SALE OF THE CENTURY STARTS OCTOBER 1: A JAPAN POST

C O N F I D E N T I A L SECTION 01 OF 11 TOKYO 002716 SIPDIS SIPDIS USTR FOR CUTLER, BEEMAN, AND MEYERS NSC FOR TONG GENEVA FOR USTR PARIS FOR USOECD DOC FOR 4410/ITA/MAC/OJ/NMELCHER TREASURY FOR IA/DOHNER, CARNES, AND POGGI STATE PASS TO FEDERAL RESERVE BOARD FOR JKOHLI STATE PASS TO FEDERAL RESERVE SAN FRANCISCO FOR AMAYEDA AND RNAYLOR STATE PASS TO FEDERAL RESERVE NEW YORK FOR RHEESELER AND SNAGEL STATE PASS TO OCC FOR RGAFFIN AND SHOPKINS STATE PASS TO FDIC FOR JDICLEMENTE E.O. 12958: DECL: 06/14/2017 TAGS: ECON EFIN PGOV JA SUBJECT: SALE OF THE CENTURY STARTS OCTOBER 1: A JAPAN POST PRIMER REF: A. 04 TOKYO 4173 ¶B. 06 TOKYO 5686 ¶C. TOKYO 894 ¶D. TOKYO 967 ¶E. TOKYO 1916 Classified By: Ambassador J. Thomas Schieffer for reasons 1.4 b/d. Summary -------------- ¶1. (SBU) Japan Post -- a public corporation with assets the size of China's GDP -- begins a ten-year privatization process October 1. The institution, which encompasses a bank and an insurance company and is collectively the world's largest financial institution, has played a central role in Japan's postwar economic and POLITICAL life, and its privatization presents a number of reform opportunities. The privatization also poses potential risks, however, particularly to U.S. commercial interests. What follows is a primer on the privatization process, which lays out the stakes, identifies key players, and explains the top financial, competitive, and POLITICAL issues likely to affect the quality of privatization over the next two years. A reference of key dates is appended. End summary. Mark October 1 on the Calendar -------------- ¶2. (SBU) On October 1, Japan Post, a government-run public corporation with almost $3 trillion in banking and insurance assets, 24,800 post offices, and 260,000 employees, will begin a ten-year process of privatization. It will be split into six entities: a holding company; new insurance, banking, delivery, and postal service entities directed by the holding company; and a bridge "successor corporation" to hold pre-existing, government-guaranteed savings deposits and insurance contracts. According to the postal privatization laws passed in 2005, the government must sell off all of its stock in the insurance and banking entities within ten years, as well as two-thirds of its stock in the holding company, leading to the full privatization of the insurance and banking operations and the partial privatization of postal delivery and service units. ¶3. (SBU) Japan Post's privatization presents a number of economic and POLITICAL reform opportunities, but it also poses potential risks to U.S. interests. Those interests include maintaining Japanese financial system stability, ensuring that U.S. companies are not disadvantaged competitively during the transition, and fostering a successful privatization process (to encourage further privatization in Japan's economy and to strengthen the economy of a key global partner). The Japanese government will need to carefully implement the privatization process to manage its impact on financial markets, given the sheer scale of the postal banking and savings systems, their role in their respective markets, and their large holdings of TOKYO 00002716 002 OF 011 government bonds. The Stakes -------------- ¶4. (SBU) Japan Post sits at the center of Japan's postwar economic development model. Through its banking and investment arms, Japan Post has funneled cheap capital -- sometimes at negative real interest rates -- to the so-called "second budget" Fiscal Investment and Loan Program (FILP),a key source of public works monies, funding for government-owned lending institutions, patronage for the ruling Liberal Democratic Party (LDP),and construction contracts (many of which have fueled Japan's "dango" bid-rigging problem). ¶5. (SBU) It has also been a vote-getting machine for the LDP. Japan Post's "special postmasters," whose samurai ancestors were bought off by the Meiji government with sinecure small post offices (many of which do not accept or deliver mail),have manned the LDP's POLITICAL machine in its rural powerbase. Through the system, LDP politicians collect votes and campaign contributions from postmasters and then use their influence with bureaucrats to win contracts for pork barrel projects to benefit local areas. In return, the bureaucrats can aspire to cushy post-retirement jobs in the extended "postal family" network of companies and quasi-governmental institutions. ¶6. (SBU) Privatization thus threatens the iron triangle of entrenched LDP, business, and bureaucratic interests, but the opportunities loom large