversal

Less than 5% of Pre-Crisis Combined Less than 5% of Pre-Crisis Combined Domestic Savings of $2.3 Trillion Domestic Savings of $2.3 Trillion

Only 1/6Only 1/6thth of Pre-Crisis Foreign Exchange of Pre-Crisis Foreign Exchange Reserves of $700 BillionReserves of $700 Billion

Accumulated by 5 Crisis-Affected Accumulated by 5 Crisis-Affected Economies Plus China, Hong Kong, Economies Plus China, Hong Kong, Japan, Singapore, and TaiwanJapan, Singapore, and Taiwan


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What Would Have Happened?

Had These Domestic Savings Been Had These Domestic Savings Been Channeled Into Corporate Financing Channeled Into Corporate Financing Without Relying on Short-term Financing Without Relying on Short-term Financing from Abroadfrom Abroad

Had 15% of Foreign Exchange Reserves Had 15% of Foreign Exchange Reserves Been Allocated for the Region’s Capital Been Allocated for the Region’s Capital Account CrisesAccount Crises


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Valuable Lessons from the Recent CrisisSufficient Funds Were There in Asia, Sufficient Funds Were There in Asia,

but the Region Lacked:but the Region Lacked:

Short-Term Financing Facilities to Utilize Short-Term Financing Facilities to Utilize Region’s Foreign Exchange Reserves Region’s Foreign Exchange Reserves

Fully Developed Domestic Bond Markets Fully Developed Domestic Bond Markets and Regional Bond Marketsand Regional Bond Markets


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Two Major Initiatives

““Chiang Mai Initiative” by Chiang Mai Initiative” by

ASEAN + ThreeASEAN + Three

Bilateral “swap” arrangements and Bilateral “swap” arrangements and repurchase agreements repurchase agreements

Need A New Initiative to Create Need A New Initiative to Create Regional Bond MarketsRegional Bond Markets


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Gaisai Bond Issues Unit: ¥ trillionUnit: ¥ trillion

Number of Samurai Number of ShogunNumber of Samurai Number of Shogun

YearYear IssuesIssues BondsBonds IssuesIssues Bonds Bonds 19911991 27 27 0.71 0.71 1 1 0.41 0.41 19921992 37 37 1.57 1.57 0 0 0 0 19931993 49 1.23 49 1.23 1 1 0.59 0.59 19941994 60 60 1.26 1.26 0 0 0 0 19951995 85 85 2.11 2.11 0 0 0 0 19961996 154 3.79 154 3.79 0 0 0 0 19971997 66 66 1.58 1.58 0 0 0 0 19981998 10 10 0.15 0.15 0 0 0 0 19991999 24 24 0.87 0.87 0 0 0 0 2000 2000 63 63 2.38 2.38 0 0 0 0


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New Miyazawa Initiative

Three measures under the NMI Three measures under the NMI are related to regional bond are related to regional bond market activities market activities a.a. Acquisition of sovereign bonds by Acquisition of sovereign bonds by

Japan Bank for International Japan Bank for International CooperationCooperationb.b. Use of credit guarantee and/or Use of credit guarantee and/or interest interest subsidies subsidies c.c. Establishment of international Establishment of international guarantee institution guarantee institution


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Size of Government Bond Markets

Outstanding Government SecuritiesOutstanding Government Securities(as of December 2000)(as of December 2000)

Hong Kong:Hong Kong: $13.94 billion$13.94 billionSingapore:Singapore: $24.97 billion$24.97 billionAustralia:Australia: $40.33 billion (as of March 2001)$40.33 billion (as of March 2001)

--------------------------------------------------------------------US:US: $2,966.9 billion$2,966.9 billionJapan:Japan: $3,176.7 billion$3,176.7 billion


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Why the Tokyo Market Did not Capitalize on the NMI?

