The Tokyo Stock Exchange is the second largest stock market in the world by domestic market capitalization. Japan has either fully or broadly implemented the International Organization of Securities Commissions' Objectives and Principles of Securities Regulation, according to the International Monetary Fund's (IMF) 2003 Financial System Stability Assessment. The assessment further concludes that the system of securities regulation in Japan is broadly designed to ensure investor protection, promote fair, efficient and transparent markets, and reduce systemic risk. Substantial improvements have also been made in the supervisory process since the Financial Services Agency (FSA) and the Securities and Exchange Surveillance Commission were set up as the securities regulators in July 2000. However, it is unclear whether the authorities are in a position to enforce their requirements fully, especially with regard to the valuation of assets and the quality of capital. The institutional structure also creates scope for both agencies to be subject to political pressures. In its 2006 Article IV Consultation, the IMF reiterates the importance of reducing the role of government financial intermediation, clarifying securities regulation, and improving financial risk management in order to enhance efficiency and stability of the financial system. As part of its 2007 Plan for Strengthening the Competitiveness of Japan's Financial and Capital Markets, Japan's FSA has introduced an internal control report system, also known as the Japanese Sarbanes-Oxley Act (J-SOX), which took effect in April 2008.

General Overview

Until the creation of the Financial Supervisory Agency, established under the Financial Reconstruction Commission (FRC), securities firms were supervised by the Securities Bureau of the Ministry of Finance (MoF). Similarly, banking and insurance supervision was carried out by the Banking Bureau. The Securities and Exchange Surveillance Commission (SESC) was a separate entity under the MoF. In June 1998, the functions of the Securities Bureau and the Banking Bureau were transferred to the Financial Supervisory Agency, and the SESC was separated from the MoF to come under the control of the Financial Supervisory Agency. In July 2000, the Financial Supervisory Agency was renamed to the Financial Services Agency (FSA). The FRC merged into the FSA in January 2001.

In September 2003, the International Monetary Fund (IMF) conducted a Financial System Stability Assessment (FSSA), including an assessment of Japan's compliance with the International Organization of Securities Commission's (IOSCO) Objectives and Principles of Securities Regulation. The report concludes that the system of securities regulation in Japan is broadly designed to ensure investor protection, promote fair, efficient and transparent markets, and reduce systemic risk. However, it is unclear whether the authorities are in a position to enforce their requirements fully, especially with regard to the valuation of assets and the quality of capital. The IMF's 2003 FSSA notes that the MoF has effective management control over the FSA, and consequently the SESC. The FSA also lacks a board with outside members. This institutional structure creates scope for the FSA to be subject to political pressures.

At the time of the 2003 FSSA, the Japan Post, which offers deposits, a payment system, and life insurance products, benefited from an explicit government guarantee. The government financial institutions (GFIs), which offer long-term loans with low fixed interest rates, also benefited from subsidies. Furthermore, the Japan Post and most GFIs were subject to limited prudential supervision. The long-term involvement of the public sector in financial intermediation has impeded the development of the financial system, including the securities market. The IMF report recommended reducing the involvement of the government in financial intermediation, by restricting the activities of the GFIs, as well as postal savings and insurance schemes. As of October 1, 2007, according to the IMF's 2008 Selected Issues report, efforts of the government to privatize the Japan Post have resulted in the creation of a single holding company with four separate businesses, namely the Japan Post Service, Japan Post Network, Japan Post Bank (JPB) and Japan Post Insurance (JPI). Under this new structure, the JPB and JPI are subject to similar regulatory and supervisory requirements as other private institutions.

The Financial Instruments and Exchange Act No. 25, which replaces the Securities and Exchange Law, was adopted in June 2006, and came into force in April 2008. The U.S. Department of Commerce (DoC) 2008 Country Commercial Guide states that the Act may help promote investment in the financial, insurance, and real estate sectors by establishing "a more flexible regulatory system for financial markets" and applying "a uniform set of rules for similar financial instruments." According to a May 2008 International Financial Law Review (IFLR) article by the law firm Nagashima, Ohno & Tsunematsu, a bill to amend the Financial Instruments and Exchange Act was submitted to the Diet on March 4, 2008, which will create a new market for professional investors; revise firewall regulations affecting banks, securities, and insurance firms; and expand the administrative monetary penalty system. As part of its 2007 Plan for Strengthening the Competitiveness of Japan's Financial and Capital Markets, Japan's FSA has introduced an internal control report system, also known as the Japanese Sarbanes-Oxley Act (J-SOX), which took effect in April 2008.

