Chapter 14 Outline

Merrill Lynch in Japan

Merrill Lynch is an investment banking titan. The US-based financial services institution is the world's largest underwriter of debt and equity and the third largest mergers and acquisitions advisor behind Morgan Stanley and Goldman Sachs. Merrill Lynch's investment banking operations have long had a global reach. The company has a dominant presence in London and Tokyo. However, Merrill Lynch's international presence was limited to the investment banking side of its business until recently. In contrast, its private client business, which offers banking, financial advice, and stock brokerage services to individuals, has historically been concentrated in the United States. This is now changing rapidly. In 1995, Merrill Lynch purchased Smith New Court, the largest stockbrokerage in Britain. This was followed in 1997 by the acquisition of Mercury Asset Management, the United Kingdom's leading manager of mutual funds. Then in 1998, Merrill Lynch acquired Midland Walwyn, Canada's last major independent stockbrokerage. The company's boldest moves, however, have probably been in Japan.

Merrill Lynch started a private client business in Japan in the 1980s, but met with limited success. At the time, it was the first foreign firm to enter Japan's private client investment market. The company found it extremely difficult to attract employee talent and customers away from Japan's big four stockbrokerages, which traditionally had monopolized the Japanese market. Plus, restrictive regulations made it almost impossible for Merrill Lynch to offer its Japanese private clients the range of services it offered clients in the United States. For example, foreign exchange regulations meant it was very difficult to sell non-Japanese stocks, bonds, and mutual funds to Japanese investors. In 1993, Merrill Lynch admitted defeat, closed its six retail branches in Kobe and Kyoto, and withdrew from the private client market in Japan.

Over the next few years, however, things changed. In the mid-1990s, Japan embarked on a wide-ranging deregulation of its financial services industry. This led to the removal of many of the restrictions that had made it so difficult for Merrill to do business in Japan. For example, the relaxation of foreign exchange controls meant that by 1998, Japanese citizens could purchase foreign stocks, bonds, and mutual funds. Meanwhile, Japan's big four stockbrokerages continued to struggle with serious financial problems that resulted from the 1991 crash of that country's stock market. In November 1997, in what was a shock to many Japanese, one of these firms, Yamaichi Securities, declared it was bankrupt due to $2.2 billion in accumulated "hidden losses" and would shut its doors. Recognizing the country's financial system was strained and in need of fresh capital, know-how, and the stimulus of greater competition, the Japanese government signaled that it would adopt a more relaxed attitude to foreign entry into its financial services industry. This attitude underlay Japan's wholehearted endorsement of a 1997 deal brokered by the World Trade Organization to liberalize global financial services. Among other things, the WTO deal made it much easier for foreign firms to sell financial service products to Japanese investors.

By 1997, it had become clear to Merrill Lynch that the climate in Japan had changed significantly. The big attraction of the market was still the same: the financial assets owned by Japanese households are huge, amounting to a staggering ¥1,220 trillion in late 1997, only 3 percent of which were then invested in mutual funds (most are invested in low-yielding bank accounts and government bonds). In mid-1997, Merrill started to consider reentering the Japanese private client market.

The company initially considered a joint venture with Sanwa Bank to sell Merrill Lynch's mutual fund products to Japanese consumers through Sanwa's 400 retail branches. The proposed alliance would have allowed Merrill Lynch to leverage Sanwa's existing distribution system, rather than having to build a distribution system of its own. However, the long-run disadvantage of such a strategy was that it would not have given Merrill Lynch the presence that it felt it needed to build a solid financial services business in Japan. Top executives reasoned that it was important for them to make a major commitment to the Japanese market in order to establish the company's brand name as a premier provider of investment products and financial advice to individuals. This would enable Merrill Lynch to entrench itself as a major player before other foreign institutions entered the market--and before Japan's own stockbrokerages rose to the challenge. At the same time, given their prior experience in Japan, Merrill Lynch executives were hesitant to go down this road because of the huge costs and risks involved.

The problem of how best to enter the Japanese market was solved by the bankruptcy of Yamaichi Securities. Suddenly Yamaichi's nationwide network of offices and 7,000 employees were up for grabs. In late December 1997, Merrill Lynch announced it would hire 2,000 of Yamaichi's employees and acquire up to 50 of Yamaichi's branch offices. The deal, which was enthusiastically endorsed by the Japanese government, significantly lowered Merrill Lynch's costs of establishing a retail network in Japan. The goal for the new Merrill Lynch subsidiary is to have $20 billion under management by 2000. The company got off to a quick start. In February 1998, Merrill Lynch launched its first mutual fund in Japan and saw the value of its assets swell to $1 billion by April. The company now has a significant head start over other foreign financial service institutions contemplating building a private client network in Japan. Merrill Lynch's hope is that by the time other foreign institutions enter, it will already have a commanding presence in Japan that will be difficult to challenge.

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Source: "Japan's Big Bang. Enter Merrill," The Economist, January 3, 1998, p. 72; J. P. Donlon, "Merrill Cinch," Chief Executive, March 1998, pp. 28 - 32; D. Holley, "Merrill Lynch to Open 31 Offices throughout Japan," Los Angeles Times, February 13, 1998, p. D1; and A. Rowley, "Merrill Thunders into Japan," The Banker, March 1998, p. 6.