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vol.45
(28.November.2008)
Special Edition
Current state of Japan's securitization market
Current state of Japan's securitization market
vol.45
(28.November.2008)
Special Edition
Current state of Japan's securitization market
Introduction
Repercussions from the subprime mortgage crisis epicentered
the securitization market to a sound development path would
in US continue to roil global securitization and, in turn, financial
contribute substantially to Japanese financial markets' further
markets. Once widely hailed as a seminal financial innovation,
growth and development.
securitization currently remains under fire from some quarters
for widely dispersing risk, thereby delaying detection of
From such a standpoint, we discuss below challenges that
subprime problems and complicating price discovery and risk
must be overcome for investors that have become wary
management. Nonetheless, securitization remains an extremely
of securitized products to regain the capability to invest in
valuable means of distributing underlying assets' risks and
securitized products by upgrading their risk management
repackaging cash flows into products appealing to investors.
practices. We begin with an overview of Japan's securitization
Amid the ongoing adverse investment environment, we believe
market.
that surmounting the current market upheaval and restoring
History of Japan's securitization market
Japanese financial markets have historically been dominated
idea of balance-sheet downsizing was completely foreign to
by indirect finance, with banks gathering deposits from the
them (back then, banks' status was determined by the scale
household sector to fund loans to the corporate sector. During
of their funding or total assets). Japanese banks consequently
the postwar reconstruction period, Japan adopted a policy of
had no interest in embracing securitization, even as the US
having banks aggregate scarce funds in the form of deposits
and European securitization markets were growing apace
and lend them to designated industries on a priority basis. This
during the 1980s.
system of bank-intermediated finance functioned extremely
effectively to meet the corporate sector's burgeoning demand
Subsequently, however, the situation changed dramatically.
for funds amid Japan's rapid economic growth from the
With the advent of BIS capital adequacy regulations in
1960s. On the downside, this system had the drawback of
the 1990s, banks became subject to a regulatory capital
concentrating risk in the banking sector, but banks avoided
constraint on the size of their balance sheets. Moreover, banks
excessive competition with each other pursuant to MOF
found themselves saddled with NPLs in the aftermath of the
administrative guidance. In lieu of competing, banks banded
Japanese asset bubble's collapse. The ensuing NPL cleanup
together in a so-called convoy system to ensure their survival
process forced banks to drastically curtail their lending
and profitability. As long as the convoy system existed and
capacity. In 1997–98, a full-blown financial crisis erupted as
the assets (e.g., real estate, shareholdings) that collateralized
several major financial institutions failed in rapid succession.
bank loans continued to briskly appreciate in value, the risk of
In response, financial institutions intensified their efforts to
a banking crisis was essentially nil. Even in the unlikely event
downsize their loan portfolios and rid their books of NPLs,
of a bank failure, the authorities stood ready to orchestrate
forcing major corporate borrowers (e.g., nonbank financials)
a rescue by merger. The risk of bank failures thus posed no
to shift from bank loans to other funding sources. One widely
threat to the overall financial system. Bankers of that era
used alternate funding method was securitization. Japanese
consequently focused exclusively on growing their assets. The
financial markets saw heavy issuance of ABS (asset-backed
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
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Current state of Japan's securitization market
securities) and CLOs (collateralized loan obligations) from the
In most cases, securitized products' underlying assets
late 1990s.
are pools of financial claims owed to a specified creditor
(nominative claims). To assert the validity of the assets'
Meanwhile, another factor that contributed greatly to the
transfer to the SPV (i.e., to legally perfect the transfer against
Japanese securitization market's development was certain
third parties), originators previously had to individually notify
legislation enacted in the 1990s.
or obtain the consent of each and every debtor in accord with
a provision of Japan's Civil Code. In cases with hundreds or
The securitization process begins with an originator that
thousands of debtors, however, this legal requirement imposed
owns the underlying assets to be securitized. The originator
an onerous administrative burden that was a major impediment
typically transfers the assets to a special-purpose vehicle (SPV)
to securitization. Against such a backdrop, the aforementioned
such as a trust or special-purpose corporation, which issues
two laws were enacted. They permit originators to perfect
securities backed by cash flows generated by the underlying
asset transfers through mass notification (i.e., public notice
assets. The key to structuring a securitization deal is ensuring
or registration), provided that certain conditions are met. This
that these cash flows remain available to stably fund interest
legislation that enabled transfers of underlying assets in an
and principal payments on the securities as initially planned.
