Regulatory Developments Reform of the Japanese financial sector has been high on the Government's agenda ever since the burst of the bubble in the early 1990s. The Hashimoto "Big Bang" reforms initiated in 1998, which allowed for the formation of financial holding companies, was followed by consolidation of the banking sector and efforts to clean up bad debts and non-performing loans under the Koizumi cabinet. Multiple financial services regulators were streamlined and a no-action letter process was introduced to enhance transparency, while limited structural reform was achieved by enabling Japanese city banks to engage concurrently in trust and banking businesses. However, much remains to be done to bring current regulations and practices in line with international standards. Reforms of trust banking have not been extended to foreign bank branches. Although an integrated legal framework supposedly covering all financial products was introduced with the Financial Instrument and Exchange Law in 2007, Japan has persisted in trying to manage risk through firewall regulations. This means the costly separation of banking, securities and asset management operations, long after the recourse to such regulations was abandoned in other major financial jurisdictions. The focus of financial regulators across the world has indeed shifted from simply forbidding companies to engage concurrently in certain types of businesses, to enforcing internal control and corporate governance mechanisms, which ensure that potentially conflicting interests (such as underwriting and brokerage) are kept separate. The trend is for regulators to work together with industry participants to develop clear codes of conduct and rules of enforcement. This kind of cooperation is still rare in Japan, hindered by a lack of understanding of the business on the part of the regulator as few personnel and experience transfers occur between the private sector and government. Prospects for EU-Japan Economic Integration Japan's relative prosperity has decreased considerably in the past decade, apparent in the steady decline of Japan's GDP per capita ranking, from second highest in the world in 1995 to a ranking of twentieth in 2006. Japanese consumers have continued to save throughout this period, but while the rest of the industrialized world has enjoyed record capital growth, their own return on their capital has been extremely poor. Innovative financial products and instruments commonly used in Europe have not been available in Japan as the regulatory framework is not conducive to services and structures that do not fit into predetermined categories and prescriptions. Firewall regulations not only imply administrative inefficiencies and obstacles to integrate the Japan business with global operations but also are, at times, in conflict with European home regulator requirements. Discrepancy in views on basic principles relating to risk management and handling conflicts of interests between regulators, makes it inherently difficult for firms to integrate Japan and EU businesses. European and Japanese financial institutions active on both markets have a lot to gain if the EU and Japan could unite on the general principals for good governance in the financial sector, once established, under a principle-based system. Common or mutually accepted principles of good governance in the financial sector should also lead to mutual acceptance of the home country regulator as the core regulator for generic aspects such as capital adequacy and proper governance structure. Such an acceptance of the home regulator as the core regulator, as is practiced in the integrated European market, would eliminate redundant administrative burdens and open up for a true integration and seamless development of innovative products for both markets. Priorities
Key Issues and Recommendations ■ Integrated financial services market Yearly status report: limited progress. Measures taken todate to relax the firewall regulations applicable to banks and securities companies have had little practical impact. Foreign groups are not permitted to be represented by a single country manager in Japan. Each of the business entities needs to maintain certain separate functions and organisational structures, which could otherwise be shared on a group basis. Such duplication creates inefficiencies, extra costs and makes it very difficult to integrate the Japan operations into the global business. The Globalisation Subcommittee under the Council for Economic and Fiscal Policies as well as the Internationalisation of the Financial Market Subcommittee under the Financial Council have recommended a review of firewall regulations to be concluded within 2007. The issue of foreign bank branches not being allowed to concurrently engage in trust and banking business through Japanese city banks remains unresolved. Recommendation:
■ Regulatory transparency Yearly status report: progress. Duplicate inspections by the Financial Services Agency (FSA), Securities & Exchange Surveillance Commission (SESC), Tokyo Stock Exchange (TSE), Japan Securities Dealers Association (JSDA), Ministry of Finance (MOF) and Bank of Japan (BOJ) have long caused an excessive administrative burden on regulated firms. The EBC welcomes efforts to streamline processes and clarify purpose, processes and legal sanctions applicable to the respective inspections, and encourages the Government to further increase efficiency and transparency. One area of critical concern is the lack of clear, generally valid guidelines. The trend in the industry is to seek "informal" advice rather than go through the cumbersome no-action letter process. The fact that the regulators are willing to give such informal guidance is welcome, but this approach presents a serious drawback: the guidance given is known to only one regulated entity and does not benefit the industry as a whole. Recommendation:
■ Promote financial innovation by moving towards principle-based regulation Yearly status report: new issue. Despite gradual change, the rule-basis of the Japanese regulatory environment leaves little room for innovation by the regulated entity, without extensive prior consultation with the regulator. This prescriptive, yet unclear, regulatory framework cannot keep up with the pace at which financial products and markets are changing. Regulated firms must be allowed greater flexibility to decide by themselves what business controls and processes should be put in place to achieve regulatory outcomes decided by the regulator. Over time, this would lead to a more competitive and innovative market. Continuous innovation and improvement are to be encouraged, not stifled, as they benefit consumers and markets. Continuous dialogue, rather than one-way consultation, between regulators and regulated entities on principles and structures is a prerequisite for good governance. Recommendation:
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