Japanese ATS Regulation: Its Development and Remaining Issues

Sadakazu Osaki

 

I.     Regulation before 1998

II.    ATS Regulation after the “Big Bang”

1.   Removal of Ban on ATS

2.   Restrictions on Price Discovery Mechanisms

3.   Further Restriction Imposed by May 2000 Revision

III.   New Guidelines on ATS Regulation

1.   Expansion of Price Discovery Mechanisms

2.   Clarification of the Terms Used in Regulation

3.   Prevention of Unfair Trading Through ATS

IV.   Remaining Issues

 

I.     Regulation before 1998

An alternative trading system (ATS) is a means of matching orders from multiple market participants (including institutional investors and broker-dealers) to buy or sell securities such as equities and bonds using a computer network. The function carried out by an ATS is similar to that of a traditional stock exchange or organized OTC market. However, ATSs are regulated as broker-dealers, not as stock exchanges in many jurisdictions. Thus, institutional investors are able to participate directly in an ATS, instead of placing orders through broker-dealers which have membership in a stock exchange.

ATS was commonly known as a proprietary trading system (PTS) until recently. The U.S. Securities and Exchange Commission (SEC) formally referred to it as an ATS in their rule called Regulation ATS adopted in December 1998.^[1] The first example of a PTS (or an ATS) was Instinet (then called Institutional Network), which began life in 1969 in the United States. In the 1970s and 80s, Instinet and other PTSs were regulated as broker-dealers. SEC issued a number of no-action letters allowing PTS to operate without exchange registration required to stock exchanges under the Securities Exchange Act of 1934.^[2]

In Japan, on the other hand, operation of an ATS was effectively banned by a pro­vision of the Securities and Exchange Law.^[3] Art. 87-2 (before the 1998 amendment) of the law prohibited the formation of an organized securities market similar to a stock exchange market. Anyone who carried out transactions on securities and securities de­rivatives utilizing such an organized securities market could face criminal sanctions. It

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