According to the International Monetary Fund's (IMF) 2003 Financial System Stability Assessment (FSSA), the Bank of Japan (BoJ) has designated four systems, namely, the BoJ-NET Funds Transfer System (BoJ-NET FTS), the Tokyo Clearing House's Bill and Check Clearing Systems (TCH-BCCS), the Zengin Data Telecommunication System (Zengin System) and the Foreign Exchange Yen Clearing System (FXYCS) as systemically important payment systems (SIPS). The latter three systems are privately-run and operated by the Tokyo Bankers Association. Of the four, the BoJ-NET FTS is the core system, and accounts for about 65 percent of the aggregate value settled by the four SIPS. Furthermore, the three private systems settle their net obligations over the BoJ-NET FTS. The IMF FSSA concludes that both modes of the BoJ-NET FTS - the real-time gross settlement mode and the deferred gross settlement mode - accord closely with the Core Principles for Systemically Important Payment Systems (CPSIPS). According to the report, the deferred gross settlement mode of the BoJ-NET FTS broadly observes Core Principle (CP) III, and does not fully observe CP IV. A 2003 self assessment by the BoJ of its system, however, concludes that the BoJ-NET FTS is compliant with all 10 CPs. Nevertheless, the IMF assessment is a third party assessment and therefore its conclusions are a more adequate evaluation of BoJ-NET FTS' compliance with this standard. The 2003 IMF assessment also notes that the Zengin System and the FXYCS observe all core principles with the exception of CP I, which they partly observe. The FSSA, however, notes that the TCH-BCCS is deficient in several respects and less robust in its observance of the CPSIPS. The IMF assessors noted that at the time of the FSSA, in 2003, TCH-BCCS settled only 5 percent of the volume of transactions in the four SIPS.

General Overview

The International Monetary Fund's (IMF) 2003 Financial System Stability Assessment (FSSA) states that the Bank of Japan (BoJ) has designated four systemically important payment systems (SIPS) that includes the BoJ NET Funds Transfer System (BoJ-NET FTS), the Zengin Data Telecommunication System (Zengin System), the Foreign Exchange Yen Clearing System (FXYCS), and the Tokyo Clearing House's Bill and Check Clearing Systems (TCH-BCCS), the latter three of which are privately-run systems operated by the Tokyo Bankers Association (TBA). The BoJ-NET FTS, owned and operated by the BoJ, has two modes, the real-time gross settlement mode and the deferred gross settlement or simultaneous processing mode. The IMF FSSA concludes that both modes of the BoJ-NET FTS accords closely with the Committee on Payments and Settlement Systems' (CPSS) Core Principles for Systemically Important Payment Systems (CPSIPS). According to the report, the deferred gross settlement mode of the BoJ-NET FTS broadly observes Core Principle (CP) III, and does not fully observe CP IV. Other than these two minor shortcomings, the system generally observes the CPs. Furthermore, the BoJ's 2003 "Self-Assessment of Compliance with the Core Principles for Systemically Important Payment Systems: The BoJ-NET Funds Transfer System" concludes that the BoJ-NET FTS is compliant with all 10 Core Principles. However, even though the report was conducted against the CPSIPS, it is a self-assessment, and the IMF's conclusions are judged to be a more adequate evaluation of Japan's compliance with this standard.

The 2003 IMF report also assesses the three privately owned systems and concludes that the Zengin System and the FXYCS observe all core principles with the exception of CP I, which they partly observe. In the case of CP I, the deferred net settlement mode of the FXYCS partly observes this principle. Other than these minor shortcomings, the systems are identified as well functioning, sound, and efficient systems. Similarly, a 2001 self-assessment report by the Japanese Bankers Association on the privately-run SIPS concluded that the Zengin System and the FXYCS are basically in compliance with all of the CPs (ZENGINKYO 2003). However, the self-assessment itself has not been published.

