FY2022 Management Strategy Meeting Q&A [PDF:268KB]

FY2022 Management Strategy Meeting Q&A

This presentation may contain forward-looking statements about the Daiwa Securities Group. You can identify these statements by the fact that they do not relate strictly to historic or current facts. These statements discuss future expectations, identify strategies, contain projections of results of operations or of financial conditions or state other "forward-looking" information. These statements are based on currently available information and represent the beliefs of the management of the Daiwa Securities Group. These statements are subject to numerous risks and uncertainties that could cause the Daiwa Securities Group's actual results, performance, achievements or financial condition to differ materially from those described or implied in the forward-looking statements. The Daiwa Securities Group undertakes no obligation to publicly update any forward-looking statements after the date of this presentation. These potential risks and uncertainties include, but are not limited to: competition within the financial services industries in Japan and overseas, our ability to adjust our business focus and to maintain profitable strategic alliances, volatile and sudden movements in the international securities markets, foreign exchange and global economic situations affecting the Daiwa Securities Group.

Date: May 18th, 2022 (Wednesday)

Speaker: Seiji Nakata, President and CEO

Q1. Regarding DX-related IT investment on P30. I believe the target for IT investment can be divided into sales growth and productivity. What are your thoughts and intentions on that at this time?

A1. As you've noted, IT/digital investment can have two goals: raising operational efficiency and productivity within the firm, and raising the bar for external services. We are pursuing both aims.

Consequently, while we are lowering costs through a reform of our cost structure, we are maintaining a high level of IT investment, which naturally involves related expenditures.

For example, we have spent over 15 billion yen in a fundamental overhaul of our systems over the past 3-4 years without regard to the pandemic. We were working at the same time to put all of our ordinary systems onto a public cloud for remote access, so we were able to transition quickly when the pandemic hit.

We plan to continue to invest around 35 billion yen a year in systems. Also, we have a function known as a "reception panel" used by our sales staff to develop new wealth management business models, which we will seek to customize further. For middle and back office work, we will continue our systems investment, such as a gradual transfer of compliance monitoring via AI.

Meanwhile, we need to carry out further cuts in IT costs in order to pursue a reform of our cost structure. That is, we need to keep cutting costs even as we continue to make new investments.

Q2. Regarding P14. Japan would appear to have greater potential for discretionary investment than the US, but the net growth in investment trusts and fund wraps shrank in 4Q FY2021 (January-March 2022) from the previous quarter. In contrast, major US securities firms enjoyed record-high inflows into their managed accounts over the same period. What do you think is lacking in your current efforts to use personal advisors to attract new funds in uncertain times such as 4Q? Is it possible to isolate net earnings and asset growth from market movements?

A2. It is important that we be able to achieve higher net growth in products such as wraps even when the market environment is unfavorable. Unfortunately Japanese securities firms are still highly dependent on brokerages, so a market downturn inevitably leads to slower growth.

However, we are seeing some change. Growth slowed in 4Q, but in our case, fund wraps were up a net 58.5 billion yen during that period, meaning a net increase of some 20 billion yen per month. The quarterly figure was around 35 billion yen during the last market slumps in 3Q FY2018 and 4Q FY2019, so fund wraps have reached a point where they can achieve constant net growth even when the markets are uncooperative. I don't have specific figures, but the total in April exceeded January-March.

Investment trusts, on the other hand, remain a challenge. That said, a closer look shows that while equity investment trusts overall were down a net 5.7 billion yen in 4Q, while asset based fee plan for investment trusts grew by a net 26.1 billion yen.

One reason that asset based fee plan for investment trusts and fund wraps posted net increases was that they are major products in the transition to a wealth management business model. Fund wraps are held for an average of eight years, so we invest in these products with an eye to asset management over a long horizon. Moreover, fund wraps allow for rebalancing and changes in style in accordance with the market climate. Once this approach is established, we can conversely achieve higher new fund wrap sales when the markets worsen and provide guidance such as trying other investment styles.

In the end, I think we have no choice but to accept straightforwardly a wealth management approach based on a medium- to long-term perspective.

Q3. Regarding how the company promotes net asset inflows during market downturns. I understand that at Morgan Stanley and elsewhere, risk analysis services developed over the past several years have contributed to net asset inflows during the pandemic. There was talk at Daiwa Securities about portfolio risk analyses at other firms, but what is your approach to these?

A3. I don't know what tools that Morgan Stanley uses for its risk analysis, but we use a tool called Wealth Bench in our asset management planning, which incorporates risk analysis software. We make use of this asset management planning tool for individual Japanese investors. We consider this a necessary and sufficient condition for this investor class.

Japan is still in a transitional phase in the shift to a wealth management approach. We were relatively early, working on this now for five years. I mentioned that we have analyzed 18 trillion yen in assets using our asset management planning tool, but it's only been around a year and a half since we started. By looking at even greater number of assets, I think the risk analysis function of our asset management planning tool will work effectively even in a correction phase as at present.

