Panel 1 - Capital Market Challenges in Japan, the U.S., and the World 日米及びグローバル資本市場の課題

Key Concepts

• Japan's Asset Management Initiative: A government strategy to boost economic growth by increasing household savings flow into productive investments, aiming for a virtuous cycle of growth and distribution.
• Nippon Individual Savings Account (NISA): A tax-exempt savings scheme for Japanese retail investors, recently overhauled to increase investment limits and become permanent.
• Corporate Governance Reform (Japan): Ongoing efforts to improve the functioning of Japanese capital markets by enhancing company performance, shareholder returns, and transparency.
• U.S. Treasury Market Vulnerabilities: Concerns about the liquidity and stability of the U.S. Treasury market due to fiscal discipline issues, changes in dollar behavior, and the dominance of short-horizon investors in specific trading strategies.
• Relative Value Convergence Trade: A hedge fund strategy involving buying a treasury security, borrowing against it, and selling a futures contract to profit from small price differences, often with high leverage.
• Asset Manager Benchmark Hugging: A strategy where bond funds buy corporate debt to earn credit spreads while using futures contracts to match their benchmark duration, creating imbalances in the Treasury market.
• Japan Exchange Group (JPX): Operates the Tokyo Stock Exchange (cash equity), Osaka Exchange (derivatives), and Tokyo Commodity Exchange (energy futures).
• "U.S. Plus One" Strategy: A geopolitical and economic trend where investors diversify away from U.S.-centric strategies, with Japan emerging as a candidate.
• Digital Finance: The increasing role of technology in financial services, including tokenization and stablecoins, and the associated regulatory challenges and opportunities.

Capital Market Challenges in Japan, the U.S., and the World

This panel discussion explores the current challenges and ongoing reforms within capital markets in Japan, the United States, and globally. The conversation highlights efforts to revitalize Japan's economy through financial market reforms, concerns about the stability of the U.S. Treasury market, and the broader implications of geopolitical and technological shifts.

Japan's Initiative to Promote Asset Management and Economic Growth

Main Topics and Key Points:

• Government Economic Strategy: Japan faces challenges from an aging and shrinking population. The government's initiative aims to create a "virtuous cycle" of economic growth and distribution by channeling household savings into productive investments, leading to increased corporate value and economic expansion.
• Three Pillars of the Initiative:
  1. Promoting Steady Asset Building by Households:
     • Goal: Double household asset-based income.
     • Key Measure: Expansion of the tax exemption regime for retail investors.
  2. Corporate Governance Reform:
     • Objective: Improve capital market functioning and enhance long-term corporate value.
     • Focus: Shifting from mere compliance to achieving substantive results.
  3. Reform of Asset Management Industry and Asset Ownership Patterns:
     • Strategy: Encourage new entrants (domestic and international) to stimulate the sector.
     • Asset Owner Responsibility: Expectation for asset owners to act in the best interest of beneficiaries.
• Customer-Oriented Business Operations: Defined as a separate pillar, emphasizing the importance of prioritizing customer interests in financial services.

Specific Details and Progress:

• NISA Reform (Pillar 1):
  • Overhaul: Implemented in January 2024, tripling the investment limit and making the scheme permanent.
  • Components:
    • Tsumitate NISA (Accumulation Segment): For novice investors, promoting long-term, diversified, and regular investments in simple, low-cost investment trusts.
    • Seichō Tōshi Waku (Growth Segment): For experienced investors, allowing investment in individual stocks and active funds.
  • Impact: Significant increases in NISA account numbers and purchases.
• Financial Literacy (Pillar 1):
  • Initiative: Establishment of the Japan Financial Literacy and Education Corporation (J-FLEC) in April 2023.
  • J-FLEC's Role: Public-private partnership producing educational materials, offering consultations, and certifying financial professionals committed to client best interests.
• Corporate Governance Reform Progress (Pillar 2):
  • History: Dates back to the 2015 Corporate Governance Code.
  • Evolution: Focus shifted from compliance to substantive results through collaboration with the Tokyo Stock Exchange (TSE).
  • Evidence of Fruit: Listed companies responding to TSE's requests for efficiency enhancements have outperformed those who haven't. Profitability still has room for improvement, presenting opportunities for global investors.
  • Shareholder Returns: Increased dividends and share buybacks.
  • Cross Shareholdings: Steadily decreasing due to accelerated reforms.
  • Financial Disclosure Rules: Amended to clarify "pure investment purposes" versus cross-shareholding, making the latter more difficult.
• Asset Management Industry Reform (Pillar 3):
  • Measures: Requiring major financial groups to plan asset management business strengthening and creating special zones.
  • Stimulating the Industry: Encouraging new entrants through deregulation.
  • Deregulation Bill: Passed by the national diet, allowing asset managers to outsource middle and back-office operations (key cost factors), effective May 2024.
  • Asset Owner Principles: A set of common principles for asset owners, adopted by 219 entities by the end of June 2024.

