Capital Market Competitiveness: Burnishing Tokyo's Image in the Face of Global, Asian Challengers

Thursday, February 12, 2009
At Academyhills, Tokyo

View an image gallery of the event

Sponsors:  

Mizuho Securities USA

University of Tokyo Center for Advanced Research in Finance

Co-organized by: Harvard Law School’s Program on International Finance Systems
The University of Tokyo Graduate School of Economics

In-kind support provided by: Mori Building Co., Ltd.
Supporting Organization: The American Chamber of Commerce in Japan

Panelists

Japan

Robert Feldman, Director of Economic Research Department & Managing Director, Morgan Stanley Japan Securities Co., Ltd.
Hideki Ito, Director for Financial Markets Operation, Planning and Coordination Division, Financial Services Agency
Takatoshi Ito, Professor at Graduate School  of Economics, University of Tokyo
Atsushi Saito, President & CEO, Tokyo Stock Exchange Group, Inc.
Heizo Takenaka, Professor & Director, Global Security Research Institute, Keio University
Kotaro Tamura, Member of the House of  Councilors; Chairman, House of Councilors Committee on Land Transport 

Hong Kong

Anthony Neoh, Former Chairman, Securities  and Futures Commission Hong Kong; Barrister-at-Law, Anthony Neoh, SC

Singapore

Frank Wong, Vice Chairman, DBS Group Holdings & DBS Bank, Singapore  (retired August 2008)

United Kingdom

Alastair Clark, Former Executive Director of Financial Stability, Bank of England

United States

David Shuler, Senior Vice President, Business Development (Asia), NYSE Euronext, Inc.
Paul Speltz, President, Kissinger Associates, Inc.

Moderator

Hal S. Scott, Nomura Professor of International Financial Systems, Harvard Law School

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On February 12, 2009, Japan Society, in conjunction with the Program on International Financial Systems at Harvard Law School and The University of Tokyo Graduate School of Economics, hosted a business conference at Academy- hills in Tokyo to examine capital market competitiveness issues in Japan. The session, sponsored by Mizuho Securities USA and University of Tokyo Center for Advanced Research in Finance, featured a panel of 11 high-level pan- elists from Japan, the U.S., Hong Kong, Singapore and the U., drawn from government, industry and academia, who discussed Tokyo’s relative global competitiveness and examined strategies for making Tokyo’s capital markets more accessible to foreign companies.

I. Introduction

Professor Scott introduced the themes of the discussion. Japan has been concerned with its place in the sun as a world financial center since the decline of its financial system during the “lost” decade. The City of London’s Global Financial Centres Index ranked Tokyo as seventh best in September 2008. London was first, New York was second, Singapore was third and Hong Kong fourth.

Of course, we also know that Japan ranks much higher in its overall economic importance. Its GDP and stock market capitalization are second to the United States, and its total bank assets rank third behind the U.S. and London. Yet its competitiveness as a financial center lags behind. As of January 2009, only 16 non-Japanese companies were listed on the Tokyo Stock Exchange compared to 127 in  1991. Of course, Tokyo is not the only financial center with  competitive problems. As reported by the Committee on  Capital Markets Regulation, 15.1 percent of foreign companies  delisted from the New York Stock Exchange in 2007, and it appears about another 5 percent have done so in 2008.

Panelists elaborated on the measurement of whether a country was an international financial center. One view was an international center reduced the average distance All photos © Yuki Yamada.between financial players. Another was the importance  of total assets of financial firms. One panelist emphasized that the financial system was composed of various parts, e.g. asset management and stock trading. Some centers, like Singapore, excelled in some but not all of the component parts. Professor Scott outlined the further topics for discussion: 1 benefits to being a financial center; 2 obstacles to Japan increasing its role as a financial center; and 3 the impact of the credit crisis.

II. The Benefits of Being a Financial Center

Services, particularly financial services, are becoming more important to Japan’s economy. While Japan still has a reputation as a manufacturer, manufacturing only accounts for 25 percent of its GDP. Furthermore, efficient financing is a key ingredient in the future of the manufac- turing sector. Given the aging of Japan’s population, the productivity of the financial center needs to be improved. Japan’s financial system should contribute more than its current level of 5 percent to GDP, compared to 8 percent in the UK and U.S., and 12 percent in Hong Kong. Without being an international financial center, Hong Kong would not have been able to sustain its past economic growth. While it is clear that Japan needs an efficient financial system to support its own economy, why does it have to be an international financial center to accomplish this? The answer seems to be that in a global world, if you are not competitive internationally, you are not efficient. The fact that Japan is losing out as a financial center is an important indication of the weakness of its financial system more generally.

