Shrugging off subprime

Japan has remained relatively immunised from the liquidity crunch being felt in major economies following the US subprime fallout, according to speakers and delegates attending the Risk Japan conference on September 6. Yet senior risk officers on the keynote panel of Asia Risk's flagship event in Tokyo said the future development of the market is still unclear. "We do not have perfect information," said Tsuyoshi Monri, general manager in the risk management division at Mizuho Corporate Bank in Tokyo.

Yasuyuki Tateda, chief manager of credit derivatives trading at Mitsubishi UFJ Securities - now seconded to Japan Post, where he joins a team of 50 to help the huge savings institution improve its asset and liability management - said investors in credit products had received a warning two years ago from a severe repricing in credit correlation levels across different credit tranches. He says investors should have been aware of potential problems in the credit markets. "(The risks) were not done away with," said Tateda, referring to structured credit investments such as collateralised debt obligations, which bundle risks and repackage them into tranches offering an array of risk/return levels. But he cautioned that there is "no clear-cut answer at this stage" as to whether the crisis is over.

Hisayoshi Nogawa, chief strategist in BNP Paribas' Tokyo investment research department, said unexpected developments could still take place, highlighting the liquidity issues faced in August by his bank in Europe after BNP Paribas Investment Partners halted redemptions on three of its credit funds, Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia. "We didn't expect it to blow up into such a serious concern," said Nogawa, referring to the management's decision to freeze the funds rather than sell assets at low prices to meet redemptions. "It became difficult to arrive at the fair value of some assets. Investor protection is very important."

The three funds were suspended when their net asset value was down by 2.6%, said Nogawa. "Today they are down 3.7%, so they saw a fall of 1% during the suspension period," he added, implying that management may have been correct not to have offloaded assets at fire-sale prices. But he accepted that the move triggered "panic", as many investors in other products "ran for the exits".

Mitsubishi UFJ's Tateda questioned why the market reaction in August was fundamentally different to what took place in January and February, when he there was also a "wobble" in the US subprime mortgage market. On that occasion, however, the impact was not felt in Japan. "So what was different this time?" he asked. In response, Tateda pointed to the way subprime concerns had triggered problems in other markets without any exposures to subprime. "It became a balance-sheet issue," he said.

BNP Paribas' Nogawa reckons the problems in credit markets peaked at the end of July. "We are now in the end-phase", he said. But the panel was in broad agreement that much depended on the financial results of US securities dealers due for release in mid-September. "Then we will see what kind of losses occurred," Nogawa said.

"The Japanese market is not much affected," said Kenji Fujii, general manager of the integrated risk management division at Aozora Bank in Tokyo. "Q3 earnings will show if there is a winding down or if (problems will) expand further." Fujii, who chaired the keynote panel, added that the liquidity situation still needs to be watched. He also said the combination of Basel II implementation and subprime problems would mean "life will be difficult" for some institutions, without elaborating further.

Despite the uncertainty, several parties said the return of volatility in the credit markets represented an opportunity for investors. "Now the market is at this lower level, it would be a good entry point," said Tateda. "Some are trying to stay away, but quick investors have started to take advantage."

Regulatory roadblocks

Another major issue centred on regulation: for example, Basel II, adopted in Japan earlier in the year, is having a serious impact on the hedge fund business. And the new Financial Instruments and Exchange Law (Fiel) is playing havoc with the structured products business (see Fieling blue in Japan, page 54).

Tsuyoshi Ooyama, deputy director-general in the financial systems and bank examination department at the Bank of Japan, commented on the specific capital management issues faced by Japanese banks due to their different approach from other banks. Partly because Japanese banks still keep their unique business model, he said, they face many challenges when establishing economic capital management as a tool of business judgments. Some are recognising the risk associated with strong relationships with large borrowers, setting the globally persuasive confidence level and gaining the understanding of senior managers, who often have a very long time horizon with regard to their businesses, added Ooyama.

Meanwhile, speakers at Risk Japan's hedge fund roundtable said the introduction of Basel II in March this year had led to massive redemptions by regional banks that had invested up to $27 billion in hedge fund assets. This is due to the amount of capital banks need to put aside against their investments under Basel II.

Frank Packard, Tokyo-based head of north Asia for HSBC's alternative investment group, reckoned the redemptions from hedge funds by regional banks was about $15 billion in the past 18 months. In part, this may be due to the relatively poor performance of Japan's 270 hedge funds last year, as well as the high-profile blow-ups of Eifuku in Japan and Amaranth Advisors in the US. What's more, regional banks have ramped up their traditional corporate lending businesses, where demand is higher and returns are stronger than they have witnessed in recent years. But the main contributory factor is the risk weighting of 12.5 times asset investment required under the Basel II guidelines, speakers said.

A greater understanding of underlying positions by hedge funds can lead banks to secure less of a capital tie-up. But this requires significant levels of disclosure by typically secretive hedge funds. According to guidelines published last year by Japanese regulator the Financial Services Agency, credit risk assets may be deemed to be equal to the amount of hedge funds held multiplied by 400% in cases where there is a high possibility that the weighted-average risk weight of individual assets will be below 400%. It is 1,250% in other cases.

Shinchiro Shiraki, managing director of Monex Alternative Investments, said hedge funds "need to do their part" and called for funds to offer weekly or monthly net asset value disclosure. But some parties said the costs to hedge funds in terms of systems, not to mention the possibility of giving away details of their trading strategies, would be too prohibitive. An alternative approach might be to use a managed account, or a market could potentially develop for structured funds with principal protection - in the latter case, the credit exposure would be to a AA-rated banking counterparty, thereby easing the 1,250% credit charge.

Disclosure concerns dismissed

Angus McKinnon, a senior partner and fund manager at Tozai Investment Advisory, a small hedge fund, said risk management and disclosure at even small funds is not an overriding concern. "There has been a big increase in the amount of software available to smaller funds," said McKinnon. And Stefan Nilsson, a Tokyo-based associate director in the asset management product sales division at Bear Stearns in Japan, who also runs the Tokyo Hedge Funds Club, said hedge funds were not pulling out of the Japanese market, as many media reports have claimed.

Meanwhile, Akihiro Wani, a partner at law firm Linklaters in Japan and an expert on the new Fiel laws, which are effectively the pre-eminent rules in the country, covering all derivatives instruments, with the exception of commodities and emissions. But delegates expressed deep concerns that the new rules will hamper their structured products businesses in the country.

Many of the views expressed in this article are the those of speakers and do not necessarily represent the opinions of their employers.