CONTENTS

Letter to Shareholders 1

Brand Statement 2

Discussion & Strategy 4 Interview with President and CEO, Mr. Hara

Daiwa Securities Group Inc. 14

Daiwa Securities Co. Ltd. 28

Daiwa Securities SMBC Co. Ltd. 48

Other Main Group Companies 74

Consolidated Financial Statements 82

The Daiwa Securities Group/ 122 Overseas Directory Letter to SHAREHOLDERS

The financial year to March 2001 was a mixed one for the Daiwa Securities Group. This report describes the opportunities and challenges we faced, the progress and setbacks we recorded and the strategies we have adopted in our journey to become Japan’s strongest securities company.

In addition to the resources of our IR Department, this year’s annual report has been produced with the active involvement of over 25 of our most senior board members, executive officers and department heads who have col- lectively dedicated several hundred hours in providing information and reviewing texts. This in turn was done in pursuit of a single goal. That goal is to provide our employees, customers and, most particularly, our shareholders with sufficient information that they may arrive at a reasoned and independent assessment of our current business and future prospects.

I hope that we have succeeded in this task. In the meantime, I would like to extend my personal thanks to each and every reader for the interest shown in the Daiwa Securities Group.

July 2001

Yoshinari Hara president and ceo daiwa securities group inc. The brand mark is a graphical representation of The Daiwa Securities Group’s flight into the twenty-first century as a provider of superior financial services building on the three core values of the brand statement.

2 Brand Statement We the Daiwa Securities Group are committed to acting as our clients’ best partner and promote their financial well-being. In order to achieve this, we shall redefine currently accepted best practice drawing on the following three core values.

We Shall Provide Products and Services that Exceed Expectations It is important that we apply detailed knowledge of customer needs, innovation in our internal processes and a strong customer focus to provide solutions that routinely exceed customer expectations.

We Shall Bring the Full Strength of the Group to Bear Cooperation among Group companies sweeping aside traditional corporate barriers, a flexible approach to business and swift decision making will enable us to offer comprehensive financial services precisely geared to meeting our customers’ financial goals.

We Shall Continually Challenge the Limits of Financial Best Practice Exploitation of our substantial store of professional knowledge and a pro-active approach to team build- ing will enable us to remain pioneers in our marketplace.

3 YOSHINARI HARA President & CEO of Daiwa Securities Group Inc.

4 Discussion & STRATEGY

Could you please, in your own words, give us your and, as such, might be regarded as “as-expected” given the analysis of major developments affecting the Daiwa prevailing market conditions. Securities Group during the financial year under review? Needless to say, as with any company, there were areas where we feel we made real progress and areas where we The biggest external influence on our business during FY feel we need to make further efforts. 2000 was the rather poor situation pertaining in Japanese securities markets. The reasons behind this include the In some areas I am happy to say that the Daiwa Securities growing sense of a slowdown in the outlook for IT-related Group made a great deal of progress. This progress was businesses, which had performed the role of a global manifested in operating results in several ways. Allow me engine of growth, and growing anxiety in Japan about the to cite several specific examples. We achieved progress in future direction of Japan’s economy, which was beginning equity trading, M&A, structured finance, and in the IPO to show signs of a recovery. As a securities group, the markets at Daiwa Securities SMBC, our investment bank- Daiwa Securities Group, like all of its competitors, was ing arm, and successfully implemented the three-service- greatly affected by these conditions, which generally dete- package strategy in Daiwa Securities’ retail securities busi- riorated throughout the year. ness, where we are also steadily expanding our number of customer accounts. At other Group companies we report- In this environment, our consolidated revenues for FY ed higher ordinary income than in FY 1999 thanks to 2000 increased by 10%, to 718.1 billion yen. Ordinary stronger earnings in our asset management business at income was down by 21%, to 177.7 billion yen, and net Daiwa Asset Management, even as total investment trust income for the year by 39%, to 64.5 billion yen. net assets fell because of the stock market decline, and at Although our profits compared to FY 1999 declined to a Daiwa SB Investments as the result of solid growth in level that is certainly unacceptable to us, these numbers equity investment trusts. Daiwa Institute of Research, appear similar to those reported by our main competitors which manages our systems development and research

5 DISCUSSION & STRATEGY

businesses, also improved its contribution. Finally, NIF market prices, however, so even under this difficult envi- Ventures, our venture capital operation, is well placed to ronment the net asset inflow exceeded more than 1 tril- go public during FY 2001, and Daiwa Securities Business lion yen. Center, our securities-related back office, made progress in several areas including acquisition of ISO9001 certifi- Certainly bearish sentiment in the stock market was a cation and Daiwa Real Estate increased efficiency. large factor that prevented us from achieving the asset growth we had planned in FY 2000. I believe the steep decline in the stock prices of IT-related companies made investors very risk-averse. Furthermore, at the introduc- tion of mark-to-market accounting, due to the effect of past investment policy, we were unable to introduce com- petitive products with the result that returns on our medi- um-term government bond funds and certain bond investment trusts were less attractive than those offered by the competition. This resulted in a reduction in the bal- In yet other areas we took steps that, although lacking an ance of bond investment trusts outstanding. During the immediate payback, nevertheless strengthened the current year, as mark-to-market effects have been elimi- Group’s foundations for future growth. Here I would nated, we are once again starting to compete on a level mention the establishment of Daiwa Pension Consulting playing field with the result that we are again starting to Co., Ltd. which will enable us to address opportunities see a flow of funds into Daiwa Securities. Our equity that will accompany the introduction of 401(k) style investment trusts were affected by the decline in the stock defined contribution pension plans in Japan. We also market, and the performance of some of our flagship took decisive steps to equip our staff, including those serv- funds, like those of our competitors, underperformed the ing at near-board levels, with the skill sets needed to com- main equity index during FY 2000. Overall equity invest- pete successfully in modern securities markets through the ment trusts were weak and the flow of funds into such inauguration of the Daiwa Management Academy and instruments has slowed dramatically. Before the start of other measures. FY 2000, we had anticipated that large amounts of capital would flow into the securities markets because a substan- On the other hand, there were also a number of areas tial amount of fixed-term postal savings deposits were set where there is room for improvement. At Daiwa to mature. Unfortunately, the majority of such funds ulti- Securities a core management objective is to increase retail mately remained in postal savings deposits, and the shift client assets under custody. Unfortunately, such assets fell of funds into securities markets failed to materialize to the by approximately 2 trillion yen since individual investors degree we had been expecting. became more conservative during FY 2000 as the stock market declined. This amount reflects approximately 3 Conversely, at Daiwa Securities SMBC, although we trillion yen in valuation write-downs due to the fall in recorded good results judging purely from the level of

6 profits recorded, this was very dependent on our success of 28.3 trillion yen, and a single A or better rating from in equity trading. The bond markets were affected by a the main credit rating agencies, we have suffered the reduction in profitable trading opportunities. This was greatest setback in client assets under custody, as I have aggravated by the introduction of the Real-Time Gross mentioned before. Settlement (RTGS) system for government bonds leading us to record disappointing earnings there. In addition, our investment banking operations were mixed. Our struc- In which case, have you rethought your corporate tured finance, mergers and acquisitions and IPO business- strategy or changed the goals outlined in the plan? es reported good progress. On the other hand, our equity underwriting business turned in a disappointing perform- No, we have not. As I mentioned before, the Daiwa ance and lagged our major competitors in the lead-man- Securities Group’s corporate strategy stresses new oppor- agement of large-scale global issues. tunities in the securities markets for both individuals and corporations. In the retail securities market, for example, we have been expecting a wave of investors new to securi- On the face of it, overall you would seem to have ties markets looking to increase returns while maintaining performed in line with your major competitors. In risk at acceptable levels through appropriate use of portfo- some areas the Daiwa Securities Group has done lio diversification. The logic for this shift in investment well; in others it has lagged. Would you regard behavior is irrefutable. However, the sad fact of the matter this situation as satisfactory? is that it simply has not happened to the degree expected. Many Japanese continue to favor low-risk investments Frankly speaking, I am not satisfied with the current situ- such as postal savings and bank accounts. Consequently, ation. As you point out, if we simply judge by the num- as I have mentioned, a disappointingly high proportion of bers, we have turned in a performance that might be the large volume of postal savings time deposits maturing described as satisfactory given the market conditions. during 2000 bypassed the securities markets entirely and However, as you know, over the last two years we have was reinvested in postal savings deposits. expended much effort in restructuring this company to address the opportunities thrown up by deregulation and Were we to accept that such an investment style was structural change in Japanese securities markets. To this somehow so ingrained in Japanese investors that there was end, in March 2000 we implemented our new Group no opportunity for change, then this would constitute a Medium-Term Management Plan to be achieved by bona fide reason to change our corporate strategy and the March 2003. While our performance relative to our com- measures of success that we have adopted. For my part, I petitors has been in some sense satisfactory, relative to the would like to point out that the level of individual Group’s management objectives our progress has been involvement in securities markets in Germany, which is in decidedly unsatisfactory. In terms of our three central tar- some ways a more appropriate comparison for Japan than gets for March 2003, which are to achieve a sustainable the more oft-quoted U.S., rose from 23% in 1991 to 33% return on equity of 15%, retail client assets under custody in 1999. It is quite possible, therefore, for a securities

7 DISCUSSION & STRATEGY

This is not to say that we are simply constrained to take a wait and see attitude. On the contrary, much of the responsibility for promoting the sort of changes we antici- pate rests squarely with the Daiwa Securities Group itself and with the securities industry in general. In the retail sector, our major task is to shake off the old-fashioned image of securities companies as self-serving and unreli- able partners. For some time now we have addressed these investment culture to be established in a relatively short issues in many ways, including a shift in our internal time. We should not be tempted to believe that general mind-set toward stressing asset accumulation over broker- attitudes of Japanese individuals toward securities invest- age commissions, enhanced staff training, implementation ment are irretrievably fixed for all time. The evidence is to of strict compliance procedures, and increasing use of the contrary. Moreover, once this sort of shift starts to technology. In terms of deliverables, we are well posi- happen, even in Japan the chances are that it will gain tioned. The remaining hurdle we need to surmount is the momentum relatively quickly. Consequently, thorough ingrained resistance to securities investment among the preparation by the Daiwa Securities Group is a necessity. general public. I believe that the lesson last year has been that it is necessary but not sufficient for us to offer our A second point I would like to make is that sustainable customers and potential customers superior service and long-term recovery in the Japanese economy as a whole is products. It is also necessary for us to disseminate our core itself contingent on those same variables on which we value proposition in clear and unambiguous terms. This have staked our prosperity. It is hardly a new observation applies across the whole Group but is most relevant to the that reform of Japan’s financial markets and reform of her retail securities business conducted by Daiwa Securities. economic structures are intimately linked. Absent any This is the reasoning that underlies our corporate brand- progress in reform of the financial markets, it is difficult ing project, which is destined to play a key role in our to see how progress in the wider economy can proceed. future development. Although the economy clearly continues to face many problems that are separate from reform of the financial In the wholesale securities markets, which are addressed markets, we simply do not see the kind of situation that by Daiwa Securities SMBC, our 60%-owned subsidiary would be necessary for us to abandon our offensive pos- formed as a joint venture with the former Sumitomo ture. The formation of Mr. Koizumi’s Government has Bank (now Sumitomo Mitsui Banking Corporation), we bolstered this belief further. The Government’s aggressive face a somewhat different set of challenges. Here regulato- proposals to restart the Japanese markets are based on uti- ry changes and market opportunities have been quicker to lization and activation of the securities and capital mar- take root. In some areas, such as equity trading, structured kets, which is exactly what our industry needs. finance, and principal finance, we already rank as the mar- ket leader among securities companies. In other areas, such as M&A, although still a relatively small player, we are growing rapidly and gaining in strength.

8 To optimize the quality of our earnings, our two biggest these days we need to promote the Group as a whole. A challenges in the investment banking business are to regulated world was one where our individual operations reduce our dependence on equity trading profits in our were not really given incentives to look beyond the con- business mix and to improve our relative competitive fines of their individual areas of responsibility. Today, positioning in other areas, then to improve our competi- however, things are vastly different. Financial innovation tive position in equity origination and underwriting. we cannot even imagine today will require the different Unfortunately, we were not able to make much progress entities in the Daiwa Securities Group to collaborate in toward these goals during the last year. While we remain new and probably unpredictable ways. Moreover, as Japan confident that benefits from our relationship with evolves from a so-called producer economy to a consumer Sumitomo Mitsui Banking Corporation, particularly in society, customers will demand ever higher levels of serv- our investment banking operations, will accrue over time, ice in ever more diverse areas. to date the benefits have not been of a sufficient scale to make a dramatic change to the business mix of our invest- ment banking operations.

So to answer your question, there is no doubt in my mind that strategically we have made the correct decisions. The move to a holding company structure and tie-up with a major city bank have greatly improved the ability of the Daiwa Securities Group to address the opportunities secu- rities markets will offer us in the twenty-first century. I would like to stress that defining the Daiwa Securities Although a more distant target than seemed likely a year Group Brand is not simply a matter of advertising or pro- ago, we fully believe that under the right circumstances moting a consistent visual image. Certainly, these are one our medium-term targets are attainable. Of course this way in which the Daiwa Securities Group reaches out to will not simply happen. We need to adopt a highly pro- its customers, and I do not want to belittle the importance active approach. Our strategic thrust remains unaltered. of the external communications process. However, if the But we fully recognize the need to react swiftly to chang- Daiwa Securities Group Brand were nothing more than ing market circumstances at the tactical level. this, it would amount to little more than an empty ges- ture. On the contrary, the sum totality of the customer experience across every interaction with every member of Could you elaborate somewhat on your branding the Daiwa Securities Group, embracing not only external strategy? communications but individual transactions, our tele- phone manners, and word-of-mouth recommendation as The reason for undertaking our corporate branding proj- well, is what defines the Daiwa Securities Group Brand. ect is simple. The financial world is now a more complex Experience gives rise to expectations toward the Daiwa place than it used to be. Whereas it used to be possible to Securities Group and fulfilled expectation gives rise to compete on the basis of individual products and services, trust. It is this central position in our customers collective

9 DISCUSSION & STRATEGY

consciousness that we wish to occupy. Apart from the stood and appreciated by every employee. Ensuring that immediate benefit of breaking down barriers and estab- the values expressed in that vision are reflected throughout lishing ourselves as the customer’s partner of first resort, the Group is a key goal. We will also work to ensure that the fact is that a trusted brand carries real economic value these values are reflected in our advertising, corporate for corporations across the globe. communications, and in fact at every point at which the Daiwa Securities Group interacts with its customers.

I realize that many people, especially in Japan, may not understand the relevance of branding issues to the Daiwa Securities Group. Certainly, the potential benefits from creating a brand are less easily quantifiable than the finan- cial information provided in an annual report. However, an inability to quantify an immediate benefit does not imply that the issues are peripheral or unimportant. On I therefore believe that the logic for building a brand for the contrary, we believe that, ultimately, the value of our the Daiwa Securities Group is strong. Yet when we go out brand equity will form a large component of shareholder into the real world and investigate how we actually are value and justify attention by all of our stakeholders. perceived the answer is relatively disappointing in the sense that our customers have no clear image of what the Daiwa Securities Group Brand is. That is, they have only Now, after two years, how do you feel the relation- a vague idea of what our core value proposition to them ship with Sumitomo Mitsui Banking Corporation actually is. On the positive side, while our main competi- has worked out? What do you feel about the out- tor is mainly described in terms of over-aggressiveness, the look following the merger of the former Sumitomo general public most often mentions “professional,” “styl- Bank and the former Sakura Bank? ish,” and “gentle” when describing the Daiwa Securities Group. These are traits I am personally very proud to be The most significant benefit of this partnership for the associated with and have been adopted as key elements for Daiwa Securities Group was the increased exposure to building our “brand personality.” clients that might be garnered by drawing on the former Sumitomo Bank’s extensive customer base. In our mergers The most important task that faces us in promoting the and acquisitions business, for example, or in the IPO Daiwa Securities Group Brand is actually to ensure that business, referrals from customers of the former shared Group values, which have actually always been Sumitomo Bank are increasing and the profitability of strong within this company, are given sharper focus. We such transactions is also steadily growing. In other areas, have spent a lot of time and effort during the year articu- such as structured finance and derivatives, where we lating a management vision in terms that are easily under- already rank at the top of the market, we have certainly

10 benefited from the relationship, although quantifying that we can establish strong relationships in all areas with these benefit is more difficult. However, in a few areas, such as companies simply because we now have a closer relation- equity underwriting, I think it is fair to say that significant ship with their main bank. On the other hand, we should benefits have yet to be seen. not dismiss these opportunities just because it will take effort to exploit them. I believe that Sumitomo Mitsui As for the benefits we expect from the formation of Banking Corporation has opened the door to forming Sumitomo Mitsui Banking Corporation in April 2001, of closer relations with their corporate clients. How success- course it is far too early to make firm predictions. ful we are in establishing close business relationships with Nevertheless, we are expecting tremendous benefits in var- these new customers will depend on how hard we push on ious fields. that door.

The most important will be that in contrast to the cus- tomer bases of the former Sumitomo Bank and the Daiwa Looking forward, could you please give us some idea Securities Group, which do exhibit a large measure of of what you believe is in store for the Daiwa commonality, we have traditionally had only a fairly dis- Securities Group during fy 2001 and beyond? tant relationship with the customers of the former Sakura Bank. For example, of 721 (as of April 1, 2001) compa- Looking first at our retail securities operation, I believe nies to which we are lead underwriter, only 68 have the that we will see a continuance of the trend to concentra- former Sakura Bank as their main bank. This compares tion of market share in the existing major companies, with 140 lead underwriter relationships with companies including this company. We may see one or more new having the former Sumitomo Bank as their main bank. foreign brokerages entering the Japanese retail securities Clearly, the new client base that the former Sakura Bank market during FY 2001, but I feel it will be very hard for brings to us represents virgin territory in many ways. In them to establish a significant toehold. By contrast, sec- addition, Sakura Securities, the securities subsidiary of ond-tier brokerages are increasingly being forced to focus that bank, has now been merged into Daiwa Securities on areas where they can squeeze out some competitive SMBC. The infusion of approximately 100 qualified staff advantage, to date almost entirely concentrated in the has been immediately beneficial in several areas. So going online segment of the marketplace. This trend to special- forward we expect to see substantially greater benefits than ization will only grow stronger. In my opinion, it may be we’ve enjoyed to date. difficult for such brokerages to retain clients, especially into a market upturn, if their service continues to be driv- Looking ahead, this means we can expect some repetition en by price alone. While bank participation in retail secu- of our experience with the alliance with the former rities markets remains muted, I believe that the real com- Sumitomo Bank, although on a grander scale. In some petition will continue to be between the three major areas it would be reasonable to expect concrete results fair- Japanese securities houses. ly quickly. Nonetheless, it would be naïve to assume that

11 DISCUSSION & STRATEGY

As I mentioned above, I am not happy with the results we and may account for some of the resistance we have seen produced at Daiwa Securities during FY 2000. On the among individual investors to dealing with securities com- other hand, we took a number of steps that should bear panies. Having devoted much time and effort over the last fruit during FY 2001 and beyond. To start with, Daiwa two years to equipping Daiwa Securities SMBC with cut- Securities continues to boast the strongest presence of all ting-edge systems, our attention is now turning to Daiwa three of the major securities companies in the online Securities. The next several years will see significant channel. The lead we have enjoyed in this channel has investment in this area in systems and branch remodeling. been reinforced by the successful introduction of the call center channel, where we have established a first mover Also looking forward, we now believe that offering a advantage. Our three-service-package strategy enables cus- broader product range to the retail market will contribute tomers to choose freely from among Daiwa Consulting at to our growth in profitability. To date, we have been our branch offices, Daiwa Call at our call center, and rather conservative in our product development strategy Daiwa Net Internet accounts to best meet their needs, for fear of oversegmenting the market before it had fully while allowing seamless migration between packages. We matured. However, looking back at the last year, we firmly believe these services are superior to the general would probably have benefited from adopting a more approach taken by our competitors. adventurous approach in which the full strength of the Daiwa Securities Group’s product development capability We are also taking a number of steps at Daiwa Securities could have been brought to bear. to bolster our ability to provide superior service to cus- tomers and enhance consulting service sales as our “Next In the investment banking business, the primary competi- Century Innovation Project.” In addition to our compa- tors of Daiwa Securities SMBC are the other Japanese ny-wide infrastructure activities, we have invested heavily securities houses and, in certain areas, foreign investment in Siebel System’s CRM (Customer Relationship banks. Bank subsidiaries, unsupported by a solid retail Management) and data-mining tools that will enable us to securities base, have not yet proved to be a significant more rapidly analyze and disseminate best-practice across force outside of their historic areas of expertise such as the company. We have also spent a lot of effort over the bond underwriting and asset securitization. Certainly, the last year refining our strategy for the consulting channel foreign houses can bring superior product development centered on our branch network. Although the online expertise and human resources to bear as well as privileged channel now accounts for fully 40% of the unit trades access to an overseas client base. On the other hand, they handled by Daiwa Securities, the branches continue to be lack the domestic reach that we and the other Japanese central to our future development and competitive advan- companies can apply, including access to the crucially tage in this segment. In this respect, we have also made important retail securities market. By comparison with much progress in defining plans to revitalize the branches our direct competitors, having operated by dint of necessi- over the coming years. In many ways the design and func- ty over many years according to almost identical business tion of securities companies’ traditional branches, both models, we are now following very different paths. One of our own and those of our competitors, is now quite dated us has remained an unreformed monolith, and one has

12 chosen to partner with a major foreign financial group; we Development of our intellectual asset base is also a priori- have chosen as our partner one of Japan’s leading city ty. We aim to do this drawing both on our own resources banks. While we might have obtained better access to and those of external parties where appropriate. An exam- advanced product development skills and greater global ple is our comprehensive alliance with the Hitotsubashi placing power for equity offerings by tying up with a for- University Graduate School of International Corporate eign company, we believed that the greater domestic reach Strategy. Finally, we are considering entry into the broad- and access to capital offered by a major city bank were casting business since this complements our information more attractive. In this respect, as I have mentioned distribution capabilities. above, we regard the merger between the former Sakura Bank and the former Sumitomo Bank to form Sumitomo Mitsui Banking Corporation as an added bonus unfore- So to wrap up, how would you summarize the cur- seen at the time we did the original deal. rent situation for the Daiwa Securities Group?

