Q&A at 1Q FY2022 Telephone Conference [PDF:232KB]

Q&A at 1Q FY2022 Telephone Conference

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: Friday, July 29th, 2022

Speaker: Eiji Sato, Executive Managing Director, CFO

Q1. My question is regarding the Market Division. You explained that customer transactions declined and that you struggled with position management. Regarding the latter, can you tell me what issues occurred in relation to equity and FICC. Looking at the US and other companies that released earnings today, overall trading for equity and FICC were favorable when excluding credit. Please discuss what types of issues exist and what measures you took to address them.

A1. Both customer order flow and position management declined. Although it is difficult to separate flow and position, a general summation would be to say that, while both decreased significantly compared to the previous quarter, of the declines for equity, flow represents 60 percent and position represents roughly 40 percent. On the other hand, looking at FICC, flow represents roughly 20 percent and position represents roughly 80 percent. As this suggests, declines from position management represent the major factor behind decreased revenues.

As contributing factors, equity saw decreased customer order flow due to the impact of market deterioration. Additionally, some of our derivative position hedging proved ineffective due to the drop in US and Japanese stock prices and dramatic fluctuations in interest rates and foreign currency exchange rates. As a result, we recorded losses.

With FICC, widening of credit spread made hedge management difficult, resulting in losses associated with our position management. Additionally, we struggled due to trends in derivatives for interest rates and foreign currency exchange that diverged from market assumptions. The market was extremely difficult, resulting in incredibly severe results for the first quarter.

However, this has not been the case since July, and we project improvement in our position management.

For overseas business, we are not involved in primary of credit in the US. We are expanding revenues mainly on treasury, repos, and MBS. We think our involvement in primary had a significant impact on earnings.

Our business revolves around customer order flow. At our overseas sites, our business model is not rooted in generating revenues based on our own position. This is one of the ways in which differ from other companies.

Q2. Looking at monitoring results from the FSA and other reports on FICC, we are seeing some harsh expressions being used in relation to structured bonds. Is there a possibility there could be some sort of impact on future trading related to structured bonds?

A2. Structured bonds are a product that responds to the needs of customers seeking income revenues. At the same time, these are complex products that carry significant risks, such as being packaged with options. We have always recognized the need for a careful sales approach.

With this topic being covered in the Progress Report on Enhancing Asset Management Business and the Japan Securities Dealers Association having published a warning letter concerning solicitations for structured bonds, we do understand that this is an important issue.

During sales activities for structured bonds, it is important to promote appropriate product design based on customer needs and to make proposals to customers suited for the characteristics of the product, instead of simply attempting to customer needs. Reinforcing these processes is important.

We have always maintained a policy of ensuring we ascertain customer needs, thoroughly explaining product characteristics, and clarifying the customers to target for solicitation.

As far as the future of the structured bond business is concerned, although I cannot say those issues will have no impact whatsoever, I can say that we have always employed an appropriate sales structure. Moving forward, we will continue working to provide the appropriate products proposals to customers we deem suitable for the characteristics of those products.

Q3. How is July momentum for the Retail Division?

A3. We feel there is strong need for fund wraps, the core product of our asset-based revenues. Both contract amounts and net increases are maintaining the strong momentum seen in the first quarter.

TSE transaction amounts for July are down by roughly 20 percent compared to the monthly average for the first quarter. This indicated that while sentiment is gradually improving, the market is not at a point of flow recovery.

Although stock-based revenues have been extremely strong, the market is not currently showing signs of strong recovery in flow. However, we believe that Retail Division revenues will recover once the market environment settles and we begin adding transaction revenues in addition to asset-based revenues.

On the subject of costs, we are beginning to see the benefits of revenue restructuring and intend to maintain this pace to aim for further benefits.

Q4. My question is about cost management. While you are controlling costs overall, it appears that overseas bonuses are increasing due to the impact of foreign currency rates. Although domestic costs are decreasing, how do you intend to manage costs overseas amid inflation and rising personnel costs?

