The Journal The Authority on Global Business in Japan

The Securities and Exchange Surveillance Commission (SESC) is the government body that oversees the legal compliance of Japan’s capital markets. Operating under the authority of the Financial Services Agency, the SESC is marking 25 years of operations this year. Secretary General Kiyotaka Sasaki sat down with The Journal to talk about the part the commission plays in the Japanese economy, how the markets are evolving, and Tokyo’s new role in international regulation.

What role does the SESC play?
The SESC’s mission is to ensure integrity in the capital markets by addressing misconduct, such as insider dealing or financial fraud. That is the direct objective of our organization. However, we must remember that the integrity of the capital markets is essential for a sound financial system, as well as for attracting investment from overseas. So, integrity of the markets serves as the base for the effective development of the Japanese economy and, due to the interconnection of capital markets around the world, the global economy.

Why was the SESC created?
We were set up in 1992, so this year marks our 25th anniversary. Before that, our functions used to come under the Ministry of Finance, which was very powerful. With the collapse of Japan’s economic bubble of the late 1980s, however, there were lots of problems. That collapse hit the capital markets first and the banking sector somewhat later. The immediate impact was felt by the securities sector, brokerages and dealers, so by 1990 there were problems at the big Japanese securities companies in relation to lost earnings. A number of investors had suffered significant losses, and some were demanding compensation. In some cases, brokerages were offering their most important institutional investors compensation. This led to a scandal and big problems, politically, in the Diet and the Ministry of Finance. The ministry, in particular, came in for very strong criticism. There were additional problems in the late 1990s—non-performing loans at Japanese banks—but this was the initial reason for the creation of an organization independent of the ministry.

How does the SESC compare with similar organizations in other jurisdictions?
Other countries have units with similar functions—such as the Securities and Exchange Commission in the United States, the Financial Conduct Authority in the United Kingdom—although there are differences depending on the legislation and legal framework in each country. In the United States, oversight of the financial sector is more segregated, so the models for supervision can be quite different.

What distinctive challenges do you face regarding other jurisdictions?
Firstly, due to changes in the structure of the capital markets, there have been more and more institutional investors coming into the Japanese markets in the past 10 to 20 years. Previously, the number of overseas hedge funds, investors, and traders used to be very small; but that has been growing and now accounts for about 60 to 70 percent of transaction volume on the Tokyo Stock Exchange. In addition, global institutional investors play a very significant part in the Japanese market. If wrongdoers are domiciled in Japan, it is easy for us to trace them and address the issue. But if they are outside Japan, it is more difficult and that requires increasing collaboration among regulators.

How do you cooperate with authorities abroad?
Compared with 10 years ago, I think we have very close communications and collaboration with other regulators. Typically, we work with the United States, United Kingdom, Hong Kong, Singapore, and some others. For oversight of the financial sector, information is crucial and we are active in exchanging and sharing such information. We also collaborate on enforcement and inspections, sometimes sending our teams to other jurisdictions to interview offenders. And that works both ways as we have investigative teams coming to Japan from abroad. We could not operate without such collaboration, because no single regulator can address very complex, cross-border wrongdoing.

 

And how do you overcome differences in approach to SESC violations when they cross borders?
This is a very important issue. Even though a framework for collaboration is in place, each country has a different legal system and a different way of carrying out an investigation. Working out how to coordinate and address market misconduct is a very time-consuming issue. We share information through discussions and face-to-face meetings to identify wrongdoers and impose penalties. Obstacles to cross-border cooperation are being discussed and addressed at the international level, such as through the International Organization for Securities Commissions.

Have you noticed an increase in the instances of misconduct?
Even though we have been getting more resources and we are conducting more investigations and inspections, still the number of misconduct cases has been increasing. There are a number of reasons. First, the size of the market and the volume of transactions have been increasing. Second, a number of new products and technologies have emerged—so even though we address misconduct, new techniques and developments in IT enable wrongdoers to avoid regulatory oversight. Macroeconomic changes have also affected the market a lot; for example, since the Bank of Japan introduced negative interest rates last year, there has been increasing demand among individual Japanese investors for non-Japanese products, typically US Treasuries and other products with some yield. That’s a very good business opportunity for brokerages and investment banks in the United States, but it is also an increasing chance for wrongdoers to cheat individual investors.