I think that it is fair to say that in the investment banking FY 2000 was not a great year for the Daiwa Securities market, in those areas such as structured finance, initial Group. We had thought that the thorough restructuring public offerings, bond underwriting, and equities trading, we had implemented in earlier years would have allowed we have managed to establish ourselves very quickly at the us to not just match the market, but also to steal a march forefront of the industry. Where we lag our major on our competitors. That did not happen for the reasons I Japanese competitor is in areas such as equity underwrit- have outlined above. Our goals are sufficiently ambitious ing where a strong track record and established relation- that average performance is not for us analogous to satis- ships are important. For example, compared to the market factory performance. Therefore our internal assessment of leader, Daiwa Securities SMBC is lead underwriter to our own performance is harsh. only around one-half the number of companies. The value of the alliance with Sumitomo Mitsui Banking Conversely, our faith in the underpinnings of our corpo- Corporation to us is the ability to leverage their client net- rate strategy is unshaken. We have identified many issues works. Looking forward to FY 2001, therefore, I think that need to be addressed both by the Daiwa Securities that our efforts will be directed toward better exploitation Group as a corporation and on a wider level as an influen- of those new client networks combined with continuing tial economic player with a role to play in promoting the reinforcement of our traditional areas of relative strength. healthy development of securities markets for reasons that are simultaneously selfish and for the common good. Outside of the two main securities companies, I think that How well we address these issues will determine our the major event of potential interest will be the listing of future success or failure as a corporation. I am personally NIF Ventures. In addition, we are giving careful thought confident of success and a bright future for the Daiwa to how best to structure Daiwa Institute of Research, Securities Group. which currently operates simultaneously as the think-tank for the Group and as our main systems development arm.

13 HOLDING COMPANY Daiwa Securities Group Inc.

Directors:

Yoshinari Hara, President and CEO • Shuichi Komori, Senior Managing Director and CFO

Shigeharu Suzuki, Senior Managing Director • Kenichi Fukuda, Managing Director Naoaki Takahashi, Director and CIO

Executive Officers:

Junichiro Wakimizu • Junji Takasaki • Ikuo Mori (and all Directors above)

Group Executive Officers:

Akira Kiyota • Teruwo Hatano • Tatsuhiko Kawakami

Corporate Auditors:

Hiroyasu Kawaguchi • Mitsugi Kishimoto • Tetsuro Kawakami • Masahiro Yoshiike

Advisory Board: Kazuo Inamori, Founder and Chairman Emeritus Kyocera Corporation, Jiro Ushio, Chairman and CEO USHIO INC. Glen S. Fukushima, President and CEO Cadence Design Systems, (Japan) B.V.

Remuneration Committee: Koichi Uno, CPA, Tax Accountant Ichiro Kawamoto, Attorney-at-Law, Senior Partner, Kawamoto & Miura Yukio Yanagida, Attorney-at-Law, Senior Partner, Yanagida & Nomura Yoshinari Hara, President and CEO, Daiwa Securities Group Inc.

(As of June 27, 2001)

14 setting the STANDARD DAIWA SECURITIES GROUP INC.

HOLDING Company

Daiwa Securities Group Inc., the holding company for Investments Ltd., which are active in investment manage- the Daiwa Securities Group, came into being on April 26, ment and investment advisory businesses; Daiwa Institute 1999, as the listed successor to the former Daiwa of Research Ltd. (DIR), involved in research, systems Securities Co. Ltd. The company is the quoted entity development, and consulting; Daiwa Securities Business within the Daiwa Securities Group and is a pure holding Center Co., Ltd., which operates common infrastructure company engaging in controlling and monitoring Group on behalf of the Group companies; The Daiwa Real business activities. The retail securities operations of the Estate Co., Ltd., which manages some of the Group’s former Daiwa Securities were incorporated as the New offices, including most of the branches of the retail securi- Daiwa Securities Co. Ltd. (Daiwa Securities). On April 5 ties company; and NIF Ventures Co., Ltd., a leading ven- of the same year, the wholesale securities operations were ture capital company. merged with certain securities market operations of the former Sumitomo Bank, Limited to form Daiwa Review of FY 2000 Securities SB Capital Markets Co. Ltd. (Daiwa SBCM), a During FY 2000 the Japanese economy continued to 60%-owned subsidiary of Daiwa Securities Group Inc. grow, albeit slowly, supported by rising industrial produc- with the remaining 40% held by the former Sumitomo tion and private-sector capital expenditure. This was Bank. In April 2001, The Sumitomo Bank, Limited and largely attributable to strong overseas demand for much of The Sakura Bank, Limited merged to form Sumitomo the year. However, signs of deceleration in this growth Mitsui Banking Corporation. At the same time, Sakura were seen during the second half of the fiscal year as Securities Co., Ltd., a securities subsidiary of Sakura exports showed a sharp decline and producer inventories Bank, was integrated into Daiwa SBCM, which was sub- started to rise. Private consumption remained anemic, sequently renamed Daiwa Securities SMBC Co. Ltd. while housing investment also fell.

In addition to the two main securities subsidiaries, other Japanese securities markets saw active unwinding of cross- main companies within the Daiwa Securities Group shareholdings from the financial sector and business cor- include Daiwa Asset Management Co. Ltd. and Daiwa SB porations in advance of the introduction of mark-to-mar-

16 PROGRESS OF MEDIUM-TERM MANAGEMENT PLAN

Consolidated ROE 15% Double Retail Client Assets Under Custody (JPY 28.3 Trillion)

(Trillions of Yen) FY 1998 FY 1999 FY 2000 March 1999 March 2000 March 2001

– 16.1%* 9.3% 10.5 14.7 12.7

* Figure for FY99 is 8.7% after adjustment for amortization of goodwill of Daiwa Securities SMBC.

Rating of single A or better by domestic/overseas rating agencies

Rating Agency May 1999 March 2000 March 2001

R&I BBB+/A A/A A/A+ JCR –/– A/– A+/– Moody's Baa3/Baa2 Baa3/Baa2 Baa1/Baa1 S&P BBB-/BBB BBB-/BBB BBB/BBB+ Fitch –/– –/– –/A-

Daiwa Securities / Daiwa Securities SMBC * Daiwa Securities Group Inc. presently rated: A by R&I, A+ by JCR, Baa2 by Moody's, BBB+ by Fitch

ket accounting standards from April 2001. Interest in quarter and despite recording losses on equity trading in securities investment from the retail sector was, however, the third quarter. badly affected by the uncertain market environment and recorded a sharp decline from the levels recorded during For FY 2000, Daiwa Securities Group Inc. reported con- the previous fiscal year. solidated operating revenues of 718.1 billion yen, up 10% on the previous year. Ordinary income was 177.7 billion Reflecting this trend, there was a sharp divergence in the yen, down 21% while net income amounted to 64.5 bil- performance of the two securities subsidiaries. Daiwa lion yen, 39% below the previous year. Securities Co. Ltd., the retail securities arm of the Daiwa Securities Group, recorded four consecutive quarters of Strategies adopted by the Group are described below: decline culminating in a fourth-quarter loss, the first recorded since formation of the company. By contrast, Medium-term Management Plan Daiwa Securities SMBC Co. Ltd., the wholesale securities FY 2000 was the first year of the Group’s Medium-Term company, chalked up healthy gains in revenues and earn- Management Plan to be achieved by March 2003. ings, with an especially strong performance in the last Although the Group saw deterioration in some of the

17 DAIWA SECURITIES GROUP INC.

ASSETS UNDER CUSTODY

(Billions of Yen) March 1999 March 2000 March 2001 Former Daiwa Daiwa Daiwa Daiwa Daiwa Securities Securities Securities* Change Securities Change SMBC SMBC Equity 13,355 8,783 9,037 7,431 -1,352 7,257 -1,780 Fixed Income 7,854 3,167 5,650 3,212 45 6,483 833 Investment Trust 9,832 7,448 4,444 6,247 -1,201 3,395 -1,049 Equity 1,692 2,026 324 1,591 -435 412 87 Fixed Income 8,020 5,421 4,120 4,655 -766 2,983 -1,136 Others 117 120 371 53 -67 500 129 Total 31,159 19,521 19,504 16,945 -2,575 17,637 -1,866

*Retail assets under custody was JPY 12,716 billion. (JPY 14,718 billion at 3/00)

QUARTERLY EQUITY BROKERAGE COMMISSIONS AND TRADING INCOME

(Millions of Yen) FY 1999 FY 2000 1Q* 2Q 3Q 4Q 1Q 2Q 3Q 4Q DAIWA SECURITIES

Brokerage commissions 16,097 31,668 32,450 32,619 22,626 17,759 12,397 12,963

Trading income 756 -476 896 768 -185 317 -55 125 Total 16,854 31,192 33,346 33,388 22,441 18,077 12,342 13,089 DAIWA SECURITIES SMBC

Brokerage commissions 9,786 12,274 5,065 6,041 4,033 3,922 2,790 2,784 Trading income 4,459 4,928 15,040 8,784 27,178 19,346 -8,917 77,795 Total 14,245 17,203 20,105 14,825 31,212 23,268 -6,126 80,580

(Billions of Yen) Average daily 663.3 817.2 1,039.8 1,350.6 1,042.5 867.5 757.8 859.2 trading value on TSE

Source: Monthly TSE statistics for average daily trading value * Daiwa Securities commenced operations on April 26, 1999; Daiwa Securities SMBC on April 5, 1999.

18 numerical measures of success it has adopted, it continues During FY 2000 the Daiwa Securities Group continued to vigorously pursue these goals which are: to build on these foundations in the following ways: 1. Achieve a stable consolidated ROE of 15%. 2. Double retail client assets under custody to 28.3 Establishment of a Remuneration Committee trillion yen. The Remuneration Committee acts as an advisory panel 3. Obtain a rating of single A or better from domestic to the CEO. Its purpose is to promote transparency in the and overseas rating agencies. setting of compensation and to ensure that remuneration for directors and executive officers is set at appropriate The company’s progress towards meeting these goals was levels. as follows: 1. ROE for the Group was 9.3% for fiscal year 2000. The committee met in July and December 2000 and 2. Retail client assets under custody declined to 12.7 again in April 2001. trillion yen. The fall in market valuation is the main reason for this decline as there was in fact a 1.1 tril- Market-Based Compensation lion yen net inflow of funds into Daiwa Securities. In FY 1999 Daiwa Securities SMBC introduced a system 3. The credit ratings for both securities companies of employment and remuneration dubbed “market-based were upgraded during the year. Moody's upgraded compensation” in which compensation is set by reference Daiwa Securities from Baa3 to Baa1 and Daiwa to so-called prevailing market rates for employees in cer- Securities SMBC from Baa2 to Baa1 while tain departments such as the Derivatives & Structured Standard & Poors upgraded Daiwa Securities from Financial Products Department. The Group is consider- BBB- to BBB and Daiwa Securities SMBC from ing wider application of this system to include the BBB to BBB+ Strategic Advisory Department (M&A) of Daiwa Securities SMBC. Personnel In April 1999 the Daiwa Securities Group totally Evaluation System revamped its personnel system on the occasion of its tran- In FY 1999 Daiwa Securities SMBC formally adopted a sition to a holding company structure. At the time it dis- system of Management by Objectives for the wholesale carded traditional seniority practices while adopting a new securities company in which supervisors and subordinates system in which personnel evaluations are reflected in agree on goals and evaluations based on the degree to remuneration and promotion. Remuneration consists of which the goals have been achieved. Under a system several components, including monthly salary, annual dubbed “180 degree evaluation,” supervisors are also sub- bonus, retirement allowance, stock options and incentive ject to evaluation by their subordinates. During the year warrants. Each of these is now more variable in nature under consideration, application of this system was and dependent on personal ability and achievement. expanded to the holding company, Daiwa Securities Group Inc.

19 DAIWA SECURITIES GROUP INC.

Expansion of the Training System Ventures are responsible for their own financial manage- During FY 2000, the Daiwa Securities Group formally ment, subject to oversight from Daiwa Securities Group inaugurated the Daiwa Management Academy in order to Inc. For the remaining Group companies, this system is provide high-level training for senior employees. designed to reduce financing costs by reducing the size of Candidates for the academy are selected from among the Group’s external debt and also to minimize debt approximately 400 senior managers in the Group based rollover risk. Under this system, Group companies have on the recommendation of the president of the relevant replaced external liabilities with loans from Daiwa company. The training, with an enrollment of 20 students Securities Group Inc., which has assumed the role of the per course and lasting some five months, is deliberately Group’s sole channel for external financing. Funds arising demanding and features courses in marketing, financial from the sale of assets and surplus funds arising within the theory, management methods, and other subjects. The Group are being applied to reduce the external liabilities Daiwa Management Academy is destined to play a leading of each Group company. role in helping the Group companies develop the intellec- tual capital needed to succeed in increasingly complex Under the Group’s Medium-Term Management Plan securities markets and to broaden the horizons of senior unveiled in March 2000, the company targeted a reduc- managers from a company to a Group level. tion of 500 billion yen in external debt over the three-year period in question for the Group companies, excluding Financial Strategy Daiwa Securities, Daiwa Securities SMBC and NIF The Group’s financial management strategy is based on Ventures. At the end of the first year of the plan, the the corporate imperative of maximizing shareholder’s CMS had yielded a reduction in external liabilities of value. To this end, the Group was extensively restructured approximately 320 billion yen. This has resulted in esti- in FY 1999, when the old Daiwa Securities was reorgan- mated savings of approximately 3 billion yen in net inter- ized into a holding company structure. At that time the est expenses. Group concentrated its resources in areas in which it pos- sesses competitive advantage such as Japanese-related During FY 2000 the company also made headway in securities, cross-border securities transactions, and other diversifying its sources and modes of funding. In addition related businesses. to issuing a 5 year, 100 billion yen domestic bond, the company established commitment facilities in the amount During FY 2000 the financial foundations of the compa- of 100 billion yen from a syndicate led by Sumitomo ny were further strengthened by the introduction of a Mitsui Banking Corporation and foreign banks and a Group Cash Management System (CMS). Under the facility of 20 billion yen from Sumitomo Life Insurance Group CMS, in light of the business and financial charac- Company. The company is seeking to diversify its sources teristics of the businesses in which they are engaged, of funding further by increasing borrowing from the mar- Daiwa Securities, Daiwa Securities SMBC and NIF ket and foreign banks.

20 Furthermore, the risk management system is continuously employed offsite, for a total headcount of approximately being upgraded to accommodate corporate clients’ need 1,350. This latter number compares with a figure of 650 for large scale transactions in equity products. as of March 2000, underlining the degree to which the Group has augmented its resources in this area. In addition, the Group is preparing to list on the NYSE during FY 2003. During FY 2001 and beyond, Daiwa Securities will con- tinue to invest in new integrated terminals and in Information Technology Customer Relationship Management (CRM) systems. Information technology (IT) is a core area of competitive The new terminals integrate many of the functions previ- advantage for the Daiwa Securities Group as a whole. The ously handled by dedicated terminals. This has allowed Group’s Medium-Term Management Plan calls for the company to make savings over the cost of dedicated spending between 130 billion yen and 150 billion yen leased lines and terminals previously used. In addition, over the three-year period started April 2000. Actual CRM systems have already been introduced into selected spending during FY 2000 was approximately 38.8 billion branches, with full-scale introduction into the call center yen, as the company invested mainly in infrastructure for and the remaining branches scheduled to take place the branches and the call center of Daiwa Securities and between fall 2001 and spring 2002. in trading systems for Daiwa Securities SMBC. In addi- tion, major systems investment was also seen in Daiwa Within Daiwa Securities SMBC, the cutting-edge ATRAS Institute of Research, in Daiwa Asset Management, and and PowerTradeII systems, which underlie much of the related to the 401(k) defined contribution pension activi- company’s success in equity trading, were upgraded signif- ties of the Group. icantly prior to FY 2000 and are slated for further enhancement in FY 2001. Looking forward, a further increase in IT investment geared to improving the competitive edge of the company In the fixed income area, much of the high reputation the is likely during the current year. Daiwa Securities is slated company enjoys can be attributed to the strong systems to see the greatest increase due to heavy investment in support provided by the Total Bond Analysis (TBA) sys- new terminals, the call center, and client database systems. tem. During the year under consideration, this system was Approximately 54 billion yen is budgeted in new IT upgraded and modified to run over the Internet using investment across the Group in FY 2001. standard computer terminals. The new system, dubbed “TOL” (TBA Online), was introduced in February 2001 During FY 2000 the Group increased its own headcount after completion of beta testing. The importance of this in this area from 200 to 300. Additionally, the Group system will increase in future as the introduction of mark- increased the number of subcontractors employed perma- to-market accounting gives rise to greater needs for accu- nently onsite from 400 to 850, with another 200 rate portfolio valuations.

21 DAIWA SECURITIES GROUP INC.

January 2001 saw the introduction of Real Time Gross The Group will continue to communicate its core values Settlements (RTGS) in JGB markets. The Group intro- at various stages of product and service development as duced appropriate settlement systems, which are used by well as through the various points of contact with clients. both Daiwa Securities and Daiwa Securities SMBC. Initially, the system operated on a stand alone basis. Group Communication However, interfaces to custodian organizations are expect- The Group is presently conducting Group wide branding ed to be implemented during 2001. seminars and training programs which the CEO, Mr. Hara, leads. In addition, a booklet explaining the Group Corporate Branding Project brand has been distributed to all employees while the The Daiwa Securities Group announced its brand state- “management caravan” takes management to offices and ment in March 2001. The brand statement is the branch offices worldwide. Furthermore a system to dis- Group’s commitment to its customers and constitutes the seminate and share best practice concerning the brand core values the Daiwa Securities Group will continue to around the Daiwa Securities Group is being put in place. preserve.

Last fall, the Group conducted an extensive survey target- External Communication ing general consumers, customers, academics and employ- The Group is also engaging a series of newspaper articles ees regarding the Daiwa Securities Group’s name recogni- and TV commercials to increase recognition and under- tion and image relative to competitors in the context of standing of its goal of “Setting the Standard,” which lies the corporate culture. The results have been analyzed and at the root of the brand statement. A brand mark will discussed at the Group Management Meeting leading to also be used extensively to strategically establish the the production of the brand statement as a first step Group’s visual identity. towards production of a distinctive corporate identity giv- ing form to the Group’s goal of serving as the customer’s “best partner”.

OVERSEAS ORDINARY INCOME GEOGRAPHICAL BREAKDOWN

(Millions of Yen)

US Europe Asia Total

FY 2000 11,254 5,233 810 17,297 FY 1999 2,890 7,326 2,570 12,787

22 BRAND STATEMENT independent and accurate assessment of the current busi- We, the Daiwa Securities Group, are committed to act- ness and prospects of the Daiwa Securities Group. ing as our clients’ best partner and promoting their finan- cial well-being. In order to achieve this, we shall redefine Senior management, including the president, takes an currently accepted best practice, drawing on the follow- active part in the disclosure process, including contribu- ing three core values. tion to the annual report. In addition, the company pro- motes disclosure through investor meetings and other dis- We Shall Provide Products and Services that Exceed closure materials. Expectations It is important that we apply detailed knowledge of cus- The Group has also embraced the Internet as a key ele- tomer needs, innovation in our internal processes, and a ment of its disclosure program. IR-related materials are strong customer focus to provide solutions that routinely available on a dedicated website geared to the timely dis- exceed customer expectations. semination of information and interactive communica- tions with investors. In addition, the company makes use We Shall Bring the Full Strength of the Group to Bear of e-mail broadcasts and streaming media (via Daiwa Cooperation among Group companies, sweeping aside Internet TV) to facilitate the widest possible disclosure. traditional corporate barriers, a flexible approach to busi- ness, and swift decision making will enable us to offer Overseas Operations comprehensive financial services precisely geared to meet- In FY 1998 the former Daiwa Securities reorganized its ing our customers’ financial goals. overseas network to focus its managerial resources on Japanese securities markets and related businesses. Since We Shall Continually Challenge the Limits of Financial then the Group has started to rebuild its overseas presence Best Practice in support of the new Medium-Term Management Plan. Exploitation of our substantial store of professional knowledge and a proactive approach to team building Major developments during FY 2000 were as follows: will enable us to remain pioneers in our marketplace. • Branch offices in Madrid and Milan were reopened as branches of Daiwa Securities SMBC Europe. Investor Relations The Daiwa Securities Group has maintained an active • Daiwa Securities SMBC hired staff for its subsidiary in investor relations (IR) program for a number of years. The London, Daiwa Securities SMBC Europe, primarily to company’s policy is to provide disclosure of sufficient support the Fixed Income Division of the company. information to allow each investor to arrive at a reasoned,

23 DAIWA SECURITIES GROUP INC.

• NIF Ventures moved to expand its overseas presence by could be achieved over a period of 10 years. In fact, under forming relationships with a number of overseas con- a number of reasonable scenarios, including an extension cerns. in the scope of eligibility, and increase in contributions allowed, the outcome could exceed expectations. During FY 2000 the overseas operations of the Group reported operating revenues of 229.0 billion yen (an 84% To the Daiwa Securities Group, this business is attractive year-on-year increase) and ordinary income of 17.2 billion for three main reasons. yen (up 35%). • It offers opportunities for the Daiwa Securities Group to This gain is mostly attributable to the U.S. operations, establish close working relationships with corporations which accounted for 11.2 billion yen of total ordinary or to cement relationships with companies to which it is income, up almost four times on the previous year. This already close. in turn was primarily related to domestic Japanese trans- actions rather than locally originated business. However, • It offers opportunities to establish financial relationships there was noticeable improvement in the London opera- with employees of companies adopting defined contri- tions, with Daiwa Securities SMBC re-establishing a pres- bution schemes, many of whom may be first-time ence in the Eurobond markets. investors in securities markets.

