Blowing Out the Walls ...with a Big Bang

Back to Contents of Issue: January 2000

by Yoko Shibata and Hugh Ashton

Online trading 1
Yoshitaka Kitao

Managing director of Softbank Finance Corporation and head of E*Trade Japan Yoshitaka Kitao told J@pan Inc. contributing editor Yoko Shibata that E*Trade can easily secure 50% market share.

E*Trade Japan was established early last year as a JV between Softbank and U.S. online securities trade giant E*Trade. Since then, a growing number of competitors have entered the fray, and the chances that any one player will dominate appear slim. Further, a survey by Daiwa Research Institute reports that investors typically execute online trades only once or twice per month, with most transactions falling in the ¥50,000 ($485) to ¥1 million ($9,709) range. That means the monthly commissions on 10,000 accounts would come to some ¥100 million ($970,873), so securities companies will have to sign up a considerable number of accounts to remain above the break-even point. E*Trade Japan, however, is backed by Masayoshi Son's Softbank and should be able to trade on the widespread brand recognition of its U.S. partner.

With over 40 companies moving to offer online trading services, do you still think E*Trade Japan can grab the lion's share?
I still think that it can. The Nihon Keizai Shimbun recently announced that Nomura and Daiwa have 80,000 and 70,000 online accounts, respectively. But those numbers include accounts opened by individuals simply to obtain research information, statistics, or market quotes-they don't reflect actual assets under management. Nomura with a 26.3% commission discount and Daiwa with 28% aren't offering significant discounts. Who in the world is going to place online trading orders with such high brokerage fees? We have some 40,000 subscribers at present, I think, and ours are bona fide traders, with ¥110 billion under management-the largest amount among online brokers. This indicates we have a large number of quality customers. With our zero commission rate campaign running from December until February, we're looking to see explosive growth.

Do you foresee any restructuring in the industry?
Online trading imposes significant system development and advertisement expenses. DLJdirect, for example, is running its business with only 27 staff, and because of the low personnel costs can offer ¥1,000 commission fees. But a company employing only 27 people can't cope with increasing orders: Sooner or later they will have to upgrade their infrastructure and hire more people-meaning that they'll have to raise their commission fees. In this respect, E*Trade has a competitive edge, since we already have 260 specialists looking after our front- and back-office systems, including 130 at our call center, and we can still provide competitive discount commission fees. I believe that the number of online brokers will fall to one-third of the current level. Further, if E*Trade started Net-based margin transactions, there'd be a flight of customers from medium and small brokerage houses to E*Trade, choking off their customer base.

It's been rumored that E*Trade is planning a capital increase from the current ¥1.5 billion to ¥3 billion. Why?
The increased cap is required to be able to serve as lead manager for underwriting IPOs-and as such to obtain a larger allocation of potentially hot IPO stocks. In Japan, it has been almost impossible for individual investors to participate in IPOs, as these stocks were offered exclusively to favored institutional investors, quid pro quo for high brokerage commission fees. But E*Trade has already offered IPO shares to our customers-including allocating 40,000 IPO and existing shares by lottery for software developer Being Co. when it registered on the OTC market last October 29. For Net consultant Internet Research Institute's IPO, which listed on Mothers on December 22, we offered 18% of the IPO shares for sale over the Net.

What investment products is E*Trade offering online?
In our first phase, we're offering Japanese equities and Japanese investment trust funds (mutual funds). In the second stage, convertible bonds, U.S. equities, and U.S. mutual funds will be offered, and European equities in the third phase. It will take a year for the system development work to be able to offer all of these. We're making a big push into the Japanese investment trust funds by offering as many as 230 funds from some 20 domestic and foreign fund companies. This is the largest offering in Japan, surpassing even the lineups sold over-the-counter at banks and brokerage houses. E*Trade's website will offer fund ratings from Morningstar Inc., allowing investors to search by rating as well as other criteria. This will let individuals make investment decisions based on their own assessment of risk.

How is your system development going?
Our online trading system is being developed in part by E*Trade U.S., and our back office is being set up by Nomura Securities.

