May 13, 2015

Bank of Japan

Toward Further Development of the Tokyo Financial

Market: Issues on Repo Market Reform
Keynote Speech at the Futures Industry Association Japan
(FIA Japan) Financial Market Conference 2015 in Tokyo

Takehiro Sato
Member of the Policy Board
Introduction
It is a great honor to have the opportunity today to exchange views on the further
development of Japan's financial markets with distinguished participants from major
financial institutions, pension funds, and portfolio managers in Japan, the United States,
Europe, and other Asian countries.

Today, I would like to talk about the repo market in Japan. The Bank of Japan, collaborating
with market participants at home and abroad, is taking active steps to help create a
market-wide infrastructure. This is done with the aim of further enhancing the functioning
of Japan's financial markets -- which are a focus of the Bank's monetary policy
implementation and a touchstone of policy effectiveness.

The repo market plays the extremely important role of supplying liquidity to the primary
and secondary markets, as does the Japanese government bond (JGB) futures market. Repos
and futures transactions are an integral part of market-making activities and the markets'
price discovery mechanism. In this sense, the futures market works hand in hand with the
repo market. In the same vein, the development of the repo market drives further
development of the futures market by boosting the liquidity of the JGB market. Hoping for
such positive feedback to continue, I would like to talk about the international discussions
on repo market reform. I will also touch on issues related to the role of market participants
and the Bank in such discussions.

As you are well aware, repos are transactions that involve the exchange of cash and
securities for a set of period. The repo market is an important place for borrowing and
lending of cash and securities in many global financial markets. The amount outstanding of
repos in Japan declined temporarily in 2008 due to the collapse of Lehman Brothers, but has
regained its size markedly in recent years. It now accounts for almost half of the total
transaction amount in the money market (Charts 1 and 2).

Currently, market participants are taking initiatives in repo market reform in accordance
with international discussions. In my view, these initiatives center on four key ideas:
transparency, stability, efficiency, and globalization. I would like to touch on each idea.

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I. International Discussions on Repos
Drawing on the lessons learned from the recent global financial crisis, discussions on repos
have taken place at international forums such as the G20 and the Financial Stability Board
(FSB), with the aim of further increasing the transparency and stability of the repo market.
The Bank is also taking part in these discussions (Charts 3 and 4).

The awareness here is that the financial crisis was worsened by the large increase in repos
using illiquid securitized products, particularly in the United States. Excessive leveraging
and risk taking in the repo market posed a serious threat to financial stability. This
development drew attention to the so-called shadow banking problem. To prevent the repo
market from seizing up, the FSB deemed it necessary for regulatory authorities to closely
monitor the repo market. It also required further strengthening of risk management by
setting haircuts appropriately. In sum, from a prudential policy perspective, there has been
an international agreement that increasing transparency and stability of the repo market is
an important step in addressing global financial stability risks.

A. Reforms to Increase Transparency (Building of a Data Collection Framework)

With regard to transparency -- the first key idea that I mentioned -- the FSB set out its
policy recommendation for strengthening repo data collection at both the national and the
global level. This was aimed at collecting detailed data on repos such as the type of
collateral. By collecting such data, national authorities can monitor financial stability risks
such as a buildup of leverage, the degree of maturity mismatch, and the risk concentration
among certain market participants. An FSB Data Experts Group is working on the details of
this data collection framework, and the Bank is also taking part. A consultation paper
containing details such as the data template was released in November 2014, and the
framework will be finalized by the end of 2015, after taking account of the results of public
consultation.

In the coming months, active discussion on the domestic data collection framework will
take place in Japan, mirroring developments at the global level. To facilitate the smooth
introduction of the framework, it is necessary to pay due attention to the burden on market
participants and implications for the market.

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National authorities see the data collection project as marking significant progress toward
increasing transparency of the repo market as well as shadow banking activities. The project
should also help to contain financial stability risks. Active participation in it will contribute
to global financial stability. Furthermore, the project will enhance Japan's international
competitiveness by ensuring global trust in the nation's money markets. In cooperation with
stakeholders both at home and abroad, the Bank will continue to contribute actively to this
project.