New Opportunities: 401(k) Defined Contribution • It offers opportunities to expand assets under manage- Pensions ment. The introduction of defined contribution pensions into Japan is currently expected in fall 2001. There is no doubt The company expects there to be two critical success fac- that 401(k) plans address a real need due to the so-called tors in addressing this market. The first will be establish- pension hole faced by many Japanese corporations in their ment of sufficient infrastructure for matters such as existing defined benefit plans and to the underlying record-keeping and reporting. The second will be to demographics at work. develop products, particularly investment trusts, geared to the pensions market and establishment of a strong track Unfortunately, it seems likely that initial attempts to fos- record in this area. ter a viable market for defined contribution pensions will be somewhat impeded since the contribution limit has The Daiwa Securities Group has taken a crucial step in been set at a relatively low level while eligibility for partic- these areas through the establishment of Daiwa Pension ipation in the system and the number of participants are Consulting Co., Ltd. in March 2001. Daiwa Pension limited. Nevertheless, the company estimates that a mar- Consulting will cooperate with the Investment Trust ket size of 30 trillion yen in assets under management Evaluation Institute and pension consultancy operations

24 of Daiwa Institute of Research to provide advice on retire- designed to contribute to the development of a healthy ment allowances and pension schemes. In the initial peri- civil society. Sustained corporate development depends on od, this company will engage in providing consultation to a healthy and dynamic society. As a leading company, the corporations that are planning to set up a defined contri- Daiwa Securities Group has an important duty to play an bution pension scheme. Further out, this company will active role in this area. The establishment of the also introduce investment products to plan participants, Corporate Community Affairs Department has created a providing information over the Internet and via the call framework for group-level social contribution activities, as center, and educate and support participants concerning well as an organized support structure for voluntary activi- investment decisions. ties by directors and employees. In addition to its own social contribution activities, the Daiwa Securities Group The Investment Trust Evaluation Institute monitors the also works through the Daiwa Securities Health performance of investment trusts and other financial Foundation, the Daiwa Foundation and the Daiwa products to provide the Group with advanced bench- Anglo-Japanese Foundation. These organizations also marking and competitive intelligence data. Furthermore, engage in social activities that meet its goals. the consultancy operations of DIR have long focused on pensions business and have established what the Group The principal social contribution activities of the Daiwa believes to be the most advanced capability in this area Securities Group are described below. available in Japan. The Group also has two asset manage- ment companies, Daiwa Asset Management and Daiwa Regional community action programs SB Investments, which will provide investment trust The global business activities developed by the Daiwa products for defined contribution plans. Securities Group though its nationwide branch network and overseas offices rely on the support of regional com- Competition in the 401(k) pension field is certain to be munities and the many people engaged in them. The fierce. Among the major competitors are other securities Group aims to be a good corporate citizen by fostering a houses as well as trust banks and life insurance companies relationship of trust with communities, and by basing its having established pensions businesses and city banks. corporate activities on the ideal of growth in partnership The Group has, however, made extensive preparation as with society. This approach is based on the belief that described above and believes that it has established a posi- healthy and dynamic communities are the foundation tion of competitive strength. stones for business success. The Daiwa Securities Group puts considerable importance on communications with Social Contribution local communities and flexible support in response to spe- In July 1999 the Daiwa Securities Group established the cific needs, as part of its efforts to contribute to the devel- Corporate Community Affairs Department to foster opment and maintenance of a truly prosperous and awareness of social contribution and organize activities dynamic society.

25 DAIWA SECURITIES GROUP INC.

Ecological programs The Daiwa Securities Group regards voluntary activities The 20th century was a period of economic growth with- as a way to enhance the value of people, and it offers a out precedent in human history. That growth is now lead- variety of guidance and support to encourage participa- ing to the evolution of a global society in which money, tion by as many of its employees as possible. goods, information and services all flow freely across national boundaries. Yet economic growth has also Examples of this support include the arrangement of sem- brought problems, including environmental damage, with inars to promote better understanding of the needs of the potential to jeopardize living standards and perhaps people with hearing- and vision-impairments. Activities the survival of the human race. Environmental problems include sign language lessons, and opportunities to meet are closely linked to our value systems and lifestyles. Their guide dogs. Seminar participants also wear eye masks so solution will require efforts to enhance every individual’s that they can experience the effects of blindness for them- understanding of ecological issues. It will also be necessary selves. to modify existing social and economic systems to create structures that can support sustainable development. We In August and September 2000, past and present staff and need to create a new social model capable of reconciling directors of the Daiwa Securities Group collected approxi- economic prosperity with the development of a society mately 800 abacuses, which were donated to schools in that will be responsive to the needs of people and the the African nation of Eritrea to improve the standard of environment. The Daiwa Securities Group is helping to arithmetic education. Group directors and staff also con- build this environmentally aware society. Of particular tributed goodwill donations to assist victims of the vol- significance in this context is the “Forest Giant” program. canic eruption and earthquake on Miyake Island and the Under this program, 100 large trees throughout Japan Tokai floods in Japan, and a major earthquake in India. have been selected as symbols for tree protection cam- paigns. The aim is to ensure that the rich diversity of The Daiwa Securities Health Foundation nature, as represented by these trees, can be passed on to This foundation was created in 1972 to commemorate the future generations. Daiwa Securities is encouraging its 30th anniversary of the establishment of the former customers to support this program by placing donation Daiwa Securities. Its purpose is to fund research into the boxes at its branches. prevention and treatment of lifestyle-related diseases, and to disseminate information about the maintenance and Support for employee participation in voluntary activities promotion of health in adulthood. The Foundation also In addition to their contribution to society, those who contributes to public welfare by supporting health-care participate in voluntary activities themselves gain certain and welfare programs for the aged. tangible and intangible benefits, including the discovery of new worlds, as well as lifestyle diversity. To achieve Activities are funded using investment income from the these benefits, it is necessary to provide initial support to basic endowment, which in the year ended March 31, promote the development of such voluntary activities. 2001 amounted to 131.1 million yen, together with dona-

26 tions from the Daiwa Securities Group. During FY 2000, Kingdom through international exchange between the donations of 30 million yen were made to 30 projects. two countries. The funds are used mainly for grants for research into health-care, medical treatment and welfare for the middle- As of March 31, 2001, the Foundation’s endowment aged and elderly. amounted to approximately 37.4 million pounds (approx- imately 6 billion yen). It uses its investment income to The Daiwa Foundation award grants and fund the Daiwa Scholar Program and The Daiwa Foundation was established in 1994 to mark the Daiwa Japan House. Under the Daiwa Scholar the 50th anniversary of the founding of the former Daiwa Program, young British people are invited to Japan to Securities. Its role is to contribute to the good of society learn the Japanese language and participate in other study and create an environment in which all people can partici- programs. It is hoped that this will lead to the emergence pate in voluntary activities, by providing grants to support of a future generation having an understanding of voluntary activities in such areas as welfare and medical Japanese politics and culture and the Japanese economy. care, and by promoting the volunteer spirit. To date 67 scholars have participated in the program. Total grants provided amount to approximately 2.6 mil- Funding for the Foundation’s activities includes invest- lion pounds (approximately 550 million yen). ment income from its basic endowment, which amounted to 1.9 billion yen as of March 31, 2001, and donations The Foundation also provides grants for activities in the from the Daiwa Securities Group. Grants are provided United Kingdom and Japan that contribute to the growth principally for voluntary activities in the areas of home of international exchange between the two countries in care for the aged, support for children and adults with dis- such areas as education, science and the arts. Some 1,300 abilities, and children’s issues. The Foundation also pro- grants totaling approximately 6.6 million pounds (approx- vides grants for research in such areas as welfare, medical imately 1,400 million yen) have been provided. care and public health. Donations of 48.1 million yen to fund 197 projects and grants of 2.6 million yen were pro- vided to 3 projects in FY 2000.

The Daiwa Anglo-Japanese Foundation This Foundation was created in 1988 to commemorate the 25th anniversary of the establishment of the London operation of the former Daiwa Securities. It was estab- lished in the United Kingdom with an endowment of approximately 5 billion yen from the former Daiwa Securities. Its mission is to contribute to mutual under- standing and goodwill between Japan and the United

27 (As of June 22, 2001)

28 exceed EXPECTATIONS

RETAIL SECURITIES COMPANY Daiwa Securities Co. Ltd.

Directors:

Yoshinari Hara, President • Shinichi Yamamura, Deputy President • Tetsuo Mae, Senior Managing Director

Tatsuei Saito, Senior Managing Director • Akira Hasegawa, Managing Director

Takatoshi Okuyama, Managing Director • Akira Sakiyama, Managing Director

Executive Officers:

Hiroshi Ota • Yoshihide Shimamura • Tetsuya Ikeda • Taro Tanaka • Hiroshi Fujioka

Toshifumi Shimizu • Yoshimi Murakami • Hiroshi Takeuchi • Tokuzo Takagi

Corporate Auditors:

Isao Tada • Toshio Shirai • Mitsugi Kishimoto

(As of June 22, 2001)

29 Interview with HISASHI OTSUKA General Manager of Daiwa Securities Co. Ltd.

Mr. Hisashi Otsuka joined the former Daiwa Securities in ments and have also positioned them to allow seamless 1980. In 2000 he was appointed general manager of the switching between channels as investors’ needs and experi- Call Center, with responsibility for its development within ence change. This differentiates us from the competition, Daiwa Securities Co. Ltd., and in April 2001, shortly after where the call center and Internet operations are either this interview, he was also given responsibility for the online integrated into a traditional service package or have been securities business within Daiwa Securities. separated as a wholly separate company. In the former there is a danger that promotion of the non-traditional routes will be hindered by fears of cannibalizing the The call center forms one of the three channels branches, while in the latter case synergies between chan- being offered by Daiwa securities in its three ser- nels will be harder to come by. I believe that our own vice packages, the others being the consulting approach, which segments our distribution according to (branch) channel and the Net (Internet) channel. client needs but also allows migration between channels as Do you have any observations on how the three- the need arises, allows us to enjoy the best of all worlds. channel policy is working in practice?

Overall, I believe that the three-service-package strategy is Daiwa securities was the first major securities com- potentially a very strong point of competitive advantage pany in Japan to embrace the call center channel, for Daiwa Securities as a whole. Channel by channel it is which was introduced in July 2000. Now, with too early to compare our call center strategy with those of almost one year’s experience under your belt, how our competitors. However, I believe that in the Internet do you feel in general terms about progress to field our own approach is far superior, a fact that has been date? reflected in our superior market share. I also believe that many of the features of our strength here are also probably As you mention, we were the first securities company in relevant to the call center as well. Basically, we have posi- Japan to offer services via a call center channel when we tioned each of our channels to serve distinct investor seg- introduced Daiwa Call. We were also the first to embrace

30 the Internet for securities transactions and the first to margin trading, options, or new bond issues, although we introduce i-mode as well as EZ-Web and J-Sky channels plan to start offering some of these services in the future. for securities execution using mobile terminals. I believe However, we do handle the full range of investment that we at Daiwa Securities have a tradition of innovation trusts, which means that we offer a somewhat broader in these areas that has served us well over the years. We range of products than is available through the Daiwa Net have one of the largest shares of the Internet securities online channel. channel among the big three, and I believe we have now established a first-mover advantage in the call center chan- In terms of client demographics, we have, as we expected, nel as well. attracted a client base positioned between that of the branches (Daiwa Consulting) and that of Daiwa Net. I would be misleading you, however, if I pretended that While the typical branch customer is probably in his this success came either easily or painlessly. In fact, fifties to seventies and the typical Daiwa Net customer in although we formally introduced the call center channel his twenties to forties, our own client base seems to appeal in July (that is when the call center started taking orders; to the thirties to fifties age group. In addition, while before that it was just an online help desk), we did not around 45 percent of Daiwa Consulting customers are actively market it, by widely publicizing the service female, only 17 percent of Daiwa Net customers are. We through newspaper advertising, for several months. fall solidly between these two, with around 35 percent of During this period we honed our approach basically our customers being female. through a process of trial and error, with the result that it was only in October 2000 that we felt comfortable mov- While the style of investment practiced by our branch ing to full introduction of the service. Currently, our call network might be labeled “outbound,” requiring a high center has around 200 seats and 192 TSRs (telephone ser- level of personal consultation and advice, the call center vice representatives). We offer services from 8 a.m. to 10 channel seems to be attracting a high level of what I p.m. on weekdays and from 9 a.m. to 5 p.m. on would term “inbound” investment, in which the investor Saturdays, Sundays, and national holidays, with IVR is generally acting on his or her own initiative and analy- (interactive voice response) services available out of hours. sis. The characteristics of customers in each channel are actually very different. Thus, for example, when the The call center channel is the middle channel in Daiwa’s Nikkei first broke below 14,000 in December 2000, the three-service-package strategy, bridging the gap between branches were very quiet. However, on that very day, the the over-the-counter consulting channel and the Internet- call center marked all-time high volumes. based Daiwa Net channel. The rationale for setting it up was to offer facilities to place orders as well as to answer It is difficult at this point for us to give meaningful figures various questions raised by investors. In terms of product for revenues and income in light of the novelty of this line, we differ from the consulting channel in not offering operation. However, our experience, such as it is, to date

31 DAIWA SECURITIES CO. LTD.

has been wholly satisfactory. In fact, we now estimate that not have had the same in-depth knowledge of securities we will reach breakeven over a period of between 18 markets, turned out to be far more adept at gaining client months and two years, compared with the three-year peri- acceptance by providing easy-to-understand answers. od we had originally estimated. In short, I guess that we discovered that operating a call center is a more delicate operation than we had anticipat- You say that you proceeded through trial and ed. Not only is the balance between the application of error. Could you elaborate on this point, please? technology and personal service more tricky than we had expected, but the characteristics of good service itself are Well, you should bear in mind that, as the pioneer in this less easy to define than we had imagined. Fortunately, area, we had no experience to draw on. Consequently, from an early stage we have taken a much more hands-on some of our initial attitudes and assumptions turned out approach to the management of our call center than our to be rather naïve and required us to change our rivals in the securities industry. Consequently, I believe approach. that we have established a much steeper learning curve and position of advantage within the sector than they will In general terms, I think that in the initial phase we be able to. placed too much emphasis on technology. For example, IVR services. We had assumed that the self-help aspects offered by IVR would appeal to the clientele we were try- Again, could you elaborate? ing to attract. But many callers were more interested in being quickly connected to a TSR than in self-help, con- One major difference between our call center and those sidering the IVR only a supplementary service. being constructed by our rivals is that we have retained a very large measure of direct control of the management of In other areas we had assumed that TSR duties would be the operation. By contrast, the other companies have out- fulfilled if they were able to offer the best information to sourced a lot more of the day-to-day operations to tele- callers. Actually, the attributes that make a good TSR are marketing companies. While we do recruit almost one- rather more multifaceted than that. Some TSRs turned half of our staff from agencies, we retain strict managerial out to have an ability to offer superior information to control within the company. This has allowed us to keep clients but nevertheless proved totally inadequate in pro- a close watch on and control over quality, enabling us to viding client satisfaction. Indeed, some TSRs with the implement appropriate policies much faster than would most in-depth knowledge and experience adopted such a otherwise have been the case. haughty and condescending attitude to customers seeking clarification of some aspect of transactions undertaken that those clients became offended. Other TSRs, who may

32 For example, we have implemented a policy of monitor- To wrap up, looking forward, how do you see the ing TSRs on a real-time basis to evaluate the quality of call center channel developing within Daiwa services they provide. We have produced a checklist of Securities? over 60 items to which a TSR must conform in the course of a single telephone conversation. All telephone conversa- I think that our contribution to overall Group objectives tions are monitored, and the performance of the TSR is will fall into two broad areas. In the first place, we have a rated against this list. In addition, from April 2001, we role to play in filling that gap in the market that exists have started to follow up with random questionnaires by between the full-service over-the-counter consulting chan- mail and telephone to try to gauge the level of client satis- nel and the Internet channel to address the diversifying faction with our service. Finally, maintaining direct con- needs of our customers. I believe that we are well on our trol over the management of the call center has allowed us way to fulfilling that role. to integrate experience gained in other parts of the com- pany. One example here is the fact that the Call Center, In addition, I believe that we have a wider role to play in Daiwa Direct Department, and the Sales Planning promoting greater efficiency within Daiwa Securities Co. Department for the branches meet monthly to analyze Ltd. Daiwa Securities operates 124 branches. Every one of and resolve issues, including customer complaints them offers its customers telephone-based services similar received. All customer complaints are logged, no matter to those we offer here. There are obvious gains in both what the channel, and are considered at these meetings. efficiency and quality of service to be had by centralizing This sort of process will be greatly augmented by the and streamlining these functions. Moreover, staff brought introduction of full-scale CRM systems into Daiwa up in the call center will gain a great deal of customer Securities Co. Ltd. exposure in a controlled environment. Over time, these staff will become available to other areas of the group. I One further issue I would mention would be in the area therefore believe that we have a role to play as a training of staff recruitment and training. Again, by retaining ground for Daiwa Securities staff, particularly in the area direct control over these activities we are able to imple- of customer relations. ment our own policies born out of long experience operat- ing in retail securities markets. Our training programs are For all of the above reasons — although I may be biased identical for our own staff and for those dispatched to us — I believe that the call center is a major step forward for from agencies. Attracting suitable staff is a high priority Daiwa Securities. for us, one over which we wish to maintain direct control. All TSRs are required, as a minimum, to obtain a securi- ties representative license to take orders. However, further development of knowledge and skills is necessary to address higher-level customer needs.

33 DAIWA SECURITIES CO. LTD.

RETAIL Securities Company

Daiwa Securities Co. Ltd. is the retail-securities arm of the view is supported both by international comparisons with Daiwa Securities Group. This company operates through other developed economies and by fundamental analysis a network of 124 branches as well as non-traditional of the underlying demographic and economic forces at routes, including the Internet. Since July 2000, Daiwa work in the Japanese economy today. Securities has also operated a full-fledged call center to provide telephone-based securities-related services. The general population’s lack of exposure to securities markets is extreme. Measured as a percentage of personal Daiwa Securities, in common with most other informed financial assets, Japan lags most other developed countries observers of the Japanese retail-securities markets, believes in the amount of personal wealth held in securities. that the potential for increase in the general level of retail Whereas securities holdings account for about 53% of the investment in securities markets in Japan is high. This financial wealth of U.S. households, in Japan that num-

34 ber is around 14%. Household financial assets are concen- • The company has embarked on a companywide corpo- trated in so-called safe-haven investments such as postal rate-branding campaign, which will be multifaceted and savings accounts and bank deposits. include not only external communications and advertis- ing, but also an intense program of internal education However, greater personal involvement in securities mar- and training. This project will be initiated by the CS kets would seem to be a necessity for a variety of reasons, (Customer Satisfaction) Promotion Department with including changes in prevailing employment and pension the goal of increasing customer satisfaction by reviewing systems, low returns available on low-risk investments, day-to-day operations. The branding initiative was and increasing availability of a wide range of solutions described in an earlier section of this report. addressing personal financial needs. Efforts to draw funds into risk assets have attracted a high level of governmental • Daiwa Securities has initiated a strategic program calling support, with reform to securities-related taxation laws, for the creation of a Customer Relationship for example, being widely discussed. Management (CRM) system designed to promote rapid and timely responses to customer needs through multi- In light of the above, much of the company’s strategy is ple channels, and the New Century Innovation Project predicated on the need to attract funds from investors which aims to restructure the branch network to make new to securities markets. Key initiatives in this respect the branches more attractive to first-time investors. To include the following: facilitate the creation of its in-house CRM system, the company has tied up with IBM Japan and Siebel • Daiwa Securities has diversified its distribution channels Systems Japan, a subsidiary of Siebel of the United to include the Internet and call center channels in addi- States, a leader in the field of CRM systems. The com- tion to its traditional branch channel to provide a range pany expects to complete the introduction of the CRM of services, each geared to meeting the needs of a target- system into its call center and its 124 branches nation- ed segment of the population. From July 2000, the wide by the end of FY 2001. company has introduced the three-service-package sepa- rating its service offerings into three main channels— • The company has changed the evaluation system used Daiwa Consulting, Daiwa Call, and Daiwa Net—offer- for its sales force to emphasize asset accumulation over ing differing levels of service using different commission commission income. structures.

• The company has developed programs and initiatives Review of FY 2000 specifically geared to the needs of first-time investors in Japanese retail-securities markets have been subject to sev- securities markets. Daiwa One-Two Desks have been eral rounds of deregulation culminating in full liberaliza- established at branches nationwide specifically to address tion of stock-brokerage commissions in October 1999. FY the needs of this target audience. There has been a 2000 was thus the first full financial year in which the steady increase in the number of new accounts opened Japanese securities industry operated in a wholly deregu- by customers registered with the Daiwa One-Two Desk. lated environment. Unfortunately, the year was also

35 DAIWA SECURITIES CO. LTD.

marked by very poor performance from equity markets Bond and foreign exchange trading gains rose by nearly and a major decline in the level of retail participation in 50% on active retail demand for foreign-currency-denom- Japanese securities markets. In general, conditions deterio- inated bonds, facilitated by close cooperation with Daiwa rated throughout the year. Securities SMBC in this area.

Fiscal 2000 also saw the maturation of a large volume of In addition to the decline in revenues, retail assets under postal savings deposits. Initial expectations were that a custody, a key measure of corporate success embraced by respectable proportion of these deposits would be shifted the Daiwa Securities Group, fell from the level of 14.7 into securities markets in light of the long-term trend to trillion yen recorded in March 2000 to 12.7 trillion yen investment in securities markets and the very low yields one year later. However, the decline in the value of assets available on reinvestment. However, a disappointingly under custody was the result of a decline in underlying low inflow of funds was seen. Of 53 trillion yen in postal asset values amounting to some 3 trillion yen seen during savings deposits maturing during the year to March 2001, the year. Daiwa Securities did record a net inflow of funds 65% of the after tax amount of 49 trillion yen, was rein- amounting to 1.1 trillion yen. vested in similar instruments while a substantial portion of the remainder seems to have flowed into bank deposits The number of Cash Management Accounts, which is a or similar investments and appears to have been “parked” core vehicle for Daiwa Securities, rose steadily through the pending the availability of better rates of return. Only a year, although the pace of increase was slower than in pre- relatively small percentage of the outflow seems to have vious years. At year-end there were approximately 1.87 found its way into securities markets for the purpose of million CMP accounts versus 1.62 million at the end of achieving superior long-term returns. Retail contribution the previous financial year. to trading on the Tokyo Stock Exchange dropped from 22% to 13% of the total. Investor activity was most pronounced in the online seg- ment. While it is difficult to make direct year-on-year Reflecting the above, there was a significant drop in retail comparisons since online trading picked up only in investor activity, particularly via the branch-based consult- October 1999, with the last round of deregulation, there ing channel. As a result, operating revenues fell from was an increase in the number of transactions recorded, 258.2 billion yen in FY 1999 to 178.9 billion yen in FY reaching a record high in March 2001. 2000. By segment, brokerage commissions fell from 112.8 billion yen to 65.7 billion yen, and distribution commis- The relative importance of this channel increased. For the sions, the majority of which consists of investment trust month of March 2001, Internet trading accounted for sales commissions, from 91.4 billion yen to 52.3 billion 39% of unit stock transaction trades and 15% of broker- yen. By contrast, other commissions, which consist main- age commissions. This segment was characterized during ly of agency commissions relating to investment trusts, the year by active trading conducted by extremely price- rose from 36.6 billion yen to 39.8 billion yen. In addi- sensitive and short-term oriented investors. Consequently, tion, net gains on trading accounts rose from 13.1 billion a number of companies specializing in the online route yen to 17.0 billion yen.

