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Interview

Ex-MUFG CEO reveals background of investment in Morgan Stanley

Importance of Japan-US economic security serves as push: Hirano

Nobuyuki Hirano, a top Japanese banker of international caliber, revealed the whole picture behind MUFG's capital tie-up negotiations with Morgan Stanley and discussed the problems of and expectations for Japan's economy and financial sector, which are mired in a series of difficulties, describing his opinions as 'my last words'. (Source photos by Yoichi Iwata)

TOKYO -- Mitsubishi UFJ Financial Group invested $9 billion in Morgan Stanley amid the global financial crisis triggered by the collapse of Lehman Brothers in 2008, due to the importance of "economic security" between Japan and the U.S., former MUFG CEO Nobuyuki Hirano said.

In an exclusive interview with NIKKEI Financial, Hirano, a top Japanese banker of international caliber, revealed the whole picture behind MUFG's capital tie-up negotiations with the American investment bank and discussed the problems of and expectations for Japan's economy and financial sector, which are mired in difficulties, describing his opinions as "my last words."

Hirano, who was a CEO and chairman of MUFG, and president of its core banking unit, resigned from the board of the biggest Japanese lender at its general shareholders meeting on June 29.

Edited excerpts from the interview follow.

Q: MUFG has made Morgan Stanley an equity method affiliate, holding a 20% stake. This capital tie-up is a rare international alliance between big financial institutions. What do you have to say about this?

A: There are a total of 30 G-SIBs (global systematically important banks) designated by the FSB (Financial Stability Board) in Japan, the U.S., Europe, China and Canada. There had never before been a capital tie-up between G-SIBs, and there hasn't been another to date.

There are three points that have made our combination successful. First, our business model is simple and supplementary. We provide our customer base, while Morgan Stanley offers products and professional services. There is no conflict. Our alliance, including cross-border mergers and acquisitions, equity finance and initial public offerings, is smooth.

A strong relationship of trust is the second point, such as between our top executive [Nobuo] Kuroyanagi [then-CEO of MUFG] and [Morgan Stanley's] then-CEO John Mack at the time of the investment, and the relationship of mutual trust established by then-MUFG Bank President [Katsunori] Nagayasu continues to this day. James [Gorman, current CEO of Morgan Stanley] and I often talk about the third point, saying, "Our corporate cultures are similar."

 Former MUFG Chairman Nobuyuki Hirano. (Photo by Yoichi Iwata) 

Q: The Bank of Tokyo-Mitsubishi UFJ, now known as MUFG Bank, was established in 2006 through the merger of the Bank of Tokyo-Mitsubishi and UFJ Bank. While the Group's banking unit had solidified its position as Japan's biggest bank, the securities unit hadn't done so well, had it?

A: We were painfully aware of this. Although there was growing demand for overseas M&A and fund-raising among our corporate clients, we were not prepared to help them. We set up a top-secret project, inviting consulting firm McKinsey to participate, to discuss how to strengthen our investment banking unit.

Three options came up, namely, the reinforcement of our existing securities operation, acquisition of a midsize U.S. investment bank, and a capital tie-up with a "bulge bracket" big investment bank.

Q: The Lehman Shock-induced global financial crisis, which broke out in September 2008, suddenly created opportunities for the third option. But as the financial market was falling apart, it must not have been an easy decision?

A: The "BNP Paribas shock" occurred in the summer of 2007, the year before the global financial crisis. As I was responsible for the corporate planning division at that time, I had a vague feeling that something unexpected would occur.

Q: Japanese banks were in an advantageous position in terms of creditworthiness, but Mizuho Financial Group and Sumitomo Mitsui Financial Group were ahead of you. Mizuho invested in American investment bank Merrill Lynch for preferred shares, while SMFG bought a stake in major British bank Barclays.

A: A number of options, including Merrill Lynch, began to emerge early in 2008. We were in the loop on tie-up talks. But such deals and capital tie-ups were in the form of investment in preferred shares and the like, and would not establish the genuinely deep relationship that comes with making the partner an equity method affiliate. In short, we brushed aside all of them because none fit our strategy. In the end, Morgan Stanley was the only suitable target.

Q: And on September 15, Lehman Brothers abruptly went belly up. Merrill Lynch sold itself to Bank of America, sending a shockwave through Wall Street. How did you decide to invest in Morgan Stanley?

