Japanese Brokerage Commissions Bottoming Out, Says Greenwich

As Japanese institutions squeeze broker margins in a weak market, commission rates continue to decline, but there are signs that the decline may soon come to a halt. Or so says a recent study of the Japanese market by Greenwich

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As Japanese institutions squeeze broker margins in a weak market, commission rates continue to decline, but there are signs that the decline may soon come to a halt. Or so says a recent study of the Japanese market by Greenwich Associates.

For all institutions investing in Japanese stocks, the average brokerage commission rate has fallen from 17 basis points (bps) in 2001 to 14 bps this year. For foreign subsidiaries and offshore institutions, the rate has fallen from 18 bps to 14 bps. For the largest institutions – those with commission volume of 1 billion and more – the average is down even further: from 15 bps to just 12 bps.

Additionally, 59% of institutional investors in Japan (including 70% of the largest) are now putting “caps” on brokerage commissions – paying on a negotiated per-bargain rate which is generally set at a very low level. Although this points to increasing pressure on brokerage commission rates, Greenwich Associates’ studies – and our recent discussions in the marketplace – also reveal some indications that they may be reversing course. Overall, institutional investors in Japan are expecting average rates to rise from 14 bps to 15 bps in the course of the next year, with foreign subsidiaries and offshore organizations expecting exactly the same upward shift, and the largest institutions anticipating an increase from 12 bps to 13 bps.

“Given that Japanese equity commission rates are now the lowest in the world, this is not too surprising,” says Greenwich Associates consultant John Webster. Domestic equity commission rates in the United States are at the 15-bps level, which is also the rate in the United Kingdom – leaving Japan, for the moment, below the other largest markets.

The average commission rate on portfolio or “basket” trades is even lower than the overall basic average – just 11 basis points, and only nine for the largest institutions. Not surprisingly, in the macro circumstances described, Greenwich Associates research shows that more institutions are making use of this cost-cutting technique this year, and that they are employing more brokers to do so.

The proportion of institutional portfolio trading in 2002 is over 60%. This includes 100% of institutions with commission volumes over 1 billion. While institutions generally are cutting back on the number of brokers they employ overall, from an average 14.2 to an average 13.7, they are increasing the number they use for portfolio trading – from an average 4.1 to 4.4.

Meanwhile, Greenwich Associates global research shows electronic trading in other markets cutting brokerage costs considerably – and investment managers clearly count on it to do so in Japan.

Although only 15% of Japanese institutions are using the technique at present, they are already conducting 41% of their trading this way – and expecting the proportion to rise to 46% in the next 12 months. Still more striking is the anticipated increase in electronic trading by institutions overall: an expected near-doubling – from 6% of total business to 11%.

Greenwich Associates believes that institutions active in Japanese equities may be well advised to reduce – be it ever so slightly – their pressure on brokerage commissions.

Greenwich Associates research indicates that the largest institutions in Japan are content to pay brokerage commission averaging 18 bps. Our consultants contend that many other active managers need to consider doing something similar if they want to continue to be competitive.

“Our studies in the investment management area demonstrate that plan sponsors in Japan are moving farther and more swiftly into passive than their counterparts anywhere else in the world,” notes consultant William Wechsler, “principally because they are so disappointed with the recent performance of active managers.”

Institutions in Japan are looking at all possible means of boosting returns – and one means to which many have recently turned is an increased investment in “small cap” value stocks. “They’re looking outside the traditional Nikkei 225 type of benchmark equity to try to add value to their investment process,” comments John Webster, and this shift parallels a move by pension plan sponsors to greatly increase their use of alternative asset classes such as hedge funds.

Other findings include:

* Almost 80% of all institutions investing in Japanese equities now invest in small company shares, and execute 14% of their total trading volume in these securities.

* The proportion of assets held in small company stocks by all such institutions has risen from 7% two years ago to 10% in 2002; at institutions with portfolios of more than 500 billion, the increase is from 6% to 10%.

Greenwich Associates conducted in-person interviews with 156 portfolio managers and analysts and 63 brokers at Japanese institutions and foreign subsidiaries and offshore institutions about market trends, compensation, and broker relationships in the Japanese market. Interviews were conducted in July and August, 2002.