TOKYO -- Japan will look into tweaking its primary dealer system for government bonds, aiming to keep the scheme on solid footing as one bank plots an exit.
The Ministry of Finance currently designates 22 banks and securities companies as primary dealers, granting them various benefits such as chances to sound out authorities on market movements. But dealers are also required to bid on at least 4% of the planned issue amount each time Japanese government bonds are auctioned -- an obligation that has become an outsize burden for many institutions.
Officials at primary dealers aired fears about the growing risks associated with overly large JGB holdings at a meeting with ministry officials Friday. A decline in liquidity could cause interest rates to suddenly spike, some said, while others complained that the U.K.'s pending exit from the European Union would likely cause debt yields to keep dropping.
Holding even long-term JGBs to maturity has become a loss-making endeavor since the Bank of Japan introduced negative interest rates this year. Bank of Tokyo-Mitsubishi UFJ has told the finance ministry it plans to give up its primary dealer status, citing difficulty meeting its bidding requirement. Japan's other megabanks have also complained that the obligations of the status outweigh the benefits.
The ministry will begin weighing changes as soon as autumn to make the system more attractive. A leading plan would increase the amount of debt available to primary dealers outside of price-competitive auctions. Currently, just 10% of each planned issuance is set aside for distribution through that scheme, while the rest is open to competitive bidding from all institutions. The set-aside portion is sold at the average price produced by bidding on the open-market portion.
Companies frequently enlist primary dealers to buy bonds for them on the condition that they will be able to pay that average price. Increasing the amount set aside to 15-20% of a planned issuance, as some suggest, would make it less likely that primary dealers would incur losses on such transactions.
The finance ministry is also expected to consider reforms modeled on auction systems in the U.S. and Europe, where primary dealer status is considered a good deal more favorable than in Japan. In the U.K., for example, government debt auctions are completely closed to those outside the dealers' circle. Prices and yields on a certain portion of issued bonds are set by negotiation between the government and primary dealers.