The system identified by the 2003 IMF FSSA as most problematic is the TCH-BCCS. This system, according to the IMF, partially observes CP III, does not observe CPs IV and V, lacks an effective business continuity arrangement (CP VII), and in regards to CP VIII the report observes that the system "is relatively cost-inefficient and impractical for the large-value and time-sensitive payments that typically characterize systemically important payment systems" (p. 58). The IMF notes that the BoJ-NET FTS is the core system, and accounts for about 65 percent of the aggregate value settled by the four SIPS. Furthermore, the three private systems settle their net obligations over the BoJ-NET FTS. Moreover, the TCH-BCCS, according to the 2003 FSSA accounted "for only about 5 percent of the aggregate volume of payments cleared and settled by the four principal systems and [even] this share has been declining in recent years" (p. 56).

According to the BoJ's 2007 Payment and Settlement Systems Report, in 2006, the volume and value processed by payment and settlement systems in Japan expanded or steadied at a high level due to improvements in monetary policy and overall economic growth. The BoJ-NET FTS is a real-time gross settlement (RTGS) that settles call loans, the cash legs of securities transactions (i.e. those of Japan Government Bonds or JGBs), and the net positions of private-sector deferred net settlement (DNS) systems. The BoJ report observes that the BoJ-NET FTS recorded (in 2006 and the first quarter of 2007) the highest level of activity since 2001. In March 2007, BoJ-NET FTS settled JPY 188 trillion, which represents the highest daily value since the BoJ-NET FTS converted to RTGS in 2001. The BoJ attributed this recent growth to the introduction (in January 2007) of the delivery-versus-payment (DVP) technique for the settlement of dematerialized investment trusts.

Like the BoJ-NET FTS, the FXYCS has two modes, the real-time gross settlement and deferred net settlement modes. The FXYCS processes yen payments from cross-border financial transactions, such as foreign exchange transactions. According to the BoJ report, in 2006, FXYCS processed JPY 18 trillion per day, which represented a growth of 8.6 percent year on year. The Zengin System is an inter-bank clearing system for retail credit transfers. According to the BoJ report, there was a slight increase in the daily average value processed by the Zengin System in 2006, which represents a trend of such increases since 2003. The TCH-BCCS, which clears bills and checks, is the largest Bill and Check Clearing System in Japan, processing more than 70 percent of the total value of bills and checks exchanged at BCCSs. According to the BoJ report, in 2006, the daily average value processed by TCH-BCCS showed a continued decline year on year. The BoJ attributed this to "a long-term shift away from bills and checks to credit transfers, which are usually processed by the Zengin System" (p. 7).

The BoJ's self-assessment observes that the Bank of Japan Law, specifically Article 33, Article 39 and Article 61-2, provides the legal basis for the BoJ's operation of the BoJ-NET FTS. Beyond the BoJ Law, the BoJ NET FTS is also governed by general Japanese law, statutes and contracts between the BoJ and system participants. The system rules governing BoJ-NET also provide for prompt final settlement, which is achieved for both the RTGS and simultaneous processing modes of the BoJ-NET FTS. The BoJ self-assessment also notes that the rules and procedures of the BoJ-NET FTS, which are part of contracts between the system participants and the BoJ, enable participants to have a clear understanding of the financial risks they incur through their participation in the system. In addition, the self-assessment states that "credit and liquidity risks to the participants are managed and contained effectively under the rules and procedures of the BoJ-NET FTS, which provide appropriate incentives for the participants to identify and manage those risks" (p. 6). Specifically regarding potential credit risk to the participants, the BoJ's self-assessment observes that the BoJ-NET FTS' RTGS mode is not exposed to credit risk since settlement is completed immediately upon receipt of the payment instruction by the system. Furthermore, according to the assessment, there are no credit risks to the participants of the BoJ-NET FTS' simultaneous processing mode, despite the fact that settlement of payment instructions is deferred until designated times in this mode. This is so because the simultaneous processing mode is used to settle payments between the BoJ and participants.