The Tokyo Stock Exchange (TSE) is the second largest stock market in the world by domestic market capitalization. According to the IMF's 2003 FSSA, trading of securities in Japan is conducted on securities exchanges and alternative trading systems. Over-the-counter (OTC) trading in stocks is also common. Trading further takes place on the JASDAQ market - an OTC market managed by the Japan Securities Dealers Association (JSDA) - over a proprietary trading system, and in off-exchange trading sites for listed stocks. As of 2007, there were 2389 domestic and 25 foreign companies listed on the TSE, as stated on its website. According to a June 2008 IFLR article by the law firm Nagashima, Ohno & Tsunematsu, the TSE will revise its listing rules and publish guidelines regarding shares without voting rights. The change should enable companies to list more non-voting stocks, and to protect shareholders of these stocks. Regarding the further development of capital markets, as stated in the IMF's 2007 Article IV Consultation, Japanese authorities seek to enhance Tokyo's appeal as an international financial center. Initiatives include relaxing barriers between banks and securities firms, and consolidating financial exchanges.

In October 2007, as reported in the IMF's 2008 Selected Issues report, the G7 finance ministers and central bank governors asked the Financial Stability Forum (FSF) to analyze the causes and weaknesses of the market turmoil, and to set out recommendations for increasing the resilience of markets and institutions going forward. The IMF report notes that most of the FSF recommendations are relevant to Japan, and in line with recommendations of the Financial Markets Strategy Team - an advisory group established by the Japanese Minister for Financial Services - to study the implications of the subprime crisis for Japan.

The IOSCO multilateral memorandum of understanding (MMoU) is based on the thirty IOSCO Objectives and Principles of Securities Regulation adopted in 1998 and the experience gathered by securities regulators in using bilateral memoranda of understanding. The IOSCO MMoU provides a standardized framework for sharing enforcement-related information and a gradually expanding network of participating regulatory agencies. IOSCO members who wish to sign the IOSCO MMoU participate in a comprehensive screening process to establish that they have the legal capacity to fully comply with the terms of the IOSCO MMoU. The FSA is a signatory of the MMoU and an ordinary member of the IOSCO, whereas the SESC is an associate member of the IOSCO.

The Principles

1. The responsibilities of the regulator should be clear and objectively stated.

FC

Until the creation of the Financial Supervisory Agency, established under the FRC, securities firms were supervised by the Securities Bureau of the MoF. Similarly, banking and insurance supervision was carried out by the Banking Bureau. The SESC was a separate entity under the MoF. In June 1998, the functions of the Securities Bureau and the Banking Bureau were transferred to the Financial Supervisory Agency, and the SESC was separated from the MoF to come under the control of the Financial Supervisory Agency. In July 2000, the Financial Supervisory Agency was renamed to the FSA. The FRC merged into the FSA in January 2001. The IMF's 2003 FSSA states that the principles relating to the regulators are assessed as "fully or broadly implemented" (p. 43). The FSA is entrusted with the mandate "to assure the stable and efficient functioning of the Japanese financial system, as well as to protect depositors, policyholders, securities investors, and similar persons" (p. 43). In particular, the FSA is responsible for policy making, supervision and inspection, whereas the SESC has investigation and enforcement powers. The IMF's 2003 FSSA notes that in addition to administering specific provisions of the Securities and Exchange Law - which has been replaced by the Financial Instruments and Exchange Act - the SESC was given authority in January 2003 to supervise some aspects of the Law on Customer Identification.

