Steven M. Dickinson ^*
& Takeo Kosugi ^{* *}

III. The Struggle Between Banks and Securities Firms over the Introduction of Commercial Paper

The key factor that shaped the process of introducing commercial paper into Japan is the continuing conflict between banks and securities firms. Throughout the postwar period, the activities of Japan's banking and securities businesses have been separated pursuant to article 65 of the Japanese Securities and Exchange Law (SEL). ⁵³This sharp functional division was borrowed from the Glass-Steagall Act of the United States.⁵⁴

As in the United States, and in part because of developments there, the 1980s have witnessed a gradual erosion of the separation between banking and securities activities in Japan. Each industry has sought to invade the territory of the other while simultaneously trying to defend its own turf. Since any new business opportunity would allow one industry to gain at the expense of the other, much of the government activity concerning the introduction of new financial instruments has been concerned with mediating between the interests of the two industries. The Bank of Japan (BOJ) and the MOF's Securities and Banking Bureaus have played a central role in this mediation process.⁵⁵

Throughout the 1980s, securities companies and the business community have supported the introduction of commercial paper in Japan. Banks, on the other hand, have been strongly opposed. ⁵⁶Short-term financing has traditionally been the central function of the Japanese city banks, and the income from such loans has been a major source of bank. revenue. For this reason, the city banks feared that the creation of a commercial paper market would displace them from the short-term lending market.⁵⁷

In particular, the banks accurately perceived that the introduction of commercial paper would threaten both the continued existence of the main bank system and their continued role in Japan's financial system. Thus, throughout the 1980s, the banks opposed the introduction of commercial paper. The economic forces driving Japan toward introducing commercial paper eventually prevailed. Nevertheless, the course of introduction and the final form of the commercial paper market were largely shaped by the regulators' efforts to accommodate the banks' concerns.

IV. The Introduction of Foreign Commercial Paper in Japan

Most of the issues concerning the introduction of commercial paper into Japan were settled by the banks and securities companies in the long process of establishing a market for the purchase by Japanese residents of non-yen-based commercial paper issued outside of Japan. This process, which began with the revision of the FECL in 1979, culminated in April 1984 when banks and securities firms began to deal in foreign commercial paper. ⁵⁸

A. The Designation of Commercial Paper as a Security Under the Foreign Exchange and Foreign Trade Control Law

The legal status of commercial paper in Japan was first addressed in the 1979 amendment to the FECL.⁵⁹ Under the revised FECL, commercial paper is treated as a "security" (shoken), ⁶⁰ rather than as a "means of payment" (shiharai shudan).⁶¹ The FECL itself does not expressly refer to commercial paper. The law defines the term "securities" as "public bonds, corporate debentures, stock, shares, certificates giving title to public bonds or stock, bonds, treasury bills, mortgage bonds, profit certificates, coupons, dividend certificates, [and] talons."⁶² These are what may be called "traditional" securities. In order to provide some flexibility to include new or "non-traditional" securities, the definition further provides that "securities" may also mean "[other instruments] prescribed by Cabinet Order as a security or document similar thereto."⁶³ The MOF invoked this power by issuing a new ministerial ordinance which added commercial paper to the list of designated securities.⁶⁴

As a result of this new designation, commercial paper transactions are treated as "capital transactions" under the FECL. ⁶⁵Consequently, advance notice must be given to the Minister of Finance for the purchase or issuance by a Japanese resident of foreign commercial paper,⁶⁶ the purchase or issuance by a non-resident of commercial paper issued within Japan,⁶⁷and guarantees by a Japanese resident of foreign commercial paper issued by a non-resident (e.g., a foreign subsidiary of a Japanese company).⁶⁸

Article 23 of the FECL gives the MOF substantial control over guarantees and new issues of commercial paper. For example, notice of the proposed transaction must be provided to the MOF at least twenty days in advance.⁶⁹ During this period, the MOF may recommend that the party make specified changes in the transaction if the ministry determines that the transaction might have certain specified adverse effects.⁷⁰ If a reporting party does not accept the MOF's recommendation, the ministry may order the revision or suspension of the transaction.⁷¹

B. The Dispute Between Securities Companies and Banks over the Opportunity to Deal in Foreign Commercial Paper

Because commercial paper had not yet been issued in Japan when the FECL was revised in 1979, the only local market for commercial paper was that for foreign commercial paper.⁷² Under the general scheme of the FECL, "traditional" foreign securities such as stocks and bonds are sold to customers in Japan through securities companies designated by the MOF, which are exempt from the prior notice requirement that otherwise applies to such transactions.⁷³ It was naturally assumed that commercial paper, as a "non-traditional" security, would also be handled by such companies.⁷⁴

