TOKYO -- Toshiba, the Japanese conglomerate that two years ago was pressured by activist investors to restructure its operations in one of the country's most controversial corporate sagas, may soon join the ranks of hedge funds by becoming one itself.
The Japanese industrial major, which is known for its high-technology research, is obtaining a license to operate a hedge fund after it developed an ultrahigh speed machine that employs quantum computing and a proprietary algorithm to seek out arbitrage opportunities in foreign exchange trading.
With this new technology, Toshiba plans to launch a high frequency trading business and start a trial operation using its own funds. Over time, it plans to sell this technology to financial institutions, which have shown strong interest in the project.
The venture represents in many ways an about face for the company, which perforce welcomed global hedge funds onto its shareholder register two years ago after dozens of them participated in a $5.4 billion emergency rights issue, arranged by Goldman Sachs. Since then the company's share price has gained by a fifth, handily outperforming the wider market.
Now there is growing interest in how much Toshiba will be able to achieve if it embarks on hedge fund management too.
The technology was created in Toshiba's corporate research and development center in Kawasaki, Kanagawa Prefecture. In this university campus-style facility, around 1,000 researchers develop various advanced technologies that Toshiba has invested in. Visitors have to put masking stickers on the camera lenses of their smartphones to prevent industrial espionage.
It was here, in the spring of 2018, that Toshiba Chief Researcher Hayato Goto, a specialist in quantum computing, developed an algorithm that makes an optimum selection from huge numbers of permutations based on a new "simulated bifurcation machine" theory.
In incorporating the algorithm into a machine, Goto was able to rely on the vast resources the company has built over many years in the manufacturing business. Together with a Toshiba computer science expert, Tatsumura Kosuke, Goto created a parallel processing circuit to try to boost processing speed. A demonstration prototype was unveiled in October.
In that same month, Google announced its researchers had succeeded in completing a calculation in just three minutes and 20 seconds using a quantum computer that would have taken a supercomputer at least 10,000 years to work out.
Although Toshiba's ultrahigh speed machine is not as fast, it will soon be ready for practical use, the company said. It also does not require any special equipment, such as freezers, and is compact enough to be transported in a taxi to venues for exhibition.
"We used to complete a technology first before starting to discuss its commercializing possibilities," said Osamu Hori, director of Toshiba's corporate research and development center.
Toshiba researchers trialed the technology on foreign exchange transactions, based on the actual price movements of eight key currencies, including the yen and the U.S. dollar. If a large order is placed between the yen and the U.S. dollar, it disturbs the supply-demand balance, causing slight distortion in transaction rates, including the yen- euro and dollar-euro rates. It is this distortion that offers arbitrage opportunities.
Toshiba's high-speed machine, which company insiders call a "intelligent spinal reflex," can analyze the combinations of the eight currencies and execute an arbitration transaction in 30 microseconds, each of which is a millionth of a second. As a result, it was able to find transactions that maximized profit margin in more than nine out of 10 transactions, according to the company.
The researchers plan to develop systems to make short-term market forecast and develop risk management. When Toshiba announced details of the quantum machine, a flurry of inquiries came in from financial institutions.
Tatsumura said there are still hurdles to clear before Toshiba can actually execute transactions. Japan's Financial Services Agency in 2018 introduced a regulation requiring high-frequency traders to obtain licenses. To put together a licensed team, Toshiba is in the process of recruiting quantitative analysts.
Toshiba President Nobuaki Kurumatani, who was previously Deputy President of Sumitomo Mitsui Banking and has experience of overseeing investment banking and securities operations, said: "This innovative technology can break new ground in the area of fintech."
He added that the technology "can bring about a change in society after we will introduce it in wide areas, including logistics, mobility and drug discovery."
The Toshiba researchers have also succeeded in closely recreating the price movements of the Tokyo stock price index, or Topix, which comprises about 2,000 stocks on the Tokyo Stock Exchange, by using its 500 constituent issues.
As the passive, index-tracking investment style gains popularity, Toshiba said the potential for the technology to create efficient investments is huge.
The industry agreed. "Potential of Toshiba's research results is immeasurable," an executive at a large asset manager said.
Ironically, since Toshiba's 2017 stock issue, the role of activist investors and hedge funds on Japanese corporate governance has become a hot topic. Under a controversial bill passed last week, foreign investors in Japan must now obtain regulatory approval if they buy a 1% stake in a company that is deemed to have strategic importance.
The line between technological engineering and the financial industry is increasingly blurring, but has precedence. Nippon Steel in its former incarnation used its derivatives know-how in blast furnace control technology, and has provided it to financial institutions for risk management.
Indeed, many engineers have left manufacturers to take on positions in the financial industry. It is well known that many former NASA scientists have migrated to Wall Street jobs after the end of the Cold War and became a driving force behind the development of products, including derivatives.
Japanese financial institutions are slow to this trend though. A survey by the Financial Services Agency found that IT engineers represent about 30% of total employees at U.S. banks. By contrast, less than 4% of Japanese banks' employees are engineers.
Umar Farooq, who oversees technological innovation at JPMorgan Chase, said the U.S. company's technology spending has totaled $11 billion annually. The amount is larger than annual net profit of Japanese megabanks, including Mitsubishi UFJ Financial Group.
A FSA official said there was "no way Japanese banks can win the game if they are only playing catch-up with U.S. banks." He said that innovative technologies that are employed at manufacturing companies may be transferable to Japanese banks and help to turn these entities around as they seek new revenue sources.