Special Feature

ONGOING SECURITIESSETTLEMENT SYSTEMR E F O R M I N J A PA N

The implementation of a DVP system for NETD, including stockcertificates, marked the halfway point for securities settlement system reform in Japan. The next challenge is to introduce changes
geared toward the ultimate goal of dematerializing stock certificates.
The following section highlights JASDEC’s efforts in this area, specifically the DVP for NETD launched in May 2004 and the special features and structure of the book-entry transfer system for straightbonds that is scheduled to go online in January 2006.

99Special Feature

SYSTEM IMPLEMENTED MAY 2004

DVP for NETD

PROGRESS ON
PSMS AND DVP
SYSTEMS2001
May DVP for exchangeBASIC STRUCTURE

trade transfers begins.
DVP for NETD is a gross-net-type DVP settlement system that links book-entry transfer of stocks and other securities
September First phasewith payment of funds, based on settlement instruction data produced byof first stage of PSMS
the pre-settlement matching system (PSMS). With this type of system,
implemented.
book-entry delivery of securities is processed on a trade-for-trade — orCovers stock transactions
gross — basis, whereby at the end of the day each participant pays orby domestic institutional
receives the balance that remains when payable amounts for receipts ofinvestors.
securities and receivable amounts for deliveries of securities are netted out.
These procedures, already adopted by the Depository Trust & Clearing Corporation, effectively
reduce securities settlement risk and facilitate efficient processing of numerous settlements.
Connecting PSMS and the DVP for NETD represents the last step on
the road to achieving STP for securities settlement in Japan. Once the twoJASDEC DVP CLEARING CORPORATION
systems are connected, PSMS-generated instruction data on settlements
In June 2003, we established JDCC as
will be relayed to the DVP system automatically, obviating the need to input
a wholly owned subsidiary to provide
instructions through a separate process and bringing settlements to their
DVP settlement services. In April 2004,
respective quick conclusions.
the company was licensed as a securities
CONTROLLING RISKS IN THE DVP FOR NETD Controlling
clearing agency to undertake securities
risk in the DVP for NETD is a priority for us. Major risk-management
obligations, in accordance with theefforts are outlined below.
Securities Exchange Law, and it launched
1. Principal Risk Management: We will limit risk by having our clearing
DVP settlement services for NETD insubsidiary hold assets for each DVP participant that exceeds theMay 2004.
balance owing by that same DVP participant.
LOCATION: TokyoDATE OF INCORPORATION: June 6, 2003
CAPITALIZATION: ¥310 million
SHAREHOLDER: Japan Securities
Depository Center, Inc. (100% equity)
PRESIDENT AND CEO:Yoshinobu Takeuchi
NUMBER OF EMPLOYEES:Four directors (including one auditor)and eight full-time staff
BUSINESS CONTENT: Undertaking
securities obligations and providing
supplementary and related services.

2. Liquidity Risk Management: We will establish participant funds andcredit lines with banks to maintain an appropriate level of fundliquidity and to offset possible participant default on final payment. To
avert a shortfall in fund liquidity, we have set a net debit cap for each
DVP participant.
3. Participant Management: We will require DVP participants to satisfy aset standard for management soundness, such as a certain capital
adequacy ratio, and will monitor each participant against this standard
for any changes in status.
4. JASDEC DVP Clearing Corporation (JDCC), our recently establishedsubsidiary, ensures thorough legal compliance with rules for risk
management and netting.

Pre-Settlement Matching System (PSMS) 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 in Japan are the introduction of a PSMS
and the creation of a DVP system that links to the PSMS. The PSMS is a system that electronically matches information related to trades
and settlements among institutional investors, securities firms, trust banks and other entities once stock certificates or other securities havebeen traded.
Delivery versus payment (DVP) A system that simultaneously attaches specific conditions to the delivery of and payment forsecurities. International standards, recommended by the G30 and other organizations, require the application of a DVP system toall securities settlements to eliminate settlement risk.

102002

2003

2004

February Second

May Third phase of
first stage of PSMS
implemented.

May DVP for
NETD went online.

phase of first stage ofPSMS implemented.

Covers convertible
bonds, initialofferings and tradesby nonresidents.

Covers government
bonds, and listed
futures and options.

Pre-Settlement Matching System
Trade Matching

Delivering
Participant

1
DVP book-entry
transfer request

SSISettlement

1
DVP book-entry
transfer request

Receiving
Participant

LINKING PSMS
AND DVP SYSTEMS
Matching

2 Settlement instructions

DVP Book-Entry
Transfer System for Securities

ParticipantA
Account

Execution
Completion
Participant
JDCC
37B
Account Conditions for
Conditions forAccountExecuting Book-Entry
Completing Book-Entry
Transfer of Securities
Transfer of Securities–Securities balance is sufficient.
–Delivery conditions are met.
–Net debit cap is not exceeded.
–Net receivable amount is confirmed.
–Assurance asset monitor–Payment of balance owing
remains positive.
is completed.
If all conditions have been
If any condition has beensatisfied, stocks will besatisfied, the stocks will bedelivered to the JDCC account.
delivered to the JDCC account.
Book-entry transfer of securities executed/completed according to instructions
Funds recorded by netting/recording valueof settlement based on book-entry of securities
4 Transmit settlement value (net owing)

BOJ Financial Network System

Participant
AAccount

Payment
6JDCCAccountPayment
5Participant
BAccount

Funds received by book-entry transfer of settlement amount.

