Harvard Law School Program on International Financial Systems
International House of Japan

Symposium on Building the
Financial System of the 21st Century:
An Agenda for Japan and the United States
Odawara, Japan | October 4-6, 2019

Final Report

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2019 Symposium on Building the Financial System of the 21stCentury: An Agenda for Japan and the United States
The twenty-second Japan-U.S. Symposium on Building the Financial System of the 21st Century
was held in Odawara, Japan, on October 4-6, 2019. The sessions addressed cross-border lending,
impact of the rise of passive investment, corporate governance, and implications of trade frictions
for global finance. U.S.-China trade frictions and financial market fragmentation were seen to beof particular concern by participants.

第 22 回 日米国際金融シンポジウム「21 世紀金融システムの構築：日本と米国にとっての課題」
第 22 回日米国際金融シンポジウム「21 世紀金融システムの構築」が、2019 年 10 月 4～6 日に神奈
川県小田原市にて開催され、「成長促進に向けた対外融資の拡大：金融規制と金融安定性上の論点」、「パッシブ運用対アクティブ運用：市場機能とコーポレートガバナンスへの影響」、「経済摩擦の国
際金融への影響」の３つの議題について議論がなされた。中でも、参加者にとっての大きな関心課
題は、米中貿易摩擦と金融市場の分断であった。
＜セッション１＞
成長促進に向けた対外融資の拡大：金融規制と金融安定性上の論点
本セッションでは、国際融資の状況と重要性について話し合われた。市場の分断によって国際融資や資金の流れが制約されている現状への強い懸念が示された。参加者からは、その潜在的な要因として過度な規制や各国規制当局間の相互信頼の欠如などを指摘する意見などが述べられた。また、政治家と規制当局が資本移動障壁の削減に最優先で取り組むことの必要性が強調された。
＜セッション２＞
パッシブ運用対アクティブ運用：市場機能とコーポレートガバナンスへの影響
本セッションでは、パッシブ投資戦略が市場や価格発見、コーポレートガバナンスにどのような影響を与えるかが議論された。パッシブ運用が個人投資家、経済成長、市場機能にもたらす便益と負担について、さまざまな見解が示された。さらに、日本のコーポレートガバナンスに関連する問題についても集中した議論が行われた。
＜セッション３＞
経済摩擦の国際金融への影響
本セッションでは、今日の米中貿易摩擦が国際金融に与える影響について話し合われた。この二国間の対立によって最も悪影響を受けているのは、米国か、中国か、それとも日本などの第三国かといった点について議論が交わされた。さらに、米中のいずれかが自国の金融システムへのアクセスを紛争上の武器として利用する可能性についても言及された。
PIFS Japan-U.S. Symposium 2019, p. 1

Session 1: Promoting Cross-Border Lending for Economic
Growth—Regulation and Stability
In Session 1, participants discussed the status and importance of cross-border lending. There wasconsiderable concern that cross-border lending and financial flows were being constrained bymarket fragmentation. Potential causes put forward by participants included overregulation andlack of trust among national regulators. Participants urged politicians and regulators to prioritize
efforts to reduce barriers to movement of capital.

Status of Cross-Border Financial Activities
Participants discussed at length the current status of cross-border lending, as well as other related
financial activities. One item of concern was the decline in cross-border bank lending. However,it was emphasized that cross-border lending markets should be understood broadly, and not just as
cross-border bank lending. Non-bank lending had increased considerably both absolutely and as ashare of total cross-border lending. Other types of financial intermediation, such as swaps, could
also be seen as forms of non-bank lending. Even accounting for all of these elements, however,participants felt that cross-border lending was significantly constrained.
Participants also expressed unease about the quality of data and information available to bothmarket participants and regulators. While there was a general sense that cross-border lending was
decreasing, some participants argued that the lack of data on non-bank lending and derivatives
activities made it hard to know for certain whether overall lending was actually in decline. For
regulators, this raised significant concerns about the ability to do macroprudential supervision,
since it was not always apparent how much cross-border lending had accumulated, let alone thesectoral patterns or denomination. The problem of data was seen as particularly acute for emerging
market economies, which had less comprehensive data and where information on denominationand maturity were most essential to ensure economic stability.
Market participants raised additional concerns as they considered cross-border loans. At theindividual loan level, participants felt that there was a lack of data on credit quality, debt
concentration, and counterparty risk. This was not just an issue of data sufficiency, but also of data
quality. It was argued that weak standards on disclosure and data quality in many jurisdictions,particularly in emerging markets, made it impossible for lenders to understand the risks they faced
when lending across borders. This led to high risk premiums and greater reluctance to lend; foremerging market borrowers, that would mean reduced access to badly needed funding.
In addition to the problems of data and information, participants raised several other obstacles tocross-border lending growth. One set of obstacles resulted from regulation. Many participants
pointed to regulatory fragmentation as raising the costs and difficulty of cross-border lending. In
addition, there was considerable concern over the problem of “trapped capital.” It was argued that
capital and liquidity rules that forced banks to hold large amounts of high-quality liquid assets
restricted their ability to direct lending to firms—and particularly across borders. Another obstaclethat some participants identified was weak financial infrastructure in emerging markets, including
PIFS Japan-U.S. Symposium 2019, p.

