TOKYO, March 30: Many Japanese financial firms preparing for tougher competition after "Big Bang" deregulation are eyeing a new type of financial derivative product called equity swaps.Equity swaps could become another prosperous Japanese derivatives market, emulating the success of foreign exchange and fixed-income derivatives, brokers and bankers say.
Equity swaps are commonly traded in major markets worldwide, but legal technicalities have hindered their development in Japan.
The government is seeking to allow trading of equity swaps as part of Big Bang market liberalisation, so pending parliamentary approval they will likely debut in Tokyo later this year.
Japan will start to implement a series of steps on April 1 aimed at liberalising its financial markets through a Big Bang reform to make them "free, fair and global" by 2001.
An equity swap is a transaction in which fixed- or floating-rate interest payments can be acquired in return for covering the price fluctuation of equity holdings at alater date.
Bankers and brokers say equity swaps could be useful in hedging the downside risk of share prices.
Many Japanese companies own shares in other companies as tokens of their close relationships as well as a method of stabilising ownership.
But the recent poor performance of the Tokyo stock market has seen share values plunge and caused many companies to rethink the practice of cross-shareholding.
Some companies are inclined to sell the shares they hold, but fear of souring their business relationships with other companies holds them back.
Equity swaps could address the needs of these companies, bankers and brokers said. By exchanging an obligation on the future change in stock prices for a more stable interest rate, a company could enjoy an effect similar to selling stocks and buying bonds.
"There may be a lot of people using equity swaps to try to hedge price risk of shares they hold for business reasons," said Masashi Namatame, a manager at the financial engineering and derivativesdepartment of Long-Term Credit Bank of Japan Ltd.
"Using equity swaps, you can separate ownership of stocks from their price risk. I think there will be strong demand for hedging downside risk of stocks without actually selling them," he said.
On the other hand, investors also have much to gain from equity swaps, bankers and brokers said. As it is an over-the-counter (OTC) transaction, it is possible to create a product tailor-made to investor needs.
"It is possible to create a product for hedging stock price risk up to a point of time so far ahead that such futures contracts do not yet exist in exchanges," said Yasuhiko Matsunaga, joint general manager of the derivatives and fixed income department at the Industrial Bank of Japan Ltd.
"Some American pension funds use equity swaps often," said Tetsuo Ochi, managing director of the structuring department at Credit Suisse Financial Products (CSFP).But many bankers and brokers said whether the equity swaps market becomes a third pillar of derivatives inJapan depends largely on liquidity of the market.
One fund manager at an investment advisory company said:"I'd like to wait for a while and see if the market becomes liquid. If it does, and efficient investment is possible, I'd be ready to join the market."
If the market obtains liquidity, even individual investors might be able to tap into it, said Ochi of CSFP.
"In the future, someone might sell products incorporating equity swaps to individuals, something like stock index-linked deposits," he said.
Ochi said mutual funds and insurance companies could also use them. "If you come up with a mutual fund with the price linked to a stock index, while guaranteeing principal, you might pick up a lot of investors' money that has nowhere to go because of recent low interest rates."
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