Notes: 1. Assurance asset monitor = Value of assurance asset — Net debit
2. JDCC: JASDEC DVP Clearing Corporation, a subsidiary of JASDEC
3. SSI: Standing Settlement Instructions

11Special Feature

NEW BOOK-ENTRY TRANSFER SYSTEMCORPORATE AND MUNICIPAL STRAIGHT BONDS
SOLE BOOK-ENTRY TRANSFER INSTITUTION FOR STRAIGHT BONDS In Japan,registering agencies, which number about 160, are used to settle the majority of corporate bondtransactions through registration. These agencies execute the required book-entry transfer and essentially dematerialize the securities into registered bonds. In January 2003, introduction of The Law
Concerning Book-Entry Transfer of Corporate Bonds, etc. 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 SB settlement. To execute this duty, we will adopt a book-entry transfer system for SBs
to realize a DVP system and take us one step closer to the use of STP for securities settlement inJapan. Through these efforts, we expect to raise SB liquidity, enhance settlement efficiency and set
the stage for shorter settlement periods.
JASDEC announced a breakdown of the book-entry transfer procedures for corporate andmunicipal SBs in June 2003 and a summary of the book-entry transfer system processing in October
2003. It is our goal to place ourselves at the center of an STP system that electronically executes aseries of procedures, from trade matching to securities and cash settlement.
TWO SETTLEMENT METHODS A choice of two settlement methods will be available: by DVP
system and by non-DVP system, otherwise known as free-of-payment settlement. For the DVP system, we will apply the real-time, gross-net format known as BIS model 1, which transfer instructions
settle for both securities and funds, with delivery of securities occurring at the same time as paymentof funds. In August 2005, we will initiate a comprehensive test — our final check — to confirm connections with the systems of users, with a view to launching the book-entry transfer system for SBs inJanuary 2006. In addition, management has prioritized the development of high-quality systems andthe trouble-free conversion of existing SBs, with an outstanding amount of about ¥200 trillion, fromtheir current registered status to book-entry status.

TRANSITION PERIOD By government ordinance, the prevailing Corporate Bond Registration
Law will be abolished by January 5, 2008. JASDEC will establish a transition period lasting about twoyears, during which registered bonds will be issued either as book-entry transfer bonds, based on thenew law, or actual delivery of bonds, based on the principles of the Commercial Code. With theapproval of issuers and investors, it will become possible to convert an outstanding registered bondinto a book-entry transfer bond for handling by our system. To maintain a smooth transition, we willcontinue to pursue activities that elevate awareness of book-entry transfer bonds.

INVESTMENT TRUST BENEFICIARY RIGHTS
The basic legal framework for a book-entry system applied to investment trust beneficiary rights issimilar 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 bookbased 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 canceling investment trusts, settlement systems foreach type of investment trust, procedures for handling earnings dividends, and methods to ensurethat the pool of some three 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 corporate and municipal
bonds on its registry so investors may settle transactions without bond certificates.

12

SCHEDULE FOR CORPORATE AND
MUNICIPAL STRAIGHT BONDS
2004

2005

October

May JASDEC

August JASDEC

JASDECannounced
summary of bookentry transfer
system processing.

announced
connection
specifications.

plans to startcomprehensive
connection test.

2006

2006-72008

January JASDEC

Registered bonds
already in issue will
be changed to bookentry bond status.
By government
ordinance, registeredbonds will no longer
be issued afterJanuary 2008.

January End of2003
January The Law

concerning Book-Entry
Transfer of Corporate
Bond, etc. goes intoeffect. (Abrogation ofthe Corporate Bond
Registration Law
expected within five
years of the new law’simplementation.)
June JASDEC

announced breakdownof book-entry transfer
procedures forcorporate andmunicipal straightbonds.

expects to launch
book-entry transfer
system for straightbonds.

temporary grace
period applied tointerest income tax
on registered bonds.

JASDEC
Pre-Settlement
Matching System
1
Trade Report Data
4
Notice ofAffirmation

Affirmation/
Disaffirmation

SSI
Notice ofSettlement Matching
Status76

Settlement
Matching

8
Transfer Application(linked with 6)

JASDEC
Participant2
Trade Report Data
3
Affirmation of Trade5
Automatic
Generation ofSettlement
Instruction Data
7
Notice ofSettlement Matching
StatusJASDEC
Participant

Transfer
System9(Deliverer)
10
Notice of Recording

15
16
Securities Transfer
Notice(Receiver)

Record inTransfer
Account
Security
Transfer

14Settlement
Completion

Securities Transfer
Notice1611FundSettlement Data

12
Notice of Receipt
14
Notice of Receipt
Completion

FundTransfer
Bank of Japan

13
Payment Instruction
14
Notice of Payment
Completion

13