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poor liquidity in debt and foreign exchange markets, underdeveloped payment and settlement
systems, lack of derivatives markets, and limited regulatory and supervisory capacity.
Participants worried that the apparent weakness of cross-border lending was having at least threenegative effects. In emerging economies, which had large unmet needs for finance, the reluctanceof foreign lenders to provide credit was seen as limiting opportunities for investment in crucial
infrastructure and productive capital. They saw this as problematic not only for emerging
economies themselves, which would lose opportunities for economic growth, but also for potential
lenders, which would have to forego potentially attractive opportunities because of trapped capitaland the difficulty of assessing credit and other risks.
A second negative effect that concerned many participants was fragmentation of global credit
markets, which they saw as primarily a function of regulation. Regulatory fragmentation raised thecosts of cross-border finance. Banks faced multiple regulatory regimes, raising costs of compliance.
Moreover, the common regulatory practice of ringfencing capital also created complications for
multinational banks. Meanwhile, the fragmentation of derivatives markets due to conflicting
regulation and barriers to cross-border clearing made it more difficult and expensive to hedge
cross-border financial flows. Fragmentation was seen not only as an obstacle to cross-borderfinance. A number of participants argued that it was also a threat to financial stability—banks andother financial institutions would be unable to redeploy capital and liquidity across borders in theevent of a problem in one jurisdiction, raising the likelihood of failures. Some argued thatwidespread resort to ringfencing would also make resolution of failed multinational financial
institutions much more difficult—in effect, rendering the principle of single point of entry
meaningless. There was, however, some disagreement about how far that argument should betaken.
Third, some participants raised concerns about global dollar funding, noting that even Japanesefinancial institutions were vulnerable. They noted that a great deal of cross-border dollar funding
was done by non-U.S. financial institutions that relied on wholesale funding and swap markets,
which could dry up in a crisis, as they did in 2008. Some saw new signs of stress in those markets,
which they saw as worrisome, especially because of Dodd-Frank restrictions on the Fed’s ability
to act as lender of last resort. Given the centrality of the dollar to global finance, trade, andinvestment, an inability to access sufficient dollar funding could easily lead to disruptions forinternationally active firms and financial institutions.

Global Standards, Local Practices
As noted, an issue of particular concern to participants was regulatory fragmentation, which they
saw as both impeding cross-border lending and hurting financial stability. For banks, especiallythose designated as systemically important, the Basel standards for capital and liquidity
substantially raised the costs of lending and had the effect of “trapping” capital in low-return uses.
This was seen as particularly impacting lending to emerging markets and innovative firms andprojects with higher risk weighting. The differential implementation of global standards only
raised those costs as well as the complexity of compliance.
One important issue was how time-consuming and complex the processes of determining
equivalence were. Compounding the challenge was differing approaches to determining
equivalence. For example, it was argued that U.S. and Japanese regulators typically followed a
PIFS Japan-U.S. Symposium 2019, p. 3

functional approach—i.e., to determine whether the overall impacts of a particular set of
regulations was equivalent. In contrast, EU regulators took the approach of trying to determine
legal correspondence of each regulation or rule, which many participants felt was unhelpful andmore burdensome.
A second set of concerns about regulation had to do with extraterritoriality. While foreignauthorities and financial institutions had long seen the U.S. as the major source of extraterritorial
financial regulation, many participants argued that EU extraterritoriality had become asignificantly larger problem in recent years. Japanese banks had previously expressed frustration
with extraterritorial enforcement of U.S. regulations such as the Volcker Rule, but the regulatory
reforms and changes to regulatory practice under the Trump administration had reduced theircomplaints. Other aspects of cross-border equivalence had also been worked out. In contrast, both
U.S. and Japanese participants raised concerns about the rise of EU extraterritoriality, which they
saw as contributing to fragmentation. For example, the effectively global reach of the General Data
Protection Regulation (GDPR) was seen as affecting non-European financial institutions ability to
manage client information and to market services. Other concerns included the EU’s asserted rightto regulate any benchmark used by European financial institutions or investors no matter its
location, and the unbundling rule for research by investment banks and asset managers.
A third issue of concern regarding regulatory fragmentation was about data localization
requirements, which were increasingly being mandated by jurisdictions around the world,
including China and India. In contrast, Japanese and U.S. authorities were resistant to the principleof data localization, which they saw as a barrier to trade in services; indeed, openness of data flows
was a principle both had advocated in the Trans-Pacific Partnership negotiations and was includedin the new U.S.-Japan trade agreement. Participants expressed concern about the effects of data
localization in other jurisdictions on the ability of multinational financial institutions to operate
across borders, and urged the U.S. and Japan to continue to champion the principle of not
restricting data flows in that way.
Finally, some participants raised concerns about recent reforms to Japan’s Foreign Exchange andForeign Trade Act. The reforms would require prior notification for investments in Japanesesensitive sectors such as information and communication technology. While some participants
defended the new rules as a necessary response to the possibility of Chinese state-owned
enterprises controlling critical technologies, others worried that it would be an obstacle to crossborder direct investment.