Online trading 2

Oki Matsumoto of Monex

On October 1, 1999, Japan introduced deregulation of trading commissions, meaning brokers were free to set their own prices. A vicious throat-cutting war started, with a positive flood of brokers coming online. Of these 36 (as of early November 1999), some were old hands in Japan, but novices to the online game, and some were entirely new faces. Prices have been dropping dramatically, with flat fees of between ¥2,000 ($19.42) and ¥1,000 ($9.71) being quite common, and some players (e.g., E*Trade Japan) even offering free-of-charge services for a trial to attract and retain customers.

As a result of the commission war, the number of online investors has increased dramatically, in only one month, and at the same time, the number of e-brokerages has ballooned, with 40 currently competing and another 20 waiting in the wings. Nomura Securities, the market leader in this field, as in so many financial activities in Japan, recorded an increase from 60,000 to 80,000 online investors in this period (see chart). Other players, such as Nippon Global, have recorded even bigger gains in percentage terms. If the figures are a reliable guide, commission pricing is the biggest single factor in attracting individual investors.

This runs contrary to the conventional wisdom that Japanese consumers do not buy on price, but rather on quality, but in an age when the fastest-growing sector of the retail industry is in the ultra-discount "100 Yen" stores, maybe it's not too surprising. However, in a later, more mature phase of this market, it is predicted that quality will come to the fore and price alone will be less of a factor in influencing customer decisions.

New faces, new styles of selling
Of the brand-new players, one of the most interesting structures is Monex, a joint venture between one of the world's most instantly recognized brands, Sony, and an in- dividual, Oki Matsumoto, whose knowledge of the industry as a trader and partner at Goldman Sachs brings a valuable skill set to the alliance. With a relatively small staff, and an even smaller management team, Matsumoto prides himself on Monex's agility, being able to make corporate decisions in a matter of minutes, rather than the months that it might take for a larger, traditional Japanese brokerage. In addition, Monex's wide nationwide publicity as a result of the unusual corporate birth (the combination of a large company and an individual is an almost unheard-of combination in Japanese business circles), and the high visibility of the Sony name, has helped attract a large number of new users: 11,000 in the month to the start of November 1999.

Even so, this lack of size is perceived as a problem by some. Not that there's any doubt whatsoever regarding the financial stability and integrity of Monex, but Yoshitaka Kitao, EVP and CFO of Softbank, speaking at Comdex Japan '99, questioned Monex's ability to provide back-office support to its users. He pointed out that E*Trade Japan, in which Softbank holds a 58% stake, will be able to provide telephone and other more personal support, corresponding to the hand-holding traditionally provided to Japanese investors.

The main age group for online subscribers is expected to be males in their 30s and 40s, as these are the traditional Internet users with the money, but of course there will be both computer virgins and investment virgins who will want to use the online services. To help with the computer virgins, DLJdirect SFG proposes to use some of the synergy afforded by Sumitomo facilities (SFG--Sumitomo Financial Group--is one of Japan's most well-known financial organizations). Large branches of Sumitomo Bank may be equipped with computers, and onsite staff can assist would-be day traders to guide their cursors over the screens. Also using the ubiquitous Sumitomo presence, DLJdirect SFG can offer class-based training nationwide to its customer base.

Those new to investment will be assisted by DLJdirect SFG's investment game, whereby investors are provided with a sizable chunk of play money, which must be divided at least ten ways. At the end of the game period, the most successful trader will win a prize of some value (for example, a wireless-capable PDA), with the obvious aim being to have successful virtual traders at some time stop playing with matchsticks and start buying their chips with real money, preferably at DLJdirect SFG.

Why the gold rush?
In the U.S., Japan is traditionally regarded as being slow to "get the Net." While it's true that there are fewer online users than in America (in both absolute and proportional terms), it's also true that there's a lot of personal wealth in Japan. A lot of that wealth is squirreled away in government-run, time-locked postal savings instruments, which are due to mature--and disgorge a flood of anything up to ¥100 trillion onto the market--in the next two years. This, combined with the predicted collapse of the Japanese state pension system and the almost certain adoption of 401(k)-like defined contribution pension plans as a reaction to this, and together with the new corporate accounting standards imposing a declaration of market rather than book value assets, will release money onto the Japanese markets. The current pitiful (less than 1%) bank interest rates remain somewhat less than attractive for investors. Of course, any 401(k)-like pension fund money will not appear in individual accounts, but the Viagra-like effect on the Japanese equities (investment trust) market is likely to be startling, to say the least.

