Practical Guidelines for Handling of Fails Charges

I.

PurposeThe purpose of these Guidelines is to provide for practical handlings of “Fails
Charges” stipulated in Section “III. Guidelines concerning Fails” of “The Japanese
Government Securities Guidelines for Real Time Gross Settlement” and “Book-Entry
Transfer Guidelines for ‘Corporate Bonds’” issued by Japan Securities Dealers
Association (“JSDA”), in particular, preparations prior to the introduction of Fails
Charges, and the practice regarding calculation, claim, payment, and receipt of Fails
Charges. Transactions covered by these Guidelines are purchase and sale transactions andrepo transactions (conditional purchase and sale transactions and lending transactions,
hereinafter meaning the same).

II. Preparations before introduction of Fails Charges
1.

Regarding contractual terms
With respect to conditional purchase and sale transactions and lending transactions, wefind the provision, which stipulates, “matters not specifically stated in this masteragreement shall be handled according to … and the regulations and practices establishedby Japan Securities Dealers Association” in Article 22 of “Master Agreement concerning
Gensaki Transactions in Bonds, etc.” (JSDA’s reference format) with respect toconditional purchase and sale transactions, and in Article 22 of “Master Agreement
concerning Bond Lending transactions” with respect to lending transactions. Based on theabove-mentioned provisions, it is understood that no additional contract or amendment toan existing contract will be required for introducing Fails Charges in any conditionalpurchase and sale transactions or lending transactions because the rules concerning thehandling of Fails Charges are already provided in Section “III. Guidelines concerning
Fails” of “The Japanese Government Securities Guidelines for Real Time GrossSettlement” and “Book-Entry Transfer Guidelines for ‘Corporate Bonds’” issued byJSDA.
However, with respect to bond lending transactions with cash collateral, it isrecommended to exchange a “Memorandum concerning Fails” to clearly specify thehandling of a settlement fail if the parties to the transaction have not yet exchanged one.1

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For bond lending transactions with cash collateral for corporate bonds, it is possible to conclude amemorandum between the parties to the transaction using as reference said “Memorandum concerning Fails”
regarding Japanese government securities.

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As in the case of repo transactions, it should be understood that Fails Charges in purchaseand sale transactions shall be handled according to the provisions of the “The Japanese
Government Securities Guidelines for Real Time Gross Settlement”, the “Book-Entry
Transfer Guidelines for ‘Corporate Bonds’” and these Guidelines.
2.

Prior notice(a) Since the scheduled introduction of Fails Charges will be a material change in themarket practice which is the prerequisite for trading, it is recommended that market
participants should give a written notice to that effect to their counterparties prior tothe introduction of Fails Charges. If the counterparty raises no objection in responseto the written notice and a new transaction is executed after the date specified in thenotice (“Confirmation Date” specified in Annex 1) as the date for introduction ofFails Charges, an agreement for the introduction of Fails Charges shall be deemed
to have been made.
(b) The written notice shall be sent at least from one party to the transaction to theother party.
(c) The written notice shall be prepared with reference to Annex 1 and contain
information concerning the date to introduce the Fails Charge, the Fails Charge tobe imposed on the receiving party upon occurrence of a fail on and after theintroduction date (“Effective Date” specified in Annex 1), types of transactions
subject to Fails Charges, and the method of calculating Fails Charges.
(d) The written notice can be delivered by hand, post, facsimile transmission, or e-mail.
It is recommended that after the delivery of the notice, market participants who
have sent the notice should confirm by any means that the notice has reached theircounterparty.

3.

Notice in confirmations or similar trade notifications(a) It is recommended that market participants should incorporate a notice to that effectin the confirmation or a similar trade notification to indicate that the relevanttransaction shall be subject to Fails Charges and to use as an evidence for claiming
the Fails Charge. Parties to the transaction shall confirm by such notice that anagreement has been established between the parties pursuant to the prior notice thatthe transaction shall be subject to Fails Charges.
(b) The notice to be incorporated in the confirmation or a similar trade notification
shall be prepared with reference to Annex 2 and indicate that the transaction
specified in the notice shall be subject to Fails Charges.
(c) Unless the confirmation or similar trade notification has been sent in connection
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with transactions between the parties, the parties can omit giving the notice.

III. Calculation and claim of Fails Charges
1.

Calculation method(1) Applicable formula
Fails Charges shall be calculated according to the following formula:

Σ1／365 × max (3%－Reference Rate,0) × Amount of Funds to be Delivered

fail period(2) Definitions and explanations of terms in the formula(a)

The “Reference Rate” shall be set at zero percent (0%) so long as the Bank ofJapan is pursuing a strategy of controlling the monetary base as the operatingtarget in its money market operations.