Regulatory Cooperation
Participants discussed at length how to deal with the challenges of regulatory fragmentation. Whilesome bemoaned the lack of consistency of application of global standards across jurisdictions,many agreed that differing local conditions—such as financial system structures, legal systems,
political systems, and administrative structures—justified a degree of variation to achieve similar
ends. This raised the question of how best to manage the differences across borders. Participantsconsidered several approaches to the challenge.
Many participants looked to ongoing efforts to improve regulatory coordination through various
international bodies, from the G20 and Financial Stability Board to the specialized bodies such theBasel Committee. There was some debate over whether that was the best structure to manage
PIFS Japan-U.S. Symposium 2019, p. 4

differences. Some argued that there needed to be a more extensive structure with more meetings
and working groups to try to reach consensus on how to regulate at a granular level. Others were
skeptical. They felt that there were already too many groups and meetings and that granular
discussions only tended to focus on small distinctions rather than the main principles, on which
there was still often not a consensus. More broadly, they were suspicious of a focus on technicallevel coordination and adjustment. They argued that the sometimes passionate disputes overseemingly minor details actually reflected gaps over the underlying principles, and so politicalleaders rather than technocrats should be driving the discussion.
Given the lack of political consensus on some of the key elements of financial regulation, what
would be a better approach to policy coordination? Some argued that there needed to be deeper
political buy-in in coordination processes. Others argued that this was not realistic, especially once
legislatures had acted. One suggestion was that regulators should focus their efforts at
harmonization before legislatures had acted—in other words, regulatory dialogues could help to
set a common set of questions and understandings that political leaders could then discuss
introducing in tandem, but they would not be nearly as effective in removing differences that had
already been legislated.
Another point of view was that part of the problem was overregulation. The very extent ofregulations under the G20 principles meant that there were an extraordinarily large number of rules
or interpretations in which different regulators and supervisors could diverge. While they agreed
that the increased costs of compliance and fragmentation could be worth it if the G20 financial
regulatory agenda improved financial stability, several expressed skepticism that that was the case.
Thus, they called for a review of the costs and benefits of financial regulations, both individuallyand cumulatively, with an eye to stripping out unnecessary or counterproductive ones. By doing
so, they argued that financial stability could be maintained, while reducing the conflicts acrossregulatory systems.
Other participants felt that a more pragmatic alternative would be to develop a common approachto equivalence. They argued that differences across jurisdictions were both inevitable andappropriate, and harmonization was an unreasonable goal. Instead, they argued that some of themost important successes in reducing barriers to cross-border finance had come about through theprinciple of equivalence, regulatory deference, and substituted compliance even though these
determinations were time-consuming and often arduous. To improve the efficiency of equivalence
regimes, they called for an agreed approach that was based on principles or outcomes, rather thanrule-by-rule correspondence. While there was considerable support for this in concept, someparticipants cautioned that in practical terms, some degree of dispute over particular rules andprocedures was inevitable, so that adopting a common approach would not necessarily make actual
equivalence determinations easier (even if they made them more explicable).
For some participants, the key was to build trust. They argued that if regulators could better trust
their international counterparts, regulatory deference would be much easier and there would beless need for ringfencing. Others argued that trust-building among regulators would have limited
impact. Their reasoning was that the driver for ringfencing and extraterritoriality was the desire toprotect domestic investors and taxpayers; since governments could be hit with significant burdensthat would ultimately be the responsibility of political leaders who were accountable to theircitizens, mutual trust among regulators could not substitute for the political concerns of leaders.
Thus, while interpersonal trust among regulators was seen as important for communication and
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coordination around technical issues, these participants argued that it would not ensure effective
cross-border resolution.
In this interpretation, the key to building trust would be to build robust national systems forprotecting investors, managing risk, ensuring capital and liquidity buffers, and managing crises.
Crisis management was seen as particularly important, because of governments’ primaryaccountability to taxpayers. The post-crisis reforms had considerably improved resolution
mechanisms in major countries and reduced the likelihood of taxpayer money being used for
bailouts of banks and clearinghouses. However, several participants pointed to one glaring
exception—the weakening of the lender of last resort function in the U.S. They argued that in acrisis, emergency liquidity from the central bank is the key to preventing contagion, as
demonstrated by the decisive actions of the Fed in 2008-09. Without confidence in the Fed’s
willingness and ability do the same in the future, it was argued, regulators and central banks inother countries would continue to see the need for ringfencing and other forms of self-protection.
Nonetheless, participants generally supported efforts by regulators to communicate regularly andto establish common understandings and data on common issues. Even if “trust” were no longer
the goal, it was argued that regulators should strive for transparency, predictability, and mutual
understanding.
Many participants also felt that trust of international regulators was even more elusive in thecontemporary world, which they saw as being in an age of anti-globalist populism. The rise of
populist leaders in a variety of developing countries (with the notable exception of Japan) reflecteda suspicion and even resentment of elites who were seen to have brought about the global financial
crisis followed by unsatisfactory and unequal recoveries but who were never held responsible for
their role in the crisis. There was also suspicion of global cooperation—populists in many countries
had drawn a picture of global elites and corporations working together to take advantage of local
populations, whether through financial regulation, trade policy, or other regulation. Meanwhile,even aside from the populist turn, many participants agreed that it was a challenging problem forleaders to figure out how to be accountable to citizens, stakeholders, and foreign partners.
Among the populist “solutions” to the problem of lack of trust and need to ensure clear
accountability, participants noted the increasing popularity of technical alternatives to political
discretion. This was particularly pronounced in the enthusiasm of some groups forcryptocurrencies, blockchain, and stablecoins. While few participants viewed cryptocurrencies as
viable alternative channels for payments or financial intermediation, they found blockchain
applications and stablecoins as being potentially important going forward. In particular, there wasconsiderable interest in the use of permissioned blockchains to improve settlement processes andto manage trading data. However, while participants saw these technological advances aspotentially useful for streamlining processes and reducing costs, they did not see them as
substitutes for effective regulation and supervision or for cooperation and confidence-building
across borders.

