Special Report: Online Brokers

More Japanese than ever are trading online, and despite the market downturn, Web brokers are booming. But how many will survive?

Michio Matsui of Matsui Securities

Oki Matsumoto of Monex

Atsushi Kunishige of DLJdirect SFG

"WE ARE GOING THROUGH a major change, probably more dynamic than the Meiji Restoration," says Michio Matsui, president and CEO of online broker Matsui Securities, headquartered in the center of Tokyo's old financial district. Just as the introduction of trains and then cars 120 years ago swept away hard-working rickshaw drivers, 80,000-plus Japanese equities salesmen are now threatened by online trading, he claims. Matsui, son-in-law of the firm's former president, was dubbed "the Alien" of Japan's securities industry after he announced that his firm would replace its sales staff with a call center in 1990. "Back then, everybody said I was crazy. No one could accept the idea," says Matsui. Having gone online ahead of its competitors in 1998, the company now appears to have secured one of the top slots as measured by the number of online retail transactions for Tokyo Stock Exchange (TSE)--listed securities. Matsui proudly claims that the "oligopoly" of the Big Three -- Nomura, Daiwa, and Nikko -- is over.

But his statement may be a little premature. Given the fact that a significant portion of active individual investors are older than 50, it appears unlikely that many will move to the Web, says Kenji Tamura, editor-in-chief of Nikkei NetTrading magazine. These investors still rely on traditional salespersons, and, he says, "They go for the Big Three for credibility and brand name. These conservative people will not disappear." But oligopoly or not, online trading is on the rise. While the growth in total retail turnover has been slow due to the past year's stock price massacre, more than 30 percent of retail transactions on the TSE are now done via the Web. And while the share of Japan's total retail trading volume done online is still smaller than that of the US (40 to 50 percent) and Korea (70 percent), there seems to be no doubt that more and more Japanese investors will go online in the near future, since they have a greater cost incentive for doing so. Kristine Li, a Lehman Brothers analyst, sees the share of trading done online reaching 50 percent in Japan by the end of this year.

DEREGULATION LAUNCHES COMMISSION WAR
Online trading in Japan has made a spectacular debut. Many companies entered the new territory when brokerage commissions were deregulated in October 1999, and over 60 online firms have been competing for new customers in a cutthroat market, with retail commissions in some cases falling to 2 percent of their pre-deregulation levels. Minimum fees have averaged ¥1,000 to ¥2,000, almost one-tenth of what they were. Meanwhile, the number of online brokerage accounts has continued to grow, reaching 1.89 million in March -- an increase of about 168 percent in the past year alone.

The rise of Web investing has, perhaps, a more significant connotation in Japan than elsewhere. Throughout the post-WWII era, the Big Four securities firms (the Big Three plus Yamaichi Securities, which went belly-up in 1997) dominated the market; Japan's peculiar fixed commission system didn't leave much room for competition. In the absence of the Web, the Big Four maintained de facto control over information through their extensive national networks of sales staff, and there were no truly independent financial advisors serving the small investor. Since these companies generated revenue from position-taking, information and advice provided by their salespeople was largely biased so as to secure the parent company's own position. But with the variety of services offered by today's online trading sites, investors have gained access to much of the real-time information once limited to institutional investors and big securities firms, and the wave of deregulation has sparked competition not only in commissions, but also in services.

In order to attract the younger generation, online brokers have introduced products such as the mini-kabu (smaller stocks), which allow them to buy a smaller lot than the minimum trading unit (share prices in Japan are typically far higher than those in, say, the US). They have also introduced e-warrants and covered warrants, allowing investors to try high-risk, high-return products with initial investments as little as ¥30,000 to ¥50,000.

THE DINOSAURS CHOKE
Online brokers continue to eat away retail share from the traditional dinosaurs, which have also been hard hit by the weak equity markets. In reaction, both Nomura and Daiwa have established their own online trading operations to catch up with the change, while Nikko set up an online subsidiary, Nikko Beans Inc. While they offer value-added services, their online commissions are still three to four times higher than other Web brokers. With their huge off-line expenses (each maintains fully staffed retail operations), it appears impossible for the Big Three to afford further discounts.

