Tokyo’s global ambition
The move to position the Japanese capital as an international financial centre is gaining momentum
Japan’s stock market has risen to unprecedented levels, spurred by a surge of foreign investments and supported by favourable macroeconomic conditions. This has given rise to a renewed sense of optimism in the country’s economic outlook, and boosted Tokyo’s ambition to position itself as a preeminent international financial centre.
The benchmark Nikkei 225 index broke a 35-year-old record and breached the 40,000 barrier for the first time ever in early March. It was not only a historical milestone but also an important psychological watershed.
The previous record was set in 1989 when it epitomised Japan’s multi-decade post-World War II growth boom. But the bubble burst soon after and the economy sank into 30-plus years of anaemic growth and deflation, commonly referred to as the “lost decades”. Investors endured repeated disappointment with various government attempts at reflation, reform and rejuvenation. These triggered occasional equity rallies but ultimately turned out to be deceptive.
However, Japan has witnessed a resurgence of investor enthusiasm since last year, attracting continuous inflows of investment capital. Foreign portfolio investments rose to the highest level in nine years in 2023 after three years of net outflows.
The influx of foreign capital has continued into 2024 as more investors recognise the promising prospect of the Japanese market. In January, the Tokyo Stock Exchange’s market capitalisation overtook Shanghai to become the largest bourse in Asia.
Data from the stock exchange show that foreigners currently own about one-third of all listed stocks and account for two-thirds of daily trading volumes, underscoring their growing confidence in Japan's economic revival.
According to news reports, global hedge funds and asset managers, including Citadel, Point72, Impax Asset Management, UPB and others, are capitalising on the market surge by expanding in Tokyo. There is strong demand for traders, portfolio managers and analysts specialising in equity long-short strategies and macro strategies, as well as marketing and business development people.
It’s worth noting that the S&P 500 has gained by 13 times and the Euro Stoxx 50 by 3.4 times since 1989. This shows that the Japanese market has room to chart more new highs.
Asset management reform
Analysts from JP Morgan Chase, Goldman Sachs and many others believe that the market rally this time is different from the past, arguing that deflation is finally drawing to a close and that the “Abenomics” policies initiated a decade ago by former Prime Minister Shinzo Abe are making a notable impact on improving corporate governance and delivering better shareholder returns.
The Japanese yen’s weakness against other major currencies such as the euro and the US dollar enables foreign investors to acquire Japanese assets at a significant discount. And the prevailing low interest rates offer them an opportunity for profitable leveraged yield on investments. Even though the Bank of Japan recently raised interest rates for the first time in 17 years, the monetary policy stance of maintaining low interest rates is expected to persist for some time.
Meanwhile, the Japanese government is pushing for reform of the country’s US$5 trillion asset management industry to make it more sophisticated and foster greater competition. It has launched a programme to encourage pension funds and endowments to outsource a certain portion of their portfolios to emerging managers for investing. And the tax-exempt threshold for individual investor’s Nippon Individual Savings Account or NISA scheme was raised this January.
These initiatives aim to motivate Japanese households to convert their over 2,000 trillion yen ($15 trillion) of bank savings into investment assets to create a form of “new capitalism”. The objective is to boost incomes and consumption through dividend distributions and asset appreciation.
Japanese banks are responding by beefing up their asset management businesses, which have long been underinvested. They are not only hiring asset managers and analysts but also expanding product capabilities into areas such as project finance loans, private equity, private credit and infrastructure, and pursuing mergers and acquisitions where needed to bolster their positioning.
Transforming Tokyo
These developments boost Tokyo’s allure as an international financial centre, an ambition that Governor Yuriko Koike has prioritised over the past six years.
In 2017, the second year of her first term in office, Koike unveiled her vision of “Global Financial City: Tokyo”, including positioning the city as Asia’s financial hub; attracting financial talent, funds, information and technologies; growing the asset management and financial technology industries; and promoting environmental, social and governance investments. These initiatives had strong support from then Prime Minister Suga Yoshihide. A public-private partnership organisation, FinCity. Tokyo, was created to drive these goals.
After securing her second term four years later, Koike presented an updated “Vision 2.0” for transforming Tokyo by building a robust financial market based on the green theme, accelerating digitisation of finance, and creating a market that attracts global financial players.
Her ambition is strongly supported by the administration of current Prime Minister Fumio Kishida. During a visit to the US last September, Kishida spoke about his commitment to revitalising Tokyo’s position in the global financial system and raising the city’s profile as a preeminent financial hub in Asia.
Japan’s push to achieve this ambition is underscored by the implementation of various measures over the past five years based on feedback from the international financial community. They include offering official business documentation in English, establishing a one-stop centre for fast-tracking business approval, and introducing support programmes to make it simpler for foreign professionals to work and live in Tokyo.
Adjustments have also been made to tax laws to exempt inheritance tax on overseas assets of foreigners, and to allow companies to claim performance-based compensation paid to executives as a deductible expense under certain conditions.
But it’s unclear how much progress Tokyo has made in achieving its goal to become a global financial city. According to a posting by FinCity.Tokyo on LinkedIn in November, the city is now home to 92 bank headquarters and over 650 fintech startups, but comparative data tracking the number of financial firms that have established operations in Tokyo since 2017 are not publicly available.
Last September, the Global Financial Centres Index produced by UK think-tank Z/Yen Group ranked Tokyo in 20th spot, a sharp drop from fifth in 2016 when Koike took office.
Right direction
It’s probably not reasonable to expect drastic advancements in just a few years considering failed efforts to raise Tokyo’s standing for the past 30 years. But the city can refine its strategy further.
Rather than aiming to become a broad-based international financial centre, perhaps a more realistic approach is to focus on specific areas of strength and implement comprehensive measures to make Tokyo stand out in those areas. Vision 2.0, with its emphasis on areas like green finance, is a step in the right direction.
But progress on this specific goal is facing significant hurdles due to the reluctance of Japanese industries to align with international green finance taxonomy, and Japanese investors’ conservatism in adopting ESG ratings in their investment decisions. It will take time to overcome these hurdles through negotiations and investor education.
Some analysts suggest that Tokyo should instead aim to become a leading centre for transition finance, leveraging Japan’s unique advantages. For certain economies, it may be more practical to go “brown” as a transition before going completely green.
Tokyo has a real opportunity to become a prominent, revitalised international financial centre if Japan’s economic revival can be sustained. The proactive measures taken by the government to enhance the city’s commercial vitality will require ongoing changes and adjustments that deliver the greatest benefits with minimal pain.
The city is heading in the right direction, and results will manifest over time through persistent policies and efforts.
*This article was published in Asia Asset Management’s April 2024 magazine under the same title.