Without joint effort by the region’s Without joint effort by the region’s economies, Japan alone cannot economies, Japan alone cannot create a truly a regional bond marketcreate a truly a regional bond market

The Japanese government bond The Japanese government bond (JGB) market suffers from its own (JGB) market suffers from its own weaknessesweaknesses


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Big Bang Financial Reforms: Japan (I)

1.1. Deregulation of cross-border transactions Deregulation of cross-border transactions and and foreign exchange businessforeign exchange business2.2. Adoption of a competitive auction method to Adoption of a competitive auction method to issue issue financing billsfinancing bills3.3. Abolition of securities transaction tax Abolition of securities transaction tax 4.4. Deregulation of brokerage commissionDeregulation of brokerage commission5.5. Preparation of legal framework for loan/asset Preparation of legal framework for loan/asset securitizationsecuritization6.6. Allowance of off-exchange tradingAllowance of off-exchange trading


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Big Bang Financial Reforms: Japan (II)7.7. Allowance of banks and financial Allowance of banks and financial

institutions institutions to issue bondsto issue bonds

8.8. Entry by banks, securities companies, and Entry by banks, securities companies, and insurance companies into each insurance companies into each

other’s other’s businessbusiness

9.9. Introduction of individual stock optionsIntroduction of individual stock options

10.10. Replacement of merit-based licensing Replacement of merit-based licensing system system with a disclosure-based registration with a disclosure-based registration system system for securities companiesfor securities companies


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Government Bond Markets

Japan United States United Kingdom

Turnover Ratio 6.9 22.0 7.0 Bid-Ask Spread (10-Year Bond) 7.0 3.1 4.0 Maturity Distribution

< 1 Year 5% 21% 7%

1-5 Year 8% 62% 29%

5-10 Year 78% 0% 34%

>10 Year 9% 17% 30% Average Issue Size ($Billion) 8.2 13.9 5.6 Government Holding (%) 46.3 13.1 3.6 Non-Resident Holding (%) 10.0 36.9 14.4 Settlement T+3 T+1 T+1 DVP-Basis Settlement 68% of registered JGBs

and 43% of book-entry

JGBs

All JGBs through BOJ-

NET

100% 100%

No. of Primary Dealers None 37 16


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Post-Big Bang Reform Measures

Creation of the primary dealer systemCreation of the primary dealer system Adoption of the uniform-price auction Adoption of the uniform-price auction

methodmethod Introduction of when-issued tradingIntroduction of when-issued trading Revamping the REPO marketRevamping the REPO market


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Creation of the Primary Dealer System

Existence of primary dealers does not Existence of primary dealers does not necessarily guarantee intense competition on necessarily guarantee intense competition on the primary market but they are experts in the primary market but they are experts in pricing, market pricing, market making, and distributionmaking, and distribution

No primary dealer system: Japan and GermanyNo primary dealer system: Japan and Germany MOF’s dual role (buyer and seller) to be blamed MOF’s dual role (buyer and seller) to be blamed

for the lack of primary dealer system in Japanfor the lack of primary dealer system in Japan Syndicated underwriting: Past normSyndicated underwriting: Past norm Public auction systems are now used for: Public auction systems are now used for:

2-, 4-, 6-, and 20-year bonds2-, 4-, 6-, and 20-year bonds

Issuing Techniques ofGovernment Bonds

Fixed Price Public SubscriptionsFixed Price Public SubscriptionsUnderwriter consortium utilized Underwriter consortium utilized

Private PlacementsPrivate PlacementsIn the absence of well-functioning secondary marketsIn the absence of well-functioning secondary markets

Tap IssuesTap IssuesSold directly into the secondary market through Sold directly into the secondary market through

branch network of banks or securities companies branch network of banks or securities companies

AuctionsAuctionsMultiple price auction vs. Uniform Price AuctionMultiple price auction vs. Uniform Price Auction

Issuing Techniques ofamong OECD Members

Uniform Price AuctionUniform Price AuctionFinland, Italy, Netherlands, Norway, and Finland, Italy, Netherlands, Norway, and Switzerland, UKSwitzerland, UK

