Fed to Rule on Dealers of U.S. Bonds in Japan
When the governors of the Federal Reserve meet in Washington today, Japan’s most powerful financial institutions will be paying close attention. The Fed will rule whether to allow seven Japanese securities firms to maintain their status as primary dealers of U.S. government bonds.
That status is threatened by the Primary Dealers Act, a little-noticed provision in last year’s Omnibus Trade Bill that requires the Fed to deny a primary dealership to any firm whose home country does not give U.S. companies a fair opportunity to compete in its government securities market. The law takes effect Wednesday.
Primary dealers are an elite group of companies authorized to deal directly with the Fed when it buys and sells U.S. government bonds. Aside from prestige, primary dealers gain new business opportunities, since many large investors in government securities will only conduct business with primary dealers.
Removal Doubtful
Fewer than 50 firms have primary dealer status, including four Japanese securities firms (Nomura, Daiwa, Nikko, Yamaichi), and subsidiaries of three Japanese banks (Industrial Bank of Japan, Sanwa, and Long-Term Credit Bank).
Most industry experts believe that the Fed will not remove the dealerships from the Japanese, largely because recent reforms have opened new doors for foreign financial companies in Japan.
“It’s unlikely the Fed will rescind our primary dealership,” says Scott Pardee, chairman of Yamaichi International (America) Inc., a subsidiary of one of Japan’s Big Four securities firms.
The stakes are high. A ruling against the Japanese firms could disrupt the flow of Japanese funds to the United States, making it more difficult to finance the federal budget deficit. U.S.-Japan collaboration on other financial issues, including third-world debt, could be hampered.
The reforms center on the method of distributing Japanese government bonds. Shortly after the Primary Dealers Act passed last August (with the strong backing of U.S. financial firms), Japan’s Ministry of Finance sought to head off a confrontation by announcing that 40% of all new 10-year bond issues would be sold through a competitive auction system that took effect last April. The remaining 60%, following the old system, is allocated in fixed shares to each of the more than 800 firms that belong to an underwriting syndicate. The share allotted to foreign firms has risen from 2.5% to 8%.
Syndicate Structure
Four foreign firms are now members of the syndicate’s executive committee, which negotiates the terms for new bond issues with the government. Salomon Brothers Inc. is a permanent member, while nine other foreign firms divide up the remaining three positions on a rotation basis.
Access of this kind was long sought by U.S. companies, since Japan’s government securities market is the second biggest in the world, after that of the United States. By 1984, 15 foreign firms had joined the syndicate and the number is now more than 60.
Until the 1980s, only a few foreign firms were active in the syndicate because Japanese government securities were unattractive investments. The government deliberately set yields below market rates to keep a lid on financing costs and domestic interest rates. Japanese financial firms were forced to accept their share of each new bond issue. But yields have gradually improved, and foreign firms have tried to boost their participation.
The new access has been welcomed by U.S. firms as a big step toward competitive markets.
The Securities Industry Association, a trade group, recommended to the Fed in an early May memo that it “refrain from suspending or delaying the primary dealer status of any foreign firm.”
Improved access notwithstanding, many industry executives insist that their firms still face competitive disadvantages in the Japanese government securities market. The syndicate system continues to be controversial, since large city banks receive the bulk of the 60% of new bond issues not subject to competitive auction.
Another complaint is that structural features of the Japanese market affect foreign firms disproportionately. In particular, the lack of a wide range of secondary market trading activities in Japan deprives U.S. firms of their competitive advantage in innovative trades like futures and options, and makes it more difficult to finance costly bond market activities.
If the Fed decides to keep Japanese firms as primary dealers, but progress is not made toward resolving these issues, then pressure to withdraw the primary dealerships could easily rise again.