36 and offering services geared to short-term speculation, lion yen, and net income for the term fell from 51.3 bil- including low commissions and margin trading benefit- lion yen to 13.3 billion yen. ted. In spite of the disappointing outcome in FY 2000, Daiwa Operating expenses increased slightly, from 151.4 billion Securities continues to stress a basic strategy of increasing yen the previous year to 154.9 billion yen in FY 2000. retail-client assets under custody and of making securities SG&A expenses grew by 3 billion yen, to 153.6 billion investment attractive to first-time investors. Key elements yen. As Daiwa Securities commenced operations on April in achieving this goal are described below. 26, 1999 the figures for FY 1999 are only for 11 months distorting year-on-year comparisons. Three Service Packages Looking at SG&A, aggressive advertising activities boost- In July 2000, Daiwa Securities introduced the three-ser- ed advertising and publicity expenses to 9.4 billion yen, vice-package, as follows. an increase of 4.3 billion yen over the 5.1 billion yen recorded in FY 1999. Furthermore, depreciation expenses Daiwa Consulting. This channel provides a full range of rose on the back of higher IT-related investment. services drawing on Daiwa Securities’ extensive branch Meanwhile, company efforts to cut costs are showing network and access to trained personnel capable of offer- results in the form of lower real-estate-related and office ing a high level of advice and support. expenses. Daiwa Call. This channel is geared to those customers As a result of the above, Daiwa Securities’ ordinary who prefer to conduct transactions by telephone. These income fell from 106.8 billion yen in FY 1999 to 24.3 bil- include customers who wish to conduct transactions from

37 DAIWA SECURITIES CO. LTD.

the comfort of their own homes but who require advice may receive discounts of up to 15%, if they take advan- and customers who have trouble using the Internet. tage of a special fee-discount service offered to subscribers Presently, Daiwa Call customers have access to a some- of the Daiwa CMP service and a 25% discount for trades what restricted range of products compared to those avail- conducted over the Internet. able to Daiwa Consulting customers, but these will be gradually expanded to include the majority of products. The goal of the three service packages is to offer Daiwa Securities customers services geared to their individual Daiwa Net. This channel is geared to investors who needs while enabling seamless migration between chan- appreciate the benefits of Net trading and do not require nels. investment advice. The range of products offered through Daiwa Net is somewhat more restricted than those avail- able through either of the other packages. Branch Network Daiwa Securities operates a network of 124 branches ATM services at branches are available to all Daiwa throughout Japan. Despite the poor out-turn in the retail Securities customers regardless of channel selected. segment, Daiwa Securities made much progress in honing However, counter service is available only to Daiwa its distributional strategy. The company had earlier estab- Consulting customers. Brokerage commissions for Daiwa lished a policy of expanding the number of sales offices, Call customers for trades placed with the call center or via sometimes dubbed “minibranch offices” throughout the Internet are set at 70% of the full commission rate Japan while keeping the number of full branches at the applicable to Daiwa Consulting customers. This discount current level. Sales offices employing fewer than 20 staff rises to 50% in the case of orders placed over the Internet members have a solid cost advantage over the full branch- by Daiwa Net customers. Daiwa Consulting customers es, costing only one-eighth as much to establish. In addi-

38 tion, these outlets can be flexibly located in attractive areas Drawing on this experience, the company has produced a such as those close to major transportation terminals. set of six standard office layouts geared to meeting the needs of various locales, ranging from central locations in Three experimental sales offices were operational during the major metropolitan areas to suburban locations and FY 2000. These offices had floor areas of 55, 100 and 330 local cities outside of the main metropolises. Although square meters as well as differing interior layouts. differing in certain respects, these plans share a common Experience with this format has yielded a number of feature, which is the elimination of the “across-the- interesting conclusions. counter” layout common in Japanese securities offices — including those of Daiwa Securities — in which cus- Daiwa Securities has concluded that the minimum feasi- tomers and staff areas are largely segregated. Each features ble floor area for a sales office is in the 250 to 400 square an open-plan approach, with segregated areas reduced to a meters range since smaller offices tend to build a psycho- minimum. The great majority of the space in each of the logical barrier to entry, especially among the core target approved layouts consists of common area. These innova- population of first-time securities investors. A second key tions break down the psychological barriers — still strong conclusion drawn from experience over the last year is among many segments of the Japanese population — to that the optimal design for an office is dependent on the entering a securities company’s offices. Technological demographics and characteristics of the location. progress has also allowed a reduction in the space needed for information systems in sales outlets.

Example of New Branch Layout

39 DAIWA SECURITIES CO. LTD.

Building on experience gained during FY 2000, additional function as an on-line help desk for Daiwa Direct and outlets are expected to open in 2001 at Ofuna (near retains its role as a remote help desk for the Group as well Kamakura in Kanagawa Prefecture) and Mizonokuchi (in as offering telephone services to Daiwa Call customers. Kawasaki, also part of Kanagawa Prefecture) as well as the Tokorozawa Branch Station Plaza in Tokorozawa City, The Call Center currently employs approximately 200 Saitama Prefecture, which opened in June. Now that suf- TSRs, some 130 of whom are qualified as registered repre- ficient experience has been built, Daiwa has started to sentatives. identify additional locations. The company’s objective is to open 20 to 30 sales offices over the next two years. Although full-scale deployment was seen only during the latter part of FY 2000, experience to date has been highly Furthermore, plans are in place to remodel the existing satisfactory. The Call Center seems destined to play a traditional branch network in a similar fashion. The com- major role in the development of Daiwa Securities’ distri- pany will change the floor plan to increase common space bution strategy. An interview with Hisashi Otsuka, the shared by staff and clients and to improve the quality of general manager in charge of the Call Center, is included the client experience in using the existing branch network. in this report. In addition, current back-office systems, which are based around dedicated single-use terminals, will be replaced with multi-use PC-based terminals. Daiwa Securities Daiwa Direct intends to remodel and upgrade the information-systems Daiwa Direct is the online brokerage within the Daiwa infrastructure of all branches. Securities Group. It offers Internet-based services to Daiwa Consulting, Daiwa Call, and Daiwa Net cus- Serious consideration is also being given to other methods tomers. Daiwa Securities became the first securities com- of improving customer service, including extended open- pany to start Internet brokerage operations in Japan when ing hours at selected branches and opening on weekends. it commenced service in April 1996. In addition, it was Daiwa Securities is also working with IBM Japan and the first to offer services through NTT DoCoMo’s i-mode Siebel Systems Japan, as mentioned above, to more accu- mobile Internet service. rately record and analyze trends in customer preferences and transaction data. During FY 2000 Daiwa Direct continued to maintain a leadership position in the online segment of the retail- securities markets, with the number of accounts more Call Center than doubling to just over 340,000 as of end-March In July 2000 Daiwa Securities again became the pioneer 2001. The company believes that this represents an in the industry when it formally introduced the Daiwa approximately 18% market share of approximately 1.9 Call service package, giving clients access to a call center million accounts extant across the industry. The online staffed by telephone service representatives (TSRs) quali- channel continued to gain momentum during the year. fied to offer intermediate advice on securities investment. Although the absolute levels of commissions received fell, The Call Center had been introduced in April 1999 to this channel accounted for a full 39% of unit trades in the

40 retail company, up from 25% in the previous year, and sion in the product range offered via the Internet, includ- around 15% of commissions, up from 8%. This is despite ing higher-risk products, is under consideration, these will an increase in the discount applied to the Daiwa Net be embraced only as an integral part of the asset-accumu- channel on inauguration of the three-service package in lation process. July 2000. For certain products the reliance on the Internet channel is much higher. For example, around During the year Daiwa Direct made a number of incre- three-quarters of so-called mini-kabu transactions are con- mental improvements. Among these was extension of ducted via the Net. online trading services to cover J-Sky and EZ-Web portable terminals. Daiwa Direct has pioneered the use of Although Daiwa Direct maintained a strong position the Internet in all of the major extant formats, including within the industry and continued to outpace the online operations of its nearest competitors, some ground was given up to smaller pure-play Internet brokerages offering steeply discounted commissions and additional services, such as margin trading, geared to short-term speculation. Daiwa Direct operates as an integral part of Daiwa Securities in which stress is placed on asset accumulation and the proper application of diversification in search of higher returns at an acceptable risk level. Consequently, the company has refrained from over-orienting its opera- tions to the facilitation of speculative activity. It did not, for example, offer margin accounts or investment trusts employing derivatives during FY 2000. While an expan-

41 DAIWA SECURITIES CO. LTD.

all of the main portable formats. The proportion of trad- An IPO system that allows Daiwa Net and Daiwa Call ing via mobile terminals has risen rapidly and accounted customers to participate in initial public offerings through for 17% of the number of on-line transactions as of a lottery system was introduced in April 2001. March 2001 compared to approximately 11% during the previous year. Other innovations in the non-traditional channels include discounts for investment in mini-kabu stocks. In addition to the above, the information-provision capa- Henceforth, a discount of 30% of standard commissions bility of the service was enhanced when Nikkei Telecom will be applied for Daiwa Call and 50% for Daiwa Net 21, an online information service operated by the Nihon customers. These discounts have been applied in order to Keizai Shimbun (Japan Economic Daily newspaper), was promote securities investment among first-time investors, made available through Daiwa Direct. many of whom come first to the non-branch channels.

In a move to further consolidate its position as the front- With the number of available terminals for Internet use runner in Internet trading, Daiwa Securities also formed a expanding rapidly, Daiwa Securities will increasingly take relationship with the leading Japanese portal, Yahoo special care in providing products and services to cus- Japan, to produce a co-branded extension to the Yahoo tomers to tailor its offerings to the characteristics of the website. Named "Daiwa My Yahoo," this branch of the channel concerned. Yahoo website draws on content supplied by both Yahoo and Daiwa Securities. The site is dedicated to providing online access to useful securities-related information to investors interested in online trading and allows visitors to customize pages to suit their information needs.

42 INCOME STATEMENT

Fiscal 2000 Fiscal 1999 Apr. 1, 2000 - Mar. 31, 2001 Apr. 1, 1999 - Mar. 31, 2000 Millions of yen Millions of yen

Operating revenues 178,959 258,286 Commissions 157,918 240,898 Net gain on trading securities 17,021 13,162 Net gain on other commodities trading 13 5 Interest and dividend income 4,006 4,220 Operating expenses 154,965 151,426 Selling, general and administrative expenses 153,638 150,594 Commission and other expenses 33,022 30,984 Employees’ compensation and benefits 66,243 64,623 Real estate expenses 26,613 27,179 Data processing and office supplies 22,066 22,762 Depreciation expenses 2,233 1,720 Taxes other than income taxes 483 367 Others 2,976 2,957 Interest expenses 1,326 831 Operating income 23,994 106,859 Non-operating income 1,083 184 Non-operating expenses 722 206 Ordinary income 24,355 106,837 Extraordinary gains -- Extraordinary losses 196 17,484 Provision for multiemployers’ pension plan - 15,220 Expenses for foundation - 1,078 Provision for securities transaction liabilities 196 236 Expenses for reorganization of system - 950 Income before income taxes 24,158 89,352 Income taxes - current 6,100 52,200 Income taxes - deferred 4,662 -14,191 Net income 13,396 51,343

Unappropriated retained earnings - carryforward 37,788 -7 Unappropriated retained earnings 51,185 51,336

STATEMENT OF APPROPRIATION OF RETAINED EARNINGS

Fiscal 2000 Millions of yen

Unappropriated retained earnings 51,185 Reversal of reserve for special depreciation 34 Total 51,219 Appropriations of retained earnings 13,484 Legal reserve 1,220 Cash dividends * 12,000 Directors’ bonuses 102 Reserve for special depreciation 162 Unappropriated retained earnings - carried forward 37,735

* Cash dividends for fiscal 2000: 3,750,000 yen per share.

43 DAIWA SECURITIES CO. LTD.

BALANCE SHEET (Assets)

Fiscal 2000 Fiscal 1999 As of March 31, 2001 As of March 31, 2000 Millions of yen Millions of yen

Current assets: 507,636 1,017,259 Cash and time deposits 118,831 279,799 Cash segregated as deposits related to securities transactions 1,363 1,787 Receivables 8,545 15,230 Trade date accrual 687 199 Advance payments on securities subscribed 293 510 Short-term loans receivable 61,103 22,446 Accrued income 8,670 11,699 Trading assets: 36,331 9,924 Trading securities and others 36,217 9,885

Derivative valuation accounts 113 39 Receivables related to margin transactions: 90,644 308,210 Loans receivable from customers for margin transactions 88,171 308,011 Cash deposits as collateral for securities borrowed from securities finance companies 2,472 198 Cash deposits as collateral for securities borrowed 6,035 19,703 Securities in custody 168,527 331,852 Short-term guarantee money deposited 2,587 6,809 Deferred income tax assets-current 2,018 7,307 Other current assets 2,415 2,347 Less: Allowance for doubtful accounts-current -417 -568 Non-current assets: 79,017 68,955 Tangible fixed assets 6,717 4,334 Intangible fixed assets 10,936 1,898 Investments and others: 61,362 62,721 Long-term loans receivable 5,000 5,000 Long-term guarantee deposits 46,724 48,954 Deferred income tax assets-non-current 7,511 6,884 Other investments 2,354 1,893 Less: Allowance for doubtful accounts-non-current -227 -10

Total assets 586,653 1,086,214

44 (Liabilities and Stockholders’ equity)

Fiscal 2000 Fiscal 1999 As of March 31, 2001 As of March 31, 2000 Millions of yen Millions of yen

Current liabilities: 364,922 867,793 Short-term borrowings 67,500 268,000 Deposits received 57,164 88,258 Advance receipts on securities subscribed 811 725 Accrued expenses 6,245 8,829 Trading liabilities: 56 205 Trading securities and others -0 Derivative valuation accounts 56 205 Payables related to margin transactions: 23,367 29,994 Loans from securities finance companies for margin transactions 14,453 24,747 Proceeds from securities sold for margin transactions 8,913 5,247 Short-term securities borrowed 12,015 32,687 Cash deposits received from customers 29,812 70,140 Securities deposited by customers as collateral 156,511 299,164 Accrued income taxes 297 52,073 Accrued bonuses 8,100 9,500 Other current liabilities 3,040 8,212 Non-current liabilities: 18,653 16,838 Accrued retirement benefits 3,189 1,618 Multiemployers’ pension plan 15,220 15,220 Other non-current liabilities 243 - Statutory reserves: 433 236 Reserve for securities transaction liabilities 433 236 Total liabilities 384,009 884,868 Stockholders’ equity Common stock 100,000 100,000 Legal reserve: 51,220 50,010 Additional paid-in capital 50,010 50,010 Earned surplus reserve 1,210 - Retained earnings: 51,424 51,336 General-purpose reserve 238 - Unappropriated retained earnings 51,185 51,336 (Net income for the current year) 13,396 51,343 Total stockholders’ equity 202,644 201,346 Total liabilities and stockholders’ equity 586,653 1,086,214

45 DAIWA SECURITIES CO. LTD.

BREAKDOWN OF COMMISSION INCOME BREAKDOWN OF NET TRADING GAINS (Asset class)

Fiscal 2000 Fiscal 1999 Fiscal 2000 Fiscal 1999 Millions of yen Millions of yen Millions of yen Millions of yen

Stock and other * 78,609 125,141 Stock and other 203 1,945 Bond and other 11,720 8,999 Bond, Forex and other 16,818 11,216

Beneficiary certificate 65,725 105,268 (Bond and other) (10,765) (6,930) Others 1,863 1,488 (Forex and other) (6,053) (4,286) Total 157,918 240,898 Total 17,021 13,162

(Activity)

Fiscal 2000 Fiscal 1999 Millions of yen Millions of yen

Brokerage commission 65,764 112,856 (Stock and other) * (65,747) (112,835) (Bond and other) (14) (16) Distribution ** 52,312 91,430 (Beneficiary certificate) (35,783) (78,229) Other commission 39,841 36,611 (Beneficiary certificate) (29,939) (27,034) Total 157,918 240,898

* Including commission revenue on CBs and warrants. ** Including secondary offering and private placement.

UNDERWRITING ACTIVITIES

Fiscal 2000 Fiscal 1999 Millions of shares, Millions of yen Millions of shares, Millions of yen

Distribution *: Stock: number of shares 59 92 Yen amount 528,329 464,488

Bond: face value 289,097 365,732 Beneficiary certificates: face value 10,640,152 12,809,138 * Including secondary offering and private placement.

46 TRADING VOLUME OF STOCKS (EXCLUDING FUTURES TRANSACTIONS)

Fiscal 2000 Fiscal 1999 Millions of shares, Millions of yen Millions of shares, Millions of yen Number of shares Amount Number of shares Amount

Total 9,631 10,221,530 11,606 17,752,427 (Dealing) (a) (593) (958,064) (542) (1,057,218) (Brokerage) (b) (9,037) (9,263,466) (11,064) (16,695,208) (b) / (a+b) 93.8% 90.6% 95.3% 94.0% TSE share 2.5% 1.9% 3.3% 3.0% Brokerage commission per share 6.90 Yen 9.87 Yen

CAPITAL ADEQUACY RATIO

March 31, 2001 March 31, 2000 Millions of yen Millions of yen

Basic item: Total stockholders’ equity (A) 190,542 201,346 Supplementary item: (B) 648 814 Statutory reserve 433 236 Allowance for doubtful accounts 215 578 Assets excluded from capital: (C) 82,487 72,126 Capital after exclusion (A)+(B)-(C): (D) 108,702 130,033 Risk equivalent: (E) 43,239 49,494 Market risk equivalent 565 1,487

Counterparty risk equivalent 3,605 7,810 Fundamental risk equivalent 39,068 40,196 Capital adequacy ratio: (D)/(E) X 100% 251.3% 262.7%

* Dividends, directors’ bonuses are excluded as of March 31 2001, as "Cabinet Office Ordinance on the Capital Adequacy Rule for Securities Companies" (Cabinet Office Ordinance No. 23, 2001) was implemented on March 31, 2001.

47 WHOLESALE SECURITIES COMPANY Daiwa Securities SMBC Co. Ltd.

(As of June 25, 2001)

Directors:

Akira Kiyota, President • Kensuke Uchida, Deputy President • Yoshiyuki Takemoto, Deputy President Michihito Higuchi, Senior Managing Director • Mitsutoshi Koyama, Senior Managing Director Masaki Hirabayashi, Senior Managing Director • Yoichiro Inoue, Managing Director Nobuaki Ohmura, Managing Director • Masayasu Ohi, Managing Director Yasuo Nakamura, Managing Director Sumio Fukushima, Director • Taro Sumitani, Director

Executive Officers: Toshiro Ishibashi • Kenji Hayashibe • Mamoru Ohtani • Hideo Shimada Hidehiro Fujii • Kiyoshi Matsuba • Yutaka Murakami • Jun Kiseki • Tatsuro Inoue Hideo Watanabe • Kazuo Ariake • Akira Tanabe • Shinji Sunouchi • Shin Yoshidome

Corporate Auditors:

Masayuki Kano • Isao Takemura • Yoshiaki Senoo • Takayoshi Kobayashi

(As of June 25, 2001)

48 making things CHANGE Interview with AKIRA KIYOTA President of Daiwa Securities SMBC Co. Ltd.

Could you possibly start by reviewing the year of mark-to-market accounting from the fiscal year starting under consideration for us? We would be grateful April 2001. Equity-trading gains were 115.4 billion yen, if you could let us know, in general terms, which 2.5 times that of the previous fiscal year. areas of the business of Daiwa Securities SMBC you feel made progress and also any areas of the busi- I should mention in this context, that in the third quarter ness where you were less satisfied. we recorded a loss of some 8.6 billion yen from equity trading operations. This episode has required us to review I believe that we can claim with some justification that our risk-management procedures to place more emphasis Daiwa Securities SMBC made progress during the year to on stock liquidity risk. March 2001. While comparison with other companies is somewhat complicated by differing corporate structures, At the same time, our bond operations reported sharply consolidation methods, and disclosure, we believe that lower earnings than in the prior fiscal year due to narrow- this company recorded the best performance of any major er credit spreads compared to the situation pertaining pre- Japanese securities company in the investment banking viously which reduced opportunities for profitable trad- sector. For example, in spite of the very poor conditions ing. In addition, the introduction of the RTGS (Real affecting the markets we serve, our revenues rose 34%, to Time Gross Settlement) had a depressant effect on activity 230.7 billion yen, while our ordinary income rose from in government bond markets, further affecting our ability 73.0 billion yen to 123.6 billion yen. Net income was to make money. Operating revenues from these opera- 70.8 billion yen and our return on equity was 19.7%. tions thus fell by more than 60%, to 13.5 billion yen. On the positive side, we continued to narrow the gap with the The largest contributor to this performance was our equi- market leader in underwriting of domestic straight bonds ty trading operations. In particular, we were successful in and maintained our strong position in the JGB auction generating order flow from many institutional investors rankings. and continued to make gains in off-floor and out-of-hours trading, where we extended an already established leader- Both our structured finance and principal finance opera- ship position. Our basket-trading business was brisk due tions had a very good year. Daiwa Securities SMBC is the to corporations and, more especially, financial institutions only securities company with a significant presence in unwinding cross-shareholdings ahead of the introduction these fields and has maintained its lead position ever since

50 these products were introduced to the Japanese market. In We even have good news to report in our IPO operations, securitization we have had great success in extending our where we ranked as number one in terms of number of domestic distributional reach and have established an lead underwriter positions obtained in spite of the disap- enviable record for creativity and innovation, as witnessed pointing market conditions seen during the year. Of the by the fact that two of the deals (one being the first issue top ten companies (in terms of issue size) that went pub- using the master trust method and the second being the lic, Daiwa Securities SMBC was lead manager for seven. first securitization in connection with a life insurance Since we regard this operation as key to improving our company’s fund raising exercise) completed during the competitive position in equity underwriting, an area of year were voted number one and two structured deals of relative historic weakness for this company, we regard this the year in the influential publication, the Nikkei out-turn as encouraging. Newsletter on Bond & Money published by R&I. In principal finance, which has just been separated from the Unfortunately, our public offering operations for public old structured-finance department to form a new depart- companies once again failed to distinguish themselves. ment in its own right, we have seen active buying of Most disappointing was the fact that we failed to obtain a financial assets, including non-performing loans. Going significant role in any of the major issues during the year. forward, this operation will expand into other alternative Increasing our presence and competitive position in this asset classes such as private equity. area are matters of some importance for us.

Our M&A operations also grew apace, with revenues ris- Considering all of the above, I would sum up by saying ing by 50%. In this area, although we have yet to become that I am fairly happy with the overall performance of the a major player, we have seen business rise briskly and are company considering the adverse conditions we faced. On well placed to continue this growth through our relation- the other hand, there are certain issues that we need to ships both with Sumitomo Mitsui Banking Corporation address. The most critical issue in the short term is our and with Lazard. dependence on equity trading revenues. Although I am happy that we were in a strong position to benefit from In absolute terms, our derivatives operation, which ranks the demands of the market, I do not believe that it would as number one in the industry in terms of client penetra- be too strong to describe our current revenue stream as tion in most major segments according to an independent unbalanced. Reducing our dependence on equity trading survey by an authoritative U.S. consultancy, did not have is an immediate priority. Further out, improving our a great year. However, much progress was made in broad- reach among corporations and the standing of our equity ening the product line and client penetration of this oper- underwriting operations are perhaps the most pressing ation with the result that, going forward, the outlook concerns we have. In this respect, our relationship with seems good. In addition, the introduction of so-called Sumitomo Mitsui Banking Corporation will have a major market-based compensation schemes allowed this depart- role to play. ment to attract a relatively large number of qualified spe- cialists from the market.

