Interim Report of the Committee for Reform of the Securities
Clearing and Settlement System (Memorandum)

Note: This is a tentative translation of the "Memorandum of the Interim Report of
the Committee for Reform of the Securities Clearing and Settlement System" and has not been formally approved by the issuer of the report. The
translation, prepared by the secretariat of the JSDA, is intended to facilitate
understanding of the reform by the international audience.
March 31, 2000
I. Introduction
A securities clearing and settlement system superior in security, productivity, andefficiency is a basic infrastructure for securities markets. It is one of the most important
issues yet to be tackled in Japan’s efforts to establish an internationally competitive
financial center.
In light of the globalization of securities transactions and worldwide competition amongmarkets, major Western countries have already adopted "DVP" (Clearing versus
Payment) for a wide range of securities, and begun work on "T+1" (settlements on thenext day of transactions). These efforts to reform securities clearing and settlement
systems are being made as markets strive to offer better services to meet users' various
needs.
In contrast, Japan's securities clearing and settlement system is segmented by producttype. It is therefore imperative to overhaul the system and adopt "STP" (Straight
Through Processing), "T+1" and "DVP", in order to meet international standards.
Recognizing the above issues, an across-the-board committee was set up in July 1999,
hosted by Japan Securities Dealers Association, to look into fundamental issues fordeveloping a new clearing and settlement system. With regard to reducing settlement
time to T+1 in equities, JGBs and non-JGB bonds, we have investigated the issues withthe understanding that:(a) Consistency of the entire settlement system should be achieved, and security,
productivity, and efficiency should be enhanced,

(b) Market rules and practices compatible with global standards should be developed,by making the best use of practitioners' expertise, to keep Japanese securities
markets internationally competitive, and(c) The reform should benefit each user of the system (investors, custodians, brokers
and issuers).
With respect to achieving DVP settlement, we have investigated the issues appreciating
that:(a) DVP should be adopted at the time of implementing a new settlement system andreduced settlement cycles,(b) A new DVP settlement scheme should be compatible with global standards tomaintain and enhance the international competitiveness of the Japanese securities
market,(c) Settlement risk should be kept at a minimum, although this involves costs, bydeveloping safeguards, and(d) Measures should be taken to streamline the entire settlement system, to minimize thecost associated with the introduction of DVP settlement.
I.

Reducing Settlement Time
1. Issues to cope with in achieving T+1
These issues are: those that commonly apply to all types of securities trading; thosespecific to each type of trading, and those specific to equities.
2. Direction for developing T+1
We have investigated various aspects of Japan's settlement system, including legal
and regulatory issues, technical matters and market rules and practices, andconcluded that the following measures should promptly be taken:(1) Legal issues
Dematerialization of securities (paperless, immobilization, or denominating in alarge unit)(a) To ensure STP for securities settlements, dematerialization of securities isessential. It sho uld rather be done independently wherever possible than to wait
for comprehensive legislation enabling dematerialization for all types ofsecurities.
A. New legislation to facilitate immobilization
For the near future, a new legislative initiative is needed to facilitate
immobilization of securities. Specifically, the coverage by the existing
central depository and transfer system, which currently handles equities,
should be expanded. In addition, it is necessary to revise the bondrecording system and promote the bundling of bond certificates into alarger unit.
B. Amending the Depository and Book-Entry Transfer of Securities Law, etc.
A) Expanding the scope of eligible securities to be handled by central
securities depositories (CSDs)
In major Western countries, CSDs commonly handle various types of
securities, including equities, bonds, commercial papers (CPs) andbeneficiary certificates of investment trusts. In view of this, CSDs inJapan should be allowed to handle a wider range of securities to enhance
security, productivity and efficiency. In doing so, each product's specificcharacteristics need to be taken into account. In addition to provisions forequities, the Law defines, in Article 39, that such provisions are also
applicable to other types of securities. Yet there are still various types of
securities that are not explicitly designated as eligible. Therefore, it
should be clarified whether CSDs can actually handle them and, if
necessary, the law itself should be amended.
B) Promoting deposit of stock certificates with CSDs
To make settlement procedures more efficient as well as to achieve DVP,
it is necessary to boost deposits of stock certificates at CSDs, thereby
effectively eliminating physical deliveries. A new regulation or legal
certainty is needed to enable the following:-More extensive use of the "deemed-to-be-deposited" system
Allowing securities to be deposited with CSDs at the time of issuanceshould stimulate the use of CSDs, as the costs associated with printing
and then dematerializing can be eliminated.