According to BoJ's 2007 Payment and Settlement Systems Report, during 2006 and the first quarter of 2007, the value and volume of payment and settlement activity increased significantly. The report states that this growth in transactions has presented new challenges for the BoJ-NET FTS and its participants regarding liquidity management, risk management and operational reliability. Due to these new realities, the BoJ has introduced and improved several mechanisms for reducing and managing risks. For example, the BoJ has made continuous advances in information technology to facilitate "automation of clearing and settlement processes, straight-through processing of payments, and delivery-versus-payment (DVP) for securities settlement" (p. 1). Specifically, in February 2006, the BoJ launched the next-generation RTGS (RTGS-XG) project, which includes a liquidity-saving feature (LSF) that allows participants to efficiently recycle liquidity within the system. Furthermore, as part of the RTGS-XG project, large-value payments currently processed by the Foreign Exchange Yen Clearing System (FXYCS) and the Zengin System are being incorporated into the BoJ-NET FTS and this is expected to help minimize risks. Overall, the new RTGS-XG project is expected to help participants reduce the amount of funds and collateral needed for settlement, while achieving intraday finality through RTGS, thus enhancing the safety and efficiency of the settlement of large-value payments in Japan.

The Principles

I. The system should have a well-founded legal basis under all relevant jurisdictions.

EN

According to the IMF's 2003 FSSA, the BoJ-NET FTS and the TCH-BCCS observe this principle. The FXYCS' deferred net settlement mode and the Zengin System, however, only partly observe this principle. The IMF notes that "under the corporate reorganization laws for financial institutions, stays of execution could be imposed on the liquidation of collateral pledged by a defaulting institution," adding that "under these circumstances, the risk containment arrangements in these systems would be vulnerable to failure with a default by the systems' largest net debtor" (p. 57). To address this problem, the IMF recommends that the BoJ begin negotiations with all relevant parties to facilitate the legal changes required to shield collateral pledged to key SIPS counterparties from stays on execution. The Japanese authorities' response to the FSSA and its recommendation is that "the risk control arrangements in the Zengin System and the FXYCS have already been introduced so that the legal risk pointed out in the assessment would be effectively contained and mitigated even in the event of default by the participant with the largest net debit position" (p. 60).

The BoJ's 2003 self-assessment noted that the BoJ-NET FTS, a systemically important payment system operated by the BoJ, is governed by a "sound legal framework" (p. 3). The Bank of Japan Act, specifically Article 33, Article 39 and Article 61-2, provides the legal basis for the BoJ's operation of the BoJ-NET FTS. Beyond the BoJ Law, the BoJ-NET FTS is also governed by general Japanese law, statutes and contracts between the BoJ and system participants. The system rules governing the BoJ-NET FTS also provide for the timing of final settlement.

II. The system's rules and procedures should enable participants to have a clear understanding of the system’s impact on each of the financial risks they incur through participation in it.

FC

The 2003 IMF assessment concludes that all SIPS in Japan observe this principle. According to the BoJ's 2003 self-assessment, "the rules and procedures of the BoJ-NET FTS enable participants to have a clear understanding of the financial risks they incur through their participation in the system" (p. 5). The BoJ report notes that these rules and procedures are part of contracts between the system participants and the BoJ, adding that the rules are constantly being updated and are readily available to all interested parties, including non-participants as necessary.

Specifically, the rules explain the design of the BoJ-NET FTS, its daily timetable and operating processes, including the BoJ's decision and notification procedures for handling abnormal situations, such as system failures and the inability of participants to settle. The BoJ also publicly discloses important rules pertaining to financial risks, such as the participation criteria and guidelines governing intra-day overdraft facilities and eligible collateral.

III. The system should have clearly defined procedures for the management of credit risks and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks.

EN

According to the IMF's 2003 FSSA, this principle is broadly observed in the deferred gross settlement mode of the BoJ-NET FTS and partially observed by the TCH-BCCS. The FXYCS and Zengin System observe this principle. According to the 2003 FSSA "there are no controls to cover the liquidity risks to surviving participants from a default of a counter party in the cash leg of a non-JGB transaction settled in the deferred gross settlement mode of the BoJ-NET FTS" (p. 57). In the case of the TCH-BCCS, the report notes that system has no settlement risk controls. Thus, "in the event of default by a participant, payments would be unwound, which would leave some surviving participants exposed to liquidity and possibly credit risk" (p. 57). The IMF recommends that the BoJ and the TBA equip the TCH-BCCS with effective mechanisms (i.e. an enhanced settlement fund and a loss-sharing arrangement) to limit settlement risks to surviving participants in the event of a default by another participant. In response, the Japanese authorities note "that no practical way exists for the TCH-BCCS, due to its characteristic as a debit transfer system, to satisfy Core Principle III. Although the FSAP team recommends a range of actions, it seems to be virtually impossible to implement them as they are all either too costly or impractical" (p. 60). The IMF does note that owing to the decreasing value and volume of transactions being settled through the TCH-BCCS, the likelihood of a systemic risk owing to a default by a participant in the system has diminished.

