11, 01. 2004
Earnings Making Rapid Recovery through a Rise in Share Prices
The current building of Tokyo Stock Exchange
Japanese securities companies have come up against a business slump since the collapse of the economic bubble. Among other things, the departure of individual investors from the stock market progressed, the volume of trading fell considerably, and income from stock brokerage commissions - the source of revenues for securities companies - dropped sharply. Business performance at not only small- and medium-sized securities companies, which were heavily dependent on trading for customers, but also major securities firms deteriorated rapidly. There was also a slump in corporate capital demand, fewer new issues like corporate bonds, and underwriting also flagged. A situation in which securities companies were just barley able to post profits through such measures as proprietary trading (trading stocks on its own account) continued. However, business performance is now rapidly heading towards recovery with the rebound of the stock market of the past few years. For example, a look at Nomura Holdings, Inc.'s business performance for FY2003 shows roughly a sixfold year-on-year increase in current profits.
Securities companies are making a rapid comeback in their business performance. The consolidations and rationalizations that took place in the securities industry over a period of more than ten years is finally starting to bear fruit.
Increase in the Number of Companies; Sharp Decrease in the Number of Workers
The number of securities companies, which hit a peak of 272 firms in 1990, kept on declining thereafter until 1993 when it began showing a trend towards increase, and by 1997, the number had grown to 291 securities companies. Today, the figure is hovering at a level in the 280s. The number of securities companies did not end up decreasing in spite of the serious securities slump that was seen throughout the 1990s. In fact, there are now more securities companies in Japan than there were during the bubble economy of the late 1980s. The reason for this is that market entry became easier through the Big Bang financial deregulations, and an increasing number of foreign affiliates as well as companies from other business sectors entered the securities market.
While the number of securities companies has increased, the number of branch offices and people working in the securities field (the total number of board members and employees) has declined on a major scale. The number of branch offices peaked at 3,296 in 1991, after which is began declining. As of the end of 2002, it had decreased to 1,604 branch offices. The number of people working in securities peaked at 161,695 in 1990 and continued to decline thereafter to 91,266 at the end of 2002.
In addition to the shift of investors' interest away from stock trading, severe competition led to markdowns of brokerage commissions and caused the deterioration of business performance among securities companies. Under such circumstances, they were no longer able to maintain a large number of branch offices or employees, leading to the major fall in the number of branch offices and workers despite the increase in the number of companies. Furthermore, more than 80 percent of recent individual investor trading is said to be taking place online. The spread of such trading over the Internet is spurring the further decrease in the number of branch offices and sales staff.
A Storm of Reorganization Hits Mid-ranked Securities Companies
Quasi-major and mid-ranked securities companies did not have sources of earnings as diversified as major securities companies. On the other hand, they were unable to transform themselves as easily as small- and medium-sized securities companies. These were the companies that had difficultly surviving on their own and had no choice but to consolidate.
Securities companies can be roughly divided into major securities companies, securities companies affiliated with major banks, and independents. The realignment in the industry was mainly focused around securities companies affiliated with major banks.
During the process of writing off bad loans in the 1990s, major banks in Japan themselves were realigned and consolidated into four groups. Triggered by this, the affiliated securities companies under the umbrella of such realigned banks also became the target of consolidation.
Because there has been repeated merges of bank-affiliated securities companies at a dizzying pace, it has become quite a bothersome task for even those who are well versed in the Japanese securities industry to connect current names with past names to figure out who used to be whom.
First, New Japan Securities Co., Ltd. merged with Wako Securities Co., Ltd. in April 2000 and became Shinko Securities Co., Ltd. (affiliated with Mizuho Bank, Ltd.). This was followed by the June 2002 merger of Tsubasa Securities Co., Ltd. (established in April 2000 through the merger of Universal Securities Co., Ltd., Taiheiyo Securities Co., Ltd., Towa Securities Co., Ltd. and Dai-ichi Securities Co., Ltd.) and UFJ Capital Markets Securities Co., Ltd. (formed in July 2001 through a merger between Sanwa Securities Co., Ltd. and Tokai International Securities Co., Ltd.). The merger resulted in UFJ Tsubasa Securities Co., Ltd.
