Japan is changing its stock exchange structure to improve corporate governance. IFLR’s latest primer looks at how the changes will impact asset managers and whether the changes go far enough to address corporate governance issues.
What are changes to the JPX about?
Financial services operator, the Japan Exchange Group (JPX) is planning to restructure the Tokyo Stock Exchange (TSE) from April 1 2022. Under the proposed changes the five existing market segments: first section, second section, Mothers and JASDAQ (standard & growth) will be reorganised into new market segments: prime, standard and growth.
The prime segment will include companies with large market capitalisation, excellent corporate governance, and high liquidity. This segment requires that the tradable market capitalisation of companies be at least JPY10 billion ($92.7 million). Companies under the standard segment will have basic corporate governance standards and a standard level of market liquidity. The growth segment will include companies with relatively high risks that need to disclose progress at set time periods.
For asset managers, the question is which companies will make the cut to be included in the prime section. This will determine what companies will fall under the Topix index, which tracks companies in the first section of the JPX.
Why is the JPX changing its structure?
The focus on corporate governance reform in Japan started about 10 years ago when the Japanese government and the TSE started discussions on encouraging the appointment of outside and independent directors at Japanese listed companies.
“Since then, a number of reforms, including the establishment of the corporate governance code and the stewardship code have been implemented,” said Masakazu Kumagai, partner at Mori Hamada & Matsumoto. “Investor scrutiny on Japanese corporate governance is getting stricter and stricter.”
The TSE has indicated that it will review the corporate governance code and apply higher standards to those companies listed on the prime market. This would contribute to the trend of heightened corporate governance in Japan.
Yusuke Motoyanagi, partner at Nishimura & Asahi, said: “Higher market capitalisation requirements are required because of the increase in passive investment. This and other high thresholds will give Japanese companies an incentive to improve corporate governance.”
What are the concerns of the reform?
Sources suggest that a main concern of the reform is that it does not go far enough to reduce the number of companies in the prime segment. The existing first section of the TSE has more than 2000 companies.
“We welcome the intention to simplify the market structure and clarify the role of each section, given that there are ambiguities about the distinction between the current lower sections,” said Sachi Suzuki, associate director of engagement at Federated Hermes. “However, it appears that a vast majority of the more than 2000 companies currently on the first tier of the exchange will likely stay in the new prime section after the reform.”
Suzuki is concerned that the restructuring may fail to address concerns that the top tier is overpopulated, from large global companies to very small ones. “This is one of the factors making the Japanese market less attractive to global investors,” she said.
“Investors typically investing in index funds would be investing in companies across the board on Topix,” said Chie Mitsui, senior researcher at Nomura Research Institute. “The problem is that there is no competition for companies to be better, even with the corporate governance code in place.”
She continued: “It’s easy for companies to stay the same when passive funds are investing into them but there are too many companies on the Topix."
"If the list of 2000 companies were to go down to 150, for instance, it would be much easier to engage with companies on corporate governance issues.”
How are asset managers preparing for the changes?
Since all companies currently listed in the first section of the stock exchange are included in the Topix, investors who use the index as a benchmark will need to prepare for the change to the composition of the index related to the reform of the stock exchange.
According to Kumagai, the TSE intends to review the selection rule of the Topix constituent companies so that liquidity will be more heavily weighted. It is expected that the new rule will be determined and announced by March 2022. The TSE has indicated that it will seek opinions from Topix users in the course of its review.
“For asset managers, the question will be which companies will be included in the premium segment of the Topix as they will need to sell companies that are not included,” said Mitsui. “They will be tied down by investment policies and the shift will take time because contracts between asset managers and clients will need to be changed. The challenge is that all of these existing contracts need to be changed.”
Mitsui added that there will be a lot of uncertainty as to whether companies on the borderline will be able to meet the minimum market capitalisation threshold.
What areas lack clarity?
Suzuki said that it is also encouraging that the JPX is planning to apply more stringent governance requirements to companies listed in the prime section, although it is unclear what new criteria will be introduced at the next revision of the corporate governance code.
“While it may be reasonable to make compliance a criterion for listing in the prime section with the enhanced criteria of corporate governance code, it is important for the stock exchange to ensure the compliance is not superficial but also has substance,” she said.
Kumagai said that attention should be paid to the definition of tradable market capitalisation. In particular, TSE indicated that it will review the definition of a tradable share and shares held as cross-shareholdings could be considered non-tradable. “While cross-shareholdings are still prevalent in the Japanese market, investor pressure on listed companies to unwind such relationships is getting stronger and stronger,” he said. “There might be certain companies which could be affected by how tradable market capitalisation will be defined.”
Suzuki said that plans to revise the definition of tradable shares, the amount of which will be used as an additional criterion for the each section of the market, and in particular, to exclude shares held as cross-shareholdings from the definition, are welcomed. She hopes that this will not only help select companies with sufficiently liquid shares, but may also help unwind cross-shareholdings, which are associated with a number of other issues, such as ignoring shareholders’ interests.