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A Case for Reforming the JGB Market*1

July 1998
Kazunari Ohashi (London)
Jan Milligan (JP Morgan Securities Ltd.)

The Working Paper Series aims to stimulate discussion and comment.
Views expressed in the Working Paper Series are those of the authors and not necessarily those of the Bank of Japan or its overseas representative offices.
Questions and comments on the working papers should be e-mailed to the address indicated in the document.

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I. Introduction

  1. The collapse of Sanyo and Yamaichi Securities last November gave rise to serious concerns over the structure of the foreign JGB market. A number of foreign investors were said to have moved out of the JGB market into the AAA euro-yen bond market in order to avoid perceived risks involved in JGB trading. Japanese JGB brokers that were seen to have difficulties lost much of their JGB business during the crisis. In an extreme case, one of the largest JGB brokers' brokers in London, decided to temporarily suspend the JGB trading due to "surrounding uncertainties over the JGB market."
  2. In the event, the anticipated "meltdown"--evaporation of market liquidity-- did not become a reality. Some factors have been pointed out to explain the reasons behind this outcome. Firstly, most foreign investors seem to have moved out of the yen market ahead of the crisis in response to the low yen yields and the weakening yen. Secondly, the presence of Japanese brokers in the foreign JGB market had already significantly declined at the time of the crisis and therefore actual risks were not as imminent as publicized. Thirdly, financially robust brokers seem to have been able to take over the JGB business from the weaker ones quite smoothly. In fact, some of the large foreign investment banks claimed that they had enjoyed sudden inflows of JGB business during the crisis.
  3. It is not easy to distinguish between the extent to which the yield and foreign exchange situation had temporarily sidelined the foreign JGB market and the extent to which the infrastructural problems in the JGB market fundamentally hollowed it out. Nevertheless, a closer look at the London JGB market seems to suggest that some infrastructural problems played crucial roles in drying out the liquidity of the foreign JGB market both ahead of and during the crisis.
  4. In fact, the foreign investors' community had long been noticing shortcomings in the JGB market. For instance, Japan is the only country among major developed countries that levies withholding tax on coupon payments and securities transaction tax on the sales of JGBs. Due to the existence of the withholding tax, foreign investors are relying on a paper-based delivery system in an effort to avoid the taxation. Lack of sizable issues along the yield curve is also seen to be undermining the liquidity of the JGB market. Reflecting these impediments, the holding of JGBs by foreign investors is estimated to be around 5-10%, significantly lower than Europe's 60% and the US Treasuries' 30%.
  5. This paper is an attempt to assess the actual impacts of the frequently pointed-out problems in the foreign JGB market in terms of how different problems exert different effects on different classes of market participants in accordance with their roles and characteristics. Through this analysis the paper seeks to establish broad-brush priorities to cope with each of these problems. In particular, in conclusion, it will try to argue among other things, that the taxation on the JGB is the most pressing obstacle that not only increases the financing costs of the Japanese Government, but also undermines the competitiveness of Japanese financial institutions.
  • *1 The authors wish to thank Makoto Ohtake, Aboud Sarhan, Kenichi Yoshida, Masahiro Nishide, Paul Gibb for valuable comments and suggestions. We especially wish to thank Mitsumasa Choji for his key contributions to this work. We are also indebted to the excellent works by William D. Campbell. Needless to say, however, any remaining errors in the paper are the authors'. Views expressed here are those of authors and do not necessarily reflect those of the Bank of Japan or JP Morgan.