The Financial Services Agency ("FSA") has been very active recently, so this newsletter highlights and comments on three important news items:

(1) Amendments to FIEL enacted by the Diet, 6 June 2008

The package of regulatory amendments promoted by the FSA as part of its "Plan for Strengthening the Competitiveness of Japan's Financial and Capital Markets" (the "Plan", published 21 December 2007) passed through the Diet in early June (enacted 6 June, promulgated 13 June). It was widely feared that the hung Parliament would mean that the planned amendments to the Financial Instruments and Exchange Act ("FIEL") would be delayed to very late 2008, or pushed into 2009 or abandonned. However, the Opposition parties unexpectedly decided to stand aside even though certain elements in the DPJ1 were said to oppose the deregulatory amendments as they might benefit non-Japanese firms or cut domestic employment. But, compared to the gasoline tax issue, reform of financial regulation lacks the visceral popular appeal to tabloids and chat shows.

The FSA has published a helpful guide2 to the implementation schedule of the various measures in the Plan, but we would highlight: 

  • by 12 December 2008: broader range of ETFs permitted, new markets for professional investors, broader range of business activities permitted to banking and/or insurance groups; and 
  • by 12 June 2009: revamping of the firewall regulations in respect of financial firms and reduced restrictions on dual senior posts. Development of alternative systems for controlling conflicts of interest.

The practical effects of these changes are not yet clear, but the new policy suggests greater regulatory flexibility and a more practical and cost-effective approach to potential conflicts of interest, which should improve senior managerial efficiency and enhance cross-selling of financial services.

(2) Commissioner Sato's IBA speech launches the "Better Market Initiative", 26 June 2008

FSA Commissioner Takafumi Sato gave his annual speech to the non-Japanese members of the financial services sector in Japan at the International Bankers Association on 26 June 20083 at the Okura Hotel. The only strictly new item was his announcement that the "inelegantly titled" Plan (see full title above) would henceforth be known as the "Better Market Initiative" (or "BMI") to match the FSA's other leading concept of "Better Regulation". Otherwise his speech rehearsed all the well known changes of the last few months.

However his responses to questions from the IBA audience were more interesting:

  • Reviewing the FSA policy "pillar" of an "optimal combination of rules-based and principles-based supervisory approaches" Commissioner Sato noted that the rules-based powers of the FSA were most likely to be applied to smaller domestic market participants, whilst the Principles4 were most likely to be effective in dealing with the larger domestic and foreign financial services firms. This distinction helps make the FSA's mantra-like policy "pillar" somewhat clearer. Larger financial institutions should expect the FSA to apply a principles-based approach to them, which, conversely greatly increases their need for internal controls and education based on the 14 Principles.
  • Discussing the prospective changes to the regulation of firewalls (see above) Commissioner Sato indicated that the FSA saw this as an issue that would be seen as "essentially principles-based". Firms with such conflicts of interest would be expected to regulate themselves with their own structures and disciplines, which the FSA could then assess. As conflicts of interest are generally an issue at larger integrated firms, this shows that the FSA plans, effectively, to operate a principles-based regime for larger firms in this area as well.
  • In discussing the issue of raising FSA staff's awareness of the concept of "Better Regulation", Commissioner Sato hinted at his frustration that it would be a "long time" before every member of the FSA's staff would apply the new policies of the FSA in an effective and appropriate way ("with good sense" he said). It appears that the departments of the FSA charged with inspection are reluctant to relinquish their confrontational and prosecutorial roles in exchange for principles-based dialogue.

(3) English translations of the three major finance Acts available, 27 June 2008

Another modernisation that the FSA wishes to achieve is greater international openness and cooperation. It is an explicit policy goal that an increasing proportion of press releases, legislation and other materials should rapidly be made available in English to non-Japanese users on the FSA's website or directly by email. To that end the FSA has provided English translations of the Banking Act, FIEL and the Insurance Business Act5. Whilst these are unofficial translations for reference use only (the Japanese texts are definitive), this step is also encouraging and helpful.

The related challenges of encouraging change within the FSA and ensuring implementation

With the unexpectedly fast passage of the amendments to FIEL, the FSA has no significant legislative barriers to the implementation of the BMI. However, improving the quality of FSA staff and motivating them to follow principles rather than an old rule book are significant challenges.

The Principles are, it was acknowledged by Commissioner Sato in his speech to the IBA, very closely based on the UK Financial Services Authority's (11) Principles for Business. However, he underlined the difference between the UK FSA's regime and what Japan's FSA wants to develop: namely an "optimal combination of rules-based and principles-based supervisory approaches".

However, in practice, large financial sector firms in Japan are likely to be very largely regulated by principles over the long run: their growing complexity is likely to defeat a rules-based approach. Indeed Commissioner Sato implied in his response to questions at the IBA meeting that this would be the case generally and is also likely to be the case in respect of imminent firewall deregulation.

It is, therefore, hard to escape the conclusion that the "optimal combination" is a device for the purposes of internal presentation within the FSA rather than a particularly original "Japanese approach" to financial sector regulation for the outside world. The "optimal combination" helps to sell the new principles-based regime that the sector's large firms now require to many existing FSA staff whose careers were "rules-based" and who are uncomfortable about the significant policy changes Commissioner Sato has already introduced. The current inability of many FSA staff to apply a principles-based regime is now the main factor that is delaying progress towards faster implementation of policy change.