In September 2002, Kokusai Securities Co., Ltd., Tokyo-Mitsubishi Securities Co., Ltd., Tokyo-Mitsubishi Personal Securities Co., Ltd. and Issei Securities Co., Ltd. merged and became Mitsubishi Securities Co., Ltd. (affiliated with Bank of Tokyo-Mitsubishi, Ltd.). Sakura Friend Securities Co., Ltd. (formed through a merger in April 2000 between Yamatane Securities Co., Ltd. and The Shinyei Ishino Securities Co., Ltd.) and Meiko National Securities Co., Ltd. (formed in April 1999 through a merger between National Securities Ltd. and Meiko Securities Co., Ltd.) merged to form SMBC Friend Securities Co., Ltd. (affiliated with Sumitomo Mitsui Banking Corporation) in April 2003.
Nippon Kangyo Kakumaru Securities Co., Ltd., which had changed its name to Kankaku Securities Co., Ltd. in October 1990, changed its name once again in October 2000 upon the merger of its parent bank and became Mizuho Investors Securities Co., Ltd. The only quasi-major securities company that still exists under the same name that it was known with during the economic bubble period is most likely Okasan Securities Co., Ltd.
Major Securities Companies Shift to a Holding Company System
Meanwhile, the current situation has been made more confusing by the fact that major securities companies also underwent organizational reform and established holding companies, splitting off their retail divisions (sales toward individual investors), wholesale divisions (sales toward corporations), etc. into separate companies under one group.
For example, the Nomura Group consists of such consolidated subsidiaries as Nomura Securities Co., Ltd. (retail and wholesale), Nomura Asset Management Co., Ltd., and Nomura Pension Support & Service Co., Ltd., with Nomura Holdings, Inc. as the holding company. Nomura Research Company, Ltd., although a company affiliated with the Nomura Group, has its own separate group.
The Daiwa Securities Group consists of such subsidiaries as Daiwa Securities Co. Ltd. (retail), Daiwa Securities SMBC Co. Ltd. (wholesale), Daiwa Asset Management Co. Ltd., Daiwa Institute of Research Inc. and Daiwa SB Investments Ltd., with Daiwa Securities Group Inc. as the holding company.
The Nikko Cordial Group also consists of a holding company, Nikko Cordial Corporation, under which there are such subsidiaries as Nikko Cordial Securities Inc. (retail and wholesale), Nikko Beans, Inc. (retail), Nikko Citigroup Limited (wholesale) and Nikko Asset Management Co., Ltd.
In the past, major securities companies used to point to Nomura Securities, Nikko Securities, Daiwa Securities, etc. Today, they indicate the holding companies of major securities companies, such as Nomura Holdings, Daiwa Securities Group and Nikko Cordial Corporation.
A Structure in which Bank-affiliated Securities Companies Besiege the Nomura Group
In essence, most of the business rights within the securities industry are in the hands of the four Japanese megabanks, such as Mizuho, Tokyo-Mitsubishi and Sumitomo Mitsui. A structure has been created in which these bank-affiliated securities companies besiege the Nomura Group, an independent that is clearly different from bank-affiliates.
Roughly 10 years ago, bank after bank established securities companies as their subsidiaries and advanced into the business of trading and underwriting securities. However, securities companies had a more difficult time than expected in expanding their sales channels. As a result, subsidiaries were made of various quasi-major or smaller securities companies with which they had close relationships. The reality is that they, including bank-affiliated securities companies, are not having an easy time attracting as much personal assets as they would like to.
Meanwhile, because of the rise of foreign-affiliated securities companies that specialize in large corporations as well as other factors, competition in securing orders in the wholesale business arena has continually become increasingly severe. It has become difficult for divisions that handle large corporations to earn revenues as they did in the past.
