Notes of Regular Briefing by Mr.Atsushi Saito, President & CEO, Tokyo Stock Exchange Group, Inc., on February 22 nd, 2011 1. Expansion of Trading Hours 2. Operational Status of "arrowhead" and Launch of TSE High-Speed Index Service 3. TSE to List Landmark 100 th ETF 1. Expansion of Trading Hours I would like to report first on the expansion of trading hours. The revision to the rules related to the expansion of trading hours was approved at the board of directors meeting on February 22, 2011, and the official implementation date was also decided. Specifically, TSE will move the current closing time of the morning session down from 11:00 am to 11:30 am for the cash market. With regard to the derivatives market, TSE will also move down the closing time of the morning session for TOPIX futures and options trading by 30 minutes so that they coincide with that of the cash market. At the same time, TSE will move up the opening time of the afternoon session from 0:30 pm to 11:45 am. So, the noon recess is 15 minutes. TSE will begin trading in line with the new trading hours on May 9, 2011 after Golden Week (from April 29 through May 5, a period straddling four public holidays). TSE will make partial revisions to the trading rules in connection with the migration of futures trading to Tdex+ in October 2011.Therefore, please note that we may further expand the trading hours in line with such revisions in the future. From the perspective of expanding trading opportunities, TSE will continue to discuss the expansion of trading 1
hours to promptly respond to changes in the environment and business practices surrounding the capital market. 2. Operational Status of "arrowhead" and Launch of TSE High-Speed Index Service A year and two months have passed since the launch of arrowhead without any serious trouble, as you may already know from the news. In the meantime, we have observed a significant effect on the market structure. Simply put, HFT and algorithmic trading account for more than 30% of all the transactions almost everyday. As a result, spreads between bids and offers have been reduced by around 20 to 30%, compared with the period before the arrowhead launch. This means that investors, even those not using HFT, benefit from increased liquidity, with even more correct price formation. As I mentioned before, TSE ranks first or second in terms of providing low execution costs which reflect brokerage commission, market impact when placing orders, any skew, and clearing costs, according to a US company which mathematically provides the execution cost for markets. In Hong Kong, trading costs are quite high due to the stamp duty. In Singapore, clearing fees are very high. Taking this into consideration, TSE is highly rated by professionals and specialty journals for its low execution costs and quality as an exchange. Last year, TSE launched the Co-Location Service and Proximity Service to further improve convenience for trading participants. In addition to these services, TSE introduced IOC orders (Immediate or Cancel Order) on January 24, 2011. 2
Additionally, TSE will launch the "TSE High-Speed Index-Service" as part of its efforts to improve market efficiency and services. TSE will also calculate and distribute the "best quote indexes" which are calculated based on the best quotes for each individual TOPIX constituent on a real time basis from Monday, February 28. Currently, TOPIX is calculated and distributed every second, which has already been on a global level. However, TSE will further accelerate the speed to 10 milliseconds or less from the next week. Previously, investors who were able to conduct algorithmic trading with TOPIX would generally be limited to those who were able to calculate TOPIX on their own at ultrahigh speed. However, the TSE High-Speed Index Service will expand the base of investors who are able to participate in HFT or high speed trading, thus further improving market efficiency. In the "best quote indexes", the cash amount needed for purchase or the sales proceeds of all the TOPIX constituents are calculated at any time based on quotes, not executed prices like TOPIX. As such, TSE will be able to provide indices which reflect real market conditions. Such indices which include the quotes of all the issues are rare in the world. It is a unique service in the sense that it is calculated by TSE which has its own index. By using the indices, tracking errors are expected to be reduced significantly for passive investment with TOPIX, so that pension funds, ETF managers, hedge funds, and other institutional investors improve their investment efficiency. TSE believes this service will also be highly rated by those in the industry, with its contribution to the improvement of market quality. For more information: http://www.tse.or.jp/english/news/30/110222_a.html 3
