A Gang of Four of online discounters is brashly bidding to displace Japan’s Big Three firms - and shaking up the securities industry.
By Charles Smith
May 2001
Institutional Investor Magazine
A Gang of Four of online discounters is brashly bidding to displace Japan’s Big Three firms - and shaking up the securities industry.
Michio Matsui, boss of Japan’s Matsui Securities Co., takes a drag on his cigarette and scribbles some calculations on a notepad. The projections prove, he asserts, that at its current growth rate, his online discount brokerage will overtake Nomura Securities Co. in two years as Japan’s biggest brokerage firm in sheer number of retail stock trades.
The claim sounds preposterous. After all, Matsui’s family-owned brokerage has no branch offices and only 200 employees. Mighty Nomura has 124 branches and 15,000 employees. But Matsui’s assertion should not be dismissed - not least by Nomura or by Daiwa Securities Co. and Nikko Securities Co., Japan’s Big Three traditional brokerage firms.
In just the past 12 months, Matsui Securities has shot from 89th place in Japan’s brokerage league tables to tenth. It now handles almost 8 percent of all retail trades on the Tokyo Stock Exchange. Granted, Nomura’s share is twice that, but just two years ago, it was 20 times Matsui’s. Scoffs
Michio Matsui, “Nomura will always be around, but its future lies in investment banking [not retail brokerage].”
Nomura would dispute that. But the fact is that Matsui and three other upstart firms - a Gang of Four - have surged to the forefront of Japan’s discount online brokerage business and now threaten the dominance of more conventional brokerage houses. In the process, they are changing investment habits, putting intense pressure on commissions and fundamentally altering the brokerage business.
To be sure, these aren’t normal times for brokerage firms. Japan’s stock market has been mostly floundering for more than a decade; brokerage profits have been anemic; and the economy appears headed back into recession. Japanese retail investors, who once put nearly a third of their savings into stocks, now allot less than 8 percent to equities. Moreover, the advent of deregulated commissions and the emergence of online brokerages have intensified competition. Many middle-tier traditional firms as well as several online outfits will be hard-pressed to survive.
The heavyweights - Nomura, Daiwa and Nikko - will certainly survive and can be counted on to defend their turf. Between them, Nomura and Daiwa account for roughly 14 percent of online retail trades, estimates Robert Zielinski, who follows Japanese securities firms for ABN Amro Securities (Japan). Nikko’s online subsidiary, Nikko Beans, boasts a 6.9 percent share of online retail transactions.
But what is so striking is that Matsui and three other independent online discount brokerages - DLJdirect SFG Securities, Monex and Orix Securities Corp. - control three times the estimated share of Nomura, Daiwa and Nikko Beans combined, or nearly 60 percent of all online retail trades. The remaining fifth of the market is divided among roughly 50 middle-rank traditional brokerages and a dozen strictly online operators. Prospects are grim for a number of the latter because of paltry customer bases.
“Considering the number of contenders in the online business only a year ago, things have narrowed down remarkably,” notes Kristine Li, who follows Japanese securities firms for Lehman Brothers Japan. “Investors already appear to have decided who the winners and losers are.”
The growth of online trading in Japan has been spectacular. According to the Japan Securities Dealers Association, it accounted for a mere 1 percent of retail transactions on the Tokyo Stock Exchange as of September 1999, but 23 percent barely one year later, for a total volume in the six months to September 2000 of ¥6.9 trillion ($62 billion).
How did four unheralded firms manage to open up such a commanding lead in so attractive a market? Matsui, Monex, DLJdirect SFG and Orix all have bold and clearly defined business strategies in a country where deliberate risk-taking and refusing to run with the herd constitute exceptional behavior. All four have bet their futures on how the online market develops.
Matsui Securities has staked out what its CEO calls semipro investors, or wealthy, often older Japanese who have been trading stocks for several years. Michio Matsui, 47, is hoping that a relatively small group of these high-net-worth individuals can be induced to become somewhat more aggressive market participants. One of Matsui’s showcase customers is a dentist from Hokkaido who executed more than 2,500 Web transactions in November alone. Matsui, whose wife’s grandfather founded the firm in 1918, contends that Japan is full of wealthy, conservative investors who are anxious to lock in small profits on stock trades but haven’t been able to because of the high commission rates of regular brokerage firms.