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Session 2: Passive/Active Investment Strategies and
Implications for Market Functioning and Corporate
Governance
In Session 2, participants discussed the impact of passive investment strategies on markets, pricediscovery, and corporate governance. They offered varied perspectives on the benefits and costsof passive investment to retail investors, economic growth, and market function. There was also
considerable focus on issues related to corporate governance in Japan.

The Rise of Passive Investment
Participants recognized that passive investment strategies had become increasingly popular. They
agreed that passive investment funds, particularly index funds, significantly lowered costs forinvestors while also allowing for diversified holdings across a particular asset class or market
sector. The reduced costs and risks associated with index funds provided benefits to retail investors,
while also increasing pressure for active managers to outperform benchmarks or to squeeze theirown costs.
The phenomenon was particularly apparent in the US equity markets, where shares held by passive
managers now exceeded those held by active managers. In Japan as well, passive investment
strategies were becoming more popular, although still accounting for a much smaller proportionof stock ownership than in the U.S. This raised questions about the functioning of public markets,
as well as the potential impact on corporate governance.
Some participants expressed frustration with what they saw as a sometimes inaccurate use of theterm “passive investment” in popular debates. In particular, they noted that the term “exchangetraded fund” (ETF) was often used interchangeably with passive investing, but pointed out that
this was wrong, since ETFs can follow a variety of strategies. Thus, they emphasized that passive
investing was about investing based on a predetermined index, not the wrapper in which theinvestment was packaged.
There was also considerable discussion of indexes themselves. While the bulk of passive
investment funds were based on widely recognized indexes such as the S&P 500 or the Topix,
participants also noted the proliferation of bespoke indexes and so-called alpha index funds. A
number of participants felt that alpha index funds should not really be considered to be index funds,
but rather a type of active fund, where asset managers’ judgment would have a crucial impact on
the performance of the fund. There were also mixed feelings about bespoke indexes. Participants
expressed concern that the composition of such indexes was often opaque and subject to arbitrary
change. Moreover, by not tracking major indexes, it was argued that it was impossible to compare
bespoke index funds to a benchmark, making it difficult to judge their performance relative topeers. Some participants called for regulations to increase the transparency of bespoke indexes,
but others were more skeptical, arguing that asset managers should have the choice of keeping
their investment strategies confidential. Bespoke index funds and alpha index funds were also seen
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as raising costs relative to funds tracking the major benchmark indexes; given that low cost was
one of the major selling points of passive investment strategies, some participants felt that those
funds were thus sacrificing the interests of investors.
Participants discussed at length the impact of passive investment on financial markets. Whileacknowledging that passive investment offered some valuable benefits for investors including
lower cost, more efficiency, lower volatility, and greater transparency, they addressed several
concerns as well. One was that the rise of passive investing could reduce the quality of pricedetermination of individual stocks—some participants argued that, if the bulk of trading were
driven by passive strategies, prices would reflect only investors’ preferences regarding asset
classes, not the performance of each company. The lack of differentiation could lead tomisallocation of capital, as both underperforming and overperforming firms would experiencesimilar price performance and thus access to capital. In contrast, other participants argued that thiswas not yet a problem and was indeed not likely to become one. Even in the U.S. equity markets,
passive investment accounted for a minority of total shares, and a significantly smaller proportionof trading. Elsewhere, including in Japan, passive investing remained much less common. Several
participants also argued that markets would naturally have a self-correcting mechanism—if prices
of individual company shares or other securities did not reflect their actual value, it would create
opportunities for active traders to profit, bringing active managers back into the market andensuring that prices would be differentiated by performance. In particular, some participantsargued that predominance of passive investment would create new opportunities for active andactivist investors. It was also noted that, increasingly, companies were turning to private markets
for funding; in the private markets, investors would remain incentivized to closely monitor
performance.
Another concern was the possibility of herd behavior. Some participants worried that any sudden
withdrawals or increases of funds in passively-managed could move entire markets rather than justhaving the effects isolated in a small number of stocks or other securities. Others were unconcerned.
They pointed out that investors could withdraw funds from actively managed investments as easily
as from passively managed ones. Also, they argued that there was no evidence to date that investors
in passively-managed funds were more likely to withdraw their money all at once. Rather, they
made the case that, since much of the retail investment in passively-managed funds in the U.S. washeld in individual retirement accounts such as 401(k)’s, they were less likely to see sudden runs
than other types of holdings.
Finally, some participants raised the concern that the sheer scale of the major index funds could
lead to excessive concentration of control of shares into a small number of hands. This could in
principle lead to conflicts of interest or lapses in corporate governance. This point is addressed in
the next section.

