Outright Purchases of Commercial Paper (Japan)

According to the BOJ Policy Board, the intent of the measure was to “ease capital constraints” on financial institutions, with the idea that institutional lending would increase across the financial system (BOJ Meeting, December 2008). During the BOJ’s Monetary Policy Meeting in December 2008, members of the Policy Board stated that tight credit markets contributed to a “limited availability of funds,” and thus a decrease in the issuance of CP, corporate bonds, and other corporate debt instruments. Financial institutions of all sizes found conditions to be “severe” and that there was little positive effect of maintaining low interest rates (BOJ Meeting, December 2008). A large part of the discussion surrounded how to introduce policy measures aimed at lowering interest rates on short-term paper. The consensus view was that such measures would likely be effective and improve access to funding for nonfinancial corporations while “boosting business and consumer sentiment” (BOJ Meeting, December 2008).

The BOJ hoped the purchases would “enhance the price-discovery function in the CP market” (BOJ Meeting, December 2008). The BOJ also hoped that if financial institutions could sell CP to the BOJ, those financial institutions could then go on to fund CP for other issuers or extend funding directly to cash-strapped businesses, particularly small firms (Nishimura 2009, p. 10). One Policy Board member stated that the outright purchase measure was “designed to provide a backstop and was not intended to be used actively on a regular basis” (Mizuno 2009).

The BOJ chose to implement a competitive auction format to prevent financial institutions from just selling risky CP under their own terms to the BOJ (BOJ Market Report 2008).

Any purchase of CP would be conducted as “multi-price competitive auctions” (BOJ Market Report 2008). This type of auction requires a market participant, or counterparty, to bid a yield spread on CP it wishes to sell to the BOJ. The counterparty would formulate a yield spread by taking the yield at which it wished to sell the CP minus the BOJ-established minimum yield.

The BOJ set a minimum yield for purchases to incentivize financial institutions to gradually reduce their usage of the BOJ’s measure as market conditions improved (BOJ Market Report 2008). Moreover, the counterparties could offer multiple-priced bids, often at lower and lower prices, to outbid their competitors and make the spread more attractive for the BOJ to purchase.

The BOJ would first purchase CP from the bidder that submitted the lowest yield spread, since it was the least costly for the BOJ. The BOJ continued to purchase CP from other bidders in ascending order until it utilized up to, or around, the maximum amount the BOJ planned to purchase, in this case ¥300 billion per purchase date (Outright Purchases Terms and Conditions 2009).

No additional material found on the motivation behind this design.

Initially, the BOJ said it would conduct 10 purchases between January 30 and March 31, 2009. The short time frame was to “ensure that the purchases are a bridging measure until the market function recovers” (Shirakawa 2009).

The BOJ twice increased the amount of purchases and extended the expiration date of the facility. According to one Policy Board member, the BOJ decided to extend the temporary measure because nonfinancial companies continued to struggle with financing. Moreover, financial institutions expected that lending rates would continue to increase if credit rating agencies downgraded their CP and other debt securities because of poor conditions in the overall credit market (Mizuno 2009). The Policy Board member stressed still that the BOJ’s goal was to shrink the measure as overall market conditions improved and the need for the outright purchases would decline (Mizuno 2009).

Eligible counterparties were already counterparties in the BOJ’s CP repo operations or were already eligible to borrow funds in the Bank’s Funds-Supplying Operations against Pooled Collateral. These counterparties included banks and other financial institutions, financial instrument firms, securities finance companies, and tanshi (broker) companies.^FFinancial institutions are defined in Article 37, Paragraph 1 of the Bank of Japan Act, Act No.89, 1997. Eligible financial instrument firms, securities finance companies, and tanshi companies are defined in Article 10, Paragraph 1, Clauses 2-4. Eligible instruments are defined in Article 28, Paragraph 1 of the Financial Instruments and Exchange Act, Act No. 25, 1948. The program excluded bridge banks (Outright Purchases Terms and Conditions 2009).

For the first five months of the program, the Bank of Japan set the minimum yield at 0.300% for CP with a residual maturity of up to one month and 0.400% for CP with a residual maturity of more than one month and up to three months. In June, the BOJ raised those minimums to 0.500% and 0.700%, respectively, and lowered them back to 0.300% and 0.400% in November, after bidding had ceased.

Then–BOJ Governor Masaaki Shirakawa said that the bid rates were intended to be “more favorable than the market interest rates when the market is malfunctioning, but not more favorable than the market interest rates of normal times”; since losses on any purchased CP would come at a cost to taxpayers, a penalty rate on the interest would ensure that taxpayers were compensated for taking on the credit risk (Shirakawa 2009).

The measure allowed the BOJ to purchase most types of CP, including corporate CP and asset-backed CP (ABCP) issued by domestic corporations, or by foreign corporations with a guarantee from an a-1 rated company.^FAt the time, the Japanese financial system was in the process of transitioning from physical certificates to electronic transactions, a process described as “dematerialization.” Both physical and electronic transactions were allowed under the outright purchase program (JASDEC 2008). The BOJ Policy Board excluded commercial paper issued by real estate investment trusts (REITs) on January 22, before the first auction, at the same time announcing that it would begin to accept REIT securities as collateral in the CP repo program (BOJ Amendment, January 2009).

The BOJ set minimum credit rating standards to protect itself against loss. “Given the higher risk of incurring losses compared to other monetary policy measures, the Bank will properly manage credit risks arising from outright purchases” (BOJ Press Release, 01/22/2009).

No additional material found on the motivation behind this design.

The BOJ set two limits on the total outstanding amount of a single issuer’s CP that it could accumulate. First, it would never hold more than ¥100 billion of a single issuer’s CP. Second, the total outstanding CP purchased of a single issuer could not exceed 25% of the peak amount of CP that the issuer had outstanding at the end of any month in the second half of 2008. “Since the losses of the purchases impose costs on taxpayers, it is important to avoid the concentration of credit risks in a specific firm,” the BOJ governor said in a 2009 speech (Shirakawa 2009).