Q4. Regarding the use of surplus capital. Could you update us as to the extent of the capital ratio that you anticipate with the finalization of Basel III, as Nomura Holdings did at yesterday's results briefing?

A4. The consolidated capital adequacy ratio at the end of December last year was 19.67%, as per our official release. As I noted earlier, the 11% minimum regulatory requirement plus a 3% buffer for stress test losses gives us 14%. We have added to that another 4% buffer, maintaining a minimum of 18% as a financial KPI.

We are currently refining this figure in line with the application of the Basel rules and estimate that it will decline 3-4%.

However, the rules will be phased in for equity risk assets in a process lasting through 2029, so the results will depend on how the portfolio changes once Basel is fully applied.

There will be surplus capital at that stage, as you point out. However, we invested about 100 billion yen per year or some 300 billion yen over the three years of the previous Medium-Term Management Plan, whereas the present plan calls for 50 billion yen annually or 150 billion yen in three years. In particular, the present plan seeks to lay the groundwork for greater returns from hybrid businesses with a focus on Real Estate Asset Management and Daiwa Energy & Infrastructure. Therefore, the investment amount will be somewhat less than under the previous Medium-Term Management Plan.

That does not mean, however, that we will not pursue other investments. We have made considerable investments already; those of over 10 billion yen alone include Global X, Samty, Katana, IP Bridge and Aquila Capital. In addition to hybrid projects, we have been approached with a number of projects close to the financial business and are considering several of these.

We have no intention in making any significant change to the main framework of our three-year 150 billion yen (annual 50 billion yen) investment, keeping our focus on Daiwa Energy & Infrastructure and Daiwa Real Estate Asset Management. Time is money when it comes to investment, and a missed opportunity will not come back. The company has a high consolidated capital adequacy ratio and can issue AT1 bonds and such for large-scale acquisitions. Our thinking is that we are open to investment ideas and will not rule out anything right away.

Q5. The finalization of Basel has presumably made it easier to identity the amount of your surplus capital. Has there been any change in your stance on investment and acquisition of treasury stock?

A5. Once Basel has been elaborated to some extent, the 3-4% buffer will be removed, which should help us better identify the amount of surplus capital. However, we do not intend to change our stance on treasury stock acquisition, though that may be a textbook approach.

As we are a D-SIB financial institution, we have an absolute duty to protect our capital adequacy ratio and must deal with anything above that from the standpoint of capital efficiency.

Whether it is better to return cash to shareholders or give priority to investment will depend not only on regulatory needs and ratings but on our assessment regarding investment at the time. It is our understanding that the balance between investment and return will vary somewhat depending on circumstances.

Q6. Regarding capital. Is it your contention that the total return ratio will not change even if a buffer is retained for regulatory reasons?

A6. Shareholder returns have a dividend payout ratio of over 50%, but we have not set a target for total returns.

Our policy is to aggressively return surplus funds to shareholders as long as our regulatory capital response is adequate, taking into account the balance with investment. Consequently, the total return ratio came to 77.6% in FY2020 and 78.4% in FY2021, but the figure in FY2018 was 106.9%. Our capital ratio is high, and there is no situation in which we will not carry out share buybacks. The total return ratio changes in accordance with the balance between profits and investment.

Q7: You say that customer satisfaction has improved in the Retail Division. Does that include the latest results through the end of FY2021?

A7. I think the question is whether the results reflect the rise in US interest rates since last year-end and market corrections following the Ukraine situation. The figures incorporate the 4Q results and are expressed as an average for FY2021. NPS peaked in 3Q and slipped modestly in 4Q, but our efforts have brought this back to the same level as at the start of the fiscal year. Despite some fluctuations, the figure has basically trended steadily higher. The average value includes the situation in 4Q, when the market suffered a downturn, but the NPS score remained positive.

Q8. Regarding the rise in retail foreign stock holdings on P20. Trading return data indicate that foreign stock transactions fell in 4Q. Have they recovered, and is buying on the rise?

A8. A greater focus on foreign equities is part of the main framework of our medium- to long-term strategy. The figure fell sharply in 4Q under the strong impact of the short-term market momentum, but picked up again in April and May. While the momentum in the index has not yet returned, we suspect that the markets will move to discount a faster rate hike pace in the US. The situation in the Ukraine is unpredictable, but the US is clearly superior in terms of military power. We basically expect an upturn ahead in both the NY Dow and Nasdaq. Despite the slow performance at present, I think we should continue to focus on foreign stocks based on our market assumptions.

Q9: You say on P12 that you are working on development of consulting tools and customer solutions, but the volume of AUC transferred to Daiwa as a result seems rather modest in monetary terms. Do you think consulting and planning tools will be sufficient on their own to attract more AUC from customers?

A9. The analysis total among asset management planning tools is 18 trillion yen, including 8.2 trillion yen in assets of other firms. This is still a small portion of the assets both at our group and other firms.

That 18 trillion yen is a mixture of analytic styles, including assets that were analyzed only once and those analyzed many times, and not all of the 18 trillion yen was analyzed. Even so, 450 billion yen in assets were introduced through asset management planning, which is hardly a small figure.