administratively feasible manner2) was a major impetus behind
To achieve this objective, the first priority is to transfer the
the securitization market's growth.
underlying assets from the originator to the SPV without any
legal complications (i.e., the transfer must be a "true sale"). A
In sum, Japan's securitization market developed in response
true sale means that if the originator or other involved party
to such enabling legislation and the imperatives of the
subsequently goes bankrupt, the underlying assets would be
financial environment of the 1990s. As this process unfolded,
beyond the reach of creditors and bankruptcy administrators
securitization techniques gradually gained prevalence and
1)
expanded in scope to eventually encompass other assets,
enacted in the 1990s were instrumental in enabling such
including residential mortgages. Exhibit 1 plots the trend
bankruptcy-remote securitization structures.
in securitized issuance since FY97. Annual issuance first
(a condition known as "bankruptcy remoteness"). Two laws
surpassed ¥1trn in FY98 and has since grown substantially.
Exhibit 1.
Securitized issuance by fiscal year
(¥trn)
RMBS
12
CMBS
ABS
10
CDO
Other
8
Public issuance of
straight corporate bonds
6
4
2
0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007(FY)
Source: NRI, based on Japan Securities Dealers Association and UBS Securities data
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
3 16
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Current state of Japan's securitization market
Subprime crisis's impact on
Japan's securitization market
How have subprime mortgage woes, which first attracted
Publicly available information about issuance terms is limited,
scrutiny in Japan in the first half of FY073), impacted issuance
but CDS spreads, a key determinant of synthetic CDO yields,
of securitized products in Japan?
decoupled from regular corporate bond spreads in August
2007 and widened further in March 2008 (Exhibit 3). After
FY05–06, the years immediately preceding the subprime
subsequently tightening for a while, CDS spreads resumed
crisis's eruption, were marked by an upsurge in securitized
widening sharply from May. This widening trend indicates that
issuance to a level surpassing public issuance of straight
CDS returns have been rising per unit of credit risk. According
corporate bonds, albeit largely by virtue of special factors such
to securities firms' research reports and contacts with
as Softbank Mobile's whole business securitization valued at
market participants, synthetic CDO spreads also have been
over ¥1 trillion and a rush to securitize residential mortgages
widening in sympathy with CDS spreads. Other securitized
(RMBS) before the new BIS risk-adjusted capital adequacy
products have apparently also been exhibiting similar behavior.
regulations took effect (Exhibit 1). In FY07, securitized
This widening of spreads, likewise largely attributable to
issuance fell 24% from FY06, reflecting the impact of the
investor caution toward securitized products, has created
subprime crisis and cessation of said special factors. From the
advantageous buying opportunities for the few investors
standpoint of securitized issuance's long-term trend, however,
capable of investing in securitized products.
4)
FY07 issuance can still be characterized as robust . In FY08,
investment banks were initially projecting securitized issuance
of roughly ¥6–8trn, modestly above its FY04 level and a
respectable volume in light of the adverse market environment.
As of September 2008, however, securitized issuance was
tracking well below its projected level amid a steep falloff in
securitization of commercial mortgages (CMBS) in particular
(Exhibit 2). This downshift in securitized issuance partly reflects
investor wariness towards securitized products in addition to
a slump in underlying asset markets. Securitized issuance is
likely to remain depressed for a while.
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
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Current state of Japan's securitization market
Exhibit 2.
Recent securitized issuance
Total
Other
WBS
CDO
Consumer/card loans, etc.
Credit card receivables
Auto loans
Leases
CMBS
RMBS
0
0.5
1,0
1,5
Apr–Sept 2008
2,0
2,5
3,0
3,5
4,0(¥trn)
Apr–Sept 2007
Source:NRI, based on Mizuho Securities' Structured Finance Monthly May–September 2007 and May–September 2008
Exhibit 3.
CDS spread and (A-rated) corporate bond spread (in basis points)
350
300
250
200
150
100
50
0
4/2007
5/07 6/07 7/07 8/07 9/07
10/07
11/07 12/07 1/08 2/08
CDS(ItraxxJapan)
3/08
4/08 5/08 6/08 7/08 8/08
9/08
10/08
Corporate bond spread
Source: NRI, based on Bloomberg data
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
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Current state of Japan's securitization market
Distinguishing characteristics of
securitized products in Japan
One major distinguishing characteristic of the Japanese
In light of such characteristics, Japan's securitization market
securitization market is that most deals are relatively simple,
has historically been perceived as offering moderate-risk/
single-layer structures. Multilayer structures of the types
moderate-return products (or even low-risk/moderate-return,
blamed for complicating the subprime crisis (e.g., ABSCDOs,
given that securitized products offered wider spreads than
CDOs-squared), where securitized paper is resecuritized once
other equivalently rated products), not the highly leveraged
or even twice, are relatively rare in Japan. Of the two-layer
speculative products that wreaked havoc in the US.