3. TSE to List Landmark 100 th ETF TSE publicized the listing of "Listed Index Fund Nikkei China Related 50" on February 21, 2011. With this listing, TSE will list the landmark 100 th ETF, thus attaining the goal of 100 listed ETFs by the end of fiscal year 2010. I am very pleased that our exchange has fulfilled its commitment to the listing of 100 ETFs, as laid out in the Medium-Term Management Plan. Three years ago, when I took the position of CEO of our exchange, there were only 12 listed ETFs and such ETFs were limited to those tracking the movements of domestic stock indices including TOPIX and NIKKEI 225. As you may be aware, now, TSE lists ETFs tracking the movements of almost all major overseas stock indices. The number of ETFs to be listed on TSE will continue to increase. As I mentioned in the previous regular briefing, SPDR Gold Shares created by SSGA in Boston are listed on the Hong Kong, Singapore, and Tokyo markets. However, the trading volume at TSE largely surpasses that at the other two exchanges. Additionally, TSE has also seen a significant increase in the trading volume of a gold ETF created by Japan s trust bank, which is fungible with gold itself by the gram. With the trading volume of these ETFs combined, it is clear that a significant amount of gold is actively traded on TSE. In addition to ETFs on precious metals, TSE lists ETFs backed by a variety of assets such as commodities including wheat, as is influenced by the recent news of rising prices, real estate including overseas and domestic REITs, and bonds. As such, almost all asset classes in the world are accessible for investors in Japan. Furthermore, investors are able to invest in these ETFs under trading rules and taxation same as those applying to the trading of Japanese stocks. I am sure the general investors would appreciate and value the benefit even more as they understand these advantages of ETFs. 4
Since last year, the whole world has focused on gold as a safe asset in case of emergency, rare earth resources, a sharp rise in grain markets due to abnormal weather conditions all over the world and expanding demands of emerging countries, an impact on crude oil markets attributed to riots in Egypt, booming commodity markets due to the inflow of funds following the quantitative easing of developed countries. These recent events, which have gained wide attention, clearly have an impact on the net asset balance and trading value of commodity ETFs listed on TSE. Previously, it was hard for general investors to invest in commodities, but these investors are now able to gain investment opportunities through commodity ETFs. However, 1200 ETFs are listed on NYSE, and 1300 on LSE. With just 100 listed ETFs, TSE finally ranks seventh or eighth in terms of number of listings. The ETF trading volume once reached the level of Mothers, but Mothers trading volume has increased to JPY 28 to 30 billion. Compared with this, ETF trading volume is roughly JPY 10 billion with a net asset balance of JPY 1.7 trillion. Given all that, TSE will have to redouble its efforts to increase the number and trading volume of listed ETFs. For more information: http://www.tse.or.jp/english/news/08/110221_a.html Q&A Q: I have two questions. As you mentioned earlier, we have seen unstable political situations in Middle East and North Africa, and it has had an impact on stock and crude oil markets. In particular, amid the rising tensions in Libya today, NIKKEI 225 dropped by JPY 200. My first question is, what impact will a series of unstable world affairs have on the stock market? 5
A: My source of information on Libya is limited to newspapers, so allow me just to give some comments from a market perspective. I think an excessive part of free market economy caused a crisis., We have observed, for the past 2-3 years, the rise of controlled state capitalism as a competitor against the free market economy, where the investment and ownership of assets is in the realm of the national government, while business practices take on the way of capitalism. Such controlled state capitalism has received some level of admiration. However, my impression is that the fundamental issue has surfaced earlier than I expected. State capitalism looks efficient superficially, maintaining some feature of market capitalism and democratic economy, resilient against hard shocks with its fast decision making. Some even admired its superiority over the market economy. However, as has been pointed out in the past, the fundamental issue in any system lies in the approach and solution for rooting out corruption and narrowing the income gap. After all, with the burst of these issues, any country with a dictatorship is rather in a state of confusion. Observing such situation, I feel such an economic model will have difficulty sustaining itself. The other issue is that we cannot avoid the impact on oil prices as all of these events are located near oil producing countries. In particular, the state systems of Bahrain and Egypt, which are the centers of the US's Middle East policies, are shaking. As these are countries with the US Navy and Air Force bases, I think that will make markets quite nervous and geopolitically unstable. This may not be directly related to your question, but I would like to refer to a negative comment about JGB from a rating agency today. As almost all countries issue quite a huge amount of government bonds, most countries, such as the US and Japan, have adopted a zero-short-term-interest-rate policy. However, long-term interest rates, which are called the 6