We will work to promote the inclusion of assets of other companies by further increasing the analysis volume and deepening our analysis.

In addition, I mentioned that about half of our customers purchase investment trusts for the first time through asset based fee plan for investment trusts. I think this is testimony that customers are looking for new products such as asset based fee plan for investment trusts and tools for consulting on total asset management.

Japan has only just shifted to a wealth management business model. If we proceed in a way that meets customer needs, we can encourage a shift to securities not only among those trading with other companies but those who are starting to invest anew.

At the risk of sounding boastful, I believe we offer the best tools at this stage. However, with other companies developing new tools as well, I think it is essential that we broaden our base of customers seeking asset formation services.

Q10. There was no mention of ROE at the briefing, but the performance KPI in the last Medium-Term Management Plan was 10%. I think the latest plan also calls for a 10% ROE, but can you update us on that?

A10. I purposely did not touch upon a 10% ROE, but assuming our ordinary income target remains intact at 200 billion yen in FY2023, we have effectively set a ROE of over 10%. An ROE of over 10% remains a key KPI in our Medium-Term Management Plan.

Q11. Regarding ROE. If you were to earn an ordinary income of 200 billion yen, I believe net income would come to around 150 billion yen. Core capital at the end of last fiscal year totaled nearly 1.7 trillion yen, so even if 100% were lost externally, the figure suggests that ROE would exceed 10%. Please tell me if my calculation or assumption is wrong.

A11. An ordinary income of 200 billion yen would generate a net income of around 140-150 billion yen.

The targets in the Medium-Term Management Plan are extremely important, but we have no intention of carrying out nor have we ever carried out a technical buyback simply to protect the 10% ROE figure.

We estimate that shareholder capital totals 1.4-1.5 trillion yen. If net income is 150 billion yen, ROE would thus be around 10%.

Q12. You did not touch upon crypto or DeFi (decentralized finance). Does that mean you are not active in those areas?

A12. The subject doesn't come up often in the media, so Daiwa Securities is unfortunately seen as uninterested in cryptocurrencies. Cryptocurrencies and NFT-related initiatives are mainly dealt with in Daiwa Securities Group's Corporate Planning Department and a subsidiary called Fintertech.

Fintertech aims to become a crypto bank (bank dealing with digital assets) and has offered a money lending service that accepts cryptocurrencies as collateral since March 2020. We are the only major Japanese company that offers cryptocurrency-backed loans.

In addition to Bitcoin, we become the first in Japan to begin accepting Ethereum as collateral in February this year.

Through Fintertech, we seek to make further inroads into crypto-bank functions like cryptocurrency-based deposits and lending.

The cryptocurrency mortgage loan business requires know-how, financial power, and creditworthiness, and is difficult for venture companies to enter even if they handle the cryptocurrency business. A number of venture firms were operating in the past but have since pulled out.

As for STO, Daiwa Securities actually worked as lead underwriter for placement of asset-backed security tokens by originator Kenedix, and participated as an employee when the Japan STO Association was established. We also participate in the Digital Currency Forum hosted by DeCurret Holdings and are investors in the Osaka Digital Exchange.

I don't know how fast or how large this field will grow, but I believe it has the potential to be a financial platform. We will respond appropriately.

Q13. Regarding the Retail Division. A statement on the right-hand side of P12 says the analysis results from the asset management planning tool come to 18 trillion yen. How much do you expect that to grow over the next five years? How much of Japan's 2,000 trillion yen in financial assets are you targeting? All major financial institutions are making similar efforts, but how many of the assets to be analyzed do you expect to secure?

A13. The asset management planning tool was not introduced at once at all branches. It was launched at several pilot branches and gradually became familiar to the sales staff. Considering that the analysis results reached 18 trillion yen in just one-and-a-half years, including the testing period, we assume that growth will be even faster in the coming years with the entire sales staff now able to use the tools.

We have no specific target at present for analysis results.

Any discussion of the future is mere speculation, but the volume of current results suggests that we can expect a total of 60 trillion yen in five years' time, with 2 trillion yen in assets of other companies. Therefore, along with net asset inflows in our Retail Division and through other measures, another 2 trillion yen will be added through use of our tools.

A figure of 2 trillion yen over five years may not be a very large amount, but it should not be underestimated. In the future, when the use of tools for net asset inflows becomes established, I feel personally that we can begin to set a target value for the net asset inflow volume.

Q14. On P18, what points have you noticed in the process of deepening your alliances with regional financial institutions? Please tell us what you believe Daiwa Securities can achieve by forming a partnership that it cannot accomplish alone and other advantages for your company from such alliances.

A14. Our company specializes in securities, while regional financial institutions specialize in banking. There are areas in which we simply cannot imitate each other. I feel firmly that we can complement each other's strengths by forming a partnership.

We can achieve a considerable synergistic effect by tailoring our know-how to customers in other industries. We do not believe that such effects are possible through alliances with other companies in our own industry.