as well. Fund managers in Tokyo get wistful at the thought of capturing even one percent of the $3 trillion under Japan Post's management, and reformists speak of the structural changes possible if the market, rather than the government, were allowed to allocate that much capital. They argue the freeing of Japan Post's capital for productive investment will transform the economy, rather than build bridges to nowhere. ¶7. (SBU) The Japanese government also has a significant economic incentive to manage the process such that the market judges the privatized postal entities as viable private companies. Japan's government debt, as a proportion of GDP, is the highest among OECD countries, and the greater the market valuation of those entities' public offerings, the more resources the government will have at its disposal to reduce its debt burden. ¶8. (SBU) Politically, internal LDP and external resistance to postal privatization drove former Prime Minister Koizumi to call a snap election in September 2005, which was seen by the populace as an unprecedented referendum on reform. Not only did that election result in a resounding victory for Koizumi, particularly in the cities, and surge in his personal popularity as a reformer, it strengthened Koizumi's hand against the LDP's Tsushima (formerly Hashimoto and TOKYO 00002716 003 OF 011 Tanaka) faction, which had traditionally been the main beneficiary of the web of interests surrounding Japan Post and the construction industry. The Players -------------- ¶9. (SBU) Following is a quick run-down of the major institutions involved in postal privatization. ///Japan Post Today/// ¶10. (SBU) Japan Post: A government-run public corporation that provides universal mail delivery, express mail, insurance, and banking services through its network of nearly 24,800 post offices employing 260,000 people. Japan Post is regulated by the Ministry of Internal Affairs and Communications (MIC). It will cease to exist on October 1, 2007 when the ten-year privatization process begins. ///The New Japan Post Group Structure/// ¶11. (SBU) Japan Post Corporation (JPC): An existing government-owned holding company that, on October 1, will succeed the current Japan Post and own four of the new postal entities: the new postal banking company (Yucho),postal insurance company (Kampo),delivery company, and postal service company. Currently, JPC is engaged in planning for the privatization transition. After October 1, it will offer some central services to the four new entities and manage the initial public offerings of the new insurance and banking entities. By law, it will retain 100% ownership of the postal service and delivery companies. Planning is underway to take JPC public as early as 2009, with the intention to sell off two-thirds of its stock to the public, likely in tranches over time. ¶12. (SBU) Yucho: Japan Post's banking entity. According to Japan Post Corporation's draft succession plan, on October 1, Yucho will have assets of 226,991 trillion yen ($1.89 trillion at 120 yen to the dollar) and liabilities of 220,191 trillion yen ($1.83 trillion). Its individual accounts hold 30% of all household savings in Japan, making Yucho's asset base twice the size of any other banking group in the world. ¶13. (SBU) Kampo: Japan Post's insurance arm. Kampo's business comprises nearly 30% of all life insurance policies in Japan, the world's second largest insurance market, and its assets are forecast to be 114,589 yen ($954 billion) as of October 1. It is larger than the combined size of its next four competitors in the Japanese market. ¶14. (SBU) Postal Services Company: The management unit for Japan Post's network of post offices. The Postal Services Company will act as agents for postal bank and insurance sales and services, as well as serve postal and delivery customers. After privatization, it may offer financial TOKYO 00002716 004 OF 011 products from third parties, and it is considering other business lines such as catalog sales. ¶15. (SBU) Postal Delivery Company: Japan Post's mail delivery unit. The Postal Delivery Company will be responsible for Japan's universal service obligations, the sales of post cards and stamps, and the delivery of "type three" and "type four" mail (including newspapers, magazines, and Braille materials). Domestic shipping and express mail services will also be offered. ¶16. (SBU) Public Successor Corporation: The Successor Corporation will take responsibility for managing current Japan Post banking and insurance assets that have a government guarantee. In this way, the Successor Corporation will help bridge the transition process, by allowing