structures that do exist in Japan, most differ from the types
that created additional arbitrage opportunities and induced
The above market characteristics suggest that Japan's
investors to pursue arbitrage profits in the US. When two-
securitization market is in a transitional phase of development in
layer structures have been utilized in Japan, the objective is
comparison to its counterparts in the US and other countries,
typically to make RMBS more marketable to investors by time-
but the market has also been shaped by the low-interest-rate
tranching issues into medium- and long-term maturities. In
environment in which it has developed. Such an environment
contrast to the US, where credit enhancements by monoline
prompted some yield-starved investors to overlook product
insurers enabled complex, multilayer securitization structures,
details or tolerate limited information disclosure if the product
external credit enhancements are seldom used in Japan.
carried a high rating in their pursuit of returns even slightly
better than the prevailing low interest rates.
Securitization deals are not as standardized in Japan as in
the US. Structures, covenants, and contractual terms often
differ from deal to deal even among securitized products
of the same underlying asset class. Additionally, public
offerings account for a small share of securitized issuance and
information disclosure tends to be limited by nondisclosure
agreements imposed by originators.
On the demand side, the types of investors that invest in
securitized products also differ between Japan and the US.
In the US, a diverse range of domestic and foreign investors
participate in securitized product markets in pursuit of a wide
variety of objectives. In Japan, by contrast, market participants
are predominantly institutional investors such as banks
and insurers. With the exception of arrangers, most market
participants invest in securitized products with the intention of
holding to maturity. The flipside of this buy-and-hold mentality
is that Japan consequently lacks a well-developed secondary
market.
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
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Current state of Japan's securitization market
Issues to be addressed in the aim of
upgrading investors' risk management practices
To m a t u r e b e y o n d i t s c u r r e n t t r a n s i t i o n a l p h a s e o f
Amid global calls for adequate traceability of information on
development, Japan's securitization market needs a broader
securitized products' risks and the nature of their underlying
range of issuers and investors. Concerned parties have long
assets, Japan's Financial Services Agency (FSA) has identified
been cognizant of many issues that need to be addressed to
improved disclosure as a priority 5). In response, the Japan
foster the securitization market's development. Development
Securities Dealers Association (JSDA) established a Working
of the market's legal infrastructure had been progressing
Group (WG) on Distributions of Securitized Products, which
since even before the subprime crisis arose. For example, the
has been diligently at work since March. In July, the WG issued
Financial Instruments and Exchange Act and amended Trust
an interim report6) that included a list of common information
Act, both effective from 30 September 2007, aim to promote
items presumed to constitute a uniform information disclosure
securitization and increase flexibility in terms of deal structures.
format for single-layer RMBS, CMBS, CLO, and ABS products.
Amid the prevailing turmoil ensuing from the subprime crisis,
Market participants are slated to initiate renewed discussions
however, the most immediate priority is to revive interest in
based on the WG's report from this autumn. By year-end,
investing in securitized products among Japanese investors
the JSDA aims to publicly issue a final report together with
that have turned cautious. As a prerequisite for this to happen,
proposed regulations scheduled to take effect next year.
we believe that investors must further develop their capability
Discussions to date have involved not only the banks,
to invest in securitized products by upgrading their risk
investment banks, and trust banks that are the main arrangers,
management practices.
distributors, and servicers of securitized products but also
investors, rating agencies, analysts, industry associations
Upgrading risk management practices requires (1) information,
(the Securitization Forum of Japan and Commercial Mortgage
the basis for quantifying and assessing risks, (2) quantitative
Securities Association), CPAs, information vendors, and the
techniques for quantifying fair-values and risks, and (3)
FSA and BOJ. These parties have been airing their concerns
systems conducive to swift decision-making and execution
and exchanging views. This autumn's discussions are likely
based on risk assessments derived from incoming information
to make further progress toward consensus while seeking to
and quantitative techniques. We discuss these three issues
ensure the practical feasibility of disclosure reform proposals.
below in sequence.
