Sean Lawrence is CEO of ABN AM RO Clearing Tokyo, Co. , Ltd. He has worked in Asia since 1997, most of the time in Japan but also in Singapore, Hong Kong and partly in the UK. ABN AMRO Clearing specializes in high frequency, high volume, straight through processing clearing for market makers and proprietary trading firms and ranks #1 by clearing volume on many global exchanges. Sean is also a Director on the Board of FIA Japan and the Chairman of the Market Operations Committee. FIAJ: What growth do you foresee in the Japanese financial markets? ABN AMRO Clearing is the largest volume clearer and creator of ETFs in Japan, and we see growth of ETFs as a major development for the next few years. You may recall that ETFs have only been active for 2 or 3 years since the issuers began providing more accurate underlying data in digital form, and asset managers began adopting common procedures and protocols to allow for easier processing of creation/redemption. We very much welcomed both of these ‘market reforms’.
However, ETFs still only occupy a 5% market share of traded volume of equities in Japan, which we think could grow much more. Particularly if the institutional buy side (Japanese asset managers) were to enter the market, they might be a more active user of ETFs which can be ‘tailored’ to their individual risk appetite requirements.
Plus we anticipate some organic growth in JGB and Topix derivatives, since they have migrated to the OSE, because of the simple fact that the marginal cost to trade JGB and Topix derivatives has fallen so much. For investors of OSE Nikkei, it is almost ‘zero cost’ to add the JGB and Topix contract to trading engines and so you should see more investors enter JGBs and Topix as a result. FIAJ: Do you see any limitations to growth? There are a lot of problems within our industry that we are not focusing on. Problems that will limit growth and we should be addressing them.
When we compare the prices charged by US and European brokers equivalent to 1 jpy per lot, we see that prices charged by brokers in Japan are unreasonably high. Why is that? The reason is due to inefficient and outdated practices in the Japanese financial market. Some broker firms use old systems and services, and pay for those on a ‘per transaction’ basis, rather than on the basis of single annual license cost. This matters because if software and services are purchased instead on a ‘ license’ basis, then an economy of scale with a self reinforcing motivation is created (i.e: the more volume generated, the cheaper the cost per trade. And then the cheaper the cost per trade, the more volume is created. And so on). Some broker firms are unwilling to change for a variety of reasons. Partly because they cannot afford to reinvest since volume has been low for so long and partly because they have not invested in technology in the past, and so they don’t have the skill set and experience to do so. But also because the whole industry suffers from the problem of inertia.
Take for example the problem of pricing by the Central Clearing Parties and Depositories. They have arcane and incredibly complex pricing schedules. Investors cannot understand these pricing schedules and have long complained to change them; CCPs and Depositories should simplify their pricing to make it understandable and cheaper to code/process. This would facilitate growth and lower cost per trade. But the CCPs and Depositories won’ t change because some broker firms have old systems and can’t afford to upgrade to a new scheme.
Another structural inefficiency in the market is the different clearing processes for different assets underlying within the same asset class. For example, taking only the securities law (for which there is a common law), there are large differences in process and practice between clearing JGB securities at JGBCC and clearing equity securities at JSCC. Or processing derivatives at TFX compared to equity derivatives as JSCC, and also (separately again) fixed income derivatives at JSCC. Also, very large differences between clearing ‘ on exchange’ equity securities at JSCC and ‘ OTC’ equity securities at JASDEC [Japan Securities Depository Center].
These examples demonstrate the inefficiency and high cost which is a barrier to creating economies of scale that the Japanese financial market needs to grow. The current situation does not allow a marginally decreasing cost to trade that investors require. FIAJ: What improvements to the market should be made? Take the good example of exchange execution pricing. Generally, exchanges have adopted either simple per unit pricing (e.g. yen per lot) or even better, progressive pricing where the price gets cheaper if more volume is transacted. Whilst these schemes still have some complexity, they demonstrate a pricing model which facilitates growth. I think many participants in the Japanese financial market should consider similar changes. Additionally, I think there are still many ‘barriers to entry’ which make it harder to attract new investors and the list is well known: the Permanent Establishment tax liability question, the absence of meaningful bust rules, the inefficient market for goods and services in technology, the absence of meaningful ‘remote membership’ scheme in Japan. Plus of course the ‘silo’ between securities and commodities remains in a practical sense. This is another demonstration of the structural inefficiency that exists in the Japanese financial market. Consider for example a commodity broker that wishes to diversify into securities. Whilst the law now theoretically allows the broker to diversify into securities, the broker still has to reinvest in separate systems, another guarantee deposit fund, another compliance officer, etc, etc, in order to clear securities. The ‘barriers to entry’ would be far lower if commodity derivatives and securities derivatives were cleared with the same rules, process and practice at the same single CCP. Such an arrangement would provide a lower marginal cost for the broker who wanted to diversify, and would promote growth by allowing more brokers to offer more products.
Lastly I would like to think that there are two noticeable absences in the Japanese financial market:
Firstly the absence of the large brokers in Japan in the discussion of growth strategy for the industry. It seems like all the initiatives are coming from the FSA, who is a regulator. This situation is like JP Morgan or Goldman Sachs not being present in debates on the growth strategy of the US financial market. The large brokers need to be more visible and active in the discussion of growth strategy.
Second is the absence of the Japanese institutional asset managers in the revival of the Japanese financial markets. Whilst the government is making a huge effort to kick start the economy and support the development of the capital markets, the institutional asset managers are not participating in investing Japanese money into Japanese companies. Japanese institu- tional asset managers need to be more active in investing in the future of Japanese Companies.