The BoJ's 2003 self-assessment notes that "credit and liquidity risks to the participants are managed and contained effectively under the rules and procedures of the BoJ-NET FTS, which provide appropriate incentives for the participants to identify and manage those risks" (p. 6). Regarding potential credit risk to the participants, the BoJ's self-assessment observes that the BoJ-NET FTS' RTGS mode is not exposed to credit risk since settlement is completed immediately upon receipt of the payment instruction by the system. Furthermore, according to the assessment, there are no credit risks to the participants of the BoJ-NET FTS' simultaneous processing mode, despite the fact that settlement of payment instructions is deferred until designated times in this mode. This is so because the simultaneous processing mode is used to settle payments between the BoJ and participants.

According to BoJ's 2007 Payment and Settlement Systems Report, during 2006 and the first quarter of 2007, the value and volume of payment and settlement activity increased significantly. The report states that this growth in transactions has presented new challenges for BoJ-NET FTS and its participants regarding liquidity management, risk management and operational reliability. Due to these new realities, the BoJ has introduced and improved several mechanisms for reducing and managing risks. For example, the BoJ has made continuous advances in information technology to facilitate "automation of clearing and settlement processes, straight-through processing of payments, and delivery-versus-payment (DVP) for securities settlement" (p. 1). Specifically, in February 2006, the BoJ launched the next-generation RTGS (RTGS-XG) project, which includes a liquidity-saving feature (LSF) that allows participants to efficiently recycle liquidity within the system. Furthermore, as part of the RTGS-XG project, large-value payments currently processed by the FXYCS and the Zengin System are being incorporated into the BoJ-NET FTS and this is expected to help minimize risks. Overall, the new RTGS-XG project is expected to help participants reduce the amount of funds and collateral needed for settlement, while achieving intraday finality through RTGS, thus enhancing the safety and efficiency of the settlement of large-value payments in Japan.

IV. The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the day. (Systems should seek to exceed the minima included in this Core Principle.)

EN

The 2003 FSSA notes that the FXYCS and the Zengin System observe this principle. The TCH-BCCS does not observe this principle, and the deferred gross settlement mode of the BoJ-NET FTS also does not fully observe this principle. The 2003 IMF report, however, states that "since the associated collateral available to surviving participants in a failed cash settlement of non-JGB delivery-versus-payment transactions in the deferred gross settlement mode of the BoJ-NET FTS allows ready access to intra-day credit, there would be no systemic consequences of the recalculation of settlement obligations and the associated settlement delays" (p. 57). To address these issues, the IMF FSSA recommends that the BoJ migrate payments processed through the deferred gross settlement mode of BoJ-NET FTS, which has inadequate risk controls for ensuring prompt and final settlement of some types of these payments, to its RTGS mode and implement it according to schedule" (p. 59). In response, the Japanese authorities noted that the BoJ "will continue to migrate remaining types of payments processed through the deferred gross settlement mode of BoJ-NET FTS to its real-time gross settlement mode, in accordance with its schedules such as the one published in April 2001" (p. 60). Further, at the time of FSSA in 2003, the TCH-BCCS was settling only 5 percent of the volume of transactions settled through the four SIPS. According to the 2007 BoJ report, in 2006, the daily average value processed by TCH-BCCS showed a continued decline year on year. The BoJ attributed this to "a long-term shift away from bills and checks to credit transfers, which are usually processed by the Zengin System" (p. 7).

V. A system in which multilateral netting takes place should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single settlement obligation. (Systems should seek to exceed the minima included in this Core Principle.)

EN

According to the 2003 FSSA "because of inadequate risk controls in the TCH-BCCS" (p. 57), the system does not observe this principle. However, at the time of the 2003 FSSA, the TCH-BCCS was settling only 5 percent of the volume of transactions settled through the four SIPS. Further, according to the 2007 BoJ report, in 2006, the daily average value processed by TCH-BCCS showed a continued decline year on year. The BoJ attributed this to "a long-term shift away from bills and checks to credit transfers, which are usually processed by the Zengin System" (p. 7). No deficiencies were identified in the other systems in regards to this principle by the IMF.

