BOJ Has No Magic Wand


According to former central bank deputy governor Toshihiko Fukui, with few signs the BOJ's "quantitative" easing policy, in place since March 2001, has helped the economy recover from a decade-long slump, extra spending is needed in the short term to stem sagging stock prices and in the longer term to help the country's banking sector. "The BOJ can't do magic tricks," he told Dow Jones Newswires in an interview. "I don't know what kinds of steps that the BOJ can take right now."
Fukui blamed the stock falls partly on the country's slow progress in implementing structural changes. "The drop in the stock prices is a natural result of the fact that Japan hasn't implemented necessary things," he said.


Fukui also believes the government should abandon its apparent blanket protection of all financial institutions. He said the government should force banks to quickly establish new business plans alongside offering fund injections "as a final chance for banks." The government should be willing to inject funds into the banking system to encourage banks to restart lending to private companies, he said. The government needs to create an environment for banks to take new risks, he added. "The government doesn't need to inject public funds into banks that can raise the necessary funds. But banks that can't raise the necessary funds by themselves should apply for public funds." The government should also encourage banks to be more discerning in disposing of bad loans, he added. "Financial institutions should distinguish between promising firms and companies that have no future." Still, as a result of such action, liquidation of private companies would accelerate, Fukui said.
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US Sarbanes-Oxely Act Already Having Reprecussions in Japan


Fuji Photo Film, which has had an ADR for dog years, has put off their planned listing on the NYSE, at least in part due to the stiffer requirements as outlined in the Sarbanes-Oxely Act.


The Financial Services Agency (FSA) plans to work out a package of measures to promote the disclosure of corporate information in the wake of scandals committed by leading Japanese companies, agency officials said Wednesday, but the action undoubtedly is also related to the stiffer requirements put into law in the US.
The work is expected to lead to reform of Japan's auditor system. While the Financial System Council, a government advisory panel, will begin deliberations on broad ways of promoting corporate disclosure next Monday, details will be discussed at a working group to be established later this month.

Moody's Says That Subjecting Japan's Banks to Market Discipline without Government Support is Risky


In a September 4, 2002 statement, Moody's long a bear on Japan's banking system and a critic of the government's lack of a comprehensive banking reform plan, began to sound more like the old guard LDP. In other words, they stated that the government's recent efforts to introduce market discipline without countervailing measures to protect the viability of the financial system itself presents a large risk to the banking system and to Japan's economy itself. Without stabilizing the financial system first, introducing market-oriented bank reforms could well result in a financial crisis.


Back-tracking on the re-introduction of deposit insurance caps essentially recognizes the continued weakness in Japan's financial system. The Japanese government has been trying to re-introduce caps on government insurance for bank savings deposits, having already re-introduced such caps for time deposits in April, 2002, and are planning to re-introduce caps for regular (including those for settlement purposes) deposits from April 2003. In a typical fudge, they are now trying to introduce new non-interest bearing demand deposits for settlement and payment purposes. Moody's and the market sees such action as basically an admission of the continuing weak condition of the financial system.


The balance sheet health of Japan's major banks has steadily deteriorated over the past 10 years. The financial condition of Japan's largest banks remains extremely weak, and require continued support from the bank regulators, as their average financial rating remains at "E". The solvency ratios of these banks continue to deteriorate, and given additional credit risk stress or market stress in the form of falling stock prices, are in a precarious position. The ability of these banks to absorb further losses in either their loan portfolios or in their marketable securities portfolios is extremely limited. Meanwhile, there is no improvement in corporate bankruptcies, real estate prices or stock prices.


The Koizumi Administration's Market-Driven Banking Reforms Will Backfire. The removing of full deposit insurance guarantees on time deposits in April 2002 has resulted in a continued shift in savers' funds from time deposits to regular deposits, giving an indication of the scale of possible fund shifts given a loss of saver confidence in the banking system. Moody's believes that Japan's banking system would not be able to withstand a sudden loss of confidence on the part of the nation's savers. Moreover, Moody's believes that market-driven "structural reforms" being promoted by the Koizumi Administration do nothing to solve the domestic deflationary spiral and the financial sector's structural problems. In addition, it is uncertain whether a reflation policy would work amidst a shrinking financial system.


