BOJ New Settlement System Test Leaves Players More Edgy : LUSENET : Grassroots Information Coordination Center (GICC) : One Thread

Wednesday, November 1 12:37 PM SGT

BOJ New Settlement System Test Leaves Players More Edgy By Yukiko Tsuba Of DOW JONES NEWSWIRES

TOKYO (Dow Jones)--Remember how Y2K problems were overblown last year? One year later, Japan appears to be pushing its luck.

In two months, Tokyo will introduce a new bond settlement system that will radically change the way market players here conduct deals. Early indications suggest that the new trading system could bring all sorts of technical glitches in the new year.

On Sunday, around 400 financial institutions participated in a test run of the Bank of Japan's real time gross settlement system (RTGS) - which becomes operational Jan. 4. The participants relived a bit of history, simulating bond settlements over the new system based on actual trades conducted July 21.

The results? A big flop.

Mind you, there apparently wasn't anything wrong with the RTGS system itself. But for technical reasons, July 21 happens to have been a very busy day, and the large number of transactions attempted during the test far exceeded the capabilities of many market players to handle them. Brokers' Broker, a Japanese brokerage through which many securities houses deal cash bonds, was rumored to have had around 500 failed trades Sunday, according to some participants. "That is a huge amount," said a broker at another brokerage.

Neither Brokers' Broker nor the BOJ would comment on how many practice trades attempted by the company failed to go through.

A BOJ official speaking on condition of anonymity said it appears that between 10% and 15% of total trades failed during the test, while a dealer at a foreign securities house said, "Many securities houses said that 10%-25% of all trades they had to settle ended up failing."

Suffice to say, there were plenty of foul ups.

The problem stems from the nature of RTGS: under the new system, all bond deals need to be settled in real time on a gross basis rather than at several junctures during the day on a net basis, as is done now. The result is that when RTGS goes into effect, the number of deals that need to be processed will rise sharply.

The BOJ's attempt to speed up bond trading settlement is a key pillar in its effort to make JGBs a more attractive investment vehicle for foreign investors. The Japanese government bond market is already the biggest government debt market in the world, but most of that debt is held by domestic investors. Deeper participation by foreign investors would likely boost liquidity in JGB trading, helping to make the market more efficient and convenient for fund managers.

The irony is that the introduction of RTGS could well backfire. Liquidity in the market could dry up if investors lose confidence in the system, and that could make price moves more volatile than ever.

The problems the BOJ is having show that despite heavy IT investment here over the last year, the nation's financial industry still has a ways to go. Other industrialized countries already have RTGS systems in place and financial companies overseas long ago boosted settlement capabilities through IT investment so they could keep up with the quicker pace RTGS makes possible.

Adding to Japan's problems are cultural considerations. In other countries with RTGS systems, an occasional settlement failure here and there is accepted as a normal part of the market routine. In Japan, a failure is considered taboo. No players want to be the first to fail a settlement, so there's a possibility many players will hold back from using the RTGS system at first, analysts say.

Brokerage Held Meeting About Prioritizing Failures

"I wish the implementation would be pushed back, though I think the Bank of Japan will stick with the initial start date. The new system won't work under current market practices," said a bond repo dealer at a foreign securities house.

The BOJ official acknowledged that some institutions' systems malfunctioned. And in general, institutions had trouble getting used to the high volume that needed to be settled using the new system, the official said.

However, the official said, "We have test runs in order for the market to become used to it." He added that the BOJ plans to start RTGS on Jan. 4 as planned.

There are several ways that players could fail a trade. Players could fail to deliver a bond because they oversold and no longer have the bond in their books or because the buyer of the bond failed to come up with enough cash. Failing could also occur if there were problems with the settlement system.

After the test run over the weekend, some players have come to recognize that failing will be inevitable. In order to ensure that their credibility isn't tainted by failed trades, players might become very selective in choosing counterparties.

One securities house in Tokyo apparently held a meeting Monday in order to do just that - to come up with a priority list of customers it will deliver bonds to first if it needs to fail on some trades, according to a market player.

The BOJ has made its own efforts to restore calm, some said. On the Monday after the test, the BOJ skipped a money market operation at 0030 GMT - a routine through which it had been injecting cash into the financial system every day since Oct. 10.

Some market players speculated that the BOJ skipped the operation because it wanted to calm post-test market jitters or at least didn't want to exacerbate the situation.

If the BOJ had injected year-end cash in that session, "the operation could have been undersubscribed as players - worried by confusion over the test run - backed off from doing any trades they don't absolutely have to do. Either that, or rates could have jumped on the confusion, as some scrambled to secure cash," the repo trader said.

-- Martin Thompson (, November 01, 2000

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