One shortcoming of the discussions that preceded the release
of the WG’s interim report was a lack of input from securitized
product originators, which are highly influential in terms of
information disclosure, but the WG is preparing to conduct a
Information issues
survey of originators from this autumn and solicit comments
from the public. Future discussions are therefore likely to
The primary informational issue is the quantitative and
incorporate input from originators also. In our view, originators
qualitative adequacy of information disclosure vis-à-vis both
have not always been sufficiently proactive in disclosing
securitized products and their underlying assets. Information
information. However, in light of securitization's extremely
disclosure must be dealt with as an issue relevant to all parties
valuable role as a funding method during the financial crunch
involved in the securitization market.
of the late 1990s and prospective changes in the financial
environment, we believe that originators should be more
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
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Current state of Japan's securitization market
forthcoming with information disclosure based on a recognition
how the cash flows generated by the underlying assets
that the Japanese securitization market's further growth and
are allocated among tranches). Most critical is modeling of
development is in their own self-interest.
underlying assets. Separate models are recommended for
each underlying asset class, although certain asset classes
The WG's proposed list of common information items has
may lack a widely recognized standard model. In constructing
been criticized by some as still inadequate for investors' risk
a model, it is important to correctly understand the model's
management needs. Even after a uniform disclosure format
characteristics and limitations. Additionally, users must
has been finalized and officially adopted, it will require ongoing
constantly reassess models' validity through such means
revision and improvement.
as back-testing. They also must be ever mindful of how and
when model parameters were estimated, and of backing up
On the subject of inter nal procedures for evaluating,
the model itself.
calculating, and reporting securitized products' theoretical
fair values, the WG has reportedly reached a consensus that
With many securitized products backed by multiple assets,
such procedures should be based on JDSA guidelines issued
modelers cannot neglect to assess diversification of risk
7)
in August 2000 . These guidelines instruct JSDA members to
among underlying assets. The degree of diversification can be
provide information on marketable securities' market value in
assessed as a function of the number of underlying assets and
the form of mid-prices. The guidelines also permit securities
their correlation coefficients. Of particular importance is the
dealers to refrain from providing market-value information
accuracy of correlation coefficient estimates. In the ongoing
when they deem that fair market value cannot reasonably
subprime crisis, mortgage default rates have ended up rising
be determined, although they must explain their rationale for
similarly throughout the US. Diversification's failure to work as
doing so to investors and other counterparties. Information
anticipated is cited as a shortcoming of the models employed.
recipients (i.e., investors) that use dealer-provided market-
This failure highlights the importance of ascertaining worst-
value information for accounting or tax-accounting purposes
case losses through stress-testing under various assumptions.
ultimately do so at their own discretion and on their own
responsibility. However, with exit prices increasingly being used
It is doubtful that many Japanese investors are currently self-
for accounting purposes on a global basis, a key issue that
sufficient vis-à-vis such quantitative techniques. The same
remains to be resolved is how to determine exit prices from
is true for US and European investors also, but they are
the mid-prices provided by securities dealers. This question
compensating by increasingly utilizing external vendors of
requires further discussion as a procedural issue.
valuation and risk assessment services, having valuations and
risk assessments checked by third parties, and/or outsourcing
quantitative functions 8) . By adroitly utilizing such external
resources, investors should be able to efficiently acquire
Issues concerning techniques for
quantifying fair-values and risks
expertise in advanced quantitative techniques. Such an
approach is an option for Japanese investors also.
Improving quantitative techniques is an issue to be addressed
I n t e r m s o f s e c u r i t i z e d p ro d u c t e v a l u a t i o n a n d r i s k
mainly by investors. It will require utilization of external
quantification, many investors' highest-priority is likely
resources such as outside vendors and/or support from
assessment of market liquidity. Liquidity is conventionally
academics.
measured by (1) bid-ask spreads, (2) the depth of market
makers' order books at a given point in time, and (3) the
To quantify securitized products' risk, one must model the
speed with which price returns to its pre-trade level after a
underlying assets and measure cash flows based on credit
price movement triggered by trade execution 9). However, it
enhancements and the so-called cash flow waterfall (i.e.,
will take quite some time for market infrastructure to develop
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
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Current state of Japan's securitization market
and secondary trading volume to increase to where bid-ask
spreads and other such information on individual products
become readily available. Investors consequently must make
Case study of foreign investors'
risk management practices
do with whatever information is available concerning market
In February–April 2008, we conducted a study of overseas
liquidity, but any such information is currently very difficult to
investors' risk management approach to investing in relatively
obtain for many types of products. As a workaround solution
illiquid products such as securitized products. Our sample
to the difficulty of obtaining information on individual products,
comprised three major commercial banks, three major
it may be useful to produce and distribute analysis of market
investment banks, and one hedge fund. The study was
liquidity for a certain market segment or types of products on
designed not as a survey of investors in general but a case
an ongoing basis and utilize the information gathered for such
study of selected investors. We believe that our study findings
reports to gauge liquidity. One idea is to devise hypothetical
offer a number of risk-management suggestions for Japanese
standard products by product category (like JGB futures
financial institutions. Our key findings are summarized as
with a 6% notional coupon) and periodically contact leading
follows.
