Japan's securities industry is in a state of rapid transition. In the 1998 fiscal year, ending in March 1999, the industry's top three brokers - Nomura, Daiwa, and Nikko - all reported big after-tax losses, in part because of poor performance in overseas markets and bad debts accumulated by non-bank subsidiaries. But a sharp recovery in prices and trading volume on the Tokyo Stock Exchange between January and March resulted in a surge in earnings from brokerage commissions during the final quarter of the fiscal year.

Looking slightly further ahead, the prospects are a complex mixture. The complete deregulation of brokerage commissions from October 1 this year seems certain to cut into the industry's traditional main source of income. But a whole new series of businesses, including internet and off-market trading, could help to broaden the customer base.

The possibility that Japan's long-dormant mutual fund industry may at last be approaching take-off is another reason for optimism. That, however, does not mean that things are looking up for the entire industry - consisting of 23 market-quoted companies and another 200 or so unquoted.

Robert Garone, Tokyo-based financial analyst for Dresdner Kleinwort Benson Securities, feels that while the "Big Three" Japanese houses may be able to capitalise on new business opportunities, life could be about to get much tougher for a dozen or so second-tier companies which may not have the capital or expertise needed to move into new markets.

Paul Heaton, Tokyo-based non-bank financial analyst for Deutsche Securities, predicts that the industry will undergo reorganisation, with the number of listed brokers shrinking to 10 by 2001 as a result of mergers, liquidations, or absorption of securities houses by banks.

In fact, this process has already begun. In April, New Japan Securities and Wako Securities, currently the industry's fifth- and sixth-largest houses, announced plans to merge into a new company - Shinko Securities - which should rank fourth in terms of assets under management.

Another series of moves centres on Universal Securities, which may emerge as the seventh-largest brokerage in the industry following planned mergers with Taiheiyo Securities and Towa Securities. Both Shinko and Universal will form part of larger diversified financial groups dominated by banks. Industrial Bank of Japan, which already owns minority stakes in Wako and New Japan, is expected to take a 25 per cent stake in Shinko. Sanwa Bank recently acquired a 30 per cent stake in Universal.

Underlying the turmoil in the securities industry is Japan's 18-month-old "Big Bang" programme for deregulating the entire financial sector, including securities, banking, insurance, and the pensions industry. One of the main purposes of "Big Bang" has been to demolish previously-existing barriers between different sectors.

A second aim of the programme is to create a western-style market in which individuals take responsibility for investment decisions instead of being protected by a web of laws and ministerial regulations.

As part of its new strategy of encouraging "self-responsibility" among investors, the finance ministry has withdrawn bans on "risky" products and services such as single stock options and stock lending. In the mutual fund industry, the ministry now permits a wide range of new types of funds, including collective investment vehicles that have a corporate structure allowing investors to sack fund managers. A system of automatic approval for new funds was substituted for a laborious licensing process at the end of 1998.

Optimists believe the government's more liberal attitude towards licensing mutual funds should encourage a shift of personal savings into equity-based funds from bank deposits which in Japan's current interest rate environment generally yield returns of under 1 per cent per year. If this happens securities companies which currently depend mainly on brokerage income derived from individual share trades may be able to shift to an asset-based business strategy based on management fees and on offering consultancy services to investors.

The probable introduction next year of direct contribution (DC) pensions based on the US401(k) system could provide another important boost to the mutual fund business. Even so, it is doubtful whether income from this source will grow fast enough to offset the big fall in brokerage income most companies are expected to suffer when commissions are deregulated in October.

r Heaton at Deutsche Securities thinks commissions paid on small share trades may fall to about two-thirds of the current level after deregulation if the trades are conducted through security branches. Trades conducted through the internet could be about one-third of current levels. These losses will be only partly offset by the abolition from April 1 of a securities transaction tax which was paid partly by investors and partly by the companies handling the transaction.

Increased competition resulting from the deregulation of brokerage commissions is not the only reason why conditions in the industry are likely to get tougher. Japanese securities houses face a formidable challenge from foreign companies in the wholesale sector, where the main activities include underwriting initial public offerings, trading large blocks of shares for institutional investors, M&A advice, and helping companies to restructure their balance sheets through asset securitisation.

The fact that foreign companies have accounted for as much 35 per cent of Tokyo stock market turnover in some recent months provides some clue to the dominance of foreign companies at the wholesale end of the business.

Japanese concerns may not be able roll back this dominance in some sectors of the wholesale market. But recent changes, such as the establishment by Daiwa Securities of a holding company system which will allow staff dealing with wholesale business to earn more than those working in the retail sector, suggests they are at least getting ready to counter the challenge.


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