Not so splendid isolation
A lively but often painful debate over whether the financial industry in Japan risks being left behind the rest of the world is gaining intensity. Some argue that its island mentality is seeing it drift further away from the rest of the world. Mia Stubbs reports.
The phrase “Galapagos syndrome” was coined originally to describe the incompatibility of high-tech Japanese mobile phones with those rest of its foreign rivals. But the phrase now seems to apply to any Japanese business custom that is perceived as being out of sync with the rest of the world. Lately, the phrase has often been applied to the Japanese financial system.
In the stock, bond and even restructuring markets, parts of the Japanese financial system do indeed seem to exist in isolation.
Japan’s stock market continued to underperform in 2010, offering little upside to investors. Partly as a result, the uniquely Japanese practice of three-week long equity offerings, usually accompanied by a plunge in the issuer’s share price, not to mention often one-third dilutions, came under the spotlight once again.
The past two years have been dominated by repeat capital increases by Japan’s mega banks, Mitsubishi UFJ, Sumitomo Mitsui Financial Group and Mizuho. The triumvirate tapped the equity markets twice each between December 2008 and July 2010, to raise some ¥6trn (US$72bn). By the second round, starting in December 2009, grumbles were getting louder that the mega banks were drowning the Tokyo stock markets.
The criticism took on a sense of urgency as questions were raised about the wisdom of ploughing ahead with hugely dilutive deals given the wobbly stock markets. In 2010, heavy trading drove down shares ahead of the launch of several deals, such as partly state-owned Inpex’s ¥507bn offering in July, Nippon Sheet Glass’s ¥37bn tap in September and regional electricity operator Tokyo Electric Power’s ¥407bn deal in early October.
In response, the Tokyo Stock Exchange and the Financial Services Authority are looking into the introduction of a ban on shorting stock, similar to regulation M in the US, during a public offering. The regulators are also investigating possible insider trading by foreign hedge funds, which are practically non-existent in Japan.
Japan’s first rights issue in living memory generated intense interest, coming after the TSE changed its rules in late 2009 to allow fractional rights issues. One small-cap company, Takara Leben, served in effect as the test case by launching in March a one-for-one rights issue at a discount of 46%. Trading of the stock acquisition rights, which were listed on the TSE for two months, were lively and the eventual exercise rate came in at 90%.
Takara Leben’s experiment was generally considered successful, or at least novel. But several obstacles remain for any company with a market capitalisation and shareholder base larger than the apartment developer’s ¥20bn market cap and two-thirds free-float.
Under the current law, for example, underwriters could be forced to launch a tender offer if their even temporary ownership of stock acquisition rights confers ownership of more than a third of the rights issuing company.
Another issue is the uniquely sacred status of the retail investor, also known as Mrs Watanabe. The introduction of a regulation M-style rule may help soothe suspicions over alleged insider trading by supposedly favoured hedge funds ahead of capital increases. But Japanese equity syndicate bankers believe that retail investors are equally guilty of shorting stock and driving the price down ahead of the pricing of a public offering to secure a favourable purchase price.
Either way, in a country where fees for large offerings are fixed in stone at 4%, Japanese equity offerings do appear to inhabit a universe of their own. Retail investors are usually allocated about 80% of offerings and the underwriting market is dominated by just one firm, Nomura, which this year will have been bookrunner on more than 50 deals. Daiwa Capital Markets, the next biggest player, has done about 20.
The nearly no yield debt zone
Bond issuance in Japan is reserved exclusively for a small elite of issuers rated at least Single A, a phenomenon for which the extremely conservative and defensive pension and life insurance fund managers are largely to blame.
While some South Korean Samurai issuers have managed to slip in, even Triple B rated Mexico cannot tap the Japanese market without a guarantee from the quasi-sovereign Japan Bank for International Cooperation. As a result, issuing bonds has become a right of passage for Japanese blue chips to test their independence from the mega banks.
The huge Japanese domestic bond market exists, in effect, in isolation from the rest of world, said one debt syndication banker. Spreads are so tight and unattractive to foreign investors that the repeal of taxation at source has made no difference, failing to attract any foreign investors.
The triumvirate also continues to dominate corporate loans, choking off the development of accompanying markets. The anomalous absence of a high-yield debt market is partly explained by the hold that the mega banks have on second-tier corporations.
Since many non-blue chips cannot afford to upset their main mega bank relationships, and Japanese institutional investors are loath to buy any debt rated less than Triple B, any company that cannot clinch at least a Single A rating is fated to pay hefty yields to its main banks rather than tapping a liquid market for debt.
Japan Airlines’ bankruptcy in February this year also confirmed the power of the mega banks. Public bondholders were dictated a recovery rate of 17%, based on what the mega banks, which were not even the airline’s biggest creditors, had agreed behind closed doors before the court filing. Yet the mega banks are still intimately involved with JAL’s restructuring as they continue talks about providing additional financing to the bankrupt airline.
The demise in September of Takefuji, an independent consumer finance company, as well as the credit default swap auction of another, Aiful, also served to underline the dominance of the mega banks.
Aiful was, ironically, saved by being more bank loan-dependent than Takefuji. It applied for the out-of-court mediation scheme known as Alternative Dispute Resolution to reschedule and restructure its debt with creditor banks. While Aiful managed to avoid bankruptcy, the announcement that it had reached an agreement under ADR triggered Japan’s first-ever CDS auction.
Consumer finance rivals Acom, part of MUFG, and Promise, a subsidiary of SMFG, are considered safe only because they are under the mega bank umbrellas. The pair, which along with rivals have essentially stopped granting new loans, are said to be surviving by collecting fees as sub-prime assessors and collectors for the more respectable outposts of the parent companies’ empires.
The collapse of the listed, independent consumer finance companies also exposed a hidden reality: that Japanese consumers and small businesses do not have access to emergency loans in a cash crunch, creating a potential pool of “loan refugees” reduced to borrowing from illegal loans sharks.
To turn to the East or West
In the midst of a boom in the rest of Asia and the seemingly relentless rise of China, Japan is still struggling to emerge from its decade-long deflationary recession. A country that has looked to the West and away from Asia for more than a century is struggling to come to terms with the new world order.
The yen’s seemingly relentless rise against the dollar provoked a tidal wave of doomsday reports in the Japanese press about the imminent death of Japan Inc in its current form. In January, the yen tipped under ¥90 against the dollar. By November 1, the exchange rate hit ¥80.22 and looked close to reaching the historical high of ¥79.75 last seen in April 1995.
Japan’s exporters, long the country’s economic stars, will learn to adapt to the stronger yen. But because of Japan’s fragile growth rate, the strength of exports can tip the country into negative or positive GDP growth, even though exports represent just 18% of GDP.
Economists expect exports to rise next year, following the recovery of Western economies. But the dependence of Japanese exporters, and the economy, on mature Western markets to the detriment of high growth but riskier emerging economies has only added fuel to the debate about whether Japan needs to change its ways.
Turning its back on Asia is not a realistic option. Japan may have to learn to feed off Asia’s growth, instead of being the lone rich country to be emulated in the region, said one Tokyo-based fund manager.
