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The reforms in the Japanese government securities market*1

  • *1 This was prepared as a note to be presented to the "Round Table on Capital Market Reforms in Asia" on April 11-12, 2000, organized by the Asian Development Bank Institute (ADBI) and the Organization for Economic Co-operation and Development (OECD).

April 21, 2000
Masaaki Shirakawa

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Today, I would like to address the issues related to the reforms in the Japanese government securities market from central bank perspectives. It is my hope that my presentation could provide a food for thought in the discussions aimed at further reforms in the Japanese government securities market. I would also be very happy if my remarks could stimulate thinking in other markets.

In my remarks, after outlining the characteristics of the market, I will touch on why market liquidity needs to be enhanced. Next, I will outline the basic strategy to improve market liquidity. And finally, I will discuss key issues in pursuing market reforms in Japan and how such reforms could be implemented. Please note that the views presented in this speech are my personal ones, and so they do not necessarily represent the views of the Bank of Japan.

Outline of the JGS market

The Japanese government securities market, hereafter I call the JGS market, is the largest government securities market in the world. The volume outstanding is US$ 3.4 trillion (359 trillion yen) as of end-1999, which is increasing contrary to the trend in most industrial countries. Total issues in fiscal 2000 will be around US$ 800 billion (86 trillion yen), reflecting the growing fiscal deficit. Chart 1, drawn from the OECD Economic Outlook, clearly shows Japan's fiscal conditions. JGSs will account for as much as 36% of the global government securities outstanding as of end-2001, according to an estimate by JP Morgan. As a result of the trend, as you can find in Chart 2, the OECD forecasts the ratio of outstanding volume of government debt to gross domestic product will hit 122% in year 2001, which will be the largest among the G7 countries. The growing fiscal deficit is a bad sign, but it can be a driving force of market reform.

Partly pushed by the need to absorb a large amount of new issues and partly pushed by the need to respond to financial market globalization, several reforms have been implemented in the JGS market. As to taxation, the securities transaction tax was abolished in April 1999. The coupon bearing JGSs held by non-residents were exempted from withholding taxes under certain conditions from September 1999, though there still remain a problem concerning the use of non-resident custodians and International Central Securities Depositories (ICSDs), which I will mention later. As to product design, the issuance of 1-year TBs, 5 and 30-year coupon bearing bonds started in fiscal 1999 and public tender of FBs, which are financing bills issued for cash management purposes, started in April 1999. As to settlement practices, the settlement lag was shortened to T+3 in 1997, and the Real-Time Gross Settlement of JGSs will start by the end of this year.

In fact, the efficiency of the JGS market seems to have improved. For example, as indicated in Chart 3, the smoothness of yield curve, a proxy of market efficiency, has improved significantly.

Nevertheless, further reforms seem to be required in many areas, given the facts that, as shown in Chart 4 and 5, the liquidity of the JGS market is low compared to other major markets. According to the report of the study group on market liquidity, which I chaired, under the Committee of the Global Financial System of the G10 central banks, the liquidity of the JGS market is the lowest in the major countries, in the sense that the bid-ask spreads are the largest in Japan and the turnover ratio is the lowest in Japan among G7 countries.

Another salient feature of the JGS market is who holds the securities. As you find in Chart 6, in Japan, more than half of the outstanding JGSs is held by the public sector, which is composed of the government and the central bank. On the other hand, the share of non-resident holdings is marginal. These features may have diminished market liquidity since the volume of trading supply, which is a pool of tradable securities, is smaller and the profile of market participants is less heterogeneous. These figures seem to imply the need for further reforms in the JGS market.

Need for market reforms to enhance market liquidity

Before elaborating on specific market reforms in Japan, I would like to briefly touch on why it is important to enhance liquidity of the JGS market.

First of all, improved market liquidity will help absorb the large amount of new issues. In a more liquid market, investors would demand smaller additional yield to buy more securities, because they can liquidate their holdings immediately. If market reforms could halve the bid-ask spreads, the decline in liquidity premium could enable the Japanese government, and eventually taxpayers, to save as much as US$ 30 million per year for the issuance of 10-year bonds.

In addition, a liquid JGS market will be a key factor in developing a whole range of fixed income markets including an efficient corporate bond market. This is because the yield curve of government securities, which are virtually credit risk free, serves as the benchmark of pricing other financial products. In this sense, the lack of a reliable JGS yield curve across maturities can be considered as one of the reasons why the corporate bond market is not well developed in Japan in comparison with the United States.

Furthermore, a deep and liquid JGS market could make the Japanese financial system as a whole more resilient to external shocks, especially in cases where the creditworthiness of individual financial institutions were questioned, as happened in the autumn of 1997. This is because non-resident investors can put their money in the JGS market as a haven, which facilitates smooth capital flow across markets.

