It’s impossible to win over a crying baby, or government officials, or so the Japanese say. Nobuyuki Koga, CEO of Nomura Holdings, Japan’s mightiest investment bank, hardly needs the reminder. For years he preached the benefits of robust capital markets, lobbying the government for key changes to aid in their development.
Now, Koga, 54, has gotten his wish. The reform-minded administration of Prime Minister Junichiro Koizumi is tearing apart Japan’s carefully orchestrated postwar development plan, a cozy arrangement between banks and the government that all too often left capital markets -- and traditional investment banks -- on the sidelines. In December the Japanese government began a long overdue revamping of its securities laws, introducing a program that’s expected to push trillions of yen into the capital markets as Japanese citizens move their money out of bank deposits and into securities. The program, called shoken chukaigyo, allows the country’s banks to act as sales agents for securities companies and thereby sell stocks and bonds over the counter at branches for the first time (“shoken” means stock, and “chukaigyo” means middle agent).
These changes, ironically, present Koga and Nomura with the challenge of a lifetime. Long the market leader in merger advisories and IPO book running, Nomura still dominates investment banking in Japan, but the new reforms will allow unfettered access to the country’s capital markets for big banking companies that dwarf Nomura in size -- and ambition. Under shoken chukaigyo, banks choose which securities firms they will work with. That’s not a problem for Japan’s other top-tier brokerage firms -- Daiwa Securities Group, Mitsubishi Securities, Mizuho Investors Securities Co. and Shinko Securities Co. -- all of which are linked with either a huge financial conglomerate or a banking company. Nomura, however, is the only securities firm without a ready-made shoken chukaigyo partnership in place.
The conglomerate-backed banks have hit the ground running. Most inaugurated their securities efforts in December, rolling out full-scale programs last month, the start of the new fiscal year in Japan. Bank of Tokyo-Mitsubishi, Japan’s biggest bank, which launched the sale of Japanese equities and foreign bonds at 31 branches at the end of 2004, extended the service to all 472 of its branches on April 1. The country’s second-largest bank, Sumitomo Mitsui Banking Corp., began selling foreign-issued and structured bonds -- though not equities -- at all of its outlets in December. These products, says Takeshi Morita, a spokesman for SMBC, generate “very interesting new business” and fill a gap between low-risk, low-yield bank deposits and the high-risk investment trusts that the bank was limited to selling before shoken chukaigyo was launched. The bank is using SMBC Friend Securities Co., a retail subsidiary, as its affiliate. Mizuho Bank has partnered with its sister company, Mizuho Investors Securities Co., to pursue high-net-worth customers as potential buyers for new securities products and as clients seeking investment advice tailored to individual needs.
No one expects Nomura to lose its dominant position overnight, but experts say that unless it takes decisive action -- buying a bank, merging with a rival institution or at the very least investing heavily to develop banking services -- the proud independent with the 80-year heritage could be bumped from its top spot in the markets. “Commercial banks will form the core of the Japanese financial system as deregulation progresses,” says one portfolio manager at a major European money manager in Tokyo, who is avoiding Nomura shares. “Nomura will face difficulties in forming a relationship with a bank, partly because of its independent spirit and its desire to keep its name.”
The shoken chukaigyo change comes at a time when Nomura’s business results are already showing signs of strain: The firm’s pretax profits in the fiscal year ended March 2005 fell by 27.5 percent, to ¥204 billion ($1.94 billion), with a return on equity of just 5.2 percent, half the 10 percent figure set by Koga as a medium-term target. In contrast, rival Daiwa boosted its profits by 25 percent, while Nikko Cordial Corp. held steady with a 1 percent increase.
Nomura did report strong results in some areas. The retail side, for example, where the firm earns 45 percent of net revenue, turned in a solid performance, with profits up from ¥79.5 billion to ¥81.2 billion. And Nomura Asset Management Co. turned a loss of ¥1 billion in the previous fiscal year into a profit of ¥7.4 billion.
