Development and Current Issues of JAPANESE SECURITIZATION MARKET

Development and Current Issues of JAPANESE SECURITIZATION MARKET Bank of Japan Yoshitake Hattori Financial Markets Department Bank of Japan

Contents 1. Overview of Securitization 2. Overview of Japanese Securitization Market 3. The background for the development of Japanese Securitization Market 4. Issues on Japanese Securitization Market 5. Bank of Japan’s Initiatives to Date 1

1. Overview of Securitization Financial Markets Department Bank of Japan 2

• Basic Structure and Effects of Securitization (Origination) （Primary Market） Reducing risk by diversification of collateral assets originator Asset Adding liquidity by issuance of securities investor SPV transfer issuance of securities Asset Simplifying risk analysis by isolating assets （Secondary Market） Securities Using credit enhancement by the “senior-subordinated” structure Financial Markets Department Bank of Japan intermediary investor 3

• Major Types of Securitization Products [Underlying Assets] [Products] Equipment Lease, Credit Card Receivables, Consumer Loans ABS Receivables ABCP Corporate Loans CLO Corporate Bonds CBO Residential Mortgage Loans RMBS Commercial Mortgage Loans CMBS Ownership of Real Estate REIT Financial Markets Department Bank of Japan 4

• Examples of Securitization Procedure ① ABS Lessee B ② ABCP Program (Multi Seller Type) Lessee C Lessee A Lessor (Leasing Company) Transfer payment Lease Receivables SPV(Special Purpose Vehicle) Issuance of ABS Obligor z) Obligee A Obligee Z Lessee D Lease payment Assignment of Receivables Obligor a) Investment Principal + interest Transfer Assignment of payment Receivables Payments SPV(Special Purpose Vehicle) Issuance of ABCP Investors Investment Principal + interest Investors Financial Markets Department Bank of Japan 5

• Significance of the Securitization Market Characteristics of securitization market • Provide new methods of financing/investment • Unbundle and/or mitigate credit risks • Enhance liquidity by issuance of securities • Price discovery function for credit risks • New business line for the financial institutions • Multiple routes to intermediate credit flows Strengthen the financial infrastructure to support economy Financial Markets Department Bank of Japan 6

2. Overview of the Japanese Securitization Market Financial Markets Department Bank of Japan 7

• The Comparison with Other Credit Markets Financial Markets Department Bank of Japan 8

• Size of Japanese Securitization Market Total ABS Issuance in Japan (Jan-Sep) Note: The above chart does not include products with short-term credit ratings. Source: Deutsche Securities Limited, Japan Securities Dealers Association Financial Markets Department Bank of Japan 9

• Underlying Assets in Japanese Securitization Market (CY 1998) CDO 38% (CY 2004) Equipment Lease 30% 15% 7% 16% 15% 5% CMBS 27% Credit Receivables and Consumer Loans 47% RMBS Source: Deutsche Securities Limited Financial Markets Department Bank of Japan 10

• Issuance Schemes in Japanese Securitization Market Source: Deutsche Securities Limited Financial Markets Department Bank of Japan 11

3. The Background for Development in Japanese Securitization Market Financial Markets Department Bank of Japan 12

What Has Promoted the Development of Japanese Securitization Market? • Financial Environment Before the Collapse of “Economic Bubble” Bank-Based Financial System • Heavy Interdependence between Banks and Corporate Enterprises • Limited Channels for Corporate Finance • Limited Alternative to Stocks and SBs Financial Markets Department Bank of Japan 13

• Financial Environment The Collapse of “Economic Bubble” Malfunctioning of Bank-Based Financial System • Heavy Burdens of NPLs (Non Performing Loans) on Banks • Credit Crunch • Significant Drop in Stock Price Index Stock Price Source: Bank of Japan Financial Markets Department Bank of Japan 14

• Financial Environment After the Collapse of “Economic Bubble” Needs for …. • Off-balance of NPL from B/S (Major Commercial Banks) • Various Channels of Funding (Corporate Enterprises) • Investment Alternatives to Stocks and SBs (Investors) Non Performing Loans NPLs (Left Scale) NPLs /Loan Outstanding (Right Scale) Securitization Financial Markets Department Bank of Japan Source: Bank of Japan 15

• Progress in Legal Framework regarding Securitization (since 1993) -- Enabled originators to issue ABS more smoothly < Major Laws regarding Securitization (Effective Year)> • The Law for Regulating Business of Specified Claims (Jun. 1993) • SPC Law (Sep. 1998) • Perfection Law (Oct. 1998) • Amended SPC Law (Nov. 2000) Financial Markets Department Bank of Japan 16

4. Issues on Japanese Securitization Market Financial Markets Department Bank of Japan 17

• Overview establishing the framework toward more accurate and effective evaluation of securitized products establishing the framework toward more efficient origination and trading Reducing the cost of transfer of collateral assets Improvement of disclosure investor issuance of securities transfer SPV originator Improvement of quantitative analysis intermediary cash flow debtor Reducing the servicer risk Improvement of flexibility of SPV Financial Markets Department Bank of Japan investor 18

• Reduction of the Costs in Origination and Trading Financial Markets Department Bank of Japan 19

