28 November, 2013
Secretariat of the Financial Stability Board
c/o Bank for International Settlements
CH-4002
BASELSwitzerland
Submitted by e-mail: fsb@bis.org
Dear Secretariat
Second Consultative Document: Strengthening Oversight and Regulation ofShadow Banking – Policy Framework for Addressing Shadow Banking Risks inSecurities Lending and Repos
1. Introduction
The Japan Financial Markets Council (JFMC)1 is grateful for the opportunity tocomment on the Financial Stability Board’s (FSB) second consultation on theregulation of shadow banking with respect to risks in securities lending and repos.
The JFMC is supportive of the FSB's objective to introduce proportionate
regulation to tackle financial stability risks posed by the shadow banking system
whilst also recognising the important role these markets play to the wider
financial system.
We note and welcome the changes and the developments that the FSB has madein response to the first consultation and how the policy recommendations havebeen refined to include proposals to exempt government collateral, which is ofparticular interest to market participants in Japan. We believe the first QIS was auseful step to help understand market practice that helped shape the proposals.
We are also supportive of the FSB prioritising improvements in data transparency,
1

The JFMC is an association which includes representatives from five Japan-based institutions and five internationalfirms active in Japanese capital markets. Its aim is to ensure that authorities deciding on regulatory initiatives that have aglobal impact are aware of and take into account the effect of new regulations on Japanese capital markets. The current
JFMC members are: Bank of Tokyo-Mitsubishi UFJ, Daiwa Securities Group, Mizuho Securities, Nomura Holdings, SMBC
Nikko Securities Inc, BNP Paribas, Citigroup Japan Holdings Corp, Deutsche Bank Group, JPMorgan Securities Japan Co.,
Ltd. and Morgan Stanley Japan Holdings. The co-chairs of the JFMC are the representatives from Morgan Stanley andNomura.

which will allow well-founded assessments to be made of any buildup of risks tofinancial stability.
We do however believe that some of the issues highlighted in our response to thefirst consultative document remain valid, including some of our thoughts related
to minimum standard for haircut methodologies and numerical floors on haircuts
and the potentially negative impact on available liquidity.2
Securities lending and repos are a key source of liquidity for the global financial
markets and the Consultative Document also makes this point. We therefore
need to ensure that we do not take actions that might impede the supply of thisliquidity, but we believe this could be the case with the current proposals as theywould apply to the wider market and at a transactional level. In the worst casescenario, the minimum standard for haircut methodologies and numerical floors
might cause considerable disruption to market practices and distort incentives formarket participants, resulting in increased, rather than decreased, risk.
2. Difficulties in applying minimum standards to haircut methodologies
The consultative document calls for regulatory authorities to introduce minimum
standards for the methodologies that firms use to calculate haircuts. This, theproposal suggests, is key to minimising the pro-cyclicality of securities financing
and repo transactions. But, to the extent that liquidity is likely to suffer under theproposal, the JFMC has significant questions over whether such methodologies
are practical or how effective they would be in reaching the stated objectives.
A standardised calculation of methodologies may appear attractive from atheoretical perspective but in practice there are a number of problems. Market
participants are diverse and include banks, brokers, funds, investors and anumber of other categories of market participants. They have varying levels ofresources and expertise, as well as varying levels of access to historical data; it isdifficult to envision the application of a single standard across all categories ofparticipants. The detailed requirements proposed in the consultation, call for amethodology based on historical priced data from a period spanning a number of

JFMC response to FSB’s first consultative document on Strengthening Oversight and Regulation of Shadow Banking (seewww.japanfmc.org)
22years and including “at least one stress period”; this is rather vague and leaves toomuch to subjective interpretation.
There are also questions as to whether sufficient market data will be available toall participants. If this were not the case it could create an uneven playing field.
The resulting distortions could restrict trading, hurt liquidity, and ultimately drive
participants away from collateralised funding toward much riskier un-secured
funding and thereby run counter to the goals of consultative document to reducerisk.
The JFMC understands that qualitative guidelines may lead to better risk
modeling. But securities lending and repo transactions are privately-negotiatedtransactions between independent parties exercising their own discretion andjudgement. Often that judgement is based on each counterparties’ unique
circumstances, including levels of credit quality. Any distortion of this pricesetting mechanism, however well intentioned, may cause confusion, create
inefficiencies and ultimately force participants to restrict or terminate trading
thus reducing liquidity in this crucial market and drive participants to riskier
alternatives.
Ultimately, if what might appear to be arbitrary minimum standard
methodologies are applied, it may result in a majority of securities financing andrepo transactions being concentrated amongst a handful of high quality players. It
is not clear to the JFMC how this plausible scenario, including the likely reduction
in liquidity from the market as a whole, can be reconciled with the goal ofreducing risk.
3. Scepticism of the impact of numerical floors on haircuts
We understand the proposal is to reduce the pro-cyclical effect during periods ofstress by limiting the buildup of leverage in the system through the introductionof numerical floors on haircuts. We also believe the numerical floors proposed in
the consultation are fair and reasonable, and fully support the exclusion of
government securities entirely from such calculations.
However, we remain sceptical that such numerical floors can be effectively
introduced without significant pitfalls and a resulting negative impact on market

