Miles Apart : U.S., Japan Taking Widely Different Post-Crash Courses

Consider this brief tale of two cities:

Scene: Washington, May 11.

Under bright television lights at a public hearing, former White House chief of staff and Wall Street titan Donald T. Regan calls for a ban on program trading based on stock index futures. He tells Congress that, in the aftermath of last October’s stock market crash, “the public has every reason to believe the present game is rigged. It is.”

Regan’s testimony adds new spice to the most voluble and divisive debate about U.S. financial market reform in 50 years. At the center of the controversy are stock futures, innovative financial instruments first approved for trading in 1982 and now blamed by critics for fostering speculation and market volatility.

Scene: Tokyo, May 25.

Without fanfare or public controversy, the House of Councilors of the Japanese Parliament approves the Financial Futures Trading Law, which will permit stock index futures contracts to begin trading on the Tokyo Stock Exchange as soon as July.

Although the new law represents a carefully negotiated compromise among sometimes antagonistic business interests and government regulators, it also reflects a strong national consensus that trading in stock futures--including the forms of program trading under attack in the United States--will enhance the depth and international appeal of Japan’s financial markets.

For many U.S. policy-makers, last October’s global stock market crisis highlighted an increasingly obvious trend--namely, that the world’s major financial markets have become inextricably linked by technology and big institutions. Since then, regulatory responses to the crash have illuminated another, opposing truism: All politics is local.

During the past six months, the United States and Japan have followed sharply divergent courses. While the Tokyo stock market has recovered quickly and soared to new heights, U.S. equity markets have languished as prices fluctuated wildly and overall trading volume waned. Faced with these disparate market performances, regulators and politicians in the two countries have reacted in dramatically different ways.

Those political responses are certain to have a lasting effect on the ongoing contest between Tokyo and New York for recognition as the world’s most important financial center, according to executives and policy-makers on both sides of the Pacific.

In the pluralistic United States, the debate over possible market reforms--particularly concerning stock index futures--has been loud and long as rival financial exchanges and government bureaucracies have struggled for political supremacy.

In homogeneous Japan, where consensus is valued above all else, there has been virtually no public debate about market reform--and the Parliament has decided to permit more, not less, stock futures trading.

“The aftermath of Black Monday in the U.S., where you have had all this finger-pointing and name-calling and scapegoating, has been pretty much irrelevant to the Japanese here,” said Mitchell Fulscher, a partner in the Tokyo office of Arthur Andersen & Co., a major accounting firm.

‘Substantial Differences’

“We are interested in the political situation in the U.S., but we think the differences between the (stock) markets here and in the U.S. are very substantial” and obviate any need to curtail program trading in Japan, said Yasayuki Fuchida, an executive at Tokyo’s Nomura Research Institute, which is developing program trading formulas in anticipation of stock futures trading in Tokyo.

(Stock index futures are financial products, now mainly traded in Chicago, that represent large baskets of stocks and allow investors to bet on the overall direction of the stock market. Program traders, in a strategy known as index arbitrage, use computers to attempt to profit on temporary price differences between futures contracts and the underlying stocks. In a separate strategy known as portfolio insurance, program traders use complex mathematical formulas to help portfolio managers protect the value of their stock investments by using stock futures.)

Some U.S. policy-makers and executives, especially those who support stock futures, worry that the different political responses to the October crash in the United States and Japan portend a worrisome decline in the international position of U.S. markets.

“It’s almost as if the United States thinks it doesn’t have to pay attention to what the others are doing,” said Leo Melamed, chairman of the executive committee at the Chicago Mercantile Exchange, where the most popular stock index futures are traded. “That’s hogwash. We have to pay attention or we’re going to lose markets and market share. It’s happened in many other industries.”

“There has been an unfortunate and, I think, somewhat unnecessary amount of hand wringing in the U.S. over the possible effects and causes connected to the October crash,” said Robert Davis, a commissioner at the Commodity Futures Trading Commission, which regulates U.S. futures markets.

Question of Confidence

Other politicians and regulators, who believe stock futures have spurred volatility and damaged investor confidence, argue the opposite: They say the historic international strength of U.S. financial markets has derived from a worldwide perception that American markets are fair and well regulated. By tackling the tough regulatory questions about stock futures soon, these officials say, the United States can build international leadership and restore investor confidence in its stock markets.

Of course, the complete recovery since October of stock prices in Japan is one powerful reason that regulators there are less concerned about the impact of stock futures on financial markets. Moreover, Japanese regulators believe that the Tokyo Stock Exchange is less vulnerable to disruptions caused by futures trading.

For one thing, Japanese exchanges already have daily limits in place to control the extent to which prices can move in a day. In addition, the Tokyo Stock Exchange does not have a computer system comparable to the one that speeds program trades to the floor of the New York Stock Exchange.

The U.S. political debate about stock futures has been shaped in part by open rivalry between two regulatory agencies, the Securities and Exchange Commission and the Commodity Futures Trading Commission. In Japan, a similar and even more complex bureaucratic wrangle slowed the effort in Parliament to authorize financial futures trading.

Whereas one U.S. agency, the CFTC, regulates all futures products, in Japan the regulatory scheme is balkanized. Regulation of a specific futures product is assigned to the agency that oversees the corresponding commodity--whether stocks, gold, rice or currency.

Under this system, stock futures regulation will be assigned to the securities bureau of the Japanese Ministry of Finance, which regulates stocks. Gold futures are regulated by the Ministry of Trade and Industry, rice futures are supervised by the Ministry of Agriculture and so on.

Before stock futures trading was authorized by the Japanese Parliament late last month, the securities and banking bureaus of the Ministry of Finance struggled for regulatory authority.

The May compromise in Parliament achieved a goal that the Tokyo Stock Exchange has been pursuing for two years: It ensured that the first important futures product corresponding to the Japanese stock market will be traded in Tokyo, not in the United States.

That accomplishment has angered the Chicago Mercantile Exchange, which has been trying since the summer of 1986 to win approval for trading in Chicago of futures on the Nikkei 250-stock index, the Japanese equivalent of the Dow Jones industrial average.

SEC Defends Its Role

The SEC, which has veto power over new domestic stock futures contracts, insisted that the Merc obtain a satisfactory information-sharing agreement with the Tokyo Stock Exchange so that U.S. regulators could be sure the Nikkei contract wouldn’t be subject to manipulation.

Tokyo, however, was slow to provide the agreement, apparently because it wanted to get its own, competitive product approved for trading first. When the Japanese Parliament gave Tokyo the go-ahead May 25, the exchange finally moved to sign an agreement with the Merc.

“The Merc got short-changed by its own government,” Melamed said.

The SEC vigorously defends its role. Officials there said they are required by law to protect U.S. market integrity. They also said they shared the Merc’s concern that the Tokyo Stock Exchange was withholding a surveillance agreement for competitive reasons.

The Merc, which has been busy since October defending its stock futures products on Capitol Hill, has taken cold comfort from the SEC’s clearance. Merc officials said Tokyo’s stock index futures products will have an enormous head start over whatever product the Merc is eventually permitted to trade in Chicago.

Moreover, the Merc’s Nikkei proposal still faces regulatory hurdles at the CFTC, which itself is under intense political pressure from Congress because of proposed post-October regulatory reforms.