Nonetheless, Nomura and Daiwa, with their traditional brand strength, have maintained the top two slots as measured by number of online accounts, with Nomura holding 30.9 percent (in March) and Daiwa 18.2 percent, according to Bloomberg. But this ranking may be misleading since, according to Nikkei NetTrading, many investors have four or five online accounts at different brokers. "Investors are smart. They use a high-quality site such as Daiwa's for research purposes and then do their trading through super discounters like Jet Securities or Get Securities," says Tamura. He estimates that only half of existing accounts are active. The top three online brokers (by retail volume) -- Matsui, DLJdirect SFG Securities (a 50-50 joint venture between DLJdirect in the US and the Sumitomo Financial Group), and Sony-brand Monex -- account for over 50 percent of the total volume of online retail transactions on the TSE. According to ABN Amro Securities Japan, these three actually had March shares of 29.4, 12.6, and 9.8 percent, respectively.

BLOOD FOR BLOOD
Despite the success of the online brokerage industry as a whole, the vicious war has now reached a point where only a handful can expect to survive, industry sources say. "I see our competitors as partners, who work with us to enlarge the pie for online brokers as a whole," says Atsushi Kunishige, president of DLJdirect SFG. But when it comes to sharing that pie, even the seemingly good-natured ex-Sumitomo banker admits with a grin that it's a brutal world out there. "We are already in a state of blood-for-blood war." According to Lehman analyst Li, Japanese brokers are highly dependent on retail customers for their revenues. Retail customers contribute 80 to 90 percent of medium-sized brokers' sales commissions, which account for 40 to 50 percent of their total revenues. "Commissions have already reached the lowest levels. Online brokers can cut the average cost per account only by increasing volume," she says.

Robert Strickland of Tokyo-Mitsubishi TD Waterhouse Securities

MORE DEREGULATION?
The future of Japan's online brokers depends heavily on whether savers will become investors. Japan has huge personal savings -- a total of ¥1,388 trillion in September 2000 according to the Bank of Japan -- but only seven percent of this is invested in equities (compared to about 30 percent in the US). Even with the maturation over the past two years of high-yield postal savings stashed away during the bubble era, there has not been a significant transfer of assets from savings to stocks. The unwillingness of Japanese savers to invest is often attributed to Japan's traditional savings orientation -- Japanese investors are risk averse. But the root of the problem goes much deeper than this simple cultural analysis.

According to regulations concerning the minimum equity unit, an investor cannot buy just one share. Someone wishing to buy into TDK Corporation, for example, must buy at least 100 shares, so they would need a minimum of ¥792,000 to start investing (based on a recent TSE closing price). This has been a big obstacle for individual investors with small initial capital. Preferential taxation on postal savings has also encouraged a high savings rate, while the equity markets' gyrations during the 1990s has not contributed to investor confidence. Since the collapse of the bubble economy, returns on Japanese equities haven't been rewarding; meanwhile, US investors -- until recently -- enjoyed high returns boosted by strong equity markets.

But structural change, while slow, is happening. The possible introduction of a new fixed-contribution annuity system, the equivalent of the US 401(k) system, and other pending deregulatory moves may contribute to an increase in equity investment (see "Veryan Allen's Market Outlook," page 48, May 2001, for a contrasting take). There has been some discussion in the ruling Liberal Democratic Party about introducing measures to support ailing stock prices, such as lowering the minimum equity transaction unit, abolishing the dual taxation on dividends, and lifting restrictions on so-called treasury stocks (stocks bought to be held by the same company that issued them), but so far, not much has happened. A plan to establish an independent government-funded institute to buy up banks' crossholdings (thus freeing their balance sheets from large latent losses) was actively under consideration as of mid-April.

Despite the severe competition, online brokers remain relatively optimistic about the future. Tokyo-Mitsubishi TD Waterhouse Securities COO Robert Strickland says, "We didn't come here to have any fast capture of dominant market share. We anticipated that the market would be over-built. We are patient." The company does not disclose account numbers. "We believe that given opportunities and education, savers will migrate to investors," Strickland says. Société Générale is another overseas entrant in Japan's brave new online trading world. In partnership with electronics manufacturer NEC, the French bank started a new service, SG Online, in February.

Overall, who will survive is an open question, but it seems fair to say the current top three (as ranked by retail transaction volume) online brokers, Matsui, DLJdirect, and Monex, have the best chance based on their solid customer bases. Softbank-backed E*Trade Japan should similarly do well with its strength in the underwriting business (E*Trade says it's getting 300 to 400 new accounts daily). But no matter how the online brokers shake out, there's little doubt that the revolution has started, and individual investors here can anticipate better service, lower costs, increased deregulation, and greater opportunities to make a profit, however modest. Says Monex's president Oki Matsumoto: "I believe that once structural impediments are eliminated, Japan will buy shares."