International Regulatory Reform and New Financial Infrastructure in Asia
| International Regulatory Reform and New Financial Infrastructure in Asia 1. Introduction More than four years have passed since the Lehman Crisis, and during this period, a variety of discussions on financial regulatory reforms have progressed. In many areas of the reforms, at present authorities are discussing the details to reach a final agreement, or have just proceeded into the implementation stage. I believe it is useful now to pause and think about financial regulatory reforms, and their implications for Asia. I am very honored to be able to speak here at the Asian Financial Forum as I did last year. Today, I would like to talk about 4 topics: 1) the necessity for financial regulatory reforms and issues to be considered; 2) the importance of appropriate macro-level policies; 3) outstanding issues relating to the Asian financial system; and 4) financial cooperation in Asia. 2. The necessity for financial regulatory reforms and issues to be considered Global discussions on financial regulatory reforms have been driven forward by the strong political commitment of G20 leaders after its agreement at the November 2008 Summit. The progress we have already seen makes me confident that we are heading in the right direction to avoid the recurrence of a financial crisis. Based on what we have learned from the financial crisis in 2008, for the purpose of enhancing financial stability, it is unarguably important to limit excessive risk-taking and leverages and to redress distorted incentive mechanisms, by applying more rigid capital requirements and other appropriate financial regulations. We should not forget, however, that a liberalized and vigorous financial sector plays a key role in economic growth by effectively allocating resources to growing sectors with risk being managed appropriately. Excessive regulations would reduce market liquidity, damage its price discovery function, and eventually cause a negative impact on the overall macro economy. In addition to the globally coordinated reforms led by standard setting bodies such as the Financial Stability Board (FSB), several countries are now introducing their own regulations at a national level. We should be mindful that these regulations in various financial areas in various countries (a) do not cause a negative impact on financial markets and the real economy as a whole, (b) do not result in a distortion of the level playing field in the financial sector of each country, and (c) do not exacerbate issues of regulatory arbitrage and circumvention. From this perspective, I would like to make comments on several specific issues. 【Basel Ⅲ】 【Volcker Rule in the US】 Second, I would like to talk about the Volcker Rule in the Dodd-Frank Act in the US. I am particularly concerned that the proposed rule prohibits proprietary trading of government bonds except US Treasury bonds. For instance, US banks are not allowed to conduct proprietary trading of Japanese Government Bonds (JGB) with Japanese banks even if they are traded in Japan. When this regulation is implemented, it may cause serious harm to the market liquidity of government bonds including JGB. On this point, a number of governments have expressed their concern to the US authorities, and are asking for appropriate consideration of such issues in the process of finalizing the rule. 【Over-the-counter(OTC) derivatives reform】 Third is OTC derivatives reform. Regarding this reform, representatives of authorities responsible for the OTC derivatives regulation in 9 jurisdictions, including Japan, US, EU, and Hong Kong, met on Nov 28, and agreed to enhance their coordination to avoid excessive burden on the regulated entities and to prevent regulatory arbitrage. I would like to welcome this effort among authorities, and I hope this agreement will expedite working-level coordination among these jurisdictions. One of the important issues in OTC derivatives reform is margin requirements. Although margin requirements are an effective tool to prevent systemic risk stemming from derivatives, I would like to clearly mention that foreign exchange swaps should be exempt from the initial margin requirements. While such requirements are meant to be applied to transactions executed outside central counter parties, foreign exchange swaps are not suitable for central clearing any way. In addition, risks associated with foreign exchange swaps are limited, with most transactions being short-term and physically settled. As foreign exchange swaps are core transactions for maintaining the liquid foreign exchange markets, it is essential that these transactions continue to be conducted smoothly. In that regard, I would like to welcome the recent US decision to exempt foreign exchange swaps from the OTC derivatives regulations under the Dodd-Frank Act. 【Comprehensive assessment and review of the regulatory reforms】 In addition to the margin requirements for OTC derivatives, other reforms such as the Basel III liquidity rules and the minimum haircut requirements on repo transactions are being discussed. Incidentally, on Jan. 6, the Group of Governors and Heads of Supervision (GHOS) agreed on the modifications and phase-in implementation of the Liquidity Coverage Ratio (LCR) of Basel III. It is really important that these requirements as a whole do not cause unexpected negative consequences to the financial market and the real economy, and to make sure of this, I think we need to set up a comprehensive assessment and review process of these requirements. For example, while these requirements, as a whole, are likely to enhance demand for safe and liquid assets, especially the government bonds of the major economies, it is necessary for us to study whether there is sufficient supply of safe and liquid assets in the markets to satisfy all these requirements. 3. The importance of appropriate macro-level policies Needless to say, sound macro-level policy management, along with financial regulatory reforms, is certainly essential to prevent the accumulation of economic and financial imbalances. If we look back to the background leading up to the recent financial crises in the US and the Eurozone, it is obvious that there accumulated various imbalances, such as prolonged extremely low interest rates, asset price hikes, excessive leverage in households, enterprises, and the financial sector, and widening current account deficits. In this respect, central banks should not only pay attention to price stability measured by Consumer Price Index, but also to developments in asset prices, the speed of financial asset expansion, and the leverage and risk-taking activities of financial institutions. Also, efforts by individual governments to carry out medium-term fiscal consolidation, avoiding public debt accumulation, should be crucial foundations to sound macro-economic development. So called macroprudential policy is also important. When speculative and massive capital inflow occurs, it should be an option to limit the inflow under certain conditions, as the IMF has recently suggested. 