But the weakest figures came from what had been known as the global wholesale division, which included investment banking, global markets and merchant banking until it was divided into three autonomous units in March. Overall the pretax earnings of the former wholesale division empire fell 38 percent, to ¥86 billion. Nomura blamed the setback mainly on lower profits in its global markets subdivision, where profits from bond trading slumped by 50 percent.
Still, results from Nomura’s investment banking division were a mix of good and bad news. Investment banking turned in a ¥29.2 billion pretax profit, up 70 percent, as healthier capital markets boosted income from corporate bond underwriting and IPOs. But the numbers don’t tell the whole story: In the final quarter of the fiscal year, Nikko Citigroup, an investment banking joint venture between Nikko Cordial and Citigroup, edged out Nomura as the top underwriter of Japanese IPOs, with $3.1 billion worth of deals to Nomura’s $2.4 billion.
Even in the face of weaker-than-expected results, and despite some pessimistic forecasts for Nomura’s future in light of Japan’s regulatory reforms, Koga professes to see shoken chukaigyo as an opportunity, not a threat. His view: Any loss in the firm’s dominant market share will be more than made up for by a vastly bigger pie.
“If the proportion of personal assets invested in securities doubles to 20 percent from 10 percent, there will be an extra ¥150 trillion to go around,” he tells Institutional Investor during an interview in his sun-filled office overlooking Nihonbashi, the elegant 19th-century bridge in the heart of old Tokyo. “I can at last envision long-held dreams coming true.”
Koga, who has held the top job for two years -- he succeeded Junichi Ujiie in April 2003 -- insists that Nomura doesn’t need to make a splashy acquisition or pawn itself off to a megabank. But alliances with equals are definitely on the agenda. In February, Nomura announced that it will offer cross-border M&A advisory services in a tie-up with London-based Rothschild group. The two firms will share client referrals, but not capital. Nomura is also expanding overseas, by hiring professionals away from U.S. investment banks to launch specialized new products, such as equity derivatives. Within Japan, Nomura and Koga are trying to meet the new competition head-on by offering a range of new, better products, such as floating-rate Japanese government bonds tailored to meet the needs of individual investors, and investment trusts designed to maximize dividends rather than capital gains.
Nomura’s March decision to break up the unwieldy global wholesale division into three units, investment banking, global markets and merchant banking, each reporting directly to the CEO, was designed to give management the power to make faster decisions, and be more flexible, in a fast-changing business environment. This way, Takeshi Yanagiya, the new head of investment banking and the former head of global wholesale, will be better able to fight back against underwriting challenges from Nikko Citigroup and Daiwa. The reconfiguration will also help Nomura present a more accurate picture of its results, which currently reflect widely different performances in different sectors.
And Nomura is looking to do an end run around the massive banks by teaming with smaller regional institutions all over the country to sell securities. “Of course we face intense competition,” Koga admits, “and it’s going to get tougher.”
THIS ISN’T THE FIRST TIME THAT MANAGEMENT has been forced to defend Nomura’s territory. The firm has had ample opportunity to sharpen its survival instincts since 1925, when it was spun off from Nomura Bank (later Daiwa Bank and now Resona Bank) as a fledgling bond house and chose to steer clear of Japan’s bank-dominated keiretsu, or conglomerate-based, system of ownership.
Nomura’s most recent near-death experience occurred six years ago, just after the disastrous fiscal year ended March 1999, when the firm got whacked by the weak Tokyo stock market, the Asian financial crisis, Russian bond defaults and big losses from an ill-advised foray into U.S. commercial-mortgage-backed securities. Already staggered by years of declining stock markets and economic malaise, Nomura lost ¥595 billion and had to rely on its capital base to survive as an independent firm.
But when Japanese stocks rallied in 1999 and 2000, Nomura came roaring back, earning ¥263 billion in profits in the fiscal year ended March 2000. It was, in fact, the only one of the Big Three firms left standing without outside help. Daiwa got a cash infusion in 1998 by entering into an investment banking joint venture with Sumitomo Bank, one of the forerunners of Sumitomo Mitsui Financial Group; Nikko Securities Co., now named Nikko Cordial, struck its partnership with Citigroup the same year.