51 DAIWA SECURITIES SMBC

Speaking of Daiwa Securities SMBC, it is now two In addition, while the success our IPO operations enjoyed years since this company was formed as a joint ven- during the year can probably be attributed to efforts made ture between Daiwa Securities Group Inc. and the before the formation of this company, cooperation with former Sumitomo Bank. How would you rate your the banking channel seems poised to become more impor- experience as a joint venture to date? tant in future. The IPO market is of extreme importance to us since, in spite of the greater access to listed corpora- The main benefit to the Daiwa Securities Group of tying tions we now have, we believe that strengthening our IPO up with a major city bank was the increased domestic operations will be the single biggest lever we can use to reach it gave us. Secondary but still important benefits improve the relative standing of our corporate-finance included access to a pool of qualified staff with skill sets activities. that complemented those of a securities company and access to capital. To develop this point somewhat further, it would be nice if we could report that we had achieved a large increase in This company was formed as a joint venture with the the number of corporations to which we serve as lead long-term goal of becoming Japan’s strongest investment underwriter due to our relationship with a major city bank. Although it is fair to say that approximately half of bank. Unfortunately, hopes for quick progress on this the revenues during FY 2000 came from equity trading as front were always destined to be disappointed. We our- I mentioned above, this is not a situation we would regard selves have never hoped for immediate results here for the as particularly conducive to achieving our long-term goals. simple reason that we understand very well the strong ties Indeed, while we are pleased with progress overall, diversi- that bind corporations and their lead underwriters. We fication of our earnings base is a corporate priority. A rea- are under no illusions that we will automatically succeed soned assessment of the success or failure of our status as a simply by virtue of our connection to one of Japan’s joint-venture company drawing on the strengths of two major banks. On the other hand, we do benefit from parents will ultimately come down to an assessment of our improved information flow and contact. These are progress in this area. weapons that might, over time, open doors for us that would otherwise have remained closed. This is likely to be In some areas we have made rapid progress. Our relation- truer of the companies within the Mitsui Group, where ship with the former Sumitomo Bank has directly and vis- historically we have been poorly represented, than was the ibly contributed to the progress recorded in our M&A case within the Sumitomo Group, where we have always operations and in bond underwriting. While less quantifi- had a strong presence. We have high hopes of eventual able, all of our operations, including our securitization, success but warn that we would not expect obvious results principal finance, and derivatives operations, have benefit- for another several years. ed from the advanced risk-management and compliance skills as well as client access that we have inherited.

52 You reorganized your investment banking business Although the Group has been unable to gain necessary in April. Could you please explain the reasoning approval to integrate the U.S. operation into Daiwa behind this move? Securities SMBC, for the time being, this does not repre- sent a particular problem. At present, coordination with As you mention, we brought our relationship-manage- the New York branch is sufficient to support our current ment, underwriting, syndication, M&A, and structured- goals. finance divisions together under a single umbrella. The rationale for doing so was to realize synergies and leverage internal resources more efficiently than in the past. By this So, to wrap up, what would you say are the most reorganization, we aim to be able to accurately and quick- important issues for Daiwa Securities SMBC going ly monitor our clients’ diversifying needs, and provide forward? appropriate and high value-added solutions. I think that these should be clear from the preceding dis- cussion. In the short term, it would be to build our fixed- Could you please say a few words about your over- income and investment banking income streams to the seas operations and your plans for expansion over- degree that our dependence on equity trading is reduced. seas? In the longer term, improvement in equity underwriting, rebuilding the overseas networks, and squeezing as much As you know, as part of the strategic redistribution of benefit as possible from our unique position as a joint management resources within the Daiwa Securities Group venture between a securities company and a major city to concentrate on Japan-related securities operations, we bank are all central issues. Furthermore, corporate restruc- were forced to sharply scale back our overseas operations turing in Japan is inevitable, resulting in an increase in in 1998. However, during FY 2000 we started to rebuild investment banking opportunities. We will increase our those networks. To date, most expansion has been in pur- capacity in M&A, securitization, mobilization of assets suit of strengthening our Japanese equity and bond under- and alternative investments to take advantage of these writing, with related actions including the reopening of business opportunities. And, of course, it is important our branches in Milan and Madrid to expand our that we retain our ability to develop innovative new prod- Japanese equity business. Furthermore, we have also start- ucts across the board. ed to strengthen our overseas presence in relation to our fixed-income operations. This has happened primarily in London, the center of our international fixed income business, where we have made a number of key appoint- ments and have started to rebuild our position in the Euromarkets. However, we are committed to building the business profitably rather than quickly.

53 DAIWA SECURITIES SMBC

WHOLESALE Securities Company

Daiwa SB Capital Markets was formed in April 1999 as a during that year. However, reported net income for FY 60%-owned joint venture with the former Sumitomo 2000 came in over 70 billion yen, with return on equity at Bank. In April 2001 The Sumitomo Bank, Limited and 19.7%. The Sakura Bank, Limited merged to form Sumitomo Mitsui Banking Corporation. Associated with this merger, Sakura Securities, a securities subsidiary of Sakura Bank, Equities was integrated into Daiwa SB Capital Markets, subse- The Equities Division is one of the leading players in con- quently renamed Daiwa Securities SMBC. ducting transactions with institutional investors. In non- auction (out-of-hours and off-the-floor) transactions During FY 2000 Daiwa Securities SMBC Co. Ltd. where Daiwa Securities SMBC ranks as the leading com- recorded a 70% increase in ordinary and operating pany in the industry in terms of market share, the compa- income on a 34% increase in operating revenues. This was ny confirmed its leading position with said share rising made possible during a very difficult year principally due from 25% during the previous term to 29%. to a sharp rise in equity trading revenues, which rose almost 2.5 times year-on-year, to just over 115.4 billion This result was achieved in spite of poor overall stock yen, supported by a modest rise in equity underwriting market conditions. The total average value of daily trading and distribution revenues, included in commission on the Tokyo Stock Exchange fell from a recent high of income, which rose 11%, to 29.3 billion yen, on the back 1.35 trillion yen in the fourth quarter of FY 1999 to only of firm revenues from initial public offerings. 758 billion yen in the third quarter of FY 2000, with the decline accelerating into the second half of the financial The rise in revenues was complemented by tight cost con- year in spite of some recovery seen in the fourth quarter. trol with SG&A expenses rising only marginally from the Daiwa Securities SMBC was able to record good trading level of the previous year. Comparisons with the previous income in an adverse market primarily due to its ability to year at the net income level are not meaningful because capture demand from financial institutions and business the company elected to write off goodwill acquired on for- corporations such as for unwinding of cross-sharehold- mation of Daiwa SBCM in FY 1999 and therefore record- ings, owing to its highly regarded execution capabilities ed a sizable extraordinary loss and consequently a net loss and risk management techniques. It should be noted that

54 this result was achieved with no unwarranted increase in clients. Furthermore, various seminars and meetings with risk, as can be verified by examining the value at risk top executives are arranged in coordination with other (VaR) data presented in the section dealing with risk departments within the company to accommodate institu- management at Daiwa Securities SMBC. tional investors needs.

Outside of the non-auction markets, which are geared to The Equities Division is aggressively preparing to facilitate the needs of institutional investors, the Equities Division the increasingly diversified needs of institutional and cor- has also been quick to stake a claim to leadership. This porate clients. Looking forward, demand for unwinding position was reinforced when Daiwa Securities SMBC of cross-shareholdings remains strong and seems set to became the first in the industry to provide market making continue through at least the first half of FY 2001. for all applicable OTC issues (260 as of March 2001). Further out, fluctuations in new listings, the move to dis- The company is further increasing its presence as a pio- cretionary management of public funds, and overseas neer in this market. demand for Japanese equities will all have an impact on the future course of the equity market and the opportuni- The success of the Equities Division draws heavily on the ties available to Daiwa Securities SMBC. company’s advanced infrastructure, including the experi- ence and capabilities of the sales force, traders and dealers, At a strategic level, the division will continue investing in as well as the ATRAS system, and the PowerTradeII sys- its front-end systems to further enhance the level of execu- tem, which provides traders and sales personnel with an tion capability. It will also increase its capacity to provide advanced EUC (End User Computing) environment. high-quality global research facilities to clients through cooperation with DIR. This division works closely with Daiwa Institute of Research (DIR) to offer timely analysis and advice to

Source: Daiwa Securities SMBC

55 DAIWA SECURITIES SMBC

Derivatives & Structured Financial Products choice of traditional Japanese salaried employment or The Derivatives & Structured Financial Products annual contracts with remuneration decided with refer- Division of Daiwa Securities SMBC is one of Japan’s ence to market rates. The effect of the introduction of this leading players in derivatives markets. It ranks as the lead- system was that the division was able to attract 17 valu- ing company for customer satisfaction in equity deriva- able, qualified staff members bringing with them a diverse tives and structured bond markets and also is ranked set of experience and skills. The company believes that number three in interest rate derivatives, these figures such measures are essential to attract high-quality staff and being based on independent surveys conducted by a rep- maintain long-term competitiveness. utable U.S.-based consultancy. Other major developments during the year included During FY 2000, this division suffered a decline in rev- enhancements to internal risk management systems. Now enues due to the continuing low interest rate environment an Integrated Value at Risk (IVaR) system has been intro- and poorly performing stock market. Although deal flow duced for all products, enhancing the division’s ability to from investors improved significantly, a decline in liquidi- control risk at the portfolio level. In addition, advanced ty reduced earnings. Monte Carlo simulation methods were introduced for efficient use of capital and for measuring and controlling However, revenues from interest rate derivatives rose market risk. greatly on the back of brisk demand for Medium Term Notes (MTNs). Establishment of Daiwa Securities Two major new systems are being tested for implementa- SMBC’s own MTN program and the internalization of tion in the near future. The first is a core system for equi- structuring which was made possible by an upgrade in the ty derivatives and the second is a system geared to exotic company’s credit rating also contributed to increased products incorporating interest and foreign exchange profitability. The introduction of mark-to-market and derivatives. Both systems are based on state-of-the-art IT hedge accounting increased the demand for consultancy technologies and are expected to be introduced during FY services regarding construction of off-balance-sheet port- 2001. folios. Daiwa Securities SMBC, having strong structuring capabilities, advanced quantitative abilities, and an in- Current Market Position and Outlook depth knowledge of client needs faced minimal competi- Moving forward, a key goal for the division in FY 2001 tion in serving these clients. will be to introduce customers to alternative investment opportunities based on hedge funds and fund-of-funds. Currency derivatives recorded a substantial increase in This will provide customers who are suffering from limit- revenues due to client transactions in structured bonds ed investment opportunities with products that enhance and successful dealing. returns as well as portfolio diversification.

Starting from FY 2000, the Derivatives & Structured In addition, retail-oriented products are also slated for fur- Financial Products Division of Daiwa Securities SMBC ther expansion. In this area the appropriate product and has changed its compensation system to give employees a sales channel mix is undergoing detailed review.

56 The division is also making efforts to build its exposure to volumes, particularly in the third quarter, due to investor overseas investors, a first step in this direction being taken concern over the potential for failed settlements. In addi- during FY 2000, when a presence was established in tion, securities companies, which traditionally have main- London. tained large bond positions, were forced to adopt a very defensive stance in the run-up to the introduction of RTGS. Meanwhile, widening spreads on corporate bonds Fixed Income in overseas markets lead to valuation losses on holdings. The main business of the Fixed Income Division is to Consequently, the division reported trading revenues for facilitate the bond trading needs of Japanese institutional bonds and others of 18.6 billion yen for FY 2000, signifi- investors. This division maintains a leading domestic mar- cantly below the level of 37.4 billion yen reported for the ket presence as gauged by the fact that for two years run- previous financial year. ning a survey of institutional investors by a leading U.S. consultancy has ranked Daiwa Securities SMBC first in On the other hand, although the Fixed Income Division terms of client satisfaction. According to this survey, this reported disappointing earnings due to the adverse market division boasts penetration among institutional investors conditions, its market presence was strengthened in a of more than 90%. number of ways.

The volume of domestic bond market transactions was The company maintained its position as number two in lower during FY 2000 than it had been during the previ- JGB auctions and the gap with the market leader was once ous year. FY 1999 had benefited from a contraction in again narrowed. credit spreads from the very high levels reached during the unsettled years of FY 1997 and FY 1998. This yielded Sales of bonds, including JGB’s, regional, corporate and opportunities for profitable trading that were not present foreign bonds through Daiwa Securities, the Group's during FY 2000. Daiwa Securities SMBC consequently retail securities company increased from a monthly aver- experienced a dramatic drop in profitability. Trading in age of 76 billion yen to 97 billion yen in FY 2000. domestic bond markets was further disrupted by the Corporate bonds geared to the retail channel are slated to introduction of Real Time Gross Settlement (RTGS) in become increasingly important to this division over the January 2001, which had the effect of depressing trading next several years.

BEST DEALS OF 2000 - ISSUE ( Lead Manager )

Domestic SB Sumitomo Bank Subordinated Bond Series 2 (Daiwa Securities SMBC) Global / Euro SB Japan Bank for International Cooperation (UBS Warburg / Goldman Sachs) Samurai Bond IBM Series 1 (Daiwa Securities SMBC / Merrill Lynch) Structured Bond QUOQ Master Trust (Daiwa Securities SMBC) Equity Finance NEC CB Series 11 (Daiwa Securities SMBC)

Source: Nikkei Newsletter on Bond & Money, published by R&I

57 DAIWA SECURITIES SMBC

FY 2000 DOMESTIC SB ISSUANCE LEAD UNDERWRITER will serve to further improve Daiwa Securities SMBC’s position in bond underwriting. Number of Value Share Issues (Millions of yen) (%) FY 2000 saw an improvement in the ratings awarded to Nomura Securities 82 1,528,833 20.5 Daiwa Securities SMBC by the major credit rating agen- Daiwa Securities SMBC 69 1,361,333 18.3 cies. Reflecting this improvement in credit standing, the Tokyo Mitsubishi Securities 46 1,011,083 13.6 company was able to resume business with a number of NSSB 63 917,667 12.3 customers, including certain central banks, which main- Mizuho Securities 61 819,250 11.0 tain minimum thresholds for the credit rating of counter- Source: Nikkei Newsletter on Bond & Money, published by R&I parties.

Current Market Position and Outlook During FY 1998 the former Daiwa Securities was forced Looking forward, the introduction of RTGS, mark-to- to significantly scale down its overseas network. This has market accounting, and further out, T+1 settlements left the bond business under-represented overseas and has seems slated to have a major effect on the structure of made rebuilding of those networks to serve the corporate Japanese fixed income markets. Most likely, in the opin- goals a priority. A measure of success was recorded during ion of the company, the bond business will become domi- FY 2000, with the number of staff employed in the nated by a limited number of market participants. A key London office rising by 10 as Daiwa Securities SMBC success factor in this business is likely to be the degree of continued to strengthen its position in bond syndication systems sophistication brought to bear. Fortunately, and trading in that office. A further rise in headcount of Daiwa Securities SMBC is well equipped in this respect. around 15 is planned. A greater international presence

Source: Daiwa Securities SMBC

58 JGB AUCTION RANKING

FY 2000 Billions Market FY 1999 Billions Market of Yen Share (%) of Yen Share (%)

Nomura Securities 6,079.3 12.5 Nomura Securities 4,759.9 14.1 Daiwa Securities SMBC 4,162.9 8.6 Daiwa Securities SMBC 3,113.1 9.2 Goldman Sachs 3,041.8 6.3 IBJ Securities 2,300.3 6.8 Morgan Stanley Dean Witter 2,893.2 6.0 Tokyo Mitsubishi Securities 2,014.8 6.0 Tokyo Mitsubishi Securities 2,835.0 5.8 DKB Securities 1,976.7 5.9

Source: Daiwa Securities SMBC

Daiwa Securities SMBC remains one of a handful of mar- established role in the primary markets. Daiwa Securities ket participants that can provide the pricing information SMBC has taken steps to prepare for this trend and is a services needed to analyze bond portfolios. During the shareholder in the Internet-based bond trading system year, demand for such services exploded in advance of the Yensai.com Co., Ltd. introduction of mark-to-market accounting standards. Daiwa Securities SMBC is capable of providing pricing The introduction of Internet-based bond trading will information for more than 15,000 securities. Demand has enable efficient automated price checking and compar- been so strong, however, that traditional reporting meth- isons. This in turn will make it possible for Daiwa ods such as mail or fax have become strained. The compa- Securities SMBC to reallocate human resources to higher ny therefore intends to make increasing use of the value-added areas. Internet for this purpose.

Daiwa Securities SMBC has for several years now provid- IPO ed customers with access to its proprietary Total Bond In spite of the bearish underlying tone of the equity mar- Analysis (TBA) system for analyzing bond holdings. kets during the year, due to the establishment of TSE During FY 2000 the company rolled out the first version Mothers and Nasdaq Japan, the number of initial public of its next-generation TOL (TBA Online), which features offerings in Japan rose greatly, from 126 to 201 issues (on enhanced functionality while utilizing the Internet and a listed date basis). This was, however, below the 250 or standard computing equipment rather than the dedicated so level expected at the start of the year, as certain compa- lines and terminals used by its predecessor. This system nies that had previously expressed an interest to list or to has been in full-scale use since February 2001, having pre- seek listings for subsidiaries deferred or canceled these viously been opened to a test group of 250 customers plans. from whom feedback has been positive. Although the number of new initial public offerings FY 2001 is slated to see the start of full-scale use of the emerged below expectations, Daiwa Securities SMBC’s Internet in Japanese secondary markets to complement its IPO operations could boast some success, ranking first in

59 DAIWA SECURITIES SMBC

terms of number of companies to which it acted as lead • In recent years, the IPO market has tended to be highly manager. During FY 2000 Daiwa Securities SMBC acted stratified, with a relatively small number of major issues as lead manager to 53 companies (on a listed date basis) accounting for the majority of the market in current and as manager to a further 102. Major IPOs to which value terms. During FY 2000, for example, of 201 Daiwa Securities SMBC served as lead underwriter during issues, 125 had issued offering value of less than 5 bil- FY 2000 include Shinkin Central Bank, TV Asahi, Toys lion yen. "R" Us Japan, Rakuten, NEC Soft, and JSAT (as joint- lead with Nomura Securities Co. Ltd.). Improving Daiwa Securities SMBC’s position in the IPO market is regarded as one of the top priorities by manage- Current Market Position and Outlook ment since success here will eventually feed through into The division operates in a Japanese IPO market having other areas, including equity underwriting. In this respect, the following characteristics: the division’s progress during FY 2000 can be regarded as very good and, in light of the long lead times applying in • In recent years, many issuers have been subsidiaries of this business, reflects favorably on significant efforts made larger corporations; this naturally favors the parent’s lead over the last several years. manager. Reflecting trends in the overall market, the division • In Japan, IPOs are often sold through the retail channel emphasizes business opportunities with IT and other directly with individual investors. The proportion of an high-growth companies. However, life science, industrial issue placed in this manner can reach 90% in certain waste management, as well as welfare and health care are cases. This differs from overseas IPOs, particularly in the also regarded as attractive targets. U.S., where the majority of new issues are placed with institutional investors. This has tended to strongly favor Since the formation of Daiwa SBCM, latterly Daiwa Daiwa Securities SMBC and the other major domestic Securities SMBC, this division has sought to exploit the securities companies having strong retail securities distri- extensive customer networks of Sumitomo Mitsui bution networks in domestic IPOs. Banking Corporation. The long lead times involved in this business means that results so far have been relatively small. Nevertheless, information-gathering activities have IPO LEAGUE TABLE (April 2000 to March 2001 (listed date)) been significantly strengthened with the addition of access Lead Manager Number of Value to the former Sakura Bank’s customer base, and Daiwa Issues (Billions of yen) Securities SMBC believes that it can achieve further Daiwa Securities SMBC 53 464.0 progress in this area. Nomura Securities 51 520.5 NSSB 33 112.2 Kokusai Securities 20 30.1 Equity Offering for Public Companies Shinko Securities 16 35.6 Equity related offerings by public companies totalled only TOTAL (Including Others) 201 1,243.1 3.6 trillion yen for just over 100 companies. Like the IPO

Source: Daiwa Securities SMBC market, the public offering market was affected by the col-

60 lapse in IT stocks at the beginning of the year and the Bond, the only convertible bond to be structured as a subsequent lackluster stock market. A recent trend that global offering, was named the best equity finance deal of has continued into FY 2000 is the increase in issues tar- 2000 by Nikkei Newsletter on Bond & Money. geted to the global markets. The company’s recent per- Furthermore this issue was chosen as the equity linked formance in this segment of the market has lagged expec- deal of the year and Daiwa Securities SMBC (formerly tations. Various measures to remedy this situation are cur- Daiwa SBCM) was chosen as House of the Year in this rently being considered and executed. category by Thomson DealWatch.