Moody's believes that three scenarios are required to fix Japan's banking problem. Each scenario ultimately involves an increased burden to Japan's tax payers.The scenario with the smallest impact would be solving the problem of insufficient capital in the financial system. This would prevent major losses among the debt holders, and prevent damage to an extremely credit-sensitive banking system. With strengthened capital bases, the major banks could see improved confidence from market participants. An alternative method of improving weakened capital bases would be to purchase the bad credits from the banks, which would allow the continuance of current bank management, and allow balance sheet restructuring that would lead to a normalization of loan activities.


The worst-case scenario would be merely delay countermeasures to solve the problem. Under this scenario, savers are not required to bear any losses, but the financial system remains berefit of any monetary controls (i.e., the BOJ continues to push on a string), and the banking system remains unable to fulfill its traditional economic role of being a money multiplier for the economy. Given such a scenario, the worst thing to do would be to remove the safety net of government support and subject the banks to the discipline of the market place, which could well result in the failure of a major bank, and severely exacerbate currently ongoing deflation, and exert substantial damage to the economy.

Financial Sector Revitalization Will Take Several More Years


In an interview with the Nikkei Financial Daily, the Bank of Japan's director for Japan's financial system, Mr. Takahiro Mitani, claimed that regulatory capital ratios for Japan's major banks would remain above 8% (the level required for them to continue their international business activities) even if the Nikkei falls to 8,000 by the end of September, when March fiscal year companies report their interim FY2002 results. He claims the banks have written off or written down over JPY100 trillion of non-performing loans since Japan's 1980s bubble burst. However, he admits that given the structural consolidation in Japan's industries and ongoing deflation, the level of non-performing loans will continue at a high level for the foreseeable future, and that it is very possible that new non-performing loans will continue to exceed their bad loan write-offs for the foreseeable future.


More importantly, he doesn't see how Japan's banking system can solve its problems in the next one or two years, but that it could take 10 years or more. Moreover, the nation's banks are in a weakened state, and in need of new capital infusions. As a countermeasure, it is better to bolster the capital of banks that presently have capital ratios above regulatory levels, but he expresses doubts about whether a political consensus could be achieved to do this. Since additional capital infusions would most likely require that current bank mangements be held responsible, the banks themselves are cautious of any additional capital infusions.


Regarding the government's decision to maintain blanket guarantees on bank deposits used for settlements, payrolls, etc., he basically agrees because of the fact that the majority of settlements between banks occur online, and that a failure of one bank in the system would cause confusion. While he denies the possibility of an imminent bank failure, he also admits that there has been no significant improvement in their weakened state.


The major banks have been trying to raise interest rates on loans to their weakest borrowers, and are targeting a 35 basis point improvement in loan margins. However, due to continued high non-performing loan balances, the banks continue to shrink their loan books.


a) Since the volume of outstanding loans continues to shrink, the resulting decline in total interest income is offsetting the improvement in individual loan yields. For example, even if a bank could achieve an improvement in average loan rates from 1.5% to 1.75%, if their overall loan book declines 10%, the net favorable impact to overall loan yields would be a mere 0.075%. If their loan book declined by 15%, the net impact on interest income would be minus.


b) The banks are pushing borrowers with credit ratings of double B or lower the hardest. By significantly raising the borrowers interest costs, the banks are probably
hastening the day these firms declare bankruptcy. Thus the program to improve loan yields will lead to higher NPLs (non-performing loans).


c) Thirdly, the banks are practicing a double standard with regards to their borrowers. For large general construction contractors, for example, strong political ties and the sheer size of loan exposure the banks have prevent them from pushing these firms for higher loan rates. Thus they go after those that are easiest to go after first, often leaving the larger, more difficult borrowers untouched.


Consequently, the overall profit impact of the move to improve loan yields is very mixed, and could well prove to be a net minus net of NPL disposals.

The Koizumi Cabinet Bears Come Out of the Closet


Ryo Takasugi is representative of what PM Koizumi calls the "opposition forces" within his own LDP party. Mr. Takasugi's recent book Japan that is Manipulated by America is a best-seller in Japan.
Japanese of Mr. Takasugi's frame of mind have difficulty seeing a successful outcome resulting from PM Koizumi's reforms.


Their view is that the Japanese economy is getting worse (ABW concurs). Whatever Prime Minister Koizumi has done has proven to be wrong. If the situation continues as it is now, he will have to resign or reshuffle his cabinet, according to Mr. Takasugi (ABW concurs again). According to the "opposition forces", all of the Koizumi cabinet's economic policies are wrong. They see Heizo Tekanaka, Minister of Economic and Financial Policy, Hakuo Yanagisawa, Minister of Financial Affairs and Masajuro Shiokawa, Minister of Finance as ineffective in handling Japan's economic policy, and wonder why they are still in office.