Are the types of misconduct you investigate changing? What are some of the trends you are witnessing?
We are still seeing conventional cheating—insider dealing and Ponzi schemes—but trends very much depend on broader market and economic conditions. In the past few years, for example, the Japanese economy has been doing relatively better, and the markets are more active than previously, which is good. But when the economy was not doing so well, five or 10 years ago, Japanese companies were suffering increasing losses and we identified cases of fraud. [Companies] are also becoming increasingly globalized, meaning that they are opening branches and manufacturing facilities in emerging or developing countries, typically in Asia. This has led to an increased risk to their operations of financial fraud outside Japan. We have noticed that more listed Japanese companies have suffered losses due to the decline of the Chinese economy in the past couple of years, and that has sometimes led to financial fraud or insider dealing.

You have outlined a significant change in your approach to the SESC’s four-year strategy and policy plan through 2019. Why?
Regardless of us marking our 25th anniversary, the environment surrounding the SESC has changed dramatically in terms of the market, macro-economic conditions, and the political environment. There are more and more uncertainties, even compared with recent years, so the SESC has to review the challenges and risks that face us on a continuous basis. I thought this was a good opportunity for quite drastic change.

You have said you want your organization to be proactive and forward-looking in its tackling of misbehavior. How can you guess what is just over the horizon?
Our conventional business model—still our basic mission—is to address individual market misconduct. That remains the objective of our organization. So, we look at individual cases to see what happened in the past. However, looking at a number of cases, we see some common trends that very much depend on macro-economic conditions, market conditions, regulatory changes, and so on. Looking at the cases themselves, we are able to see what will be the next problem or risks.

Despite our attempts to be forward-looking and to alert the market, however, there are still cases of wrongdoing. But, if we send a message to the market, some potential wrongdoers feel nervous about what they are planning and stop. Without market discipline, we cannot address all the wrongdoings.

There are a number of other mechanisms—including companies themselves, internal controls, the stock exchange, auditors, and lawyers. These are the gatekeepers, in a sense, so we are not doing it solely by ourselves.

What is the importance of the International Forum of Independent Audit Regulators?
The history of the regulation and supervision of audit firms is relatively new, and only traces back to scandals such as Enron in the United States [in 2001], which was important to the audit industry because of the involvement of Arthur Andersen, one of the big accounting companies. Supervision of accounting firms is essential for investors’ confidence in their financial statements, particularly among listed companies. Audit quality is the basis of market integrity and an international organization is needed to ensure that.

What precisely does the forum do?
The International Forum of Independent Audit Regulators (IFIAR) is an organization of audit regulators, so the mission and activities include, for example, sharing experience and the development of a framework for the exchange of information. Capital market oversight bodies such as the SESC already have such a framework for international cooperation, but IFIAR has only recently been set up, so it needs to determine ways to enhance international collaboration among audit regulators.

How significant is the decision to base the permanent secretariat of IFIAR in Tokyo?
For Japan, it is very significant. I would even say that it is historic. The Japanese government and the city of Tokyo want Japan to become a more globalized financial market. The market here is large, but it lags behind Hong Kong and Singapore in terms of globalization. More hedge fund managers, for example, live in Hong Kong and Singapore due to high costs or regulations here. The government wants to make Tokyo a more globalized financial center, which is important to the growth of the Japanese economy and, ultimately, to global economic development.

What selling points did Japan’s government use to make the case for the establishment of IFIAR in Japan?
There are currently 52 members of IFIAR. About 30 are European, 10 are from Asia, including Japan and Singapore, [while others are from] the United States, Canada, and some states in Africa and the Middle East. European nations dominate the membership—but we stressed that IFIAR has global aims and the organization needs to be globalized to attract more members. China is not a member, nor are India or the Philippines. Asia is leading global economic development, but many states here are not members. And if we do not have more members from Asia and other developing regions, then IFIAR’s mission to improve audit quality globally cannot be achieved. I emphasized that, to make IFIAR globalized as an organization, we need to have its headquarters outside Europe, and to have the office in Tokyo would be beneficial for attracting more Asian countries. We also emphasized Tokyo’s infrastructure in terms of a financial center and the city’s livability. And, finally, we had the strong commitment of the Japanese government and the firm support of the private sector here, such as Keidanren. And while it was in a sense natural for Japanese organizations to support our mission, we also received support from the American Chamber of Commerce in Japan and the European Business Council. I think that was a very positive selling point.

Julian Ryall is Tokyo correspondent for The Daily Telegraph