Table Speech

How to Deal with Stock Price Volatility

May 24, 2017

Mr. Masashi Iwakigawa
Executive Deputy President & Representative Director,

 In my speech, I will make a comparison between personal financial assets in Japan and the U.S.A. and show some smart ways to deal with financial risks. Personal financial assets increased by 20% in Japan from 2008, the year when Lehman Brothers filed for bankruptcy, and 2016, while it increased by 82% in the U.S.A. The Nikkei and NY Dow Jones Indexes increased at similar rates of 115% and 125% respectively, so what caused asset increase rates to differ so much? The answer is asset portfolio composition. Deposits and savings account for 52% of assets in Japan and 14% in the U.S.A., while the figures reverse for stocks and investment funds which account for 14% in Japan and 46% in the U.S.A.

 Corporate managers and institutional investors are expected to adhere to quasi-legal rules, including Corporate Governance Code and Stewardship Code, to ensure responsible and sustainable investing. The Seven Principles of Fiduciary Duty stipulate that financial business operators must pursue the best interest of clients. Despite these measures, not a few people in Japan feel uneasy or even afraid of stock price volatility, which has made the total number of accounts for securities industry to remain around 25 million.

 To deal smartly with price volatility risks, we can learn from the past and analyze the timeframe and process it took to achieve recovery from major stock market collapse. Following the 1929 New York Stock Market Crash, the government enacted various legislations to overcome depression and to strengthen regulations, including the New Deal program and the Securities Act of 1933 as well as the Securities Exchange Act of 1934. It took eight years for the economy to recover when the government raised taxes in an attempt to balance the budget and increased interest rates in 1937. Last year marked the eighth year from the collapse of Lehman Brothers, and it might be no coincidence that the Federal Reserve raised interest rates after careful scrutiny on different economic parameters, including the unemployment rate.

 Before I close my speech, let me give you some financial advice, based on my own experiences over the past 15 years. I found the best-performing asset for individual investors with long-term strategy would be installment funds. For the securities companies, they are not profitable but will help improve the securities services and increase the number of investors with successful investment experience. I feel a deep responsibility to build a framework that will enable our new clients to deal smartly with financial risks through safer assets like installment funds for a long-term investment. We must also work towards providing accurate advice by making active use of AI and improving our management practices through better cost control.

Light and Shadow of Derivatives

May 24, 2017

Mr. Shozo Ohta
President & CEO, Tokyo Financial Exchange Inc.

 A derivative is a financial contract that derives its value from an underlying asset. The most common underlying assets include stocks, currencies, interest rates and credits for “financial derivatives” or energy, metal and agricultural commodities for “commodity derivatives”. There are four types of contracts, namely, futures, options, forwards and swaps. Derivatives provide investors a way to hedge the risk resulting from adverse price fluctuations or to speculate by taking on additional risk.

 The volume of financial derivative markets surged in the early 2000s, especially interest-rate swaps, yet stagnated for a while after the financial crisis triggered by the bankruptcy of Lehman Brothers in 2008. The market is re-surging, with monetary easing measures taken by many developed countries. By 2013, the market size exceeded 700 trillion dollars, which was 10 times as large as the world’s nominal GDP or 300 times of direct investment value. In Japan, annual transactions of equity index derivatives totaled 1,400 trillion yen in 2015, which was 1.8 times of spot transactions. Interest-rate derivatives totaled 2,100 trillion yen, which was 4 times as large as outstanding loans of all domestic banks.

 The first record of derivative transactions can be traced back to the futures trading of rice in Osaka during the Edo era, followed by the establishment of Chicago Board of Trade in 1848 that promoted the development of grain futures market. In the U.S.A., foreign currency futures exchange was launched in 1972 and interest-rate futures started in 1975 to hedge against the risks of exchange or interest-rate volatility. Financial futures market expanded among major countries in the world from the 1980s up to the Asian currency crisis in the late 1990s, followed by the IT bubble and subsequent burst of Internet-related assets in the early 2000s. Governments took monetary easing measures to counter aftershocks from the crises, which caused excessive liquidity that went directly into asset markets where financial institutions invested heavily in subprime mortgages and credit default swaps. Again, we witnessed the collapse of housing bubble in the U.S.A. that triggered the global financial crisis.

 Derivatives have been recognized as beneficial tools with highly sophisticated risk management mechanisms and thus grown into essential instruments in the global financial and capital markets. But we must not overlook some serious issues associated with them. One is that derivatives have made tremendous impact on the business model of financial institutions which have traditionally taken a “commercial-bank model” of providing loans to companies and mortgage borrowers. Now a new “reselling model” has been formulated which uses these loan claims as underlying assets of derivatives to be sold to wide-ranging investors for credit risk dispersion. As so many unspecified financial institutions and investors have entered the derivatives market, transactions have become highly complicated. Consequently, it is now difficult to identify the location and magnitude of risks and to grasp the whole picture including losses. Any financial instability, therefore, can unduly amplify suspicions or anxiety of investors and creditors, exacerbating a credit crunch and trigger financial turmoil throughout the world. We must take due note of both the light and shadow of derivatives.