In October 1999, Nomura came under attack again. Just as Internet trading was taking off, Japanese regulators ended fixed brokerage commissions. Low-commission electronic trading upstarts like Matsui Securities Co., Monex and ETrade Securities Co. walked off with many of Nomura’s day-trading customers.
Fighting back, Nomura set up its own online brokerage service, Nomura Home Trade, but chose not to go toe-to-toe on price with its feisty new competitors. Instead, it plowed ahead with a widespread revamping of its brokerage business, says Hiroaki Honda, managing director in charge of retail strategy. Nomura segregated its clientele by income, offering carefully mapped out strategies for its most affluent customers while providing the less wealthy with cheaper over-the-counter advice. The firm subsequently redirected much of its sales and marketing effort toward an older, wealthier -- and potentially more profitable -- demographic. The plan worked: Nomura now has 3.7 million retail accounts (1.59 million of them online), up from 2.9 million three years ago. “We have to segment our clients clearly according to wealth in order to provide what they really need,” Honda explains.
Nomura has reduced its emphasis on commissions in general. When brokerage commissions were deregulated in 1999, notes Takumi Shibata, CEO of Nomura Asset Management, “we had two options: to go cheap or to generate more earnings per head at branches.” Nomura chose the second route, focusing on asset gathering, which gives it more opportunities to provide management services that generate fees, while leveraging its sizable customer base to sell still other commission-generating products, such as initial public offerings from its corporate customers.
Koga argues that Nomura’s huge market share -- and its knack for rebounding -- will allow the firm not just to survive, but to prosper, as Japan reforms its capital markets over the next two years.
Details of the full reform program remain sparse, although a draft of the Insurance Services Law -- meant to allow banks to diversify from lending into capital markets -- is due to be completed next month. The ultimate goal of the Financial Services Agency (Japan’s chief financial regulatory organization) is to turn the existing four megabanks (soon to be three, once UFJ Holdings and Tokyo-Mitsubishi complete a merger in fall 2005; the other two are Mizuho Financial Group and Sumitomo Mitsui) into universal banking groups able to offer a full range of financial services, including banking, investment banking and securities.
“In light of what we hear from the government, the shoken chukaigyo program could be just the start of a process that will transform Japan’s financial landscape,” says Hironari Nozaki, a bank analyst for Nikko Citigroup.
The government could not have picked a better time to launch shoken chukaigyo. Japanese savers hold more than ¥700 trillion in bank deposits; the yield on a one-year time deposit is currently about 0.03 percent. The first big wave of Japan’s baby boomers will retire in three years, and many of them are expected to venture into low-to-moderate-risk bonds and stocks in the hope of generating higher returns.
“One reason we think people may be ready to put more money into securities is that risk assets as a percentage of people’s holdings have been falling steadily,” says Takahide Mizuno, chief investment officer at Nomura Asset Management. “At the height of the bubble, when property values were inflated, risk assets were 65 to 70 percent of total individual assets. Now they are down to about 40 percent.”
The banks will be able to profit from the coming market shifts, thanks to their massive distribution systems. There are some 30,000 bank outlets in Japan, compared with roughly 3,000 securities company branches. Banks have demonstrated their savvy at marketing new products: First allowed to offer investment trusts (equivalent to U.S. mutual funds) in 1998, banks now sell half of all newly issued investment trusts. What’s more, banks and their conglomerate parents have belatedly recognized that consumer finance -- unlike corporate lending -- holds the best prospect of profitable growth. In the past year, Mitsubishi Tokyo Financial Group and Sumitomo Mitsui Financial Group have both made acquisitions to gain strong positions in the fast-growing unsecured-personal-loan marketplace.
Brokerages have prepared for shoken chukaigyo by continuing to partner up. Until recently, the only big domestic brokerage other than Nomura without a local affiliation was Nikko Cordial, which instead had a joint venture with Citigroup. But in late December, Mizuho Corporate Bank, a unit of Mizuho Financial Group, announced that it would buy nearly 5 percent of Nikko, making it the second-biggest stakeholder behind Citi. In February, Tokyo-based financial newspaper Nihon Keizai reported that Daiwa Securities Group and Sumitomo Mitsui Financial Group, which owns Sumitomo Mitsui Banking Corp., were discussing a merger. The CEOs of both groups have denied that talks are in progress but have acknowledged the possibility of a partnership. Daiwa and SMFG are already linked through Sumitomo’s 40 percent stake in Daiwa Securities SMBC Co., an investment banking joint venture.
