With the economy enjoying its longest postwar period of growth, exports surging and the property market booming, Japan appears finally to have left its painful years of economic gloom behind it.
But in one respect, the country’s lost decade has left a lasting mark that is now troubling the government of Shinzo Abe, prime minister. Nearly 10 years since introducing its own version of the “Big Bang” reforms that deregulated London’s markets, Japan is in danger of losing its place among the world’s leading international financial centres.
Over the past decade or so, Tokyo has seen its competitiveness as an international financial centre fall far behind New York and London. The Japanese capital is looking increasingly in danger of being threatened by its Asian neighbours, Hong Kong and Singapore.
Unless drastic action is taken, “it is not impossible that we could be overtaken by China as a global financial centre”, says Kotaro Tamura, parliamentary secretary of the Cabinet Office responsible for economic and fiscal policy and financial services. “Our [back] is on fire so we have to work really hard” to reverse the trend, he says.
Tokyo still has the second-largest stock market after New York and is by far the largest financial centre in Asia, with a stock market capitalisation of $4,614bn (£2,312bn, €3,388bn) compared with $1,715bn for Hong Kong and about $384bn for Singapore. But even as other economies have seen their capital markets surge since 1990, such growth in Japan has been anaemic. Having comprised a third of global market capitalisation in 1990, Japan’s market capitalisation is now less than one-tenth that of the world’s $49,900bn.
The situation has set off alarm bells in the political corridors of Tokyo because, as competition from lower-cost countries challenges Japan’s industrial base and as its society ages, there is mounting concern that Japan needs to derive more of its growth from services, particularly high value-added financial services.
“Japan cannot be totally dependent on manufacturing alone,” says Yuji Yamamoto, financial services minister. Unless Japan can boost the competitiveness of its financial services and claim a position among the world’s leading financial centres, it faces the prospect of a slow but steady decline in its economic vitality, Mr Yamamoto warns.
Part of the problem is that, while the country was caught up in a prolonged financial crisis, its capital markets failed to keep up with global developments in key areas. In a stark sign of Tokyo’s decline, the number of foreign companies listed on the Tokyo Stock Exchange has plummeted from 125 in 1990 to just 25. That is a fraction of the 446 foreign listings in New York, the 315 in London and the 150 in Singapore.
What is more, Japan is being shunned by many of the new funds that are becoming a growing force in world markets and which can provide alternative sources of financing as well as sophisticated financial expertise. Brian Heywood, the chief executive of Taiyo Pacific Partners, for example, lives in Monterey, California, and makes the long trip across the Pacific once a month to Japan where his work as an activist fund manager is based.
Taiyo Pacific, which manages a $1.2bn activist investment fund specialising in Japanese stocks, is not the only financial institution that avoids locating its operations in Japan. Most Japan-focused hedge funds are also located outside the country and even big investment banks have staff in neighbouring cities doing work that would normally be done in Japan. “We have Japanese jobs being done by people in Hong Kong,” concedes the head of a foreign investment bank.
If it is to reverse Tokyo’s declining competitiveness, the government needs to address problems in three key areas: “The field, the players and the umpire,” says Takatoshi Ito, economics professor at Tokyo University, who uses a sporting analogy to make the point that the markets, their participants and the regulators all need to change.
For a start, the Tokyo Stock Exchange is in dire need of a systems upgrade. The TSE’s credibility was severely dented last year when the system crashed after being hit by an unexpected flood of orders.
Meanwhile, the regulatory burden and cost of having to translate documents into Japanese and meet Japanese accounting standards, which are different from international standards, have discouraged foreign listings.
But perhaps the most critical problem is that Japan’s financial markets do not offer investors the range of financial products available in New York or London. Partly as a result, there is a surplus of domestic funds chasing too few investment opportunities, which in turn has made spreads so tight that the market is unattractive to foreign funds that want higher yields, says Mana Nakazora, credit analyst at JPMorgan in Tokyo.
The lack of new and varied products available to invest in is partly due to the fact that the markets have only recently been deregulated. “It is only four to five years that we have had very liberalised environment, so we haven’t had time to build the field or nurture the players,” says Mr Ito, who is a member of the powerful Council on Economic and Fiscal Policy (CEFP) chaired by Mr Abe, which is compiling recommendations on financial sector reform to be presented to the government by June.
For example, the value of securitisation products issued in Japan last year was a fraction of that in the US, according to Deutsche Securities. Even Japan’s enormous bond market, at Y718,000bn, is comprised mostly of government bonds and government-related issues, with only 7.2 per cent made up of corporate bonds. “We need to upgrade our markets so that the whole spectrum, from low to high-yielding products, is available,” Mr Ito says.
Another major reason why innovative products have not taken off is a lack of sophistication among market players – the second problem area. “There aren’t enough people who can take risk,” says Teruhisa Kurita, director of the supervisory research office at the Financial Services Agency.
In a bid to address this, Mr Yamamoto at the FSA wants to encourage more foreign investors and service providers to come to Japan. Foreign banks, hedge funds and private equity funds have financial expertise that Japanese investors and service providers could learn from, he notes.
To lure more foreign institutions to set up operations in Japan, Mr Yamamoto is spearheading a campaign to build a modern financial centre for Tokyo along the lines of London’s Canary Wharf. The government’s policymaking bodies under the FSA and the CEFP are also working to address a broad range of issues to increase foreign participation and build Tokyo into a financial centre that can claim a place alongside London or New York. These range from high costs, including burdensome taxes, onerous regulations such as the separation of banking and securities, and a lack of qualified professionals with fluent English.
One of the most challenging aspects for foreign financial institutions working in Japan is dealing with the Financial Services Agency – the market watchdog – which has enormous discretion over interpreting Japan’s notoriously opaque regulations.
“Compliance officers in other countries feel very comfortable calling up the regulator for advice on a compliance problem. But in Japan the fear is that if they go to the FSA with a concern it is an invitation to the FSA to investigate them, so the tendency is to try and deal with the problem without FSA input,” says Christopher Wells, a partner at White and Case in Tokyo. One banker puts it more bluntly: “Everybody is absolutely afraid of the FSA.”
Nevertheless, industry officials and policymakers alike stress that there is growing momentum for change, spurred by Mr Yamamoto’s rallying cry to improve the competitiveness of Japan’s financial markets and reform proposals being put together by policymakers.
“The Abe government is very serious about doing this,”says Mr Tamura. The latest reforms, he assures, will be “something bigger than [the] Big Bang”.