-

Treatment of those issuers yet to agree to CSD handling
In view of the objective of the Law, it is desirable that publicly tradedequities can be automatically deposited with CSDs even in the absenceof the issuers' consent.
-

Removing restrictions on shareholder rights
Minority shareholders who deposit shares with CSDs should be able toexercise their rights as soon as they are on the list of beneficial
shareholders, which is updated every six months.

-

Treatment of odd-lot shares
Odd-lot shares, for which certificates are not issued, should be eligible
for CSD handling.

-

Treatment of those shares with restrictions on holding by foreigners
For such securities other than NTT shares, clear interpretations of theapplicable laws or legislative modification are needed regarding thetreatment of those shares held by foreigner in excess of the restrictions.

-

Efficient operation of CSDs
It may be necessary, depending on further discussion by the committee,
to consider how to run CSDs more efficiently.

C. Revising the corporate bond recording system
A) Revising the system- Abolishing the serial number-based management and abolishing/easing
the rule for processing registration applications
Doing so will pave the way for the management of balances on acreditor-by-creditor basis, currently employed for the settlement ofregistered JGBs, as it will no longer be necessary to record the trading
history of individual bonds. This would enable thorough online
processing of registration applications, thereby making theadministrative procedures more efficient.
-

Delegation of registration business among registration agencies
To keep administration costs low, it is desirable to consider legislation
allowing registration agencies to delegate the whole or primary portionof registration business to other well-equipped agencies.

-Introducing a method of registration under depositories' names
For efficient settlement, it is very useful to introduce a system in which
depositories' names are registered in lieu of those of beneficiary
creditors. Adopting such a multi- layered structure of bond holding
would also boost the growth of bond lending and othersettlement-related businesses. In doing so, it is necessary toaccommodate those bondholders already registered under their names.
In addition, arrangements should be made for transfers across/within
depositories, and protection must be provided for good- faith acquirers.
There are a couple of ways to introduce such a system. Under a"multi-depository" method, vario us institutions such as banks,
securities companies and CSDs function as depositories, whereas a"single depository" method designates a CSD as the sole depository as
in the case of the JGB book-entry settlement system.

B) Adopting book-entry for settlements of Non-JGB bonds
As in the JGB book-entry settlement system, book-entry should be
introduced for settlements of municipal and corporate bonds (bar private
placement ones held to maturity), because it would significantly lower
administrative costs. It would also effectively eliminate one of the major
obstacles in the bond market, namely the three-week suspension ofregistration prior to the interest/principal payment. One possibility of
introducing a new book-entry system is to designate a CSD as the sole
depository of registered bonds, whereby all transfers are made at the CSD
on a book-entry basis. Another is to issue a single certificate for each bond,which a CSD then holds on behalf of all beneficiary bondholders.
A. Dematerialization of CPs
New legislation should be introduced for dematerialization of CPs, aswell as a corresponding settlement system. Also, the possibility ofdematerializing CPs ahead of other products needs to be explored.
B. Dematerialization of beneficiary certificates of investment trusts
It is desirable that beneficiary certificates of investment trusts bedematerialized to streamline the administrative procedures.

(a) Electronic processing of trading reports
To reduce settlement time, particularly with regard to transactions withinstitutional investors, online delivery of trading reports should be allowed.
In addition, investment trust managers should be allowed to give instructions
electronically.
(b) Revising the interest tax regime for bonds
A. Under the current tax regime, foreign-owned bonds deposited with global
custodians are subject to a withholding tax. As this inhibits a shift tobook-entry JGBs from directly- registered JGBs, as well as the growth of the
JGB market itself, certain tax arrangements should be made.
B. As different interest tax regimes apply to financial institutions' holdings andcorporate customers' holdings of registered bonds, the bond market has
effectively been divided. To promote the growth of the bond market,
taxation should be coherent regardless of the category of investors. In
addition, book-entry Non-JGB bonds should be exempted from a
withholding tax if such bonds are to be introduced.
(2) Improving the system architecture(a) The need for a confirmation system to facilitate STP
A. A trade/settlement confirmation system linking all parties involved
It is essential to have a confirmation system that facilitates quick
processing of trade/settlement information. To reduce settlement time,such a system should be efficient and cover a wide range of securities.
B. Developing an industry-wide trade/settlement confirmation system
Market intermediaries, such as trust banks, securities companies,
investment advisors and managers, should reorganize their post-tradeadministrative procedures to enable online information flow among themas well as electronic data processing. We are divided as to what kind of aconfirmation system is preferable. Some argue that for greater
productivity and efficiency, a standardized, comprehensive confirmation
system should be developed so that it covers a wide range of products.
Others insist that a single system should not be forced upon the market,
because such a move discourages competition as well as neglects thedifference in the nature of individual products and market participants.

