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Bank of Japan backs away from ETF buying scheme

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The Bank of Japan’s decision to abandon its ¥6tn ($55bn) annual target for exchange traded fund purchases and to cease buying those tracking the Nikkei 225 or Nikkei 400 raises questions about the future direction of Japan’s ETF market.

The central bank made its widely expected announcement to abandon the target on March 19, adding it would only now buy ETFs tracking the Topix.

However, it said it would retain the ¥12tn upper limit to what it can purchase annually, which it introduced last March as a support measure in response to the coronavirus pandemic.

The BoJ’s total ETF holdings hit ¥47tn last month and the unrealised profit from these purchases reached ¥13tn at the end of January. It became the largest owner of Japanese stocks in early December last year, surpassing Japan’s Government Pension Investment Fund.

This article was previously published by Ignites Asia, a title owned by the FT Group.

Government officials, scholars and market participants have long been urging the BoJ to wean itself from the scheme, calling it “unsustainable” and “with huge demerits”. They have criticised the massive purchasing drive for distorting financial market pricing and trading.

Now some question what the BoJ will do with its ETF holdings.

“What is the BoJ going to do with the ETFs they have bought so far? That is always the trillion-dollar question,” said Jackie Choy, Morningstar’s Hong Kong-based director of ETF research for Asia.

“We have not heard what they would do with the existing holdings. They’ve launched a lending facility, effectively making it more liquid, but that’s not selling the ETFs,” Choy added.

The central bank rolled out a lending facility in June last year through which it can temporarily lend its ETF holdings to market participants. But the programme has struggled to attract investor interest.

Driven by purchases by the BoJ, some of Japan’s broad market ETFs have regularly seen the largest inflows of any locally domiciled products in Asia.

Last year, these included Nomura Asset Management’s Nomura Topix ETF, Nikko Asset Management’s Nikko Listed Index Fund Topix ETF and Daiwa Asset Management’s Daiwa ETF Topix.

The central bank bought ¥6.845tn of ETFs last year. The largest five ETFs tracking domestic stocks reached ¥4.29tn in AUM combined by the end of last year, according to data from the two Japanese securities exchanges.

Among them, the Next Funds Topix ETF and Next Funds Nikkei 225 ETF, which were both launched by Nomura AM, topped the list, with ¥1.44tn and ¥773bn in assets respectively. Nikko Exchange Traded Index Fund Topix, Daiwa ETF Topix and Nikko Exchange Traded Index Fund 225 ranked third, fourth and fifth, with ¥670bn, ¥668bn and ¥361bn in respective AUM.

The BoJ has acknowledged that its buying activity may have had a negative impact on other investors in the ETF space, because how and when it will clean its balance sheet of the ETFs remains the primary concern among global asset allocators when investing in Japanese equities.

Whatever the BoJ decides to do with its ETF holdings, it will “definitely not” offload them, at least not in the near future, John Vail, chief global strategist at Tokyo-based Nikko Asset Management, told Ignites Asia.

“They may slow the pace of buying, but I personally don’t think that they will offload the ETFs they already hold,” Vail said.

Nikko AM surveyed top investment strategists in Japan two weeks ago and the vast majority did not think BoJ would release its holdings in any way that would affect the market for at least the next 10 years.

The central bank’s ETF shopping spree has not done much to encourage greater competition among ETF providers.

“As far as I know, the BoJ has been buying ETFs from funds based on their market share,” Morningstar’s Choy said. “So they are doing it on a proportionate basis to avoid favouring any fund.”

Yasunori Kasai, Asia director of trading desktop at Refinitiv, a London Stock Exchange Group business, said that, if anything, the BoJ’s policy direction change offered hope that the central bank might start to diversify.

“The BoJ tends to buy ETFs that target the entire market, like [those tracking the] Topix index or Nikkei index, and may not have bought many [environmental, social and governance] or thematic ones. But the GPIF and the general market are moving towards the sustainable finance market,” Kasai said.

Kasai added that he had observed that the central bank was purchasing some ETFs with exposure to companies that invest in sustainable development and human interests, although those holdings were still minuscule.

Scrapping the ¥6tn target should not have come as a surprise to market participants. There have been signs that the BoJ was looking for more flexibility in its ETF purchasing scheme since the beginning of the year.

