Are Tokyo's Giant Traders Strong Arming U.S. Rivals?

Like bourses around the globe, the Tokyo Stock Exchange went on a wild buying spree on Jan. 17, as the U. S. launched its war on Iraq. But the Tokyo action ended with a surprise twist. Just before the close, Morgan Stanley & Co. hit the floor with a 3 million-share program trade, which helped push the Nikkei stock average up 161 points in the final hour.

The big buy was the latest evidence yet that Wall Street's brash, high-tech traders are making an indelible mark on Tokyo's tightly knit financial markets. They are also making a bundle, while the Japanese, who depend on brokerage commissions for much of their income, are looking at sagging profits in their depressed market. Most important, the foreigners are using their skills at trading futures, options, and other innovative "derivative" instruments to win major corporate-finance clients away from Tokyo's big four securities houses--Nomura, Daiwa, Nikko, and Yamaichi--which still control most Japanese trading and underwriting.

Fearful of losing their control, the big four aren't sitting idly by as Wall Street moves in. They are complaining loudly, for example, that U. S.-style program trading is a principal cause of their malaise. Many U. S. securities executives charge that the Japanese are leaning hard on longtime clients to discourage them from giving underwriting business to U. S. brokers. And the Japanese are seeking to limit further Wall Street inroads until they can develop trading skills of their own. An American executive with a major Japanese bank insists that "there isn't a lack of long-term commitment to opening up the market." But, he adds, even as Japanese brokers and banks build up futures- and options-trading expertise in New York, "they are saying 'slow down' " in Tokyo.

So far, the go-slow campaign seems to be more bluster than outright financial conflict. But it is raising some hackles in Washington, which is growing impatient with Japan over its limited contribution to the gulf war effort. In December, for example, the Bush Administration charged that the Japanese still deny foreign brokers and banks an equal footing. Says Representative Charles E. Schumer (D-N. Y.): "The Japanese have an approach that says to the innovative firms, 'You lose.' "

JOIN THE CLUB. That seems to be the lesson of a recent flap involving Salomon Brothers Inc., Tokyo's biggest foreign securities house. Early in 1990, Salomon scored a coup when it was chosen with Nomura to lead management of a Eurodollar bond issue for Mitsui Toatsu Chemicals Inc. Shortly thereafter, Morgan Stanley played a major role in a $150 million bond offer for Toyo Sash Co. Them came the eye popper. Last fall, Salomon became the first foreign broker to be picked to lead two issues of yen-denominated convertible Eurobonds--$148 million worth for Fujisawa Pharmaceutical Co. and $111 million for Oji Paper Co.

Sources say Salomon won the deal by offering to raise the money at about 5%--a percentage point lower than the going rate on similar bonds sold by Japanese houses. According to these sources, Salomon proposed keeping the cost down by issuing options alongside the bonds. Salomon planned to keep the options for itself, eventually selling them on the open market and using any profits to help fatten its earnings from the bond issue.

As word of the planned underwriting spread, Nomura tried to dissuade Oji and Fujisawa from jumping ship, sources say. Pointing out that such financing techniques are still not well understood in Japan, a Tokyo-based industry expert says that officials at Nomura Securities Co. even warned the companies that Salomon's financing technique was not risk-free. But the Japanese head of a Wall Street broker's Tokyo unit has another explanation: "Nomura was worried that if Salomon succeeded, its own clients would demand better pricing."

WEAKER GRIP? Upset by the controversy, Fujisawa and Oji scrapped the bond issues. Sources say that Hitachi Credit Corp. and several other companies also dropped plans for similar Salomon-led bond sales. But several bond deals involving other investment banks have sailed through. Indeed, one U. S. source in Tokyo says such financings "will fundamentally change" the way Japanese companies, now nearly cut off from raising equity by the sagging stock market, obtain cash. "Companies will become more adventurous," says the source. "The traditional hold of the big four on Japanese issuers will weaken."

Nomura officials deny pressuring Fujisawa and Oji on the abandoned Salomon deals, but the Treasury Dept. has already "raised this as an issue,"says Assistant Treasury Secretary Charles H. Dallara. Japan's Finance Ministry is also investigating the incident.

The attention only points out how high the stakes are these days. With Tokyo trading just 300 million or so shares a day, vs. nearly 3 billion at its 1988 peak, Nomura's net income for the six months ended Sept. 30 plunged 63%, to $414 million, from its 1989 level. But by trading aggressively, Salomon boosted its Japanese net income by 39%, to $37 million, in the six months ended in September.

Faced with Wall Street's inroads, Japanese regulators are foot-dragging on their commitments to freer markets. For example, after permitting the introduction of stock-index options and futures in 1988, the Finance Ministry imposed trading limits last spring despite protests by Salomon and Morgan. The Japanese are also slowing the introduction of new products. Last year, the Tokyo Stock Exchange pressured the American Stock Exchange to stop listing its popular put and call warrants on the Nikkei average. Issued by Salomon and others, the warrants allow investors to hedge Japanese stockholdings by placing long-term bets on whether the Nikkei will rise or fall.

These warrants were among the most heavily traded instruments on the Amex last year. And despite claims by the Amex that interest in the warrants was waning by the time the Japanese made their request, the moratorium forced at least one U. S. investment bank to scrap a planned issue of call warrants last summer. With Japanese approval, the Amex has since introduced a new line of options based on the Tokyo market. But their appeal is limited because their three-month duration curbs their use in hedging.

Even as the big four and other Japanese financial institutions preach the evils of program trading at home, they are rushing headlong to get up to Wall Street's speed. On Jan. 22, Sanwa's New York-based securities unit hired E. Craig Coates, a former top Salomon and First Boston Corp. bond trader. A day earlier, Nomura's U. S. subsidiary announced that it had lured away Louis T. Margolis, Salomon's program-trading guru, to help the Japanese firm expand in equities and money management.

Nomura already has 125 staffers in Tokyo who are assigned to trading and researching derivatives, securitization, and other new strategies. "We wear two hats," concedes Executive Director Hitoshi Tonomura. "As the leader of the Japanese securities industry, we have to protest program trading. But we also have to develop this area." Indeed, adds Salomon Vice-Chairman Deryck C. Maughan, Nomura's increasing participation in the new business eventually "will legitimize it in Japanese eyes."

Such a sea change could give Wall Street's go-go traders the fight of their lives. "The window of opportunity won't remain so wide open once Nomura jumps in," says Maynard Toll, president of CS First Boston (Japan) Ltd. With 130 branches across Japan, Nomura earned $1.3 billion from commissions from April to September--in a weak market.

As the business slows, Salomon and other brokerage houses that have grown slowly and positioned themselves to ride the trading wave may fare best. "There will be a few major firms that are going to establish leadership and make a good living," says Maughan. "The rest are going to wither away." Perhaps. But right now, Tokyo is a gravy train for many Wall Streeters--and they are hell-bent on keeping it that way.

                  Six-month revenues*
                 Millions of dollars
      SALOMON BROTHERS    $160
      GOLDMAN SACHS         85
      MORGAN STANLEY        79
      MERRILL LYNCH         59
      LEHMAN BROTHERS       47
      CS FIRST BOSTON       32
      *Ended Sept. 30, 1990
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