for the separation of newly corporatized banking and insurance entities (which will not be able to offer products with a government guarantee) from previous product lines. As part of its bridge function, the Successor Corporation will have a re-insurance relationship with the new postal insurance company and undertake a contract with the new postal savings bank to manage previous deposits. ///The Regulators/// ¶17. (SBU) Ministry of Internal Affairs and Communications (MIC): As successor to the Ministry of Public Management, Home Affairs, Posts and Telecommunications (MPHPT),MIC is the primary regulator of Japan Post. Once privatization commences on October 1, MIC will continue to regulate the service and delivery businesses, but its role with respect to the postal banking and insurance businesses will be reduced to participation in the review of new financial product applications. ¶18. (SBU) Financial Services Agency (FSA): The government agency responsible for supervision of financial services firms, including insurance companies. Once privatization begins, the FSA will be the primary regulator of the new postal banking and insurance entities. ///The Referees/// ¶19. (SBU) Office of the Privatization of Japan Post (OPJP): Part of the Cabinet Secretariat, OPJP represents the prime minister's interests in the privatization process. It also serves as the secretariat for the Postal Services Privatization Committee (PSPC). While not its official description, a senior OPJP member has told us that one of OPJP's roles is to balance the interests of MIC and FSA in the transition. ¶20. (SBU) Postal Services Privatization Committee (PSPC): A quasi-governmental group of advisors on the privatization process. Mr. Naoki Tanaka, a long-time think tank expert and TOKYO 00002716 005 OF 011 close associate of former Prime Minister Koizumi, chairs the PSPC. While the PSPC does not have the legal authority to compel MIC and FSA to follow its advice regarding the privatization and the introduction of new products, it is understood that the regulators should follow the PSPC's direction in implementing the process. Tanaka has told Embassy officials that the PSPC's role is to ensure a successful privatization by balancing the need for Japan Post to have "management freedom" in executing the change with the imperative to minimize market and competitive distortions. The PSPC so far has seemed to be able to strike an appropriate balance, but U.S. industry remains apprehensive. As privatization commences, the PSPC will evaluate the impact of all applications for the banking and insurance entities to offer new products and will periodically review the overall process's progress. The Issues -------------- ¶21. (SBU) Looking out over the next two years, the Japanese government and the new postal entities face a number of challenges that will substantially determine the quality of the privatization process, both in terms of its effect on the economy and on the fairness of competition in the marketplace. There also remains a POLITICAL dimension to privatization, given Japan Post's size and its ties to the LDP. ///Financial System Stability/// ¶22. (SBU) Risk Management Expertise. Under Japan Post, the postal bank has offered straightforward, government-guaranteed savings accounts, and it has invested in conservative instruments like government, FILP, and municipal bonds. As of October 1, however, the postal bank's core product -- government-guaranteed savings accounts -- can no longer be offered, and restrictions on its investments will be relaxed. Financial analysts point out that as the new banking entity diversifies into products such as mortgages, commercial loans, and credit cards, it will face serious transition challenges in matching the risk profiles of its changing asset and liability mix -- and it will face those challenges with no in-house expertise or experience in assessing credit or interest rate risk. The postal insurance company, with its current guaranteed life product and similarly conservative investment portfolio, faces parallel challenges. How the new postal bank and insurance companies acquire and deploy product development and risk management expertise will therefore be critical to their viability as companies and their potential effects on the marketplace. ¶23. (SBU) The Possibility of Failure. The larger question encompassing risk management is, however, whether the new postal bank and insurance entities will be considered "too big to fail." Heftier than any of their competitors, Yucho and Kampo will be in a position to move the markets, and TOKYO 00002716 006 OF 011 Tokyo's old insurance