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Japan Boosts CLO Scrutiny as Banks Buy Risky Assets

Toru Fujioka, Takashi Nakamichi and Takako Taniguchi

(Bloomberg) -- Japanese regulators are surveying the nation’s financial firms to determine their exposure to foreign assets including risky credit products as the global economy slows, people with knowledge of the matter said.

The Bank of Japan and Financial Services Agency want to get a fuller picture of domestic banks’ and insurers’ investments in collateralized loan obligations and leveraged loans to assess how they would fare if the borrowers run into difficulties, the people said, asking not to be identified.

The inspection comes as some investors and analysts fret that years of low interest rates have led to overheated credit markets, with packages of leveraged loans known as CLOs under particular scrutiny. Big Japanese investors including large banks and other financial companies are thought to have snapped up the CLOs as negative rates eat into their returns.

Now the worry is that large amounts of credit investments could leave them exposed to swings in global financial markets or a slowdown in the world economy.

Read a QuickTake on the risky U.S. loans that Japan’s banks adore

Still, there’s a dearth of public data on the exact scale of exposure following the recent surge in buying. The survey will allow the BOJ to access information on the holdings of insurers, which the FSA has the authority to request, the people said. While banks already disclose their holdings of securitized products in various forms, standardizing the data will give regulators a more coherent picture, they said.

“We see the importance of closer coordination with the Financial Services Agency for macro and micro prudence,” said Makoto Kasai, a senior official at the Bank of Japan’s financial system department.

“As there are various reports on overseas credit investment and lending activities by Japanese financial institutions, it’s vital to share the accurate understanding of the financial system by reporting detailed information based on actual facts as Japanese authorities,” Kasai said.

Yoshitaka Wada, a spokesman at the FSA, declined to comment.

‘No Choice’

The joint research also underscores how officials are trying to assess the effects of Japan’s more than six years of unprecedented monetary stimulus. Lowering interest rates further into the negative zone “is always an option,” BOJ Governor Haruhiko Kuroda said in a Nikkei newspaper interview last week.

“Investors have had no choice but to take credit risks because the yield curve has all but collapsed,” said Tomohiro Miyasaka, chief securitization analyst at SMBC Nikko Securities Inc. While Japanese investment managers have probably take necessary measures to keep such risks under control, closer attention from authorities could still make them “nervous,” he said.

In the absence of Japanese government figures on financial firms’ leveraged loan holdings, analysts have been relying on corporate filings and other sources. Researchers at UBS Group AG used evidence from clients and analysis of the cross-currency basis swap market to estimate that Japanese banks soaked up a third of new top-rated U.S. CLOs issued in recent years.

Analysts have also turned to a Bank of England report, which last year contained a table suggesting Japanese banks held about 10% of the $750 billion global CLO market in 2017. That number has probably since risen, given that agricultural lender Norinchukin Bank alone had 8 trillion yen ($75 billion) of the instruments in June.

The Bank of Japan may publish part of the survey results if needed, some of the people said. Authorities may also use the findings to inform the Financial Stability Board, a Basel, Switzerland-based body that monitors the global financial system and is also examining banks’ exposure to leveraged loans, one of the people said.

The FSA has been questioning banks including Norinchukin, Japan Post Bank Co. and Mitsubishi UFJ Financial Group Inc. on how they manage risks tied to their CLO portfolios, officials from the regulator told Bloomberg earlier this year.

(Updates with BOJ governor comment to Nikkei in ninth paragraph)

To contact the reporters on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.net;Takashi Nakamichi in Tokyo at tnakamichi1@bloomberg.net;Takako Taniguchi in Tokyo at ttaniguchi4@bloomberg.net

To contact the editors responsible for this story: Marcus Wright at mwright115@bloomberg.net, ;Paul Jackson at pjackson53@bloomberg.net, Russell Ward

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