Special Feature

S P U R R I N G G R E AT E R
CONFIDENCE IN
T H E J A PA N E S E M A R K E TDVP

Reform of the securities settlement system has become an urgent
priority in Japan. Dematerialization—paperless securities—and thereduction of settlement risks paralleling shorter settlement periods

have gained favor in global financial markets. It is therefore important to Japan to establish integrated STP schemes linking a DVP
system to the PSMS. JASDEC is also working on its own securities

settlement system to enhance the reputation of the Japanese marketin the eyes of overseas investors.

PSMS

Electronic CP
7

Special Feature

Pre-Settlement Matching System
The move toward STP for securities settlement has acquired greater urgency as a means of reducing settlement risks and lowering costs. The indispensable steps toward implementing STP inJapan are the introduction of the PSMS and the creation of a DVP system that links to the PSMS.
Expanding PSMS to handle DVP for non-exchange transaction deliveries

The third phase of the first stage in our development of the PSMS, which went online in May
2003, has expanded the system to cover transactions for government bonds and stock
exchange–traded futures and options. We also added a transmission function that routes net asset
value on investment trusts as well as information on the subscription and redemption of such
trusts by investment trust management companies to trust banks.
In the second stage, we will be working to connect the system to DVP for non-exchangetransaction deliveries (NETD). Once linked, PSMS-generated instruction data on settlements will
be relayed to the DVP system automatically, obviating the need to input instructions through a sepCONTROLLING RISKS IN THE DVP FOR NETD
arate step and bringing the settlement process to a
We are preparing several schemes for the DVP
smooth conclusion.
system, based on a risk-control perspective.

DVP for NETD
W e plan to apply a gross–net type DVP settlement system that links book-entry transfer ofstocks and other securities with payment of funds,
based on settlement instruction data generated by
the PSMS. Under this structure, each book-entry
delivery of securities will be processed on a tradefor-trade—or gross—basis, while payment offunds will be made on a net basis, wherein eachparticipant pays or receives at the end of the day
the balance that remains when payable amounts
for receipts of securities and receivable amounts
for deliveries of securities are offset.
Connecting the PSMS and the DVP for
NETD will mark a major step forward in realizing
STP for securities settlement in Japan.

1. PRINCIPAL RISK MANAGEMENT: We will limit riskby having our clearing subsidiary hold assets foreach DVP participant that exceeds the balanceowing by that DVP participant.
2. LIQUIDITY RISK MANAGEMENT: We will establish
participant funds and credit lines with banks to maintain an appropriate level of fund liquidity and offset
possible participant default on final payment. To
avert a shortfall in fund liquidity, we have set a netdebit cap for each DVP participant.
3. PARTICIPANT MANAGEMENT: We will require DVP
participants to meet certain financial criteria, andwe will watch for any change in status.
* We will establish a clearing subsidiary to executefund netting with participants, thereby separating
the netting function from our book-entry functionand ensuring compliance with rules for risk management and netting.

Pre-Settlement Matching System (PSMS) This system electronically matches information, such as trade reports and investment instructions, on trades and settlements among institutional investors, securities firms, trust banks and other entities, once stock certificates or othersecurities have been traded.

Delivery versus payment (DVP) This system establishes a strong connection between the delivery of and payment for securities.
International standards, recommended by the G30 and other organizations, require the use of a DVP system in all securities settlements toeliminate settlement risk.

8PROGRESS ON PSMS AND
DVP SYSTEMS
2001 May DVP for exchange tradetransfers begins.
September First phase of firststage of PSMS implemented.
(Covers stock transactions bydomestic institutional investors.)

2002 February Second phase of
first stage of PSMS implemented.
(Covers convertible bonds, initial offerings
and trades by nonresidents.)
2003 May Third phase of first stage of PSMS
implemented.
(Covers government bonds and stock
exchange traded futures and options.)
2004 May Anticipated start of DVP for NETD.

LINKING PSMS AND DVP SYSTEMS
Pre-Settlement Matching System
Trade Matching
Delivering
Participant

1
DVP book-entry
transfer request

SSISettlementMatching

1
DVP book-entry
transfer request

Receiving
Participant

2 Settlement instructions

DVP Book-Entry Transfer System for Securities
ParticipantA
Account

Execution

JDCC
3Account
Conditions for Executing
Book-Entry Transfer of Securities–Securities balance is sufficient.
–Net debit cap is not exceeded.
–Assurance asset monitor remains positive.
If all conditions have been satisfied, stocks
will be delivered to the JDCC account.