B. Reforms to Increase Stability (Implementation of Appropriate Risk Management)

The second key idea concerns the stability of the repo market. In this regard, "haircuts" are
intended to increase the safety of a transaction by reducing the market value of the collateral
in proportion to factors such as fluctuations in the collateral price. At the height of the
financial crisis, the prices of asset-backed securities (ABSs) plunged. These securities were
used as repo collateral, and the level of haircuts for them rose sharply. This led to a further
decline in prices and liquidity, destabilizing the entire repo market.

With these experiences in mind, the FSB is requesting regulatory authorities to apply two
measures to all the repo transactions that are not cleared by a central counterparty (CCP).

The first measure is numerical haircut floors (Chart 5). The thinking is that in good times
market participants tend to underestimate price volatility risk and set haircuts that are too
optimistic. By setting a floor, this measure aims to avoid "procyclicality": excessive buildup
of leverage in good times and rapid deleveraging in stressed market conditions due to a
sudden rise in haircuts.

Repos using government securities are exempted from the numerical haircut floors. This is
because price movements in government securities tend not to be procyclical, and haircuts
on government securities are zero or close to zero for most transactions. Unlike in the
United States, where a considerable amount of repos uses ABSs, government securities are
mainly used in Japan (Charts 6 and 7). For this reason, the implementation of numerical
haircut floors would have little impact on the repo market in Japan.

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The second measure requested by the FSB concerns methodology standards. Regulatory
authorities are required to establish qualitative standards for the methodologies that market
participants use to calculate haircuts, incorporating stress scenarios.

As just mentioned, nearly all the repos in Japan use government securities, for which
haircuts are hardly applied. However, even the most creditworthy and liquid assets such as
government securities can entail a risk of price fluctuations. Therefore, to ensure repo
market stability, it is important to establish a common understanding among market
participants on what risk management, including methodology standards, should entail.

The FSB will establish a monitoring process to prevent market participants from avoiding
numerical haircut floors by booking transactions in different jurisdictions. Depending on the
results of this monitoring process, the FSB will consider reviewing the scope of the
application, which currently excludes repos using government securities, as well as the level
of haircut floors as necessary. The Bank deems it necessary to continue actively
participating in the international discussions regarding the framework for numerical haircut
floors, while making sure that these do not have unintended consequences for liquidity in
the global repo markets.

II. Reforms to Increase Efficiency (Shortening of the JGB Settlement Cycle)

In parallel with the international discussions just mentioned, there is an ongoing initiative
on efficiency. In Japan, market participants are aiming to further shorten the settlement
cycle for outright transactions of JGBs from two business days (T+2) to one business day
(T+1) after the trade date.

This initiative was taken in response to the significant increase in settlement fails in the JGB
market at the height of the Lehman crisis. By compressing the unsettled transaction amount,
it intends to reduce settlement risks. In addition, shortening the settlement cycle would
bring drastic changes to the repo market, because the initiative is accompanied by the
creation of a new market-wide infrastructure.

The repo market complements the JGB market, because it accommodates the need to adjust

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excesses or shortages of cash resulting from outright transactions. Therefore, it is essential
to introduce a T+0 settlement cycle for the general collateral (GC) repo market in
conjunction with achieving the T+1 settlement cycle for outright JGB transactions. To this
end, much greater speed and efficiency are required in processing repo transactions. This
leads to the third key idea: increasing efficiency. Japan's repo market is planning to
introduce the subsequent collateral allocation method for GC repo transactions. For this
purpose, the market will establish a new collateral management infrastructure with
sufficient allocation capacity.

Heightened efficiency in the repo market has the potential to bring considerable change to
the money market in Japan. More specifically, it could lead to the creation of a significantly
expanded T+0 funding market.

If all of the overnight GC repos currently settled on T+1 shift to T+0, the market size is
roughly expected to reach 20 to 30 trillion yen (Chart 8). On the other hand, the size of the
brokered and uncollateralized overnight call market is currently 2 to 3 trillion yen. This
suggests that there is a high probability that the size of the T+0 GC repo market will exceed
that of the call market and become the largest money market in Japan, offering same-day
liquidity.

As I mentioned, the size of Japan's repo market is expanding. From a broader perspective,
while unsecured funding has been diminishing globally after the financial crisis, secured
funding has been relatively robust. This result seems to reflect structural factors, such as the
increase in the awareness of credit risks of interbank transactions following the financial
crisis, as well as the introduction of financial regulations that discourage unsecured
short-term funding.