hands are quick to recollect how Japan Post's non-market-driven decisions in the late 1990s exacerbated problems in the insurance market and contributed to the failure of seven insurers. Any missteps of the new banking and insurance entities -- and how the regulators react to them -- will be closely watched, because the perception that the companies will not be allowed to fail could fuel unwarranted risk-taking on their part, which would undercut competitors and push them toward non-commercial behavior. Regional banks could be particularly vulnerable in such a situation, as Japan Post Corporation plans indicate an intent to compete in their core product areas. Moreover, a "too big to fail" image would feed consumers' complacency and perceptions of an implicit government guarantee of deposits and insurance products. ¶24. (SBU) The Bond and Stock Markets. It is hard to overstate Japan Post's role in the market for Japanese government debt. Japan Post's banking and insurance arms held 186 trillion yen (more than $1.5 trillion) in Japanese government bonds in FY2005, almost 28% of all outstanding JGBs. The details of how the new postal bank and insurance companies will structure their businesses are unknown, but plausible developments, such as greater competition for customers after October 1 (resulting in a need to balance products with higher risk profiles) and a desire to increase returns on investment, could lead them to a smaller role in the JGB market, with difficult-to-forecast results for the economy, JGBs, and other investment options. In the stock market, a well-known analyst has discounted early speculation that privatization would lead depositors to suddenly switch assets from postal savings into equities (because most savings are held as term deposits),but a medium-term reallocation is likely. Most concretely, the analyst warned of the privatization's potential direct effect on the stock market: governments undertaking privatizations, she explained, tend to sell a tranche of stock each time its price moves up, thereby capping the stock's upward movement. That could weigh down the entire banking or insurance sector, or even the whole Japanese market. ///Commercial and Competition Policy Concerns/// ¶25. (SBU) Although not well known as a successful U.S. export to Japan, U.S. insurance companies alone take in about $50 billion in premium revenue per year, making the market critical to the bottom lines of well-known companies like AFLAC, AIG, The Hartford, and Prudential. The re-birth of Kampo as a private company, with no governmental limitations on its product offerings, will directly affect their competitive environment. Similarly, U.S. banks and express delivery services will face head-to-head competition with Japan Post spin-offs in Asia's largest market, as will Japanese domestic insurance, banking, and delivery firms. Noting the competitive implications of Japan Post's privatization, the American Chamber of Commerce in Japan, the TOKYO 00002716 007 OF 011 European Business Council, and a variety of Japanese banking, insurance, and delivery associations have all publicly weighed in on the privatization. Tax, regulatory, cross-subsidization, and transparency issues are among these industries' greatest concerns. ¶26. (SBU) Equivalent Regulatory Regimes. As a public company, Japan Post has been exempt from corporate taxes and subject to unique regulations arbited by the Ministry of Internal Affairs and Communications (MIC),among other perks. Simply put, will these advantages over private sector companies end on October 1? For some, like the elimination of the tax exemption, the result will be evident, but it will not be easy to determine in other instances. For example, Japan Post's delivery services enjoy preferential parking and customs procedures, giving their express mail services a leg up on their private sector competitors. Monitoring implementation of new rules (assuming they are adopted) will be difficult, particularly given the number of rural post offices affected. ¶27. (SBU) Japan Post's Readiness. Beyond the implementation of equivalent regulatory regimes, there are doubts that the new Japan Post entities will be ready for the transition. The Japan Post Corporation has acknowledged that the postal banking company's information technology system will not be up to its private sector competitors' standards on October 1, and industry experts have wondered aloud about the new companies' ability to comply, given their new exposure to FSA regulations. The FSA, for its part, has established a unit to supervise the new postal banking and insurance entities, but its special