To strengthen their position in the budding commercial paper market, the securities companies requested the MOF to take specific action to designate commercial paper as a "valuable security" (yuka shoken)⁷⁵ under article 2, paragraph 1 of the SEL.⁷⁶ Under Japanese law, the provisions of the SEL, including its disclosure and anti-fraud provisions,⁷⁷ apply only to valuable securities specifically enumerated thereunder.⁷⁸Furthermore, the entire basis for regulation of the "securities business" (shokengyo) under the SEL rests on the definition of "valuable security" because only businesses that handle valuable securities specifically enumerated in article 2, paragraph 1 of the law are subject to such regulation.⁷⁹ This is in contrast to the approach under U.S. law, where the scope of the securities laws is based on the broad definition of the term "security" in the various federal and state securities statutes. ⁸⁰

While traditional securities, as defined in the FECL, fit easily within the SEL's definition of valuable securities, foreign commercial paper, which in the U.S. market is issued in the form of a promissory note, in not covered by any of the SEL's enumerated securities.⁸¹ However, the SEL allows the selective expansion of the definition's scope through the designation of "[O]ther securities or certificates" by Cabinet Order.⁸²Since the 1980 Cabinet Order passes on the task of designation to the MOF,⁸³the ministry can accommodate new financial instruments as it sees fit. ⁸⁴

The securities companies requested the MOF to issue a cabinet order designating commercial paper as a valuable security under the SEL to parallel its previous designation of commercial paper as a security under the FECL. ⁸⁵ Because all of the instruments specifically defined as securities under the FECL fall within the definition of valuable security under the SEL, it was quite logical to request that commercial paper, which had been designated as an FECL security, also be designated as an SEL valuable security. Such designation under the SEL would have excluded banks from dealing in the commercial paper market,⁸⁶thereby providing securities companies with a monopoly in this market.

Not surprisingly, the banking industry strongly opposed designating commercial paper as a valuable security. The banks argued that, unlike the "traditional" securities defined in the FECL, commercial paper was a financial instrument traded in the short-term financial market. For this reason, the banks maintained that both they and the securities companies should be permitted to participate on an equal basis in the short-term market. The banks further argued that this objective should be incorporated into the Banking Law, which was being revised while this debate occurred.⁸⁷The banks' arguments proved persuasive, and the SEL, the Banking Law, and the enforcing regulations thereunder were revised to allow both banks and securities companies to act as dealers for foreign commercial paper. The question of domestic commercial paper was left to be resolved at a later date.

To enable securities companies to deal in foreign commercial paper, the MOF first revised article 43 of the SEL⁸⁸ to provide that securities companies may engage in ancillary business (kengyo) related to securities, in addition to business related to valuable securities, subject to the approval of the Minister of Finance.⁸⁹ The MOF then issued a ministerial circular (tstltatsu) stating that sales and brokerage of foreign commercial paper would be treated as an ancillary business subject to the MOF's approval.⁹⁰

To enable banks to enter the foreign commercial paper market, the new Banking Law provides that banks may engage in a "business incidental to the banking business" (ginkogyo ni fuzuisuru gyomu), relating to the "[a]cquisition or transfer of monetary claimable assets" such as negotiable CDs.⁹¹ The enforcement regulations for the new Banking Law provided specifically that foreign commercial paper would constitute a "monetary claimable asset" (kinsen saiken ). ⁹²

C. The Rules of the Ministry of Finance for Dealing in Foreign Commercial Paper

By revising the SEL and the Banking Law in the manner described above, the MOF succeeded in providing securities companies and banks with equal access to the foreign commercial paper market. Since these revisions did not designate foreign commercial paper as a valuable security under article 2 of the SEL, however, the disclosure and anti-fraud provisions of the SEL were not applicable to dealings in foreign commercial paper. Foreign commercial paper thus existed in a legal and regulatory vacuum.

The MOF filled the gap by working with securities companies and banks to develop the "Rules for Dealing in Foreign CDs and CP" (Rules).⁹³Issued on March 31, 1982, the Rules provided, inter alia, for the term, minimum amounts, approved issuers, and approved customers for foreign commercial paper transactions.⁹⁴ The Rules lacked any specific statutory basis and had the force of the MOF's "administrative guidance" to the banks and securities companies.⁹⁵ Thus, unlike the disclosure and anti-fraud provisions of the SEL, violation of the Rules carried no legal sanction, and did not provide an aggrieved customer with a basis for a claim against a dealer.