2. The regulator should be operationally independent and accountable in the exercise of its functions and powers.

CP

The IMF's 2003 FSSA states that the principles relating to the regulators are assessed as "fully or broadly implemented" (p. 43). According to the IMF report, the FSA is funded from the central government budget, hence, lacking budgetary independence. Furthermore, the FSA operates with minimal supervisory staff levels. The removal of supervisory responsibility from the MoF, and the setting up of the FSA in 2000 were major steps forward, as stated in the IMF's 2003 FSSA. However, there appears to be a lack of operational independence due to the MoF's remaining control over the operations of the FSA, and consequently the SESC, creating scope for political pressures. In addition, the FSA lacks a board with outside members. It is recommended that the FSA be given full operational autonomy, and that the FSA's mandate be limited to the prudential supervision of financial institutions. Structural independence of the FSA should also be enhanced "to better assure its ability to autonomously perform and be seen to perform all of its responsibilities" (p. 47). The FSA is encouraged to set up a board to help ensure visible autonomy and accountability. In order to guarantee the FSA's budgetary independence, it is further recommended that the supervised institutions be charged by the FSA for the cost of supervision.

3. The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers.

CP

The IMF's 2003 FSSA states that the principles relating to the regulators are assessed as "fully or broadly implemented" (p. 43). According to the IMF report, the FSA operates with minimal supervisory staff levels. In addition, the frequent rotation system for FSA staff does not allow sufficient expertise in a given area. In this regard, it is recommended that the FSA and SESC "build up industry knowledge and expertise and also alleviate current shortages of specialized staff" (p. 47). The specialization of supervisors and examiners should also be enhanced by recruiting staff with private sector experience.

4. The regulator should adopt clear and consistent regulatory processes.

CP

According to the IMF's 2003 FSSA, the principles relating to the regulators are assessed as fully or broadly implemented.

5. The staff of the regulator should observe the highest professional standards, including appropriate standards of confidentiality.

CP

The IMF's 2003 FSSA states that the principles relating to the regulators are assessed as "fully or broadly implemented" (p. 43). As civil servants, the staff of both the FSA and SESC are subject "to the duties and responsibilities, to removal for cause, and to transfer and rotation among agencies under the relevant general rules for all civil servants in Japan" (p. 44). The IMF report further recommends protecting by statute the staff of both agencies "when acting bona fide in the course of their duties" (p. 47). Responding to the IMF assessment, the Japanese authorities point out that the FSA has made efforts to develop the expertise of its staff through internal and off-the-job training. In addition, the FSA and the SESC have increased the number of specialized staff by hiring former employees of securities firms, lawyers, and certified public accountants.

6. The regulatory regime should make appropriate use of Self-Regulatory Organizations (SROs) that exercise some direct oversight responsibility for their respective areas of competence, to the extent appropriate to the size and complexity of the markets.

FC

The IMF's 2003 FSSA states that the principles relating to the use of self-regulatory organizations (SROs) are assessed as "fully implemented" (p. 44). In addition, "Japan makes extensive and effective use of self regulation" (p. 44). Weaknesses remain, however, with regards to the overlapping of activities and mandates between the FSA, SESC and other regulators - including the stock exchanges, the JSDA, and the Bank of Japan. The IMF report further stresses that SROs need "to reconcile sometimes conflicting roles as SROs, industry bodies and market operators" (p. 44).

7. SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.

FC

See Principle 6.

8. The regulator should have comprehensive inspection, investigation and surveillance powers.

FC

The IMF's 2003 FSSA states that the FSA and SESC share "comprehensive inspection, investigation, surveillance and enforcement powers" (p. 45).

9. The regulator should have comprehensive enforcement powers.

FC

See Principle 8.

10. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program.

FC

See Principle 8.

11. The regulator should have authority to share both public and non-public information with domestic and foreign counterparts.

FC

The IMF's 2003 FSSA states that the principles relating to cooperation are assessed as "fully implemented" (p. 45). While the FSA has the authority to share both public and non-public information with domestic counterparts, it only has a small number of formal MoUs. It is recommended that the powers of the FSA and SESC to share information domestically be expressed more clearly. Provisions enabling both agencies to cooperate with their foreign counterparts should also be reviewed and strengthened. Furthermore, the FSA and SESC should continue their efforts to formalize MoUs with other supervisory agencies.