Matsui Securities’ success attests to the power of these active traders. The firm accounts for an estimated 28.7 percent of total online transactions, or more than twice the share of its nearest rival, DLJdirect SFG. To attract the semipros, Matsui offers a “box rate” commission system that allows investors to conduct an unlimited number of transactions per day for a flat fee of ¥3,000, provided the total transaction value doesn’t exceed ¥3 million. Another lure is margin trading. In August 1999 Matsui overtook Nomura as the firm with the largest volume of retail margin business.
But Matsui may have already enlisted 50 to 60 percent of Japan’s limited population of semipros, estimates one analyst, and thus could find its growth slowing. In response Michio Matsui is expanding Matsui Securities’ range of services and recently added foreign exchange trading.
Oki Matsumoto, the 37-year-old ex-Goldman, Sachs & Co. partner who set up Monex in April 1999 in partnership with Sony Corp., takes a much broader market view than Michio Matsui. Given Japan’s aging population and huge and chronic budget deficits, he argues, the government won’t be able to maintain its lavish pension benefits, so individuals will have to do more to generate their own retirement savings. Moreover, says Matsumoto, they will simply grow tired of keeping the bulk of their money in bank accounts earning less than 0.2 percent a year and will shift a substantial proportion into stocks.
Matsumoto’s big bet is that the great mass of Japanese savers will make a historic shift into stocks once the market shows signs of stabilizing - and that he can win their business by offering trustworthy service and a price structure that lets them do a bit of trading on the side. Monex charges ¥1,000 per trade with no limit on the number of daily transactions, one of the lowest rates currently available in Japan. Matsumoto has not ventured into the lucrative margin business. “It isn’t safe if you’re not dealing with investors personally,” he contends.
Monex outsources everything except long-range business strategy, compliance, product selection, public relations and production of a four-times-a-day market report. But Matsumoto does employ five investment bankers to chase down deals. “Selling IPOs over the Web is the wave of the future,” he says.
Monex’s immediate challenge is to generate enough business to turn a profit. Right now, it’s losing about ¥700 million a year. A competitor assets that an online brokerage with a ¥1,000 commission like Monex’s needs about 300,000 account holders to cover costs, even with outsourcing. Monex hit 100,000 accounts in November - becoming the first of the online Gang of Four to do so - and should pick up 50,000 more online accounts this June when it completes its takeover of old-line brokerage firm Saison Securities Co.
But beyond this instant boost to his client base, Matsumoto sees Saison as an important catalyst in Monex’s bid for mass-business trade because of its affiliation with the Saison retail group, issuer of Japan’s most popular credit card. By exploiting cross-selling opportunities with Saison’s 6 million cardholders, Matsumoto reckons he can gain access to an extra 250,000 potential online subscribers.
A crucial element of Monex’s expansion strategy was its ¥5 billion IPO in August 2000. One of just two listed online brokerages, the firm was able to use its shares to buy Saison. A competitor estimates that, despite Monex’s losses, it could ride out a four- to five-year bear market, because Matsumoto had the good sense to bank the IPO proceeds. Matsumoto says he fully expects to “go through tough times” before his strategy pays off. But he’s counting on the emergence of a “true equity culture” in Japan to help Monex grow.
If Matsui and Monex represent opposite poles of online strategy - niche and mass market - DLJdirect SFG falls somewhere in between. Confides president and CEO Atsushi Kunishige, “It’s obvious the number of online accounts is going to double over the next couple of years, but the question that bothers me in setting strategy is just how it will double.” The former head of Sumitomo Bank’s wholesale securities subsidiary, the 55-year-old Kunishige is pursuing three distinct types of online investors: semipros, beginners willing to play the market but not sure how and risk-averse sorts who are interested in mutual funds or mini-kabu trading (buying and selling in batches of 100 shares instead of the customary 1,000).
Kunishige says he shades closer to Matsui’s approach than to Matsumoto’s. For one thing, his firm’s services, though a bargain compared with those of a traditional brokerage, are more expensive than Monex’s. But they are also more sophisticated. DLJdirect SFG has invested heavily in state-of-the-art technology that most of its competitors can’t match. In December the firm launched Market Speed to allow customers to track share prices in real time and buy and sell almost instantaneously. The service, which cost ¥1.5 billion to develop, has acted as a magnet for new accounts, Kunishige says.
