[Bloomberg Column] The Secret Behind Japan's Stock Rebound: The Paradox of 'Regulatory Tightening'

Efforts to Improve Japanese Governance Up 42%
South Korea Also Launches 'Corporate Value-Up Program'

Mark Rubinstein, author of Net Interest and Bloomberg columnist
[Photo by Bloomberg]

At the pinnacle of the capital markets are not only banks and asset management firms but also stock exchanges. Compared to the traditional owners of capital markets, stock exchanges are quiet and humble, yet equally powerful. Currently, this phenomenon is most evident in Japan.

First, stock exchanges operate many indices that increasingly lead global capital flows. The London Stock Exchange Group (LSEG) owns and manages the UK's FTSE indices along with other benchmark indices under the 'Russell' brand. The Nikkei index, the best-known index in the Japanese stock market, is owned by the Nihon Keizai Shimbun, but the Tokyo Stock Exchange has the more useful market capitalization-weighted TOPIX, which is tracked by assets exceeding 83 trillion yen (approximately 741 trillion won).

Secondly, there is clearing. This refers to the process of confirming the items, quantities, and transaction amounts between buyers and sellers after the execution of stock or derivative trades. Regulations were designed to create more transparency and reduce systemic risk. Due to regulations, trading activities have moved away from opaque over-the-counter markets managed by banks to clearinghouses mostly owned by stock exchanges. Japan Securities Clearing Corporation (JSCC), a major clearinghouse in Japan, is a subsidiary of Japan Exchange Group, the operator of the Tokyo Stock Exchange. It currently clears about 70% of yen-denominated interest rate swaps worldwide. With imminent changes in Japanese monetary policy and increased activity based on the yen, I am confident that JSCC's role in global markets will be strengthened.

Now their influence is penetrating deeper inside corporate boards. Exchanges have always promoted corporate governance policies through companies listed on their exchanges. However, exchanges are increasingly exerting influence, especially in Korea and Japan.

In 1869, the New York Stock Exchange formed a special committee to evaluate companies wishing to list securities. The committee was interested in the character of potential issuers. Over time, stock exchanges added more specific requirements, such as mandatory annual report distribution, quarterly earnings disclosures, and independent audits. Eventually, Congress incorporated most of these rules into the Securities Exchange Act of 1934. But the New York Stock Exchange continued to push further. They required companies to obtain shareholder approval for large acquisitions, have at least two outside directors on the board, and establish audit committees composed of independent directors.

However, exchanges generally do not interfere with whether stock prices rise or fall. As long as stock prices remain above the NYSE’s strict requirement of $1, companies are left to manage their businesses.

In Japan, this is not the case. After decades of declining stock prices, Japan Exchange Group grew sufficiently frustrated. In 2022, Japan Exchange Group reorganized market segments and urged top companies to "focus on constructive dialogue with investors and commit to sustainable growth and medium- to long-term corporate value improvement." Then it focused on companies whose shares traded below book value and encouraged consideration of factors such as cost of capital and return on equity.

In March 2023, it demanded companies "take measures to implement management that considers cost of capital and stock price." It also launched the 'JPX Prime 150,' an index covering "leading Japanese companies estimated to create value," leveraging the appeal of indexing. In January, it began publishing a list of companies that disclose information upon request.

The results were positive. The number of Japanese companies trading below book value decreased, and stock prices rebounded. Since early 2023, the overall market has risen about 42%.

This was not bad for Japan Exchange Group either. In July 2023, Moriyuki Iwanaga, Chairman and CEO of the Tokyo Stock Exchange, said, "If corporate executives recognize public interest in corporate governance and can continuously raise stock prices, it is expected that profits in business will increase correspondingly." He added, "It may sound simple, but this is the principle."

Now Korea is trying to do the same. Like Japan, many Korean stocks trade at prices discounted to book value. According to a Goldman Sachs Group survey, as of the end of January, 64% of KOSPI index constituent stocks recorded return on equity below 8%. In contrast, TOPIX recorded 51%, and the S&P 500 recorded 23%. In February, authorities announced a 'Corporate Value-Up Program.' A 'Korea Value-Up Index' composed of profitable companies or companies expected to increase corporate value will be introduced. Penalties may also be imposed on companies that do not meet the criteria.

What differs in Korea is that financial authorities are leading reforms rather than the exchanges directly. However, this also shows another reason why exchanges are at the top of the market. Unlike banks, whose market positions have been eroded by burdensome regulations over the past decade, exchanges have benefited from regulations and even helped draft regulatory proposals. Along with control over clearing and indexing, exchanges’ power now also comes from driving corporate strategy.

Mark Rubinstein, author of Net Interest and Bloomberg columnist

This article is a translation by Asia Economy of Bloomberg’s column 'Where More Regulation Leads to Higher Stock Prices.'