Toward Creating a Competitive Capital Market

Introduction

Financial and capital market reform is making substantial progress on the legal front with the enforcement of the Financial System Reform Law on Dec. 1998. However the necessary capital market infrastructure such as highly utilization of information technology is not in place yet. Accordingly, the companies are forced to over-rely on bank finance which delays the pace of economic recovery.

Therefore, Japan must move quickly to develop highly secure and efficient infrastructure, as well as rules for collective investment schemes for the personal financial assets, in order to stimulate direct financial system and market-based indirect financial system. Also related systems such as the accounting and disclosure system should be revised in line with international bases in order to keep accessibility both for issuers and investors.

From this perspective, Keidanren suggests that the following measures should be taken to establish a competitive capital market suited an age of globalization which allows active participation by domestic and foreign market players, namely issuers, intermediaries, and investors.

Establishment of a Secure and Efficient Securities Delivery and Settlement System

Reform of the securities delivery and settlement system

In order to rationalize the separately operated delivery and settlement system for government bond, corporate bonds, stocks, and other financial instruments, the Liberal Democratic Party (LDP) decided to look into the integration of the system with an eye to creating a more secure, efficient, and convenient system. Discussions were subsequently launched by the Ministry of Finance and the Japan Securities Dealers Association. Keidanren hopes that these discussions will focus on the form of a system in the twenty-first century and that execution will be done as soon as possible.

In the course of discussions, consideration should be given to the mechanism of delivery versus payment ¹( D.V.P.), the introduction of straight through processing ² (S.T.P.) for the transaction process, the achievement of T+1 methods ³, and review of the Corporate Bond Registration Law. In terms of system integration, discussions should be oriented toward the early realization and the cost efficiency.

Paper-less commercial paper

Commercial paper (CP) is expected to become the core instrument for corporate short-term capital procurement. At present, however, because CP is essentially a promissory note requiring issuance of the note physically, the complex issuing procedures and the delivery risk involved have kept the amount of CP issuance at around a tenth of the U.S. level. To encourage CP usage, steps need to be taken immediately to make the process paper-less from the issuance stage and develop the issuance and distribution markets. In line with the deliberations on the rationalization and integration of the securities delivery and settlement system, discussions should be carried forward with a view to system improvement and to the drafting of a paper-less CP law during the next regular Diet session.

Transaction procedures for certificates of deposit (CD) also should be more efficient by the introduction of computer processing.

Boosting the Efficiency of Domestic Stock Exchanges

Now that the requirement to trade listed stocks through stock exchanges has been abolished, domestic stock exchange operations need to be made more efficient by merging, integrating, incorporating them as companies, and utilizing computer networks. Transaction fee and trading hours, etc., must be adjusted to a competitive level, particularly in the Asian market. In this context, a proprietary trading system ⁴ (P.T.S.) should be actively utilized to intensify inter-market competition and consequently boost stock exchange efficiency.

Implementation and Strengthening of the Accounting and Disclosure System

Enhancing the international credibility of Japanese accounting standards

The Finance Ministry's Business Accounting Council and the Japanese Institute of Certified Public Accountants must work to publicize Japanese accounting standards reforms so that Japanese system will be judged more fairly in other countries, and audit quality must be improved through measures such as expanding the number of certified accountants, thereby improving the quality of them and increasing audit credibility. To respond to society's growing expectations of accountants, Keidanren recommends that the Certified Public Accountants Law shall be amended to clarify their duties, etc.

Acceptance of foreign accounting standards

To reduce the burden of Japanese global corporations to produce financial statements both in domestic standards and foreign standards, the authority should accept financial statements produced under the SEC standards ⁵ or International Accounting Standards ⁶ which are adopted by global corporations. Consideration should also be given to admitting the financial statements of foreign securities issuers, including financial statements in English, in order to induce these foreign players to list, procure capital and interest at Japan's capital market.

Early introduction of EDINET

As part of efforts to improve Japan's disclosure system, deliberations are currently underway on the introduction of EDINET (the Electronic Disclosure for Investors' Network), a system for the electronic submission and disclosure of documents such as financial statements via the Internet. EDINET should be implemented as soon as possible, with construction of this system financed as a millennium project.

Market-Oriented Diversification of Management Methods

Special treatment of cancellation of own stock

In recent years, company executives have been actively implementing cancellation of own stock to increase the ratio of return on equity (R.O.E.) and disposing of cross-holdings. To support for this trend, the special treatment of cancellation of own stock using capital reserves which will expire at the end of March 2000, and exception on taxation of deemed dividends related to the cancellation which due to expire at the end of March 2002 should be established as permanent regulation.

