Junichi Nakajima Deputy Director-General of the Planning and coordination Bureau of the Financial Services Agency (FSA). Responsible for policy planning and coordination of financial markets and exchanges since 2016.
Junichi Nakajima joined the Ministry of Finance (MOF) in 1985 assumed various positions mainly at the MOF and FSA, including executive secretary to the Minister of State for financial Services; Director, Insurance System Planning Office, FSA; Director-General of JETRO Vancouver; Director, Market Finance Division, MOF; Director, Debt Management Policy Division, MOF; Director, Policy Planning Division, FSA (while also Deputy Director, Financial Research Center, FSA); Director, General Coordination Division, FSA; and Deputy Director-General, Planning and Coordination Bureau, FSA (responsible for credit systems). He graduated from the Faculty of Engineering, the University of Tokyo, in 1985 and Harvard Kennedy School in 1995.
FIA Japan: the Working Group on financial Markets, an advisory body to the Financial Services Agency (FSA), covered issues around high-speed trading in the Japanese financial markets. Could you give us an overview of the discussion as well as its background?
Advances in information technology have spurred exchanges around the world to undertake measures to minimize latencies for their markets. In Japan as well, the January 2010 launch of “arrowhead,” the trading system of the Tokyo Stock Exchange (TSE), has greatly accelerated TSE’s order response and information distribution speeds. In combination with the co-location service, which allows trading participants to install their servers close to the exchange’s trading system, the latencies associated with transactions have been drastically reduced. In response to these trends, the share of orders (placed, modified and cancelled) through the co-location area among all orders at the TSE in 2016 amounted to around 70%, and that of transactions executed reached 40-50%. This indicates a greater share of high-speed trading in theJapanese market.
Under these circumstances, securities companies’ involvement with investors engaging in high-speed trading has been limited, and the authority and exchanges have difficulty grasping the full picture of high-speed trading and strategies used therein.
While high-speed trading is said to provide liquidity to the market, concerns have been raised with respect to its impact on market stability and effciency, fairness between investors, price discovery functions of the markets based on medium to long-term enterprise value and system vulnerabilities. If this situation is left unattended, it could undermine efforts to create a market with suffcient depth where a variety of investors, including pension funds and individual investors, feel comfortable to participate.
With these in mind, the Working Group on Financial Markets (hereinafter the “Working Group”) discussed how best to deal with issues related to high-speed trading in Japan. We welcomed representatives from FIA Japan to the meeting of the Working Group on 19 October, 2016, where they kindly shared comments from the FIA Japan Proprietary Trading Study Group. A report based on discussions at the Working Group (hereinafter the “Working Group Report”) was published in December 2016.
FIA Japan: the Working Group report suggests that it is appropriate to introduce a registration system concerning investors engaging in high-speed trading. Could you elaborate?
The Working Group Report proposes to develop a regulatory framework in which high-speed traders are required to be registered with the authority while giving consideration to regulatory responses taken by other jurisdictions. This framework is intended to require high-speed traders trading in the Japanese markets to meet organizational/system requirements including risk controls, and to allow the authority to identify transactions and trading strategies of such traders.
Specifically, measures to be taken under the regulatory framework are as follows:
Organizational/system requirements including risk controls
• Proper management and operation of trading systems
• Appropriate organizational arrangements and capital requirements
Notification and provision of information
• Notification of engagement in high-speed trading to the authority
• Flagging of algorithmic orders
• Provision of a description of trading strategies to the authority
• Maintaining trading records
Other measures • Submission of business reports to the authority, etc.
When introducing the framework, its effectiveness should be ensured for traders who are based overseas and trading in the Japanese markets. Therefore, it is appropriate to prohibit securities companies from accepting orders from an unregistered high-speed trader. In addition, overseas high-speed traders should have a designated representative or agent in Japan.
FIA Japan: Do you think there are any points that need particular attention when introducing the registration framework?
We are aware that high-speed trading is said to contribute to improve liquidity and tighten spreads, which is beneficial to general investors. Therefore, the regulatory framework should not uniformly exclude from the Japanese markets all high-speed trading, including the ones that contribute to the facilitation of market transactions.
In addition, it is necessary to ensure that the specifics of the above-mentioned requirements and measures can be flexibly adapted in light of future developments in the United States and Europe, while ensuring the effectiveness of the regulatory framework.