status (it is the only FSA unit matched to specific companies) has raised some eyebrows among industry observers, who have asked whether special status will equate to special treatment. ¶28. (SBU) Implicit Government Guarantee. Dispelling the perception of an implicit government guarantee for the new banking and insurance entities will be equally difficult. The privatization laws eliminate the government's guarantee of their products, but many consumers will likely continue to believe such a guarantee exists, especially while the government remains a large stockholder. At what percentage of ownership, it has been asked, is it reasonable to expect the perception of a government guarantee to disappear? Is it reasonable for the public to assume an implicit government guarantee if the institutions are considered "too big to fail"? Moreover, does an implicit government guarantee constitute a competitive advantage over the private sector, in sales, marketing, or in raising capital? ¶29. (SBU) Cross-Subsidization. Despite the eventual privatization of Japan Post's banking and insurance arms, and the partial privatization of its delivery and service units, the four companies will remain closely tied. The privatization laws require that post offices continue to TOKYO 00002716 008 OF 011 offer postal bank and insurance products (though they may offer private sector competitors' products as well); they also mandate the Postal Successor Corporation re-insure its inherited policies through a contract with the new Postal Insurance Company. Moreover, Japan Post Corporation has suggested that it will provide some services centrally, including strategic planning and some back office functions. This situation will require complex contracting and accounting, and a high degree of transparency, to assure private sector competitors that a set of non-competitive subsidies is not buried in this web of relationships. Express mail delivery services illustrate the issue's complexity. Despite the Japan Fair Trade Commission's designation of Japan Post's Express Mail Service (EMS) as a competitive product, MIC maintains that EMS is part of Japan's universal service obligations for international mail. This interpretation allows the product to be lumped together with Japan Post's monopoly letter delivery service and could allow cross-subsidization to undercut private sector competitors. Further complicating the picture is the "Social and Regional Contribution Fund," which the Japan Post Corporation must establish under the privatization laws. With up to 2 trillion yen in the fund and a mandate to maintain service levels in underpopulated areas, businesses fear it could become a convenient mechanism for Japan Post Corporation to inappropriately subsidize operations that compete with the private sector. ¶30. (SBU) Transparency. Throughout the privatization planning process, U.S. industry, supported by the U.S. government, has pushed for meaningful and timely opportunities to comment on new policies and regulations. Advocacy has achieved a number of successes, including improved access to the PSPC's deliberations for interested stakeholders, but transparency will likely continue to be a concern, particularly as the new postal entities apply to introduce new products to the market. The Japan Post Corporation's recent submission of its Implementation Plan underscored this sensitivity. Although the Japan Post Corporation is wholly owned by the government, the Office of Japan Post Privatization has maintained that the PSPC cannot compel JPC to release the plan, and interested stakeholders have so far seen only an 86-page summary of a planning document we have been told exceeds 500,000 pages. Understandably, U.S. and Japanese industry have taken the position that they cannot judge the privatization's likely competitive impact without more meaningful disclosure. ///Political Dimensions/// ¶31. (C) While the postal privatization will commence on October 1, powerful domestic opponents remain. The risk is not to the process itself (none of our contacts doubts it will proceed) but some question whether the Abe administration has sufficient POLITICAL will to pursue a high-quality process. TOKYO 00002716 009 OF 011 ¶32. (C) Special Postmasters (ref E). The role of the special postmasters is at the heart of questions about the quality and effect of the privatization. There are concerns, for example, that since PM Abe's election, the special postmasters have gained power vis-a-vis the Japan Post Corporation leadership, and without reform of the bloated and expensive special postmaster system, the new postal companies will have a