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Japan's temples, universities, hospitals haunted by yen bets

Monday, 22 Jul 2013 | 9:44 PM ET
Luc Novovitch | Photographer's Choice | Getty Images

Ryusho Soeda, 66, has taken on a job for which his career as a Buddhist priest never prepared him: forensic accounting. Soeda's temple is the 1,200-year-old Koyasan, a World Heritage site deep in the mountains of western Japan and long prized as a haven for quiet contemplation. But in recent months monks here have been debating a very worldly question: How did a complex bet on the yen go so horribly wrong?

Soeda, who was picked to head Koyasan in June after his predecessor was forced out, has promised a full accounting of the temple's losses, which at one point last year threatened to wipe out half of its endowment.

"My duty is to find out exactly what has happened and to publish it. Just like Greece published its window-dressing only after they had a new government, the truth will not come to the light unless you change the power," Soeda told Reuters.

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The financial crisis at Koyasan is an example of an overhang of losses that cash-rich Japanese religious groups, schools, small firms and wealthy individuals are facing - and in some cases fighting in court - because of financial derivatives tied to the yen.

Fujita Health University, which runs one of Japan's biggest hospitals, lost $240 million on currency derivatives. Nanzan University in Nagoya said this year it had lost over $230 million. Both schools took their losses from derivatives that were sold to them in the unsupervised, over-the-counter market. In many other cases, the losses have been driven by a product called a "power-reverse dual currency bond," a derivative marketed heavily to non-profit investors in Japan.

The losses highlight a problem Prime Minister Shinzo Abe has vowed to address: Japan's long-running economic slump has left its massive savings stranded in dead-end investments and left investors desperate for yield.

Abe has pledged to revive the world's third-largest economy and foster growth that can outstrip renewed inflation of 2 percent. But doing so will also mean driving a change in mindset by Japan's investors and driving home the message that risk follows return.

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"Power reverse dual currency bonds" - known by the acronym PRDC - offered a higher return at a time when the yield on 10-year Japanese government bonds was stranded at less than 1 percent. Their popularity peaked in 2006 and 2007, just before the onset of the global financial crisis.

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Yoshio Yoshimoto, a professor of economics at Kansai University, said many universities jumped without reading the fine print. "One might wonder whether these schools should teach economics to students in the first place'" he said.

Non-profits in Japan are not required to mark losses to market. Partly as a result, total losses from derivative bets gone bad are hard to estimate. But in one indication of the extent of the problem, there are about 300 ongoing lawsuits over such losses, according to Akiyoshi Motosugi, a lawyer in Tokyo.

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Most claim that the risks of the derivatives were not fully explained by the banks that sold them.

One of those is by Komazawa University, a Buddhist-affiliated school in Tokyo. The university lost $160 million in 2008 on currency derivatives purchased from Deutsche, BNP Paribas and UBS.

Deutsche and BNP Paribas declined to comment. UBS said it was contesting the claim. "We have challenged these allegations and are defending ourselves accordingly'" the bank said.

'Like a daydream'

PRDC bonds were often structured to carry a high coupon for the first year. After that the coupon was determined by the rate of the yen. A knockout clause was typically set so that the bonds would be redeemed if the yen weakened past a certain threshold against the dollar or the Australian dollar.

That meant the investors accepted the risk of no interest payments if the yen were to strengthen - as it did from late 2007 to late 2012. The knockout clause capped upside.

Many of the bonds were issued in London's unregulated offshore eurobond market. According to Thomson Reuters data, there are about 5.2 trillion yen ($518 billion) of eurobonds with a complex coupon outstanding. A large share of those are PRDC bonds or similar derivatives. Others have yields linked to other volatile assets like the Nikkei share average.

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The yen's fall since Abe took office has eased the pain for investors but many still have unrealized losses since the dollar has not recovered to its levels of 2006 and 2007 when it traded above 110 yen.

Koyasan is a case in point. The temple had a loss of about $6.5 million in March, although that was half of what it faced in May last year, said Yasuo Wakita, an official in charge of accounting. The derivatives were sold to Koyasan by Nomura Securities and Daiwa Securities. Both declined to comment.

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The temple first made its foray into derivatives in 2002 when it was looking to make quick money to pay back a loan. Things went sour when it held the investment and losses began to mount.

"For me, the whole thing felt like a daydream'" said Kosho Shono, 70, who had run the temple for seven years but faced criticism over his handling of the investment and questions about whether the temple had tried to conceal its losses.

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In late June, Shono convened a special convention of monks clad in traditional black robes intended to end months of bickering. Shono denied any wrongdoing and urged the assembled monks to put their differences behind them.

"There should not be infighting like this in the future," he said as he handed over stewardship of Koyasan to Soeda.

After 2008, Japan's Financial Services Agency (FSA) took steps to tighten rules on marketing of complex derivatives to colleges and other non-profits. Regulators said they were not aware of any large losses from products that came after the tighter rules were in place.

The FSA has urged investors to be more aware of investment risks and for fund managers to adopt appropriate internal checks on investment decisions. Yoshio Shima, a professor of business at Tamagawa University, says the Japanese government should go further, drawing an example from the British government.

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In 2012, London's financial watchdog, then the Financial Services Authority, forced four banks to compensate small and medium-sized firms for some interest rate derivative losses as well as tightening rules on the marketing of those products.

"Japanese banks are almost like professional baseball teams that are winning big only by playing with little league teams," said Shima, who estimates small firms in Japan have lost some $10 billion from mostly currency derivatives in recent years.

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