3confidence. The introduction of minimum haircuts would effectively force one
side to the transaction to take on more exposure than the counterparty mightdeem adequate given considerations such as market conditions or counterparty
credit quality. That would result in the counterparty either limiting transactions
with the most credit-worthy partners, which may cause an overconcentration inthe market and a buildup of interconnectedness between counterparties, orrefraining from trades all together. Alternatively, it might drive a participant tothe unsecured funding market. Either way, liquidity will suffer, and participants
will face more difficulty raising funds and managing this risk in their portfolios.
If the FSB believe minimum haircuts are absolutely necessary, we would
encourage that the introduction of such a regime – including the calculation of asupervisory haircut – should be conducted through the Basel Committee on
Banking Supervision (BCBS) or other capital regulatory standard setters. The
proposals may have an impact on the how the Basel regime treats securities
financing transactions and therefore the appropriate authorities should assess
the current capital rules when considering any amendments so as to avoid any
duplication or negative effects caused by cumulative actions. Standard settersshould also use QIS data and accumulated experience of Basel regulations toestimate the overall impact on the market in making their recommendations.
4. Greater clarity on interaction with other regulations
In introducing new regulations, it is always important to gauge how they will workin tandem with existing requirements and the potential impact of overlaps orunintended consequences.
There are a number of areas where some further clarification to the proposals
would help market participants to assess the possible impact including:·Whether the minimum methodological standards and a numerical haircut
floor are being considered alongside each other and how these two
proposals would interact. For example, if the scope of the haircut, ascalculated under the standard methodology, is wider than the numericalfloor what actions might participants need to take? Should the scope of themethodologies match the scope of numerical haircuts?

4·Whether government bonds, which may not be in scope for numericalhaircut floors, are being considered as part of the minimum standard
methodology.

·The definitions used for the scope of the application of the haircuts (e.g.
“entities subject/not subject to regulation of capital and liquidity/maturitytransformation” and “regulated intermediaries”).

·

Whether the proposal of numerical floors for haircut is intended to be
implemented through the regulatory capital regimes for regulatedintermediaries or minimum margin regimes for regulated intermediaries.

We would welcome further clarification on the above items so that an effective
dialogue can be held between standard setters and the industry in producing asensible regulatory framework.
5. Government bonds and other non-government collateral
Finally, we would like to highlight our concern on the impact of the proposal onhigh quality collateral assets, including government securities. The new global
regulatory landscape , including reforms such as the Basel III liquidity coverage
ratio and margin requirements of non-centrally cleared derivatives, are creating aheightened demand for these types of assets.
The JFMC is grateful that a number of exemptions from the scope of proposed
numerical floors, including government collateral, have been put in place. But webelieve that transactions backed by government securities should also beexcluded from the proposed minimum methodological standards requirements.
As stated in our response to the first consultative document, applying minimum
methodological standards and numerical floors on haircuts to liquid government
bond markets is likely to have a significant negative impact on the liquidity of therepo and securities lending markets. This could result in a number of unintended
consequences, including the possible disruption of market operations of central
banks which might ultimately have an impact on the cost of funding bygovernments.

5Market conditions for non-government collateral, such as corporate bonds,
securitisation products and equity, vary considerably across jurisdictions; thisincludes the liquidity available, the size and depth of market, and also the stage ofmarket development and market conventions. We therefore encourage the FSB
to make an assessment of the potential impact of the proposals on different
markets. It is important to avoid a situation in which a well-intentioned regulationfor one market leads to unintended consequences in another. Liquidity within theJapanese market for non-government bonds remains weak and transaction
volumes are low. Market participants are therefore trying to improve liquidity
and encourage the development of the market; introducing measures that might
dampen this activity could have wider negative impacts.
6. Conclusion
In summary, the JFMC is pleased that the FSB has revised its policy
recommendations to limit the scope of numerical haircut floors including theexemption of government collateral. We also welcome empirically-based policy
making. We do however have considerably doubts about applying minimum
standards to haircut methodologies and the numerical haircut floor as we believe
a number of risks to financial stability could build up. We therefore urge the FSB
to look again at this area. Further clarity on a number of points as set out above
would also be helpful for market participants to assess the impact of theproposals. If you have any queries about any of our comments we would be happy
to provide further information.
Yours faithfully,

Jonathan B. Kindred
Shigesuke Kashiwagi
Co-chairs of the Japan Financial Markets Council

Contact: International Bankers Association (IBA Japan): Paul Hunter
Telephone +81 (0)3-6225-2211

E-mail g-info@ibajapan.org

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