Positive Trends for Japanese Brokers

Improving industry dynamics and possible government reforms provide new opportunities to foreign and domestic banks and brokerages

by Justin Menza From Standard & Poor's Equity Research

There are some changes afoot in the Japanese brokerage industry that may benefit banks and brokerage firms doing business in Japan. Market reforms may soon allow banks to operate securities businesses with fewer restrictions, while Citigroup's (C) controlling stake in blue-chip broker Nikko Cordial could force a number of domestic and foreign firms to reassess their competitive positions. Amid these changes, merger activity roared back in the first quarter of 2007 after a slow 2006, and underwriting trends remained positive.

In mid-April, Japanese Prime Minister Shinzo Abe requested the Financial Services Agency to begin drawing up plans to dismantle the barriers between banks and brokers. The new rules are expected to give financial-services firms the ability to operate both businesses and further develop the country's financial markets. Currently, banks can only operate brokerage units as independent subsidiaries with rules in place limiting how they are run.

The new rules should help further liberalize the market by allowing banks to run brokerage firms more freely and better integrate these businesses into their existing operations. Banks, both domestic and foreign, would have more freedom to expand their Japanese operations and offer more integrated financial services to corporate customers. These reforms come at a time when Japanese corporations are becoming increasingly global and are in greater need of comprehensive financial services to meet the challenges of running a global operation.

Direct Competition

Citigroup (S&P investment ranking, 5 STARS, strong buy) has moved to increase its ability to provide a wider range of services to Japanese corporations through the acquisition of a majority stake in Nikko Cordial. After a battle with Nikko Cordial's hedge fund shareholders, Citigroup was able to secure a 61% stake in the brokerage firm in late April for about $7.7 billion.

The majority stake will allow Citigroup to compete more directly with the major Japanese securities firms, which include Nomura Holdings (NMR; not ranked) and Daiwa Securities Group. Citigroup now has a Japanese asset management business, an online brokerage, and 109 retail brokerage branches to complement its previously existing corporate and investment banking operations in the country.

The potential new investment banking rules and Citigroup's increased presence in the Japanese market may prompt more firms to look to expand their Japanese businesses, particularly as mergers and acquisitions and underwriting trends become more favorable. After a down year in 2006, Japanese merger-and-acquisition activity is picking up steam in early 2007. According to data from Thomson Financial, there were $103.2 billion worth of announced deals in Japan in 2006, down 36% from the $161.7 billion in 2005, after a strong year in 2005, and after a slate of companies adopted anti-takeover measures.

Some Inflated Numbers

In the first quarter of 2007, deal volumes surged to $46.3 billion from $16.5 billion in the first quarter of 2006, a 180% increase. The financial-services sector was the most active, with about $27 billion worth of deals announced. These deals included Citigroup's bid for Nikko Cordial, Shinko Securities' acquisition of Mizuho Securities, and the acquisition of a securities unit by Mitsubishi UFJ Financial Group (MTU; not ranked).