In the midst of such circumstances, securities companies are focusing, under the slogan of corporate rejuvenation, on investment banking targeting mid-ranked or smaller companies. They are earning commissions by proposing and executing schemes to support ailing companies, venture firms, etc., as well as proposing and executing schemes for real estate redevelopment. Other measures being taken include the injection of capital through specialized funds and selling off the company being supported after enhancing its value.
One of the aims of the alliances, inclusive of equity participation, between major American investment bank Goldman Sachs Group, Inc. and Sumitomo Mitsui Financial Group, Inc., and between major American securities company Merrill Lynch & Co., Inc. and UFJ Holdings, Inc., was that the Japanese partners wanted to introduce investment banking know-how into their on-site operations. Meanwhile, the Nomura Group, which is aiming to gain dominance in the investment banking field, is leveraging its strength as an independent and making efforts to strengthen ties with regional banks by providing them with financial products, such as investment trusts, as well as by underwriting public stock offerings.
Status of the Securities Market Lower than That of Banks
The former building of Tokyo Stock Exchange (used from 1931 to 1982)
The securities industry was placed in an odd position within the financial sector for a long time. Japan's economic recovery after World War II was conducted through indirect financing via banks. The government kept deposit interest rates low through its low-interest rate policy, and the low-interest funds collected were loaned out to industries through banks. This kind of policy in which a government regulates interest rates does not fit in with a market economy where prices are determined through price mechanisms.
In stock and securities markets, prices are fundamentally determined through supply and demand and speculation by investors. It can be said that under normal conditions, the utilization of market functions brings about the best economic efficiency and is also desirable in terms of asset allocation. However, it can also be said that in consideration of the shortage of funds in Japan after World War II, focusing limited funds to industries, and furthermore, providing them at a low cost in a type of fund allotment policy, was more effective than direct financing made through stock markets and capital markets.
In a normal situation, companies boost capitalization or issue corporate bonds in order to secure long-term capital investment funds, etc. However, under the Japanese financial system, long-term funds were provided by banks, particularly through long-term credit banks and trust banks. Commercial banks also, in actuality, supplied long-term funds through rollovers of short-term loans. Under this kind of a system, the stock market and bond market were a peripheral market. In other words, they were only a supplementary financial market. This was what determined the characteristic of postwar Japanese securities companies.
Stocks Account for Only a Small Proportion of Individual Assets
For many years, the biggest resource for the distribution of assets in Japan was bank deposits; not stocks or investment trusts. Equity holding by individuals remained at an extremely low level. Although there were times when the amount of shares held by individuals increased during several stock booms, shareholding never became a mainstream form of asset management in Japan. Securities companies made an effort to increase the number of individual investors by conducting movements to popularize shareholding, but they were not very productive. There was a strongly rooted feeling among individual investors that investing in stocks was a gamble. Furthermore, one of the aspects of the adverse effects caused by the oligopolization of the stock market was that it distanced individual investors from stock investment.
There was an oligopolistic framework of four securities companies established in Japan's post-war securities industry. The four companies were: Nomura Securities, Daiwa Securities, Nikko Securities and Yamaichi Securities Co., Ltd. These four companies virtually monopolized the securities market, not only in the handling of trading on the stock market but also in the underwriting of stocks and corporate bonds. The four companies had a strong influence on stock pricing, and at times there were even actions such as those that could be taken as stock manipulation. Japan was very much behind in the democratization of the stock market, and even investment trusts were substantially controlled by securities companies. Stocks could not necessarily be said at the time to be a high-quality investment product for individual investors.
Liberalization of Securities Transaction Fees
Financial liberalization, which progressed in the 1980s, played the role of vitalizing the securities industry. First, as budget deficits expanded, it no longer became possible for the government to continue regulating interest rates.