Asset Managers and Corporate Governance
There was considerable discussion of whether and how passive managers would be able to carryout effective corporate governance. This was seen as a crucial question by many participants, whoargued that companies that followed good corporate governance practices, such as having amajority of outside directors on their boards, would have better performance than similar
companies that did not. Some participants questioned the extent of the evidence to support that
PIFS Japan-U.S. Symposium 2019, p.

8statement, pointing out that studies (mostly in the U.S.) had shown relatively little effect on
corporate performance. Others countered this skepticism. They pointed out that between-country
studies showed strong effects for better corporate governance, even if between-company evidence
was lacking. Looking at Japan, measures of corporate governance quality had been quite low
compared to the U.S. and other countries, and corporate profitability was also low. Moreover, there
was some preliminary evidence presented at the Symposium that suggested that Japanesecompanies that followed better corporate governance practices also had better performance thantheir peers.
There were some questions about the goals of corporate governance. For example, it was notedthat there was increasing investor demand for environmental and social responsibility (ESG) on
the part of firms. Similarly, the U.S.-based Business Roundtable had recently called for a shift
from pure shareholder value to considering the concerns of a wider variety of stakeholders inmaking investment decisions. Some participants worried that this complicated the question of how
funds could or should work as fiduciaries of their investors’ interests. This challenge would holdfor actively-managed funds as well.
Some participants raised the concern that passive managers would be hands-off in their approachto corporate governance issues at the companies in which they invested. Passive managers would
have no choice but to invest in companies in their index according to a particular formula. Thus,
these participants questioned whether fund managers would feel the fiduciary duty to monitor
directors and to enforce good practices. Given the low management fees charged by most passive
funds, some participants also questioned whether they would have the capacity to monitor
companies’ governance and activities.
Discussions revealed that passive-managed funds were actually quite active in voting shares andengaging boards in the companies in which they invested, with the goal of improving corporate
governance and responsiveness to shareholders’ interests. Proponents argued that large passive
funds would have as much voice as large actively-managed funds. Others were not convinced.
They argued that active managers would have more voice because they would have a credible
threat of exit (which could lower a firm’s share price), so companies would have to listen to
criticisms or concerns. There was also a concern expressed about delegation of voting decisions toproxy advisors, who were a further step removed from the interests of the beneficial owners. It
was argued that the push to keep down costs, combined with the challenges of delegation, could
lead to a “checkbox” approach to corporate governance, rather than deep and sustained
engagement.
Participants also discussed the roles of active managers and activist investors in promoting good
corporate governance practices. Active managers were more similar to passive managers in theways in which they engaged with firms, while differing in two important ways. The first was that
active managers were in a position to make investment decisions based on their evaluation of firms’
corporate governance—in other words, unlike passive managers, they had a credible threat of exit
if they were not satisfied with management practices. Second, because they typically had a smaller
number of holdings, they could more directly manage their engagement with firms. Activist
investors were even further involved in corporate governance, picking investments that they saw
as poorly managed, taking a small number of concentrated positions, then pushing hard to change
corporate governance and managerial decision making to improve profitability. It was argued thatthe relatively hands-off approach of passive managers gave an opening for active and activist
PIFS Japan-U.S. Symposium 2019, p.

9investors to choose underperforming companies and improve them, which could be a way ofoutperforming the index funds. Although many participants agreed in principle that this approach
could yield superior returns and improve companies’ performance, some also cautioned about what
they called “engagement fatigue.” In other words, they argued that the heightened focus by
institutional investors on corporate governance and stewardship in recent years in Japan andelsewhere had led corporate managers to be frustrated with the constant oversight of investors andto impede efforts of investors to impose changes.
Some participants suggested that the ability of investors to improve corporate governance andoversee the decisions of managers was inherently limited. They argued that corporate insiders
would always have superior information in comparison to outside directors, and would therefore
be able to thwart oversight if they wished. For some participants, this implied that efforts toimprove corporate governance would only work if management were receptive and actuallywanted to incorporate outside perspectives and insights. Others argued that the information gap
was insurmountable except in the case of private equity, which allowed for full ownership anddirect control of companies. They felt that the advantages of private equity over the public
corporation model were driving a more generalized move away from the public corporation towardprivate equity, especially in the U.S. There was some discussion as to whether private equity would
begin to take on a larger role in the Japanese corporate world, but no conclusions.

Corporate governance in Japan
Participants discussed in particular how investors might be driving a transformation in Japanese
corporate governance. They saw this as a particularly important issue, as many argued that one of
the reasons for Japanese economic stagnation was poor corporate governance and lack of attention
to profitability and shareholder value. Thus, they were particularly keen on delving into whether
and how new efforts by investors were transforming the Japanese corporate landscape.
Many participants agreed that there had been significant progress in recent years in the quality ofcorporate governance in Japan. This included some important initiatives such as the voluntary
Stewardship Code for institutional investors and the Corporate Governance Code for listedcompanies on the Tokyo Stock Exchange. This had led to a variety of practical effects, including
perhaps most notably a large increase in the number of independent directors, which advocates ofcorporate governance reform had long called for as a way of injecting new ideas and shareholderinterest into companies that had often been insular and characterized by lifetime employment andmanagerial control. An increasing number of listed firms were also moving toward a committee
structure that clarified the roles and responsibilities of directors and executives, and moving awayfrom previous models where the distinction was more ambiguous. Beyond the board room, it wasnoted that Japan had experienced a significant increase in shareholder proposals, proxy fights, andM&A, albeit from a low base. While the numbers were still fairly low and success of shareholder
proposals and proxy fights still uncommon, many participants felt that investors were increasingly
taking their role as owners seriously and managers were paying attention.
These developments were seen by participants as significant, but they offered varying observations
as to how profound the changes were. In some firms, it was argued, the role of outside directors
and clearer board responsibilities had been very important in bringing in outside ideas andimproving shareholder oversight of managers. In contrast, some participants described other firms
PIFS Japan-U.S. Symposium 2019, p. 10

