Margins on buying and selling transactions - Japan’s case - Hidetoshi Takeda Balance of Payments Division International Department Bank of Japan Item 19 BP-12-48

1. Introduction 2. Target 3. How to estimate margins 4. Japan’s margin Appendix. Data source for spreads 1 Contents

2 BPM6 para D ealers or market-makers in financial instruments may charge, in full or part, for their services by having a spread between their buying and selling prices. Dealers render a service through financial transactions. In doing so, they often charge a service (a margin) by setting a spread. 1. Introduction BPM5 para. 258 I ncluded are intermediary service fees, such as associated with….foreign exchange transaction. (For the latter, the spread between the midpoint rate and buying or selling rate is the service charge.) BPM5 briefly mentions such a service in the context of foreign exchange transaction. In contrast, BPM6 treats it as an independent item and defines it more broadly.

3 1. Introduction A spread is implicitly included in a concerned financial transaction; it should be excluded from financial account and should be included in services. Under current version, Japan does not count it as services, and implicitly includes it in financial account. After implementing BPM6, Japan will count it as services, and will explicitly exclude it from financial account.

4 1. Introduction Spread (services) Value of a bond (portfolio investment) Value of a bond (portfolio investment) When buying, an investor pays more: value of a bond plus a spread When selling, an investor receives less: value of a bond minus a spread Example: a transaction of a bond Spread (services) An investor pays An investor receives BPM6 para T he dealers’ service charge are included indistinguishably in financial transactions to which they relate.

5 BPM6 para T he difference between the reference price and the dealer’s buying price at the time of purchase represents the service charge to the seller. Similarly, the difference between the reference price and the dealer’s selling price at the time of sale represents the value of the service provided to the buyer. T he reference price is usually a mid-price between the buying and selling prices. A spread is a difference between a mid-price and a buying/selling price. Data venders and statistical agencies often provide information on these prices; Japan will use data from Bloomberg(see appendix). 1. Introduction

6 BPM6 states that various financial instruments are traded with spreads. BPM6 para F oreign exchange, shares, bonds, notes, financial derivatives and other financial instruments are often bought and sold in this way. 2. Target

7 For the following reasons, Japan will estimate margins for bonds(&notes) only. 1.Bond are traded in OTC market, and services are implicitly charged as a spread. Some financial assets are traded at exchanges, and explicit fees are charged(e.g. equities traded in a stock exchange) ; in Japan, such explicit fees are reported. 2.There are sufficient data to estimate. 2. Target To compute margins, both transaction volume and spreads need to be identified. For bonds, that information is readily available. Transaction volume and spreads are difficult to capture in other categories: especially, in derivatives. Foreign exchange is traded in OTC market, but most transactions with clients occur within a border; many interbank transactions are cross-border, but we regard that they do not generate a service for their counterparts. （ note) Japan employs ITRS and direct reporting systems for financial transactions: no security-by-security data; just aggregate data.

8 So, how do we estimate margins?

9 3. How to estimate margins Margins Transaction volume Spreads (as a ratio to mid-price) To compute margins, we need transaction volume and relevant spreads. = × Transaction Volume: Total of gross transactions. Spread: The difference between a mid-price and a buying/selling price. ・ For example, if a mid-price is 100 and a buying price is 101, then a spread is 1% (1% of transaction volume will be margins).

Resident Dealers 10 In most cases, a resident dealer exports services through inward investment transactions. Correspondingly, a resident investor imports services through outward investment transactions. Abroad(e.g. US) Non-resident Dealers Inward Investment Outward Investment Trading Japanese Government Bond (Resident’s export of service) Trading US Treasury (Resident’s import of service) Resident Investors Non-resident Investors Therefore, Japan assumes that export of services occurs only in inward investment, and that import of services occurs only in outward investment. 3. How to estimate margins - Transaction volume ◆ Export of service ◆ Import of service Home(Japan) Some inward (outward) investment transactions are conducted with non-resident (resident) dealers. Such transactions are preferably excluded.

11 Margins Transaction volume Spreads (as a ratio to mid-price) Now we have transaction volume. = × Export of service Import of service Margins Inward Investment (BOP Portfolio Investment) Transaction volume = × Outward Investment (BOP Portfolio Investment) Spreads (as a ratio to mid-price) Next, we identify spreads. 3. How to estimate margins - Transaction volume

12 Export of serviceImport of service Every single transaction has a different spread, but there is no means to capture each of them respectively. US Treasury Bond (short/long-term) French Government Bond (short/long-term) Italian Government Bond (short/long-term) German Government Bond (short/long-term) UK Government Bond (short/long-term) Others (apply Australian Government Bond) Japanese Government Bond (short/long-term) As JGB is dominant in Japanese bond market, we lumps inward investment in JGB only. If a country has other prominent bond markets(e.g. mortgage), it can be also reflected. Given the limitations of data sources, Japan picks up most common products and uses their spreads for approximation. Spreads are fixed in the short-run(say 3-month), but are reviewed periodically. Outward Investment 3. How to estimate margins - Spreads Inward Investment

13 Margins Transaction volume Spreads (as a ratio to mid-price) Now we have both transaction volume and spreads. = × Export of service Import of service Margins Inward Investment (BOP Portfolio Investment) Transaction volume = × Outward Investment (BOP Portfolio Investment) Spreads (as a ratio to mid-price) US Treasury(for Investment to the US), German Government Bond (for Investment to Germany), etc. Japanese Government Bond 3. How to estimate margins - Spreads

14 Export of service Import of service Armed with transaction volume and spreads, we compute margins. ①②①×②①×② 3. How to estimate margins

15 4. Japan’s margin Japan’s marginSpread(measured in 2011) Our estimation indicates that Japan is a net exporter of the service. This is mainly because the spread of JGB is relatively wider than those of others. Among major government bonds, the spreads of US, UK and German ones are relatively tight.

16 Thank you so much! The Bank of Japan offices Overseas ■ London ■ Frankfurt ■ Paris ■ New York ■ Washington, D.C. ■ Beijing ■ Hong Kong

17 Appendix. Data source for spreads Step1: Log-in Bloomberg and type“Govt TK”.Step2: Select a country of your interest.

18 Appendix. Data source for spreads Step3: Scroll down and select “Current Treasury Notes/Bonds”. Step4: Compute spreads. For 10YR, bid is and ask is ; then mid is and the spread is 0.01% ( calculated as (ask-mid)/mid ). A “current ” bond, or an on-the-run bond, is a bond most recently issued in a category. Time series data are also available at a “GC” screen. We use 1YR for short-term and 10YR for long-term.