The importance of being a financial center is not just about economics. If Japan’s position as a financial center slips, so does its influence in the world, particularly in Asia, where it is in active competition with China for leadership. The country identity of Japan is very important. With success  comes added clout in international discussions. For example,  its role as a financial center has allowed the UK to hit well above its weight in international policy discussions.

The discussion also explored whether there were any costs of becoming a financial center. While being a global center opened one more to global forces—an exposure which India seems to have avoided through foreign ex- change and capital controls—there was no support for the idea that Japan should move in that direction. While there were costs, they were clearly outweighed by the benefits.

One panelist underscored the importance of being a financial center by recommending that Japan establish  Left to right: Atsushi Saito, Takatoshi Ito, Alastair Clark.a council on financial strategy in the cabinet, chaired by the prime minister, along the lines of the successful council on IT strategy created during the Mori administration.

III. Obstacles to Japan Becoming a Financial Center

The panelists discussed four potential obstacles to Japan improving its status as a financial center: 1 use of the English language; 2 taxes and cost of living and doing  business; 3 law and regulation; and 4 Japanese politics.

The Use of the English Language

Other major financial centers are English-speaking—the U.S. and the UK, Hong Kong and Singapore. From the point of view of international financial firms located in Japan, the ability to speak and write in English is essen- tial, since this is the language in which business in the firm is conducted. In one major international firm, while the overwhelming number of employees were Japanese, most of them were very good at English. On the other hand, English may really be more of a secondary problem because international firms have pulled most of their international business out of Japan. Addressing the reasons for the pullout is more important. English capability may go beyond the financial world. For example, if a foreign worker cannot find a doctor who speaks English, he or she may not find living in Japan appealing.

The English-speaking issue is different in Japanese firms. In the case of Japanese management, most CEOs and executives do not understand English and, given their domestic focus, this has not been seen as a big need. However, with the acquisition by Nomura of Lehman personnel and the investment by Mitsubishi in Morgan Stanley, this may be changing. Obviously top Japanese management will need to communicate with these new parts of their firms.

One conundrum is why the Chinese seem to do better in English than the Japanese. The simple reason may be that more Chinese people are educated abroad in English-speaking countries.

The Japanese government is addressing this problem by funding a variety of programs meant to increase English proficiency generally and particularly for people employed in the financial sector. Perhaps we can look forward to the next generation, where this will be much less of a problem.

Just addressing English as a language problem, however, may be missing the fundamental point that the English “culture” and English-based standards play an important Left to right: Kotaro Tamura, Anthony Neoh, David Schuler.element in finance. Even where there are translations of laws, people still look at the English language text as the authoritative one.

Taxes and Cost of Living and Doing Business

Japan has a significantly higher tax rate than its most important Asian financial center competitors. The top marginal tax rates in Japan are 38 percent for corporate tax and 50 percent for personal income tax. This compares with Hong Kong and China, which are 15 percent across the board, and Singapore, which is at 17 percent. There are also special tax breaks in these two jurisdictions for foreigners and foreign activity.

The tax rates in the UK and the U.S. are closer to those of Japan. In the UK the corporate rate is about 30 percent and the top personal rate 40 percent, albeit that the government has proposed to raise the top personal rate to 45 percent. In the U.S. the top corporate tax rate is 38 percent, while the top personal income tax rate is 35 percent (which the Obama administration has proposed to increase since our meeting). National debt incurred in the credit crisis (and already incurred during Japan’s previous crisis) is likely to drive taxes higher in the foreseeable future. Comparison of tax rates can be misleading since different countries have different tax bases against which the tax is imposed. Also, U.S. and UK taxes can be reduced by booking transactions offshore—nevertheless, it is clear that Japanese taxes are significantly higher than those of its Asian competitors. But details of the tax law can matter to Japan’s role as a financial center. For example, in Japan you cannot offset a gain on a cash equity and a loss on an option—not a good outcome if one wants to promote the use of the options market.

Tax reduction may be difficult to achieve in Japan given the large government deficits and outstanding debt.

In terms of the cost of doing business, some people have said that companies have taken every operation out of Japan that they can because the cost of doing business there is so high. While costs may be high, so is the benefit of being in Tokyo. A panelist pointed to the Mori Foundation survey, which ranked Tokyo fourth after New York, London and Paris, for its attractiveness as a city. Also, the cost of being in Tokyo has to be measured against the business that can be done in Tokyo—the problem is more that the costs do not justify the business benefits. Some believed the Japanese were in denial about the problem, Left to right: Paul Speltz, Hideki Ito, Robert Feldman. while China is taking off. Others thought some improvements could be made through the new airport underway and by better marketing. The moderator said he was pleased by the development of the new airport and hoped one day to fly to Tokyo directly from Boston.