C. Real-time data processing
Participants, in particular those involved in "Tokkin" transactions, suchas trust banks, investment trust management firms, investment advisory
firms, and settlement banks, should be capable of real- time dataprocessing.
(b) Standardizing protocols to enable STP
To enable STP, a standardized system protocol is needed whereby data areprocessed by all participants in a coherent, compatible manner, andinter-operability between the buy side and the sell side is ensured. In
addition, it is important to set a time limit for each stage of data processing,as well as to have codes of practice.
(3) Improving market rules and practices(a) An infrastructure to facilitate efficient transactions and settlements
A. Swift confirmation of the amount of funds/stocks which securities firms
borrow from securities finance companies in loan transactions
It is necessary to review the administrative procedures at securities financecompanies, namely their handling of securities firms' applications for loansof funds and stocks.
B. Developing a stock borrowing/lending market
On the trading day, T+0 stocks should be available, after the clearance of the
day's transactions, in a stock borrowing/lending market for next-day
settlements. With T+1, the settlement period, specifically at CSDs, should be
kept as long as possible.
C. Developing a T+0 bond repo market
To facilitate T+1 settlements of bond transactions, it is essential to develop a
T+0 repo market with sufficient liquidity.
D. Rules for failed settlements
Rules for failed settlements must be in place to allow deferred deliveries, atappropriate costs, for technical/temporary settlement failures, rather thanautomatically treating any settlement failure as a default.
E. Revising the procedures of correcting executed orders

In a T+1 settlement environment, it is difficult to handle requests forcorrection of executed exchange orders because of time constraints. Thus, a
new set of procedures must be developed to accommodate legitimate
requests to the greatest extent possible.
F. Extending operating hours of settlement systems
Operating hours of securities/fund settlement systems, such as the BOJ Net,the Zengin system, the JB Net and those at CSDs, should be extended.
(b) Developing rules and practices for non-resident transactions
A. Developing a global electronic confirmation system
Market intermediaries should have electronic, seamless procedures forhandling non-resident transactions.
B. A round-the-clock confirmation system
It is necessary to develop an electronic, 24-hours-a-day settlement
confirmation system so that confirmation can be done anytime with global
custodians from various time zones.
C. Payments in foreign currencies
Arrangement should be made for payments in foreign currencies to beconverted to yen on the same day.
(c) Promoting the use of CSDs
A. Incentives to promote deposits with CSDs
Custody/transfer costs and deposit fees need to be lowered so that deposits
with CSDs can be further promoted.
B. Collateral transactions through CSD accounts
Some banks have recently begun to use CSD transfer for collateraltransactions, instead of physically taking certificates from borrowers. Suchuse of CSD transfer should be further encouraged.
C. Advance deposit
Deposits of funds/securities prior to making buy/sell orders should be
mandatory.

D. Physical deliveries of certificates
As physical deliveries are incompatible with T+1, they must be ruled out in a
T+1 settlement regime.
E. Lottery-based redemption of bonds
Current administrative procedures of such redemption of bonds should be
reviewed, as it is in part treated manually.
III. Achieving DVP
1. Current Analysis and Approaches to Achieving DVP(1) Current Analysis by Product(a) JGBs
Currently, both funds and securities are settled on a net basis through the
BOJ Net, and virtually all settlements occur at 3:00 p.m. By the end of
2000, an RTGS-based DVP model will be introduced. In our discussions,the following views were presented by our participants:
A.

B.

It is hoped that a clearance institution will provide a netting
and guarantee function. Also, the legal status of such an
institution should be clarified.
To secure enough intra-day funds, participants of the
BOJ-Net might be obliged to use the "SPDC" (simultaneous
processing of DVP and collateralization) function for
non-proprietary transactions. Consequently, the existing
collateral law should be amended so that participants of the
BOJ-Net can use customers' JGBs as collateral.