Major issues that debuted during the year included In recent years, following the financial big bang, there has Nippon Oracle, NTT Tranche 6, and NTT DoCoMo. been a paradigm shift in domestic corporations’ attitudes These three issues alone accounted for 83% of the total to capital structure. In the past, Japanese corporations mentioned above. Unfortunately, Daiwa Securities have tended to regard the cost of equity as comprising the SMBC did not manage to secure a lead position in these cost of the dividend. Consequently, equity capital markets three issues. But on the other hand, of 104 issues, the were heavily utilized as they were regarded as a low cost company lead managed 33, including a 77 billion yen method of raising funds. But now, with wider under- global issue for Fuji Television. In addition the company standing of the real cost of equity, management has placed ranked top in the league table for issuance of convertible increased emphasis on efficient use of capital. bonds. The 100-billion yen NEC Series 11 Convertible Maximizing corporate value has become the most impor- tant issue for management, with corporations seeking FY 2000 PUBLIC OFFERING LEAGUE TABLE advice from investment banks, such as Daiwa Securities Number of Value SMBC. The company faces stiff competition mainly from Issues (Billions of yen) experienced US investment banks, and needs to take Nomura Securities 36 555.8 immediate measures to bolster its competitiveness in this Daiwa Securities SMBC 33 143.8 area. NSSB 19 1,733.2 Shinko Securities 6 5.5 Looking forward, the outlook for the new issues and offer- Kokusai Securities 3 4.1 ing market as a whole remains subdued. There will be Goldman Sachs 2 783.6 continuing needs for financing on the part of young Mizuho Securities 2 5.1 growth firms, which have been actively accessing the capi- Tokyo Mitsubishi Securities 2 2.9 tal markets for the last several years. In addition, the need Tokai Tokyo Securities 2 0.8 for share offerings in pursuit of cross-shareholding Merrill Lynch 1 308.4 unwinding remains strong. However, other demand for UBS Warburg 1 38.5 financing via the equity capital market remains weak. Mizuho Investors Securities 1 3.2 BNP Paribas 1 0.4 On the other hand, there is no doubt that the demand TOTAL 104* 3,585.3 from large scale corporates for advice on ways to maximize * Issues with multiple lead managers are counted as one issue in the corporate value will remain high. Daiwa Securities SMBC TOTAL. has reorganized its structure integrating the product Source: Daiwa Securities SMBC

61 DAIWA SECURITIES SMBC

departments within the Investment Banking Division structure when necessary. However, the banking sector with the Corporate Institutions Department, responsible now faces its own problems in disposing of nonperform- for relationship management, from April 2001, to pro- ing loans and is no longer able or willing to serve in this mote further cooperation between the departments and role. This has opened the door to greater participation by strengthen its capability in this area. third parties. These opportunities have been further extended by a greater willingness on the part of the bank- The company’s domestic reach has been strengthened by ing sector to take a tougher approach to bad loans. It virtue of access to the client networks of Sumitomo seems likely that one benefit of increasing M&A activity Mitsui Banking Corporation, one of Daiwa Securities will be increasing pressure on management to improve SMBC’s two parents. In particular, the client base of the corporate governance. former Sakura Bank is regarded as a key competitive strength, representing new territory for the division. In Furthermore, there is a trend for cash rich blue-chip cor- fact, among companies to which the former Sakura Bank porates who are consolidating their operations to actively served as main bank, Daiwa serves as lead underwriter to pursue M&A as a tool to invest in and acquire businesses only 68 companies compared with 140 companies having including overseas businesses. a main bank relationship with the former Sumitomo Bank (as of April 1, 2001). The company anticipates that this This has been reflected throughout the market in an access to new corporate clients will yield it a competitive increasingly serious attitude to consideration of M&A advantage, particularly among the midsize listed compa- with Daiwa Securities SMBC’s team now negotiating nies having a main bank relationship with Sumitomo increasingly with clients willing to bow to the logic of the Mitsui Banking Corporation. market. Approximately 60% of referrals during FY 2000 were from the former Sumitomo Bank. During the year demand continued at such a high level that the division Mergers and Acquisitions was capacity limited. Consequently, it became more selec- Over recent years the domestic market for mergers and tive in the transactions accepted, with the result that aver- acquisitions has greatly expanded. During FY 2000, age deal size rose although the number of transactions Japanese M&A activity stayed on a growth trend in terms handled remained constant. of number of deals, although in volume terms some slow- down was recorded from the previous year. According to In spite of the favorable increase in revenues, Daiwa figures compiled by Thomson Financial, the total value of Securities SMBC does not yet rank as a significant force announced deals involving Japanese targets was U.S.$99.9 in the mergers and acquisitions market in Japan. In partic- billion, showing a 49% decline from the previous year’s ular, the company has not yet established a significant figure of U.S.$197.3 billion, while the number of deals presence in large cross-border transactions. Key to increased from 1,450 in 1999 to 1,517 in 2000. improving this position has been a tie-up with the Lazard Freres & Co. LLC. This relationship was forged in Traditionally the banking sector has taken an active part November 1999 and has already produced tangible in facilitating necessary corporate restructuring by pro- results. Major transactions completed during the year moting changes in management, financing, and corporate include the following:

62 • Daiwa Securities SMBC and Lazard advised Takata in Structured Finance their purchase of over 50% of Petri Germany’s out- In April 2001 the Principal Finance Section of the standing shares. As a result, Takata increased its market Structured Finance Department was separately organized ranking in airbags from No.4 to No.3. as the Principal Finance Department. Henceforth, the Structured Finance Department will concentrate on securi- • Daiwa Securities SMBC and Lazard advised Rihga tization and REITs, while the Principal Finance Royal Hotel New York in its $193 million takeover by Department will continue to take principal positions in Thayer Hotel Investors. assets that are nontraditional for a securities company.

• Daiwa Securities SMBC and Lazard advised Hotel Daiwa Securities SMBC is the only securities company to Nikko de Paris in its takeover by ACCOR and Colony. maintain a substantial presence in this area, which is oth- erwise the province of domestic banks. The success that • Daiwa Securities SMBC and Lazard advised Hokuriku this division enjoys can be attributed to its high level of Seiyaku a subsidiary of BASF, in its takeover by Abbott expertise and reputation for problem solving. The division Laboratories in a deal valued at $445 million. boasts a strong track record for innovation in this area since having pioneered the market by launching the first Current Market Position and Outlook domestic ABS issue in 1996. It seems likely that a large increase in transactions handled will be seen in this division during FY 2001. This is espe- This strength was in evidence during FY 2000 and is illus- cially so given the transaction stream that is expected to trated by the fact that two of the transactions completed result from the client networks of the former Sakura Bank during the year were voted the first and second best deals which merged with the former Sumitomo Bank on April of the year by the Nikkei Newsletter on Bond & Money. 1, 2001. As a consequence of this merger, the division gained 33 highly qualified staff from the former Sakura • During FY 2000 the division securitized shopping card Bank, taking total headcount to 75 and greatly augment- receivables owned by QUOQ on two separate occasions. ing its capacity to handle this increase in business volume. This issue broke new ground by introducing the master trust structure into Japan and was voted best deal of At the same time, the division regards it as a priority to 2000. build on the network of the Daiwa Securities Group, Sumitomo Mitsui Banking Corporation and Lazard to • In September the division securitized 180 billion yen of increase involvement in prominent M&A transactions, Kikin funds for the Nippon Life Insurance Company. increasing its ability to complement the business originat- This marked the first time a mutual life insurance com- ing within Daiwa Securities SMBC. In addition, a further pany was able to raise funds through securitization and strengthening of the relationship with Lazard is under was voted second best deal of 2000. The company holds consideration in order to increase the division’s position high expectations that similar future needs for securitiza- in cross-border M&A. tion will be forthcoming.

63 DAIWA SECURITIES SMBC

ABS MARKET COMPOSITION

FY 2000 FY 1999 Billions of yen (%) Billions of yen (%) Lease Receivables 265.1 15.2 490.0 25.2 Shopping / Auto Loans 404.4 23.1 568.0 29.2 Credit Card Receivables - - 10.0 0.5 Consumer Loans 49.9 2.9 19.1 1.0 Residential Mortgage-Backed Securities 223.6 12.8 50.3 2.6 Commercial Mortgage-Backed Securities 478.6 27.4 324.5 16.7 Collateralized Debt Obligations 128.0 7.3 476.9 24.6 Others 200.2 11.4 3.2 0.2 TOTAL 1,749.8 100.0 1,942.0 100.0

Source: Daiwa Securities SMBC

Current Market Position and Outlook in terms of issue amount. The market for securities The key success factors in this business are structuring backed by bank loans or corporate bonds continued to fall capability and distribution power. The ability to produce rapidly during FY 2000 and seems unlikely to increase leading-edge products in turn draws on a wide array of during FY 2001. The major areas in which an increase in knowledge, including legal, taxation, and financial expert- activity is expected are securities backed by commercial or ise. Daiwa Securities SMBC has established an enviable residential mortgages (CMBS, RMBS), as well as new position in this area and a strong first-mover advantage. areas such as securitization of kikin (funds) for life insur- ance companies. Further diversifying the investor base is a continuous goal for the division, which also believes that this will yield it a The market for commercial mortgages-backed securities competitive advantage with respect to its major competi- (CMBS) continued to grow briskly in FY 2000 after the tors, which do not boast the domestic reach among mid- surge in activity recorded in the previous financial year. size financial institutions that Daiwa Securities SMBC can There was a trend to inclusion of a wider range of under- bring to bear. The division is also considering more lying assets, including hotels, department stores, and actively addressing the potential of the retail channel shopping malls to complement the strong demand for together with the creation of retail and overseas investors- securities over office buildings, land, and non-performing oriented products, the most significant example of which real-estate backed assets seen during the previous financial are ABS products targeting retail clients and REITs con- year. The driving force behind this market growth is a sidered below. change in accounting standards, which may force Japanese corporations to reevaluate the value of their land holdings Looking forward to FY 2001, it seems likely that the secu- under certain circumstances and thereby make securitiza- ritization of credit and lease receivables, historically a tion an obvious and attractive option. mainstay of the industry, will continue to be maintained

64 Residential mortgage-backed securities (RMBS) also REITs showed brisk growth during FY 2000 following issue of The Financial Services Agency has approved seven asset the first Japanese RMBS in FY 1999. Strong growth is management companies including Mori Trust Daiwa Real also expected in FY 2001 since the Government Housing Estate Investments Co., Ltd. to engage in managing Loan Corporation issued its first RMBS in March 2001 REITs. and is expected to issue at regular intervals from now on. It is currently expected that the first Japanese REIT will While official statistics for the size of the market for asset- be launched in summer 2001. Daiwa Securities SMBC backed securities in Japan are not available, Daiwa anticipates a great deal of interest from individual Securities SMBC estimates that the total size of the mar- investors, trust banks, life insurance companies, and pen- ket is around 1.7 trillion yen for structures with a maturi- sion funds due to the relatively high yield that is likely to ty of one year or more. If shorter-term securities such as be available. trust certificates and asset-backed commercial paper were included, this number would rise by perhaps another 1 Adequate supply seems to be assured, with several very trillion yen, for a total of 2.7 trillion yen. Going forward, large-scale construction projects suitable for securitization the division expects this latter figure to rise to around 3.0 going forward amid an expected rise in the supply of trillion yen during FY 2001. If integration among major office buildings in 2003 and with REITs being clearly financial institutions results in reviews of asset portfolios, attractive to companies such as major real estate develop- however, it is possible that there will be a sharp increase in ers in controlling balance sheet risk. Consequently, by the ABS issues relating to loan assets, etc., including housing end of FY 2001, Daiwa Securities SMBC anticipates that loans, thus further expanding the market. In any event, a the total value of REITs listed on the Tokyo Stock year of market growth seems highly likely. Exchange will rise to 500 billion yen. The company expects that this figure will rise further, to around 5 tril- Key goals for the division during the year in addressing lion yen, over the next 10 years. these opportunities will be to maintain the strong pres- ence it already enjoys in structuring expertise while aggres- Daiwa Securities SMBC will contribute to the develop- sively building channels to new classes of investors as ment of the REIT market by providing financial advisory described above and increasing its presence among domes- services to REIT management companies, educating tic originators. A key facilitator of this latter goal will be investors, and providing REIT analysis to domestic and Sumitomo Mitsui Banking Corporation, where the client overseas investors holding real estate. networks of the former Sakura Bank can be utilized to effect. The integration with the former Sakura Securities It is the division’s intention to exploit its established posi- has already led to measurable benefit in this area since it tion in ABS markets and its domestic and overseas was already active in the securitization markets, with a investor base to establish a leading position in the client base complementary to that of the former Daiwa Japanese REIT market as it develops. SBCM.

65 DAIWA SECURITIES SMBC

Principal Finance hence the increase in MBO activity. Also, privately owned This department, which as mentioned above operated small and midsize companies facing succession problems within the Structured Finance Division during FY 2000, should offer good MBO opportunities for the Fund. makes principal investments in asset classes that are non- traditional for a securities company. The two main assets J-Cap can serve as a strategic and financial partner for are loans including non-performing loans sold by banks portfolio companies by applying certain managerial tech- and other financial institutions, and equity of distressed niques used by the sponsors. After creating value through companies. these processes, J-Cap expects that the Fund’s typical exit strategies will include sales to strategic or financial buyers The department ranks as a major participant in the bulk- or initial public offering. sales market for loans. A vitally important area of compet- itive advantage here is the department’s ability to accu- rately assess the value of future cash flows and underlying Risk Management real estate collateral. As a company involved in wholesale securities markets, risk management for Daiwa Securities SMBC is a matter The potential for investing in distressed equity has been of the utmost importance. The role of risk management enhanced by a change in Japanese corporate restructuring has increased generally within the industry due to a rising laws and the advent of procedures similar to those of reliance on investment banking activities relative to bro- Chapter 11 in the United States. The division has formed kerage commission as a consequence of deregulation of a relationship with Wilbur Ross of the United States, one financial services. The company’s risk management is of the most successful participants in corporate restructur- grounded in the following fundamental policies: ing. • Active management involvement in the risk manage- Japan Equity Capital Co. Ltd. ment process Daiwa Securities SMBC is a 25% stakeholder in Japan Equity Capital Co., Ltd. (J-Cap). The other shareholders • Active internal supervision are GE Capital International Holdings Corporation of the U.S. (50%) and Sumitomo Corporation (25%). These • Unified risk management, including setting of appropri- three shareholders, together with their affiliates, have ate risk limits committed a 20 billion yen fund (the Fund) to which J- Cap provides investment advice. • Stress testing and contingency planning

J-Cap’s advice to the Fund focuses on both controlling • Documentation and standardization of the risk manage- and minority growth equity investment opportunities in ment process to promote transparency midmarket businesses in Japan. Acceleration of restructur- ing of the domestic economy, increase in M&A activity, Active Management Involvement unwinding of cross-shareholdings, and increase in labor Ultimate responsibility for risk management rests with the mobility have stimulated the need for corporate spin-offs, Risk Management Committee, which meets every three

66 months to set basic goals and policies. A subcommittee of In addition, middle offices have been established in the this committee decides the agenda in advance. The mem- trading divisions to manage credit, market, and liquidity bers of the Risk Management Committee consist of the risk. These offices are independent of the front offices, president, deputy presidents, and divisional directors. The although having a common reporting line. members are charged with setting applicable risk manage- ment policies for credit, market, and liquidity risk; with The Risk Management Department, which is independ- establishing appropriate rules covering transactions in ent of the marketing and trading divisions and has a sepa- each product category; with deciding appropriate levels of rate reporting line, is responsible for overall control and credit, market, and liquidity risk; and with considering monitoring of credit and market risk as well as settlement the current risk profile. risk. It manages these risks in consultation with the mid- dle offices mentioned above. A subcommittee of the Risk Management Committee meets monthly to preview the agenda to be submitted to The Treasury Department takes responsibility for manag- the full committee; to discuss details relating to the imple- ing liquidity risk and for fund-raising. The department is mentation of stated policy; and to consider the current also functionally independent of the marketing and trad- profile of credit, market, and liquidity risk. The members ing divisions. of this subcommittee are the general managers in charge of the product planning, marketing and administration A similar system to the above, with independent middle activities of the company. offices, has also been introduced in overseas branches. Overseas branches report market risk and funding sched- In addition to the above, market risk and liquidity risk are ules on a daily basis and credit risk on a weekly basis. measured and reported daily to management by the Risk Management Department and the Treasury Department, Unified Management respectively. Credit risk is reported to the director of the Risk limits are set by product using the most appropriate Risk Management Department on a weekly basis. The measures for each category. However, these individual director also attends the executive director’s weekly meet- limits are supplemented by integrative measures centered ing and reports on the current status of credit, market, on VaR. This measure has been applied to market risk for and liquidity risk. A report is also submitted to the hold- some time. From September 2000 it has also been applied ing company on a timely basis. to credit risk.

The Risk Management Department also calculates Active Internal Supervision Regulatory Market Risk using the standard methods laid The front office divisions are the first line of risk manage- down by the Financial Services Agency to measure regula- ment within Daiwa Securities SMBC. In particular, mar- tory risk capital. The minimum level for this ratio is keting and trading divisions are responsible for monitor- 140%. As of end-March 2001, the corresponding ratio for ing the credit standing of counterparties, while trading Daiwa Securities SMBC was 364%. divisions also bear responsibility for market risk.

67 DAIWA SECURITIES SMBC

VALUE AT RISK (Billions of Yen)

March June September December March 2000 2000 2000 2000 2001

Equity 6.4 1.8 3.5 2.5 2.7 Interest 0.3 1.2 0.6 0.6 0.9 Currency 0.1 0.1 0.1 0.2 0.1 Sub-total 6.6 3.0 4.1 3.1 3.6 Diversification benefit -0.2 -0.8 -0.5 -0.6 -0.5 TOTAL 6.4 2.1 3.6 2.5 3.1 Total figures may differ due to rounding up of VaR figures and rounding down of Diversification benefit figures. • Confidence level: 99% • One day • High 19.4 billion yen (July) Low 1.4 billion yen Average 4.4 billion yen

Stress Testing and Contingency Planning most extreme case, positions would be reduced to within The events of the last several years have highlighted the the limits of the company’s long-term available funds and limits of risk management based on statistical analysis. access to finance already granted by banks. Daiwa Securities SMBC has consequently supplemented its traditional risk measures with additional measures, Documentation and Transparency including stress-testing for equity specific risk and bond The authority and responsibilities of each department and spread risk for emerging market bonds. The specific sce- division within Daiwa Securities SBCM have been thor- narios assume sudden and serious disturbances, including oughly documented to nullify any possible confusion or those seen in recent years as, for example, during the peri- ambiguity. In addition, the internal procedure of the Risk od of the Japan Premium, hedge-fund crisis in the U.S. Management Department itself is has also been formally and disorder in emerging market debt. It also includes specified in writing. theoretical scenarios, including the assumption of severe disruption to domestic repo markets. Transparency of the risk-management process is also being promoted by the introduction of an internal rating In the event of a sudden and catastrophic decline in the system to standardize credit reviews. company’s ability to maintain liquidity, in addition to having established commitment lines, contingency plans are in place to implement a phased reduction in the com- pany’s trading positions to within specified limits. In the

68 INCOME STATEMENT Fiscal 2000 Fiscal 1999 Apr. 1, 2000 - Mar. 31, 2001 Apr. 1, 1999 - Mar. 31, 2000 Increase / Comparison Millions of yen Millions of yen decrease (%)

Operating revenues 230,735 172,069 58,665 134.1 Commissions 73,643 92,471 -18,828 79.6 Net gain on trading securities 128,934 70,679 58,255 182.4

Net gain on other commodities trading 2 340 -337 0.7 Interest and dividend income 28,155 8,578 19,577 328.2 Operating expenses 107,251 99,488 7,763 107.8 Selling, general and administrative expenses 94,993 93,816 1,176 101.3 Commission and other expenses 34,743 37,518 -2,775 92.6 Employees’ compensation and benefits 24,963 22,834 2,128 109.3 Real estate expenses 9,917 9,832 85 100.9 Data processing and office supplies 14,282 16,364 -2,082 87.3 Depreciation expenses 5,768 4,115 1,653 140.2 Taxes other than income taxes 2,833 1,913 919 148.1 Others 2,485 1,237 1,247 200.8 Interest expenses 12,258 5,671 6,586 216.1 Operating income 123,484 72,581 50,902 170.1 Non-operating income 677 579 98 117.0 Non-operating expenses 521 150 371 346.8 Ordinary income 123,640 73,010 50,629 169.3 Extraordinary gains - – - - Extraordinary losses 797 219,392 -218,595 0.4 Write-off of goodwill - 208,000 -208,000 - Consumption tax incurred regarding goodwill not falling under other deductions - 4,359 -4,359 - Provision for multiemployer pension plan - 4,232 -4,232 - Business start-up-related expenses - 2,056 -2,056 - Provision for securities transaction liabilities 797 744 52 107.1 Provision for financial futures transaction liabilities 0 0 0 13.4 Income/losses before income taxes 122,843 -146,382 269,225 - Income taxes - current 36,661 17,358 19,302 211.2 Income taxes - deferred 15,379 -78,659 94,039 - Net income/losses 70,802 -85,080 155,883 -

Unappropriated retained earnings - carryforward 517 8 509 - Unappropriated retained earnings 70,284 -85,088 155,373 -

STATEMENT OF APPROPRIATION OF RETAINED EARNINGS

Fiscal 2000 Millions of yen

Unappropriated retained earnings 70,284 Reversal of reserve for special depreciation 260 Total 70,545 Appropriations of retained earnings 56,652 Legal reserve 5,141 Cash dividends * 51,200 Directors’ bonuses 210 Reserve for special depreciation 101 Unappropriated retained earnings carried forward 13,892

* Cash dividends for fiscal 2000: 16,000,000 yen per share.

