Capital, Not Technology Keeps Tokyo Stock Exchange Prices Stable

In the search for a perfect market structure that began after the October 1987 stock market crash, much attention has been focused on the Tokyo Stock Exchange's method of trading. But it would be a mistake to attribute the stability of the Japanese stock market solely to its trading system, according to an expert on Asian capital markets.

Government commitment and surplus capital have played a greater role in keeping prices aloft on the TSE than its method of trading, Anne Cabot-Alletzhauser told a conference on the role of technology in trading and fund management held by the Berkeley Finance Foundation Sept. 26-27 in Silverado, Calif.

Cabot-Alletzhauser said some analysts have suggested the structural problems of the U.S. financial markets could be remedied by adopting three features of the Japanese trading system. These include:

the itayose, a single-price auction trading system that establishes an opening price for each session;

the computer-assisted trading method that matches trades on the basis of price/time priority; and

the saitori members, whose open book provides a clear picture of the market but who are not allowed to trade for their own accounts.

System Less Than Perfect "While the three elements cited would appear to offer much sought solutions to improving market efficiency and minimizing market volatility," Cabot-Alletzhauser said, "in practice, the system is still less than perfect."

Trading can be subject to price discontinuities from order imbalances, order matching can become bogged down when the saitori becomes overwhelmed by a flood of computer-directed orders and existing technology results in delays of more than a minute before order confirmations are received, said Cabot-Alletzhauser, formerly an executive with Sanyo Securities.

The saitori, Tokyo's answer to the specialist, matches buy and sell orders whether trades are executed manually or by the TSE's Computer- assisted Order Routing and Execution System (CORES), said Hideaki Yamashita, director of the TSE's department of international affairs.

For regular auction trading, an order is telephoned from the member firm's office to a clerk on the exchange floor. The clerk uses hand signals to convey the order to a floor representative, who delivers it to the saitori. The order is written down in the saitori's book, which can be seen by the floor representatives.

For CORES trades, an order is entered through a device in the member's firm office and transmitted to the TSE trade room. The order is displayed on an electronic book, which also allows the saitori to match buy and sell orders. Execution reports are sent to a printer in the member firm's office.

Although the saitori's book on the TSE floor is open and can be read by member firm floor representatives, the orders to buy and sell in a stock traded on CORES are displayed only in the TSE trade room, not in the upstairs offices of member firms.

CORES is currently used to trade all issues in the TSE's first section except the most active 150 stocks. Japanese government bond futures and the TOPIX stock index contract, which began trading last month, are also on CORES. In Japan, stocks and futures are traded on the same exchange.

Yamashita told the Berkeley conference that the TSE plans to put U.S. Treasury bond futures on CORES when they begin trading in early 1989. Options on TOPIX and options on yen bond futures as well as less active bonds with equity elements will also be added to CORES during the next two years, he said.

Trading in the 150 most active stocks, the 50 most active equity- linked bonds and all bonds and debentures without equity elements will remain on the floor for the foreseeable future, Yamashita said.

Historically, the most important market participant in Japan has been the retail investor, whom the trading system has served most effectively, said Cabot-Alletzhauser. But now that institutional trading has grown to more than 50% of the market, there "is some cause for concern as to how the system will be able to handle this increasingly sophisticated client base," she said.

A number of Japanese firms have gone offshore to serve the needs of their institutional clients, Cabot-Alletzhauser said. Should the TSE and other Asian exchanges fail to meet the requirements of institutional investors, business will move to foreign securities firms that can facilitate sophisticated trading strategies, she said.