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January 1996

Japan: A game of catch-up


After a disastrous few years, Japanese securities houses have begun to rediscover how to make money in international business. They are cutting costs, building up proprietary trading operations and taking advantage of the demand from Japanese retail investors for foreign bonds. But can they ever catch up with their US and European rivals? Garry Evans reports.




Daiwa Securities has gone through an irritating few months. When the $1 billion bond-trading loss at Daiwa Bank's New York branch became public in October, the securities firm began to feel the repercussions too. But the two firms are not in any way connected. In fact, Daiwa Bank used to be a part of, and is still close to, Nomura, Daiwa Securities' greatest rival.

In London, Daiwa Securities' officials had to chase away cameramen from the BBC mistakingly camped outside the firm's eye-catching building in King William Street. One senior executive of Daiwa Securities recalls that he received many letters from business contacts commiserating with him on the scandal. "I don't know how to respond," he laments. "If I write back, these people will be so embarrassed they'll never do business with me again."

Such annoyances aside, Daiwa Securities has every reason to feel pleased with its progress over the past 12 months. Profits from the London operation reached £9.4 million ($15 million) in the April-to-September half-year, according to figures published by the Nihon Keizai Shimbun newspaper. Says Alex Monnas, deputy chief executive of Daiwa Europe: "Over the past five years, we have slowly been building a portfolio of enduring businesses in London. We haven't completed the process yet, but the development has finally started to pay off in terms of profitability." In New York, too, Daiwa has been more consistently profitable than the other three big Japanese securities firms [see table at end of article].

Indeed, all the big four firms had a decent year in international business in 1995. Nomura and Daiwa remained in the top 10 of Eurobond lead managers. Nomura was up two places to fourth; Daiwa rose one place to seventh. Even Yamaichi - virtually ruled out of contention for major international mandates a few months ago - rose to 17th place on the back of a $2 billion deal for Sweden at the beginning of December.

The Japanese have made inroads in other areas, too. Nomura achieved a number of breakthrough deals that suggested, almost for the first time, that it is capable of winning major non-Japan related business. In the UK, for example, it was part of the GRS Holding consortium that bought one of the rolling-stock leasing companies sold by the government. Nomura provided the debt for the deal, and will eventually securitize the lease receivables. In Vietnam, it is financing an industrial zone in Haiphong. It monopolizes the lead managing of bond issues by Baltic states: it brought the debut issues of both Latvia and Lithuania in 1995, and is rumoured to be planning a Deutschmark issue for the Estonian capital Tallinn in January.

The securities houses' greatest successes this year, however, have come from selling large bond issues into Japan. With bank deposit rates in Japan little over 1%, Japanese retail investors discovered in early summer that they could make better returns, with little extra risk, by buying sovereign Euroyen bonds. By the autumn, investors were becoming more adventurous, buying Eurodollar and Euro-Australian dollar paper.

Suddenly, the Japanese securities houses had a bonanza on their hands. They were able to provide the cheapest funding available in the market to many of the world's largest borrowers. Consequently, Daiwa and Nomura jointly led a ¥550 billion (then worth $6.3 billion) three-tranche Euroyen deal for Italy in May - the largest-ever Eurobond. In October, Daiwa again brought Italy to market for $1.5 billion in dollars, reflecting the shift in Japanese investors' preferences. In May Nomura was the first to reintroduce Brazil to the market after January's turbulence in Latin America. Nikko's highlight was probably a ¥100 billion deal for Argentina in August.

The Japanese know this windfall won't go on for ever, but they are prepared to enjoy it while it lasts. Says Monnas: "We don't see an early end [to retail-targeted issues]. But we are not budgeting, or basing our medium-term strategy, on this lasting very long." Although there is no sign of interest rates rising in Japan, redemptions in 1996 will not be as large as last year. Redemptions of all personal assets by individuals are predicted to total ¥35 trillion in the first quarter and ¥32 trillion in the second, according to estimates by the Yamaichi Research Institute. Those are still large figures, but well down on the ¥50.4 trillion in the last three months of 1995.

Indeed, there are signs that selling Eurobonds into Japan is already getting harder. Daiwa's Italy dollar deal saw a lot of flowback a month after placement, as investors sold to take advantage of the capital gain they had obtained from the sudden fall in the yen. In December, the Nihon Kinyu Shimbun, an influential trade newspaper, reported that the sales staff of the securities houses were up in arms at having to sell excessive amounts of bonds from high-risk sovereign issuers to retail investors. The paper quoted one broker as saying: "Some individuals do not even know that the value of bonds changes as a result of price fluctuation ... Some countermeasures must be taken against possible trouble with individuals."

Masashi Kaneko, co-chairman of Nikko Europe, agrees that the Japan-targeted deals have got too big. Between $200 million and $1 billion is the ideal size, he suggests. "It behoves all of us to do the right issues for the right borrowers at the right price," he argues.

But these are the niggles that come from success. In general, business for the Japanese houses is in far better shape than 12 months ago. When Hitoshi Tonomura, head of Nomura's international business, was brought back to London by the firm in April to shake up the European operation (he had headed London in the 1980s), he found an institution in disarray. "My reaction was that we had a lot of talented people not well organized," he recalls. "There was a lack of communication. Everything had gone wrong."

Nomura suffered from high overheads (partly because of its palatial building near St Paul's Cathedral), little focus and poor morale. Since then, Tonomura has reduced staff in London from 700 to 600 (and throughout Europe from 1,500 to 1,200). He has cut fixed overhead by 16%, and begun linking pay more closely to performance. He says there is "a little bit more room for rationalization in continental Europe" where he "may close one or two offices".
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