On the basis of this broad trend, the establishment of the T+0 repo market has the potential
to not only affect the current call market but also bring structural change to the money
market, which is vital to the money market operations of the Bank. Currently, banks and
money market brokers are major cash borrowers in the call market, while in the GC repo
market securities firms are major cash borrowers (Chart 9). The T+0 repos may greatly

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increase the depth of the T+0 funding market and the diversity of its participants. These
changes could help to further vitalize the money market as a whole.

With these possibilities in mind, the Bank will work closely with market participants and
follow the potential impact of these changes. Specifically, the Bank is greatly interested in
the potential impact on the size of call and repo market, the diversity of participants, and the
money flow. Changes in these factors might also affect the behavior of the money market
rates.

III. Reforms toward Globalization (Shifting to the New Gensaki Method)

Another important initiative is the unification of contract types for repos. Recently, market
participants agreed on the uniform adoption of the new gensaki method, a more globally
accepted form of a repurchase agreement. They are now working on the transition process,
such as amending the master agreement. This leads to the fourth key idea: globalization.

In Japan, loan-type repos (called gentan repos) have been widespread in the market. This is
because the securities transaction tax -- although now abolished -- used to be levied on the
purchase and sale of securities. Thus, there have been three types of repo contracts in Japan
(gentan, new gensaki, and old gensaki), with correspondingly diverse market conventions
(Chart 10). This is considered to be one factor that impedes efforts to improve efficiency
and automation in the processing of repo transactions.

In addition, it is often said that the loan-type repos cause difficulties in communication
among domestic participants, and overseas authorities and participants, because the
loan-type repos have the same legal characterization as securities lending in major overseas
markets.

Consequently, the unification of repos to the new gensaki contracts will contribute to the
further globalization of Japan's money market and lead to the vitalization of Japan's repo
market, including transactions with foreign investors who are present here today. Market
participants are expected to improve their IT systems, change market conventions, and seek
clients' involvement. The Bank is committed to offering support to achieve these goals.

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Concluding Remarks
Today, I have talked about the four key ideas regarding the reform of Japan's repo market:
transparency, stability, efficiency, and globalization. In the creation of a market-wide
infrastructure, these four ideas are important for not only the repo market but also the
financial markets as a whole.

The share of JGB holdings by foreign investors is expected to expand over the medium and
longer term, reflecting changes in domestic savings and investment. Developing a safe and
attractive repo market for investors both at home and abroad would contribute to boosting
liquidity in the JGB market. This would also increase trust in Japan's financial markets.

Reforms in the repo market, which were initiated by the failure of the Lehman Brothers, are
expected to reach their final stage in two to three years. In this regard, we are at a critical
moment for fulfilling the reforms. The Bank judges that it is extremely important for the
repo market, the epicenter of Japan's money market, to become more transparent, stable,
efficient, and easily accessible for foreign investors.

The Bank will hold a Repo Market Forum on May 14, and will exchange opinions with
major repo market participants on the four key ideas behind the reform. The Bank aims,
together with market participants, to contribute further to the development of the repo
market and to the Tokyo financial market.

Thank you very much for your attention.

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 Toward Further Development of 
the Tokyo Financial Market
― Issues on Repo Market Reform ―

May 13, 2015
Takehiro Sato
Bank of Japan

Chart 1

Amount Outstanding of Repos

tril. yen
160
Gensaki transactions
140 Gentan repos

120

100

80

60

40

20

0
CY 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Japan Securities Dealers Association.

1
 Chart 2

Amount Outstanding in the Money Market

tril. yen Transactions with the Bank's operations
300
CD/CP, CD/CP repos
Currency swaps
250 Repos
229 Call (collateralized/uncollateralized)
222
33 28
200 188
34 35 26 38
37 33 43
150 34
34
33 37
34
100
109
110
82 88
69 61 61
50

38 28 28 26 28 27 29
0
Jul.08 Jul.09 Jul.10 Jul.11 Jul.12 Jul.13 Jul.14

Note: Cash borrowing side.

2
Source: Bank of Japan

Chart 3

Discussions by the G20 and the FSB

The G20 asked the FSB to develop recommendations to strengthen the

Nov. 2010
oversight and regulation of the shadow banking system (Seoul summit).