Completion

Participant

7
B
Conditions for Completing
Account
Book-Entry Transfer of Securities–Delivery conditions are met.
–Net receivable amount is confirmed.
–Payment of balance owing is completed.
If any condition has been satisfied, thestocks will be delivered to the receiver's account.

Book-entry transfer of securities executed/completed according to instructions
Funds recorded by netting/recording value of settlement based on book-entry of securities
4 Transmit settlement value (net owing)

BOJ Financial Network System
ParticipantA
Account

Payment
6JDCC
Account

Payment
5

Funds received by book-entry transfer of settlement amount.
Notes: 1.Approval from BOJ required to use the BOJ Financial Network System.
2. Assurance asset monitor = Value of assurance asset — Net debit
3. JDCC: JASDEC DVP Clearing Corporation, a subsidiary of JASDEC.
4. SSI: Standing Settlement Instructions.

9Participant
BAccountSpecial Feature

Preparing to Handle Corporate and Municipal Straight
Bonds and Investment Trust Beneficiary Rights
JASDEC is studying approaches for handling corporate straight bonds and local government
bonds, as well as investment trust beneficiary rights in 2005.
Corporate and Municipal Straight Bonds

In Japan, registering agencies, which number about 150, are used to settle the majority of corporate bond transactions through registration. These agencies execute the required book-entry
transfer and essentially dematerialize the securities into registered bonds. In January 2003, introduction of the Transfer of Corporate Debt Securities Law enabled a new system for corporate andmunicipal straight bonds (SBs).
This law confirms the trend toward paperless securities and consolidates SB settlement
operations with JASDEC, wherein the Company is the sole book-entry transfer institution for SBsettlement. To execute this duty, we will adopt a book-entry transfer system for SBs to realize aDVP system and take us one step closer to the use of STP for securities settlement in Japan.
Through these efforts, we aim to raise SB liquidity, enhance settlement efficiency, and set the stage
for shorter settlement periods in the future.
Discussions in our Subcommittee on Corporate and Municipal Straight Bonds led to an
implementation document for a book-entry transfer system for SBs. The document addresses thescope of eligible bonds; the participation format for interested parties; the content of the bookentry transfer account ledger; the procedures for issuing, transferring and redeeming bonds; bondsettlement methods for all DVP systems; payment methods for principal and interest; andschemes for switching outstanding bonds to the new system.
We will utilize this document as a guide to determine book-entry operations and todevelop the appropriate computer systems.

Investment Trust Beneficiary Rights

The basic legal framework for a book-entry system applied to investment trust beneficiary rights
is similar to that applied to commercial paper (CP) and SBs. We will dispense with processes previously deemed necessary to accommodate certificated beneficiary rights, and we will utilize
book-based records on such aspects of investment trusts as subscription, transfer and redemption
to streamline book-entry operations.
Our Subcommittee on Investment Trusts is discussing the scope of eligible investment
trusts, the procedures for establishing, distributing and redeeming investment trusts, the application of DVP for each type of investment trust, procedures for handling earnings dividends, andmethods to ensure that the pool of some two million beneficiary certificates already issued will
make a smooth transition to the new system.

Registered Bonds The Corporate Bond Registration Law (1942) allows a registering agency to register municipal and corporate
bonds on the registry that the registering agency maintains so investors may settle transactions without bond certificates.

10

TRANSITION SCHEDULE FORCORPORATE AND
MUNICIPAL STRAIGHT BONDS
2003

January 6 Transfer of Corporate Debt
Securities Law goes into effect.
(Abrogation of the Corporate Bond
Registration Law expected within five
years of the new law’s implementation.)

2005

Second half of 2005 JASDEC plans

start of book-entry transfer system forSBs.
2006–07

Registered bonds already in issue will bechanged to book-entry bond status.

2008

January 5 Temporary grace period

applied to interest income tax onregistered bonds ends.
(No more registered bonds will be issued.)

