‘This time we mean business,’ was the message from the Japanese government as it announced its package of deregulatory measures for the financial sector in mid-June. Collectively known as Big Bang, the reforms aim to remove barriers and promote competition in a lackluster sector long built upon cosy relationships rather than efficiency.
By using the term Big Bang the LDP government is hoping to draw parallels with the reforms made in the City of London in 1986, which were widely credited with reinforcing London’s position as Europe’s leading financial center.
But London’s Big Bang – unlike Tokyo’s – coincided with a bull market and a buoyant City. Moreover, doubts remain about how far Japan’s reforms will actually go, in practice. For years Japan’s Ministry of Finance has tinkered with deregulatory measures, either prompted by US pressure or in a bid to reestablish Tokyo’s position as one of the world’s top three financial centers. But past measures have been half-hearted adjustments to a highly regulated system, often blocked or significantly toned down before implementation. Opponents to reform are numerous and entrenched interests have won many of the arguments so far.
But things may be different this time. Prime Minister Ryutaro Hashimoto has thrown his weight behind the measures; he established three advisory panels last November to recommend a wide-ranging package designed to make the market ‘free, fair and global’ over the next five years and to bring Japan’s financial sector roaring into the 21st century.
Still on Top
So far, at least, Hashimoto seems to have just retained the upper hand. The June recommendations proposed two-phase elimination of limits on broking commissions; lifting the ban on financial holding companies; and removing many limits on business activities for securities firms, banks and insurers. Many of the measures will come into effect next April, most of the rest by 1999. The whole process is scheduled to be wrapped up by 2001.
However, skeptics suspect that many of the proposals will fail to see the light of day or will be substantially watered-down in the adoption process. ‘In every reform effort, covert attempts to protect vested interests can be expected,’ commented Junichi Hayakawa, business editor of the Yomiuri Shimbun, just a few days after the Big Bang reforms were announced. ‘Success or failure of the deregulatory drive will depend on the degree to which all those involved can resist such temptations. If loopholes are allowed, the Big Bang could end up as a small pop.’
Hayakawa is by no means alone. Since the reform process got under way last November, the racketeering scandals at Nomura Securities and Dai-Ichi Kangyo Bank have further exposed the corruption which allegedly pervades much of Japan’s corporate sector and the financial sector in particular. Critics say it will take a tidal wave of reform to bring the system up to the oft-quoted and much disrespected ‘global standard’. Big Bang is a mere trickle in comparison to what is needed, they say.
Home and Away
But there are reasons for optimism; and potentially some major implications for IR officers both in Japan and around the globe. After all, Tokyo is the world’s biggest equity center: institutions based there manage some $1.63 trillion of equity funds. The reforms would see domestic companies being exposed to a much more competitive environment for capital than ever before. No longer would life and trust fund money be pumped into Japanese companies for little or no return. And for non-domestic companies, Tokyo could prove an extremely lucrative source of capital, especially for those that take the initiative early – adding Tokyo to their roadshow schedules now, ahead of the crowds.
One reason for optimism about this round of reforms is that they are not just politically driven but inspired by real economic need. There is now widespread acceptance that more effective management of the huge Japanese savings base is needed to help bolster the economy; and that, if they don’t go ahead, the Japanese economy will likely falter further in the years ahead.
That’s because the current low returns on pension funds will be insufficient to support the country’s aging population into the next century; and liberalization could open the market up to competition and, thus, better returns. The beginning of these trends is already evident but Big Bang would accelerate the process. Deborah Hayden, vice president at Gavin Anderson in Tokyo, points out that for many Japanese institutions, concentrating so much of their investment domestically is no longer a realistic option – they need growth at a level which is simply not available at home. According to Hayden, the life companies need 5.5 percent investment returns to meet their liabilities; and for that they must look abroad.
Several deregulatory moves have already contributed to an economic push. Last year’s relaxation of the so-called 5:3:3:2 asset allocation rules for pension funds allowed more funds to be allocated to domestic and international equity. The rule had required that at least 50 percent of pension funds be invested in fixed-interest assets (invariably Japanese bonds); up to 30 percent in each of domestic equity and foreign securities; and up to 20 percent in real estate.
