Japan’s stock market reforms plan to attract more investors

The exchange recently unveiled its biggest overhaul in 60 years that includes tougher standards for its top segment, which will be renamed “Prime” and begin operations in April.

However, some foreign investors say that the real problem of the exchange is not some net around the corner, but the entire edifice of corporate management in Japan, where many large companies are sitting on cash and are at a standstill. These investors say that many companies view a listing on the top section of the exchange as an honorary distinction rather than a motivation to engage with shareholders.

“Japan is not an easy country for the global community to invest in. There is also a peculiar corporate culture,” said Masakazu Takeda, portfolio manager at the Hong Kong-based Hennessy Japan Fund.

Hiromi Yamaji, president of the Tokyo Stock Exchange, says the lifting of standards is done slowly and steadily. His supporters point to signs of change in recent years: more foreigners and women serving on Japanese boards, bargaining increased and active investors helping to value some of the market’s giants.

In an interview Mr. Yamaji said, “The overhaul is only a starting point and I think it is a good starting point.”

They also drew an inherent contrast with China’s larger but more volatile market. “In Asian markets, we are the only market with a large and deep economy and it is a democracy,” he said.

The Tokyo market, which accounted for about 40% of the world’s stock market value in the late 1980s, is now less than Apple Inc., Microsoft Corp. and Alphabet Inc. together in its entirety. In market value, Tokyo’s total of $6.2 trillion makes it fifth globally behind the New York Stock Exchange, the Nasdaq Stock Market, and the markets in Europe and China.

Another sign of the underestimation in which investors hold Tokyo stock: Nearly half of them trade at less than their book value, which equals assets minus liabilities. This measure, while not commonly used outside of Japan, is often cited by investors as a sign that the market expects management to destroy more value than it creates.

According to the theory behind the overhaul, the presence of a few unqualified companies on the first section has a massive impact on the market and makes Tokyo look like a backwater.

To qualify as prime, a company must have at least one-third of its independent directors, and at least 35% of its shares must be free-floating or available for trading by the public. Companies are expected to agree to greater communication with investors and to make disclosures in English.

“If you choose Prime, you know you need to start working on a regime with foreign investors in mind,” said Mr. Yamaji of the exchange.

The overhaul has one major drawback. Companies that don’t clear the threshold can still claim the Prime distinction by declaring themselves Prime-eligible and offering a plan to meet the standards someday.

There is no fixed time limit. Mr. Yamaji said the exchange wants to see how companies are adapting, and most said they will be ready in five years or less.

The prime market is set to include 1,841 companies, which is only slightly less than the 2,182 companies currently present in the first segment. Most non-core companies will move to the new “standard” category, while the “growth” segment will have startups and smaller companies.

“Most international managers are focused on high-quality, globalized Japanese businesses. In practice these companies should see little impact from the new rules,” said David Mitchinson, who runs the Zenor Japan Fund in London. “The bad news is that almost all companies are on Prime, so it doesn’t serve as a meaningful marker of quality.”

While most of the criticism has centered on Prime’s lax admissions procedures, some foreign fund managers say the theory behind the overhaul is flawed. They say that large companies that dutifully comply with all exchange regulations—what Mr. Mitchinson calls “box-ticking-following governance”—do not necessarily have good prospects.

At Tokyo-based Ryos Capital Works, which has a fund focused on smaller companies, Vice President Mitsuhiro Yuasa said the Tokyo Stock Exchange left investors with the impression that more established companies are better. He denied aiming to revive the market with aggressive young companies.

“Changes tell us that big companies are good. High liquidity is good and low liquidity is bad,” Mr. Yusa said.

He said that in addition to setting entry rules for listings, the Tokyo Stock Exchange should also establish clear rules for exiting listed companies when it is clear that they are “zombies” and have no interest in forming a business.

This story has been published without modification to the text from a wire agency feed