market interest rates, are shooting up and the yield curve is also rising sharply. This means we have a sign of inflation in addition to the geopolitical instability. As you can see, commodity prices including oil and agricultural products are going up due to the geopolitical instability and abnormal weather conditions. If interest rates also rise, I think securities markets around the globe will face quite a difficult situation. Q: Moving on to the other question. An increasing number of listed companies including GENTOSHA INC. and other well-known companies have chosen delisting through MBO. I believe an important social mission of stock exchanges is to promote listing to assist the growth of the capital market. In fact, however, some listed companies say that listing fees are high and they do not benefit from being listed on TSE, which result in an increasing number of companies choosing voluntary delisting. What do you think about this as the top of TSE? A: Simply put, I think it is regrettable. As MBO is legal, decided by corporate managers and effected through the markets, I am not in a position to comment on or criticize MBO itself. Our roles are to check that the company adequately explains reasons for conducting MBO to its investors, that there is no misconduct in the process, or as it is often pointed out, that the pricing is fair. I looked into 17 companies which have conducted MBO since 2009 and I found that only two companies' repurchase prices were higher than their IPO prices. Out of the two companies, one was operated by young and aspiring managers. I was impressed and looked forward the future prospects of the company, but they actually owned 40% of all the company's shares by themselves. I can not understand their reasons behind this. Listing is also called "going public". This means handing shares privately owned by 7
managers and related-parties to the public. I can still understand those managers who continue to hold 30% ownership even after the listing, but some managers own 40% to 50% or more of the company's shares and would not let them go. I would feel very uncomfortable if such managers choose delisting just because the stock prices fell to the half of IPO prices and they are annoyed by the voice of shareholders, after selling out their stocks to the public at high prices, increasing capital after the listing thus absorbing risk money from investors. In my view, such acts ridicule investors. At the same time, it may damage the credibility and quality of the capital finance system, which is the foundation of capitalism. If you borrow money from a bank, the bank will strictly check your financial positions. In this process, you have to adequately explain the necessary matters to the bank and repay all the money you borrowed. If you invest in equities, the principal is not guaranteed. Listed companies do business using that risk money from investors. Listed companies should adequately explain how the money is used to their investors, however troublesome and bothering it may be. If companies feel it is troublesome and they choose delisting, the capital market of this country will not work. As I mentioned earlier, I cannot deny MBO itself. It is legal, and some companies may take advantage of the system. However, some listed companies have recently ceased to be listed just because they feel the explanation to investors is troublesome or burdensome. Personally, I think these companies lack appreciation of the investors who invest risk money in their businesses. This may be a little bit emotional, but I do not feel comfortable with these companies. This is my comment on your second question. Q: In a merger implementation agreement, SGX offered about ASD 8.35 billion to ASX, which is equal to about 18 times the EBITA of ASX. On the other hand, Deutsche Borse 8
offered an amount, which is equal to about 8.3 times the EBITA of NYSE Euronext. Compared with these amounts, I feel the amount offered by SGX to ASX is a little bit higher than that offered by Deutsche Borse to NYSE Euronext. What do you think about this as a shareholder of SGX? A: It is said that SGX is paying an abnormally high premium to ASX. I remember that the spread was 19% initially, but ASX shares have been bought up and the spread has decreased to 12%. Perhaps, SGX has concluded that it would not be able to acquire ASX without such a huge premium. As you all know, Singapore imposes a cap on foreign ownership. This is the reason why TSE owns only a 4.9% stake of SGX. This time, however, SGX is trying to purchase 100% of ASX shares. SGX will also have to gain approval from Australian Parliament, which it will not give according to popular expectations, so my interpretation is that SGX judged that it would not be able to acquire ASX without a huge premium. I think the valuation of the merger agreement between Deutsche Borse and NYSE Euronext is very reasonable and logical from a financial and accounting perspective. Q: What do you think as a shareholder of SGX? A: We cannot be happy because we have to bear dilution of share ownership. I often talk with people at SGX, and they said the other day they would make efforts for raising its value and avoiding an appraisal loss for TSE due to dilution. They also said they would not change the high 90% dividend ratio. Therefore, we will remain patient regarding this matter. 9