(b) When the Reference Rate is changed during the fail period, the Fails Charge forthe fail period after the effective date of the change shall be calculated byapplying the Reference Rate after the change.
If the Bank of Japan changes the operating target in its money market
operations from the monetary base to the uncollateralized overnight call rate,the Reference Rate shall be changed to the target level (or if it is indicated bytarget band, the lower limit of the target band). If the said operating target ischanged from the monetary base to any indicator other than theuncollateralized overnight call rate, the Fails Charges shall be calculated byusing tentatively the Reference Rate before the change. In this case, theReference Rate shall be reviewed promptly.
In addition, even during the time the monetary base is the Bank of Japan’s
operating target in its money market operations, if it becomes inappropriate tokeep the Reference Rate at zero percent (0%) because of change in money
market conditions (e.g., the actual uncollateralized overnight call rate
remaining far from zero percent for a certain period of time), the Reference
Rate shall be reviewed promptly.
(c) The “Amount of Funds to be Delivered” in conditional purchase and saletransactions or in lending transactions shall mean the amount of funds to be3

delivered for the starting leg of the transaction, or the amount of funds to bedelivered at the time of lending in the case where a fail is confirmed in thestarting leg of the transaction, while in the case where a fail is confirmed in theclosing leg of the transaction, it shall mean the amount of funds to be delivered
for the closing leg of transaction or the amount of funds to be delivered at thetime of returning.
2.

Claim of Fails Charges(1) Claimant and claimee
Claims for a Fails Charge shall be made by the receiving party suffering from theFail against the delivering party failing the delivery.
(2) Interval of claims
Fails charges shall be claimed monthly for the total amount of Fails Charges
accrued in the relevant period for the Fails Charges calculation, which shall start on
the first day and end on the last day of a month (on a calendar-day basis).
(3) Due date to claim
The claimant shall claim Fails Charges to the claimee by delivering a bill on orbefore the tenth (10th) business day of the month following the month for which
the Fails Charges calculation is made. If the claimant fails to claim Fails Charges
with respect to any calculation period, the claimant can not carry over theunclaimed amount of Fails Charges to two (2) or more months after suchcalculation period.
(4) Method of claiming and matching
In view of the fact that a claim for Fails Charges involves payment of money, it isrecommended to make claims in writing. In addition, it is recommended that theamount of Fails Charges claimed shall be matched without delay between theparties to the transactions after the claims.
(5) Confirmation of contact information
It is recommended to confirm in advance between the parties to the transaction
about their respective contact information regarding the claim, matching, settlement
and other matters relating to Fails Charges. Especially, in the case of transactions
where two or more counterparties are involved, such as nonresident transactions ortransactions through trust banks, contact information shall be confirmed thoroughly
to prevent operational troubles.
4IV. Payment and Receipt of Fails Charges(1) Date for payment and receipt
Payment and receipt of Fails Charges shall be completed within the month inwhich the Fails Charges are claimed. Considering the cases where substantiallylarge amount of Fails Charges may be paid and received, it is recommended tomake payments and receipts promptly after completing the claim and matchingprocedures between the parties to the transaction. In this case, the parties to thetransaction are required to confirm the settlement date before processing thepayments and receipts.
(2) Netting
If agreed between the parties to the transaction, the amount of Fails Charges canbe netted. In this case, parties to the transaction shall carefully confirm as towhether or not the Fails Charges claimed by each other will be netted.
(3) Minimum amount of a Fails Charge(a) In order to ensure efficient handling of operational processing and to avoid
payments or receipts in a small amount, if agreed by the parties to thetransaction, the minimum amount of payments and receipts can be set to fifty
thousand yen (¥50,000), and payment and receipt of Fails Charges less thanfifty thousand yen (¥50,000) can be omitted.
(b) The minimum amount can apply either to an amount of payment and receipt of
the parties calculated on a gross basis or such an amount calculated on a netbasis, that is, the amount remaining after deducting payments and receipts
between the parties. However, basically, from the standpoint of facilitating
efficient operational processing, if Fails Charges are paid and received on agross basis, the minimum amount shall apply to the gross amount, while if theparties to the transaction have agreed to pay or receive Fails Charges by netting
method according to the provisions of Section IV, (2) above, the minimum
amount shall apply to the net amount. The parties to the transaction shallthoroughly confirm between the parties before payment and receipt as to whichbasis should be applied to the payment and receipt of Fails Charges.
(4) Method for payments and receipts
Settlement through a BOJ current account is recommended as a means forpayment and receipt of Fails Charges. However, if some parties, who do not have a5

BOJ current account, settle through bank transfer or other means, the parties to thetransaction shall thoroughly confirm between the parties as to payment methods
before payment and receipt of Fails Charges.
(5) Handling of delayed payment of a Fails Charge
If payments and receipts of Fails Charges are not conducted within the monththey are claimed, the parties to the transaction shall consult about the handling of
the delayed payments with each other, and if so agreed, a certain overdue interest
can be imposed from the day following the due date.

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