The Interim Report (Framework) of the Working Group
concerning Review of Fails Practice for Bond Trading
November 26, 2009
Japan Securities Dealers Association
1. Purpose of establishing the working group
Since the outbreak of the global financial crisis triggered by the bankruptcy of Lehman
Brothers last September, the necessity to review the fails practice and other processes inbonds settlements has been strongly recognized in light of the drastic change of the market
environment. Considering this background, with the intention of further establishing thefails practice while preventing frequent occurrence of fails, the “Working Group concerning
Review of Fails Practice for Bond Trading” was established this May as a subordinate
organization of the Japan Securities Dealers Association (JSDA) Bond Committee and hassince started reviewing the fails practice and discussing specific measures.
2. Meaning and role of Fails Practice*
When starting the discussions at this working group, market participants who experienced
the disruption after the bankruptcy of Lehman Brothers expressed the view that preparing asystem which enabled the handling of fails was necessary because a situation where a failcould not be handled practically (or accepted) would hinder emergency market operations.
Furthermore, the promotion of the understanding of fails was also cited as essential,
especially at the executive level, as some arguably do not accept the Fails Practice due to alack of understanding of fails.
Taking these opinions from market participants into consideration, this working groupdecided to reconfirm the meaning and the importance of the role of the Fails Practice and,while preventing frequent fails occurrence, review the Fails Practice and discuss specificmeasures with the intention of further establishing the Fails Practice.

*As real-time gross settlement (RTGS) was implemented for government securities settlements and forfunds settlements through the funds transfer system of the BOJ-NET, JSDA compiled the “JapaneseGovernment Securities Guidelines for Real Time Gross Settlement” as a market practice. This was to beobserved for reducing settlement risks and securing smooth settlement in the settlement environment in place
after the settlement of JGB transfers on an RTGS basis was introduced in January 2001. JSDA also specified
the “Fails Practice” assuming DVP settlements, where the JGB and the funds are settled at the same time, in
the “Guidelines concerning Fails” contained in the guidelines.
-1-3. Specific agenda
Among the agenda items, the group discussed measures to modify the existing Fails
Practice or related categories at the meetings held before the release of the interim report.
(1) “Policy regarding costs incurred under fails (introduction of Fails Charges)”(a) Introduction of Fails Charges
In the process of inviting opinions on the agenda items of this working group anddiscussing the items based on those opinions, many expressed the view that a Fails Charge
is effective in preventing frequent occurrence of fails and the introduction of a Fails Charge
should be discussed positively. In light of this, it was agreed that discussions shall becarried out assuming that a Fails Charge would be introduced as a consensus of not only
JSDA members but also a wide range of market participants, including the representative ofeach business type, and then complied by them.
Additionally, it was agreed that a Fails Charge shall be discussed assuming that it would
be introduced not as a rule but as a market practice, just as implemented in the United States.
At the same time, it was agreed that discussions shall not make a distinction between
intentional and unintentional fails, and the status of a Fails Charge, whether it should beconsidered to be a penalty or not, was left open.
(b) Level of Fails Charges
Regarding the calculation method for a Fails Charge, it was agreed that practical solution
shall be explored, with a reference to the U.S. type “α% – policy interest rate(uncollateralized overnight call rate),” with which the effect preventing frequent occurrenceof fails under low interest rate conditions are expected.
Additionally, regarding the specific level of the Fails Charge (α%), considering that while
there is a concern that a level lower than the U.S. level (3%) might not ensure enough effectof preventing frequent occurrence of fails, a high-level Fails Charge would mean the“penalty,”—it was agreed that discussions shall be carried out assuming that α% would beset at 3%.
(c) Applicable scope of a Fails Charge
Regarding the applicable scope of a Fails Charge, after the group discussed the applicationto overseas transactions and loop transactions (i.e., a chain of transactions among multiple
entities which begin and end with the same entity, thereby forming a loop), it was agreed
that a Fails Charge would be applied without exceptions.

-2-(2) Review of the cut-off time
Regarding the cut-off time, considering business operations after a fail is confirmed andthe investment of surplus funds where fails have never been accepted, it was agreed that thetime would be moved forward from the current 15:30 to 14:00. It was also agreed that theperiod between the new cut-off time and the closing time of the BOJ-NET JGB Services(16:30) shall be regarded as reversal time and that fails can be confirmed even before thecut-off time based on agreement between the parties concerned.

After guideline review
14:00

Current guidelines

14:00 cut-off time

15:00
14:00–16:30
Reversal time

15:30 cut-off time
15:30–16:30
Reversal time

16:00
16:30

Closing of BOJ-NET JGB Closing of BOJ-NET JGB
Services
Services

4. Future agenda items and discussion on practical issues
This working group is scheduled to discuss “good-faith efforts and related issues,”“information disclosure and related issues,” and “margin calls and related issues” as othermeasures that require development of, for example, the new practice.
Note that it was agreed that the group would ask the Bonds Gensaki Transaction Study
Group to discuss the actual operations concerning the claim for and the payment of Fails
Charges. Additionally, the group plans to specifically discuss the actual operations concerning
the claim for and the payment of Fails Charges involving overseas transactions after
establishing a sectional committee composed of a small number of relevant parties.

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