A: [September] 15 was a Monday. The first request [for the investment] came to me as head of the corporate planning division at midnight on Sunday, the 21st. The share price of Morgan Stanley was lower than its real value. But, of course, there were risks [about investing] under such abnormal circumstances.

Former MUFG CEO Nobuyuki Hirano and his ally James Gorman, CEO of Morgan Stanley, pose wearing red ties, MUFG's color.

Needless to say, due diligence is the prerequisite for investment and price assessment. Word circulated that we had done it "in 24 hours" but that is not true. Actually, we spent three days, 72 hours. But it was still too short a time to decide on a huge, $9 billion investment. Fortunately, there was a behind-the-scenes tailwind.

At that time, Morgan Stanley and Goldman Sachs were making preparations to become bank holding companies [for the smooth procurement of liquidity]. We were able to use financial documents already prepared by them for submission to financial regulators. They couldn't submit potentially false information to the Federal Reserve!

Support from an expert team at U.S. asset manager BlackRock also helped a great deal with our due diligence. As I look back, however, our management team's determination to "do it" was more important than the due diligence. It was the key factor.

Q: On September 22, MUFG announced the launch of negotiations to invest in Morgan Stanley via common shares. But more difficulties lay ahead. In the run-up to the presidential election (that put Barack Obama in the White House for the first time), increasing partisan confrontation in Congress threw the stock market deeper into confusion. Investing in Morgan Stanley via common shares (which would trigger asset impairment losses) became impossible. Can you talk about this?

A: Given the time difference between [Japan and] the U.S. [where negotiations were held], and that I was responsible for the state of the negotiations, I didn't have time to go home. Fortunately, our head office has a room for the in-house tea ceremony club, with tatami mats, where I was able to take a nap for two to three hours per day, keeping my mobile phone by my pillow.

Morgan Stanley shares were the most heavily sold on Friday, October 10, hitting $6.71, less than one-tenth their value before the Lehman Shock. Next Monday, October 13, was the Columbus Day holiday. Market participants expected the company to go bust at any moment unless there was an injection of capital. Columbus Day is an unusual holiday in the U.S. as it is a bank holiday but the stock market is open. In short, it was a risky and unstable day.

Q: Eventually, the capital injection was realized as MUFG Bank President Nagayasu, who was in the U.S. then, made the final decision to issue a check with an unprecedented face value of $9 billion. But another key point in the process was the alteration of a condition: to invest via preferred shares instead of common shares.

A: It was pretty tough because the memorandum of understanding initially signed did not include clear clauses permitting unilateral changes to conditions. In the case that Morgan Stanley went to court (rejecting an investment via preferred shares), we wondered if we could win. We discussed the possibility of resorting to force majeure with our legal advisors.

In reality, it was an act of providence both objectively and substantively and we hoped that Morgan Stanley would negotiate in good faith. They accepted our alternative proposal, and that became the source of our mutual trust.

Q: By that time, meanwhile, the negotiations had gained significance beyond that of simple capital tie-up talks between private businesses.

A: The U.S. government felt a sense of crisis at the possibility that the American financial system could be fundamentally shaken. Naturally, the Japanese government and financial authorities showed a strong interest in the negotiations too. As I look back, it seems to me that the deal was concluded because it was between a Japanese [not Chinese or others] and an American financial institution. There was the weight of economic security, which has become an important theme in recent years.

Q: I wonder if there was an option to acquire the whole of Morgan Stanley instead of keeping your stake at 20%?

A: Yes, we could have bought it outright. But as I said, our investment banking strategy was to make equity method affiliates with a stake of 20%. The 20% stake policy was carefully considered. With a stake of 25% or more, U.S. regulations regard you as a source of strength. Should Morgan Stanley have fallen into another slump, we would have to provide additional support such as unlimited capital and supporting further fundraising. We decided to avoid such a potential situation.

Another thing I should mention is that global investment banking was neither the core nor strength of our business. As we were trying to work together with Morgan Stanley, we should not have ownership or management rights.

Q: You, Mr. Hirano, were sent to Morgan Stanley for a year as a trainee when you were young. Is how things turned out a kind of fate?