In the government bond issue market, the Japanese government sold bonds at a high price (i.e. government bonds with low coupon rates) to financial institutions through the regulations imposed on the market. Meanwhile, there was a precipitous fall in bond prices (rise in interest rates) in the trading market - where liberalization of interest rates had advanced earlier - caused by the massive issuance of government bonds. This meant that there would be loss on sales if, out of cash flow necessities, a financial institution tried to sell, in the trading market, the government bonds which it had been "forced" to buy in the issue market. For this reason, they started to become reluctant to underwrite (purchase) government bonds at its high price in the issue market. Such problems had not arisen when the amount of government issues had been low because financial institutions had held on to them until maturity.
Such reluctance on behalf of financial institutions to purchase government bonds made it difficult for the government to issue low coupons in the issue market, leading to the advance of the liberalization of interest rates. As a result, deregulated interest rate products such as medium-term government securities funds appeared, and they became a medium to promote the liberalization of deposit interest rates.
The liberalization of capital market issuances has kept pace with the liberalization of interest rates. Furthermore, individuals, who were maturing as investors, were no longer willing to settle for low interest rates or low returns, and they began seeking higher returns on their investments. A problem that then arose was that brokerage commissions on the buying and selling of securities were high. In the West, the liberalization of trading commissions had progressed since the 1970s. The liberalization of securities brokerage commissions was also implemented through Japan's Big Bang financial reforms. The liberalization of trading commissions greatly changed the business environment surrounding securities companies.
The Security Industry's Oligopolistic Framework Crumbles
The oligopolistic framework of four securities companies began to crumble from underfoot as if to keep pace with the advance of such liberalizations.
During the 1980s, securities companies savored the stock market boom of the bubble economy. Backed by the economic boom, securities companies made excessive investments in systems, such as computers. However, the bubble burst in the early '90s, share prices took a nosedive, and the volume of trading on the stock market fell rapidly. Securities companies, which had made excessive investments, were in serious financial trouble.
In 1997, Yamaichi Securities Co., Ltd., which had been one of the four oligopolists, liquidated voluntarily in de facto bankruptcy. In the case of Yamaichi Securities, the downfall was caused by a cover-up of massive losses resulting from illegal "tobashi" practices, or compensation of investor losses. Sanyo Securities Co., Ltd., a quasi-major securities company that had made excessive capital investments, also liquidated in 1997. Yamaichi Securities had faced a similar financial crisis back in 1965, but it had survived through special loans extended by the Bank of Japan. It was impossible, however, to bailout the company through conventional methods under the new circumstances that had been created in the 1980s through financial liberalization. Yamaichi Securities, which had been one of the biggest securities companies in Japan, had no choice but to liquidate.
Shift from an Approval System to a Notification System Promotes Market Entry
The four-company oligopolistic framework crumbled with the failure of Yamaichi Securities. At the same time, the promotion of new entry into the securities industry also greatly changed the map of the industry.
In 1989, the procedures for establishing a securities company changed from a licensing system to a notification system, making it easy for companies from other industries to make market entry. Before then, the securities industry had been shielded from competition by new market entrants and been able to enjoy vested interests. However, they were now forced to make a drastic review of their operations upon the change of the system.
The former stock trading floor of Tokyo Stock Exchange with many stockbrokers
Examples of entry from outside industries include Sony Corporation's investment in MONEX, Inc.; the acquisition of majority stakes in DLJdirect SFG Securities Inc. (name changed to Rakuten Securities, Inc. in July 2004) by Rakuten, Inc., an e-commerce company; and the establishment of Softbank Frontier Securities Co., Ltd. by Softbank Corp. (Softbank Frontier Securities merged with World Nichiei Securities Co., Ltd. and became World Nichiei Frontier Securities Co., Ltd. in 2004). The characteristic of such new securities companies is that many are Internet-based. Profitability is low through the conventional method of setting up branches and injecting a large number of sales staff.
Armed with low brokerage fees, these companies are establishing a unique operational base by expanding online transactions. The largest of these online securities companies is Matsui Securities Co., Ltd., and its share of the volume of Internet-based trading among online securities companies is expanding rapidly.
