Unwinding of Japan's web of corporate cross shareholding likely: report

Tokyo

FOR years, there had been speculation that Japanese financial institutions and business firms were about to unwind their webs of mutual cross shareholdings, thereby freeing up capital while at the same time increasing the "free float" of their shares traded on stock markets.

Wholesale disposal of cross holdings was said to be imminent after the collapse of Japan's bubble economy at the end of the 1980s and again at the time of the pro-reform government of former prime minister Junichiro Koizumi in the early 2000s. But it never really happened.

The introduction in February this year of Japan's Corporate Governance Code (which came formally into effect on June 1) may, however, provide a final catalyst for change where financial institutions are concerned, according to a report by US-based investment bank Jefferies.

A part of Prime Minister Shinzo Abe's Abenomics reforms, the code is being taken seriously by Corporate Japan and requires that "when companies hold shares of other listed companies as cross holdings, they should disclose their policy with respect to doing so", as Jefferies notes

What's more, the code requires corporate boards to examine the economic rationale of significant cross shareholdings, taking into account risks and returns, and to provide a "detailed explanation" to their shareholders of why they believe it advisable to maintain such networks.

This is the first time that Japanese business firms and financial institutions, which are at the heart of the corporate structure, have been formally required to divulge and justify their reasons for what has long been regarded as cosy mutual shareholding relationships.

The potential implications, analysts say, go beyond a simple desire to increase financial transparency. They could result in a significant shift in corporate ownership, both within the country and from outside, if firms begin to unwind their cross holdings in line with the code

The crossholding structures originated in the "Zaibatsu" system of financial and industrial conglomerates, which was transformed after World War II into a somewhat looser "Keiretsu" system which still retained many of the mutually protective crossholding characteristics.

According to Nomura Securities, the total percentage of shares held by Japanese listed companies (excluding insurers) in other listed companies was around 11 per cent in 2014, having declined steadily for many years. However the proportion held by financial institutions could be significantly higher.

Domestic equity holdings account for some 41 per cent of the net assets of the five largest banks - MUFJ, SMFG, Mizuho, SMTH and Resona - according to the Jefferies analysis. These holdings also account for 58 per cent of these groups' total market capitalisation.

Shareholders "want (these) crossholdings gone", says Jefferies, for a number of reasons including the fact that sales could increase the net income of the five biggest banks by as much as 45 per cent on average over a period of years.

The cross holdings are often held for strategic reasons, such as mutual support for business operations and the awarding of contracts among the companies concerned, analysts say, although sometimes cross holdings are held simply as portfolio investments by the groups concerned.

Cross holdings extend widely between financial institutions such as banks and life and non-life insurance companies and also into major trading companies such as Mitsubishi and Itochu as well as business corporations, such as Toyota and Central Japan Railway, and property groups.

Critics of the system say that it can stifle competition and limit merger and acquisition activity among firms, within the country and from outside.

They point to the fact that Germany felt moved to dismantle a similar system 10 years ago, using tax incentives to spur change.

With large Japanese corporations becoming more aware of the need to demonstrate higher earnings (largely due to the fact that foreign shareholders now account for a large part of the free float of Japanese stocks listed on stock exchanges), the urge to unlock unrealised gains is growing

There are some holdouts: Koichi Miyata, president of SMFG, has said that cross shareholdings are "not necessarily a bad thing", the Jefferies report notes. But others such as Mizuho have led the way in saying that they will no longer hold strategic stakes unless it makes financial sense.