Lehman’s Li worries, however, that the two-year-old firm may have spent too much too soon on cutting-edge services. DLJdirect has run up its share of losses: ¥1.5 billion in its first full year of trading, ended March 2000, and a further ¥1 billion in the six months ended last September. But Kunishige contends that since DLJdirect introduced margin trading in September, losses have greatly eased. The firm actually eked out a small profit in December. “If we can keep that up,” he says hopefully, “we may be able to go public before the end of 2001.”
Orix Securities doesn’t need to worry about going public. It’s the one member of the Gang of Four owned by a financial conglomerate, leasing giant Orix Corp. Like DLJdirect, Orix Securities has adopted a balanced approach. CEO Koichiro Muta, 60, sees online trading changing Japan’s entire approach to stocks. Market research conducted by Orix has convinced him that many Japanese investors don’t want to have to fend off securities salesmen; they prefer trading online because it is less stressful. The clear rules and impersonal nature of the Web benefit both investor and brokerage, argues Muta. “When we had to deal directly with investors who had bought shares on credit and were required to raise their deposits on a falling stock, we were always at risk of being swayed by personal considerations, like the length of time we had dealt with that customer,” he recalls of his brokerage days. “With the Web, everything is done by the rules, so we don’t have to worry.”
Orix is targeting “moderately rich” investors who now deal over the counter with the big brokerages. Investors “sometimes seem to go to Nomura for advice and come to us for execution,” Muta observes. Orix is generally cheaper than DLJdirect for lower-value trades but slightly more expensive for transactions of more than ¥200,000. But in the near future, Muta aims to woo the “several tens of thousands” of small-business owners who are the prime customers of Orix Corp.'s leasing service.
What becomes of traditional brokerages if online trading continues to gain? The small firms with long-standing client relationships will probably always have a place. But the Web poses grave problems for a dozen or so midsize brokerages that depend heavily on retail business but aren’t as close to their customers as family-run firms and that can’t match the commission rates of the online firms. Nevertheless, a number of midsize firms, such as Shinko Securities Co., Mizuho Investors Securities Co. and Kokusai Securities Co., have strong backing from banking parents or affiliates that aren’t going to give up on them easily. “But how long can they hang on if their affiliates lack a viable business strategy?” asks Paul Heaton, an analyst for Deutsche Securities in Tokyo.
What of the Big Three? They are far less vulnerable. For a start, they have a deep and diverse revenue stream. Brokerage commissions account for less than 15 percent of their sales. Moreover, they have met the enemy and - wisely - decided to emulate him. Nomura already has 460,000 clients signed up for trading online.
But the Big Three have sought to sidestep direct price competition with the online firms by rebundling their services and creating new options for clients. For instance, Daiwa gives a 50 percent discount to customers who close branch accounts and agree to trade only over the Net. Nikko charges customers its standard over-the-counter rate for online transactions, but encourages those seeking cheaper fees to open accounts at Nikko Beans. Still, Nomura, Daiwa and Nikko will at some point have to join the discount war or see a substantial part of their business seep away, suggests Deutsche’s Heaton.
Sadakazu Osaki, head of the capital market research unit at Nomura Research Institute, says Nomura could slash its commission rates to the discount online level “any time it wants,” but that the cuts would have to be across the board, not just on Internet services. Nomura would then need to look for new sources of revenue to plug this huge gap. It could substitute spreads for commissions - that is, execute retail orders through an in-house market maker system instead of having to pay transaction fees to the Tokyo Stock Exchange. The hitch, notes Osaki, is that Nomura president Junichi Ujiie happens to be chairman of the exchange’s board of governors.
Some heartening news - for the online firms as well as for the traditional brokerages - is that the Web could conceivably change Japanese savers’ widespread skepticism toward owning shares. Many Japanese have shied away from stocks simply because they’re reluctant to go into securities firms’ branch offices, whereas they’re not intimidated by banks, notes Toshihiro Yanai, a manager in Nomura’s retail strategy department. “Once they trade on the Net,” he says, “they’ll be free of at least that inhibition.” Daiwa’s online boss, Mamoru Takahashi, says that there’s no way his firm could meet its target of doubling its retail accounts over the next three years without resorting to the Web. Adds Monex’s Matsumoto, “Online trading can help lay to rest the chronic distrust of Japanese equity markets.”
On one point, all observers agree: The Nikkei 225 stock average must recover from its decadelong depression before either online or traditional brokerages can truly prosper.