difficult time cutting costs and competing like a private entity. Perceived POLITICAL need to accommodate those costs -- and the imperative to avoid a "failed" privatization or IPO -- would create a temptation to allow Japan Post to retain some of its public sector advantages, or to allow cross-subsidization of the weaker units within the whole. ¶33. (C) The "Postal Rebels." The fight over postal privatization continues to affect the LDP, though the confrontation is not as open as it was prior to the snap election Koizumi called in 2005. After taking the party's helm, PM Abe re-instated 12 of the "postal rebels" Koizumi had ejected from the party for opposing the privatization (ref D). While PM Abe extracted promises of policy support from the returnees, the process dimmed public perceptions of the party's seriousness about reform and has contributed to an image of weak leadership. It has also set up a longer term conflict within the party between the rebels and the "assassins" Koizumi hand-picked to run in the rebels' places. In any case, divisions within the party over postal privatization -- coupled with special postmasters' stronger hand -- invite the survival of the old Japan Post model, with all its tendencies toward pork barrel politics and cozy, insider deals. ¶34. (C) MIC's role. In recent months, MIC has taken a more active role in bilateral discussions about Japan Post under the U.S.-Japan Regulatory Reform Initiative, displacing OPJP as our key interlocutor on many issues. While OPJP has explained the shift as a natural result of the end of its planning role, a Ministry of Foreign Affairs official speculated that MIC's enhanced role is a reflection of MIC Minister Suga's personal interest in postal privatization. Suga has a reputation as a reformer, but the privatization will be a ten-year process, MIC's traditional interest has been to shield Japan Post from reform, and MIC's role should arguably be diminishing as the FSA takes over as the postal banking and insurance entities' primary regulator. Comment: Ready or Not, Here We Go -------------- ¶35. (C) As October 1 approaches, foreign and domestic industry are increasingly focused on the postal privatization process and its potential competitive impact, and while we expect this trend to continue, the attention may well reach new highs when the privatized postal banking and insurance entities apply to introduce new products and bring new TOKYO 00002716 010 OF 011 competition to areas of the Japanese domestic market where they have been restricted. As in any undertaking of this size, we also expect there will be unexpected and unintended consequences to be managed. We will remain actively engaged in the process. End comment. Reference: Postal Privatization Timeline -------------- ¶36. (U) Following are key dates in the privatization process: 10/14/2005 Set of six postal privatization-related laws passed the Diet 01/23/2006 Japan Post Corporation established 04/01/2006 Postal Service Privatization Committee established 07/31/2006 "Framework for the Implementation Plan Regarding the Succession of Japan Post's Business Operations and Others" submitted by the Japan Post Corporation 09/01/2006 Yucho Bank (preparation company) and Kampo Insurance Company (preparation company) established 12/20/2006 PSPC issued the "Findings Regarding the Investigation and Deliberation Over New Business Operations by the Postal Savings Bank and Postal Insurance Corporation" 01/31/2007 U.S. government submitted public comment on the PSPC's "Findings" 04/27/2007 "Implementation Plan Regarding the Succession of Japan Post's Business Operations, etc." 05/01/2007 PSPC put out a summary of the "Implementation Plan" for public comment (due May 21) 05/21/2007 U.S. government submitted public comment on the "Implementation Plan's" summary. 05/21/2007 PM Abe and MIC Minister Suga officially asked PSPC for its opinion on the Implementation Plan 06/08/2007 PSPC issued its opinion on the "Implementation Plan" to MIC and FSA 09/01/2007 Deadline for MIC and the FSA (as the prime minister's designee) to approve the Implementation Plan 10/01/2007 Privatization process to begin 2007-2008 Kampo and Yucho expected to make applications for new or altered products 2009 Suggested target date for initial public TOKYO 00002716 011 OF 011 offerings of Kampo, Yucho, and Japan Post Corporation 10/01/2010 Earliest possible initial public offering for new entities without a waiver from the Tokyo Stock Exchange rule that limits public offerings to companies in existence for three years 10/01/2017 Deadline for full sell-off of postal banking and insurance entities' stock SCHIEFFER