VI. Assets used for settlement should preferably be a claim on the central bank; where other assets are used, they should carry little or no credit risk and little or no liquidity risk.

FC

The 2003 IMF FSSA states that "all the systems settle on BoJ current accounts to satisfy the requirement of CP VI for a virtually riskless settlement asset" (p. 57) and, in effect, observing this principle. According to the BoJ's 2003 self-assessment, settlement assets used in the BoJ-NET FTS are current account balances at the BoJ, which are claims on the central bank.

VII. The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely completion of daily processing.

EN

The 2003 IMF FSSA notes that all systems have "adequate back-up arrangements in primary and remote sites and all but the TCH-BCCS have effective business continuity arrangements" (p. 58). Hence, the remote concludes all the SIPS, with the exception of TCH-BCCS, observe this principle. The 2003 IMF report mentions that the "TCH-BCCS has a contingency plan for switching to an off-site manual-entry PC system in the event of a failure of both its primary and back-up systems at its primary site. However, the contingency plans have not been adequately tested nor are the primary and back-up on-site and off-site systems of the TCH-BCCS independently audited" (p. 58). The IMF recommends that the TBA and the BoJ jointly design an "effective testing program for the primary site and PC-based back-up systems for the TCH-BCCS and institute periodic independent audits of the systems" (p. 60).

VIII. The system should provide a means of making payments which is practical for its users and efficient for the economy.

EN

The 2003 FSSA concludes that "all systems with the exception of the TCH-BCCS are efficient and practical systemically important payment systems" (p. 58) and hence observe this principle. In the case of TCH-BCCS, the FSSA notes that the system is practical for participants that provide bill and check payment services to business customers, however, "is relatively cost-inefficient and impractical for the large-value and time-sensitive payments that typically characterize systemically important payment systems" (p. 58). However, the IMF report notes that owing to the relatively low value and volume settled through this system and its ability to transfer business payments to the Zengin System, the significance of this shortcoming in the TCH-BCCS to the overall payment system in the country is limited. The IMF report makes no particular recommendation with regards to this principle for Japan.

According to the BoJ's 2003 self-assessment, the BoJ "makes efficient use of its resources" (p. 14). The report states that, when identifying ways to improve the system, the BoJ typically solicits suggestions from system participants and other relevant parties. For example, following public consultation with relevant parties, the BoJ decided in March 2002 to improve the BoJ-NET FTS' network infrastructure. Furthermore, according to the self-assessment, the BoJ performs a thorough analysis of potential safety and efficiency implications before altering the design and operation of the BoJ-NET FTS. The BoJ defines efficiency based on actual payment flows and the manner in which they are processed. As such, the BoJ carefully estimates the peak volume and distribution of payments. In addition, the BoJ "continuously monitors the capacity and performance of the system so that payment instructions are processed at an appropriate speed" (p. 15). Perhaps most importantly, the BoJ-provided overdraft facility, which gives participants access to intraday liquidity, helps prevent gridlocks and delays in the processing of BoJ-NET FTS payments.

IX. The system should have objective and publicly disclosed criteria for participation, which permit fair and open access.

FC

The 2003 IMF FSSA notes that all SIPS in Japan observe this principle and the "access and participation criteria are objective and now publicly disclosed by all systems" (p. 58). According to the BoJ's 2003 self-assessment, "criteria for access to current accounts with the Bank permit fair and open access, and are publicly disclosed" (p. 17).

The BoJ self-assessment notes that Article 1 of the Bank of Japan Law lists the participation criteria to hold a BoJ current account and to have access to BoJ lending. Both sets of criteria are publicly available, including on the BoJ website. Additionally, the BoJ has a clearly-defined procedure for the exit of a participant from the BoJ-NET FTS, and this process is applicable whether the exit is at the participant's request or by the BoJ's decision.

