Tokyo’s bid to become a global financial centre

Tokyo’s plan to become a global financial centre bumps up against reality

 It’s almost a fashion statement for Asian cities to declare their intention to become an international financial centre once they have attained a certain level of economic maturity.

Several have done so over the last 40 years, but thus far, only Hong Kong and Singapore have earned that status through decades of tireless efforts.

 However, Hong Kong’s ability to maintain that coveted position under China’s ‘one country, two systems’ framework is again being questioned, with the city becoming a flashpoint in the intensifying tensions between the US and China, coupled with concerns around the implementation of the National Security Law.

There have been keen discussions in a score of cities around the region, including Tokyo, Seoul, Mumbai, Taipei and Sydney, on how they can take over Hong Kong’s crown as a premier international financial centre in Asia. But most of the talk has fizzled out without gaining much momentum. Tokyo, however, is putting its rhetoric into action.

Japan’s ambition to become an international financial centre is not new. Government officials have launched one initiative after another since the Japanese asset price bubble in the 1980s, but to no avail.

Prime Minister Yoshihide Suga, who took office last September, sees an opportunity to increase his chances of winning the upcoming general election by pushing Tokyo to become an international financial centre as part of his reform agenda.

“Strengthening Japan’s capabilities as an international financial centre is our urgent priority,” Finance Minister Taro Aso said at a news conference in November. “We are making efforts to bring over the centre of Asia’s financial market from Hong Kong in light of the turmoil in the city.”

Pandemic opens opportunity

The need for companies to diversify their operations in the coronavirus era also helps to create a window of opportunity for Japan.

In December, the Japan Financial Services Agency announced a range of measures aimed at making Japan an attractive place for foreign nationals to do business, mainly in the asset management sector, such as a one-stop financial market entry office to handle registration and supervision in English for incoming foreign financial firms. There were also revisions to several much-criticised tax policies, including corporate tax deduction for performance-based executive compensation, exempting foreigners from inheritance tax, and treating income distribution from carried interest as capital gain at a tax rate of 20% instead of income at 55%.

There were also measures to relax eligibility requirements for residency status, waiver of visa requirements to allow expatriate spouses to work full time, and allow the hiring of two domestic helpers instead of one.

All of these were implemented on April 1, except for the corporate tax revision, which is scheduled for December.

Japan is the world’s third largest economy and a stable global power. The Japanese yen is the third most-traded currency globally after the US dollar and the euro. And the Tokyo Stock Exchange is the largest in Asia by market capitalisation, and the third largest in the world.

Tokyo’s time zone also dovetails neatly with London and New York, and its logistics are top-notch, with both Narita and Haneda airports having the ability to handle long-haul flights. The workforce is highly educated and extremely hard-working even though the working environment is largely non-English speaking.

In addition, years of deflation have made rentals of offices and homes in Tokyo around 40% cheaper than in Hong Kong and 50% cheaper than San Francisco or New York, according to cost-of-living calculator Numbeo.

Shortcomings

Unlike past efforts, the game plan now is different and specifically targeted at attracting foreign fund houses to move to Tokyo. 

Japan has some 1,900 trillion yen (US$18 trillion) of household savings, the largest in the world, but these assets are not being put to use effectively.

The largest fund houses in Japan are part of the mega banks that control the credit lifelines of corporate and individual clients. This cosy state of affairs doesn’t promote product innovation and leading-edge investment capabilities.

The mutual fund market has been stagnant and the sales model needs a complete revamp. There are too many distribution layers between investors and fund managers, leading to very high fees for mutual fund investors. Sales agents often encourage fund churning to earn front-end fees to meet their sales quota.

And fund managers are practically under the control of sales companies on what funds to launch and how much money is raised. As a result, fund performance suffers and the Japanese would rather keep their money in bank deposits.

The institutional sector isn’t any better. Investors are generally allocating as much as 50% of their portfolios to low-yield Japanese government bonds to avoid risk, given decades of near-zero price inflation.

The $1.6 trillion Government Pension Investment Fund (GPIF) has been increasing the amounts of investment under external management every year and raising its allocation to overseas assets, including private equity and hedge funds. But the results are not good enough to meet the growing liabilities of Japan’s ageing population.

Tax cuts and other tweaks to regulations are nice, but they ultimately matter less than whether Japan can provide business opportunities for incoming foreign fund houses. “In the end, what matters is whether Japan can smell of money,” an unnamed foreign fund manager was quoted as saying in a report in Hong Kong’s South China Morning Post newspaper on October 9, 2020.

The Suga administration’s plan cannot just be about earning revenues and creating employment by attracting foreign fund managers to use Tokyo as the base for providing services aimed at overseas clients. It has to also provide opportunities for foreign managers to manage Japan’s domestic and international assets. This will also create competition and sharpen the skills of Japanese managers and raise the standard of the industry.

The absence of initiatives in the new package to reform the mutual fund market and to create a more risk-taking culture led by official institutions means that the money issue which matters most to foreign fund houses has not been addressed.

One potential game changer could be to allow the GPIF to open up its investment choices and entrust some of its assets to capable boutique managers, both foreign and domestic, similar to the Monetary Authority of Singapore’s programme for developing its asset management industry. But this consideration is not on the table.

The China lure

Multinational fund houses put people where the money is. Currently in Asia, that means getting closer to China, where economic growth has outpaced that of Japan six-fold in the last decade. China’s investment management industry has grown to over $3 trillion in just two decades, and its $9.6 trillion household savings is growing at about 8% a year. China’s financial markets have become  increasingly attractive as Beijing loosens its grip.

Hong Kong is the best gateway to access China’s financial market. The Hong Kong dollar is pegged to the greenback, backed by over $490 billion in foreign reserves. This means firms dealing in the Hong Kong currency can assume that it is fungible with the US dollar, with minimal foreign exchange risk. As long as its commercial law, low tax regime and business regulations remain unchanged, and China continues to be an attractive market, foreign investors are willing to weather the storm and use Hong Kong as the base to access the Mainland. 

The wide use of English in Hong Kong’s business sector is an additional perk that would be difficult for Japan to match in the short term.

The city is not international

A city’s openness to global capitalism and culture would also determine how far it can grow its financial sector.

Tokyo may be an important financial centre globally, but the city is not international. There are currently only around 13,000 foreign nationals with high-level professional visas living in Japan. The country may be a fantastic tourist destination, but the language barrier and a staid culture mean that foreigners are not received with openness as residents.

Perceptions of inequality could be another issue. Ordinary people might question why well-paid foreigners are being exempted from estate taxes or benefiting from a special low levy on capital gains at a time when some Japanese citizens are homeless.

Moreover, if the Carlos Ghosn fiasco provides any lessons, how would the news media react should a financial scandal erupt – which is inevitable even in the best-run jurisdiction? Would the Japanese public feel that they are getting a raw deal?

Ultimately, Tokyo’s biggest challenge could be the difficulty of getting the Japanese public onside with its ambitious plans.

Unless the Suga administration follows through with much deeper structural reform, it is hard to conceive that fund houses in Hong Kong would be packing their bags to move to Tokyo in droves. Right now, Japan’s pitch is unlikely to fall on keen ears.

*This article was published in Asia Asset Management’s May 2021 magazine titled “It may be a pipe dream.”