where the structural changes had had limited practical effects. They argued that many companies
resisted the influence of outsiders through various strategies. One of these was the informational
asymmetries between insiders such as long-term employees in executive positions and outside
directors who had to rely on the insiders for access to information. (Participants agreed that thiswas not unique to Japan, and several stated that they had observed the same problem in U.S. firms
as well.) A number of participants argued that the ability of outside directors to really understandwhat was going on in a given firm was dependent on how receptive the executives were to outside
input. In those companies where executives saw the outside directors as a resource for new ideas
and analyses, the impact of outside directors could be substantial, whereas executives who resisted
giving up control were often effective in minimizing outside directors’ influence. Participantssuggested that another reason that outside directors’ impact was limited in many firms was thelack of director diversity. Instead of welcoming director diversity and new ideas, they argued that
executives often preferred to appoint outside directors whose ideas and experiences were similar
to their own. Still, a number of participants felt strongly that corporate governance changes werealready having substantial impact on the decisions and performance of firms. Some pointed topreliminary evidence that Japanese firms that scored higher on corporate governance scorecards
had higher productivity and return on equity than those that scored lower, and that firms that added
more outside directors improved their performance on those measures. Many participants foundthis to be a hopeful sign.
Participants discussed at length the role of institutional investors in corporate governance in Japan.
They noted that the Stewardship Code had been signed by virtually all major domestic andinternational institutional investors in Japan, including the Government Pension Investment Fund(GPIF). The code obligated institutional investors to constructively engage with the firms in which
they invest in order to improve long-term profitability. While participants agreed that not all
signatories to the Stewardship Code were particularly active in engaging with management, many
were taking the responsibility seriously.
The activities of GPIF and the Bank of Japan were topics of particular interest in this discussion.
Participants were enthusiastic about the engagement of GPIF in promoting better corporate
governance in Japan. They noted its strict adherence to the Stewardship Code and its enthusiastic
embrace of the cause of corporate governance reform. Given the size and prominence of GPIF in
Japanese financial markets, including holding approximately 5% of Japanese equities in addition
to a large bond portfolio, the actions of GPIF were seen as having considerable impact both on thecompanies in which GPIF was invested and in the behavior of the asset managers that it used. The
desire of institutional investors to manage GPIF funds pushed these asset managers to adhere to
the code and to prioritize corporate engagement.
Participants contrasted the role of GPIF in improving corporate governance with that of the BOJ,
which also held about 5% of total Japanese equities. In contrast to GPIF, the BOJ had taken a much
more hands-off approach to corporate governance. Since its equity holdings were for the purposeof monetary policy rather than maximization of returns, it had been careful to only invest passively.
Moreover, it had outsourced all asset management decisions to outside professionals in order toprevent the appearance of favoritism. In turn, most asset managers were said to have outsourced
voting of shares, engagement, and other matters of corporate governance to proxy advisors. Thus,
some participants made the case that the BOJ was not contributing to improving corporate
governance in Japanese firms, and argued that it should be encouraged to do more. Other
participants were less critical. They argued that, even if the BOJ did not have a clear, coordinated
PIFS Japan-U.S. Symposium 2019, p. 11

approach to corporate governance, the asset managers it contracted with were all major
institutional investors that were signatories to the Stewardship Code.

PIFS Japan-U.S. Symposium 2019, p. 12

Session 3: Implications of Trade Frictions for International
Finance
In Session 3, participants discussed the implications for international finance of trade frictions
between China and the U.S. They debated whether the U.S., China, or third countries such as Japan
had been most adversely affected by the ongoing trade disputes. They also raised the question ofwhether either China or the U.S. was likely to try to use access to their financial systems as aweapon in the disputes.

