One Sentence From the Bank of Japan Leaves Traders Perplexed

(Bloomberg) -- The Bank of Japan said today it may introduce a lending facility for its exchange-traded fund buying program, which would allow it to temporarily lend ETFs to market participants.

The one-sentence line on the last page of its latest statement on monetary policy left some traders puzzled, while others speculated on whether this could be a way to allay concerns surrounding liquidity.

“The BOJ’s share in the ETF market has been considerably increasing, so the BOJ would want to show the central bank is dealing with it somehow with this ETF lending facility,” said Yoshinori Shigemi, a global market strategist for JPMorgan Asset Management Japan Ltd. in Tokyo. “With this step, the BOJ would be appealing that it would provide liquidity to the market.”

BOJ Governor Haruhiko Kuroda later told reporters there had been requests from market participants because of difficulties in market-making due to a lack of inventory. While the central bank owns about 3 percent of the stock market, about 70 to 80 percent of the ETF market is held by the BOJ, he said.

“There are opinions that bid-to-ask spreads have widened a bit and it’s difficult for market liquidity and market function to be fully realized. By creating the ETF lending facility, we expect the ETF market to function better," Kuroda told reporters at a media conference. Still, the lending facility would take some time to be realized as it would need to be discussed with market participants and need approval from the Finance Minister, he said.

The move would mark another attempt to make the BOJ’s stimulus programs more sustainable. The central bank has previously scaled back its government-bond purchases, and widened its tolerance band for 10-year yields, in an effort to address declining trading volumes.

Not everyone is positive on the BOJ’s plan.

“Sounds like a ‘grand old Duke of York’ move to me: buying ETFs to lift the market then lend ETFs to short sellers to march it down again,” said Nicholas Smith, a strategist at CLSA Ltd. “Unfortunately, there is pretty clear evidence that their ETF buying is merely serving to damage the price discovery machinery of the market, driving away investors, particularly foreign ones. I’m sure they have the best of intentions, but they’re hemlock to the market, as they were to the bond market.”

BOJ’s Footprint

With the BOJ’s ETF holdings totaling 29 trillion yen ($259 billion) as of September at market value, the central bank owns 77 percent of the nation’s ETF market. Analysts have called on the BOJ to adjust its ETF purchase program by increasing assets linked to the broader Topix index, and shifting away from those linked to the Nikkei 225 Stock Average, to help ease distortions in Nikkei 225 heavyweight stocks such as Fast Retailing Co.

The BOJ has changed the allocation of its ETF buying twice since it began the program in 2010. In July, its purchases of Topix-linked funds increased, while the weighting for the Nikkei 225 fell. Last year, the central bank bought a record 6.5 trillion yen of ETFs tracking the nation’s shares, topping its annual target of about 6 trillion yen.

“Maybe they are doing it to help improve liquidity of Nikkei 225 stocks,” said Amir Anvarzadeh, a market strategist at Asymmetric Advisors Pte in Singapore. “That’s the only thing I can think of. But lending ETFs out would suggest that there are borrowers who want to short the index, maybe. I really don’t know.”

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