brokers for hypothetical bid-ask quotes by trade size (e.g.,
when asked for quotes based on a hypothetical mid-price of
Investment objective
¥100, the broker might reply with a bid price of ¥99.5 for a
• Commercial banks' main objective is hedging risk in
¥3bn trade, ¥99.0 for ¥5bn, and ¥98.5 for ¥10bn). Compiling
conjunction with their loan portfolios. Investment banks
and publishing such information may be a means to gain
and the hedge fund's main objective is enhancement of
access to information on bid-ask spreads and the depth of
returns.
market makers' order books. Such an approach could, for
example, reveal that when a given market is highly liquid, bid-
Investment assumptions
ask spreads tend to be tight and the distribution of bid-ask
• The commercial banks, investment banks, and hedge fund
size tends to be concentrated around the mid-price, but when
all invest based on the assumption that they (a) possess
market liquidity diminishes, bid-ask spreads tend to widen and
deep knowledge of the underlying assets and underlying
the distribution of bid-ask size tends to disperse or become
asset markets, (b) can proficiently gather information, and/
lopsided. We propose taking such information on changes in
or (c) can proficiently assess risk. Most reported that they
market liquidity spreads, processing it somehow, and utilizing
it for risk management or valuation purposes.
do not invest in products in which they lack expertise.
• One commercial bank and one investment bank that
claimed to possess deep knowledge of underlying assets/
markets detected changes in underlying assets' behavior
based on their knowledge, enabling them to exit positions
before the subprime crisis erupted in earnest. Another
Management system issues
investment bank reported incurring substantial losses as
a result of overconfidence in its information-gathering and
It is up to investors themselves to build sophisticated risk
risk-assessment capabilities despite a lack of adequate
management systems whereby gathered information and
knowledge of the underlying assets.
quantified risk assessments enable swift and appropriate
decision-making and execution. All they need to do so is
Utilization of information
strong will.
• The subjects' front and middle offices both gather a broad
Below we look at examples of foreign investors' risk
range of information through various channels.
management practices and then discuss implications for
• The gathered information is utilized for risk management
Japanese investors in terms of upgrading their own risk
after its reliability has been assessed based on staff's
management.
knowledge and experience.
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
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Current state of Japan's securitization market
Quantitative information
assess rating information in comparison with their own
• The investment banks gather a broad range of market-
methodologies based on an understanding of the rating
price information, including brokers' market-price quotes,
agencies' evaluation methods.
external vendors' price data and, for reference, benchmark
• Because the hedge fund invests in illiquid products, it has
prices (e.g., spreads, substitutive-market prices). They
authorized front-office staff to close out positions to enable
also track VaR and underlying assets' performance (e.g.,
defaults, delinquencies, prepayments).
• The commercial banks place more priority on information
on underlying asset performance. The market-price
a rapid exit before liquidity dries up.
• Certain of the commercial banks practice conservative
accounting, provisioning for liquidity risk in cases that pose
difficulty in terms of valuation or access to information.
information they collect is limited in scope in comparison
to investment banks.
Implications for Japanese investors
Qualitative information
Although the overseas investors that were the subject of our
• The subjects all gather a broad range of qualitative
study do not necessarily epitomize best practices, many of
information regarding markets in general and market
their practices are instructive in terms of how to upgrade
participants' behavior. Brokers serve as an extremely
risk management. Another insight is that Western investors'
important source of such information.
putatively advanced risk management practices are by no
• The commercial banks also track originators' asset
screening policies.
means beyond the reach of other investors. Below are some
suggestions for Japanese investors as gleaned from our study.
Utilization of techniques for
quantifying fair-values and risks
Understand the underlying assets, collect
information, and acquire analytical capabilities
• T h e s u b j e c t s re l y o n s t re s s t e s t i n g a s a k e y r i s k
• Deepening one’s understanding of underlying assets
management tool.