Economic Impacts of Trade Frictions
Participants noted that the impact of frictions on actual trade relations had been significant. Tariff
hikes had been more severe and sustained than most had predicted the previous year. On the U.S.
side, imports from China had been hit hard, particularly in those product lines where the tariff hikehad been the greatest. With more U.S. tariffs planned by the end of the year, substantially allimports from China would be subject to tariffs ranging up to 25%. Given the effects to date,participants expected further reductions to Chinese exports in those product areas.
Meanwhile, Chinese imports of U.S. goods had also been significantly affected. Curiously, it wasnoted that drops in Chinese imports of U.S. goods were not differentiated by level of tariff; someparticipants argued that this was an indication of coordinated actions by Chinese importers rather
than simply a market response to changed prices. This suggested a government role in shunning
U.S. goods, which could be used as a weapon to pressure U.S. consumers, firms, and tradenegotiators.
Despite the impact on China-U.S. trade, there was some disagreement about the impact on the
Chinese economy. Several participants pointed out that Chinese exports had been redirected toEurope and Southeast Asia. There were also suspicions that at least some of the trade diversion to
Southeast Asia was actually an illusion and that it actually constituted transshipment to the U.S.
For example, one participant pointed out that the rise in Chinese exports to Vietnam over the lastyear was approximately equal to the rise in US imports from Vietnam. While this was an effective
safety valve for those Chinese exporters, others argued that domestic Chinese firms could be
adversely affected if the Vietnamese government were to crack down on the practice. Others
participants argued that the slowdown in the Chinese economy was greater than admitted by theofficial statistics. For example, reductions in electricity use were considerably bigger than the GDP
statistics suggested. Thus, they concluded that Chinese economic authorities were trying tocamouflage the negative impact of reduced trade. In contrast, several participants were skepticalthat the Chinese economy had been particularly badly affected. Moreover, they argued that
foreign—including U.S.—firms in China had been hurt more than local firms.
Participants agreed that U.S. consumers were largely paying the price for tariffs, despite someefforts by firms to insulate them from price hikes. U.S. farmers as well had been badly affected by
Chinese retaliation. It was argued that the Trump administration was acutely aware of this pain,
despite continued tough talk. On the consumer side, several participants pointed out that theadministration had delayed tariff hikes on a number of key consumer goods, including toys andpersonal computers, until after the Christmas shopping season ended. In agriculture, they noted
the decision to compensate farmers financially for losses due to inability to export to China, as
PIFS Japan-U.S. Symposium 2019, p. 13

well as the U.S. focus in recent bilateral negotiations (with Japan as well as China) on promoting
U.S. agricultural exports. Moreover, it was also noted that the U.S. trade deficit had only worsened
despite the trade war—as a number of participants pointed out, this was not surprising given that
trade balances are driven by macroeconomic forces, and the rapid economic growth and high fiscal
deficits of the Trump era naturally led to larger trade and current account deficits.
Some participants argued that EU economies were the winners in the trade conflicts, as evidenced
by their increased exports to China and increased imports from the U.S. However, other countries,
particularly in Asia, were seen to be adversely affected. One reason was increased competition
from Chinese producers of final goods. Another was the disruption of regional production
networks, which constituted much of the regional trade in East Asia. Japan, for example, was very
adversely affected by the China-U.S. trade dispute due to its role in regional production networks,even though Japan-U.S. trade frictions had been less heated than in the China-U.S. case.
Overall, participants appeared suspicious of both official and popular narratives that one side or
the other was the primary victim of trade conflicts. They felt that both the U.S. and China were
suffering. For some participants, this was actually a hopeful sign. They argued that both sides hadstrong incentives to come to an agreement soon, which would help not only China and the U.S.,
but also trading partners in Japan and elsewhere. Not everyone expected a comprehensive
solution—indeed, most expected a temporary “truce” or partial agreement in the short term thatwould address the concerns of certain key constituents, such as farmers in the U.S.
There was some debate over which side was more likely to make concessions in order to get to anagreement. Some participants argued that the strength of President Xi’s political position within
China made it unnecessary for the Chinese government to back down in the face of U.S. pressure;rather, China could just wait it out until the next election. Other participants countered the Xi wasactually in a weaker domestic position than he appeared from the outside, but were split as to theimplications. On the one hand, a weaker Chinese administration facing a softer economy could be
more willing to strike a deal. On the other hand, it was argued that if Xi’s position really was more
precarious than it looked, then he would be wary of making compromises and potentially looking
weak. A similar set of questions was raised on the U.S. side. Since the economy had been
negatively affected by the trade frictions and this was creating political challenges for the Trumpadministration, most participants appeared to agree that the administration was looking foropportunities to declare victory even if it meant a partial agreement. However, several participantscautioned that political weakness on the part of the administration would mean that even a limited
agreement would become politically difficult to justify as the 2020 presidential election season
started to heat up, as the administration would be wary of being criticized by Democrats as having
backed down to China and lost the trade war. Thus, while most participants saw mutual interest insome sort of agreement, many were skeptical that a lasting or comprehensive agreement would befeasible before the 2020 election.

Financial Impacts of Trade Frictions
Participants agreed that the impacts of China-U.S. trade frictions were not limited to trading
relations or the real economy, but also extended into cross-border financial transactions.
One major concern was about foreign direct investment (FDI). Looking globally, cross-bordermergers and acquisitions (M&A) had been in decline since 2016, which a number of participants
PIFS Japan-U.S. Symposium 2019, p. 14