69 DAIWA SECURITIES SMBC

BALANCE SHEET (Assets)

Fiscal 2000 Fiscal 1999 As of March 31, 2001 As of March 31, 2000 Millions of yen Millions of yen

Current assets: 5,490,024 5,545,267 Cash and time deposits 41,894 118,356 Cash segregated as deposits related to securities transactions 1,586 785 Receivables 1,929 5,942 Advance payments on securities subscribed 806 199 Short-term loans receivable 289,539 31,835 Accrued income 8,703 4,863 Trading assets: 2,490,598 2,592,120 Trading securities and others 2,174,429 2,470,177 Option transactions 42,341 12,343 Derivative valuation accounts 273,827 109,599 Payables related to margin transactions: 137,648 85,418 Loans receivable from customers for margin transactions - 315 Cash deposits as collateral for securities borrowed from securities finance companies 137,648 85,103 Receivables related to gensaki transactions 217,451 24,099 Cash deposits as collateral for securities borrowed 777,872 1,004,175 Securities in custody 1,501,176 1,659,021 Short-term guarantee money deposited 8,335 9,547 Deferred income tax assets-current 6,062 4,387 Other current assets 7,362 4,583 Less: Allowance for doubtful accounts-current -944 -70 Non-current assets: 136,555 141,385 Tangible fixed assets 4,972 5,333 Intangible fixed assets 21,856 11,543 Investments and others: 109,726 124,508 Investment securities 37,758 35,519 Long-term loans receivable 37 35 Long-term guarantee deposits 9,045 8,336

Deferred income tax assets-non-current 57,218 74,272 Other investments 5,790 6,344 Less: Allowance for doubtful accounts-non-current -123 0

Total assets 5,626,580 5,686,652

70 (Liabilities and Stockholders’ equity)

Fiscal 2000 Fiscal 1999 As of March 31, 2001 As of March 31, 2000 Millions of yen Millions of yen

Current liabilities: 5,050,326 5,257,012 Short-term borrowings 220,503 230,200 Commercial paper 516,300 145,600 Bonds due within one year 4,400 - Deposits received 8,471 10,763 Trade date accrual 36,658 125,262 Advance receipts on securities subscribed 1,011 6,574 Accrued expenses 5,365 4,853 Trading liabilities: 1,094,936 1,078,232 Trading securities and others 789,771 962,454 Option transactions 40,317 12,806 Derivative valuation accounts 264,847 102,971 Payables related to margin transactions: 59,876 34,198 Loans from securities finance companies for margin transactions - 168 Proceeds of securities sold for margin transactions 59,876 34,030 Payables related to gensaki transactions 741,938 1,123,837 Cash deposits as collateral for securities loaned 776,512 803,975 Short-term securities borrowed 1,321,226 1,451,897 Cash deposits received from customers 50,115 12,737 Securities deposited by customers as collateral 179,950 207,124 Accrued income taxes 27,518 16,878 Accrued bonuses 3,600 3,300 Other current liabilities 1,941 1,576 Non-current liabilities: 180,576 105,974 Bonds 73,200 - Long-term borrowings 100,000 100,000 Deferred income tax liabilities-non-current 299 - Accrued retirement benefits 1,865 1,029 Multiemployer pension plan 4,232 4,232 Other non-current liabilities 979 712 Statutory reserves: 1,541 744 Reserve for securities transaction liabilities 1,541 744 Reserve for financial futures transaction liabilities 0 0 Total liabilities 5,232,444 5,363,731 Stockholders’ equity Common stock 205,600 205,600 Legal reserve: 117,321 202,410 Additional paid-in capital 117,321 202,410 Retained earnings: 70,802 -85,088

Special reserve for depreciation 517 - Unappropriated retained earnings 70,284 -85,088 (Net income/losses for the current term) (70,802) (-85,080) Revaluation reserve for investment securities, net of tax 412 - Total stockholders’ equity 394,136 322,921

Total liabilities and stockholders’ equity 5,626,580 5,686,652

71 DAIWA SECURITIES SMBC

BREAKDOWN OF COMMISSION INCOME BREAKDOWN OF NET TRADING GAINS (Asset class)

Fiscal 2000 Fiscal 1999 Comparison Fiscal 2000 Fiscal 1999 Comparison Millions of yen Millions of yen (%) Millions of yen Millions of yen (%)

Stock and other * 44,296 59,974 73.9 Stock and other * 115,403 33,213 347.5 Bond and other 10,483 11,281 92.9 Bond, Forex and other 13,531 37,466 36.1 Beneficiary certificates 10,914 14,669 74.4 (Bond and other) (18,606 ) (37,425) (49.7) Others 7,949 6,546 121.4 (Forex and other) (-5,075 ) (41) (- ) Total 73,643 92,471 79.6 Total 128,934 70,679 182.4

(Activity) Fiscal 2000 Fiscal 1999 Comparison Millions of yen Millions of yen (%)

Brokerage commission 13,714 33,722 40.7

(Stock and other) * (13,531) (33,167) (40.8) (Bond and other) (182) (549) (33.1) Underwriting 37,296 33,979 109.8 (Stock and other) * (29,381) (26,417) (111.2) (Bond and other) (7,914) (7,562) (104.6) Distribution ** 3,384 3,713 91.1 (Beneficiary certificate) (1,680) (2,496) (67.3) Other commission 19,247 21,055 91.4 (Beneficiary certificate) (9,232) (12,167) (75.9) Total 73,643 92,471 79.6 * Including commission revenue on CBs and warrants. ** Including secondary offering and private placement.

UNDERWRITING ACTIVITIES

Fiscal 2000 Fiscal 1999 Comparison Millions of shares, Millions of yen Millions of shares, Millions of yen (%)

Underwriting: Stock: number of shares 73 92 79.7 Yen amount 648,552 662,799 97.9

Bond: face value 3,097,155 3,055,531 101.4 CP & others: face value 1,822,300 1,192,600 152.8 Distribution *:

Stock: number of shares 133 98 134.9 Yen amount 672,230 665,745 101.0 Bond: face value 3,129,498 3,136,207 99.8

Beneficiary certificates: face value 4,667,340 5,024,142 92.9 CP & others: face value 1,822,300 1,162,600 156.7

* Including secondary offering and private placement.

72 TRADING VOLUME OF STOCKS (EXCLUDING FUTURES TRANSACTIONS)

Fiscal 2000 Fiscal 1999 Comparison (Millions of shares, Millions of yen) (Millions of shares, Millions of yen) (Millions of shares, Millions of yen)

Number of shares Amount Number of shares Amount Number of shares Amount

Total 39,514 60,131,859 36,854 60,773,098 107.2% 98.9% (Dealing) (a) (20,817 ) (31,387,302 ) (17,483) (29,146,860) (119.1) (107.7 ) (Brokerage) (b) (18,696 ) (28,744,556 ) (19,371) (31,626,237) ( 96.5) ( 90.9 ) (b) / (a+b) 47.3% 47.8% 52.6% 52.0% TSE share 6.7% 7.7% 6.2% 6.6%

CAPITAL ADEQUACY RATIO

March 31, 2001 March 31, 2000 Millions of yen Millions of yen

Basic item: Stockholders’ equity * (A) 342,313 322,921 Supplementary item: (B) 102,897 101,505 Valuation profits of Investment securities 412 690 Statutory reserve 1,541 744 Allowance for doubtful accounts 944 70 Subordinated borrowings 100,000 100,000 Assets excluded from capital: (C) 137,876 141,675 Capital after exclusion (A)+(B)-(C): (D) 307,335 282,751 Risk equivalent: (E) 84,265 55,720 Market risk equivalent 49,056 28,667 Counterparty risk equivalent 16,399 9,384 Fundamental risk equivalent 18,809 17,668 Capital adequacy ratio: (D)/(E) X 100% 364.7% 507.4%

* Dividends, directors’ bonuses and revaluation reserve for Investment securities are excluded as of March 31, 2001 as “Cabinet Office Ordinance on the Capital Adequacy Rule for Securities Companies” (Cabinet Office Ordinance No 23, 2001) was implemented on March 31, 2001.

73 74 OTHER MAIN GROUP COMPANIES daiwa asset management co. ltd. daiwa institute of research ltd. daiwa sb investments ltd. daiwa securities business center co., ltd. the daiwa real estate co., ltd. nif ventures co., ltd.

75 OTHER MAIN GROUP COMPANIES

OTHER Main Group Companies

OTHER MAIN GROUP COMPANIES (FY 2000) (Millions of Yen)

Daiwa Asset Daiwa Daiwa SB Daiwa Securities Daiwa Real NIF Management Institute of Investments Business Center Estate Ventures Research Operating Revenues 66,980 78,027 6,495 9,973 44,832 12,097

Operating Expenses 57,909 71,592 5,754 8,837 37,926 7,493

Operating Income 9,071 6,435 740 1,136 6,906 4,604

Ordinary Income 10,314 6,014 833 1,145 2,227 4,809

Group Holdings 88.0% 84.4% 44.0% 100.0% 57.4% 95.6%

Daiwa Asset Management offset the gains resulting in a fall in assets under manage- Daiwa Asset Management (DAM) is one of the asset man- ment. In common with its major competitors, the compa- agement companies within the Daiwa Securities Group. ny’s main flagship equity fund Musashi underperformed As of March 31 2001, the company had net assets under the main equity market indices. On the other hand, the management of approximately 12.0 trillion yen, a decline company’s strong capability was underscored when its CB of roughly 2.5 trillion yen from the previous year. DAM Fund was one of eight funds chosen out of a field of 594 saw a decline in all major product lines, including equity as a domestic Investment Fund of the Year for 2000 by an investment trusts, bond investment trusts, and money influential investment trust rating company. management funds (MMFs). Equity investment trust assets under management fell by 0.6 trillion yen to 1.7 The balance of assets under management in bond invest- trillion yen. Although DAM saw a net inflow into equity ment trusts also fell to 10.3 trillion yen, some 2 trillion investment trusts amounting to 376 billion yen during yen below the year-earlier figure. DAM has traditionally the year, the largest amount recorded by any asset man- held a very strong position in MMFs due to a strong track agement company in Japan, the decline in equity prices record in providing superior returns. During FY 2000 this

76 position was reinforced, with the company maintaining DAM has responded to the challenges of FY 2000 by an over 40% market share. However, the year was marked revamping its internal organization to enhance monitor- by a de facto lifting of the BoJ’s zero interest rate policy, ing and control of fund performance. which in turn caused rate-sensitive holders, particularly institutional investors, to withdraw funds. Overall, the DAM is also working to exploit new channels of distribu- total balance of MMFs at the end of the year fell by tion. Currently, the majority of all products are distrib- approximately 1.4 trillion yen. uted through Daiwa Securities and Daiwa Securities SMBC, within the Daiwa Securities Group. Alternative Conversely, the balance of investment in medium-term routes being addressed include other securities companies, government bond funds, one of DAM’s most important and banks. bond fund products, surged by more than 0.6 trillion yen due to its higher return relative to other financial prod- The company is also centrally involved in the Daiwa ucts. Nevertheless, the fund was unable to match headline Securities Group’s thrust to exploit the potential of the returns offered by its major competitor, which managed defined contribution 401(k) pensions market, as described to boost assets under management in this segment to a earlier in this report. While significant revenues will prob- greater extent during the year. ably not be seen in the short term, this area is regarded as being of crucial importance. DAM has established the The potential for increasing retail participation in the Defined Contribution Business Planning Department as a investment trust market has attracted a large number of special planning section to provide 401(k) products and new competitors. In particular, recent years have seen var- to coordinate with other group companies, including ious foreign asset management companies set up or rein- Daiwa Pensions Consulting. force their operations in Japan.

77 OTHER MAIN GROUP COMPANIES

Daiwa Institute of Research does not reflect this fact and remains an important issue Daiwa Institute of Research Ltd. (DIR) supports the vari- that must be addressed. ous companies in the Daiwa Securities Group by taking responsibility for research, systems development, and con- During FY 2000, the company took various steps to sulting within the Daiwa Securities Group and serving as increase client satisfaction. For example, the number of the Group’s think tank. DIR also provides services to institutional client visits made by analysts and economists non-Group companies by drawing on its accumulated increased, while an internal reorganization has made flexi- know-how. ble cooperation between analysts covering unlisted and OTC-listed corporations possible. Furthermore, the num- Since implementation of the Group’s Medium-Term ber of analysts employed has been increased by actively Management Plan from April 2000, the company has recruiting from external sources. reoriented its operations to focus on increasing the enter- prise value of the Daiwa Securities Group as a whole. The Systems Division is the core in the planning, devel- Consequently, during FY 2000 each of the main divisions opment and operation of each of the Group companies’ — research, systems development, and consulting — has information systems. The division engaged in the devel- undertaken a wide-ranging review of its current opera- opment of Internet and next generation terminals for tions. This process was significantly enhanced during FY Daiwa Securities and preparation for T+1 trading in 2000 by improvements made to the company’s internal accordance with the Group’s aggressive IT investment management accounting systems, which has enabled man- strategy. In addition, the External Sales Division was able agement to more accurately assess profitability by line of to increase revenue from a wide range of financial institu- business. tions and corporations despite the focus on strengthening services provided to Group companies. In line with the corporate goals set in the Medium-Term Management Plan, DIR is gradually reviewing its business DIR’s consulting operations have been refocused on areas with entities outside of the Daiwa Securities Group with of strategic importance to the Daiwa Securities Group. the goal of maximizing the efficiency of its resource Areas of particular concern include the provision of con- deployment and profitability. One visible result of this sulting services to clients of Daiwa Securities SMBC, the policy during FY 2000 was an increase of 90 systems staff 401(k) pensions business, where DIR works closely with members engaged in internal projects and a retreat from other members of the Group, and internal education, unprofitable business areas in system sales and consulting. where DIR is responsible for the curriculum and training of the Daiwa Management Academy considered earlier in In the Research Division, DIR employs approximately this report. 150 professional staff members domestically and approxi- mately 60 overseas. In numerical terms this makes DIR one of the largest research organizations in Japan. However, external perceptions of the company’s expertise

78 Daiwa SB Investments Group companies. The company also provides temporary This company was formed on April 1, 1999, through the staff for securities-related businesses. merger of Daiwa International Capital Management Co., Ltd., SB Investment Management Co., Ltd., and SBIM During FY 2000 this company became the first securities Investment Trust Management Co., Ltd. In addition, at back office service provider to be certified under the inter- its inception, an alliance with the U.S. investment man- nationally recognized ISO9001 standard. agement firm T. Rowe Price was formed, with the goal of managing the non-Japanese portion of investment trust This reflects the credibility the company has gained from products for customers of the company in Japan. Daiwa its clients. For the Group companies, DSC will continue SB Investments Ltd. is included in the Daiwa Securities to provide professional and efficient services while helping Group consolidated accounts as an equity method affili- to cut administration costs. ate, the Group owning a 44% stake in the company.

As a center for asset management businesses for both the Daiwa Real Estate Daiwa Securities Group and Sumitomo Mitsui Banking The Daiwa Real Estate Co., Ltd. is mainly involved with Corporation, Daiwa SB Investments has moved quickly to the holding and renting of the Daiwa Securities Group’s establish itself as Japan’s leading investment advisory firm office premises, housing, dormitories and other properties. for pension assets. The company also develops investment The company has already made a decision to withdraw trusts. As of March 2001, Daiwa SB Investments had from housing development and now concentrates on funds under management amounting to approximately 3 rental and leasing businesses, mainly concerned with the trillion yen. Of this amount, 1.9 trillion yen consisted of Daiwa Securities Group’s branches and offices. The mis- pension funds under management, the largest amount in sion of this company is to promote efficient asset utiliza- the industry. The company actively applies knowledge tion across the entire Group. gained in the management of pension funds to the devel- opment of investment trusts. During FY 2000, the com- pany successfully launched "Global Biotechnology Fund NIF Ventures (Mr. Gene)" and the "Japan Equity Growth Fund NIF Ventures is the venture capital arm of the Daiwa (Uminokuni)" recording the highest growth in assets Securities Group. The company operates both in Japanese under management of any asset management company. and in overseas venture capital markets. In addition to the Tokyo headquarters, domestic offices are located in Osaka, Nagoya, Fukuoka and Sapporo. The company also Daiwa Securities Business Center has offices in Taiwan, Singapore, and in Silicon Valley in Daiwa Securities Business Center Co., Ltd. (DSC) is a the U.S. Furthermore, NIF has established venture capital wholly-owned subsidiary of the Daiwa Securities Group companies and funds on a joint venture basis with estab- Inc. DSC provides securities back office support to the lished venture capital companies in Taiwan, Israel and the Daiwa Securities Group as well as to a number of non- UK.

79 OTHER MAIN GROUP COMPANIES

This fiscal year, NIF Ventures invested 13.2 billion yen in for 24%, services 13%, electronics 12%, financial 11% 128 companies through investment partnerships managed and consumer goods 11%. However, due to a shift into so by itself or consolidated subsidiaries and 9.9 billion yen in called new economy companies boasting leading edge 141 companies directly, using its own funds, for a total technology and business models and having significant investment of 23.1 billion yen in 155 companies. As a potential for future growth, the composition for FY 2000 result, total investments outstanding reached 82.3 billion included computer and telecommunications 24%, services yen (investment partnerships 39.3 billion yen, direct 43.0 18% and electronics 11%. Furthermore, approximately billion yen). Of the total outstanding amount, exposure to 60% of the investment for the fiscal year, as well as for the the computers and telecommunication sector accounted total outstanding amount was in domestic companies

80 with the balance invested overseas. Among investments Israel Investments Ltd. in Israel, France’s Siparex Group made overseas the geographic breakdown was Asia 34%, and Belgium’s GIMV, mainly in Europe. Furthermore Europe/US 63% and others 3%. Considering that the the company has been chosen as the sole Japanese institu- ratio of total outstanding overseas investment is Asia 63%, tion to become a founding member of The University of Europe /US 34% and others 3%, it can be seen that the Cambridge Entrepreneurship Center. These alliances will portfolio is becoming more globally balanced. This shift enhance NIF Venture’s capabilities to invest on a global in portfolio structure is due to a strategy the company has basis. put in place over the last several years and will continue for the foreseeable future. Another major point of competitive advantage for NIF Ventures in its business is access to a network of external As of March 2001, the company had investments in 742 technical advisers whose skills to analyze and evaluate (563 domestic and 179 overseas) companies, among state-of-the-art technology and innovation complement which 27 domestic and 16 overseas companies underwent those of company personnel. This year, an advisor on the an IPO during FY 2000. bio-technology sector was added in to complement the IT section advisor, providing the company with access to This fiscal year, NIF Ventures attracted 22.6 billion yen the technological knowledge essential to successful invest- in funds for newly established investment partnerships ment in these high-potential markets. (including investment of its own funds) such as "NIF New Technology Fund No2-2000," and "NIF21-ONE Looking forward, it is the intention of the Group to seek (Series 1)." As a result, NIF Ventures and its subsidiaries an independent listing for NIF during FY 2001. By going have 30 investment partnerships with total initial paid-in public, NIF will raise its profile at the same time as capital of 126.9 billion yen and net assets of 84.8 billion becoming subject to the discipline of the markets to yen under management after distribution of profits of an increase credibility. This in turn will provide opportuni- accumulated 60.1 billion yen. Operating income from ties to expand its client base. managing investment partnerships amounted to 4.6 bil- lion yen of which 2.3 billion yen consisted of success fees.

Further expanding its overseas network where it has already been able to differentiate itself from other venture capital companies in Japan is a corporate priority. The company has strengthened alliances with established ven- ture capitalists, such as Quester Capital Management, Amadeus Capital Partners in the UK, Evergreen Canada -

81 Five-Year Financial Summary 85

Management’s Discussion & Analysis 87

Consolidated Balance Sheets 90

Consolidated Statements of Operations 92

Consolidated Statements of Shareholders’ Equity 93

Consolidated Statements of Cash Flows 94

Notes to Consolidated Financial Statements 96

Report of Independent Public Accountants 121

The Daiwa Securities Group 122

Overseas Directory 123

Corporate Data 124

82 Consolidated Financial STATEMENTS

83 Information in this annual report may contain forward-looking statements regarding expec- tations of the Daiwa Securities Group Inc. These statements are based on currently avail- able information and represent the beliefs of the management of Daiwa Securities Group Inc. These statements are subject to numerous risks and uncertainties that could cause actual results, performance and achievements to differ materially from those described or implied in the forward-looking statements. These potential risks and uncertainties include without limitation volatile and sudden movements in the international securities markets, foreign exchange and global economic situations affecting the Daiwa Securities Group.

84 FIVE-YEAR FINANCIAL SUMMARY

Daiwa Securities Group Inc. & Consolidated Subsidiaries (years ended march 31, 1997 through 2001)

Thousands of Millions of yen U.S. dollars 2001 2000 1999 1998 1997 2001 Operating Results: Revenues: Commissions ...... ¥ 254,704 ¥ 364,116 ¥ 185,450 ¥ 198,118 ¥ 242,599 $ 2,054,065 Net gain (loss) on trading ...... 169,506 126,170 (20,708) 39,385 57,159 1,366,984 Interest and dividend income ...... 223,992 103,882 190,219 286,393 282,965 1,806,388 Service fees and other sales ...... 69,909 60,482---563,782 Total ...... 718,111 654,650 354,961 523,896 582,723 5,791,219 Operating expenses ...... 538,246 427,720 443,527 538,065 534,035 4,340,694 Income (loss) before income taxes and minority interests ...... 166,615 135,173 (208,538) (83,936) (77,559) 1,343,670 Net income (loss) ...... 64,549 105,376 (127,890) (83,657) (80,021) 520,557

Financial Position: Total assets ...... 9,250,223 8,514,213 6,268,596 10,132,457 13,425,965 74,598,573 Shareholders’ equity...... 716,816 666,072 639,859 774,699 873,191 5,780,774

Yen U.S. dollars Per Share Amounts: Net income (loss) ...... ¥ 48.62 ¥ 79.43 ¥ (96.00) ¥ (62.35) ¥ (59.51) $0.39 Cash dividends applicable to the year ...... 13.00 13.00 5.00 6.00 8.00 0.10 Shareholders’ equity...... 539.72 502,05 480.47 580.08 649.42 4.35

Percent Financial Ratios: Pretax profit margin ...... 23.2 % 20.6% –% –% – % (Income before income taxes and minority interests to total revenues) Net profit margin ...... 9.0 16.1 – – – (Net income to total revenues) Return on average shareholders’ equity ...... 9.3 16.1 – – – (Net income to average shareholders’ equity) Equity ratio (Shareholders’ equity to total assets) ** ...... 9.3 10.0 12.9 9.3 8.1 Other data: Number of employees ***...... 11,114 11,415 8,855 10,006 9,880

Notes 1. Unless indicated otherwise, all dollar figures herein refer to US currency. Dollar amounts represent translations at the rate of ¥124 = US$1, the rate prevailing on March 31, 2001 2. Net income and shareholders’ equity per share are computed based on the average number of shares outstanding during the year * As of April 26, 1999 the former Daiwa Securities Co. Ltd. was reorganized and officially renamed Daiwa Securities Group Inc. ** Securities in custody account has been deducted from total assets *** Figures are the sum of the Holding Company and its consolidated subsidiaries

85 MANAGEMENT’S DISCUSSION AND ANALYSIS

86 MANAGEMENT’S DISCUSSION AND ANALYSIS

The Company and its related companies comprising the Daiwa Securities Group consists of 52 consolidated subsidiaries and 4 equity-method affiliates and operates primarily in securities businesses including investment and financial services. The company operates mainly in Japan with offices also located in the main financial centers of the US, Europe and Asia/Oceania. The Group provides a wide range of global services to satisfy customer needs for investing or raising funds through the inter- national securities markets and related services.

Summary of operating results Consolidated operating revenues amounted to ¥718,111 million ($5,791,219 thousand), a 9.7% increase and consolidated operating expenses to ¥538,246 million ($4,340,694 thousand), a 25.8% increase from March 31, 2000. Consequently, oper- ating income decreased to ¥179,865 million ($1,450,525 thousand), a 20.7% decrease from March 31, 2000.

Consolidated net income emerged at ¥64,549 million ($520,557 thousand), down 38.7%.

Commissions Brokerage commission Brokerage commission income decreased 43.8% to ¥82,881 million ($668,396 thousand), due mainly to poor stock market conditions in the second half of the year, a resultant 8.8% year-on-year decrease in daily average trading value on the Tokyo Stock Exchange and a move towards net price trading by institutional investors.

Daiwa Securities Co. Ltd. The retail securities company accounted for ¥65,764 million ($530,355 thousand) in brokerage commissions with equities accounting for a large proportion of such commissions. Brokerage commission experienced a steep decline due to the poor per- formance of the equity market and subsequent fall in retail participation, which accounted for only 13.9% of overall turnover on the Tokyo Stock Exchange compared with 22.6% during the previous year.

Daiwa Securities SMBC Co. Ltd The wholesale securities company mainly engages in transactions with institutional investors. Since the complete liberalization of stock brokerage commissions in October 1999 an increasing proportion of transactions have been conducted on a net basis. As a result, brokerage commissions amounted to ¥13,714 million ($110,597 thousand), 59.3% below the previous year's total.

Underwriting commission The majority of underwriting commission is recorded at Daiwa Securities SMBC engaging in investment banking operations. Underwriting commission at Daiwa Securities SMBC was ¥37,296 million ($300,774 thousand), a 9.8% increase, principally due to a firm contribution from IPO operations.