Although the rule still applies to each pension fund as a whole, separate parts of the fund managed by different institutions can now exceed the limits. Next year, this ‘umbrella’ rule will be relaxed, raising the demand for high returning equity.
Ross Rowbury, former head of foreign equity at BZW in Tokyo, is convinced that Big Bang means big change for fund management in Tokyo and a substantial increase in foreign equity investment. Even without further deregulation, he says, ‘New demand for foreign equity is probably going to add up to about $12 bn a year every year for the next five years. That means you’re looking at an increase of about 10 percent per year.’
Kenneth Adams, a fund manager at Hill Samuel asset management in Tokyo, warns that there could be a backlash against non-yen investment if the yen goes through a period of instability. But, he also acknowledges: ‘New clients are regularly requesting exposure to non-yen assets.’
Rowbury, too, points to the success of foreign securities firms in winning Japanese pension fund mandates in recent years; and he expects that trend to increase exponentially after the Big Bang reforms kick in. ‘Over the next six months the lines will be very clearly drawn,’ he says. ‘Until recently it’s been a very cozy environment in which institutions went and had a few drinks with the guy from the ministry of health and welfare and got the pension fund mandate. They just distributed the business among their friends. But now you’ve actually got pension fund consultants like Frank Russell advising these people. These are new concepts to institutions. The ones which will be the winners in the long run are those which are quick to adapt.’
Foreign Threat
There’s certainly no shortage of foreign securities firms positioning themselves for the expected opening of the market over the next couple of years. Examples in recent months include tie-ups between Barclays and the Hokkaido Takushoku Bank; between the Franklin/Templeton group and Sumitomo Life Insurance; and between Putnam Investments and Nippon Life.
Others, such as Deutsche Morgan Grenfell, have been aggressively hiring staff from foreign and Japanese competitors to boost their Tokyo headquarters. Fidelity was recently granted permission to establish a brokerage business in Japan and offer US-style telephone investment services. It assumes that Big Bang will lead to massive growth in Japan’s mutual fund industry and that relaxation of foreign exchange controls will lead to a large chunk of Japanese savings going offshore, tempted by specialist fund products which have not been available in the domestic environment before.
It is these competitive pressures that will prompt Japanese institutions to search for higher returns and become more innovative in their product offerings. That’s all good news for non-Japanese companies which take the opportunity to communicate their story to Tokyo-based institutions, since foreign allocations from the treasure troves of Japanese investors are bound to grow.
The story will ultimately be good for Japanese companies, too. It may take them time to appreciate the benefits but the long-overdue shake-up of Japanese fund management will mean that if companies fail to be competitive with foreign groups, investing institutions will simply increase their allocations elsewhere.
And this is not just a question of returns. Competition for capital will also produce improved disclosure and better communication efforts. The signs are that many Japanese companies have already taken that message to heart and are striving to increase their investor relations. Certainly, interest in investor relations among Japanese companies is at an all time high. Whether that stems from the experience of living under a falling market for so long or from anticipation of what Big Bang and the future may bring is difficult to say.
But one thing is sure: Japan’s cultural approach to business and finance won’t change overnight. Sokaiya scandals will continue to rear their ugly heads; disclosure levels by Japanese companies will largely remain low compared, at least, to US standards; and shareholder value will not suddenly leap to the top of the corporate agenda.
The skeptics are right to be suspicious, not least because the gaps in Japan’s planned Big Bang remain numerous. But the reforms will have a significant effect on institutional investor behavior in Tokyo; the wider economic exigencies will continue to push deregulation forward; and the resultant competition should move the whole system on a step further.
The investor relations implications are enormous. International companies which ignore Tokyo over the next few years will be doing themselves a disservice. Japanese companies which ignore the call to improve their investor relations will be taking a risk they can ill afford.
Disclosure, Disclosure, Disclosure
‘There’s likely to be more competition between domestic money managers after Big Bang which means more importance will be attached to the information disclosed by Japanese companies. There will be more pressure for better disclosure.’
