Tokyo Stock Exchange Shakeup May Trigger Increase in Mergers and Acquisitions

A plan is being considered to reduce the number of markets in the Tokyo Stock Exchange (TSE) from five to three, forming a “prime” segment for the biggest and best-governed stocks.

Such a move would potentially cut the number of companies in Japan’s bloated benchmark index. The Tokyo Stock Price Index (Topix) currently has more than 2,100 firms. Many of those companies are small with illiquid stocks and therefore hard to trade.

Financial Services Agency proposed TSE update

Market regulator, the Financial Services Agency, has proposed that the exchange should have three markets — prime, standard and growth. It is now considering the criteria for each of these markets, including the minimum market value.

If Topix index membership is reduced to a level in line with the S&P 500 index in the U.S., we could see passive funds selling companies that drop below requirements.

The size of a firm would then become a priority for attracting stock investment, leading to an increase in mergers and acquisitions by smaller companies wishing to maintain a position in the top guage.

FSA chief, Toshihide Endo’s plan would give international investors an easy way to buy and sell the most prestigious Japanese corporate stocks. This could lead to a possible rise in equity valuations and have a knock-on effect for all businesses in the Japanese stock market.

Past changes to the Tokyo Stock Exchange

The overhaul will mark the biggest change for investors in Japan’s $6.3 trillion stock market since the Tokyo exchange was restructured into the first and second section, for large- and medium-cap companies, respectively.

Then in 2013, a merger between the Tokyo and Osaka exchanges caused duplication among markets, including multiple venues for smaller shares.

The TSE’s current first section – which includes the companies in the Topix – allows unlisted firms to list there directly if they have a market cap of at least ¥25 billion ($228 million).

At $454 million, the median market value of companies in the Topix is low compared to the $23.8 billion for firms in the S&P 500. The smallest stock in the Topix has a market cap of just $23 million while its equivalent in the U.S. is valued at $3.7 billion.

Why is a first section position desirable?

Japanese companies value a listing in the TSE’s first section as the prestige makes it easier for them to recruit employees and get access to credit.

However, with listing standards being low, the first section has a lot of small-cap stocks and companies with little trading in their shares. That makes it difficult for index funds tracking the Topix because investors often struggle to tell the difference between the first and second sections.

Do you follow stocks on the Tokyo equity market? Please share your thoughts on the proposed changes in the comment section below.