The IOSCO MMoU is based on the thirty IOSCO Principles adopted in 1998 and the experience gathered by securities regulators in using bilateral MoUs. The IOSCO MMoU provides a standardized framework for sharing enforcement-related information and a gradually expanding network of participating regulatory agencies. IOSCO members who wish to sign the IOSCO MMoU participate in a comprehensive screening process to establish that they have the legal capacity to fully comply with the terms of the IOSCO MMoU. The FSA is a signatory of the MMoU and an ordinary member of the IOSCO, whereas the SESC is an associate member of the IOSCO.

12. Regulators should establish information sharing mechanisms that set out when and how they will share both public and non-public information with their domestic and foreign counterparts.

FC

See Principle 11.

13. The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers.

FC

See Principle 11.

14. There should be full, timely and accurate disclosure of financial results and other information that is material to investors’ decisions.

FC

The IMF's 2003 FSSA states that the principle requiring full, accurate and timely disclosure of financial results and other information that is material to investors' decisions is regarded as "fully implemented" (p. 45). As reported in a regulatory and standard-setting framework assessment published by the Japanese Institute of Certified Public Accountants (JICPA) in December 2004, listed companies are required under the Securities and Exchange Law, which was replaced by the Financial Instruments and Exchange Act, to comply with regulations on additional disclosure requirements, including the preparation of consolidated financial statements.

15. Holders of securities in a company should be treated in a fair and equitable manner.

EN

The IMF's 2003 FSSA notes that the Commercial Code has provisions that are "designed to ensure that holders of securities in a company should be treated in a fair and equitable manner" (p. 46). However, the Asian Corporate Governance Association's (ACGA) 2008 White Paper states that "the rights of shareholders as owners of listed companies need to be better recognized and protected" (p. 5). In this regard, the ACGA advises that the fair treatment of shareholders be aligned with that of other stakeholders.

16. Accounting and auditing standards should be of a high and internationally acceptable quality.

CP

The IMF's 2003 FSSA states that the principle requiring accounting and auditing standards to be of a high and internationally acceptable quality is "broadly implemented" (p. 46). According to the IMF report, accounting standards have been brought toward international best practices. Moreover, the accounting and auditing framework has been strengthened to implement the new standards. As reported in a regulatory and standard-setting framework assessment published by the JICPA in December 2004, listed companies are required under the Securities and Exchange Law, which was replaced by the Financial Instruments and Exchange Act, to comply with regulations on additional disclosure requirements, including the preparation of consolidated financial statements. In January 2005, per the 2005 update available from the Deloitte & Touche IAS Plus website, the International Accounting Standards Board (IASB) and the Accounting Standards Board of Japan (ASBJ) launched a joint project to reduce differences between IFRSs and Japanese accounting standards. The ASBJ was established in July 2001 as a private sector organization, under the authority of the FSA. According to the April 2008 update, the IASB met with representatives of the ASBJ in Tokyo from 8-9 April 2008. This was their second meeting in Tokyo since the announcement of the initiative to accelerate convergence between Japanese GAAP and IFRSs in August 2007.

17. The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme.

CP

The IMF's 2003 FSSA reports that the principle requiring that the regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme (CIS), is "broadly implemented" (p. 46). In order to achieve full compliance with this principle, it was recommended that Japan introduce a "fit and proper" test on persons who control managers of collective investment vehicles.

18. The regulatory system should provide for rules governing the legal form and structure of collective investment schemes and the segregation and protection of client assets.

FC

As reported in the IMF's 2003 FSSA, the principle relating to rules governing the legal form and structure of a CIS and the segregation and protection of client assets, is "fully implemented" (p. 46).

19. Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a collective investment scheme for a particular investor and the value of the investor’s interest in the scheme.

FC

The IMF's 2003 FSSA states that the principle relating to disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a CIS for a particular investor and the value of the investor's interest in the scheme, is "fully implemented" (p. 46).

20. Regulation should ensure that there is a proper and disclosed basis for asset valuation and the pricing and the redemption of units in a collective investment scheme.