Three Securities Companies Establish Holding Companies
Furthermore, banks, which had been prohibited until then to involve themselves in securities operations, began establishing holding companies and setting up securities companies under the holding company. The fact that the advance of banks into securities operations through such methods was approved was another factor that greatly changed the securities industry. Bank-affiliated securities companies have a very close relationship with companies, and they are able to get an edge over other securities companies in the issuance of stocks and corporate bonds. Furthermore, it became possible for them to sell investment trusts - an investment package for the masses - at bank counters, thereby snatching what had been a source of revenues for securities companies that had been in existence before them. Bank-affiliated securities companies include Mitsubishi Securities, UFJ Tsubasa Securities Co., Ltd. and Mizuho Investors Securities Co., Ltd.
Meanwhile, hitherto known securities companies have also established holding companies in order to respond to competition from new securities companies. The holding companies established, at present, by securities companies are Nomura Holdings, Daiwa Securities Group and Nikko Cordial Corporation. It is notable that their strategies differ. While the Nomura Group is following a path as an independent, Daiwa Securities is strengthening its alliance with Sumitomo Mitsui Banking Corporation, and Nikko Cordial Corporation is striving to survive through an alliance with Citigroup, an international capital company.
Three Key Points towards the Future
Can Investment Banking Operations Be Enriched?
The securities industry is groping for survival strategies in order to deal with the major trends of liberalization and globalization. Like leading banks, major securities companies are establishing holding companies and reinforcing their established retail field on the one hand, while also strengthening their investment banking operations.
In the case of the United States, securities companies took various measures after the liberalization of trading commissions, which included focusing on investment banking, specializing in retail, striving to enrich research functions, and so on. Japanese securities companies are taking similar measures.
In retail, major securities companies have worked to reinforce online transactions as an addition to the traditional method of sales through sales personnel. At the same time, they made efforts to upgrade investment trust operations as well as expand customer's asset management through discretionary accounts in which sales and purchases are entrusted upon them by investors.
In addition to the reinforcement of the retail field, there is a pressing need for major securities companies to upgrade their investment banking operations. Japanese securities companies have fallen far behind Western investment banks in this field. In particular, there is insufficient competency in the development of derivative products as well as not enough accumulation of know-how in the field of M&As. It is essential that major securities companies in Japan strengthen their investment banking division if they are to lead the global market and establish an international position for themselves as general securities firms.
Can Mid- and Small-sized Securities Companies Survive?
The current market center of Tokyo Stock Exchange
Meanwhile, mid- and small-sized securities companies are taking a strategy that differs from major securities firms. That is, they are focusing on specific fields. Internet-based securities firms are making thorough cutbacks in manpower and aiming to secure an operational base by providing customer investors with investment information and various investment tools. Internet-based securities transactions will undoubtedly replace the buying and selling of shares through sales personnel in the long-term. Other than Internet-based securities, there are also small- and medium-sized securities companies that are trying to survive by strengthening their dealing functions or by specializing in particular products such as Chinese stocks.
How Much Growth Can Bank-affiliated Securities Companies Achieve?
Another major movement is market entry by bank-affiliated securities companies. As mentioned earlier, banks entered the securities business by establishing subsidiaries. At the same time, banks are rapidly picking up know-how related to securities operations by acquiring existing securities companies and bringing them under their umbrella. It is easy for bank-affiliated securities companies to access corporate customers since their parent companies are banks. Furthermore, they have an edge in the underwriting of stocks and corporate bonds, and in the future, it will become possible for banks to conduct stock transactions over the bank counter. For these reasons, bank-affiliated securities companies can be said to possess innate possibilities for major growth. Sales of investment trusts are already conducted at bank counters, and with the trust that consumer have towards banks as a weapon, they are steadily increasing their sales share. It is fully expectable that the same kind of situation will arise in the case of the buying and selling of stocks.