Tokyo system errors underscore decline in Japan’s equity market

Derivatives trading was offline for 95 minutes

System, error, digital, computer, technology System, error, digital, computer, technology

Aug. 8 (Bloomberg) -- The Tokyo Stock Exchange Group Inc.’s second major system error in seven months took derivatives trading offline for 95 minutes and underscored the challenge Japan faces to revive its reputation as a global equity hub.

Share trading volumes fell, government bonds dropped and index-futures traders were diverted to Tokyo’s smaller Osaka rival during the halt, which lasted from 9:22 a.m. to 10:55 a.m. local time. The error was compounded by a failure of backup systems similar to that which caused the biggest disruption in six years on Feb. 2, said Hiroaki Uji, director of trading systems at the bourse.

The outage, which affected stock-index and government-bond futures and options, is a further setback for the Tokyo exchange as it pursues a takeover bid for the Osaka bourse, which dominates Japan’s equity derivatives business. The breakdown also highlights the vulnerability of global markets to computer malfunctions, a week after errors at market-maker Knight Capital Group Inc. led to wrong trades for more than 100 U.S. stocks.

“They need to get to the bottom of this fast or people will lose faith in Tokyo trading,” said Ayako Sera, a market strategist at Sumitomo Mitsui Trust Bank Ltd., which has 33 trillion yen ($421 billion) in assets. “Fortunately, the error took place when the market was quiet. If a system glitch happens when the market’s busy, say, with the release of GDP data, and we can’t measure the market with JGB futures. That would be a mess.”

Earnings Peak

This week is the second-busiest for earnings on the 1,672- company Topix Index, which has lost 74 percent since a 1989 peak. Japan, the world’s No. 2 equity market by value, has played host to $1.67 billion in initial public offerings this year, just 2.1 percent of the global total, according to data compiled by Bloomberg.

Japan’s reputation as a financial hub has been battered as more than two decades of equity losses and economic stagnation have combined with corporate governance scandals. Poor management at Tokyo Electric Power Co. was blamed in part for last year’s nuclear disaster, while senior board members of Olympus Corp. were found to have hidden losses through inflated fees after they fired whistle-blowing president Michael Woodford in October.

The initial error took place somewhere in the Tdex+ system used for derivatives at the bourse, not Arrowhead that handles cash equity transactions, Hiroki Kawai, director of information technology planning and corporate strategy at TSE, said. The exact nature of the first problem or its cause were still unknown, he said at a 7:45 p.m. press briefing yesterday in Tokyo. A switch that was supposed to automatically activate backup systems didn’t work. A failure of backups was blamed for the February crash as well.

‘Shouldn’t Happen’

“This shouldn’t be happening at all, and it’s a risk for investors that they can’t trade when they want to,” said Kazuyuki Terao, chief investment officer of RCM Japan Co. RCM oversees about $153 billion globally. “A system error happened earlier as well, and I have to have reservations about what’s going on.”

Volume on the Topix Index was about 20 percent below the 10-day average for the time of day when derivatives resumed trading. Average daily turnover for futures on Japan’s broadest measure of stock performance was 737 billion yen ($9.42 billion) in June, the Tokyo bourse said. Volume for the day was 12 percent below the 10-day average.

“The failure of Topix futures reduced the number of people doing index arbitrage,” said Naohide Une, head of equity derivatives trading at Goldman Sachs Japan Co. “That’s why the system error is not only affecting futures, but making cash- equity trading thinner. I thought lower volume could cause unusually big moves in stocks, but what actually happened was market participants were holding back trading.”

Trading Osaka

The breakdown diverted investors to Osaka, the only place in Japan where contracts on the benchmark Nikkei 225 Stock Average are traded, said Yuji Nakagawa, manager of derivatives trading at Toyo Securities Co. in Tokyo. Osaka Securities Exchange Co. reported daily average turnover of 1.29 trillion yen in contracts and mini contracts on the Nikkei 225 during June.

“It just prompted people to buy back short positions on the Topix using Nikkei 225 futures, because Nikkei 225 futures and cash are still being traded,” said Toyo Securities’ Nakagawa. “I haven’t seen a major effect.”

The Tokyo exchange reported an average of 45,537 10-year JGB futures changed hands during June. An auction of 40-year Japanese government bonds went ahead as scheduled. Yields on the 10-year JGB climbed as much as three basis points while the futures-trading halt was in force. The bonds extended losses after the lunch break.

“Because investors can’t sell futures before today’s auction, bonds are susceptible to selling for hedging,” said Okasan’s Suzuki, before trading was resumed. Okasan is one of the 25 primary dealers obliged to bid at government debt sales.

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