Key Arguments/Perspectives:

• Toshiyuki Miyoshi (FSA): Emphasizes the strategic importance of the asset management initiative for Japan's economic future, particularly in light of demographic challenges. He highlights the progress made across the three pillars, stressing the shift towards substantive results in corporate governance and the need for customer-oriented practices.

U.S. Treasury Market Vulnerabilities

Main Topics and Key Points:

• Doubts about Market Depth and Liquidity: Despite being described as the world's deepest and most liquid market, concerns are rising about its stability.
• Jamie Dimon's Warnings: The CEO of JPMorgan Chase has repeatedly warned of a potential "crack" in the bond market, predicting panic among regulators.
• Three Key Reasons for Concern:
  1. Fiscal Discipline Erosion: The passage of a "Big Beautiful Bill" has led to a Japanese-style debt accumulation path, expected to soar issuance and pressure the market.
  2. Dollar's Response to Interest Rates: Changes in the dollar's behavior suggest it is no longer trading like a safe-haven asset of an advanced economy.
  3. "Plumbing" of the Treasury Market: The dominance of short-horizon investors and specific trading strategies has made the market more fragile.

Specific Details and Technical Terms:

• Section 899: A provision in a recent act that would have allowed the U.S. to refuse interest payments on foreign-held Treasury securities. It was stripped out at the last minute but its proposal is seen as troubling.
• Relative Value Convergence Trade: A dominant strategy in the Treasury market where hedge funds buy a Treasury security, borrow heavily against it (e.g., 99% leverage), and simultaneously sell a futures contract. This creates a matched position with a small, leveraged profit.
• Arbitrage Collapse: During the first two weeks of COVID, the profit from this trade spiked from 15-20 basis points to 120 basis points, indicating market dislocation.
• Bid-Ask Spread Explosion: The bid-ask spread on Treasuries also exploded, indicating a significant loss of liquidity.
• Asset Managers' Role: Bond funds, insurance companies, and pension funds with benchmarks are engaging in "benchmark hugging." They buy corporate bonds for credit spreads and use Treasury futures to match their benchmark duration. This creates an imbalance where hedge funds short Treasury futures to close the gap.
• Magnitude of the Trade: Approximately $1 trillion worth of Treasuries are involved in this type of trade.
• Fragility: The market is vulnerable to shocks if hedge funds need to exit these highly leveraged positions quickly, leading to price drops and yield increases.

Examples and Case Studies:

• COVID-19 Crisis: The first two weeks of COVID demonstrated the fragility of this trade when arbitrage profits spiked and bid-ask spreads widened dramatically.
• Tariff Announcements: An announcement about tariffs in April 2024 destabilized the Treasury market, causing volatility in the spread between the futures and physical Treasury markets.

Key Arguments/Perspectives:

• Anil Kashyap (University of Chicago): Argues that the U.S. Treasury market is becoming increasingly fragile due to the dominance of short-horizon investors and complex trading strategies driven by asset managers' need to meet benchmarks. He warns that policy uncertainty and potential erosion of Fed independence further exacerbate these risks.

Japan Exchange Group (JPX) Perspective on Capital Market Challenges

Main Topics and Key Points:

• Fierce Competition for Global Investment: Markets globally compete to attract international capital, requiring attractiveness, liquidity, accessibility, and user-friendliness.
• JPX's Role: Operates the Tokyo Stock Exchange (cash equity), Osaka Exchange (derivatives), and Tokyo Commodity Exchange (energy futures). Aims to provide a fair, user-friendly, and open market.
• Market Share:
  • Tokyo Stock Exchange: Over 80% of the Japanese stock market.
  • Foreign Investor Participation: Nearly 59% of total trading value.
  • Foreign Shareholder Ownership: 32% of total listed shares.
  • Osaka Exchange: 81.6% global market share for Nikkei 225 futures.
• Brighter Outlook for Japanese Capital Markets:
  • "U.S. Plus One" Strategy: Geopolitical tensions are driving investors to diversify away from U.S.-centric strategies, with Japan as a candidate.
  • Foreign Investor Inflows: 16 consecutive weeks of net purchases of Japanese stocks, totaling 5.5 trillion yen.
  • Driving Factors:
    • Global geopolitical tensions highlighting Japan's strategic position.
    • Interest rate normalization.
    • Positive economic dynamics moving out of deflation, with strong corporate performance and investment in digitalization/automation.
  • Domestic Investor Participation: Active investment through the revamped NISA program (over 27 trillion yen invested in the first 18 months).
  • Corporate Governance Reform Impact: Generating excitement and suggesting a growth trajectory for Japanese companies.