A: I still remember the dates [of my traineeship]: September 21, 1983 to August 31, 1984. It was my first time living overseas. I hadn't been able to live abroad prior to that because I had failed the in-house examination to study abroad for an MBA.

The old Mitsubishi Bank and Morgan Stanley had fairly long-standing relations. The program to dispatch trainees started more than a decade before my time. Was it a curious coincidence or fate? The accumulation of small things, such as dispatching trainees and business deals, had continued between our firms and led to a sudden impetus to invest $9 billion at the time of the Lehman Shock. I think it might have been more than mere coincidence...

But James now jokes that "Nobu is the first board member who was a former trainee"!

Q: Having accepted MUFG's $9 billion capital injection, Morgan Stanley saw its share price reach a record high this year and is contributing greatly to MUFG through dividends and profits as an equity method affiliate. But the share price of MUFG remains weak. The question of how Japanese banks can increase their share prices under ultra-low interest rates is what you had in mind, isn't it?

A: No, it is not. To put it simply, I have not been able to do enough. I feel deeply ashamed. Let me explain: having assumed a management role, I was accountable for results. I feel apologetic towards both shareholders and customers. I also feel sorry for Morgan Stanley because they are a stakeholder too.

Interest rates have fallen because Japan's growth potential has fundamentally declined. As a manager in finance, I tried hard to cope with this structural problem, but my efforts weren't enough.

But, to return to your question, like Japan, Europe is also experiencing a struggle financially. Financial intermediation is extremely difficult in a world where interest rates do not work. In addition to the narrowing spread between deposit and loan interest rates, excessive risk-taking has wiped out the essential [for financial institutions] concept of risk premiums.

Nobuyuki Hirano, left, represented Japan's financial industry at international conferences. Standing to the right is Christine Lagarde, current president of the European Central Bank.   © Reuters

Q: I must also ask why Japan's unconventional easy money policy, pledged to last for two years from the spring of 2013, is still in force? Although the Bank of Japan can't say so officially, shouldn't it get the credit for comprehensive monetary easing, including the introduction of negative interest rates, to achieve the historic stabilization of the yen's exchange rate?

A: The exchange rate has of course been an extremely large factor in determining Japan's economic fortunes. I agree with you on that. But it is also a fact that the environment has changed. A rise in the yen's value does not directly jeopardize Japan's exports and current account balance anymore. Compared to the past, its impact has weakened considerably.

Q: But if monetary easing is relaxed now and the yen is allowed to appreciate against foreign currencies, won't earnings from Japanese companies' overseas investments decrease and the stock market be thrown into confusion?

A: It depends on how far the yen will appreciate. If returns from overseas investments are large enough, a certain degree of exchange rate fluctuation is endurable. Exchange rates always fluctuate, and businesses can withstand them if they realize returns that exceed them through careful overseas investment.

The same is true for interest rates. Although market rates are now fixed at de facto zero, one business leader declared that "businesses cannot become strong in a world without interest."

Interest rates are a kind of discipline. In essence, management is making decisions every day, such as how to adjust business portfolios and where to allocate management resources. If you cannot earn returns larger than the interest rates on capital procurement, it means the business is unsustainable. This is where management discipline works. At present, we are in a world where interest rates cannot serve as a milestone.

Q: In addition to businesses, the burden of interest rates is also being strongly felt by state finances, is it not?

A: Discipline is becoming less effective on public finances too. A sharp rise in interest rates is unlikely, and it is unlikely that the government will become unable to issue bonds. But as the discipline does not work now, there are no clear spending priorities.

Wise spending is a theme for the Fiscal System Council (an advisory panel to the finance minister), of which I am a member. If the state can spend money endlessly, it could spend it on anything. This raises the possibility of low productivity public investment, which leads to a stall in private investment. I wonder if a state-led economy is really correct?

Q: The swelling of public finances is a global trend due to the spread of coronavirus infections.

A: An essential role of the state is to create a field that encourages vitality in the private sector. Of course, it is fine for the role of public finances to grow temporarily. Now that COVID-19 infections have become so widespread, no one at the council says related spending should be curbed. But it is the mission of policymakers, corporate managers and leaders to look further ahead, especially in a crisis situation.

In addition to preparing scenarios looking beyond the present, post-factum verification is also indispensable. Though we have the Board of Audit of Japan, it is primarily tasked with checking inappropriate spending, so is not in a position to directly judge whether policy measures and projects match policies such as promoting innovation. Objective post-factum verification of policies therefore is necessary. An organ independent of the executive branch of government may be needed for this.