Regulation and Law

Regulation: Foreign financial firms have been critical of the FSA’s bureaucratic style, focusing on technical details and engaging in only limited communication with the firms it regulates. Although not as vocal, domestic financial firms have had similar concerns. One must understand, how- ever, that the FSA was created in large part due to MOF’s approach of focusing on policy to the neglect of rules and its overly close relationship to the industry as reflected in the “wine and dine” scandals.

Recent surveys of firms, conducted by both MOF and the firms themselves, indicate significant improvement. The FSA now has a better mix of rules and principles and has established better communication with industry. One complaint that remains is the “grey zone” issue, strict enforcement of vague rules. In effect, this is a call for clearer rules.

The UK has been traditionally known for its principles- based approach while the U.S. is more rules based. The UK, however, has a 6,000-page rule book, so it is not all principles. Nonetheless, while there isn’t a U.S. rule book, if one gathered the rules from the variety of regulators and court precedents, 6,000 pages would be a drop in the bucket (even taking account of the larger U.S. economy). The U.S. emphasis on rules is significantly affected by the possibility of costly private class action litigation, a problem neither the UK nor Japan face—in those countries what the regulators say is generally dispositive.

A more principles-based approach requires the right kind of personnel, those with experience and self-confidence to make judgments. What is needed is a broader perspective than is brought by lifetime government employees. This is a strength of the U.S. and UK system where, due to the revolving door between government and business, top level regulators have usually had significant experience in the private sector.

Another issue in Japan is the focus of enforcement on the behavior of financial firms rather than on the adequacy of issuer disclosure. This may affect the integrity of the market and, ultimately, the willingness of investors to transact on it. While FSA (through the JSEC) has increased its efforts in market surveillance, the number of enforcement actions against issuers can be counted on one hand. The FSA and the Japanese exchanges may have a problem in making sure there is adequate disclosure by non-Japanese Left to right: Heizo Takenaka, Hal S. Scott, Frank Wong.companies, due to their limited powers, but the major problem is with Japanese companies. Also, the onus of disclosure compliance cannot all be put on regulators, as others, e.g. auditors and corporate risk management personnel, bear responsibility as well.

The issue of regulatory independence was discussed. The Japanese FSA reports to a cabinet official, whereas the UK FSA is an independent organization, as are many of the U.S. regulators, e.g. the SEC, CFTC and the Federal Reserve. Nonetheless, independence from the government does not insure independence from the legislature. Whereas these are basically one and the same in a parliamentary democracy, the situation is far different in the U.S., where regulators’ independence is threatened more by Congress than the administration.

Legal system: One of the strengths of the Anglo-Saxon legal system has been the rule of law—the UK, U.S., Hong Kong and Singapore all share this common heritage. Many finance professionals, particularly lawyers, have been trained in this system. It is a challenge for them to deal with a non-Anglo system such as Japan, further compli- cated by the language difference.

In the Anglo-Saxon system, lawsuits and judges play an important role in clarifying legal rules. Judges often have substantial practical and commercial experience before they are appointed to the bench. They are not a separate bureaucratic class as in Japan. Some have called for a separate commercial court in Japan, with judges recruited from the private sector, to address this problem. China now has special courts for financial malpractice. Japan has also suffered from a lack of lawyers, but reform of legal education has significantly increased the number of lawyers and promises to do so even more in the future. In summary, the problem with the legal system in Japan is less the content of the law than the process of law- making and transparency.

Politics

Politics plays an important role in the ability of Japan to become an international financial center. Every regulatory act is an act of public policy subject to oversight and public discussion. Any rules a regulator makes can be overrid- den by the legislature. While this was not always true in practice in the past in Japan—for some time, politicians basically let MOF run the financial system—it is certainly true today. Today, politicians have more control but they basically do not understand finance.

Given the credit crisis, the prospect for further reform in Japan seems weaker. The financial system and financial institutions have gotten a bad name—their greed is seen by many as a cause for the crisis. These fires are inflamed by the populist media. This makes it more difficult to create a market environment in Japan that financial institutions will find appealing.

In addition, some find the electoral system an obstacle to selecting the right leadership. The people in Japan still want to see Koizumi as prime minister, a reformer. But Liberal Democratic Party politics often does not deliver the most popular or effective leaders.

IV. The Impact of the Credit Crisis

The credit crisis has already resulted in some major moves toward internationalizing Japanese financial firms, the Nomura-Lehman and Mitsubishi-Morgan Stanley trans- actions. Many (but not all) believe the balance sheets of Japanese financial institutions are healthier than those of their Western competitors, even as GDP forecasts in Japan are increasingly negative.

The impact of the credit crisis will nonetheless be severe in Japan. While we have already mentioned the tendency of Japanese politicians to resist reform in bad times, if bad times get bad enough, reform may become a necessity for survival.

—Hal S. Scott