A4. Comparing consolidated costs to the same period of the previous fiscal year, SG&A increased by roughly

2.4 billion yen but impact of foreign currency rates accounts for increase of 2.8 billion yen. So excluding this impact, costs actually decreased by 0.4 billion yen.

Foreign currency rates are having a significant impact on increases in overseas costs, but revenue is also similarly increasing. Local personnel expenses are linked to inflation but we intend to make improvements by expanding revenues or by securing and retaining personal capable of better even performance.

At present, we are not considering significant increases to the number of personnel overseas.

Moving forward, M&A will become the core of the overseas business. This is a domain with low capital requirements. Compared to the previous fiscal year, the market overall did see a drop in the number of M&A and deal amounts but our pipeline is trending on a level similar to FY2021, when we reached a record high. Excluding some extraordinary market turn for the worse, we believe we can convert these talks into completed deals and revenues.

Q5. Please explain why hedging was ineffective for GM. Typically, a company would calculate delta, gamma, kappa, etc., and hedge using futures or options. Was this the result of a rapid rise in market volatility causing sensitivity and option price trends that differed from expectations?

A5. As you suggest, derivatives are subject to various risk factors. We engaged in dynamic hedging to hedge against our position but conditions have made it difficult to completely hedge our position.

Amid such conditions, looking at the current quarter, we have seen a dramatic decrease in options transactions and other flow used for hedging. The resulting lack of liquidity has caused an increase in volatility and trends that differed from our assumptions.

With credit, we use CDS to hedge against our calculated risk exposure but we have not been able to completely hedge against our position. This quarter resulted in significant mismatches.

Q6. Regarding the impact of the increase in the credit spread within FICC, is it fair to assume that domestic FICC are facing difficult conditions? Did you record losses on a specific issue or sector, or are conditions simply difficult overall?

A6. In Japan, the credit spread is widening overall but this is not due to any specific stock.

Q7. Looking at the first quarter, it seems that you were late in establishing your hedge position and were unable to match in certain areas. It also appears that liquidity did not meet your price assumptions. Is it fair to assume that the market for since July has returned to normal and that revenues will return to previous levels on their own? Or, will conditions from July onward remain severe? How should we view market shifts since July?

A7. Volatility since July has calmed down and we have identified the reasons for the decline in performance. As such, we are currently adjusting our risk exposure to appropriate levels.

Liquidity is also returning. Although I do not know to what extend we can regain position revenue, we do feel that this will trend towards recovery.

Q8. How should we view stable revenues for the Retail Division from the second quarter onward? There was significant market correction in the first quarter but I am concerned about the potential that we could later see a delayed negative impact.

A8. Stable revenues will increase if AUM increase. Looking at June, we saw a net increase in contract amount of fund wraps of roughly 30 billion yen. As long as this trend continues, we believe we will see steady growth in stable revenues.

We were unable to significantly increase AUM of investment trust during the first quarter but we continue to record net increases for the asset based fee plan for investment trusts. Once the market settles, we expect to see unallocated capital used for purchases, which will lead to increases in asset-based products.

As a forecast for the second quarter onward, we are expecting a significant and steady increase.

Q9. In relation to GIB, what is the status of your pipeline for ECM and DCM?

A9. There were no listings of insolvent companies during the first quarter and current conditions make large- scale procurement difficult. ECM, particularly IPOs, mainly saw domestic offerings for mostly profitable companies projected to see stable growth in the 2 to 3 billion yen range.

We have adequate pipeline focused on the second half the fiscal year. As seen with the latter half of the first quarter, we are seeing multiple cases of companies increasing their shares during the offering period.

As for DCM, compared to the fourth quarter of the previous fiscal year, which was significantly impacted by market turbulence, this first quarter has seen an increase in offering amount. However, offering amount are still down compared to the first quarter of the previous fiscal year. This is mainly from postponements or cancellation of offerings due to interest rate hikes in the US triggering a hike in domestic interest rates, and a decline in the situation in Ukraine.

However, there is a constant need for corporate bond procurement, we are seeing an increase in debt procurement related to M&A, and deals are growing in size. As such, we anticipate a relatively high level of bond issuance will continue during the second quarter and beyond.