• M o s t o f t h e s u b j e c t s u s e p ro p r i e t a r y a s s e s s m e n t
models to test the validity of the incoming market-price
information.
based on proprietary and market information is extremely
important for nimble risk management.
• It is also valuable to apply in-house risk-analysis and
risk-management know-how concerning loans to risk
• T h e i n v e s t m e n t b a n k s a n d h e d g e f u n d u s e m o re
management of securitized products (we surmise that not
sophisticated and diverse quantitative techniques than the
many Japanese investors are currently effectively utilizing
commercial banks.
their in-house knowhow).
• The subjects incessantly back-test their models and
reassess them under the latest market conditions.
Management systems
Gain access to a broad range of
information sources
• Instead of depending on selected information sources,
• The investment banks and hedge funds have established
obtain a wide variety of information from a broad range of
more functional and nimble management systems than the
sources, from information about individual transactions to
commercial banks.
news and even rumors.
• Front- and middle-office staff cultivate a shared riskmanagement mentality through conversation with each
other.
• Any red flags detected through monitoring are promptly
reported to senior management.
• The subjects use credit rating information also, but they
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
Establish nimble risk-management and
rapid risk-reporting systems
• Establish triggers that alert the front office to exercise
heightened vigilance and flexibly modify them in response
to market conditions, thereby building risk-management
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Current state of Japan's securitization market
systems that enable the front office to detect prospective
agencies' risk analysis and assessment methods and the
crises in advance and swiftly take preemptive action.
assumptions underlying individual rating decisions.
• It is important to constantly ascertain the magnitude of
latent risk exposures through regular stress testing.
Japanese investors are as capable of utilizing quantitative
• The front and middle offices (risk-management staff)
techniques as overseas investors. Even with respect to
should closely communicate with each other promptly
securitized products, Japanese investors can achieve an
report any matters of operational concern to senior
equivalent if not higher level of competence as their overseas
management.
counterparts by utilizing in-house and external resources.
Currently, Japanese investors may not have an adequate
Develop judgment to
screen incoming information
understanding of the markets for their securitized product
• Cultivate the judgment (market knowledge and
themselves, but this largely reflects an existing information
experience) to identify important information essential
deficit, which should be gradually rectified by pending plans
for risk management from a diverse stream of incoming
to expand information disclosure. We hope that Japanese
information.
investors build nimble and effective risk-management systems
holdings' underlying assets or even the securitized products
• Rating information is one important information source for
based on a recognition that doing so will confer a competitive
risk analysis and assessment, but do not accept ratings at
advantage in asset management capability over the medium
face value. Assess ratings in light of your own knowledge
term.
and experience based on an understanding of rating
Conclusion
The Japanese securitization market today is reminiscent
To reiterate, development of market infrastructure through the
of events in the derivatives market in the early 1990s. The
commitment of market participants is essential to restore the
Japanese market for derivatives, another key financial
Japanese securitized products market to a growth trajectory.
innovation on a par with securitization, grew substantially
The market's future growth prospects also hinge upon the
in the 1980s, driven mainly by speculative trading of forex-
extent to which key investors upgrade their risk management
related products (carry trades). The market subsequently
practices. For investors, the path to gaining a medium-
shrank drastically for a while in the wake of yen appreciation
to long-term advantage in terms of asset management
and the collapse of Japan's asset bubble. Later, the Japanese
capabilities and competitiveness lies in building the requisite
derivatives market resumed growing through the efforts of
investment capabilities and amassing experience in nimbly
market participants. The derivatives industry went back to
capitalizing on advantageous investment opportunities.
basics, market infrastructure developed further, and interest
rate derivatives gained widespread prevalence as a financial
risk management tool for corporations.
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
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(28.November.2008)
Special Edition
Current state of Japan's securitization market
Note
1) Law Concerning Regulation of Businesses Involving Specific Claims
("Specified Claims Law," effective June 1993) and Law Concerning
E x c e p t i o n s t o C i v i l C o d e R e q u i r e m e n t s f o r C l a i m s Tr a n s f e r s
("Exceptions Law," effective October 1998)
2) The Specified Claims Law permits assignment of lease claims and
installment claims to be perfected by publication of a public notice in a
daily newspaper or official gazette, if done in compliance with prescribed
procedures. The Exceptions Law enables all nominative claims assignments
by corporate assignors to be perfected against third parties by registration
of the assignment at a Ministry of Justice Legal Affairs Bureau.
