ASSESING THE REGULATORY FRAMEWORK OF THE BOND MARKET

Category: Accounting

This section of paper will describe about the regulatory framework of bond market and credit rating industry in Japan. The figure 1 shown the Japanese financial system based on Piyadasa Edirisuriya. The structure stated in Japanese financial system divided into three major categories which are central bank of Japan (Bank of Japan), private financial institutions and public financial institution. Private financial institutions can be divided into depository institutions which consist of banks and cooperative type institutions and other institution which are insurance and securities firms. And for Public financial institutions is come into postal savings and government finance institutions.

Since the 1950s, the Japanese economy begin it's continuously development. After starting the development, Japanese economy experienced several fluctuation, this is because the affect of two major oil crises in 1974 and 1979. Despite these crises, the Japanese economy did remarkably well until 1989 when the bubble burst. In 1965, Japan starting its government bonds as same as other some Asian countries. These government bonds were the major instrument issued by the ministry of Finance (MOF) in the 1970 and 1980s.

The regulation to the financial system in Japan is complicated compare to the other countries. Japan has been constructing the regulation in several times to achieve the effective regulation. The history began when the National Banking act of 1879 and establishment of the Bank of Japan in 1882 which was introduced regulation to the financial system. The problem high volume of bond issued by the central bank became the first sign of reform in Japanese financial system in 1970s (Uchida and Tsutsui, 2005). In mid 1989s, the next financial reform was the liberalizing of deposit interest for some financial products. In the early 1990s, all deposit rates were liberalized until "Big Bang" reform process begun where financial market were controlled by number of measure such as management, day to day operations, customers and also new entrants. Since the end of 1996, Japan tried to further eliminate the existing inefficiencies and remove the barriers within the financial sector of the county through a serious reform of package. Japan expected to match other developed countries and want to make a modern financial system with the implementation of these reform programs. The package's major objective was to remove entry and (also exist) barriers to the financial industry or opening up the Japanese financial sector to the other countries in the world.

The collapsing which called "bubble economy" in late 1980s is liked to the beginning of significant reform on the Japanese financial sector. At this stage, country which introduces reform was affected by the internal as well as external pressure. Because the financial market reform process began, Japan has changed its financial sector regulatory structure in number of times. Financial system was under the supervision of powerful Ministry of Finance until 1992. In this case, there are two divisions of Ministry of Finance which are Securities Bureau and Banking Bureau. And Banking bureau has two departments, Inspection Department and Insurance Department. In July 1992, Financial Inspection Department was created under the Minister's Secretariat. In addition to this, Securities Bureau and Securities Exchange Surveillance Commission (SESC) were also established. In June 1998, the Prime Minister's Office took over the entire system and the Financial Services Agency (FSA) was established. At the same time, under MOF, Financial Planning Bureau was established. In December 1998, to introduce further reform within the financial system, the Financial Reconstruction Commission was established under Prime Minister's Office. These all new institutions and new reform is used to solve the crucial issue of NPLs in Japanese bank, but it still not worked. Because of that in July 2000, new entity which is Financial System Stabilization Division was established. The present Financial System Regulatory Structure is shown is figure 2.

Regulatory body in Japan is established to monitor financial institutions through regulatory reports and periodic direct inspections. From all the institutions which have been established before, in present, Japan categorized its financial sector in three main supervisory bodies which are Financial Services Agency (FSA), Securities and Exchange Surveillance Commission (SESC) and Bank of Japan (BOJ).

The Financial Supervisory agency merged with the financial system planning bureau of the ministry of finance in July 2000, it became FSA. This completed the transfer of supervision, inspection and policy planning functions from the ministry of finance (MOF) to an independent regulatory agency (Masahiro Kawai, 2003). FSA was established in 1998 which became as an administrative organ under the Financial Reconstruction Commission to facing of Japan's financial crisis. Trough further organization, the FSA assumed the portfolio of the Banking Bureau of the Ministry of Finance and became an external organ of the Cabinet Office, and with concurrent abolishment of the Financial Reporting Council (FRC), the FSA has responsible concerning disposition of failed financial institutions. FSA is also became the parent of SESC and Certified Public Accountants and Auditing Oversight Board like shown in figure 2. Supervising and inspecting all retail and wholesale banks, securities companies, insurance companies, investment management companies, and other non-bank financial institutions is became the FRS's responsibilities. The FSA's inspection Bureau conducts inspections of financial institutions in Japan to examining the institution must be compliant with all regulations and risk management, to solve the identified problems and ensure the effectiveness and efficiency of financial institution operations. On April 2007, the FSA began the implementation of its Financial Inspection Rating system. It provides inspection result in the form of graded evaluations (ratings) that offer significant incentives for improvement in management on the part of the financial institutions.

