A Japanese plan to reform the Tokyo Stock Exchange (TSE) is finally taking shape. The makeover may include paring the number of the TSE’s markets, guideline on market capitalization requirements, and what the benchmark index will include. While many market participants have clamored for years for change, some worry about the negative repercussions a reshuffle could have on listed companies and investors, at least initially. Currently, there isn’t a clear timetable when the restructuring will take place.

1. How is it set up now?

The TSE is made up of five sections. The top tier is where the biggest Japanese companies and most foreign investors are found. The second section has more medium-sized companies. Together they are referred to as the main markets. There are two sections geared for startups -- Mothers (Market of the High-Growth and Emerging Stocks) and the JASDAQ (Standard and Growth sectors) -- as well as the TOKYO PRO Market for professional investors only.

2. What change is being considered?

A working group at the Financial Services Agency (FSA) has said the criteria separating the current sections are too ambiguous, and has proposed paring the markets down to three: Prime, Standard and Growth. It’s now considering what the criteria should be for companies that want a Prime listing, including the minimum market capitalization. (The TSE currently requires unlisted companies to have a market cap of 25 billion yen or more, or about $230 million, to list directly onto the first section.)

3. Would the Topix index change?

Probably. The working committee has proposed making a “better index that institutional investors can find useful,” one that includes companies in both the Prime and Standard sections. The gauge today is made up of only the top tier companies listed on TSE. Market participants have complained the index has become too bloated, as compared globally to indexes like S&P 500.

4. Who was asking for this?

In addition to the huge number of components in the Topix, critics also question whether current standards are tough enough to determine which firms are in the bourse’s top tier. More than 2,100 companies trade on the first section as of Nov. 29, almost double the level in 1990, according to Japan Exchange Group (JPX), the operator behind TSE. Originally, a company needed a market cap of at least 50 billion yen to directly join the first section, but JPX relaxed the rules in 2012 and lowered it to 25 billion to let more companies raise capital. In a published summary of feedback from market participants, Japan Exchange said respondents felt there were too many “low level” companies -- as measured by profitability, market cap, liquidity, management and governance -- that still ranked in the top tier. Roughly half of the more than 2,100 members on the Topix have market values below 50 billion yen ($460 million). In comparison, the smallest company on the S&P 500 has a value greater than $3 billion.

5. Is there a downside for investors?

Some activist investors worry that changes to the market cap requirement could see some companies demoted, disrupt the market and force a sell-off by passive investors due to portfolio rebalancing requirements. Others are also interested in seeing what a new, revamped Topix index would look like. Hiroshi Matsumoto, head of Japan investment at Pictet Asset Management Ltd. is hoping for an “attractive” index that draws domestic and foreign investors and rises. On the other hand, tweaking the index could be troublesome for institutional investors, who would have to alter their investment trusts and index-tracking ETFs should the benchmark be completely overhauled.

6. What about for Japan Inc.?

There’s fear of losing status. Being listed on the top tier of the exchange is a sign of prestige that can make a company name a “brand.” By completely re-creating the sections, firms currently listed in the first section could get slotted into Standard, which could be seen as a demotion. Companies may be wary that losing that name could affect the number of clients and investors they can attract.

7. And for startups?

The startup sections -- the Tokyo Stock Exchange Mothers and two JASDAQs -- will likely come under the Growth segment in the reform. If the requirements for startups to go public don’t change as well, the impact could be minimal, according to Atsushi Kamio, researcher at Daiwa Institute of Research Group. The working group is also discussing ways the startup segments, typically a market for retail investors, can be reformed to attract more institutional investors.

--With assistance from Kurt Schussler, Min Jeong Lee and Naoto Hosoda.

To contact the reporter on this story: Shoko Oda in Tokyo at soda13@bloomberg.net

To contact the editors responsible for this story: Lianting Tu at ltu4@bloomberg.net, Paul Geitner, Andy Reinhardt

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