Why AIJ scandal will be the first of many

Author: | Published: 8 Mar 2012
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Japan’s investment management sector expects more scandals to emerge as regulatory scrutiny of the country’s domestic fund managers intensifies.

Last month, Japan’s Financial Services Agency (FSA) suspended the operations of money management firm, AIJ Investment Advisors, after it was unable to account for the bulk of $2.6 billion in pension funds it managed on behalf of 123 clients.

The suspension follows the $1.7 billion accounting scandal at the Japanese camera maker Olympus, which raised questions about the prevalence of white-collar crime in Japan and the ability of Japanese financial regulators to monitor offenders.

Japan’s financial services minister, Shozaburo Jimi, last week described the situation as deplorable and ordered a sweeping investigation into the finances of 265 other money management companies in Japan.

As part of these investigations fund management companies will be required to disclose more information on their operations including whether they had set up investment trust funds overseas and whether they use external auditors.

One Tokyo-based fund manager told IFLR the AIJ incident had revealed the fundamental weaknesses at the ground level of Japan’s pension fund system.

It has, for instance, become commonplace for the country’s mid- and small-sized pension funds to hire only one or two dedicated managers, often without the necessary skills or professional background to manage pension funds.

Such hires were often former employees of Japan’s scandal-hit Social Insurance Agency which, before being abolished and replaced by the Japan Pension Scheme in 2010, monitored Japan’s pension fund policy at the national level.

“For smaller funds, without the means to hire from big names such as Goldman Sachs, ex-employees of the Social Insurance Agency seemed the best option,” the fund manager said. “It was assumed they would be well qualified to do a good job.”

“The regulations didn’t effectively take those facts into account,” he said. “And the gaps that developed between industry assumptions and the regulatory reality created room for the AIJ to manipulate those systematic weaknesses.”

Anderson Mori Tomotsune’s partner Akihito Nakamachi believed the FSA’s investigation could identify other similar incidents.

The FSA has been criticised for not monitoring the situation closer. “Thorough investigations are expected as a result to properly address an issue which has now become the subject of national debate,” Nakamachi said.

But he questioned how deep the scrutiny could go.

“It is obvious now that certain small and mid-sized funds do not have the ability to assess risks and manage themselves so perhaps they might be better off selling with lower risk and thereby lower returns,” he added.

But if the FSA imposes too rigid restrictions, for example by limiting the investment options available to pension funds, it risks stifling the market.

Japan’s ruling party, the Democratic Party of Japan, last week announced plans to amend laws to require more stringent oversight of asset management firms in a bid to prevent the recurrence of such scandals.

Another Tokyo-based partner at an international law firm, however, was unconvinced much would change. There will obviously be a material adjustment made. But drastic change would bring with it other risks, he said, which authorities will understandably want to avoid.




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