Q: As described earlier, TSE has officially decided to expand trading hours from May 9. You commented that TSE will continue to make efforts to increase trading opportunities for investors. What is your view on further expansion of trading hours and the launch of the night session for cash trading? A: TSE had careful discussions and one-to-one consultations with almost all trading participants regardless of their business scale before we reached the conclusion. In the Japanese practices, it is impossible to completely abolish Ita, or the commonly used order book in Japan. Some trading participants make profits with this familiar order book and related rules such as Itayose, or the opening and closing sessions in our markets. If we focus on efficiency only, it would be better to abolish and replace Ita all at once, but efficiency is not the only thing TSE pursues. Furthermore, it is still widely used and accepted for at least cash trading. In addition, TSE provides ToSTNeT trading. Trading participants and investors can easily use ToSTNeT while stock prices stop fluctuating. Large securities companies wished to continue to use ToSTNeT. ToSTNeT is best used when stock prices are not moving, and so the voice for keeping the noon recess turned out to originate from Japanese investors. TSE met these requests from related-parties and this time we went no further than expanding the trading hours. We will see how it works for cash trading at this moment. On the other hand, however, I believe derivatives are products that can be traded around the clock all over the world. I m not sure whether a 15-minute noon recess is what market participants need exactly, but depending on the reception, TSE will consider abolishing the noon recess or expanding the trading hours of the night session. Though I m not able to clarify anything at this stage, TSE may consider the trading hours of the night session around October 2011. 10
One thing I want you to understand is that I think the cash and futures markets should basically be balanced and well integrated. Futures/derivatives were initially developed to hedge cash trading, as was advocated by the original group of people who developed these. We can use the phrase highly liquid even it is driven with speculative trading only in derivative markets, but I think the cash and futures markets have been, though not completely, well-balanced in the true sense of finance or in terms of society. CME is the central market for derivatives. In derivatives trading, investors trade indices as it is hard for investors to make a delivery for grains, animals, pork, wheat, barley, and corn. I have some resistance to trading of indices while delivery is not made at all. Having said that, index futures are actively traded all over the world. Therefore, TSE may have to make serious considerations for the derivative markets, rather than indulge in theoretical daydreaming. Q: Some people commented that the trading volume will increase by 6% due to the expansion of trading hours. Currently, TSE's trading volume has been decreasing for the three consecutive years. What do you think about the comment? A: I doubt it. I believe that a 1- to 2-% increase in the dividend payout ratio or ROE of Japanese stocks will increase the trading volume rather than expanding trading hours. Remember that TSE boasted the world highest trading volume when we took a one and a half to two hour noon recess. The trading volume increased because stock prices rose significantly. When stock prices rise more and more, investors buy stocks from around the world. However, once a market loses its appeal, no one buys stocks in the market. The expansion of trading hours may slightly increase the trading volume, but I don't think this will resolve the fundamental issues. 11
Many parties are currently discussing various issues including Japanese taxation, the introduction of IFRS and independent officers/auditors. I believe that the situation will dramatically change and trading volume will increase if these issues are resolved all at once, particularly if all Japanese people speak English, and investors and regulators allow English like Singapore and Hong Kong,. Discussing the expansion of trading hours is also important, but I think we have to discuss and solve more fundamental issues. Q: I understand, so you mean it has no effect on the trading volume although TSE has decided to expand the trading hours by 30 minutes. A: I didn't say it has no effect. I think it has some effect on the trading volume, but it is difficult to measure such effect. For instance, is this order placed because the trading hours were expanded? The order might have been placed during another trading session if we did not expand the trading hours. If we clearly find that the trading volume significantly increases, abolishing the noon recess may be a good idea. TSE is always prepared to respond flexibly. Q: How much of a premium should SGX pay to acquire ASX? To what extent does TSE think it reasonable as a SGX shareholder? A: Paying too much of a premium ends up decreasing the stock price of SGX. As we are an SGX shareholder, we feel that the current premium level is a little bit high. We won t be satisfied with the dilution if the level is raised further. In fact, the Singaporean government owns around one quarter of all SGX shares. The media 12
reported that the government stake will be diluted to 13% due to the merger. Considering this, and as the government is also an interested party, I think SGX cannot pay an excessively high premium to ASX. In the long run, whether it is high or not depends on the balance between the profits generated by the new company and the paid premium. If the new company does not turn a significant profit, the stock price will go down immediately, and this will be counterproductive to them. As such, we don't agree with paying such an excessively high premium. Q: Related to the MBO issue, will TSE take any measures to reduce listed companies' listing fees and clerical work? A: Before we decide to take any measures, there are various costs related to listing including costs paid to TSE, accounting firms, and lawyers. We will consider taking some measures if it decreases the number of MBO, but in the first place, we need to do some research on the kinds of costs they are indicating. Q: Related to the Libya issue, the stock market dropped sharply today. You have already commented on crude oil prices earlier, but could you elaborate on your concern on its impact on the stock market? A: At first glance, Asian stock markets also dropped significantly, and Libya, which is one of the most autocratic countries in the world, is in turmoil. The crude oil price will still stand at around 100 dollars per barrel, and I feel a bit nervous as during the oil crises in the 1970s, the oil price jumped from 3 to 4 dollars to several multiples of that. Taking this into consideration, I am a little bit concerned that the oil price will shoot up in the future. 13
