Every second counts, as they say. But in the fast-paced global financial markets, a second feels like an eternity. It’s milliseconds that are important now, a fact not lost on the Tokyo Stock Exchange, which launched a new trading system at the start of the year.

Arrowhead, as the platform is known, brings the TSE’s infamously creaking trading systems into the modern age. Indeed, it puts the market at the forefront of trading technology, on a par with the financial markets of New York and London.

The upgrade was badly needed. The antiquated nature of the TSE’s error prone former system was badly exposed in 2005, when a typing error by a broker at Mizuho Securities caused a botched trade and huge losses. The firm accidently tried to sell 610,000 shares in a company for one yen each, when it meant to buy one share for 610,000 yen. The TSE recently paid $121m in damages to compensate the firm.

Just a year after the Mizuho mistake, massive selling in the shares of one company overloaded the TSE’s systems, forcing the market to cut its trading day by 30 minutes for three months. Such errors are unacceptable for a share market that is second only in size to NYSE.

Superfast
Arrowhead should make problems like these a thing of the past. The automated system can process trades in five milliseconds, rather than the two or three seconds required previously. That 600-times acceleration in trading speed makes a huge difference. As the proportion of investors using computer-driven, automated dealing strategies continues to grow, execution speed is critical.

Such trading is now common in the US and Europe, where hedge funds and sophisticated investors try to exploit tiny spreads and market imbalances. But super-fast algorithmic trading has been slower to catch on in Asia. Only one in ten of the global financial firms that use high-frequency trading strategies are active in Tokyo, according to an analysis from Celent, the market research and consulting firm. Sniffing out the chance to seize a corner of this market, smaller, independent proprietary trading platforms have started to pop up, offering Asian investors the same opportunity to trade at speed. The launch of Arrowhead means that investors can now use their super-fast strategies on the TSE.

The Arrowhead system cost $140m to develop. When launched in January, it could handle over four million orders a day, an increase of around 70 percent on previous capacity. For now, capacity is scaled to handle twice the number of orders seen during peak times. But if needed, trading capacity can be expanded further within a week. To ensure business continuity, the system runs across 200 servers, housed in three separate locations.

Arrowhead increases both response times for order acceptance notices and the time taken to distribute stock prices and quote information.

The TSE made other important changes when it introduced Arrowhead. A sister system, called FLEX Full, provides accelerated market information and enables the TSE to significantly expand the content of market data provided to users. For example, the number of quotes disseminated to traders has increased from five to eight above and below the central price. All order book data is now provided in real-time.

The TSE has also changed some of its trading rules in an effort to promote smooth execution, better price discovery, and greater market liquidity. For example, the TSE is eliminating half-days, revising the price limits on bids/offers and quote renewals, and reducing tick sizes – the smallest increments by which a stock can move. Investors can now buy or sell Sony shares at one yen intervals, rather than five, for example.

Efforts to modernise the TSE go beyond improvements to its trading system; it is also introducing corporate governance reforms aimed at making the market a safer environment for investors.

Investor-friendly?
Corporate governance is hardly a new issue on the TSE’s strategic agenda. It issued a set of corporate governance principles for its listed companies in 2004 followed by a report on governance two years later. However, as a report that it issued on the topic last year noted, “Past efforts for improving and enhancing corporate governance in Japan are questioned to be genuine: an increasing number of listed companies have taken corporate activities which seriously damage the shareholder interests.”

It continued, “Under such circumstances and amid falling stock prices worldwide due to the recent financial crisis, some point out that investors are rapidly losing confidence and interest in the Tokyo market, and that our country as well as the market players including the listed companies are facing an urgent need to restore investor confidence and interest.”

To that end, the TSE created an advisory group to recommend a series of reforms that would improve the quality of corporate governance among Japan’s listed companies. It published a series of recommendations in April 2009 focusing on improving the rights of shareholders and encouraging better dialogue between listed companies and their shareholders.

The review said that the TSE should require listed companies to provide a more detailed explanation to shareholders if they want to make an additional private placement of shares, for example, as this might not be the best means of raising new capital and would dilute existing shareholders. It said that the TSE should ban private placements that dilute existing shareholders by more than 300 percent, as they “extremely or even unreasonably impair the rights of existing shareholders and materially affect market credibility.”

The review said the TSE should put investor protection measures in place to review transactions with shareholders who own a controlling stake in a company or those in which some investors receive new shares on especially favourable terms. And the review said the TSE should require that companies confirm and disclose the financial position of parties to whom they allocate shares under a private placement. It also called for the TSE to prevent reverse stock split issues that unfairly dilute the interests of some shareholders. “Listed companies are expected to respect their shareholder interests as much as possible,” it said.

On improving dialogue with shareholders, the review noted that “exercise of voting rights is the foundation of corporate governance” and, therefore, the TSE needed to make it easier for companies to use those rights. It said the TSE should create a system so that shareholders can get easy access to voting results, for example.

Regulatory action
The review group’s recommendations were well received, and Japan’s securities regulator, the Financial Services Agency, passed new rules recently requiring companies with a listing in Japan to disclose more information about their corporate governance practices and how much they pay their directors.

The new disclosures are aimed at giving investors more of the information they need to hold companies to account. Previously, Japanese companies were allowed to withhold information that would be taken for granted in, for example, the US and the UK.

Companies will have to reveal the names of any directors earning more than Y100m and give a breakdown showing salary, bonus, stock options, and pension payments. The same applies to “statutory auditors”, who are the Japanese equivalent of non-executive or supervisory directors.

Companies will also have to disclose the roles of their independent directors, whether they have any financial or accounting expertise, and the details of their relationship with the company’s internal audit function.

The FSA also wants to make companies report more about the outcome of resolutions put to their annual shareholder meetings. Currently, Japanese companies only have to report if a resolution was passed or not. In future, they will have to reveal the number of votes cast for or against and the number of votes withheld.

More detailed voting disclosures, “will give a clearer picture of the decisions made by shareholders, which will entail a better functioning of the market pressure over the management,” the FSA said.

Strategy
It’s important that the TSE gets Arrowhead and its other reforms right. The exchange suffered years of decline after Japan’s asset bubble burst in 1989 and was hit hard by the financial crisis. But the market has bounced back over the last 18 months, and trading volumes hit a record of 563.7bn shares in 2009.

There are plans to turn the TSE itself into a public company, via an initial public offering. Advisors were appointed years ago, but the float was put on ice after those trading system problems in 2005. There were plans to go for an IPO again last year, but the financial crisis lead to them being postponed. The latest talk is for an IPO some time this year.

When the TSE launched Arrowhead in January, its president, Atsushi Saito, said, “we will do our best to make the exchange a global financial centre.” It its reforms are successful and the IPO gets away safely, the TSE will be well on its way to achieving that goal.