Japan Financial Services Agency Firmly Responds to Subprime and Securitization Crisis
Japan’s Financial Services Agency has firmly responded to the global subprime and securitization crisis with a series of initiatives on many fronts, including increased transparency, better risk management, and improved early warning systems. The FSA has also established an Office for Supervisory Policy, Financial Market and Risk Analysis that will filter information from the financial markets for regulatory purposes. The FSA also emphasized that regulatory responses must be global and all-inclusive in order to meet 21st century market crises.
The FSA cited the recent bailout of Bear Stearns as an object lesson for the need to improve early warning systems. As business conditions deteriorate, the FSA noted, the liquidity conditions and financial soundness of a securities firm or an investment bank may deteriorate rapidly when the market environment is undergoing drastic changes.
Thus, the Japanese early warning system, which takes into consideration liquidity conditions and financial soundness with regard to banks, has been expanded to financial instruments firms. An alarm is set regarding any sharp decline in the capital adequacy ratio or a drastic change in prices of stocks and bonds held by a financial services firm, and a detailed hearing will be conducted when the situation falls below standard, thereby leading to adequate regulation.
On another front, voluntary rules and best practices have been adopted by self-regulatory organizations with regard to disclosure related to securitized products. In this connection, the Japan Securities Dealers Association has held working groups and discussed issues such as disclosure and risk measurement. In addition, fourteen Principles in the Financial Services Industry have been announced as part of the FSA’s efforts toward better regulation. Among other things, these principles embody the importance of risk management and information provision. Specifically, Principle No. 12 is to conduct proper risk management in accordance with the size and features of a business operation and inherent risk profile.
In the view of the FSA, risk proliferation uncertainty also contributed significantly to the spreading of the subprime mortgage problem. As securitization became widespread, explained the FSA, it became difficult to identify the location and magnitude of risks because the risks pertaining to the underlying assets were widely dispersed. In addition, there were problems with the arrangers and distributors of securitized products in their information collection and analysis, and their framework for communication and sales.
In an effort to enhance the transparency of the firms involved in the securitization process, the FSA revised its guidelines for financial instruments firms to encourage companies selling securitized products to acquire and provide information on the risks of original assets, and thereby improve transparency in the securitized markets.
On the separate issue of the impact of fair value accounting on the crisis, it was noted that a recent IMF report suggested that some latitude be given in the strict application of fair value accounting during stressful events. But the FSA believes that suspending the application of fair value accounting would not help stabilize the market since it would only postpone the booking of losses. The FSA cautioned that any measure that would lessen the impact of the application of fair value accounting to asset-backed securities must be given careful consideration.