Private banking: Difficult landscape

A year after Citibank's reprimand from Japan's regulator for mis-selling structured products to high-net-worth clients, the Japanese private banking market remains problematic for foreign firms. Are there any glimmers of hope? By Amanda Lee with additional reporting from Paul Lyon


Japan's structured products market is growing as low interest rates persuade high-net-worth investors to consider a range of yield-enhancing investments. The market is now worth Yen12.5 billion ($105 million), according to figures from BNP Paribas, but is dominated by a handful of Japanese banks - Mizuho, Bank of Tokyo-Mitsubishi, Sumitomo Mitsui Banking Corporation, and Resona Bank. Foreign banks, on the other hand, are finding it a struggle to make any headway.

It's not for want of trying, though. Several foreign banks have attempted - and failed - to tap the private banking space in Japan. Only one, Citigroup, appeared to have succeeded. But the US firm was ordered to suspend its private banking operations in September last year after Japan's regulator, the Financial Services Agency (FSA), uncovered an array of misdemeanours, including mis-selling structured products, an absence of governance and internal control systems, and a lack of management supervision (see box opposite).

The removal of Citibank from the private banking space created a gap that its competitors looked to fill. Several banks, including UBS and Merrill Lynch, began to expand their wealth management operations in Japan, while some foreign houses began to strengthen their structured product teams in Tokyo amid hopes that a more competitive, open-architecture distribution model would emerge.

Japanese dominance

However, domestic Japanese banks have retained their stronghold in the market, with many building on existing banking relationships to offer structured products and equity-linked unit trusts through branch-based wealth management centres. "I believe the private banking business in Japan has not taken off as smoothly as many Westerners had hoped," says Mike Watanabe, BNP Paribas's co-head of equity products and fund derivatives development group, Japan, and head of fund derivatives, Asia. "There are certainly a lot of mass-affluent investors, but they are extremely conservative and demand extra client service."

Along with the likes of Bank of Tokyo-Mitsubishi and Resona Bank, other institutions, such as Nomura Securities and Sumitomo Trust & Banking, have been adding to their wealth management operations, making it even more difficult for foreign banks to gain a foothold. "Local banks are beefing up their private banking business, so it is getting more competitive for foreign banks. Foreign banks have to offer unique products with decent margin so that they can pay off their infrastructure," Watanabe says.

As well as competitive pressures, Japan's regulatory environment has also made foreign banks wary about dipping their toes into the market - particularly in the aftermath of Citibank's reprimand. Structured product distributors have to explain the risks and returns of all investment products, and must ensure that products are suitable for the customer. The FSA introduced regulation in April 2001 to reduce the burden for investors who seek compensation by taking legal action against a distributor for the loss of their investment.

However, the regulations stop short of providing detailed guidelines for distributors. As a result, firms have become much more wary about selling new, innovative structures - especially if they put the principal at risk. "If we come up with a new idea, it may take a long time to become popular with Japanese investors compared with those in Taiwan, Hong Kong and Korea," Watanabe says.

Products linked to alternative investments - funds of hedge funds in particular - have struck a chord with Japanese investors, although most of these products incorporate a capital guarantee. Unit trusts have also been popular with high-net-worth customers. "(Japanese banks) sold more than Yen30 trillion of equity-linked unit trusts as of September," Watanabe says. "The Cayman authority passed a specific law targeting the retail offering of Cayman-based unit trusts in Japan to respond to the increase. In October, the Japanese Post Office started to sell unit trusts over the counter, which boosted the growth even further."

There are advantages to wrapping a structure in unit trusts. "It is effective for marketing purposes because the need to explain all the details can be cushioned by using the manager. Distributors are therefore more willing to embrace innovative structures in unit trusts," Watanabe explains.

However, there are glimmers of hope for further market development. "The regulator has become more aware of the developments of structured products in the past few years," says Toru Sano, managing director and head of structuring and marketing at JP Morgan in Tokyo. He says that the FSA has been introducing more regulatory changes over the past year or so. Since December 2004, Japanese banks have been allowed to act as intermediaries for securities products, which means that banks can now sell debt-related structured products.

In December 2003, the FSA also proposed the idea of an Investment Services Law (see box). This aims to consolidate the legal framework for investment services activities and to cover a wider range of financial products. The Investment Services Law is scheduled to come into force in 2006, although a draft has not yet been produced. "It is very interesting to see that the regulator is thinking about this law in order to boost the transition of money from bank deposits," Watanabe says.

Investment products providers will need to register under the Investment Services Law, with firms subject to different registration criteria depending on the nature of their business. What's more, the FSA has also announced it will place more emphasis on the inspection of derivatives embedded products targeted at retail investors.

Nonetheless, demand for medium- to long-term saving plans from Japan's ageing population may boost the wealth management industry in Japan. "The transition of Japanese wealth from a simple bank deposit to capital market products is happening much faster than everybody had previously expected. Privatisation of postal savings would further accelerate this trend. We are going to see the surge of retirement bonus payment in the next two or three years, since the previous baby boomers are going to retire soon," Watanabe says. "This will bring at least Yen15 trillion into the market every year. Pensioners may initially keep their bonus in bank deposits since they may not be experienced in investing in capital market, but they will consider medium- to long-term capital-protected investments."


In September 2004 the FSA reported that the private banking business performed "a number of acts injurious to public interest, including "extremely inappropriate transactions". These included selling structured products to high-net-worth clients without a full explanation of the risks involved, and without assessing the suitability of customers to buy those products. In some cases, misleading comments were made regarding the risks of structured products, with some customers given false assurances regarding the security of their principal.

The Japanese regulator also discovered that the bank had no established rules on the calculation of fair prices, and that in a number of instances, "large profits were obtained through unsound means" because clients were quoted prices on derivative-related transactions without proper verification of the accuracy of those figures.


The ISL is a unified approach to lift the ban on financial institutions that engage in securities introduction agency services. The new law will also widen the range of insurance products that are provided by depository financial institutions. Financial products will be covered by the ISL include bonds, stocks, investment trusts, collective investment vehicles, derivatives and mutual loans.

Under the current regime, sales and solicitation, management, and investment are each regulated under different laws. But under ISL, market players, especially international banks that wish to enter the Japanese financial services market, will be able to refer to a single source of legislation.

The Japanese financial services sector and the government would like to provide a higher degree of protection for retail investors because of the financial products development in the country.

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