3) The key catalyst that called attention to subprime problems was likely
the June 2007 news that two hedge funds run by major US investment
bank Bear Stearns were in crisis, mass downgrades of subprime securities
by major US rating agencies in July, or French investment bank BNP
Paribas's freeze of several of its funds' assets in August.
4) However, issuance was inflated by all-time record CMBS issuance,
largely because of foreign investment banks liquidating their inventories of
assets related to commercial real estate.
5) FSA Comprehensive Guidelines for Supervision of Financial Product
Dealers
6) Interim Report of JSDA Working Group on Distributions of Securitized
Products (http://www.jsda.or.jp/html/eigo/wg/com_i_i_list.pdf )
7) Minutes of Working Group's 5th and 6th meetings. Said guidelines are the
JSDA Guidelines for Provision of Market-Value Information by Securities
Companies (http://www.jsda.or.jp/html/oshirase/jika.pdf (in Japanese)).
8) NRI June 2008 IT Focus Use of Valuation Vendors Is Gaining Prevalence
on the Buy Side (http://www.nri.co.jp/opinion/kinyu_itf/2008/pdf/
itf20080604.pdf (in Japanese))
9) BIS Market Liquidity: Research Findings and Selected Policy Implications
(http://www.bis.org/publ/cgfs11overview.pdf )
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
1216
vol.45
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Column
Securitized product investment and the information divide among inancial institutions
Column
Securitized product investment and
the information divide among financial institutions
Investment products' risk-assessability has
required for risk assessment varies widely among
become a key factor in investment decisions in
financial institutions. Eliminating this information
the wake of the subprime crisis. For securitized
divide is a key issue in terms of broadening
products in particular, access to information
investment demand for securitized products.
Portfolio management survey of financial institutions
In July 2008, we surveyed Japanese financial
First, when survey respondents were asked
institutions about their securities portfolios for a
w h e t h e r t h e y h a d re v i s e d t h e i r i n v e s t m e n t
second consecutive year1). Last year's survey was
policies over the past year, about half answered
conducted in July, before global financial markets
affirmatively. In terms of how they had done so,
were roiled by the subprime crisis. Comparison
13% of these respondents had "tightened risk
of last year's survey results with this year's sheds
management through such means as setting
light on how the market turmoil has impacted
position limits by product," but a vast majority
securities portfolio management at Japanese
(74%) of them had altogether "ceased investing
financial institutions.
in products difficult to risk-assess." Financial
products' risk-assessability thus appears to have
become a key factor in investment decisions.
Exhibit 1.
Revision of investment policies
Responses
Have you revised your investment policies
since subprime problems emerged?
Yes
UT financial institutions
LT financial institutions
No
39
18
21
46.2%
53.8%
229
95
133
41.5%
58.1%
How did you revise your investment policies?
Responses
UT financial institutions
LT financial institutions
18
95
Ceased investing
in products
difficult to
risk-assess
Tightened risk
management
(e.g., imposed position
limits by product)
Other
13
2
3
72.2%
11.1%
16.7%
71
13
11
74.7%
13.7%
11.6%
Note: UT: upper-tier, LT: lower-tier
Source: NRI, "2nd Survey of Financial Institutions' Securities Portfolio Management"
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
1316
vol.45
(28.November.2008)
Column
Securitized product investment and the information divide among inancial institutions
Investment in securitized products
In terms of risk-assessment difficulty, securitized
institutions, securitized products apparently pose
products have been singled out as particularly
a formidable challenge in terms of ascertaining
opaque since the subprime crisis erupted. Among
risk.
survey respondents, some 80% of upper-tier
financial institutions (megabanks, trust banks,
Interestingly, the survey results did not reveal
and regional banks) invest in securitized products
much of a causal relationship between securitized
versus only about 40% of lower-tier financial
product investment policies and the market turmoil
institutions (second-tier regional banks, shinkin
triggered by subprime woes. Only about 7% of
banks, and credit unions).
respondents among both upper- and lower-tier
financial institutions reported that they stopped
The financial institutions that do not invest in
investing in securitized products in response to
securitized products were asked why not. Some
subprime mortgage problems. The main factor
respondents cited market illiquidity as their
behind financial institutions' reluctance to invest
reason, but the predominant response (73%) was
in securitized products is apparently difficulty of
"complexity of product structure and difficulty
assessing the risk of investing in such products.
of assessing risk 2) ." For lower-tier financial
Exhibit 2.
Securitized product investment status
Do you invest in securitized products?
