Turning Japanese: Changing perceptions in JGBs

Historically, most of that debt has been issued, held, and traded domestically. Over the past decade, the perception of the JGB market as domestically focused has increased as the Bank of Japan (BOJ) – like other central banks around the world – undertook an extensive programme of quantitative easing, by the outright purchasing of JGBs. 

According to the BOJ’s latest Flow of Funds Accounts that were published in December 2022, the central bank owned Y535.62 trillion ($3.92 trillion) of JGBs by market value at the end of September. This represented 50.3% of the total JGB issuance of Y1.07 quadrillion. This is up from 49.6% at the end of June 2022 and up from only 10% ownership in 2012. 

In some specific cases, the BOJ owns 100% of certain individual issues such as the 368th 10-year issue that was sold in October 2022. This is evidence of the BOJ vigorously following its Yield Curve Control policy, to keep the ten-year part of the yield curve from rising too much in the face of recent rate rises. 

However, at the same time, a different dynamic is emerging which flies in the face of the perception that the JGB market is almost entirely Japanese. Holdings of JGBs by foreign institutions have been steadily increasing over the past ten years. According to BOJ data, the proportion of the total JGB market (including FILP bonds and T-bills) held by foreign financial institutions has risen from 5.7% in March 2010 to 14.1% in December 2022. It reached a high of 14.4% in March 2022. In absolute terms this represents an outright increase in foreign holding of Y123 trillion or $957 billion. 

There are both macro and micro reasons for this change. On the macro side, a series of fiscal, monetary, and structural reforms that were enacted a decade ago by the late Prime Minister Shinzo Abe (called Abenomics), have brought about fundamental changes to the Japanese economy across several vectors. A key element of the so called Third Arrow – structural reforms – was an intent to increase the internationalisation of Japan’s economy. In financial services this has manifested itself by Japanese financial institutions going out, while foreign financial services firms have come in. As a result of this, JGBs have assumed a greater role not only in capital structures, but also in general financial operations. 

At the same, the global need for high quality liquid assets for use as collateral for uncleared and cleared margining has increased dramatically, not least due to the successive waves of Uncleared Margin Rules (UMR) rolling out over the last five years. 

The use of JGBs as collateral in Euroclear has doubled since 2021 and this across the different business lines of repo, securities lending and UMR. JGBs have thus become the largest sovereign collateral. We sat down with Jan Grauls, Product Manager, Collateral Management Services at Euroclear in Brussels to discuss the increasing importance of JGBs for use in global collateral and what Euroclear is doing to help clients along this path. 

A: The Bank of Japan now owns half of all the JGBs, and they've bought those to force a lot of liquidity into the Japanese market in the hope of stimulating consumption. But recent statistics from the Bank of Japan also show that despite the growth of the Bank of Japan’s holdings, the proportion of foreign-held JGBs has been going up as well. The Bank of Japan has been buying JGBs and international investors have also been buying JGBs. 

A: Historically, people would have been less willing to accept them because if you do, you're accepting something that you’re not very familiar with and that is denominated in yen so there is a currency risk to manage. There might also have been less of a presence in the Japanese market, and which would not ease liquidation if things went wrong. Our assessment is that we are seeing greater use of JGBs as collateral because there are more and more international firms that have activity in Japan and that are comfortable trading those assets. And vice versa…there are more and more Japanese firms that are finding their way into international activity, and they are using their domestic stocks of JGBs and convincing their counterparties to accept them. Our platform is the ideal place for these firms to meet and transact!

A: There has been a long-term trend towards greater JGB use in collateral, but UMR has accelerated that adoption. UMR has prompted a lot of trading relationships that were previously unsecured, to become secured by collateral. And a lot of these trading relationships are between for example, Japanese clients and their international trading counterparties and a lot of the collateral that's been exchanged within those relationships is now JGBs. That has certainly contributed to greater interest in using JGBs.

Before the Bank of Japan began its bond buying programme, it was the Japanese banks that had huge JGB inventories on their balance sheets.  At the same time, these banks had substantial foreign currency funding needs (mainly in US dollars. They used cross-currency repos to meet their funding requirements, and in the process, brought JGBs into Euroclear Bank as collateral. This trade still carries on.

Euroclear does not just service Japanese banks. When Japanese institutional investors move into Europe, they are keen to take foreign owned JGBs as collateral and turn to Euroclear to make the connections for them. These Japanese institutional investors such as insurance companies accept JGBs as collateral for non-cleared derivatives margining but also for collateral swap transactions. This brings even more liquidity and flow into Euroclear Bank.  Since there is no domestic triparty platform in Japan, any entity that wants to finance their JGBs must do so in an international environment, which Euroclear provides.

In the last decade, Euroclear Bank’s settlement link with the domestic market has further improved whilst documentation requirements to hold Japanese assets have eased. Euroclear has operated a representative office in Tokyo since 1987, to support Japan-based users of its securities settlement system. In November 2017 Euroclear Bank, the international central securities depository, was granted a licence from Japan's Financial Services Agency (FSA) to establish a foreign bank branch under the Japan Banking Act.