Further, Japan is sometimes characterized as a nation of savers rather than investors, and the caution which is supposedly exercised by the holders of the purse strings (almost invariably the women of the household) will have to be overcome for any online trading scheme to be successful. While characterizing the Japanese financial customer as a cautious saver may have some validity, a quick look around the urban landscape here will quickly reveal long lines waiting for opening time outside the ubiquitous pachinko parlors each morning, where patrons can fritter away endless hours playing on the Japanese equivalent of Vegas's one-armed bandits. Also, consider the vast amounts spent each year on lotteries, and the sums wagered on horse, motorcycle, bicycle and powerboat racing. And that's just the legally tolerated tip of the iceberg. Japan may, in fact, be a nation of compulsive gamblers under a conservative veneer. Given a 24-hour Internet stock service, it's not hard to believe that the Japanese could become a nation of manic day traders, making buy and sell calls with the same fanaticism with which they have embraced tamagotchi virtual pets, Italian cuisine, and portable telephones.

Atsushi Kunishige: opportunity

The last example is not a frivolous one. In Japan there is approximately one portable phone for every three people. Of these 51 million phones, two million are i-mode digital-capable phones operated by NTT's DoCoMo. They're not "telephones" per se, but rather are essentially a slimmed-down Web terminal with voice capability (and at current subscriber growth rates, another two million are likely to be in service by March 2000). There are millions more similar phones belonging to rival carriers, most of which are typically owned by younger people with money. DLJdirect SFG's representative director, Atsushi Kunishige, sees the portable wireless market (Internet phones and PDAs) as a great opportunity for trading and also sees the PHS (Personal Handyphone) system as ultimately being better for data communications.

Other trading houses tend to dismiss this as a gimmick, feeling that the current back-office systems lack the reliability and responsiveness to provide trustworthy customer service given the potential volume generated by such easy access. Added to this derisive attitude is the traditional wish of Japanese service providers (in all fields) to lock their customers into a proprietary solution, making it hard to change providers. Even so, many admit the viability of wireless terminals as a quoting service, even if they are not used for trading. Nonetheless, Daiwa Securi-ties estimates that the implementation of a service that uses this technology effectively could produce savings equivalent to the cost of a branch with up to 20 employees. As competition increases, this kind of cost-cutting calculation may force the hands of other later, possibly reluctant, adopters of this kind of open-technology standard.

Remembering Sony's wide range of interests, including wireless networks, it is tempting to speculate how all this could affect Monex trading. Right now, Matsumoto feels that portable telephones are unsuitable as trading tools, but who's to say what's around the corner as a replacement?

There's gold in them thar hills
With the rapid drop in commission rates, far below the fixed fees previously charged by the large brokerage houses to individual investors, who often unknowingly subsidized the institutional investor, some pundits claim that there could be as many as 1.5 million Japanese online investors by the end of 2000. Offline, these rising figures are also borne out, where the share of trading by individuals for the first half of financial 1999 was up to nearly 30% on the Tokyo, Osaka, and Nagoya Stock Exchanges, the highest it has been for nearly seven years. Another impressive statistic is that the volume of personal investment has expanded by more than four-fold for the first half of 1999, compared with the same period 12 months previously.

Is all this effort worth it? Probably somewhere in the region of 3 million online investors are needed to keep the ship afloat. Literally trillions of yen from personal investors will be surging through the markets in the next twelve months (the exact number of trillions depends on who you talk to). With the reduced commissions, as well as the ease of trading by nontraditional means, it is likely that these personal funds will be turned over more rapidly than in the past. Even with the increased number of brokers, and factoring in lower commissions, at least some of the new online traders stand to recoup their setup costs, and at least some stand to make money. Now add the money that will come from the postal savings accounts and the situation is starting to look like a veritable vein of gold, waiting to be tapped.

Why would these investors go online, though? Monex's Matsumoto feels he has at least part of the answer. Japan's birthrate is declining dramatically (he claims between 20% and 30% over the past 25 years), leading to a drop in the workforce. The government is frantically trying to figure out how to boost workforce numbers in order to maintain current levels of consumer spending-a very large part of Japan's GDP. Short of immigration (traditionally a nonstarter of a solution), the only recourse is to allow more nonworkers into the workplace. In Japan, this means women and older people. The result? There will be fewer people at home to stand in line at post offices and investment houses. The alternative is online financial services, including trading, and the market for such services may truly turn into a wealth-producing goldmine.

