How Japan’s fiduciary code could open its fund industry

Fund industry executives are braced for a revolution in product distribution, as the Japanese regulator gets tough with the dominant local players.
How Japan’s fiduciary code could open its fund industry

A Japanese government-backed regulatory initiative aimed at forcing fund managers to embrace more “customer-oriented” attitudes is driving a big shake-up in the country’s domestic fund management industry.

Experts said the move could lead to a potentially big shift by private investor wealth into mutual funds, lead to lower fees for investors and trigger some merger and acquisition activity in Japan’s asset management industry.

The Financial Services Agency (FSA), Japan’s securities regulator, has already overseen the introduction this month of a new low-fee regular saving pension vehicle, the Tsumitate Nisa plan. It intends to follow this up with a formal codification of fiduciary rules, which are due to be ratified by the Japanese parliament before April.

The latest move is part of the reformist FSA commissioner Nobuchika Mori’s intention to get tough with local fund groups. In a speech last year Mori accused these fund groups of “seeking their own benefits and acting with little regard for customers’ interests”.

The country’s asset managers and fund distributors are often part of the same conglomerate. The incoming fiduciary rules are designed to force them to justify the often-extortionate fees that they charge to Japanese investors, while the new funds offer them cheaper competition.

The FSA calculates that the average sales commission fee for the top 10 funds in Japan is 3.1%, while the average management fee is 1.5%. In other words, these funds need to return more than 4.6% a year in order for investors to avoid losing money.

“Many investment funds do not generate adequate returns. There are also many thematic funds that require the right timing to invest,” said Hisashi Kaneko, senior researcher at Nomura’s NRI Financial Solutions division in Tokyo.

Plus fund managers often release new products that they shift client assets into—after charging another round of fees.

In contrast, the new Nisa plan funds can only charge up to a 0.75% fee for both management and distribution, making it more likely that investors enjoy a decent return.

Changing the current situation is overdue. Mori has noted Japanese households have only seen a 19% return on their finanial investments, over the past 20 years, “a far cry from the growth of 132% in the US”.

Bad news for distributors

The new fiduciary code could, if implemented and enforced effectively,  radically change Japan’s fund landscape.

Industry observers told AsianInvestor that today up to 85% of retail funds and pension funds today are developed, distributed and then managed by ‘Keiretsu’—groups affiliated with the large Japanese corporate and financial conglomerates such as Mitsubishi, Nikko, Daiwa and Nomura.

Yoshihiro Hamada, head of the product strategy planning group at Asset Management One, said the FSA's intention is not necessarily to break the oligopoly of the fund industry. But he believes the regulator is well aware of the conflicts of interest Keiretsu companies pose.

“They are very nervous about so-called Keiretsu deals, where major banks or securities houses sell mutual funds provided by their subsidiaries,” he said.

The government and FSA already introduced their "Principles for Customer-Oriented Business Conduct" in March 2017. The new code will force distributors to explain why they are charging their commission rates and what services the customer is paying for, Kaneko added. They might be able to avoid lowering fees if they can explain why they are charging them.

But the pressure on fees is downwards.

“Many distributors and asset management companies are reviewing the structure of commissions and fees, especially with the new low-fee Nisa products and the growing popularity of online sales,” said Kaneko. “The general trend [in Japan] means a lowering of fees.”

If the fiduciary code works, “the focus [of remuneration] would be increasingly based on assets,” said Tsuneto Iki, executive officer at Sumitomo Mitsui Asset Management. “Many investors are questioning the high fees they have to pay over the counter [for fund investments] and we have seen a rapid increase in the growth of online fund sales in Japan.”

The new fiduciary code also requires distributors to list illustrative circumstances where conflicts of interest with clients might arise, and undertake measures to address them.

In theory, “this would make the selling (or the prioritising) of investment products from affiliated asset management companies rather difficult,” said Kaneko.

Encouraging inflows

A rigorously enforced fiduciary rule would offer non keiretsu fund houses more of a chance to compete in Japan.

“[Currently] outsiders, whether they are non-Japanese managers or independent Japanese locals, have little chance of breaking in,” said Jesper Koll, Tokyo-based chief executive of US fund firm Wisdom Tree. "This code is great news for global managers and independent Japanese managers."

"The market share of fund houses which are under the control of the large banks and brokerages will decline,” added Kaneko.

He believes this could herald a revolution in Japan financial services providers.

“We will see consolidation with a sharp pick-up in mergers and acquisitions. I expect the big domestic firms will consolidate towards core-competence at home and partner up for professionalisation and globalisation.”

Ultimately, the FSA hopes breaking down the industry oligopoly and adding competition and Nisa funds will improve returns and mobilise the estimated $8.8 trillion of Japanese private wealth currently held in low-yielding bank deposits, according to Iki.

“By making them consider what is best for the investors, these efforts are expected to make the investment trust funds more trustworthy, and consequentially Japanese private wealth is anticipated to shift from bank accounts to funds,” said Iki.

AsianInvestor is hosting its seventh Japan Institutional Investment Forum in Tokyo at the Andaz Tokyo, Toranomon Hills, on March 15. For more details, contact Terry Rayner via email or on (+852) 3175 1963.

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