The G20 acknowledged the FSB report "Shadow Banking: Strengthening

Nov. 2011 Oversight and Regulation," and consideration was begun on strengthened
regulation of shadow banking (Cannes summit).

The FSB published the report "Policy Framework for Addressing Shadow
Banking Risks in Securities Lending and Repos," and regulation was
Aug. 2013
finalized for securities lending and repos, excluding the regulatory
framework for haircuts.

The FSB published the report "Regulatory Framework for Haircuts on

Oct. 2014 Non-Centrally Cleared Securities Financing Transactions," and the
regulatory framework for haircuts was finalized, excluding some portions.

The FSB published the report "Standards and Processes for Global
Nov. 2014
Securities Financing Data Collection and Aggregation."

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 Chart 4

The FSB's Main Policy Recommendations

Recommendation Summary
Authorities should collect data on the amount of repo and
securities lending transactions and on other items at the
Data collection
national/regional level and at the global level to improve
transparency.

Qualitative standards for Authorities should set qualitative standards that must be
methodologies satisfied by the methodologies used to calculate haircuts on
to calculate haircuts non-centrally cleared repo and securities lending transactions.

For non-centrally cleared repo and securities lending

transactions in which banks provide financing to non-banks,
Numerical haircuts floors
authorities should introduce the framework of numerical floors
for haircuts by type of collateral, excluding government bonds.

Authorities should regulate re-hypothecation activity, in which

Regulations on re-hypothecation client assets deposited for a certain period as part of repo and
of client assets securities lending transactions are reused by financial
intermediaries in other transactions.

Chart 5

Numerical Haircut Floors

Other assets
Corporate and Securitized Main index
Residual maturity of collateral within the scope
other issuers products equities
of the framework

≦ 1year debt securities, and

0.5% 1.0%
FRNs

> 1year, ≦ 5years debt

1.5% 4.0%
securities
6.0% 10.0%
> 5years, ≦10years debt
3.0% 6.0%
securities

≧ 10years debt securities 4.0% 7.0%

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 Chart 6

Share of Amount Outstanding of Repos

by Type of Collateral Bond
Corporate bonds and others
Floating-rate government bonds
Inflation-indexed government bonds
% Fixed-rate coupon-bearing bonds and T-Bills
100

90

80

0
Jul.10 Jul.12 Jul.13 Jul.14 Jul.10 Jul.12 Jul.13 Jul.14
GC repos SC repos

Note: Bond lending side. 6

Source: Bank of Japan.

Chart 7

Implementation of Haircuts
3% 5%

11%
Implemented

Partially implemented

Not implemented

81%
Others

Note: Excludes respondents who do not engage in repos. The data are as of July 2014.
Source: Bank of Japan. 7
 Chart 8

Amount Outstanding of Overnight Transactions

in the GC Repo Market by Starting Date
tril. yen T+3 and over %
40 T+2 (S/N) 100

T+1 (T/N) 90
35
T+0 (O/N)
80
T+0 (O/N) ratio (right-hand scale)
30
70
25
60

20 31.1 50

40
15 17.8 27.8
23.7 22.6 30
10 12.6
11.4 20
5
10

0 0
Jul.08 Jul.09 Jul.10 Jul.11 Jul.12 Jul.13 Jul.14

Note: Cash borrowing side.

8
Source: Bank of Japan.

Chart 9

Amount Outstanding of Overnight Transactions

in the Call and GC Repo Markets by Sector
tril. yen tril. yen
35 Others 35 Others
Tanshi companies Tanshi companies
30 Trust banks 30 Trust banks
Securities companies Securities companies
City banks City banks
25 25
8.1 6.5

20 20

15 15
3.8
7.4 17.8
10 18.1 10

5 5 9.5
5.7
0 0
Call GC repos Call GC repos
（O/N） （T/N） （O/N） （T/N）
Cash borrowing side Cash lending side

Note: Among call transactions, the figures for uncollateralized call transactions include direct dealing transactions.
The data are as of July 2014. 9
Source: Bank of Japan.
 Chart 10

Share of Amount Outstanding of Repos

by Type of Contract
3%

3% 9%
Gentan repo

Kyu-gensaki

Shin-gensaki
(without substitution)

Shin-gensaki 85%
(with substitution)

Note: Total of cash borrowing and lending. The data are as of July 2014.
Source: Bank of Japan. 10