Multiple Price AuctionMultiple Price AuctionAustralia, Austria, Canada, Sweden, UKAustralia, Austria, Canada, Sweden, UK

Tap IssueTap IssueUS, UK, Germany, Canada, and most of US, UK, Germany, Canada, and most of

OECD OECD members, but not Japan members, but not Japan


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Auction Methods: Government-Issued Securities

Japan United States United Kingdom

Uniform-Price Auction

None All Treasury Securities

Index-linked

Bonds

Multiple-Price Auction

All JGBs 20-Year Bond:

Competitive Auction Only

2-, 4- and 6-Year Bond: Both Competitive and Non-competitive Auction

5- and 10-Year Bond: Syndicated Underwriting

None All Securities other than Index-linked Bonds

Adoption of Uniform-Price Auction Method (I)

Multiple-price auction methodMultiple-price auction method

a.a. Successful bidders pay the prices they bid…. Successful bidders pay the prices they bid…. …..“…..“winner’s cursewinner’s curse” ”

b.b. Bidders tend to shade their bids below the Bidders tend to shade their bids below the maximum that they are actually willing to paymaximum that they are actually willing to pay

Uniform-price auction methodUniform-price auction methoda.a. All successful bidders pay the same price for a All successful bidders pay the same price for a

given securitygiven securityb.b. Hence, some successful bidders may pay a lower Hence, some successful bidders may pay a lower

price than they actually bid. price than they actually bid.

Adoption of Uniform-Price Auction Method (II)

Empirical EvidenceEmpirical Evidence

a.a. The uniform-price auction method generates The uniform-price auction method generates higher revenue for the government higher revenue for the government

b.b. US Treasury has been utilizing the uniform-price US Treasury has been utilizing the uniform-price auction method for all Treasury securities since auction method for all Treasury securities since 19971997

c.c. Japan never adopted the uniform-price auction Japan never adopted the uniform-price auction methodmethod

Introduction of When-Issued Trading Most advanced markets allow trading during the period Most advanced markets allow trading during the period

between the time a new issue is announced and the time it between the time a new issue is announced and the time it is actually issued.is actually issued. Ranging from one week to two-weeks (US market) Ranging from one week to two-weeks (US market) As short as two days (France)As short as two days (France)

When-issued trading functions like trading in a forward When-issued trading functions like trading in a forward market.market.

Major BenefitsMajor Benefits Minimize price and quantity uncertainties. Minimize price and quantity uncertainties. Lower underwriting riskLower underwriting risk Increase revenue from the new issue Increase revenue from the new issue

By not allowing when-issued trading in Japan, the MOF By not allowing when-issued trading in Japan, the MOF foregoes these benefits.foregoes these benefits.


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Revamping of the REPO Market (I) Major Functions of REPO MarketMajor Functions of REPO Market

a.a. allows primary dealers to cover their short allows primary dealers to cover their short positionspositions

b.b. allows institutional investors to maximize allows institutional investors to maximize investment income by lending their securitiesinvestment income by lending their securities

c.c. allows foreign investors to reduce currency risk allows foreign investors to reduce currency risk through money market hedgingthrough money market hedging

d.d. facilitates clearing and settlement transactionsfacilitates clearing and settlement transactions


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Revamping of the REPO Market (II)

Traditional Gensaki MarketTraditional Gensaki Market European-style REPO (sell-and-buy-back)European-style REPO (sell-and-buy-back) Ownership to the security is transferred to the buyerOwnership to the security is transferred to the buyer No marking-to-marketNo marking-to-market Major instruments: Short-term Treasury and financing Major instruments: Short-term Treasury and financing

bills bills

American-Style REPO marketAmerican-Style REPO market Borrow and LendBorrow and Lend No transfer of security ownershipNo transfer of security ownership Marking-to-market Marking-to-market Major instruments: All Treasury and corporate Major instruments: All Treasury and corporate

securities securities


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Creation of Regional Bond Markets

