Foreign Broker Ban

China Bars Foreign Brokerage Investments at Least Until Summer

Originally published in Securities Industry News

From its founding on Dec. 25, 1925 as a spin-off of Osaka Nomura Bank Co., Nomura Securities grew into one of the giants of Japanese capital markets and a player on the global financial stage. But in terms of corporate structure, the firm didn’t change much until 2001, when its holding company, Nomura Holdings, was established. That same year it was listed on the New York Stock Exchange.

Ever since, Nomura executives have been talking about breaking new ground, taking the company in new directions, finding new areas of business. Nomura may have done just that with the agreement it announced Nov. 2 to acquire New York-based agency brokerage Instinet from owners led by private equity firm Silver Lake Partners for a cash price reportedly upward of $1 billion.

The biggest brokerage in Asia, Nomura has taken a financial hit this year due to sluggish markets at home. Revenues were down slightly, while net income dropped 8 percent year-to-year, to 64 billion yen ($540 million), according to the company’s October quarterly report. “We cannot be completely satisfied with the first half of the year,” Nomura president and CEO Nobuyuki Koga said in a statement, “[but] the strategic initiatives we have taken are steadily yielding results.”

“The purchase of Instinet marks the first, decisive move by a Japanese player to establish itself firmly in the ECN market.”
– Neil Katkov, Celent

Though revenues from domestic retail trading and the global markets business declined, global investment banking pre-tax income rose by 94 percent, and the asset management business was up 89 percent. Still, Nomura’s reputation abroad is that of primarily a seller of Japanese equities. Its image wasn’t helped by a 1991 scandal in which the firm was caught trying to hide clients’ investment losses. In the late ’90s, the company got in trouble for channeling trading profits to clients linked to organized crime. Former president Hideo Sakamaki was indicted for paying hush money to a mobster in an effort to cover up that wrongdoing. He confessed and served a suspended prison sentence.

Nomura has been doing reasonably well financially, despite the first-half setback. Total assets under management have risen from 16 trillion yen in 2003 to 23 trillion yen this year. But to go up against U.S.-based brokerage giants, Nomura needed something else to set itself apart.
With a presence in 29 countries, Nomura isn’t exactly new to the U.S. or global markets. It opened an office in New York in 1927, the first Japanese securities firm to do so. The company now has 1,200 employees across the Americas.

In a business strategy overview last March, Koga cited plans to expand beyond the securities business and “promote businesses based on a new concept, different from the previous concept in which securities business was the core.” As part of the groundwork for broader-scale competition, Nomura started in 2003 to upgrade its technology platform. The company started beefing up its staff, focusing on quantitative and algorithmic trading.

Squeeze on Agencies

But it still didn’t have a significant electronic equity trading technology platform, said Larry Tabb, founder and CEO of Westborough, Mass. research firm Tabb Group. He added: “The market is getting hard for agency-only brokers. As commissions decline, the buy side needs to direct more flow to the full-service firms as their research, corporate meetings, technology and other services still need to be paid for.”
That leaves agency operations like Nomura’s struggling for business unless they can deliver more value, he added. To Tabb, the Instinet purchase therefore looks like a good deal. “The businesses have a lot of synergies,” he said. “Instinet’s trading technology is good, and they are coming out with a new series of tools that will be even better. Instinet has the leading commission-sharing platform in the U.S.–BrokerShare–and its trading volume this year has been substantially up from last year. All in all, while this transaction was expensive and wouldn’t make sense for a significant number of other folks, it makes sense for Nomura.”

Instinet’s position as a globally prominent, technology-savvy executing brokerage made it attractive to Nomura, Silver Lake Partners managing director Mike Bingle said when the deal was announced. He called Nomura “a perfect fit for Instinet going forward.”
Nomura Securities senior managing director Hiromasa Yamazaki, citing Instinet’s “world-class front-end trading products, crossing platforms and algorithms,” said, “The firms complement each other remarkably well, and we fully expect both of our client bases to benefit greatly.”

ECN Potential

Nomura’s acquisition also sets it apart from its domestic competitors. Neil Katkov, group manager of Asia research in the Tokyo office of Boston-based Celent, said the purchase of Instinet “is unprecedented in the Japanese securities market and marks the first, decisive move by a Japanese player to establish itself firmly in the international exchange–strictly speaking, electronic communications network [ECN]–market. In this sense, Nomura is trumping even the Tokyo Stock Exchange [TSE] in making a meaningful move toward full participation in the global capital marketplace of the future.”

Instinet comes to Nomura with an existing Japanese subsidiary, JapanCrossing, that is Asia’s only alternative trading system, according to Instinet spokesperson Mark Dowd. It was introduced in 2001 and now accounts for about 4 percent of TSE daily volume. “It is an anonymous, safe and neutral venue for institutional investors to place Japanese equity orders, particularly the illiquid names that are often subject to significant market impact when traded on an exchange,” Dowd explained.

Katkov said that JapanCrossing has just a marginal presence in Japan that probably didn’t figure prominently in Nomura’s strategic decisionmaking. But, he added, “it could be an interesting precursor to an emerging ECN marketplace in Japan. The Japanese capital market, currently dominated by the problem-beset TSE, is awash with rumors that global investment banks or other international players might set up an alternative trading venue. Nomura may end up stealing the stage from the international players.”