attributed to trade conflicts. One reason they put forward was that trade conflicts had increased
uncertainty about global economic conditions, leading companies to defer decisions about
investments. For some industries, the possibility of “decoupling,” or eroding global production
networks, compounded the uncertainty and deterred cross-border M&A.
Of more particular concern was cross-border FDI between China and the U.S. particularly Chinese
FDI into the U.S., including M&A. Participants saw a number of factors that reduced the desire ofChinese firms to invest in the U.S., including the Trump administration’s strongly-stated criticismsof trade and investment with China, the failure of a number of high-profile acquisitions (e.g.,
Moneygram, Skybridge, Chicago Stock Exchange), and the strengthening of the CFIUS process.
Some participants saw this as an opportunity for Japan to draw more Chinese investment. It wasargued that a number of Chinese government investment funds, including CIC, CICC, and SAFE,
were looking at investing in Japan, in the forms of both portfolio investment and private equity,and that Japan should take advantage of the opportunity. However, there were also concerns raised
about whether Japanese authorities were comfortable with high levels of Chinese FDI, especiallyby the Chinese government. In fact, it was argued that recently proposed changes to Japan’s
Foreign Exchange and Foreign Trade Act were meant to reduce the ability of Chinese investors totake major stakes of Japanese firms.
U.S. FDI to China was also under pressure, although the decrease was much less severe than thatin Chinese FDI in the U.S. Several participants pointed out that, in contrast to the U.S., which had
tightened CFIUS rules on inward FDI, China had continued to liberalize its FDI rules. This wasparticularly notable in the financial sector and some other sectors such as resource extraction,
where restrictions on foreign ownership continued to be loosened. Some participants felt that thiswas a signal that China was trying to keep trade frictions from bleeding into other areas, as it
continued with its existing strategy of liberalization and market development. Others argued that
China was actually doubling down on liberalization in order to reduce the effects of trade war andto extend the process of integration with partners outside the U.S. Another possibility was that thiswas meant to encourage U.S. firms to advocate for a less confrontational stance on the part of the
Trump administration in managing the trade conflict.
Participants also discussed the impacts of trade frictions on other aspects of finance. They agreed
that so far the effects were limited. For example, the VIX had remained low despite the tensions
between the U.S. and its trading partners, with only occasional minor spikes following presidential
tweets. Advanced economy equity benchmarks appeared unaffected as well. It was noted thatwhile developing country equity markets had been weaker, but there were no reductions in
portfolio investment to major emerging markets, let alone capital flight. Emerging market currency
values had weakened, apparently tracking the RMB. However, a number of participants predictedthat the RMB would remain stabilized around the RMB 7/$1 mark, because the Chinese capital
account was balanced and Fed was not raising interest rates. Overall, in other words, they saw
considerable resilience even in the markets that had been most adversely affected by China-U.S.
trade frictions.

Prospects for Trade Frictions
Looking forward, participants discussed likely prospects for the future. Picking up on thecharacterization of China-U.S. trade frictions as “trade war,” some asked where the two countries
PIFS Japan-U.S. Symposium 2019, p. 15

were in the cycle of escalation. So far, it was noted, the “weapons” that were being used wereprimarily tariffs, as well as some non-tariff measures such as purchasing decisions by Chinesestate-owned enterprises. However, a number of participants worried that escalation could go
beyond just raising tariffs and move to even more disruptive measures, including currency
manipulation, capital controls, and even financial or trade sanctions.
In this context, participants discussed the prospects that the U.S. would use its financial markets
as a weapon in the trade wars. Some pointed to published rumors that U.S. regulators might deny
Chinese firms access to U.S. markets. Most participants were skeptical that the government either
could or would force a wholesale de-listing of Chinese firms from U.S. public markets. However,some participants warned that the lack of transparency of Chinese companies the unwillingness of
the CSRC to allow the PCAOB or other U.S. regulators to examine the books of Chinese firmsthat were listing in the U.S. could lead to selective de-listing that would become politically charged.
Meanwhile, most participants appeared skeptical of claims that the U.S. could impose capital
controls on China—indeed, they were not even sure that there would be a legal basis for selective
currency or investment controls against China. Another form of significant escalation would be
the imposition of financial or trade sanctions. It was noted that the U.S. had been using financial
sanctions much more aggressively in recent years, and that there had been some speculation that
U.S. authorities could block Chinese access to US markets or even dollar settlement systems such
as SWIFT. Participants expressed doubt that this would happen, however.
Whatever were to happen in terms of the trade war itself, many participants expressed concern
about the broader economic effects of a continuing conflict. They pointed to slowing
manufacturing investment around the world and the disruption of global value chains, both ofwhich were occurring in the context of weakening growth prospects in China, the U.S., and Europe.
Thus, a number of participants expressed concern that a recession was on the way, at a time whenfiscal and monetary authorities around the world were constrained.
One important question on participants’ minds was how long the trade conflict would last. As
noted, some felt that the Trump administration would accept a partial deal soon, in order to improve
the president’s reelection prospects, whereas others worried that both Trump and Xi had painted
themselves into rhetorical corners that would make compromise difficult. Looking even further
forward, a number of participants argued that the situation was unlikely to improve after the 2020
U.S. elections. On the one hand, they argued that a Democratic victory would not necessarily
increase the chance of compromise, as Democratic suspicions of Chinese trade practices andresentment of human rights practices was likely to propel more confrontation. On the other hand,
they reasoned that a Republican victory also might give the president and his party more reason toresist backing down. A contrary view was that a Trump victory might actually increase thelikelihood of a grand bargain, as President Trump would be less worried about elections in his
second term, and more interested in establishing his legacy as an economic statesman and strategist.

PIFS Japan-U.S. Symposium 2019, p. 16

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