BOJ’s ETF Position Risks Becoming Too Big to Exit, Lawmaker Says

Japan Vice Finance Minister Tsutomu Okubo Interview

Tsutomu Okubo.

Photographer: Kiyoshi Ota/Bloomberg
  • Kuroda must stop 3.3 trillion yen annual purchases, Okubo says
  • Central bank owns more than half of nation’s entire ETF market

The Bank of Japan must drastically lower its presence in the nation’s stock market if it wants to preserve the ability to one day unwind its massive position, according to the Democratic Party’s Tsutomu Okubo, a former vice finance minister.

The opposition lawmaker and former derivatives trader said that to manage liquidity and avoid large price distortions, the central bank must stop its 3.3 trillion yen ($30 billion) in annual ETF buying and lower its ownership of the funds it buys to between 20 and 30 percent. That figure stood at 63 percent at the end of March, according to documents the BOJ provided him and which he shared with Bloomberg.

“As with any investment, you must always think about the exit,” Okubo said in an interview on May 12. “But there’s no exit when you own half of the market.”

His views come as more than half of economists surveyed by Bloomberg last month forecast the central bank will instead increase ETF purchases by November, with some expecting such a move as soon as next month. Investors increasingly see more ETF buying as one of the few policy options left for BOJ Governor Haruhiko Kuroda, who has largely exhausted bond purchases and received mixed results with his negative-interest-rate policy.

Okubo didn’t say the BOJ must sell its existing ETFs to lower its ownership to his target. Instead, he said the central bank should stop buying, which would then lower its presence over time as the rest of ETF market continues to grow. Increasing purchases would only increase the risk that the BOJ would be unable to sell when the time came, he said.

"Owning 63 percent means when it’s time to exit, selling such huge amounts would result in ETFs diverging from their theoretical prices,” said Okubo, who worked at Morgan Stanley for a decade before becoming a lawmaker in 2004. “That would raise questions about how much capital brokerages have to absorb the tracking error of their ETF positions.”

Not everyone agrees with his view, including some investors who say it’s too early to discuss unwinding the BOJ’s purchases when inflation is still far from Kuroda’s target. Others point out that unlike bonds, equities don’t mature, allowing the central bank to own them indefinitely or dispose of them very slowly.

No Limit

“With equities, there’s no limit to how long you’re allowed to hold them,” said Nicholas Smith, a strategist at CLSA Ltd. in Tokyo. “I don’t think anyone is terribly happy at the current situation, but I don’t think an exit is anywhere near the top of people’s list of worries.”

Some market participants also point to Hong Kong, which at the height of the Asian financial crisis in 1998 bought HK$118 billion ($15.2 billion) of Hong Kong-listed shares. It later pooled its holdings into an ETF-like security and disposed of it through a listing on the secondary market. The U.S. government spent $245 billion to prop up financial firms during the global financial crisis in 2008 and sold the stakes back to the companies or listed them on the secondary market, earning a profit for taxpayers.

A key difference Japan faces is that the BOJ does not own stakes in underlying companies, which rules out options such as selling the shares directly back to the companies or listing them on an exchange.

Kuroda has repeatedly said that any talk of an exit strategy was premature and has denied that the BOJ’s buying was distorting the stock market. At an estimated 8.6 trillion yen as of March, its holdings amount to about 1.6 percent of the total capitalization of all companies listed in Japan. Its reliance on the Nikkei 225 Stock Average means its positions are concentrated in companies that have an outsized weight in the index.

Kuroda Rules

Kuroda mandated ETF companies must create products which would allow the central bank to buy firms making large investments in “physical and human capital” or research and development. Two such ETFs began trading on the Tokyo Stock Exchange from Thursday.

The documents shared by Okubo also showed that the central bank owned 56 percent of the nation’s entire ETF market at the end of March, slightly higher than the 55 percent estimated by Bloomberg last month. Bloomberg’s estimates for April show the BOJ’s ownership rose to 58 percent, a record. Okubo said he met with officials from the BOJ and Financial Services Agency and plans to make his case at parliamentary hearings on banking laws later this month.

Besides the dangers of an exit, he said even at current levels the BOJ’s ETF buying is already distorting the core mechanism of capital markets and diluting the nation’s efforts to improve corporate efficiency.

When a stock falls, it’s a signal as company management becomes sensitive to such a move and “and in response they may undertake new strategies or perform necessary, painful restructuring. But right now the downside is limited,” said Okubo. “The market is losing discipline.”

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