Japan Opens Door to Competition

Terry Flanagan

Japan’s public equity markets are opening themselves up to the worldwide trading community, spurred by competitive forces and regulatory change.

Chief among these are the new Japan Exchange Group, the entity formed by the merger of the Tokyo and Osaka stock exchanges, and the advent of proprietary trading systems such as Chi-X Japan and SBI Japannext.

The PTSs in Japan scored a major coup in 2012, receiving an exemption from the country’s regulator, the Financial Services Agency, from the takeover bid (TOB) rule.

The TOB rule requires investors who approach a five per cent stake in a company’s outstanding shares to launch a tender offer if they are trading off-exchange, causing many participants to have concerns for inadvertently breaching the rule when trading on a proprietary trading system (PTS), as alternative trading venues are known in Japan.

The Tokyo-Osaka merger provided the impetus for regulators to increase competition. By exempting Japan’s two PTSs—Chi-X Japan and SBI Japannext—from the TOB rule, the FSA is supporting market fragmentation and more foreign order flow to be directed into the PTSs.

“Japan’s market has yet to experience “big bang” structural reforms on par with the European and North American markets and the accompanying across-the-board tsunami of technological innovation,” said Celent senior analyst Eiichiro Yanagawa, in a report. “At the same time, deregulation of PTS) operators and margin trading have rippled through the market and will significantly impact the new Japan Exchange and Japan’s capital markets.”

By consolidating the nation’s two biggest exchanges, JPX helps create a more level playing field by enabling innovations, such as the move to smaller tick sizes.

JPX intends to let stock prices move in the smallest tick size of JPY 0.1, a tenth of the current level, bringing the trading environment in Japan closer to the international norm. JPX plans to fully implement the change in mid-2015 after launching a pilot program involving 100 or so stocks in 2014.

Atsushi Saito, CEO of the JPX, said at a press conference in March that the current tick size of JPY 1 is ”too large even, for example, for the stock price of JPY 100 or lower.”

PTS venues like Chi-X Japan and SBI Japannext have always supported smaller, decimal tick sizes, as this enables their customers to get a better deal by trading inside the spread of the primary exchange, and will benefit from the TSE’s move to decimalization, according to Steve Grob, director of group strategy at Fidessa.

Outside of Japan, tick sizes have never been a competitive differentiator because they are either standard or follow a schedule agreed by all venues, he said in a blog posting.

Therefore, alternative venues have had to find other ways to compete, either in their fee model, the customers they serve or the liquidity they provide. What’s more, a wholesale move to decimalization in Japan will widen the universe of potential participants they can address, said Grob.

Instead, the future success of the PTS venues will hinge on their ability to differentiate in other ways.

“This month, for example, SBI began experimenting with a VWAP cross venue, filling a potential gap in the market with the move of JapanCrossing from Instinet into Nomura,” Grob said. “Brokers with VWAP guaranteed positions against their clients can hedge their positions using such a venue, so this could be a strong competitive advantage for them. Going forwards, both PTS venues will clearly be looking at all parts of the execution jigsaw and TSE monopolies, and how this plays out will be key to their survival.”

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