A comprehensive study and detailed A comprehensive study and detailed blueprint are neededblueprint are neededa.a. Asian Common CurrencyAsian Common Currencyb.b. Credit Enhancement and Guarantee AgencyCredit Enhancement and Guarantee Agencyc.c. Regional Clearing and Settlement SystemsRegional Clearing and Settlement Systemsd.d. Cross-Border Securities Borrowing and Cross-Border Securities Borrowing and Lending FacilitiesLending Facilitiese.e. Cross-border Trading SystemsCross-border Trading Systemsf.f. Regional Rating AgencyRegional Rating Agencyg.g. Harmonization of Tax and Accounting RulesHarmonization of Tax and Accounting Rules

Thank You!

Asian Common Currency

Major Benefit of the Euro for Europe’s Bond Major Benefit of the Euro for Europe’s Bond Markets Markets i.i. Elimination of Exchange RiskElimination of Exchange Risk

ii.ii. Harmonization of Market PracticesHarmonization of Market Practices

iii.iii. Re-denomination of European Government Bonds Re-denomination of European Government Bonds in in EuroEuro

Full or Partial Currency Unification in the Region?Full or Partial Currency Unification in the Region?

Coordinated Monetary and Fiscal Policies?Coordinated Monetary and Fiscal Policies?

ASEM Meeting (Jan 13, 2001) supported AMUASEM Meeting (Jan 13, 2001) supported AMU


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Credit Enhancement and Guarantee Agency

Regional credit enhancement & Regional credit enhancement & guaranty agencyguaranty agency

New Miyazawa Initiative but no New Miyazawa Initiative but no follow follow throughthrough

Structured financing arrangementsStructured financing arrangements Bond InsuranceBond Insurance Borrow the idea of Municipal Bond Borrow the idea of Municipal Bond

Bank concept? Bank concept?

Cross-Border Clearing and Settlement

GovernmentGovernment Corporate Corporate

SecuritiesSecurities BondsBonds

AustraliaAustralia Reserve Bank InformationReserve Bank Information Financial TransactionsFinancial Transactionsand Transfer Systemand Transfer System Recording and ClearanceRecording and Clearance

SystemSystemHong KongHong Kong Central MoneyMarkets Central MoneyMarkets Central Clearing & Central Clearing &

UnitUnit Settlement System Settlement System JapanJapan BOJ Financial NetworkBOJ Financial Network n.a.n.a.

System (BOJ-NET)System (BOJ-NET)SingaporeSingapore Government Book-EntryGovernment Book-Entry Debt SecuritiesDebt Securities

SystemSystem C&S systemC&S system


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Regional Bond Borrowing and Lending

To promote cross-border REPO To promote cross-border REPO transactions and C&Stransactions and C&Sa.a. Uniform Legal Framework for Securities Uniform Legal Framework for Securities

Borrowing and Lending and Sell-and-Borrowing and Lending and Sell-and-Buyback ArrangementsBuyback Arrangements

b.b. Uniform Tax and Accounting TreatmentUniform Tax and Accounting Treatment

Bond Trading Systems

Order- vs. Quote-Driven TradingOrder- vs. Quote-Driven Trading

1.1. Market Makers’ InvolvementMarket Makers’ Involvement

Pre-trading negotiations and Pre-trading negotiations and personal personal relationships among market relationships among market markets markets

2.2. Inter-Dealer Brokers Inter-Dealer Brokers


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A Regional Credit Rating Agency?

a.a. Economically Feasible?Economically Feasible?

b.b. How to Harmonize Accounting and How to Harmonize Accounting and Disclosure Standards?Disclosure Standards?

c.c. How to Improve the Dialogue Between How to Improve the Dialogue Between Credit Rating Agencies and Asian Credit Rating Agencies and Asian IssuersIssuers

fima research center, university of hawai'i 1 further reforms of the jgb market for the...

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