Kenichiro Yoshida, manager of capital market and investor relations at Sony, may be sitting at one of Japan’s leading IR players but he and his colleagues are not resting on their laurels. ‘Every day we struggle to improve the information we give out,’ he adds. ‘We have to keep asking ourselves whether our current disclosure is good enough or not. Sony has been a very growth oriented company and been supported by the equity markets for a long time. Management is very aware of the need to maintain that relationship for future growth.’
Yoshida’s thoughts are echoed throughout interviews with investor relations officers at Fujitsu, Honda and Hitachi. Everyone is aware of the domestic and overseas pressure for better disclosure from Japanese companies. And they claim, at least, to be working towards that goal.
Tetsuo Oshima, assistant manager IR at Honda, believes that stronger action is needed from the regulatory authorities. ‘I think that making improved disclosure mandatory is the best way forward for Japanese companies. Something drastic has to be done, otherwise nothing will change. However, the government does seem to be implementing some measures.’
One of the measures which may help push companies in the right direction is a change to the Commercial Code to allow stock options to be introduced for the first time. Osamu Naito, manager of public relations with responsibility for IR at Hitachi, believes that stock options are long overdue and should have a positive impact on the rights of shareholders. ‘They will tie the interests of management to the interests of the shareholder. But if only the executives get stock options it will not necessarily have such a huge effect. It is a question of how we should extend that system down throughout the company.’
Shareholders Rights & Wrongs
Those who say Japan’s Big Bang will amount to little more than a small pop have gained credibility in recent months from the revelation of financial scandals at two of the country’s leading financial institutions. Senior executives at Nomura Securities and Dai-Ichi Kangyo Bank are currently under investigation for allegedly making payments to racketeers – the sokaiya – to protect their companies’ interests.
The sokaiya are an enduring problem for corporate Japan. Annual meetings of most listed companies are held on the same day to prevent their being publicly embarrassed by the sokaiya. Although payments to racketeers are outlawed, many executives are believed to prefer to pay up rather than risk the threats of disruption from the organized criminal shareholders.
The disruption is often even greater once such payments become public, despite the fact that, as Katsumi Fujimori, deputy business editor of Nihon Keizai Shimbun, notes, everyone knows that many companies are guilty of paying off the sokaiya.
Such is the case with Nomura and Dai-Ichi Kangyo Bank. Nomura, in particular, has lost contracts and clients as a result of the revelations. And the fact that this year’s largest sokaiya scandals were at such a leading financial institution has proved embarrassing for the government as it attempts to push through Big Bang. Critics argue that such is the level of corruption in the financial sector that any reforms will be watered-down and have little effect.
Shuzo Nakashima, a partner at Tokyo law firm Hijiribashi and one of the leading legal experts on Japanese corporate governance, says pressures are mounting for domestic institutional investors to be more active in overseeing companies. But it will be many years before any change has a real impact – despite the reforms. He notes that payments to the sokaiya were effectively outlawed in 1981 yet they still persist.
‘The general legal rights of shareholders are not so different to other countries,’ says Nakashima. ‘What is different is whether they are exercised and respected.’ He argues that the Japanese system of corporate cross-shareholdings prevents companies from really caring about the interests of other investors. Shareholders are often left at the bottom of the pile.
Nakashima also believes it will be necessary to change the role of the board in Japanese companies if international corporate governance standards are to be widely respected. For now, most boards are too big to function as real decision-making bodies and few companies have truly independent outside directors to maintain checks on corporate behavior.
Of course, some companies are exceptional. Sony recently received permission from shareholders to reduce the number of board directors from 38 to ten. ‘It’s to enhance the function of board meetings,’ says Kenichiro Yoshida, manager of capital market and IR at Sony. ‘It was a top management initiative to revitalize decision-making. Generally speaking, Sony is a company which is trying to set the standards.’ He adds that the new board includes three independent directors, none of whom has any previous direct relationship with the company – a rarity in Japan.
Sony may be trying to set new standards but it still held its shareholder meeting on the same day as most other companies this year. Is that due to fear of the sokaiya? Despite being extremely open in his answers up to this point, some things, it seems, are a step too far. ‘I don’t know,’ replies Yoshida. ‘I can’t comment.’