However, they also see Japan's long recession as an "Anglo Saxon Recession", created by the US
and the US's puppet, Heizo Takenaka, in that he has (according to this view) just been following US policies, and has been "brainwashed" by US economists. They jump on Mr. Takenaka's earlier claim that the IT revolution could create five million jobs in Japan, which at the current juncture seems to have been simply a dream. In fact, their views are so strong that Mr. Takenaka's "selling out" to US policies was not only a disaster, but they have gone so far as to label Mr. Takenaka a traitor.


More Fuzzy Logic Such "revisionists" don't have it right either. They see the Enron debacle as the dead-end for US capitalism. But Japan could never have reacted to such excesses with such speed and determination. As it stands now, Mr. Takasugi is correct in criticizing the Koizumi Administration's lack of results, but he (and the opponents of change) offer no viable alternatives, just more "fuzzy logic". While his book has gained an audience because it offers an outside excuse for Japan's problems, fuzzy logic will do nothing to pull Japan out of its current malaise. Nor will creating conspiracy theories.


Japan's voters have already shown with the election of PM Koizumi and the re-election of the governor of Nagano that they are ready for change, but that there is sadly no political party nor influential politician that best embodies their desire for substantiative change.

Weekly Post

The Number of CPA Opinions With "Special Exceptions" Is Up Sharply


There were 105 firms that reported March 2002 with exceptions noted in the auditor statements. The extremely poor earnings and balance sheet environment, in addition to the more stringent view of auditors seems to be behind the trend. Financial reports with exceptions numbered only 30 companies in the March 2000 fiscal year, but doubled in the March 2001 fiscal year, and another 80% increase was seen last year. Those exceptions regarding management risks are on the rise.

Number of Japanese Companies Filing Financial Results Electronically on the Increase


The number of companies filing regulatory financial reports electronically is on the increase. Of those companies required to file securities reports with the FSA (Financial Services Agency), 30% are now filing electronically. In addition to the financials, investors can view audited statements of these Japanese companies on the Web. Under study is the embedding of key words and the ability to switch from Japanese language to English language reports. In June of last year, the government introduced EDINET, its electronic disclosure system, and is encouraging firms to file electronically instead of the printed version. Over the past year, the number of electronic filers has tripled, with some 1,440 companies now having electronic versions of their securities reports. From June 2004, electronic filing will become mandatory.


Printed securities reports cannot be bought just anywhere. They are only available for purchase at the government publication offices or at the Tokyo Stock Exchange. With EDINET filings, they are available on the Web the next day.


The US accountant's association is promoting the use of XBRL, which uses a next-generation computer language called XML. XML allows the use of key word searches and conversion to English, as well as standardizing the presentation of the financials. It is highly likely that this presentation format will become an international defacto standard. Japanese companies and printers are already studying XBRL, having formed XBRLJapan.

Stock Buy-Back Programs in Japan Wane


Lots of bank deposits, lots of outstanding stock, mature market. Such a company is an ideal candidate for stock buybacks. Ostensibly, buying back stock raises a company's return on equity and other financial indicators and should be taken positively by the market, thus company's announce stock buyback programs to stimulate their stock price. However, investor response to stock buyback announcements in the Tokyo market is becoming muted, as "stock buyback" does not automatically mean higher stock prices. While many Japanese companies got permission from shareholders to make stock buybacks, thus rush to pass such proposals at the shareholder's meeting is the only chance the companies will get to establish a quota for stock buybacks until the next shareholders' meeting.


According to estimates by Nomura Securities, Japanese companies announcing stock buybacks between 1997 and 1998 saw their stock price outperform the Topix by some 3.4% in the 20 days after the announcement. But companies announcing such buybacks in 2001 saw their stock prices outperform the Topix by only 1.7% during the same period following the announcement. The reason is continuing unwinding of cross-holdings, and the fact that these buybacks are often merely a countermeasure to offset the drag on stock prices from the unwinding of cross holdings. The level at which the buybacks take place is also scrutinized. When the buybacks are announced, the company usually announces the total value and volume of the planned buyback. By dividing the total value by the number of shares, market watchers get an idea of where management is most likely to begin buying back shares.

