Experts have accused the Japanese domestic MTN market of being inefficient, slow and out of date. The clearing system is time consuming and paying agency services are risky. Radical reform and improved technology have been called for. The market harbours a wealth of opportunity. If improvements take place, borrowers of all nationalities could unlock the market to find a fresh set of investor sources in Japan. Accounting practices are central to the instability of the domestic system. Paying agency funds are not separate from a bank's main balance sheet. And in a shaky market environment issuers have cause for concern. If a bank collapses its paying agency funds are also lost and it will default on debt repayments. This is unlike the Euromarket where these funds are protected. The problem is more acute given the antiquated computer systems and procedural delays. Trades can take up to three days to settle. Most Japanese banks and paying agents acknowledge the limitations, but the subject matter is sensitive and many declined to comment. The market is small and undeveloped. Dealers estimate that there are around 10 domestic programmes in Japan. And there is only one Samurai facility - a ¥500 billion ($4.54 billion) programme signed by Svensk Exportkredit (SEK) in October 1997. The choice for regulators will be whether to update the domestic system or to allow international paying agents (IPAs) and the international clearing houses to regulate the market. As yet there are no plans for change. The domestic paying agency service is the most worrying aspect for borrowers doing business in Japan. Per Akerlind, executive director and treasurer, at SEK, says: "The paying agency side of the domestic programme has been worrying us very much. We have been speaking with the authorities in Japan, but so far nothing is being done to change the system." SEK has only issued ¥6 billion off its Samurai programme and has done no recent trades. Akerlind, at SEK, has a pessimistic outlook. He says: "If non-Japanese issuers want to find Japanese investors, it is probably less work and less risk to use a Euro-MTN programme." Market instability has led issuers and investors to be reluctant to trade highly structured paper. But Japan's low interest rate environment means investors need structured notes to gain higher yields. Therefore the domestic market is not an attractive option. Koji Omachi is deputy manager of the syndicate desk at Nomura Securities (Nomura). He says: "There are several Japanese issuers with domestic MTN facilities but issuance off them is just like issuing corporate bonds. It depends on the issuer's preferred type of trade. But generally they don't issue highly structured notes off these programmes." Yet Yutaka Fukushi, senior manager at Industrial Bank of Japan Securities (IBJS), believes he has seen some improvements. He says: "In the past there was too much regulation in the market. For example, callables and floaters were not permitted. Due to deregulation in the past few years such rules have been reduced and Japanese issuers are going back to domestic programmes." Bank of Tokyo Mitsubishi (BTM) has the largest share of arrangerships and dealing in the domestic MTN market. It is the arranger and principal paying agent off SEK's Samurai programme. But even a spokesman at BTM says: "For the last two years there has been virtually no issuance in the domestic MTN market. The Euro-MTN facility is much more convenient for frequent issuers." There is potential, but the market is crippled and some experts are far from optimistic. Omachi, at Nomura, is scathing. He says: "I don't believe a lot of effort will go into deregulating the domestic market and it probably wouldn't be that helpful anyway. Even for Japanese issuers the Euro-MTN programme is a much more flexible tool. The domestic market won't grow any more, if anything it will shrink." International paying agents (IPAs) could revolutionize this market. Graham Cox is global product manager for programme debt at Deutsche Bank in London. He comes from Bankers Trust before it merged with Deutsche Bank. As chairman of the International Paying Agents Association (IPAA), he believes that if the Japanese market was willing to become more open and inclusive change would happen very quickly. He says: "If regulators want the system to work as efficiently as possible real time settlement, clearing and the role of paying agents will all have to be considered. "For the market to be attractive to foreign issuers it has to be user-friendly. That means if foreign issuers want to use their global IPAs, those IPA businesses have to be able to have membership and access to the domestic clearing systems." But a spokesman at BTM is sceptical about whether IPAs could be successful in the domestic market. He says: "Non-Japanese banks could not serve as paying agents in the domestic market. They have not focused on this operation in the past and they do not have the necessary client relationships." And in the Japanese market relationships are crucial. Many domestic MTN facilities have two paying agents, primary and secondary. But this is simply to keep relationship banks happy. The Japanese domestic market is closely guarded by those involved. This will be the greatest hurdle for international banks looking to break into the business. Fukushi, at IBJS, thinks Japanese banks have the edge on foreign houses when dealing with Japanese investors. He says: "Now there is much greater competition in underwriting between security houses than five years ago, particularly since more American banks have arrived. However, in the domestic market I think the Japanese houses will continue to dominate because they have the long-term relationships with both issuers and investors." Yet, if changes were made to improve the domestic system and foreign banks were able to enter the market as paying agents the rewards for issuers, Japanese and non-Japanese, could be great. SEK believes there are benefits to having a domestic platform if only the problems in the market could be eradicated. Its Samurai facility enables SEK to reach investors which its Euro-MTN programme cannot. Akerlind, at SEK, explains: "SEK felt that if it standardized the documentation once it would mean less work in the future. Many Japanese investors wanted Japanese law for certain structures, so if we signed a domestic programme with domestic law we could have a competitive edge." If the market was opened up the Samurai facility would become more attractive to other non-Japanese issuers. A spokesman at BTM says: "Some small and medium regional investors in Japan are restricted from investing in paper off Euro-MTN facilities, not because of official legislation but due to their own limitations. If a corporate has a domestic programme in place it can tap a much wider investor base." And Fukushi, at IBJS, points out the advantage of domestic issuance for Japanese borrowers of lower credit, particularly in difficult market conditions when investors are risk adverse. He says: "The Samurai market is very small now due to the Asia breakdown. However, more lower-rated issuers in Japan will look to this type of facility, especially now it is easier to do structured trades." He continues saying that if market conditions were more suitable many Japanese issuers would sign domestic facilities for language reasons. He says: "Within the next few years increasingly more Japanese issuers and subsidiaries of Japanese companies in the Euromarket will shift towards domestic issues Reporting and documentation is easier for them in Japanese. It is much more work to have to do everything in English." Most dealers consider that if the regulators concentrated on updating the procedure the impact would be positive. A BTM spokesman says: "It is the documentation process that is time consuming and expensive. It is not very efficient. Deregulation in this area is not on the agenda at the moment, but if it did occur, and I hope that it will, issuance would be much more convenient." Deregulation could turn the market around. But success will depend on the attitudes of investors. And change will only happen if it is considered economical. The BTM spokesman continues: "There could be potential in the domestic MTN market, but it all depends on costs and the workload involved. If reform takes place in the system and investor appetite is there I think we would see expansion." Cox, at Deutsche Bank, says: "The decision will be whether to settle the problems in the domestic system or to use the infrastructure set up by Euroclear and Cedel. The challenge for the professionals in the local market will be to create an infrastructure that can support traditional business and local requirements, but that is flexible enough to attract foreign investors and issuers and does not restrict entry. Protectionism versus internationalization." The Japanese government is committed to rejuvenating its financial system. But whether the domestic MTN market will be considered worthy of an overhaul is uncertain. For now, IPAs are sitting back and weighing up the pros and cons of taking on the challenge. And in the meantime hidden potential in a dormant market lies waiting to be realized.
August 04, 2000