By accommodating the concerns of the banks and securities companies dealing in foreign commercial paper, the MOF created an awkward and illogical distinction between an FECL security and an SEL valuable security. Furthermore, by exempting foreign commercial paper transactions from the application of the SEL, the ministry seriously weakened the protection of investors with regard to commercial paper. This led to criticism from legal scholars that the MOF overemphasized resolving the struggle between banks and securities companies and neglected the issue of investor protection.⁹⁶

D. Resolution of the Dispute Between Banks and Securities Companies Concerning Yen-Based Foreign Commercial Paper

Although the SEL amendment, the Banking Law, their accompanying regulations and the Rules became effective on April 1, 1982, actual dealing in foreign commercial paper was delayed for an additional two-year period until April 1, 1984.⁹⁷ The primary reason for this delay was the dispute over the securities companies' plan to sell foreign commercial paper on a yen basis.⁹⁸

One of the rules for foreign commercial paper was that the instrument must be denominated in a foreign currency.⁹⁹ In order to avoid exchange rate fluctuation risks associated with the sales of foreign currency denominated commercial paper, the securities companies devised a procedure whereby the commercial paper would be issued in the foreign country along with a forward exchange contract for the same amount. This commercial paper, even though denominated in a foreign currency, would then be sold for yen at a yen-based interest rate in the Japanese market.¹⁰⁰ The securities companies argued that this process was necessary to develop the Japanese market for foreign commercial paper and CDs.¹⁰¹

The banks objected. Even though they had succeeded in obtaining the right to deal in foreign commercial paper, they remained opposed to the introduction of commercial paper into Japan.¹⁰²The banks were particularly sensitive to the adverse impact that foreign commercial paper sales might have on their role in the domestic, short-term, yen-based loan market. Thus, banks vigorously opposed the securities companies' plan to deal in yen-based foreign commercial paper. The banks argued that, because foreign exchange was central to such a transaction, the transaction had to be performed by an authorized foreign-exchange bank, and not by the securities companies. They also maintained that, because foreign commercial paper would be purchased with yen at a yen exchange rate, the issuance of such foreign commercial paper would in effect be equivalent to the issuance of domestic commercial paper, which was not yet permitted. ¹⁰³

The banks' protests precipitated yet another round of negotiations among the MOF, the banks and the securities companies. In May 1983, these groups decided to delay dealing in foreign commercial paper until April 1, 1984, for the outstanding issues mentioned above to be resolved. After a series of negotiations, it was decided that foreign commercial paper would be handled according to the Rules issued in 1982.¹⁰⁴ Securities dealers were permitted to deal in yen-based foreign commercial paper, but were required to open a special foreign exchange bank account for payments, thereby providing some fee income on the transactions to the banking industry.¹⁰⁵ The MOF restated the Rules in a series of circulars effective on April 1, 1984.¹⁰⁶

E. The Foreign Commercial Paper Market in Japan: Results

There was some concern that the introduction of foreign commercial paper would lead to a significant shift of short-term funds into foreign commercial paper and, therefore, damage other segments of the short-term market.¹⁰⁷ This concern was fueled by prevailing interest-rate differentials between the United States and Japan. Because U.S. rates are typically higher than Japanese rates, there was concern that Japanese investors would invest in foreign commercial paper rather than in Japanese instruments.¹⁰⁸ The securities companies' decision to sell foreign commercial paper at a yen-based interest rate helped to alleviate this concern.¹⁰⁹ In theory, the relatively low yen-based interest rate on foreign commercial paper should have been attractive to foreign issuers. It has proven difficult to interest Japanese investors in foreign commercial paper because Japanese investors can earn higher interest rates from traditional financial products such as CDs. This difficulty has been compounded by the fact that foreign subsidiaries of Japanese companies are prohibited from selling foreign commercial paper in Japan.¹¹⁰ Unfortunately, this is the one group that might be familiar to most Japanese investors

As a result of these factors, foreign commercial paper has not significantly influenced the Japanese market. In absolute terms, the foreign commercial paper market has grown from about $500 million in 1984 to $2 billion in 1987.¹¹¹ At the end of 1986, foreign commercial paper and foreign CDs together amounted to only 0.4% of the total Japanese short-term financial market.¹¹²Moreover, the recent creation of a domestic Euroyen commercial paper market should further constrain the growth of foreign commercial paper in the short-term Japanese markets.

Next Section: v. THE CREATION OF THE DOMESTIC COMMERCIAL PAPER MARKET IN JAPAN

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