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

I. Introduction

Japanese businesses were first permitted to issue commercial paper in Japan on November 20, 1987.¹ They responded enthusiastically, with twenty-four companies immediately issuing commercial paper, totaling ¥800 billion ($6.4 billion), at an average interest rate of 4.0%.² By the end of October 1988, the domestic commercial paper market had grown to a total outstanding balance of ¥7.72 trillion ($61.76 billion).³Also on November 20, 1987, restrictions on the issuance of Euroyen commercial paper by non-Japanese residents were lifted in order to provide access for non-residents to the yen denominated commercial paper market.⁴ On January 29, 1988, restrictions on the issuance of yen-denominated commercial paper in Japan by non-residents were also eliminated.⁵ As a result of these developments, both Japanese residents and non-residents who meet the requisite standards of eligibility are now permitted to employ commercial paper as a means of procuring short-term yen funds in Japanese financial markets.

Commercial paper is an unsecured financial device that allows businesses to raise funds directly in the short-term financial markets⁶ as an alternative to scarce or more expensive bank loans.⁷ Because the paper is backed only by the financial standing of the issuer, the ability to issue commercial paper tends to be restricted to large corporations with high credit ratings.⁸ The commercial paper market started in the United States in the nineteenth century and remained almost exclusively a U.S. and Canadian financing device until the 1980s.⁹ However, as part of the general trend toward "securitization"¹⁰ in the 1980s, the Eurodollar commercial paper market, which had been developed in the 1960s, grew rapidly in size.¹¹ In addition, in 1985 and 1986, France, the Netherlands, the United Kingdom, and a number of other countries developed commercial paper markets of their own.¹² The creation of a domestic commercial paper market in Japan is part of this global trend. It marks the culmination of a process that began in 1979 when Japan's Foreign Exchange and Foreign Trade Control Law (FECL)¹³was revised.¹⁴ The characteristics of this new market reveal much about the recent liberalization and internationalization of the Japanese financial markets.

II. FACTORS ENCOURAGING THE INTRODUCTION OF COMMERCIAL PAPER IN JAPAN

The introduction of commercial paper in Japan has been encouraged by the internationalization of the Japanese financial market, the expansion of the short-term financial market, the needs of business, and the trend towards issuance of unsecured bonds. ¹⁵

A. Internationalization

Beginning with the revision of the FECL and the repeal of the Law Concerning Foreign Investment in 1979,¹⁶ the separation between the Japanese financial system and foreign financial systems has been largely eliminated. In the early 1980s, the introduction of impact loans,¹⁷ the issuance of foreign bonds in Japan, and the establishment of foreign currency deposits quickly internationalized the Japanese financial markets. Not only were foreign residents given greater access to the Japanese financial market, but Japanese residents were allowed access to the relatively unregulated Eurodollar and Euroyen markets.¹⁸This policy of internationalization of the Japanese financial markets has been embraced by the Ministry of Finance (MOF), which has stated its desire to create an international financial market in Tokyo which is competitive with the New York and European markets. ¹⁹

One of the global financial trends initiated in the United States that has taken hold in the international capital markets is securitization.²⁰ An example of this trend is the movement in the Euro-markets away from syndicated lending to the direct issuance of Euro-bonds and Euro-notes. ²¹Commercial paper represents the extreme short-term financing side of this trend towards direct issuing. The development of a commercial paper market in Europe and elsewhere threatened to divert short-term funds from Japan to those other markets. To prevent a "hollowing out" of its short-term financial market, Japan sought to develop some form of commercial paper as a competitive alternative.²²

B. The Expansion of the Short-Term Financial Market

Between 1975 and 1986, Japan's short-term financial market grew significantly both in absolute and relative terms.²³ While the exact growth figure depends on the scope of the short-term market considered, a conservative calculation suggests that the total balance increased during this period from ¥13 trillion to ¥56 trillion.²⁴This represents an increase from 3.9% of Gross National Product (GNP) to 10.7%.²⁵

The variety of instruments available to investors has also increased rapidly, especially since 1985. In 1975, the short-term financial market was simple, consisting of a yen-call, a bill-discount and a bond-repurchase (gensaki) market.²⁶The yen-call and bill-discount markets are interbank markets that excluded (and still exclude) non-financial companies. While nominally free, the interest rate on these two instruments was actually fixed under the MOF's guidance.²⁷ The gensakimarket, in which securities companies and banks trade bonds under repurchase agreements, was the only short-term market with truly unregulated interest rates. Because the gensaki market was the only deregulated, market-rate investment vehicle available to non-financial companies, it attracted a large amount of investment.²⁸ However, since fundraising in the gensaki market requires extensive bond holdings, it does not provide a practical fundraising opportunity for non-financial businesses.²⁹

By 1986, a range of instruments comparable to those found in the United States and other developed short-term markets had been created in Japan, thereby providing a wide variety of free market interest rate opportunities for Japanese investors. Although the process of expanding available financial instruments started in 1979,³⁰most of the new instruments have been introduced since the loosening of interest rate restrictions on large-denomination time deposits and the 1985 introduction of money market certificates and yen banker's acceptances. ³¹