Specific Details and Progress:

• Corporate Governance Reform at TSE:
  • Commitment: Since 1999, gained momentum in 2013.
  • Independent Board Members: Increased from 6.4% in 2014 (first section) to 99% in 2025 (Prime companies) having one-third or more.
  • Focus on Substance: Moving beyond numerical compliance to meaningful board discussions, investor dialogue, and mindset changes for sustainable growth.
  • Market Segments (2022): Introduction of Prime, Standard, and Growth segments.
  • Cost of Capital and Share Price Awareness (March 2023): Request for Prime and Standard companies to analyze and disclose plans to improve capital efficiency.
  • Disclosure of Plans: 92% of Prime listed companies have disclosed plans.
  • Visible Changes:
    • Share Buybacks: Record high of 18 trillion yen (over $120 billion) last year.
    • Dividends: Almost the same amount as buybacks, with further growth expected.
    • M&A Deals: Record high of 4,700 deals last year, with over 2,500 in the first six months of 2024, totaling over 31 trillion yen ($210 billion), accounting for over 10% of global M&A.
• Bridging the Gap: JPX provides case studies (good and bad) based on investor feedback to promote engagement.
• Growth Market Revamp: Efforts to support startups.
• Reduction of Cross Shareholdings: A significant change observed over the past decade.

Key Arguments/Perspectives:

• Hiromi Yamaji (JPX): Believes the Japanese capital market outlook is brighter due to geopolitical shifts, economic recovery, and corporate governance reforms. He emphasizes that sustainable growth comes from voluntary efforts and encourages investors to actively engage with companies. He views the corporate governance reform as a continuous process with room for improvement.

Panel Discussion: Vulnerabilities and Future Reforms

Main Topics and Key Points:

• U.S. Capital Market Vulnerabilities:
  • Policy Uncertainty: Troubling proposals like Section 899, presidential lecturing of the Fed, and fears of diminished Fed independence.
  • Deregulation Uncertainty: Lack of a clear plan for future deregulation, with concerns about crypto seeping into the core banking system.
  • Institutional Stability: Questions about whether long-standing institutional stability could vanish.
• Japanese Capital Market Vulnerabilities:
  • External Factors: Worry about market participants (hedge funds, etc.) outside Japan for whom there is insufficient data and physical presence for monitoring.
  • Geopolitical Tensions: Potential for investment fragmentation in Asia, reducing capital inflow to Japan.
  • Post-Deflationary Environment: While exiting deflation is positive, the past two decades of deflation stalled investment incentives.
• Corporate Governance Reform in Japan:
  • Focus on Substance: Moving beyond numerical targets to achieve sustainable growth and mid-to-long-term corporate value improvement through enhanced board discussions and investor engagement.
  • Market Discipline: The market is seen as the ultimate judge of progress.
  • Tools for Engagement: Providing case studies of good and bad practices to facilitate better interaction between companies and investors.
  • Continuous Effort: Commitment to ongoing reform and annual reviews.
• Key Regulatory Reforms for FSA:
  • Regional Banks: Plans to strengthen regional finance and banks by year-end to address structural challenges like the aging population.
  • Digitalization of Finance: Crucial for increasing productivity and efficiency in an aging and shrinking population.
  • Responsible Use and Innovation: Clarifying regulatory expectations for tokenization, stablecoins, etc.
  • Addressing Digital Risks: Cybersecurity, third-party reliance, operational resilience.
  • Organizational Restructuring: Integrating cross-sectoral supervision with individual financial sector supervision.

Key Arguments/Perspectives:

• Anil Kashyap: Reiterates concerns about U.S. policy uncertainty and the potential for institutional instability.
• Toshiyuki Miyoshi: Highlights the challenge of monitoring external market participants and the impact of geopolitical tensions on capital flows. He emphasizes the importance of digitalization in finance for Japan's future productivity and efficiency.
• Hiromi Yamaji: Stresses that corporate governance reform is about substance and sustainable growth, driven by market discipline and investor engagement.
• David (Moderator): Expresses optimism about Japan's low interest rates and survival through deflation but shares concerns about potential spillover effects from U.S. market instability. He also notes the positive progress in corporate governance reforms.

Synthesis/Conclusion

The panel discussion underscores the interconnectedness of global capital markets and the distinct yet overlapping challenges faced by Japan and the U.S. Japan is actively pursuing a multi-pronged strategy to revitalize its economy through financial market reforms, focusing on household asset building, corporate governance enhancement, and asset management industry development. Significant progress has been made, particularly with the NISA overhaul and corporate governance reforms, leading to increased foreign and domestic investment.

Conversely, the U.S. Treasury market faces growing concerns regarding fiscal discipline, policy uncertainty, and the structural fragility introduced by short-horizon investors and complex trading strategies. These vulnerabilities, coupled with geopolitical tensions, create a complex global financial landscape. The discussion also highlights the critical role of digitalization in finance and the need for regulatory frameworks to adapt to these evolving technologies while managing associated risks. The overarching sentiment suggests that while Japan is on a positive reform trajectory, external shocks and policy missteps in major economies like the U.S. could have significant ripple effects. Continuous engagement, substantive reforms, and adaptability are crucial for navigating these challenges and fostering sustainable growth.