Even as Nomura’s rivals gather force, Koga refuses to consider anything but independence. The tie-up with Rothschild will not include any stakeholdings. Instead, Rothschild will introduce Nomura to its European clients for M&A advisory services in Asia, and Nomura will direct its Japanese clients to Rothschild when they need advice on European M&A.
Rather than do a merger, Koga would like to see Nomura hone its competitive edge by working more intelligently and taking advantage of its experienced advisers and brokers to offer superior products, including floating-rate bonds, investment trusts and real estate investment trusts -- products meant to respond to individual investors’ disenchantment with low-interest bank deposits. (Nomura’s latest high-dividend domestic equity fund, for example, which was launched on April 4 and sold only through the firm’s branch network, had drawn an impressive ¥100 billion by the third week of the month.)
NOMURA IS ALSO COBBLING TOGETHER AGREEments with regional lenders all over the country, offering products ranging from syndicated loans to asset securitizations, says spokesman Tsukasa Noda. To boost its role as a coordinator for syndicated loans issued by regional banks, Nomura recently applied for lending licenses, or kashi kingyo, for 20 of its 130 branches. The move should help strengthen relations with regional banks, which tend to have a surplus of deposits and a lack of lending opportunities.
Nomura’s latest efforts are off to a promising start: More than 40 regional banks have announced that they will partner with the brokerage firm. And state-owned Resona Bank has also said it will work with its onetime bond department.
Still, the firm’s piecemeal strategy holds risks. Strong local banks could choose to create their own minifinancial conglomerates, complete with securities affiliates, says Sadakazu Osaki, a senior member of the Nomura Institute of Capital Markets Research, a think tank the brokerage set up in April 2004. Such a trend could leave securities firms like Nomura in the awkward position of competing against the very regionals they currently want to partner with.
Some analysts also wonder whether Nomura, which in 1998 abandoned a long history of decentralized operation to adopt a more tightly controlled “matrix” form of management, can still wage the kind of fight that may now be necessary to stave off the banks. These worries preoccupy Nomura, too. Deputy president and chief operating officer Hiroshi Toda was quoted in a summary of the April 2004 meeting of Nomura’s managing directors as saying, “I have a vague sense that we are pretending to be champion sumo wrestlers. We mustn’t forget that our bread-and-butter work, the securities industry, is a very competitive field, and we will surely be defeated if we lose our sense of challenge and fighting spirit.”
Analysts have not stopped speculating about scenarios for Nomura’s future that include linking with other institutions. James McGinnis, a bank analyst at Mizuho Securities, suggests the Mitsubishi Tokyo Financial Group group as a partnering possibility, once the merger of MTFG’s Bank of Tokyo-Mitusbishi with UFJ Holdings is approved and gets under way in the fall. MTFG has declined to comment, although the group recently announced plans for a joint venture with Merrill Japan Securities Co. to serve high-net-worth retail clients. The Merrill-MTFG private banking venture, which will not launch until April 2006, would pit the Mitsubishi group directly against Nomura.
Such developments may shrink Nomura’s options, say analysts, who think the firm should find a deal now, when it is still the undisputed ruler of Japan’s capital markets and the banks are still clumsy novices. Nomura won’t have the luxury of any further lead time because the government is moving quickly with its liberalizing measures.
If he feels the same sense of urgency, Koga isn’t admitting it. Right now he says he’s eager to “work with banks to expand Japan’s capital markets” and see his dreams come true. He is confident Nomura will succeed if it “responds to customer needs with flexibility and speed.” Shareholders and analysts will be watching closely to see if an independent Nomura can meet their needs as well. As any sumo fan knows, sometimes even the most massive wrestler can be surprisingly nimble.