Japan's Soaring Stock Loan Market


The lending and borrowing of stocks between large Japanese institutional investors, brokerage firms and hedge funds for Japanese stocks is soaring. Over the past two years, the market has exploded three-fold, from around JPY2 trillion to over JPY6 trillion. Japan's large institutional stock holders such as private pension funds, banks and life insurers are desperate for investment returns, which stock loan helps to provide. The Government Pension Fund is also studying the use of stock loan to boost meager returns. Ten years ago, loaning Japanese equities was stickly an offshore affair, but it has now been firmly established in the domestic market as well.


Balance of Stock Loan Among Securities Companies Now JPY6.4 trillion. The balance of stock loans that are reported by the securities brokers to the Japan Securities Dealers Association now exceeds JPY6 trillion, or some 6.5 times the level in 1998. The growth over the past two years has been particularly sharp because corporate welfare pension funds have started to loan stock. In some cases, they are loaning up to 80% of their stock holdings.


If they loan out stock, institutions can earn an extra 0.05% in interest fees on an annual basis. With pension funds return being noticeably minus for the last two years, every ounce of positive returns helps. The stocks most susceptible to stock loan are those that are part of an index fund. Once the fund is created, there is little turnover of stocks in the portfolio. On the demand side, there are two factors behind the growth in demand for loaned stock;


1) Large institutional investors now typically trade in large blocks or "baskets" of stock at razor-thin commission rates from the brokers. The brokers try to augment the meager commissions on these trades by selling the borrowed stock in the market, and later buying it back. For newly listed stocks with strong demand, the brokers will often borrow blocks of stock from major shareholders and sell additional shares to dampen excessive post-listing demand.


2) However, the largest traditional source of loaned stock is from hedge funds, where a "long-short" position is popular–i.e., stocks with good fundamentals are bought, while stocks with weak fundamentals are sold short. These long-short funds tend to wring maximum returns out of the long-depressed Japanese equity market, and even domestic institutions are beginning to use this strategy. According to Gartmore Asset Management, the balance of Japanese institutional assets managed in this manner will reach JPY3 trillion by the end of this year.

The "Enemy" Within. In March of this year, the government moved to squeeze those shorting Japanese stocks into buying them back, primarily to allow the major banks to avoid reporting stock valuation losses that would technically put them in net negative equity. The implication of the autorities at the time was that such shorting was "unhealthy" for the market, and that it was being conducted by agents bent on hurting Japan. With even the Government Pension Fund loaning stock, however, the "enemy" referred to by the FSA in their actions at the end of March is actually within their midst–i.e., the large domestic institutions that manage the countries' pension funds.

Soaring Trading in Unlisted Securities


The number of companies registering under the "green sheet market" established by the Japan Securities Dealer's Association is soaring. By the fall of this year, there will be nearly 40 companies registered, or roughly half the number of companies that listed on the defunct NASDAQ Japan market, and even more than the 36 companies listed on the TSE's "Mothers" market. Despite waning interest in the "new" markets that were set up to facilitate venture company access to investor capital, this "minor league" market is seeing active interest by Japanese venture companies.


In 2000, the number of companies registered on the green sheet market just exceeded 8 companies, and 12 new firms have already registered so far this year. Of the 12 total, only 4 are located in Tokyo or Osaka. The main reason for registering on this market is of course access to capital. The reason for the increase in companies applying is a relaxation of registration requirements, mainly, relaxing the requirement for two fiscal years of audited statements to one year of audited statements. Because the number of regional companies registering is growing quickly, Toyo Securities is apportioning coverage of these stocks by branch office, to better offer investors detailed information.


The green sheet market is a take-off on the US "pink sheets" market, where approximately 4,000 companies are registered, and they are traded through the branches of the securities brokers, thereby allowing companies with a short track record to access the capital markets. Japan's green sheet market began in 1997. Companies with sales under JPY100 million or companies with deficits can register. Registered companies have their stocks publicly quoted and can attract investors. As the major exchanges try to cope with stagnation by establishing new markets for venture companies, the FSA (Financial Services Agency) is quietly pushing the Securities Dealers Association to expand the green sheet market.

Present Issues Facing Japan's Financial Disclosure System


According to Professor Yamaura of Meiji University, there are five factors which drive the functioning of Japan's disclosure system. The first is accounting standards that ensure a high level of visibility in accounting and financial information, second is auditing firms that ensure the accuracy and credibility of this information, fourth is corporate governance that ensures that management fulfill their fiduciary duties, and the fifth is administrative guidance by the government. If all of these factors do not function in a well-balanced manner, the system does not perform properly.