(b) Non-JGB bonds
Currently, a quasi-DVP scheme is adopted, where securities aretransferred on a gross basis, while funds are settled on a net basis(designated-time settlements at 3:00 pm). In our discussion, following
views were presented:

A.

B.

With appropriate safeguards, a DVP model of grosssettlements for securities and net settlement for funds should
be adopted for non-JGB bonds that is compatible withsettlement schemes for other types of products. (Some of ourmembers insist that instead of seeking compatibility indesigning DVP models, attention should be paid to thedifference in the nature of individual products and market
participants.)
It is hoped that a clearance institution will provide a netting
and guarantee function. In addition, further study is needed
regarding the range of products that such an institution covers(i.e., only corporate bonds, or other products as well.)(c)Equities<Settlements of exchange transactions>
Currently, settlements are not on a DVP basis. Instead, stock
exchanges (the Tokyo and Osaka stock exchanges only) guarantee thecompletion of settlements as the central counterparties. The two
exchanges have decided to adopt a DVP scheme, where both securities
and funds are settled on a net basis, in the first half of 2001. In our
discussions, following comments were made: 1) in addition to netting
at each exchange, re-netting should be done for multi- listed stocks, and2) funds for both exchange- and Jasdaq transactions should be jointly
settled on a net basis.
<Settlement of Jasdaq market transactions>
Currently, settlements are not on a DVP basis. Study is now in progresswith regard to developing a clearance function and establishing acontingency fund. A DVP scheme, where both securities and funds aresettled on a net basis, should be introduced.
<Settlement of other transactions (general, or non-exchange,transfers)>
Currently, settlements are not on a DVP basis. A new settlement
scheme is being studied, where securities are settled on a gross basis

and funds are settled on a net basis. In our discussions, the following
comments were made:A. The Depository and Book-Entry Transfer of Securities Law should
be amended so that settlements of funds can be done at CSDs.
B. For efficient transfers, securities held in non-resident customers'
accounts should be available for use as collateral.
C. The administrative procedures for handling two types of book-entry
transfers at a CSD, namely market transfers and general transfers,
should be streamlined, as both deal with the same types of
exchange-listed securities.
d) Investment Trust beneficiary securities
Currently, settlements are not on a DVP basis. In our discussions,the following views were presented:
A. A DVP model should be adopted, where securities are settled on agross basis and funds on a net basis. In addition, a clearancefunction should be provided.
B. We are divided as to who should handle the settlements. Someargue that all settlements should be done at a single CSD, whileothers insist that it would be better to use the existing settlement
institutions.
e) Commercial Paper (CP)Currently, settlements are not on a DVP basis. In our discussions,following views were presented:
A. Dematerialization of CPs should take place ahead of other products,
instead of waiting for comprehens ive legislation that enables
dematerialization of all types of securities certificates.
B. We are divided on the model for settlements. Some argue that bothsecurities and funds should be settled on a gross basis, as theaverage size of CP transactions is very large. Others insist that amodel of gross settlements for securities and net settlement for
funds is preferable, and that a clearance function should be
introduced.
C.CP settlements should be handled by a single CSD.
(2) Common prerequisites for introducing DVP
Common prerequisites for introducing DVP are:(a) Development of a comprehensive settlement confirmation system(b) Legislative incentives to promote a shift to dematerialization andbook-entry transfers
２．General Issues Regarding the Introduction of DVP(1) Measures against risks that arise from netting
As netting accompanies systemic risks, it is necessary to minimize therisks by employing the following safeguards:(a)Collateralization: Further study is needed regarding thecompatibility between collateralization in net settlement models
and the existing collateral law.
(b)Cross-products use of collateral: The use of collateral should becoordinated across settlement systems (some of our members,
however, insist that attention should be paid to the difference in thenature of each product).
(c)Reserve fund: Adequate sources of liquidity are needed so that notransfer need be unwound even in the event of a participant's failure
to complete settlements.
(d)Net debit position: It is important to set a limit on a participant's net
debit position.
(e)Membership criteria: Criteria for admission to a netting systemshould be carefully developed.
(f)Safeguards for each settlement system: In implementing safeguards,
attention should be paid to the difference in the nature of eachproduct, etc.