Every country's economy has yet to recover and each country is taking various measures to prop up its economy. Under these circumstances, if raw material costs rise further and they are reflected in prices as a result of the rise in consumer and production price, people will face more difficulty in making a living. So, to be honest, I am quite concerned about rising oil prices. Q: Are you concerned about the impact on Japanese economy? How is your view? A: Of course, I am concerned about the impact on Japanese economy. However, Japan ranks first in efficiency in the use of oil. Suppose it costs 100 yen of oil to manufacture a product in Japan. It would cost 210 yen in the US and 800 yen in China. This means Japan has 8 times the efficiency in the use of oil, compared with China. So, when the oil price actually rises, it would have the least impact on Japan in the world. Therefore, Japan would not lose its competitiveness. Q: What do you think about recent movements in Nagata-cho, or Japanese politics? Yesterday, Mr Yonekura, the Chairman of Nippon Keidanren, criticized that lawmakers of the ruling and opposition parties are all goldbrickers and tax snatchers. What do you think about his comment? In addition, what is required to reform Nagata-cho and Japanese politics? A: First of all, I would like them to study more about the capital market. Previously, some foreign media reported that Mr. Kan was the greatest reformer of recent prime ministers. They also said if Mr Kan carries out TPP, he will have realized something that the previous prime ministers could not do. I think TPP should be done to help Japanese agriculture. Everyone inevitably tends to 14
short-term gains. Let us suppose, for example, we try to introduce IFRS as it promotes M&A among companies and benefits them from a long-term perspective. However, some people oppose the introduction, saying it is not tax deductible in some cases and IFRS will not work in Japan. Compared to this example, I feel many politicians are more concerned with getting one vote for the next election rather than the situations surrounding Japan and our children 10 or 15 years later. It is regrettable as I believe Japan would be able to become a great country with just a small reform. I believed that we have a lot of chances. Let me use Korea as an example. I don't think the methods the Korean government employs are the best. Japan's population is twice that of Korea and Japanese still enjoy higher life standards than Koreans. However, Koreans have a clearer vision about investment than Japanese. They invest in education. As I mentioned earlier, junior high and high school students in Korea learn science and engineering in English. China starts English education from primary school. In Japan, when the government planned to start English education from primary school, some people said that there is more important thing to learn for primary school students and the plan was scrapped. To tell you the truth, I hope some leader puts it into action decisively, but in fact, things do not go that easily and continue to flip flop repeatedly anytime the opposing voices are raised. For overseas investors, it looks that Japan doesn't know where to go and, unless we stop this repetition, they avoid investing risk money in the Japanese market. Let's take rights issues as an example. The reason why many European pension funds do not invest in Japanese stocks lies in dilution. They say "related-parties in Japan should develop rules and frameworks for rights issue, and we will return to Japanese stocks". 15
The Financial Services Agency responded to this quite quickly, but to my regret, parties related to the Companies Act didn't. This situation has been repeated in Japan for a long time. In this way, Japanese people as a whole just avoid reforms. However, if we just repeat this, it will result in weakening our competitiveness and increasing tax, thus burdening ourselves with even higher costs. I think what is required for us is to understand this mechanism and pursue long-term gains, for 5 years to 10 years, even though sacrificing our short-term gains. Q: You said politicians should study more. Could you elaborate on that? A: I would like them to study market functions and global trends. When the LDP took the helm of the government, we were often invited to their study meetings and asked about the market conditions at that time. But today, we are hardly invited to such meetings. I don't know what DPJ lawmakers think about the market, but without the capital market, there would have been no prosperity in China and the US. I believe that lawmakers should understand market functions when they carry out politics. Otherwise, their overall policies will be imbalanced. 16