TRANSITION SCHEDULE FOR EXISTING REGISTERED BONDS

The Corporate Bond Registration Law, which regulates existingregistered bonds, will be abolished by January 5, 2008. JASDEC isthus working toward the start of book-entry transfer of new corporate and municipal bonds in the second half of 2005. We willthen establish a transition period lasting about two years during
which we anticipate trouble-free conversion of existing bonds
from registered status to the book-entry status used in our system.

11

Special Feature

Creation of Book-Entry Transfer System
for Electronic Commercial Paper
On January 10, 2003, JASDEC was designated as a book-entry transfer institution, under theTransfer of Corporate Debt Securities Law. The Company launched a book-entry transfer system
for CP on March 31, 2003.
The development of a book-entry transfer system for dematePROMOTING ELECTRONIC
rialized CP was prompted by a strong appeal from companies using
COMMERCIAL PAPER
CP to procure funds. JASDEC began discussions on such a system
As of June 30, 2003, the book-entryin January 2002, first identifying the primary points of a system fortransfer system for electronic CP
CP and then moving on preparations for implementation, including
covered 85 issues, and the accountthe creation of computer systems.
balance stood at ¥424 billion. We plan
CP in the conventional paper form, or paper-based CP, is preenergetic marketing and promotional
pared in certificates of certain denominations, and these certificates
campaigns, including informationmust be delivered or presented to the assigned holder at settlement.
forums and advertisements, toOur system, however, dematerializes CP, from issuance throughencourage more issuers and investors
redemption, and records ownership and transfer of rights in a transto utilize electronic CP.
fer account book. The use of “paperless” or “electronic” CP shortens
the settlement period, removes the risks inherent in transporting
certificates and eliminates the cost of safekeeping the certificates—
all drawbacks of paper-based CP.
The book-entry transfer system for CP utilizes
a gross–gross-type DVP settlement system. This feaFEATURES OF THE BOOK-ENTRY
ture makes settlement safer and more efficient thanTRANSFER SYSTEM FORwith paper-based CP.
COMMERCIAL PAPER
Paper-based CP is also hampered by a limited
assortment of denominations in circulation,
SHORTER
IMPROVEDSETTLEMENTCIRCULATION
because the stamp duty that is charged on each cerPERIOD
Circulation inNo need to produce,tificate encourages issuers to cut the burden of costsmaller denominationsdeliver or present
possibleby issuing large-denomination certificates.
certificatesElectronic CP circumvents this restriction, allowing
the issue and transfer of CP in smaller denominaELECTRONIC
tions and thus presenting greater investment flexiDVPREDUCED COSTSCPSETTLEMENTbility.
No space needed
Simultaneousfor safekeeping
The current paper-based CP market counts ansettlement of cash
certificatesand CP possible
average issuing balance of slightly more than ¥20
REDUCEDtrillion. JASDEC expects remaining paper-based CP
DELIVERY RISK
to be converted into electronic CP soon.
Avoidance of loss
and theft

Commercial paper in Japan CP is issued by companies as a measure for procuring unsecured short-term funds. To date, in Japan,
only companies with a rating for CP above a set mark have been able to issue CP in the form of promissory notes of less than one
year in duration and more than ¥100 million in value. Under the Transfer of Corporate Debt Securities Law, CP is viewed as a shortterm corporate bond rather than a note, and processing, from issuance to redemption, is handled electronically through JASDEC’s
computer systems.

12

MILESTONES IN HANDLING ELECTRONICCOMMERCIAL PAPER

2002 April 1 The Law Concerning Transfer ofShort-Term Corporate and Other Debt
Securities was introduced
2003 January 6 The law was amended andrenamed the Law Concerning Book-Entry
Transfer of Corporate and Other Debt
Securities (Transfer of Corporate DebtSecurities Law)
January 10 JASDEC was designated as atransfer institution under the Transfer ofCorporate Debt Securities Law
March 31 JASDEC commenced book-entry
transfer services for commercial paper

Electronic CP Book-Entry
Transfer System
Issuing Flow
CPIssuer(Includingissuing agent)

1
Application forissue

6 Fund transfer
execution report

FundSettlement
Corporations
Including financial
institutions

JASDEC
TransferAccountBook
New record on
6 investor’s acccountFund transfer 5
execution notice

5Fund transfer
execution noticeBank of Japan

132
Notice of CP issueand fund settlement
dataInvestor

Fund settlement 3
data report

4
Fund transfer
requestFundSettlement
Corporations
Including financial
institutions