(2) Settlement Times(a) Settlement times should be coordinated across systems. It should
be noted, however, that doing so might augment systemic risks.
(b)To facilitate an uninterrupted sequence of securities deliveries
across settlement regimes, arrangements should be made for thosesettlement systems that use the same DVP model of grosssettlements for securities and net settlement for funds.
(3) Rules for Failed Settlements
Standard industry rules should be developed for the treatment offailed settlements.
(4) Securities Borrowing/Lending
Securities borrowing and lending should be further utilized.
(5) Extensive Payment Netting(a) A common DVP model and netting method
A. A DVP model of gross settlements for securities and net settlement
for funds should be implemented for trade settlements of all
products other than exchange- and Jasdaq traded equities and JGBs.
In doing so, it is essential to make sure in advance that proper
safeguards are in place. We are divided on the applicability of sucha DVP model to CP transactions, as some participants insist thatboth securities and funds should be settled on a gross basis, notingthat the average size of CP transactions is large.
B. We are divided on the range of payment netting arrangements.
Some argue that payment netting should be coordinated as
extensively as possible. Others remain skeptical of sucharrangements, given the difference in the nature of eachproduct/market, and insist that a cost/benefit analysis of sucharrangements is needed.
C. We are yet to decide who will perform netting (i.e., any existing
clearance/settlement institutions, or a new institution to beestablished specifically for that purpose). In addition, we will needto look into the possibility of mergers/alliances of the existing
clearance institutions.
D. For efficient use of funds and collateral, a single settlement systemshould handle as many types of securities as possible, as long as
these securities' trades are settled under the same DVP model ofgross settlements for securities and net settlement of funds. (Someof our members argue, in contrast, that such an arrangement is
disadvantageous, because of the difficulty in dealing with various
types of risks that arise from the different characteristics of eachproduct/market.) Before making such an arrangement, it is essential
to make sure that proper safeguards are in place.
(b) Mergers/alliances of the existing clearance institutions
To enable extensive payment netting, it is necessary to encourage
mergers/alliances of the existing clearance institutions, and thelegal status of such institutions should be clarified. (It should be
noted, as some members insist, that methods of managing risks
vary from one product to another.)(c) Safeguards against systemic risks
Proper safeguards should be employed to prevent systemic risks.
3. Other Issues for DVP(1) Non-participant issues
For the benefit of those institutional investors who use banks (BOJ-Net
participants) to settle payments, it is important, in an RTGS settlement
environment, to give them an opportunity to confirm their intent of buying
securities, and the ability to control timing of payment/receipt of funds.
(2) The need for case studies
It is useful to study how settlement times are coordinated in othercountries, and how participants in these markets manage funds forsettlement.
IV. Remaining Issues in the Reform of the Securities Clearing/Settlement System

In our discussions, the following issues were pointed out as important and needing
further study.
1. Non-JGB bonds
As noted previously, there are a couple of ways to implement a new bond recording
system in which depositories' names are registered in lieu of those of beneficiary
creditors. They are, namely, a "multi-depository" method and a "single depository"
method.
Further discussion is needed to reach a consensus on this issue. In making a decision,
we should consider the following: the increasing number of market participants; theincreasing trading volume; globalization of transactions; possible alliances withforeign CSDs; depositories’ qualifications; costs of running a new system; duration
for developing a new system; and protection for good- faith acquirers. In addition,
we will need to pay attention to the discussion at the "Working Group on Reform of
the Securities Settlement System" under the First Committee of the Financial
System Council.
2. Developing a Confirmation System to Facilitate STP
To facilitate STP in a new securities settlement/clearing system, it is essential todevelop a confirmation system which electronically links market intermediaries. In
doing so, a system protocol must be standardized and inter-operability be ensured asin other countries where multiple providers compete to offer better STP services.
Furthermore, a timetable for each stage of data processing should be formulated,which users of a new STP system must follow.
3. Clearance and Clearance Institutions
A clearance system should have a well- founded legal basis, specifically with regard
to netting and collateralization. In addition, it should ensure adequate sources ofliquidity and set a cap on a participant's net debit position. As for a securities
settlement system without clearance, it is imperative to set up a clearance institution.
We should, as previously discussed, look into the possibility of mergers/alliances ofthe existing clearance institutions and extensive payment netting. In doing so, a
cost/benefit analysis must be performed, and attention sho uld be paid to the differencein the nature of individual products and market participants. Regarding settlements of
JGB transactions, new market practices such as bilateral netting are being developed
to facilitate efficient settlements in an RTGS settlement regime, scheduled by the endof 2000. However, in light of an expected jump in JGB issues in the future, we will
also need to consider establishing a clearance institution.