This year's recovery in the Tokyo stock market should do wonders for the profitability of Japan's "Big Three" securities companies - Nomura, Daiwa, and Nikko - assuming the market does not suffer a relapse in the next few months. But while things are certainly looking up for the "Big Three", the industry is also becoming rapidly more competitive.

The approaching full deregulation of brokerage commissions is not the only reason for this. From October 1, eight wholly-owned securities subsidiaries of banks will be allowed to start dealing in equities, as brokers, traders, or underwriters.

The eight are not expected to challenge the likes of Nomura and Daiwa at the retail end of the market, but they could provide formidable competition in underwriting and wholesaling.

One clue to what may be in store for traditional securities companies is the situation in the corporate bond underwriting market where ginko-kei (bank-related) securities firms have already built a strong position. In fiscal 1998, Nomura, Daiwa, and Nikko still held the top three places in corporate bond underwriting, but the next seven places were occupied by ginko-kei companies with a combined market share of 34 per cent.

Among the ginko-kei group the most aggressive player is IBJ Securities (IBJS), a 100 per cent subsidiary of Industrial Bank of Japan (IBJ). IBJS acted as bookrunner for more than ¥1,000bn of corporate issues in 1998 - 9.25 per cent of the market. Analysts say the company's success is due to its strong placement ability, deriving from the fact that the parent bank is financed through debentures which are issued mainly to institutional investors who also buy corporate bonds.

"Because of our debenture business we have close ties with more than 500 out of the 805 Japanese companies that control assets of more than ¥100bn," says Yoshihisa Imada, director in charge of planning at IBJS.

IBJS also benefits from the fact that its parent bank operates outside the keiretsu system which limits the customer base of many other bank-related securities firms to members of the banks' own business groups. Arm's-length rules imposed by the finance ministry until recently prohibited IBJ from directly introducing its corporate clients to IBJS, but the two concerns are now allowed to schedule joint meetings with clients.

IBJS has benefited at the expense of its parent as many top-rated Japanese companies have shifted during the past few years from bank borrowing to direct financing through capital markets. Another reason why the company is doing well is that Japan's corporate bond market is expanding downwards to accommodate issues by companies with less than prime credit ratings. Early this year IBJS underwrote its first issue by a BBB-rated company.

While corporate bond underwriting is the market on which IBJS has focused its main effort in recent years, it has not always been its main source of profit. In 1998, 90 per cent of operating profits came from the Japanese government bond (JGB) market.

IBJS is expecting operating profit to fall to ¥5bn in the current fiscal year, equivalent to a return on equity of 15 per cent, but its performance during the first two months of the year, when the company earned ¥3bn suggests that it may be a considerable underestimate.

Big mainstream securities companies have also done well in the JGB market, admits Mr Imada. But their bond earnings have to cover the cost of maintaining big branch networks and sales staffs. IBJS operates out of a single office in Tokyo's Otemachi financial district with only 370 employees.

IBJS' plans for entering the equities side of the securities business focus mainly on the sale of indexed products to big institutional investors. "We think our customers will come to us to buy products that track the Nikkei 225 or Topix (the two main Tokyo stock market indices), not to place orders for big lots of individual shares," says Mr Imada.

With that in view the company has been aggressively recruiting systems engineers. It has also built up a strong research department, with 15 analysts. Mr Imada predicts that profit from the equities side of the business may match earnings from bond underwriting and trading within three to five years. If he is right Japan's mainstream securities firms should look to their laurels.


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