“It’s only been a handful of times they’ve stepped in this year. The BoJ is not even close to hitting the ¥6tn target this year so far,” Nikko AM’s Vail said.

Although it is not an explicit rule, the central bank has tended to step in whenever the Topix index has lost more than 0.5 per cent in the morning session, analysts at Nomura wrote in a February 19 research note.

However, the BoJ did not purchase ETFs on February 18 or February 19 even as the Topix index lost 0.54 per cent and 0.76 per cent on these two days, they said.

*Ignites Asia is a news service published by FT Specialist for professionals working in the asset management industry. It covers everything from new product launches to regulations and industry trends. Trials and subscriptions are available at ignitesasia.com.

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Gensler raises concern about market influence of Citadel Securities

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Gary Gensler, new chair of the Securities and Exchange Commission, has expressed concern about the prominent role Citadel Securities and other big trading firms are playing in US equity markets, warning that “healthy competition” could be at risk.

In testimony released ahead of his appearance before the House financial services committee on Thursday, Gensler said he had directed his staff to look into whether policies were needed to deal with the small number of market makers that are taking a growing share of retail trading volume.

“One firm, Citadel Securities, has publicly stated that it executes about 47 per cent of all retail volume. In January, two firms executed more volume than all but one exchange, Nasdaq,” Gensler said.

“History and economics tell us that when markets are concentrated, those firms with the greatest market share tend to have the ability to profit from that concentration,” he said. “Market concentration can also lead to fragility, deter healthy competition, and limit innovation.”

Gensler is scheduled to appear at the third hearing into the explosive trading in GameStop and other so-called meme stocks in January.

Trading volumes in the US surged that month as retail investors flocked into markets, prompting brokers such as Robinhood to introduce trading restrictions that angered investors and drew the attention of lawmakers.

The market activity galvanised policymakers in Washington and investors. Lawmakers have focused much of their attention on “payment for order flow”, in which brokers such as Robinhood are paid to route orders to market makers like Citadel Securities and Virtu.

That practice has been a boon for brokers. It generated nearly $1bn for Robinhood, Charles Schwab and ETrade in the first quarter, according to Piper Sandler.

Gensler noted that other countries, including the UK and Canada, do not allow payment for order flow.

“Higher volumes of trades generate more payments for order flow,” he said. “This brings to mind a number of questions: do broker-dealers have inherent conflicts of interest? If so, are customers getting best execution in the context of that conflict?”

Gensler also said he had directed his staff to consider recommendations for greater disclosure on total return swaps, the derivatives used by the family office Archegos. The vehicle, run by the trader Bill Hwang, collapsed in March after several concentrated bets moved against the group, and banks have sustained more than $10bn of losses as a result.

Market watchdogs have expressed concerns that regulators had little or no view of the huge trades being made by Archegos.

“Whenever there are major market events, it’s a good idea to consider what risks they might have placed on the entire financial system, even when the system holds,” Gensler said.

“Issues of concentration, whether among market makers or brokers at the clearinghouse, may increase potential system-wide risks, should any single incumbent with significant size or market share fail.”



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European markets recover after tech stock fall

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European equities rebounded from falls in the previous session, when fears of a US interest rate rise sent shares tumbling in a broad decline led by technology stocks.

The Stoxx 600 index gained 1.3 per cent in early dealings, almost erasing losses incurred on Tuesday. The UK’s FTSE 100 gained 1 per cent.

Treasury secretary Janet Yellen said at an event on Tuesday that rock-bottom US interest rates might have to rise to stop the rapidly recovering economy overheating, causing markets to fall.

Yellen then clarified her remarks later in the day, saying she did not think there was “going to be an inflationary problem” and that she appreciated the independence of the US central bank.

Investors had also banked gains from technology shares on Tuesday, after a strong run of quarterly results from the sector underscored how it had benefited from coronavirus lockdowns. Apple fell by 3.5 per cent, the most since January, losing another 0.2 per cent in after-hours trading.

Didier Rabattu, head of equities at Lombard Odier, said that while investors were cooling on the tech sector, a rebound in global growth at the same time as the cost of capital remained ultra-low would continue to support stock markets in general.

