Japan to Privatize Its Forex Reserve Management?

Here's an experiment in foreign exchange reserve management that looks interesting. We've heard of sovereign wealth funds (SWFs) that invest in non-traditional reserve assets, i.e. those other than sovereign debt of major currency-issuing countries or precious metals alike gold. These SWFs may place funds in equities and so forth. However, the innovation insofar as SWFs are concerned is on the portfolio side: they are diversifying placements of reserve assets in search of greater yield. In other words, SWFs are state-owned in their charter.

Hence Japan purporting to allow non-governmental entities to allocate part of its $1.27 trillion stash looks unique insofar as the management side rather than the placement involves the private sector:

Japan is looking to allow private sector funds and trust banks to manage a part of its $1.27-trillion pool of foreign exchange reserves in a drive to manage them better, a government source told Reuters on Sunday. Until now the government has managed the foreign exchange reserves itself, but its ability to do so has been stretched as the reserve roughly doubled over the past decade, thanks to massive yen-selling interventions to weaken Japan's currency.

The government needs to clear legal hurdles on its use of foreign exchange assets if it wants to draft in the services of private financial institutions and will propose amending the law during a parliamentary session that begins on Tuesday. The government is now restricted to lending its foreign securities only to banks, but the new law will also permit brokerages to borrow securities, the source said, with the fees borrowers pay going to replenish government coffers. "

Although we do not think the Japanese government will outsource all of the foreign exchange reserve to the private sector, even just a 10 percent outsourcing will become a $120 billion business," Tohru Sasaki, head of Japan rates and FX research at JP Morgan Tokyo, told clients in a note. 

Interesting if risky stuff. If large losses are sustained though, who's to blame--the Japanese government, the fund manager or both? It's the governance issue that needs sorting out if this experiment in forex reserve management is to be conducted. There's also the qualification for would-be managers that Japan being America's stalwart ally in the Asia-Pacific, assets must be kept in dollar-denominated securities.