It always gives me a pleasure to join this prestigious Harvard Law School seminar with many distinguished guests, but when it comes to capital markets in Japan, I am afraid that there have been no pleasant events taken place so far.

It is apparent that when a banking system does not function well due to huge non-performing loan problems, capital market should play an important role as an alternative financial intermediary. Nobody would oppose that the U.S. experience in the 90Ġs proved it. JapanĠs capital markets, however, have had its own problems in it and have failed to attract not only overseas investors but also domestic investors until today. Of the 1438 trillion yen household financial assets, only 8.8% is in equity markets and only 2.5% is in mutual funds, while 53.0% is in bank deposits and postal savings. I have to admit that this has been a correct decision for the household in the past. Let me make four points in the problem of JapanĠs capital markets.

First, investors still donĠt trust Japanese accounting system. In addition to infamous legend clause stating Japanese accounting system as local standards, recent bankruptcy case of Mycal, large retailers, revealed that Japanese disclosure system actually hurt many domestic household investors.

Good news in this regard may be a fact that since April 2001, Japanese accounting setting body was privatized from governmental agency. Newly created private Financial Accounting Standard Foundation, like FASB in the U.S., became responsible for corporate accounting standards. At the same time, we have bad news though. Improvement is still very slow. For example, the accounting for impairment of long-lived assets which will work as non-performing assets buster in the bubble-tainted industries may not be introduced until fiscal year 2004, due to strong oppositions. In fact, the FSA still be in charge of a preliminary study of an accounting for impairment, which should have been conducted by the newly created private body.

Second, a creation of strong SEC is necessary. It is commonly pointed out that regulations and enforcement of insider trading and stock price manipulation is lax in Japanese capital markets. Recent large-scale fraud case of Daiwa-Toshi- -Kanzai, a mortgage securities company, indicated that strong quasi-judicial function should be attached to JapanĠs securities regulating body. Current securities regulating function, such as disclosure, enforcement, and supervision, is dispersed in the various bureaus in the FSA, and nobody in the Japanese government is responsible for capital market as a whole to protect investors. I also think a creation of the independent SEC will better serve for the function of the private accounting setter.

Third, an independence of mutual fund industry must be enhanced. Japanese mutual fund industry has long been subsidiaries of powerful brokers and dealers. Mutual fund industry was hardly considered as stable financial intermediaries for long-term asset management, unlike U.S., especially in terms of proper disclosure and safeguard measures against conflict of interest with fund managers or parent brokers and dealers. Given the world fastest aging society, the mutual fund problem should be addressed in the context of national strategy how to educate household investors, along with the introduction of defined contribution pension plan.

Fourth, capital gain tax system has to be overhauled. The Ministry of Finance decided to reduce tax rate in a very complicated way from fiscal year 2002, but market participant considers its positive effect as nominal or at worst harmful. I believe as long as Japanese economy lacks capital in a macro terms, capital gain tax rate should be effectively fixed to zero.

Lastly, before I conclude, I would like to mention structural aspects in enhancing function of capital markets. Inefficiency in capital market is a byproduct of historical main-bank system in Japan. Households did not have to hold equity directly, because banks held stocks of borrowers mutually, instead of households. Moreover, since bankers have been considered as brilliant next to bureaucrats, public disclosure might not be necessary as long as the best and brightest in the country managed the household asset in the forms of bank deposits and postal savings. Thus, our issues of capital market improvement have structural aspect.

But I believe the time has come. In the last Diet session, two laws were passed; one establishes public corporation to buy bank-holding stocks, the other strengthen RCC to buy non-performing assets from banks. Interestingly, if it had not been party line voting, the former legislation might not have passed, since many ruling party politicians, including me, opposed to it. But as long as the bankers are proved to have no capacity to manage the assets as is in the above cases, we have to tackle issues of capital market improvement one by one.

Thank you.