Q: Share prices are starting to rebound, overcoming the impact of the COVID-19 pandemic. Do you see any risks in the international financial market?

A: Risk premiums are not being correctly recognized as the prolonged continuation of monetary easing by central banks around the world has resulted in a surfeit of liquidity and excessive risk taking by investors. As on the eve of the Lehman Shock, there are people who say, "This time is different." And it is true that financial regulations have undergone significant preparation.

But weird developments are surfacing, such as the collapses of Archegos and Greensill as well as the phenomenon around Robin Hood. And what about how lively special purpose acquisition companies are? Those developments are independent of each other and are unlikely to be linked to financial transactions as in the case of the subprime loans that caused the Lehman Shock. I agree that they are unlikely to lead to systemic risk. But it might be a good idea to consider that magma is accumulating beneath the surface and leaking out in places. To prevent a huge eruption, careful monitoring and measures are needed, such as strengthening regulations on family office operations and non-bank financial institutions.

Q: You accepted this interview on condition that you will not comment on the strategy of MUFG's current management. But I would like to ask you one question. CEO Hironori Kamezawa called for a stable net profit of 1 trillion yen under the medium-term business plan (for the three fiscal years through March 31, 2024) he announced in May. But MUFG cleared that target in 2014 when you were CEO. Doesn't this target imply stalled profit growth?

A: The content of the target is absolutely different from when I was in office. Let me talk about it because three basic policies enacted by Mr. Kamezawa -- digital transformation, resilience and engagement -- are very good.

One question is how to rebuild the domestic retail business through digital transformation. He is an expert on digital issues. I think [the medium-term business plan] is a declaration of his resolve to carry out organizational reforms and promote digitalization as a business. Resilience is a financial strategy to promote a shift from quantity to quality by controlling expenses and risk-weighted assets and laying a premium on return on equity.

Finally, I especially welcome engagement as the third basic policy. The question for financial services is how to harness changes in society's needs and how to adjust products, services and business portfolios in response. This is the key to Morgan Stanley's success. In my time I was unable to accomplish all of this, but I believe the combination of the three will enable MUFG to keep growing beyond the 1-trillion-yen profit target.

Q: What are you going to do after leaving MUFG? You will continue to serve as an outside director at Morgan Stanley. You are still in your 60s, so should be very much in demand.

A: I told James I would quit Morgan Stanley. But he asked me to stay a little longer as Morgan Stanley has begun seeking his successor. So I will stay for another year or two.

I will continue to serve as an outside director at Mitsubishi Heavy Industries and outside auditor at Toyota Motor Corporation. Both involve heavy responsibilities and are plenty for me.

Nobuyuki Hirano, 69, was born in Gifu Prefecture, he graduated from Tokai Senior High School, a prestigious private school in Nagoya, Aichi Prefecture, and moved on to the faculty of law at Kyoto University. He joined Mitsubishi Bank in 1974 and was dispatched to Morgan Stanley as a trainee in 1983. In 1984, Hirano was dispatched to the bank's European unit.

Hirano was assigned to head the department of planning for Americas at the Bank of Tokyo-Mitsubishi in 1998 and became an executive officer in 2004 and served as head of the general planning office, a position that made him a candidate for future president of the company.

During the global financial crisis caused by the collapse of Lehman Brothers in September in 2008, Hirano spearheaded the Bank of Tokyo-Mitsubishi UFJ's capital tie-up negotiations with Morgan Stanley as managing director in charge of corporate planning. After taking such posts as executive vice-president, Hirano assumed the post of president at the bank in 2012 and became president of Mitsubishi UFJ Financial Group the following year. He stepped down from the chairmanship in April and resigned from the board in June.

Hirano had long worked in the overseas division at Mitsubishi Bank, seen as a non-mainstream section at the bank. He became the first president of the bank among Kyoto University graduates and has a strong sense of attachment to the ancient capital where his mother was born.

Hirano is known to be devoted to his wife, who is a Japanese-style painter. Now that he has retreated from the vanguard of business, he will spend more time supporting her. "I will do such things as quickly pouring champagne to visitors to her exhibitions!" he joked.

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