Responses
UT financial institutions
LT financial institutions
39
229
No, not since even
before subprime
problems emerged
Yes
No, we stopped
since subprime
problems emerged
No response
30
5
3
1
76.9%
12.8%
7.7%
2.6%
95
115
16
3
41.5%
50.2%
7.0%
1.3%
Note: UT: upper-tier, LT: lower-tier
Source: same as Exhibit 1
Information divide
This raises the question of how much information
Of the information listed in the survey, Exhibit 3
financial institutions actually have about the
lists those items that the respondents consider
securitized products that they claim are difficult
important in terms of ascertaining securitized
to risk-assess. Our survey queried financial
products’ risk. Items marked with a
institutions about their current access to
right column were designated as particularly
specific information deemed important in terms
important by respondents. Most of these higher-
of assessing securitized products’ risk. Their
priority items pertain to reliability of cash flows,
responses revealed large disparities between
such as credit ratings and delinquency rates.
in the far-
upper- and lower-tier financial institutions’ access
to certain information.
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
Among these particularly important items, credit
1416
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Securitized product investment and the information divide among inancial institutions
Exhibit 3.
Access to information related to investing in securitized products
UT (A)
Rating information
100.0%
Scheduled maturity dates
LT (B)
A–B
96.2%
3.8%
100.0%
84.4%
15.6%
Average remaining maturities
90.9%
84.2%
6.7%
Coupon rates (distribution rates)
100.0%
93.6%
6.4%
Risk controls (e.g., credit/liquidity enhancements)
90.5%
41.1%
49.4%
Subordinated tranches’ current principal balances
81.0%
48.6%
32.3%
Subordinated tranches’ principal impairment
76.2%
47.3%
28.9%
Outstanding principal balances by tranche
90.5%
65.3%
25.1%
Debtors' creditworthiness
61.9%
50.7%
11.2%
Scheduled cash flows (schedule for receipt of interest/principal)
85.7%
43.5%
42.2%
Delinquency rates
85.7%
50.5%
35.7%
Default rates
85.7%
51.4%
34.3%
Recovery rates (loss severities)
81.0%
46.4%
34.6%
Prepayment rates
71.4%
42.0%
29.4%
Importance
Note: UT: upper-tier, LT: lower-tier
Source: same as Exhibits 1 and 2
rating information is nearly equally accessible to
Our survey results suggest that limited access
both upper- and lower-tier financial institutions,
to information required for risk assessment may
reflecting the widespread availability of rating
be an impediment to investment in securitized
information. For delinquency, default, and recovery
products by lower-tier financial institutions.
rates, however, the accessibility gap between
Discussions of how to improve information
upper- and lower-tier financial institutions widens
d i s c l o s u re a b o u t s e c u r i t i z e d p ro d u c t s a re
beyond 30 percentage points. Even wider gaps
currently underway within the financial industry.
were observed for information about risk controls
Such efforts are significant in terms of restoring
(e.g., credit/liquidity enhancement) and scheduled
confidence in securitization markets. Looking
cash flows (e.g., scheduled principal/interest
ahead, we anticipate that specific initiatives will
receipt dates).
be proposed to improve information disclosure
without imposing an onerous burden on market
Securitized products vary widely in structure
participants. Eliminating the information divide
and underlying asset class. For certain types
should be a key priority of such initiatives.
of securitized products, information required
for investment decisions is extremely difficult
to access. When not only accessibility but also
currency of information is taken into consideration,
information gaps between individual financial
institutions are likely even wider than shown in
Exhibit 3. While some financial institutions have
access to ample information for ascertaining
securitized products’ risk, many others' access to
essential information is limited.
©2008 Nomura Research Institute, Ltd. All Rights Reserved.
Note
1) The survey was sent to 533 domestic financial institutions.
Responses were received from 269 of them (50.5% response
rate). The respondents comprised 8 major financial institutions
(megabanks, trust banks), 32 regional banks, 17 second-tier
regional banks, 159 shinkin banks, and 53 credit unions.
2) This question permitted multiple responses per respondent.
The second most common response was "lack of personnel
with risk management expertise" (40%) followed in third place
by "market illiquidity" (38%). The reported lack of qualified
personnel presumably reflects the difficulty of assessing
securitized products’ risk.
1516
vol.45
(28.November.2008)
Special Edition
Current state of Japan's securitization market
Author's Profile
Current state of Japan's securitization market
Kousai Arimura
Senior Researcher
Financial Technology and Market Research Department
Securitized product investment and the information divide
among financial institutions
Yasuki Okai
General Manager
Financial Technology and Market Research Department
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