FIA Japan: the Working Group had lively discussions on topics other than high-speed trading. Could you tell us about them?
In Japan, household financial assets totaling more than 1,700 trillion yen have been accumulated.
However, as more than half of those assets are held in the form of cash and deposits, the proportion of stocks, investment trusts and other investment assets is smaller than in the United States and the United Kingdom. Because of this difference, the growth of household financial assets in Japan has remained low compared with the growth of such assets in the United States and the United Kingdom, and no significant progress in households’ stable asset building can be seen in Japan.
Therefore, in order to support households’ stable asset building, the government is engaging in multidimensional initiatives, such as the provision of investment education and the reform of corporate governance.
In addition, it is also an important challenge to ensure that all participants including financial institutions involved in the sales of, advice on, or manufacturing of financial products among others, recognize their respective roles in the investment chain and make efforts to achieve customer-oriented business conduct. Another challenge is developing and disseminating financial products suitable for long-term, diverse and installment investments.
Moreover, with the advances in information technology, financial markets and exchanges in Japan as well as in the United States and Europe are faced with a variety of changes. Apart from high-speed trading, new developments are found in the areas of FinTech as well as competition among trading venues following the abolition of the concentration rule (under which securities companies were required to route orders on listed securities only to these exchanges listing them, and in accordance with exchange rules).
Therefore, the Working Group has covered the following topics in addition to high-speed trading:
Households’ stable asset building and Customer-Oriented Business Conduct (fiduciary duty);
Use of exchange-traded funds (ETFs) in households’ stable asset building and the position of indexed investments;
Competition among trading venues and alternative trading platforms; and
Exchanges’ business scopes.
FIA Japan: could you give us an outline of the discussions on each of those topics?
With regard to Customer-Oriented Business Conduct, it is desirable to create a mechanism whereby financial service providers proactively exercise their creativity and compete with each other to provide high-quality and customer-oriented financial products and services with the aim of achieving best practices and where customers select financial service providers engaging in comparatively better practices.
One effective way to do so is using a principle-based approach, rather than continuing the conventional rule-based approach. Specifically, it is appropriate that the authority formulates principles concerning customer-oriented business conduct (hereinafter the “principles”), call on financial service providers to accept the principles, and encourage them to seriously consider what is good for customers based on the principles and compete with each other to provide better financial products and services without falling into the habit of trying to do the same as others.
According to the Working Group Report, it is appropriate that the principles to be developed by the authority contain the following matters.
Development, Publication, etc. of the Policy Concerning Customer-Oriented Business
Conduct
Pursuit of Customers’ Best Interests
Appropriate Management of Conflicts of Interest
Clarification of Fees and Expenses
Easily Understandable Provision of Important Information
Provision of Services Suited to Each Customer
Frameworks for Motivating Employees Appropriately and Other Measures
Based on the above-mentioned proposal, at the FSA, we are now seeking public comments on these principles. We will work towards finalizing and publishing the principles, and take various measures to entrench customer-oriented business conduct.
Concerning the use of ETFs for household’s stable asset building, the Working Group Report encourages relevant parties to work on measures to improve ETF liquidity including considering the introduction of a market-making system and to raise awareness of ETFs. We hope that these measures will promote the use of ETFs, which enable diverse investment with a small amount of funds, for households’ stable asset management.
Regarding the exchanges’ business scopes, the Working Group Report suggests that an exchange should be allowed to consolidate common and/or duplicative operations such as the development of systems within the exchange group it is part of, and that the business scopes of exchange groups should be more flexible so that they can keep pace with FinTech developments. As for competition among trading venues and alternative trading platforms, the Working Group Report says it is appropriate to permit margin trading at a Proprietary Trading System (PTS) on the condition that an appropriate scheme be established to prevent excessive speculative trading.
Some of the proposals in high-speed trading and exchanges’ business scopes require law amendments. Accordingly, a bill to amend the Financial Instruments and Exchange Act will be submitted to this session of the Diet.
FIA Japan: Do you have any final comments to sum up the interview?
Circumstances surrounding markets and exchanges are changing rapidly in line with advances in information technology. It is therefore an urgent task for us to update our regulatory framework, paying due consideration to the proposals in the Working Group Report, in order to realize a fair and transparent market adapted to the changes.
Everyone’s continued support would be greatly appreciated. Thank you.
FIA Japan: Thank you very much.