X. The system's governance arrangements should be effective, accountable and transparent.

FC

According to the 2003 IMF assessment, "the governance arrangements in all systems accord with Core Principle X" (p. 58). The report further states that the "systems' operators all have effective communications and well-founded accountability arrangements with participating members and provide public documentation on the role and organization of the systemically important systems" (p. 58). The IMF assessors, however, recommend that the operator of the private systems consider greater transparency in terms of its governance arrangement in spite of its observance of this principle.

The BoJ's 2003 self-assessment observes that "the governance arrangements of the BOJ-NET Funds Transfer System are effective and accountable, with relevant information publicly disclosed" (p. 19). The Bank of Japan Law, the By-Laws of the Bank of Japan and the Rules on Organization of the Bank of Japan lay out the governance arrangements of the BoJ-NET FTS, and these laws are all publicly available, including on the BoJ website. As the BoJ's highest decision-making body, the Policy Board makes basic decisions regarding bank policy, operation, and governance, including making final decisions on all issues related to the BoJ-NET FTS. To maximize the transparency of governance arrangements, the Policy Board discloses all its decisions in the Monthly Report of the Policy Board of the Bank of Japan. Also, the Policy Board promptly notifies participants of all decisions regarding the BoJ-NET FTS. Conducting their duties independently from the Policy Board, the Executive Auditors, performs audits of the BoJ's overall business. The Internal Auditors' Office, which is independent from departments that oversee the daily operation of the BoJ-NET FTS, conducts all internal examinations, and the resulting audit reports are subsequently submitted to the Policy Board.

A. The central bank should define clearly its payment system objectives and should disclose publicly its role and major policies with respect to systemically important payment systems.

FC

According to the IMF's 2003 FSSA, the BoJ observes this principle. The report notes that the BoJ's objectives, role and major policies with respect to systemically important payment systems are "publicly disclosed through a variety of media" (p. 59). According to the BoJ's 2003 self-assessment, the BoJ clearly describes its roles in managing Japan's payment and settlement systems in the paper "The Role of the Bank of Japan in Payment and Settlement Systems," published in September 2002.

B. The central bank should ensure that the systems it operates comply with the Core Principles.

FC

According to the IMF's 2003 FSSA, the BoJ observes this principle. The BoJ's 2003 self-assessment observes that the BoJ uses several governance arrangements to adequately manage the BoJ-NET FTS which in turn is "essential in order for the system to achieve compliance with the Core Principles" (p. 22).

C. The central bank should oversee compliance with the Core Principles by systems it does not operate and it should have the ability to carry out this oversight.

CP

The 2003 IMF FSSA concludes that the BoJ largely observes this principle. According to the same report, the BoJ oversees compliance by "private operators of the systemically important systems using the oversight and policy tools available to it within its statutory mandate" (p. 59). The 2003 BoJ self-assessment notes that the BoJ's primary oversight tool is moral suasion. For example, the BoJ constantly monitors the structure and operation of systems it does not operate. Through open discussions, the BoJ subsequently encourages and persuades system operators to follow its suggestions for improvements and advances. The IMF FSSA observes that the BoJ also uses contractual agreements (regarding access to the BoJ's settlement and credit facilities) between it and the participants and central counterparties in these private-sector payment systems as an added incentive and as a way to bolster the moral suasion tool.

D. The central bank, in promoting payment system safety and efficiency through the Core Principles, should cooperate with other central banks and with any other relevant domestic or foreign authorities.

CP

According to the 2003 IMF FSSA, to promote payment system safety and efficiency, the BoJ "cooperates effectively with other central banks, private system operators, principal participants in all the major payment systems and relevant public agencies through a network of consultative and advisory agencies" (p. 59). The IMF concludes that the BoJ broadly observes this principle.

Additionally, the BoJ's 2003 self-assessment observes that the BoJ is a member of the CPSS of the central banks of the Group of Ten countries, where central banks contemplate developments in the payment and settlement field. Regarding cooperation with relevant domestic authorities, the self assessment also notes that the BoJ regularly shares information with relevant domestic authorities, often persuading them to revise relevant laws, ordinances, and other regulations. The BoJ is a member of the CLS Bank, which settles foreign exchange transactions. While the BoJ has not specifically designated the CLS as a systemically important payment system (SIPS), it oversees the CLS system based on the framework established among the central banks of the Group of Ten countries.