But to get the gold, you must stake your claim. Kunishige feels that education is essential to stake out the territory, and DLJdirect SFG will provide a wide range of investor data to every visitor to its site (not just to its account holders) in an attempt to woo visitors and convert them to customers. There will also be training centers, including ones located near rail terminals, such as Tokyo Station.

By contrast, Monex does not intend to hold its customers' hands, relying instead on its small size to be able to react quickly to market demand. Here, Matsumoto's personal experience as a trader shows through, focusing clearly on the needs of his clients, as well as the Sony corporate tradition of producing products that consumers want to buy.

Yet another path is being taken by Softbank and E*Trade Japan, offering a wide range of complementary products and services (loans, banking, insurance) as well as the high brand value of E*Trade (TV advertisements have already started in Japan). Also, many traditional Japanese brokerages are taking the line that low commissions alone may be enough to drive sales. Since, they argue, the majority of their customers will be Internet-illiterate, price will be the driving factor, and bells and whistles can be ignored.

The major players in the traditional fields, such as Nomura, who currently derive a relatively small (30% or so) of their profit from commissions, can still increase their profits if commissions drop by offering value-added services-such as their well-regarded research products-to a larger audience than they have at present. Who's right? Maybe all, maybe one, maybe none. Maybe the recipe for success in the Japanese online trading market has yet to be defined. Time will tell.

Baiting the mousetrap
Of course, many of the online investments will not be Japanese stocks. Money market funds will form a significant part of the portfolios, offering less risk to the neophyte traders. Matsumoto of Monex also makes the point that Japanese investing in U.S. securities, including Nasdaq equities, may attract the unwelcome attentions of the IRS and therefore proposes to offer a hand-picked selection of MMFs. Such points do not weigh very heavily with Kunishige, whose firm's ties with DLJdirect in the States mean that there will be a wide range of products offered by DLJdirect SFG, including Nasdaq and direct investment on the NYSE-this being the first time this latter has been offered as a real-time service by a Japanese company.

The competition for fees from millions of frenetically trading-online Japanese will be terrific. Right now, all the major domestic players are entering the fray. Those without the in-house expertise or resources to set up an online trading system are outsourcing the work to set up the back office, and some odd marriages are being made. Nikko Securities, for example, is linking with Fujitsu to provide an online service known as Nikko Beans, to be offered to other players, as well as being provided via its own online venture with Fujitsu, Internet Trading Securities. Charles Schwab is seeking assistance from Nomura to help set up a Japanese-tailored service, and is also setting up operations with Tokyo Marine and Fire Insurance.

Other, even less likely alliances are emerging. How about Dell, selling computers preconfigured for specific securities houses, and a securities house (Matsui) providing three hours' personal instruction to computer neophytes? Or DLJdirect SFG providing IBM PCs and dedicated trading terminals to its customers? Or computer retail chain Laox offering a trading package developed in con- junction with Daiwa Securities?

If the U.S. model is a guide, it's almost certain that we will see a shakeout with the winner-or a small number of winners-taking all. But where the Internet is concerned, it often happens that U.S. models are not applicable to Japan, usually for subtle and trivial-sounding reasons, which elude analysts. One such reason might be caution. Japanese like to see themselves as "different." Whatever the truth of this, the fact remains that different financial habits do exist in Japan. One elderly married lady I knew kept money in some ten different bank accounts, the existence and contents of which were unknown to her husband until after her death. It's improbable that this could happen outside Asia.

Another technological-based example of how the market might develop differently is the widespread use of mobile Internet terminals (disguised as cellular phones). Despite current skepticism, the sheer potential volume of trading on these devices, on a minute-by-minute basis if necessary (if the front end is made simple enough), could have a severe impact on the way that equity markets behave, and thereby on the brokerage houses themselves.

One thing is certain, though-the individual Japanese investor now has more choice of how and where his or her money goes. Encouraging average Japanese investors to take responsibility for their financial decisions will go a long way to ending the dependence on "authority" in its various forms, which has held back Japanese society in so many areas. In this sense, the coming of online investment to Japan is a Good Thing, not only for the brokers but for Japanese society as a whole.

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