Expansion and improvement of the stock option system

The stock option system should be extended to make its benefits available to more workers and other related persons, and tax benefits should be introduced. (See appendix for specific details.)

Introduction of treasury stock

Companies should be permitted to hold their own stock (treasury stock) regardless of purpose.

Introduction of a safe harbor rule

The safe harbor rule ⁷ needs to be introduced for insider trading regulations on the exercise of stock option rights and the sale of own stock, as well as for market manipulation regulations on treasury stock acquisition.

Diversification of equity finance tools

1. To facilitate the use of preferred stocks, issuance ceilings and issuance procedures to be relaxed.
2. Discussions should be carried out toward the introduction of tracking stock (stock or corporate bonds through which companies procure capital from the market based on performance in specific areas of business, without the need to split their management or organization), allowing smooth procurement of funds for thriving business segments based on a fair market assessment of their performance.

Development of a Securities-Related Tax System

An internationally consistent securities-related tax system should be developed. (See appendix for specific details.)

1. DVP (delivery versus payment) refers to simultaneous securities delivery and payment, a settlement mechanism whereby both parties are linked, with delivery contingent on payment and vice-versa.

2. STP (straight through processing) is a system whereby the entire securities trading process-from an investor's placement of an order through to checking and settlement-is computerized, eliminating the delays that arise when manual transactions and paper are involved.

3. T+1 (where T is a trade finalized through a transaction agreement) indicates settlement the day after the agreement date. The United States is looking to introduce this in June 2002.

4. PTS (proprietary trading systems) are privately established trading systems set up separately from official stock exchanges. Entry into force of the Financial System Reform Law has eliminated the previous obligation to trade listed stock only on official stock exchanges. Now proprietary trading may be conducted with prior authorization via electronic and other systems.

5. SEC standards are accounting disclosure standards established and approved by the U.S. Securities and Exchange Commission.

6. IAS (International Accounting Standards) are standards defined by the International Accounting Standards Committee.

7. The safe harbor rule clearly delineates the scope within which a company's actions will remain legal, as bound by relevant restrictions. In the United States, a safe harbor rule is in place with respect to treasury stock acquisition, defining the extent to which this is not market manipulation.

Specific Recommendations for Stock Option System Expansion and Improvement

Commercial Code measures

1. Expand stock option availability to include the directors and employees of subsidiaries.
2. Simplify regulations governing stock options to cover only the total number of eligible employees, type of stocks covered, total number of stocks, and strike price.
3. Allow concurrent use of both treasury stock and stock purchase warrants in the system.
4. Allow treasury stocks acquired through mergers, requisitioned from opposing stockholders, or otherwise obtained to become part of the stock option pool following general shareholders meeting approval.
5. When the term for the exercise of a stock option expires, or when employees granted stock options leave the company or pass away, allow these unexercised option stocks to be held until the next general shareholders meeting.
6. Relax requirements for decisions made at general shareholders meetings on stock purchase warrants (i.e., allow an ordinary rather than an extraordinary resolution).

Tax system measures

1. Raise the ceiling on the value of stock option rights exercised annually receiving preferential tax treatment from the current 10 million yen per annum.
2. Adopt measures to delay the tax assessment on stock options granted to directors and employees of subsidiaries.

Specific Recommendations for Securities-Related Tax Systems

1. Revision of withholding tax system on corporate bond interest Cease application of the withholding tax system in regard to corporate bond interest for nonresidents and business corporations(other than bankers).
2. Elimination of double taxation on dividend, paying particular attention to the imputation system (whereby income tax credits are awarded equivalent to the sum of corporate tax paid on dividends).
3. Review of capital gain taxation from securities transfers
   1. Reduce the rate of taxation.
   2. Review the method of calculating deemed purchase cost in relation to self-assessed separate taxation.
   3. Reduce capital gain taxation on long-term stock holdings and introduce carry-overs of transfers losses to the following year in order to expand the number of individual investors.
4. Develop tax treatment for market price accounting for financial instruments .
5. Commence the investigation of a taxpayer numbering system as a means of taxation that covers all monetary income, including interest, dividends, and capital gain.
6. Extend the special tax measures due to expire in March 2000 (tax exemptions for interest earned on private offshore bonds and special measures relating to stamp duties on CP).
7. Expand the system of preferential tax treatment for "angel" investors and introduce venture capital taxation (income exemptions for a certain percentage of investment into venture companies) in order to encourage the provision of capital to new industries which shall be the key players in the securities market.