A New System is Evolving, But Not Yet Established. Japan is presently in the process of shifting from an out-dated system to a new system. The new accounting framework is just about established, but the auditing system is in flux, especially after the US accounting scandals, and has not reached a turning point. In addition, corporate governance has not gone beyond the natural restrictions of the stock market, and does not yet reflect the needs of the stock market nor stakeholders. In administrative guidance, there is a lack of consistency, and much room for reform.


In terms of the auditing function, there is a need to increase visibility and quality. As for corporate risk assessment, the auditors are beginning to discuss the inclusion of such clauses in their auditing contracts. The auditing profession needs to increase its recognition of the level in terms of evaluating the level of corporate disclosure, the degree that management has achieved their performance targets and their attitude toward shareholders. Many inward looking Japanese corporations still resist having auditors make risk assessments, but managements should realize that information disclosure works to improve a company's corporate governance function. In international capital markets, investors expect companies to make proactive statements regarding risk factors. Based on credible information disclosure, investors evaluate management through the stock price or the shareholders' meeting, and the process of management responding to these evaluations raises the level of corporate governance. If a company is defensive about information disclosure, the corporate governance process is impeded.


In order to increase investor trust and promote participation in the stock market, stronger monitoring of the markets is required. When auditors refused to offer an opinion on the accounts of Sawaco Corp. in 2000, it was removed from OTC listing, and the US was the first to suspend trading. Normally, it should have been the Japanese authorities' admistrative guidance that initiated the action. Without, clear administrative guidance, corporations tend to conduct information disclosure as they wish, and the auditing profession finds it difficult to stop the practice.


As for the role of academics in improving Japan's system, they have a large role to play. Honestly speaking, however, this role is too concentrated on a few academics, exceeding their ability to cope. In addition, there are too many issues to deal with at once, and there is insufficient time to study examples in overseas systems. A major problem is that there are not enough accounting experts with hands-on experience, ranging from accounting professionals in companies, to auditors, to top management, and including the regulators.

US Accounting Scandals Have Large Impact on Japan's Capital Markets


The chairman of the Japan Certified Public Accountant's Association says that Japan's accountants are taking the loss of confidence in auditing companies because of the US Enron and Worldcom scandals very seriously, as they were shocked that US management and auditors could undermine public trust in such a blatant manner, seeing as how the US was supposed to have the most sophisticated capital markets. Japan is now in the midst of an accounting "Big Bang", with the final–and perhaps the most contentious–issue being the introduction of impairment accounting from March 2006. This will mean that Japan's auditing firms will have to pick up their game.


Under new auditing standards to be introduced from March 2003, Japanese management will have to write down any risks to their company that might lead to bankruptcy. But even if the accounting rules are clear, it is up to the accounting profession to see they are applied. In other words, accountants will have to get tougher with clients' mangement. Of Japan's listed companies, some 80% of the auditing services provided are provided by the big four accounting firms, who have their own internal quality control divisions. But while the accounting rules become more stringent, corporations are resisting higher auditor fees. He also openly admitted that Japan's auditing profession is not yet mature or on par with the US, despite the recent scandals.


Unlike Anderson, who had a major conflict of interest between their auditing services and their consulting services to Enron, "old boys" from the major accounting firms often become directors or statutory auditors for client firms. While an accountant can be considered appropriate as an outside director, the potential for conflict of interest is present, and appropriate rules need to be established. However, companies that perform management consulting services in Japan are already seperate companies.


The problem is that the oversight agencies, i.e., the Japan SEC, the FSA (Financial Services Agency) and Finance Ministry's efforts in this regard do not coordinate their oversight efforts. It is therefore necessary to create an integrated oversight agency.

Murakami of M&A Consulting Sells His Brokerage to Orient Securities


Yoshiaki Murakami, the ex-METI official who now runs the M&A Consulting takeover fund, has sold Kyosei Securiities to Orient Securities. Kyosei Securities was an affiliate of the bankrupt Kyoei Life Insurance Company before it was bought by Mr. Murakami's private company, Office Support. A portion of Kyosei Securities' client assets are Mr. Murakami's, and the ostensible reason for the sale to Orient Securities was for Mr. Murakami to be able to concentrate his resources, ostensibly in his M&A Consulting business.


Orient Securities is a subsidiary of Orient Trading, which specializes in commodities trading, and was established by several ex-Yamaichi employees in June 2000. The client assets transferred from Kyosei are roughly JPY20 billion, while the firm itself had client assets of only some JPY5 billion before the takeover.