“I’m seeing a healthy correction [in tech] and people taking their profits,” he said. “Investors want to be much more exposed to reflation and the reopening trades, so they are getting out of lockdown stocks and into companies that benefit from normal life resuming.”

Basic materials and energy businesses were the best performers on the Stoxx on Tuesday morning, while investors continued to sell out of pandemic winners such as online food providers Delivery Hero and HelloFresh.

Futures markets signalled technology shares were unlikely to recover when New York trading begins on Wednesday. Contracts that bet on the direction of the top 100 stocks on the technology and growth-focused Nasdaq Composite added 0.2 per cent.

Those on the broader S&P 500 index, which also has a large concentration of tech shares, gained 0.3 per cent.

Franziska Palmas, of Capital Economics, argued that European stock markets would probably do better than the US counterparts this year as eurozone governments expand their vaccination drives.

“While a lot of good news on the economy appears to be already discounted in the US, we suspect this may not be the case in the eurozone,” she said.

Brent crude, the international oil benchmark, was on course for its third day of gains, adding 0.7 per cent to $69.34 a barrel.

Despite surging coronavirus infections in India, the world’s third-largest oil importer, “oil prices have moved higher on growing vaccination numbers in developed markets”, said Bank of America commodity strategist Francisco Blanch.

Government debt markets were subdued on Wednesday morning as investors weighed up Yellen’s comments with a pledge last week by Federal Reserve chair Jay Powell that the central bank was a long way from withdrawing its support for financial markets.

The yield on the 10-year US Treasury bond, which moves inversely to its price, added 0.01 of a percentage point to 1.605 per cent.

The dollar, as measured against a basket of trading partners’ currencies, gained 0.2 per cent to its strongest in almost a month.

The euro lost 0.2 per cent against the dollar to purchase $1.199.



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Yellen says rates may have to rise to prevent ‘overheating’

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US Treasury secretary Janet Yellen warned on Tuesday that interest rates may need to rise to keep the US economy from overheating, comments that exacerbated a sell-off in technology stocks.

The former Federal Reserve chair made the remarks in the context of the Biden administration’s plans for $4tn of infrastructure and welfare spending, on top of several rounds of economic stimulus because of the pandemic.

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy,” she said at an event hosted by The Atlantic magazine.

“So it could cause some very modest increases in interest rates to get that reallocation. But these are investments our economy needs to be competitive and to be productive.”

Investors and economists have been hotly debating whether the trillions of dollars of extra federal spending, combined with the rapid vaccination rollout, will cause a jolt of inflation. The debate comes as stimulus cheques sent to consumers contribute to a market rally that has lifted equities to record levels.

Jay Powell, the Fed chair, has said that he believes inflation will only be “transitory”; the central bank has promised to stick firmly to an ultra-loose monetary policy until substantially more progress has been made in the economic recovery.

The possibility of interest rates rising has been a risk flagged by many investors since Joe Biden’s US presidential victory, even as markets have continued to rally.

Yellen’s comments added extra pressure to shares of high-growth companies, whose future earnings look relatively less valuable when rates are higher and which had already fallen sharply early in Tuesday’s trading session. The tech-heavy Nasdaq Composite was down 2.8 per cent at noon in New York, while the benchmark S&P 500 was 1.4 per cent lower.

Market interest rates, however, were little changed after the remarks, with the yield on the 10-year Treasury at 1.59 per cent. Yellen recently insisted that the US stimulus bill and plans for more massive government investment in the economy were unlikely to trigger an unhealthy jump in inflation. The US treasury secretary also expressed confidence that if inflation were to rise more persistently than expected, the Federal Reserve had the “tools” to deal with it.

Treasury secretaries generally do not opine on specific monetary policy actions, which are the purview of the Fed. The Fed chair generally refrains from commenting on US policy towards the dollar, which is considered the prerogative of the Treasury secretary.

Yellen’s comments at the Atlantic event were taped on Monday — and she used the opportunity to make the case that Biden’s spending plans would address structural deficiencies that have afflicted the US economy for a long time.

Biden plans to pump more government investment into infrastructure, child care spending, manufacturing subsidies and green energy, to tackle a swath of issues ranging from climate change to income and racial disparities.

“We’ve gone for way too long letting long-term problems fester in our economy,” she said.



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