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, new market capitalization and float 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 reordering could have on listed companies and investors, at least initially. The bourse hopes to have a new framework ready by June or July -- and to possibly start implementing the changes in 2022.

1. How is it set up now?

The TSE is made up of five sections. The first, or 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 Japan’s Financial Services Agency has said the criteria separating the current sections are too ambiguous, and has proposed reducing the number of markets to three: Prime, Standard and Growth. The group is looking to require companies listed on the top tier to have a tradable float of at least 10 billion yen ($91 million), in an effort to boost liquidity and simplify the rules. Currently top tier companies must have a tradable float equal to at least 35% of their market value.

3. Would the Topix index change?

Probably. Market participants have complained the index -- made up today of all the TSE’s top tier companies -- has become too bloated as compared to other global indexes. More than 2,100 companies traded on the first section as of Nov. 29, almost double the level in 1990, according to Japan Exchange Group, the operator behind TSE. (The S&P 500 Index has around 500 companies; the Dow Jones Industrial Average just 30.) The working committee has proposed making a “better index that institutional investors can find useful,” with companies selected from both the Prime and Standard sections. But Goldman Sachs strategist Kazunori Tatebe said he expects only 450 to 550 stocks to be cut, disappointing investors.

4. Who was asking for this?

In addition to the huge number of components in the Topix, critics also question whether current standards for the top tier are tough enough. Originally, a company needed a market capitalization of at least 50 billion yen to directly join the first section, but in 2012 Japan Exchange lowered it to 25 billion to help more companies raise capital. In a summary of feedback last year, 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 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. What will it mean for investors?

Some worry that changes to the market-cap requirement could see some companies demoted, which could disrupt the market and force a sell-off by passive investors due to portfolio rebalancing requirements. Some investors and experts say paring the Topix membership to a level on par with the S&P 500 could spur a wave of mergers and acquisitions. 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, an overhaul could be troublesome for institutional investors, which might have to alter their investment trusts and index-tracking ETFs.

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 fear that could affect the number of clients and investors they can attract.

7. And for startups?

The startup sections -- the TSE Mothers and two JASDAQ sectors -- will likely come under the Growth segment in the reform. If the requirements for startups to go public don’t change, 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, Kurt Schussler

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