FC

As reported in the IMF's 2003 FSSA, the principle relating to the proper and disclosed basis for asset valuation and the pricing and the redemption of units in a CIS, is "fully implemented" (p. 46). According to the IMF's 2008 Selected Issues report, the FSA and the Japan Securities Dealers Association are jointly drafting "rules requiring financial firms to put in place systems to analyze the underlying assets of securitized products and their associated risks" (p. 15). This information will be made available to investors.

21. Regulation should provide for minimum entry standards for market intermediaries.

FC

The IMF's 2003 FSSA states that the principles relating to market intermediaries are assessed as "fully implemented" (p. 46). Furthermore, minimum entry standards for market intermediaries are provided under the Securities and Exchange Law - which has been replaced by the Financial Instruments and Exchange Act. The Act further prohibits securities firms from doing business without fulfilling the standards. The IMF report notes that, in order to conduct business, securities firms need to, inter alia, register with the FSA, introduce proper test for directors, and meet capital requirements.

22. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake.

FC

See Principle 21.

23. Market intermediaries should be required to comply with standards for internal organization and operational conduct that aim to protect the interests of clients, ensure proper management of risk, and under which management of the intermediary accepts primary responsibility for these matters.

FC

The IMF's 2003 FSSA states that the principles relating to market intermediaries are assessed as "fully implemented" (p. 46). The Securities and Exchange Law - which has been replaced by the Financial Instruments and Exchange Act - provides standards for internal organization and operational conduct of securities firms.

24. There should be procedures for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk.

FC

The IMF's 2003 FSSA states that the principles relating to market intermediaries are assessed as "fully implemented" (p. 46). The Securities and Exchange Law - which has been replaced by the Financial Instruments and Exchange Act - provides procedures for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk.

25. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight.

FC

The IMF's 2003 FSSA states that the principles relating to the secondary market are assessed as "fully implemented" (p. 46). The FSA licenses and examines applications of markets "to determine whether the provisions of the articles of incorporation and business regulations conform to laws and regulations" (p. 47).

26. There should be ongoing regulatory supervision of exchanges and trading systems which should aim to ensure that the integrity of trading is maintained through fair and equitable rules that strike an appropriate balance between the demands of different market participants.

FC

According to the IMF's 2003 FSSA, the principles relating to the secondary market are assessed as "fully implemented" (p. 46). Furthermore, the law requires the ongoing regulatory supervision of exchanges and trading systems. The FSA licenses and examines applications of markets to determine whether the provisions are adequate "to ensure the fairness of, and facilitate, the trading conducted on the securities market of securities exchanges, and to protect investors" (p. 47).

27. Regulation should promote transparency of trading.

FC

The IMF's 2003 FSSA states that the principles relating to the secondary market are assessed as "fully implemented" (p. 46). The Securities and Exchange Law - which has been replaced by the Financial Instruments and Exchange Act - promotes transparency of trading.

28. Regulation should be designed to detect and deter manipulation and other unfair trading practices.

FC

As stated in the IMF's 2003 FSSA, the principles relating to the secondary market are assessed as "fully implemented" (p. 46). The Securities and Exchange Law - which has been replaced by the Financial Instruments and Exchange Act - dictates criminal sanctions, and prohibits practices such as insider trading and market manipulation.

29. Regulation should aim to ensure the proper management of large exposures, default risk and market disruption.

FC

The IMF's 2003 FSSA states that the principles relating to the secondary market are assessed as "fully implemented" (p. 46).

30. Systems for clearing and settlement of securities transactions should be subject to regulatory oversight, and designed to ensure that they are fair, effective and efficient and that they reduce systemic risk.

FC

The IMF's 2003 FSSA states that the principles relating to the secondary market are assessed as "fully implemented" (p. 46). The IMF report notes that as "the authorities in charge of oversight do not monitor on an ongoing basis the systems and settlement procedures followed by major players for those markets that are not served by a central depository" (p. 32), enhanced ongoing oversight of the securities settlement systems is needed. It is recommended to monitor on a daily basis the functioning of private securities settlement systems, as well as market practices with regards to custody and liquidity provision.