• Improvement of Disclosure - Why is it necessary? Ø Increasing liquidity is essential for the market to grow further Uniqueness (Strong) Securitized Products Loan Trust Certificates Corporate Bonds Equity Private Issues Public Issues JGB Current Status Desirable Direction (Weak) (Low) Liquidity (High) Ø Key factor is the improvement of the information disclosure (to increase transparency) (i) Enables proper pricing/evaluation; (ii) reduces the liquidity premium (funding cost); and (iii) diversifies the investment opportunities Financial Markets Department Bank of Japan 20

• Improvement of Disclosure - What are the issues? Ø Increasing number of private issues (even the fact of issuance is undisclosed) Ø Investors have difficulties in obtaining prices of individual issues and/or information necessary for evaluating quality of earnings or past performance ─ With regard to private issues and trust certificates, it is often difficult for third parties (other than direct counterparties to the issue) to obtain information ─ Public issues do not always fulfill the investors’ requirement, due to the inflexibility of terms to be disclosed and the complexity of disclosure format Current market environment is deterring the incentive for the disclosure. However, it takes time to solve these problems and the change of the market environment does not necessarily encourage the disclosure. Therefore, it is necessary to establish the incentive mechanism to encourage disclosures. Financial Markets Department Bank of Japan 21

5. Bank of Japan’s Initiatives to Date Financial Markets Department Bank of Japan 22

Bank of Japan’s Initiatives to Date – What has BOJ done so far? Financial Markets Department Bank of Japan 23

• Outright Purchases of ABSs (since July, 2003) – Strengthen the transmission mechanism of monetary easing – Contribute to sound development of the ABS market, without distorting market mechanism – The conditions were amended on January 2004. Terms and conditions ØTypes of eligible products to be purchased • Publicly offered ABSs (including synthetic-type) and ABCP ØUnderlying Assets • 50% or more of the underlying obligees must be small and medium-sized enterprises ØTerm • The purchase program shall be valid until end of March 2006 ØUpper limit of purchase • 1 trillion yen on outstanding basis 21 24

Amount of the Outright Purchases of ABSs – The outstanding amount of the purchases remains relatively small, compared to the upper limit on purchases (i. e. , JPY 1 trillion). Ø Demands from investors are so strong that securitized products are smoothly issued in the market. Ø Market participants seem to have more confidence in securitization, after our announcement of the purchase of ABS. Trillion Yen Accumulated Amount of ABS Outright Purchase Accumulated Amount (Sep 30, 2005) Amended the for condition for the outright purchase of ABS ABCP: JPY 2. 8 trillion ABS: JPY 0. 001 trillion Total: JPY 2. 8 trillion Outstanding Amount (Sep 30, 2005) ABCP: JPY 62 billion ABS: JPY 0 billion Total: JPY 62 billion 2003 2004 2005 Financial Markets Department Bank of Japan 25

• The Workshop on Securitization Ø Securitization market in Japan has dramatically developed since 1990 s Required to identify the practical issues and to explore possible solutions in order for the market to proceed to the next stage of expansion 21 26

• Survey on Securitization Market Ø BOJ, as an unbiased public sector, launched the Survey on Securitization Market, prompted by the requests from Workshop participants (in May 2004) The survey aims to improve the information infrastructure of the market at the developing stage, aside from the regulatory disclosures to provide investors protection. The survey is a temporary measure until March 2006 (some private sector is expected to take over it after the expiry). Ø Supports by market participants are indispensable to make the survey workable As the number of market players (voluntarily) participating in the survey increases, the survey becomes more significant. It is expected, as a result, more players utilize the survey as the source of information. Financial Markets Department Bank of Japan 27

• Standardized List and Model Formats for Information Disclosure Ø Standardized List for Information Disclosure ： List up the terms necessary for risk assessment, pricing, and investment decisions, clarifying the level of requirements, definition of each term, and points to consider in accordance with the current market practice [Sample of “Standardized List”] Ø Model Formats for Information Disclosure ： Model formats to be used to disclose information Intended to be customarily used as a disclosure model, through being referred to henceforth and reviewed and revised in practice Actually used for disclosure of SME-CBO issued by Japan Finance Corporation for Small and Medium Enterprise Financial Markets Department Bank of Japan 28

• Removal of Prohibition-of-Transfer Clause Ø BOJ removed the prohibition-of-transfer clause in the qualified contracts where BOJ was a debtor in October 2004. Intended as a solution to the issue of “cost reduction of origination” ─ Based on the opinion that the public sector should lead the initiatives to remove the negative image of financing through the transfer of assets Ø In practice, BOJ enabled the transfer to SPC or qualified institutional investors for the contracts with the notional amount of 5 million yen or more under certain conditions. 21 29

• The Way Forward Ø The Workshop; has identified the current issues concerning Japan’s securitization market and provided fundamental directions to solve them will serve as a milestone in promoting sound development of the securitization market has successfully contributed to establish a basis for mutual trust and cooperation among a wide rage of market participants Ø BOJ also wishes that a wide range of market participants make further efforts to address problems in cooperation BOJ continues to commit itself in supporting the ongoing endeavors 21 30