Can new stock market keep startups in Tokyo?

Last week, the Tokyo Stock Exchange announced it was tying up with the London Stock Exchange to establish a new type of market in Japan.

The new market will make it easier for startups to list by removing numerous regulations and will be restricted to professional investors. It is also slated to be up and running by the end of next year, a remarkably quick timetable by Japanese standards. Which begs the question: Why the rush?

The reason for this haste is that although Tokyo is aspiring to be a top global financial center like London or New York, it has so far failed to attract investment on the same scale as its peers. For example, when looking at the stock exchanges of these three cities, the TSE stands out as being almost completely domestic.

Of the more than 2,000 firms listed on the TSE, only 25 are from overseas, accounting for roughly 1 percent of all listed firms. In comparison, over 15 percent of the 2,773 listed companies on the New York Exchange are from outside the United States. On the London Stock Exchange, the ratio is even higher at more than 20 percent. Clearly, Tokyo faces difficulties enticing overseas firms to list on its exchange.

Even the smaller Japanese markets, such as the Jasdaq, Mothers and Hercules, have not been successful drawing international interest. But more risky than losing international business is the likelihood that Japanese exchanges will lose domestic startups to exchanges overseas.

Japanese startups are increasingly looking abroad to list, partly due to the strict rules and regulations they face back home. One place they are looking to is the Alternative Investment Market of the London Stock Exchange.

Thanks to its open regulatory structure and streamlined procedural systems, AIM has become a world leader. AIM by far has led all other international markets in number of new listings in the last two years. In 2006, AIM held 462 IPOs, well ahead of the 138 launched on the Nasdaq or the 136 at Jasdaq, Mothers and Hercules.

In contrast with Japanese startup markets, where trading is led by retail investors, including impatient and sometimes less-experienced day traders, about 60 percent of trading on AIM is executed by institutional investors.

Another striking aspect of AIM is its international base. Of all the IPOs on AIM in 2006, 124 were launched by firms outside the U.K., including Chinese and Russian firms. This overseas business accounted for over 25 percent of the IPOs held on AIM. With this track record it is not surprising that Tokyo wishes to tap London's knowhow in running AIM for the creation of its own pro market.

But will Japanese entrepreneurs wait long enough for this proposed professional market to open? More and more Japanese startups are looking to AIM, where holding an IPO is both faster and far less regulated than in Japan.

In Japan, it usually takes more than a year to prepare an IPO. On AIM it can be done in as little as 4 months. Furthermore, the so-called Livedoor Shock in 2006 and other accounting-related scandals caused Japanese authorities to tighten IPO screening rules even more, lengthening the process even further.

AIM places no restrictions on profits, market capitalization, net assets, period in operation since establishment or number of shareholders, but Japanese startup markets stipulate minimums in at least one of these areas, depending on the market.

An information seminar on AIM in Tokyo organized by the LSE in June this year drew 160 participants, far more than expected. And two months later, more than 50 Japanese firms visited the British Embassy in Tokyo to attend another AIM seminar held by Tozai Capital K.K., a Japanese company that offers pre-IPO investment and consultation to Japanese firms looking to launch in London.

One firm already has taken the plunge: Secure Design, a provider of biometric verification systems, became the first Japanese company to join AIM in July 2006, only eight months after its establishment. Others are expected to follow soon.

So with AIM acting as a magnet for startup firms around the world who want to expand their capital base with a minimum of hassle, the proposed Tokyo-AIM market (the name hasn't been announced yet) appears to be a countermove to keep startups here in Japan and attract like-minded firms across Asia and elsewhere.

But whether it will be able to provide its suggested range of services has been questioned. For example, the new market will not require companies to make quarterly reports and will let them disclose information in English. Changes like these are nothing less than radical in Japan and will raise issues about the feasibility of launching as suggested by the end of 2008.

Given AIM's track record (more than 2,800 companies admitted since launched in 1995, with almost £50 billion in capital raised), the new market will have a long way to go before it can challenge such achievements. And the market's new regulatory framework will require amendments to Japanese law, something that could slow things down considerably.

With these thoughts in mind, London's AIM appears likely to remain the premier market for globally minded startups — including Japanese ones — for some time to come. Tokyo on the other hand still has a long way to go to become a real global financial center.