Finally, a liquid JGS market with a more heterogeneous holding pattern would help maintain fiscal discipline, since international investors might be more sensitive to the risk-return profile of government securities of other countries than domestic investors who tend to have a bias to buy their home country's assets. Therefore, if a considerable portion of JGSs was held by non-residents, the government would need to explain its fiscal conditions to investors, both at home and abroad, creating incentives to maintain fiscal discipline.

Basic strategy to create a deep and liquid government securities market

The next question is how can one enhance market liquidity. To begin with, the study group of the Committee on the Global Financial System, which I mentioned earlier, identified a set of interrelated guiding principles to formulate practical policy recommendations for deep and liquid markets. Please take a look at the Appendix. On the left side, there are five guiding principles, although these principles should be tailored in a way to fit the financial environment of each country. Those are;

  • 1) A competitive market structure should be maintained;
  • 2) A market should have a low level of fragmentation;
  • 3) Transaction costs should be minimized;
  • 4) A sound, robust and safe market infrastructure should be maintained; and
  • 5) Heterogeneity of market participants should be encouraged.

Based on these guiding principles, five practical policy recommendations are shown on the right side of the Appendix. Those are;

  • 1) Regarding desirability of coherent debt management policies, an appropriate distribution of maturities and issue frequency should be ensured as a means of establishing large benchmark issues at key maturities;
  • 2) The liquidity impairing effect of taxes should be minimized;
  • 3) Transparency of sovereign issuers and issue schedule should be ensured to encourage active participation and trading activity. Also, transparency of trading information should be encouraged, with due attention being paid to the anonymity of market participants;
  • 4) Safety and standardization in trading and settlement practices should be ensured; and
  • 5) Related markets, such as repo and futures markets should be developed in a consistent manner.

The same caveat applies in that these recommendations should be tailored depending on the characteristics of the market.

Key issues in enhancing the liquidity of the JGS market

Since it is difficult to discuss market reforms common to every country, I would like to talk about the reforms in the JGS market as a case study from the viewpoint of how these guiding principles and policy recommendations apply. I hope that you would distill possible lessons from the Japanese experiences. I will touch on transparency, large benchmark issues, taxation, related markets, and straight through processing.


Transparency in this context has three facets; transparency of fiscal conditions of the government; transparency of debt management strategy, and transparency of market information.

From the viewpoint of the transparency of fiscal conditions of the government, it is important for the government to explain its fiscal conditions to the public in a clear and understandable manner. This is particularly the case when the fiscal deficit of the government is large. In this regard, recent initiatives to enhance transparency can be regarded as a welcome sign.

Next, it is important for the government to express its basic debt management strategy. For example, maturity distribution is an important component of debt management strategy. In formulating strategies, it is important to make sure that decisions are made in a transparent way so that it is predictable to market participants. Talking about debt management strategy, it is an important step forward that the government started to announce an indicative quarterly issue schedule from March 1999. Nevertheless, at this moment, it is difficult to conduct when-if-issued trading, that is trading conducted between auction announcement day and auction day. This is because redemption dates could not be determined before the auction day. If when-if-issued trading is available, more market players could participate in bidding since the true prices of the securities are well tested before auction.

Transparency of market information should not be ignored. While real-time price and trade information of JGSs is available to dealers to a great extent, the information available to investors is very limited at this moment. Only the closing prices are published by the Japan Securities Dealers Association and some individual interdealer brokers. In this regard, the initiatives in the United States and Canada are interesting. In the case of the United States, GovPx, which is a joint venture of primary dealers and interdealer brokers, was established in 1992. GovPx releases real-time price and trade information to investors, which is said to have further increased the liquidity of the U.S. Treasury market.

Large benchmark issues at key maturities

The next issue is to create large benchmark issues at the key maturities of yield curve. To this end, one could consider conducting regular reopenings, whereby an identical security is offered in several consecutive auctions, rather than being supplied in a single auction. Regular reopenings allow issuers to create a large issue while paying lower premia to dealers, as dealers do not have to bear financing costs incurred by subscribing to large amounts of securities at once. For example, one could consider conducting reopening of 10-year bonds, which are currently issued every month.

In addition to reopenings, one could consider smoothing out issue amount across the yield curve. Currently, JGSs are issued at maturities of 3 and 6 months, 1, 2, 4, 5, 6, 10, 20, and 30 years. While it is a progress that the government started to issue 1 year TBs and 5 and 30-year coupon bearing bonds in fiscal 1999, in the sense that the lineup of original maturities would cover most of different investment horizons of investors, as you can see in Chart 7, the issuance volume is still heavily skewed to 10-year bonds. Also, one could argue that 4 and 6 year bonds could be merged to create a large 5-year benchmark, and 20 and 30-year bonds for a large 30-year benchmark.