While considerable progress had been made, by 1987 it was apparent that in order to compete effectively with other international markets, Japan's short-term financial market needed even greater expansion. The Japanese short-term financial market, at 10.7% of GNP, remained relatively small compared to that of the United States, where the short-term financial market occupied 25.4% of GNP. ³²In addition, the Japanese short-term market constituted only 3% of its total financial market, whereas the comparable percentage in the United States, the United Kingdom and West Germany was 10%. ³³

It has been suggested that a major reason for Japan's relative lack of a domestic short-term market is that short-term issuers have been primarily banks and other financial institutions.³⁴ The participation of the Japanese government as an issuer has been limited to occasional offerings of short-term treasury bills and funding bills.³⁵Because the Japanese government imposed low interest rates on these instruments and offered them erratically, neither has developed into a viable market.³⁶ Prior to the introduction of a commercial paper market, there was no effective vehicle for non-financial businesses to raise funds in the short-term markets.³⁷ Creating a viable commercial paper market has been an essential step for Japan to take in order to expand the range of available short-term instruments.

C. The Needs of Japanese Business

From 1974 to the present, the Japanese economy shifted from a period of high growth to one of low growth.³⁸ This new economic situation has caused Japanese financial managers to become much more concerned about funds management. ³⁹ In the period of high growth, bank borrowing at relatively low fixed interest rates served as the primary source of short-term funds for Japanese enterprises.⁴⁰ Usually, a company borrowed and deposited funds with a single "main bank," which, because of its control over short-term funding, exercised considerable control over the company's business activities.⁴¹

In the current era of lower growth, however, this approach is no longer adequate. On the funds procurement side, businesses have tended to rely on their own funds and on direct financing, and have shifted away from bank borrowing. Companies are also increasingly sensitive to interest rate changes, and this sensitivity has led to a shift from long-term to short-term borrowing. In addition, the low growth period has resulted in reduced corporate profits and in greater pressure on companies to reduce their cost of funds. Japanese financial managers have, therefore, sought new ways to employ these funds in order to maximize rates of return.

The Japanese short-term financial market had, as of the summer of 1987, responded to the needs of low-growth businesses by providing a number of market-rate investment vehicles, the most popular of which have been certificates of deposit (CDs). However, with regard to funds procurement, no short-term market vehicle other than the traditional short-term bank lending was available. ⁴²Moreover, businesses complained that bank loans failed to meet their needs because controlled interest rate failed to respond to market conditions, and because banks failed to provide flexible schedules and terms for repayment.⁴³ These complaints indicated the desire of Japanese companies to gain a greater degree of independence from the main banks. The introduction of domestic commercial paper in 1987 resulted from pressure by Japanese business to develop a mechanism for funds procurement at short-term market rates.⁴⁴

D. The Trend Toward the Issuance of Unsecured Bonds

Business demands also resulted in the gradual trend toward the issuance of unsecured bonds in Japan.⁴⁵ After the "bond purification movement" in the 1930s,⁴⁶ there was a rigid principle in Japan that all corporate debentures be collateralized.⁴⁷ This was in keeping with a general principle, agreed upon and enforced by banks, that all corporate borrowing should be collateralized. The MOF closely monitored banks and other financial institutions which raised funds through accepting deposits (city banks) and issuing debentures (long-term banks). As a result of the banks' agreement and the MOF's scrutiny, the risk of default on these obligations was minimal. Other entities that were not so closely monitored, such as non-financial businesses, were also required to offer collateral for their loans and debentures.⁴⁸ Thus, short-term borrowing from banks was almost always secured by a hypothec⁴⁹or other security over the assets of the borrower; corporate debentures were, until recently, always secured by some sort of collateral.

With respect to corporate debentures, the securities industry and the business community increasingly pressured the MOF to allow the issuance of unsecured bonds.⁵⁰ Finally, in March 1979, the determined efforts of blue-chip issuers led to the promulgation of eligibility standards for such issuance. However, these standards were so strict that only two companies qualified.⁵¹

Under the most recent standards, issued in February 1987, 170 companies were qualified to issue unsecured straight corporate debentures. However, banks which championed the collateralization principle have consistently opposed the issuance of unsecured bonds. For this reason, the first unsecured bond was not issued until early in 1985 when TDK Co. floated a six-year unsecured straight bond for ¥10 billion ($80 million).⁵²

Recognizing this trend towards decollateralization of the bond market, business and securities firms sought the same form of decollateralization in the short-term financial market. Their efforts were concentrated on the primary unsecured short-term fund raising instrument available in the U.S. and European markets: commercial paper.

Next Section: III. THE STRUGGLE BETWEEN BANKS AND SECURITIES FIRMS OVER THE INTRODUCTION OF COMMERCIAL PAPER