4. Outstanding issues relating to the Asian financial system 【Soundness of Asian financial sector】 Since the Asian financial crisis in the late 1990s, Asian countries have continuously made efforts to impose appropriate financial regulations, strengthen the capital base of financial institutions, expand buffers of foreign currency reserve, and pursue sound fiscal and monetary policies. These are important factors for reinforcing countries' resilience in times of stress. As a result, Asian countries were able to avoid serious damage caused by spillover from the recent financial crises in advanced economies. The seriousness of Asian countries in the financial regulatory sphere has also been demonstrated by the progress of Basel III implementation. China, Hong Kong, India, and Singapore announced that they would start the implementation from the beginning of 2013, ahead of the US and the EU. On the other hand, it is also true that these international standards of financial regulation are based on the experiences of the financial crises in the US and Europe, and do not necessarily reflect the conditions of the financial sectors in Asian emerging countries. In Asia the development of financial sectors should also be a policy agenda. In that respect, it is a notable step forward that the FSB has initiated Regional Consultative Groups in 6 regions, including Asia, to pay due attention to a wide range of voices from emerging economies. 【Financing needs for infrastructure in Asia】 In Asia going forward, there will be significant financing needs for infrastructure building (highways, railways, ports, electricity, water, etc.). According to the ADB, in the 11 years from 2010 to 2020, Asia will need 8 trillion dollars for infrastructure developments in the region. To effectively finance these infrastructure developments and other investments necessary to promote growth, the financial sector in Asia will play a pivotal role. As a result of financial regulatory reforms and the Eurozone crisis, European banks have substantially reduced their lending to Asian countries. According to BIS statistics, French banks and Italian banks respectively cut 50% and 40% of their lending exposure to major ASEAN countries and Korea in the year ending at the end of June 2012. Japanese banks, on the contrary, expanded their lending exposure by 20% in the same period, and compensated for the reduction in European banks' lending. 【Maintaining open financial system】 On a different front, I would like to stress the importance of maintaining an open financial system in Asia to attract foreign financial institutions. For instance, there are still some countries that impose strict regulations, such as regulations on opening foreign bank branches, limitations on the usage of funds borrowed from abroad, and requirements to grant a certain quota of credit to designated industries. It is understandable that these countries promote so called "financial inclusion" to provide financial services to domestic SMEs and individuals who have not had sufficient access to them hitherto. Nevertheless, foreign banks have an important role to facilitate inward foreign direct investment. If too strict regulations on foreign banks are imposed, it would impede their entry, thereby contradicting with the intention of attracting foreign direct investment. 5. Financial cooperation in Asia 【ASEAN+3 financial initiatives】 It became clear in the Lehman Crisis that, once a crisis begins, it can cause the disfunctioning of interbank money markets and the rapid evaporation of dollar liquidity. We should try to avoid such a situation, in which trade and investment financing in Asia contracts and negatively affects the real economy, just because of shortage in dollar liquidity. From this perspective, the finance ministers and central bank governors of ASEAN+3 agreed in May 2012 to double the lending capacity of Chiang Mai Initiative Multilateralization (CMIM) to $240 billion and introduced a crisis prevention function. I would also like to emphasize that the Asian Bond Markets Initiative (ABMI), which aims to enable better utilization of Asian savings for Asian investment through capital markets, is making progress. 【Utilization of local currencies】 Furthermore, better utilization of Asian currencies for trade and investment activities in Asia is important. In case of the Japanese yen, efforts to increase the international use of the yen were started in the 1980s. As there are already no constraints caused by regulations and taxation on yen investment and financing, the yen is used today for around 40% of Japanese exports and around 25% of Japanese imports. Going forward, we should promote further use of Asian currencies including the Japanese yen, the Chinese renminbi, and the Korean won. 【Japan-China financial cooperation】 Regarding Japan-China financial cooperation, in December 2011, Prime Minister Noda and Premier Wen agreed to promote the use of the yen and the renminbi in cross-border transactions between the two countries and to support the development of direct transactions between the yen and the renminbi, not going through the dollar. Based on this agreement, in June 2012, direct exchange was begun in the foreign exchange markets of both countries, and 10 billion yen and 60 billion yen worth of transactions per day are being conducted daily in Tokyo and Shanghai, respectively. Moreover, as the spread, or difference between the bid and offer rate of these transactions, stably stays close to, or slightly narrower compared to, the spread of transactions through the US dollar, it is expected that the expansion of the direct exchange markets will lead to further reduction in transaction costs and settlement risk. With regard to the expansion of the international use of the renminbi ("internationalization of the renminbi"), the Chinese authorities are gradually implementing the liberalization of the capital account following the liberalization of the current account. In order to further promote the internationalization of the renminbi, however, greater exchange rate flexibility, and liberalization of interest rates and financial products in domestic financial markets will be also needed. I believe that it is to the benefit of both Japan and China to cooperate together to facilitate this process. While Japan-China relations currently have some difficulties, China and Japan are the second and the third largest economies with a strong trade and investment relationship. It is extremely important for Japan and China to further deepen economic ties also because the two countries share responsibilities for both Asian and global economic stability and prosperity. Japan would like to make utmost efforts to have close communication with China from a broad and long-term perspective. The Japanese Ministry of Finance on its part would like to continue to promote Japan-China financial cooperation. 【Hong Kong financial market】 Lastly, I would like to touch upon an important role of Hong Kong. Hong Kong has a well-developed financial infrastructure, including its legal and accounting systems. Hong Kong has a very long history and experience as a liberalized market, and it has long played a key role as an international financial center. As other financial markets such as Shanghai are emerging, Hong Kong is expected to play even more important roles. Hong Kong is also a key renminbi offshore center. Japanese financial authorities intend to further cooperate with the Hong Kong financial authorities, when the Tokyo market is increasing its effort to promote renminbi transactions there. |