The Securities and Exchange Surveillance Commission (SESC) formally established under FSA in July 1992. It became a part of FSA body to ensuring fair transaction in securities and financial future market and also maintaining the confidence of investor in these markets. SESC conducts daily market surveillance, inspections of financial instruments and firms, investigated administrative monetary errors and inspects disclosure documents to avoid securities fraud, enforcement investigation and filing criminal charges, cooperation with overseas regulators, policy proposals, and effort to reach out to market participants and investors.

Beside three main body which act as financial regulator in Japan. There are other regulators in Japanese financial system. First is the Financial Future Association of Japan (FFAJ), this body was established in August 1989 by the authorization of Minister of Finance with the primary objectives is to ensure the protection of investors and sound growth of the financial futures industry through proper business management of financial future firm. Second is Japan Securities Dealer Association (JSDA), this regulatory body is a hybrid association functioning as a self-regulatory organization (SRO) and as a trade association in the Japanese securities market. The purposes of JSDA are to contribute to the protection of investors by ensuring fair and smooth trading in securities or other transactions by Association Members and promoting sound development of the Japanese financial instrument business. And the last is Japanese Bankers Association (JBA). It is a financial organization whose member consists of banks, bank holding companies and bankers associations in Japan.

Credit rating in Japan was first introduced in 1974. Japanese Bond Research Institute is the first credit rating in Japan. It was established in 1979. In the early 1980s, the regulator began using its rating as eligibility standard for bond issues. In 1990s, the bond issuance based on net asset value and other firm's data was no longer used, this previous standard completely replaced by the ratings. Most of these extensive rating-based standards were in turn abolished in 1996, however, in a move to further liberalize financial markets. Nevertheless, the ministry of finance still relies on ratings in various ways, especially in the regulation of money reserve fund. In this case, these money reserve fund are not allowed to trade in securities rated below A (long-term) or AA (short-term). And for the issuance of euro-yen debt by both the domestic and foreign parties also subjected to the rating requirement as well.

In Japan financial system, there are three nationally-recognize credit rating agencies which are Japan Credit Rating agency (JCR), Rating and Investment Information, Inc (R&I) and Mikuni & Co. Ltd (Mikuni). These three credit rating agency get the license from Ministry of Finance to analyzing and evaluating the creditworthiness of corporate and sovereign issuers of bond. The existence of these credit rating agencies is also to solve the problem of asymmetry information between the lenders of the borrowers regarding the creditworthiness of the latter.

COMPARISON OF RATINGS

This section compares the local and international rating agencies. Table... shows their rating scales for long-term issuer ratings. Table… present the comparison of long-term issuer ratings on a sample of Japan banks and listed companies assigned by two local credit agencies (JCR and R&I), and the three major international credit rating agencies (S&P's, Moody's, and Fitch).

Referring to Table …, actually in Japan's traditional banking system was segmented into clearly defined component in the late 1980s. The Japan financial system is compress to commercial banks (thirteen major and sixty-four smaller regional banks), long-term credit banks (seven), trust banks (seven), mutual loan and saving banks (sixty-nine), and various specialized financial institutions.

City bank consolidated (seven), long-term credit banks (three), trust bank (twenty-nine), regional banks I and II (117), foreign banks (seventy-three) and others (five). (Japanese bankers association)

Rating Agency

Highest Grade

Lowest Grade

Standard &Poor's

AAA

AA

A

BBB

BB

B

CCC

CC

SD, D

Moody's

Aaa

Aa

A

Baa

Ba

B

Caa

Ca

C

Fitch

AAA

AA

A

BBB

BB

B

CCC

CC, C

DDD, DD, D

JCR

AAA

AA

A

BBB

BB

B

CCC

CC, C

D

R&I

AAA

AA

A

BBB

BB

B

CCC

CC

C

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