In terms of taxation, several measures have been taken. Above all, the abolishment of the security transaction tax in April 1999 was a great improvement for the market. Nevertheless, there is some room for further improvement.

The largest remaining issue is withholding taxes. At this moment, as to coupon bearing JGSs held by taxable entities, 20% of coupon payment is withheld by the government. The withholding tax adversely affect market liquidity in several ways. For example, the tax increases transaction costs by imposing opportunity costs to holders in the form of lost interest income on coupons. In addition, the tax fragments the market between taxable bonds and non-taxable bonds, thereby making the trading supply of an issue smaller. In such an environment, the bid-ask spread tends to be larger, since it is more costly to make markets for an issue with smaller trading supply. Furthermore, given the existing taxation scheme, the tax could discourage active participation of non-residents to the new style of repo transactions currently under discussion among market participants, if the gap between the start price and end price is considered an interest on a loan, and thus subject to withholding taxes.

As mentioned previously, coupon bearing JGSs held by non-residents are tax-exempt if non-residents deposit them to a domestic office of financial institutions that are participants of the JGS bookentry system, and if their identity is certified by the head of the domestic office. Generally speaking, international investors usually hold government securities of various countries under one account at global custodians and ICSDs which may not have domestic offices in Japan. Given this, the conditions to be tax-exempt are costly for such investors to fulfill.

Needless to say, when it comes to revamping the withholding tax, it is necessary to consider several ramifications. Collecting taxes is also an important policy objective of the government. Having understood the difficulty in reconciling the needs of the tax authority and the global financial market, many countries have tried to find practical solutions. Japan, too, is required to endeavor to find such a solution.

Related markets

If hedging, arbitrage and speculative transactions can be conducted easily, market liquidity as a whole is enhanced. In this regard, the importance of "trilogy", where cash, repo, and futures prices are simultaneously and interdependently determined, was highlighted at the experience in the JGS market of the last summer. To this end, I believe the development of related markets such as repo and futures markets is important. Repo transactions enable dealers to finance long positions and cover short positions, allowing them to respond to customers' needs quickly. A well-structured futures market reduces hedging costs, and thus makes it easier to take cash market positions. In this sense, it is important to continue efforts to develop these markets such as improving the existing master agreement to the one for the new-style repo transaction which conform to the prevailing practices in major markets, as well as revamping product design of futures contract in terms of its theoretical coupon rate, etc.

Straight through processing

Safety in trading and settlement is a prerequisite for the existence of deep and liquid markets. A shift to T+1 settlement from the current T+3 settlement is an important step in this regard. Also, a decrease in transaction costs leads to enhanced market liquidity. To achieve T+1 settlement practice and to reduce transaction costs, it is important to effect straight through processing by streamlining both front and back office operations.

As to front office operations, the introduction of electronic trading could be an important step forward. Electronic trading, where buyers and sellers can execute a transaction with a click on computer screen, enables both trading parties to eliminate trade confirmation process that is necessary under telephone-based trading. At present, several institutions are endeavoring to set up an electronic trading platform for the JGS market. As to back office operations, it is important to prepare a sound infrastructure to process information after execution and before settlement. There are several ongoing initiatives in the areas of trade confirmation and settlement instruction confirmation. At this moment, it is hardly predictable which initiatives would receive overwhelming support from market participants. In any case, since straight through processing is likely to enhance financial market liquidity and efficiency, it is important that market participants including central banks promote the moves to straight through processing.

How should the market reforms be implemented?

As a concluding remark of my presentation, I would like to emphasize two points concerning successful market reform. First, the role of a "catalyst" in the process of market reform. While all financial market participants as well as the economy as a whole enjoy the benefits of high market liquidity, the very nature of externality means that each of them individually on occasion may lack the proper incentives to initiate market reforms. This suggests a role of a "catalyst". By the word "catalyst", I mean somebody, either the private sector or the public sector, who identifies liquidity-impairing factors and explain the need for reform in a clear language.

Second, the role of market makers in implementing market-driven reforms. When it comes to conducting market reforms, the role of market participants is important. In particular, the role of market makers, who in most cases provide liquidity and are rewarded for providing this service to the market, is crucial. Market makers have, or at least ought to have, insights on desirable market reforms based on their know-hows on the market mechanisms including settlement procedure and legal and accounting treatments. At the same time, governments and central banks should pay keen attention to the market intelligence provided by such market participants in the private sector. In this sense, the collaboration between the private sector and the public sector should be fostered. I believe that my colleagues at the Bank of Japan as well as myself should be willing to play an active role in this process.


  • Bank for International Settlements (Link to an external website), "CGFS issues recommendations for the design of liquid markets", paper by the Committee on the Global Financial System, November 1999
  • Bank for International Settlements (Link to an external website), "Market Liquidity: Research Findings and Selected Policy Implications", paper by the Committee on the Global Financial System, May 1999