Consolidated underwriting commission was ¥38,859 million ($313,379 thousand), an increase of 11.4% from March 31, 2000.

87 MANAGEMENT’S DISCUSSION AND ANALYSIS

Distribution commission Distribution commission fell 55.1% to ¥39,609 million ($319,427 thousand), due to a fall in sales of equity investment trusts.

Daiwa Securities Co. Ltd. As mentioned above, the sluggish stock market dampened retail investors' appetite for equity related products, resulting in a sharp decline in sales of equity investment trusts. Distribution commission was ¥52,312 million ($421,871 thousand), a sig- nificant decline from last fiscal year. This figure includes commission earned on issues underwritten by Daiwa Securities SMBC, which have been eliminated when calculating the consolidated figures.

Daiwa Securities SMBC Co. Ltd. Sales of investment trusts also declined at Daiwa Securities SMBC causing distribution commission to fall 8.9% to ¥3,384 million ($27,290 thousand).

Other commissions Trust fees arising from investment trusts were broadly unchanged, emerging at ¥70,421 million ($567,912 thousand). Although the end-year balance of investment trust assets was sharply down from the previous year, a high balance was main- tained in the earlier months of fiscal year 2000. In total other commission was ¥93,355 million ($752,863), down 0.2% year- on-year.

Daiwa Securities Co. Ltd Agency commissions on investment trusts, amounting to ¥29,939 million ($241,444 thousand) were the primary source of other commissions totaling ¥39,841 million ($321,298 thousand).

Daiwa Securities SMBC Co. Ltd. Other commissions came to ¥19,247 million ($155,218 thousand), 8.6% below the previous year's figure. The main reason behind this decline is the fall in agency commissions on investment trusts to ¥9,232 million ($74,452 thousand), 24.1% below the previous year's total. In particular, there was a decline in agency commission on the mainstay MMF (money man- agement funds). On the other hand, commission generated from M&A, structured finance and consulting activities increased.

Net trading gains Total net gains on trading increased 34.3% to ¥169,506 million ($1,366,984 thousand).

Daiwa Securities Co. Ltd. Daiwa Securities Co. Ltd. reported ¥17,021 million ($137,266 thousand) in net trading gains for the period. Gains recorded on equities of ¥203 million ($1,637 thousand) consisted primarily of foreign stocks and mini-stock. On the other hand, income arising from bonds including spread equivalents on retail transactions in bonds and foreign exchange gains or losses contingent to trading in foreign stocks and bonds on customers' accounts increased sharply to ¥16,818 million ($135,629 thousand).

88 Daiwa Securities SMBC Co. Ltd Net gains on equity trading increased 247.5% to ¥115,403 million ($930,669 thousand), due to an expansion in order flow from corporate clients. Trading income arising from bonds and foreign exchange was ¥13,531 million ($109,121 thousand) down 36.1% from the previous year. As a result, total net gains on trading accounts amounted to ¥128,934 million ($1,039,790 thousand), a year-on-year increase of 82.4%.

Net financial income Net financial income increased to ¥28,024 million ($226,001 thousand), up 109.8% year-on-year. Interest and dividend income was ¥223,992 million ($1,806,388 thousand) with interest expenses of ¥195,968 million ($1,580,387).

Selling, general & administrative expenses Selling, general & administrative expenses remained basically unchanged at ¥286,948 million ($2,314,097 thousand). Increases in advertisement expense due to an aggressive advertisement campaign and increases in depreciation expenses follow- ing an expansion in IT investment were offset by a cut in real estate, data processing and office supply expenses.

Other expenses Other expenses were ¥13,250 million ($106,855 thousand) due to write-off of securities of ¥4,750 million ($38,306), provi- sion for doubtful accounts of ¥2,942 million ($23,726 thousand), losses on disposal and sale of fixed assets of ¥2,751 million ($22,185 thousand) and losses on sale of loan receivables of ¥1,519 million ($12,250 thousand).

Cash flow Net cash used in operating activities was negative ¥388,375 million ($3,132,057 thousand), primarily because of an increase in securities trading positions including expanded repurchase agreement transactions in the US operations. Net cash provided by investing activities was ¥4,969 million ($40,073 thousand), reflecting progress in sale of investment securities. Net cash provided by financing activities was ¥42,799 million ($345,153 thousand), mainly due to bond issuance. In consequence, cash and cash equivalents after allowance for the effect of exchange rate changes decreased by ¥332,911 million ($2,684,766 thousand) to ¥399,564 million ($3,222,290 thousand).

89 CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS (march 31, 2001 and 2000)

Thousands of Millions of yen U.S. dollars (note 1) Assets 2001 2000 2001 Cash and cash deposits: Cash and time deposits (note 12) ...... ¥ 399,564 ¥ 732,475 $ 3,222,290 Cash segregated as deposits related to securities transactions ...... 8,975 8,060 72,379 408,539 740,535 3,294,669

Receivables: Loans receivable from customers ...... 30,602 29,122 246,790 Loans receivable from other than customers ...... 379,668 114,707 3,061,839 Receivables related to margin transactions (note 5) ...... 228,292 393,629 1,841,065 Other ...... 85,575 125,946 690,121 Less allowance for doubtful accounts...... (8,163) (7,828) (65,831) 715,974 655,576 5,773,984

Collateralized short-term financing agreements (note 6) ...... 2,729,721 1,392,219 22,013,879

Trading assets (notes 7 and 12)...... 2,884,496 2,927,868 23,262,065

Securities in custody (notes 11 and 12) ...... 1,556,172 1,820,905 12,549,774

Deferred income taxes (note 18) ...... 92,200 113,538 743,548

Other assets: Property and equipment, at cost (note 12) ...... 405,911 408,529 3,273,476 Less accumulated depreciation ...... (92,005) (83,968) (741,976) 313,906 324,561 2,531,500

Lease deposits ...... 32,488 33,672 262,000 Investment securities (notes 8 and 12) ...... 326,907 285,349 2,636,347 Long-term loans receivable (note 13) ...... 14,968 24,789 120,710 Other (note 12) ...... 189,243 385,794 1,526,153 Less allowance for doubtful accounts...... (14,391) (190,593) (116,056) 863,121 863,572 6,960,654

¥ 9,250,223 ¥ 8,514,213 $ 74,598,573

see accompanying notes.

90 Thousands of Millions of yen U.S. dollars (note 1) Liabilities and shareholders’ equity 2001 2000 2001 Loans: Short-term borrowings (notes 12, 13 and 16) ...... ¥ 600,028 ¥ 826,066 $ 4,838,935 Commercial paper...... 516,300 145,600 4,163,710 Long-term debt (notes 12, 13 and 16)...... 598,839 688,333 4,829,347 1,715,167 1,659,999 13,831,992 Payables: Payables to customers (note 15) ...... 188,570 184,416 1,520,726 Time deposits received ...... 13,573 20,184 109,460 Payables from brokers, dealers and customers ...... 13,814 57,537 111,403 Payables related to margin transactions (note 5) ...... 29,772 53,618 240,097 Other ...... 20,178 47,098 162,726 265,907 362,853 2,144,412

Collateralized short-term financing agreements (note 6) ...... 3,251,220 2,418,487 26,219,516

Trading liabilities (note 7) ...... 1,412,370 1,234,298 11,390,081

Accrued and other liabilities: Income taxes payable...... 30,344 74,430 244,710 Accrued bonuses ...... 18,748 19,491 151,194 Multiemployers’ pension plan (note 17) ...... 28,443 28,443 229,379 Retirement benefits (note 17) ...... 9,413 6,329 75,911 Other (note 18) ...... 65,541 80,082 528,556 152,489 208,775 1,229,750

Securities borrowed and deposited by customers (notes 11 and 12) ...... 1,556,172 1,820,905 12,549,774 (Contra account of securities in custody) Statutory reserves (note 19) ...... 1,975 981 15,927

Minority interests ...... 178,107 141,843 1,436,347

Contingent liabilities (note 20)

Shareholders’ equity (notes 21 and 22): Common stock, par value ¥50 per share; Authorized - 4,000,000 thousand shares Issued - 1,331,735 thousand shares (1,331,733 thousand shares in 2000) ...... 138,432 138,431 1,116,387 Preferred stock, no par value; Authorized - 100,000 thousand shares Issued - 0 share ...... – – – Additional paid-in capital ...... 117,786 117,785 949,887 Retained earnings ...... 459,994 413,469 3,709,629 Net unrealized gain on securities, net of tax effect ...... 18,984 – 153,097 Translation adjustments ...... (15,807) – (127,476) Treasury stock, at cost...... (2,573) (3,613) (20,750) Total shareholders’ equity...... 716,816 666,072 5,780,774 ¥ 9,250,223 ¥ 8,514,213 $ 74,598,573

91 CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF OPERATIONS (years ended march 31, 2001, 2000 and 1999)

Thousands of Millions of yen U.S. dollars (note 1) 2001 2000 1999 2001 Revenues (note 23): Commissions (note 24)...... ¥ 254,704 ¥ 364,116 ¥ 185,450 $ 2,054,065 Net gain (loss) on trading ...... 169,506 126,170 (20,708) 1,366,984 Interest and dividend income...... 223,992 103,882 190,219 1,806,388 Service fees and other sales...... 69,909 60,482 – 563,782 718,111 654,650 354,961 5,791,219 Operating expenses (note 23): Selling, general and administrative expenses (notes 13, 17 and 25) ...... 286,948 287,498 271,085 2,314,097 Interest expense ...... 195,968 90,524 172,442 1,580,387 Cost of service fees and other sales ...... 55,330 49,698 – 446,210 538,246 427,720 443,527 4,340,694 Operating income (loss) (note 23)...... 179,865 226,930 (88,566) 1,450,525

Other income (expenses): Reversal of statutory reserves, net (note 19) ...... (994) (197) 45,883 (8,016) Other, net (note 26) ...... (12,256) (91,560) (165,855) (98,839) (13,250) (91,757) (119,972) (106,855) Income (loss) before income taxes and minority interests ...... 166,615 135,173 (208,538) 1,343,670

Income taxes (note 18): Current ...... 48,019 77,643 (1,672) 387,250 Deferred ...... 21,830 (15,273) (78,952) 176,048 69,849 62,370 (80,624) 563,298

Minority interests ...... (32,217) 32,573 24 (259,815) Net income (loss)...... ¥ 64,549 ¥ 105,376 ¥ (127,890) $ 520,557

Per share amounts: Yen U.S. dollars (note 1) Net income (loss)...... ¥ 48.62 ¥ 79.43 ¥ (96.00) $ 0.39 Diluted net income ...... 46.26 76.19 – 0.37 Cash dividends applicable to the year...... 13.00 13.00 5.00 0.10

see accompanying notes.

92 CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (years ended march 31, 2001, 2000 and 1999)

Millions of yen

Number of shares Net unrealized Treasury of common stock Common Additional Retained gain on securities, Translation stock, (thousands) stock paid-in capital earnings net of tax effect adjustments at cost Balance at March 31, 1998 ...... 1,335,554 ¥ 138,425 ¥ 117,779 ¥ 518,528 ¥ _ ¥ _ ¥ (33) Net loss ...... (127,890) Cumulative effect of adoption of tax effect accounting (note 18) . . . . 3,017 Cash dividends paid ...... (8,013) Redemption of treasury stock (note 21). (3,832) (1,970) Net in treasury stock ...... 16 Balance at March 31, 1999 ...... 1,331,722 138,425 117,779 383,672 _ _ (17) Net income ...... 105,376 Revisions in accounting for subsidiaries and affiliated companies (note 3) . . . . (68,913) Cash dividends paid...... (6,658) Bonuses to directors...... (8) Shares issued upon conversion of bonds. . 11 6 6 Net in treasury stock ...... (3,596) Balance at March 31, 2000...... 1,331,733 138,431 117,785 413,469 _ _ (3,613) Net income ...... 64,549 Revisions in accounting for subsidiaries and affiliated companies (note 3). . . . (498) Cash dividends paid ...... (17,246) Bonuses to directors...... (280) Shares issued upon conversion of bonds. . 2 1 1 Net unrealized gain on securities, net of tax effect ...... 18,984 Translation adjustments...... (15,807) Net in treasury stock ...... 1,040 Balance at March 31, 2001 ...... 1,331,735 ¥ 138,432 ¥ 117,786 ¥ 459,994 ¥ 18,984 ¥ (15,807) ¥ (2,573)

Thousands of U.S. dollars (note 1)

Net unrealized Treasury Common Additional Retained gain on securities, Translation stock, stock paid-in capital earnings net of tax effect adjustments at cost Balance at March 31, 2000 ...... $1,116,379 $ 949,879 $3,334,427 $ _ $ _ $ (29,137) Net income ...... 520,557 Revisions in accounting for subsidiaries and affiliated companies (note 3) ...... (4,016) Cash dividends paid ...... (139,081) Bonuses to directors ...... (2,258) Shares issued upon conversion of bonds ...... 8 8 Net unrealized gain on securities, net of tax effect ...... 153,097 Translation adjustments ...... (127,476) Net in treasury stock ...... 8,387 Balance at March 31, 2001...... $1,116,387 $ 949,887 $3,709,629 $ 153,097 $ (127,476) $ (20,750) 93 CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF CASH FLOWS (years ended march 31, 2001, 2000 and 1999)

Thousands of Millions of yen U.S. dollars (note 1) 2001 2000 1999 2001 Cash flows from operating activities: Net income (loss)...... ¥ 64,549 ¥ 105,376 ¥ (127,890) $ 520,557 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization...... 15,495 14,780 8,531 124,960 Provision for doubtful accounts, net...... 4,345 33,959 3,049 35,040 Provision for retirement benefits, net (note 17) ...... 4,253 (2,584) 17,237 34,298 Reversal of statutory reserves, net (note 19) ...... 994 197 (45,883) 8,016 Provision for financial assistance to related companies (note 13) ...... – – 58,200 – Losses related to fixed assets (note 26)...... 2,978 9,182 15,873 24,016 Losses (gains) related to investment securities (note 26) ...... 1,665 (10,992) 8,038 13,427 Deferred income taxes (note 18) ...... 21,830 (15,273) (78,952) 176,048 Expenses for reorganization of related companies (note 26)...... – 10,552 – – Provision for multiemployers’ pension plan (note 26) . – 28,443 – – Write-off of goodwill (note 26)...... – 8,000 – – Non-deductible consumption taxes derived from goodwill (note 26) ...... – 4,359 – –

(Increase) decrease in receivables ...... (152,635) 400,786 (517,618) (1,230,927) (Increase) decrease in trading assets ...... 180,343 (823,810) 1,658,479 1,454,379 (Increase) decrease in receivables related to margin transactions...... 141,490 (263,189) (39,670) 1,141,048 (Increase) decrease in collateralized short-term financing agreements...... (510,205) 205,822 (821,631) (4,114,556) (Increase) decrease in other assets ...... (162,742) (11,357) (21,728) (1,312,436) Other, net ...... (735) (4,612) 40 (5,927) Total adjustments ...... (452,924) (415,737) 243,965 (3,652,614) Net cash provided by (used in) operating activities . . (388,375) (310,361) 116,075 (3,132,057)

see accompanying notes.

94 Thousands of Millions of yen U.S. dollars (note 1) 2001 2000 1999 2001 Cash flows from investing activities: Payments for purchases of property and equipment ...... (10,408) (14,681) (13,875) (83,935) Proceeds from sales of property and equipment ...... 6,297 9,755 1,336 50,782 Payments for purchases of investment securities...... (22,059) (88,326) (26,292) (177,895) Proceeds from sales of investment securities...... 43,758 205,783 120,379 352,887 Decrease in long-term loans receivable...... 7,391 28,945 7,871 59,605 Other, net ...... (20,010) (673) 2,175 (161,371) Net cash provided by investing activities...... 4,969 140,803 91,594 40,073

Cash flows from financing activities: Increase (decrease) in short-term loans...... 59,441 121,138 (213,915) 479,363 Increase (decrease) in long-term debt ...... (126,904) (9,970) 95,797 (1,023,419) Proceeds from issuance of notes by subsidiaries ...... 192,109 80,000 40,919 1,549,266 Payments for redemption of bonds and notes ...... (67,707) (39,409) (140,967) (546,024) Proceeds from issuance of stocks to a minor shareholder . . . 2,145 162,000 – 17,298 Payments of cash dividends ...... (17,246) (6,658) (8,013) (139,081) Payments of cash dividends to minor shareholders...... (29) (233) – (234) Other...... 990 – (1,970) 7,984 Net cash provided by (used in) financing activities ...... 42,799 306,868 (228,149) 345,153

Effect of exchange rate changes on cash...... 7,696 8,839 (10,606) 62,065

Net increase (decrease) in cash...... (332,911) 146,149 (31,086) (2,684,766) Cash at beginning of year ...... 732,475 566,455 597,541 5,907,056 Increase in cash due to change in scope of consolidation. . . . – 19,871 – – Cash at end of year ...... ¥ 399,564 ¥ 732,475 ¥ 566,455 $ 3,222,290

Supplemental information on cash flows: Cash paid during the year for: Interest ...... ¥ 205,945 ¥ 93,939 ¥ 204,887 $ 1,660,847 Income taxes ...... 90,673 10,937 5,106 731,234 Non-cash investing and financing activities: Conversion of convertible bonds into common stock and additional paid-in capital...... 2 12 – 17

95 CONSOLIDATED FINANCIAL STATEMENTS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (three years ended march 31, 2001)

1. Basis of consolidated financial statements Daiwa Securities Group Inc. (the "Company") changed its name from Daiwa Securities Co. Ltd. and transformed into a hold- ing company on April 26, 1999, after transferring its wholesale business divisions and retail business divisions as mentioned below.

On April 5, 1999, the Company transferred its wholesale business divisions to Daiwa Securities SB Capital Markets Co. Ltd., a 60% owned subsidiary, in accordance with the agreement with The Sumitomo Bank, Limited dated on December 18, 1998 and the approval regarding the transfer in the extraordinary meeting of shareholders held on February 5, 1999. On April 1, 2001, Daiwa Securities SMBC Co. Ltd. ("Daiwa Securities SMBC") changed its name from Daiwa Securities SB Capital Markets Co. Ltd. and took over the business of Sakura Securities Co., Ltd., a wholly owned subsidiary of The Sakura Bank, Limited in connection with a merger of The Sumitomo Bank, Limited with The Sakura Bank, Limited to form Sumitomo Mitsui Banking Corporation on the same date.

On April 26, 1999, the Company transferred its retail business divisions to Daiwa Securities Preparation Co. Ltd., in accor- dance with the approval regarding the transfer in the extraordinary meeting mentioned above. This company changed its cor- porate name to (new) Daiwa Securities Co. Ltd. on the same date.

The Company is a Japanese corporation and maintains its records and prepares its consolidated financial statements in yen. The accompanying consolidated financial statements are basically an English version of those prepared for Japanese domestic purposes in accordance with the provisions of the Securities and Exchange Law of Japan and filed with the Ministry of Finance ("MOF") and stock exchanges in Japan.

In preparing the accompanying consolidated financial statements, certain reclassifications have been made in the consolidated financial statements issued domestically, including the 2000 consolidated statements of cash flows prepared in accordance with the "Standards for Preparation of Consolidated Cash Flow Statements, etc." effective in 2000, in order to present them in a form which is more familiar to readers outside Japan. The consolidated statements of cash flows for 1999 has been prepared for the purpose of inclusion in the accompanying consolidated financial statements even though such a statement was not cus- tomarily prepared in Japan and not required to be filed with MOF at that time. Consolidated statements of shareholders’ equity are also prepared, while they are not required to be filed with MOF.

Significant differences between the accounting policies followed by the Company and International Accounting Standards ("IAS") are described in Note 4.

The translations of the yen amounts into U.S. dollars are included solely for the convenience of the reader, using the prevailing exchange rate at March 31, 2001, which was ¥124 to U.S. $1. The convenience translations should not be construed as repre- sentations that the yen amounts have been, could have been, or could in the future be, converted into U.S. dollars at this or any other rate of exchange.

Certain reclassifications have been made in the 2000 and 1999 consolidated financial statements to conform to the presenta- tion for 2001.

96 2. Change in accounting policies In 1999, the Company and a consolidated subsidiary changed its accounting method to provide for directors' retirement bene- fits on an accrual basis from expensing it at the time of payment for better allocation of expenses. As a result of this account- ing change, net loss before income taxes and minority interests for the year ended March 31, 1999 increased by ¥1,482 million, which consisted of accrual for 1999 of ¥449 million classified in selling, general and administrative expenses, and the cumulative effect of prior years from the change in accounting policy of ¥1,034 million classified in other expenses (See Note 26).

3. Significant accounting policies Consolidation - The Company prepared the consolidated financial statements for the year ended March 31, 2001 and 2000 in accordance with the revised Accounting Principles for Consolidated Financial Statements (the "Revised Accounting Principles") effective for the year ended March 31, 2000. The consolidated financial statements for 2001 and 2000 include the accounts of the Company and significant companies which are controlled by the Company through substantial ownership of more than 50% of the voting rights or through ownership of high percentage of the voting rights and the existence of cer- tain conditions evidencing control by the Company of the decision-making body of such companies.

Under the Revised Accounting Principles, certain companies of which the Company has at least 15% and less than 20% of the voting rights in the case where the Company has the ability to exercise significant influence over operating and financial poli- cies of the investees are also accounted for using the equity method.

Previously, only majority-owned companies were consolidated and only investments in companies of which the Company owns 20% to 50% of the voting rights and has the ability to significantly influence financial, operational or business policies were accounted for using the equity method. Due to the revision, eight subsidiaries and three affiliates were newly consoli- dated or accounted for on the equity method in the accompanying consolidated financial statements for 2000. The prior years' consolidated financial statements have not been restated.

Significant intercompany balances, transactions and profits have been eliminated in consolidation.

Consolidated statement of cash flows - For purposes of reporting cash flows, cash includes "cash and time deposits" with matu- rities of not exceeding one year in the accompanying consolidated statements of cash flows, which is referred to the correspon- ding account balance in the accompanying consolidated balance sheets.

In preparing the consolidated statements of cash flows for the year ended March 31, 2001 and 2000 for MOF reporting pur- pose, cash is considered to be "cash and cash equivalents", which includes cash on hand, readily-available deposits and highly liquid investments with original maturities of not exceeding three months. "Cash and time deposits" are used instead of "cash and cash equivalents". Differences between "cash and time deposits" and "cash and cash equivalents" as of March 31, 2001 and 2000 are reconciled as follows:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Cash and time deposits ...... ¥ 399,564 ¥ 732,475 $ 3,222,290 Deposits segregated for customers ...... (85,500) (235,300) (689,516) Time deposits more than three months ...... (10,665) (8,310) (86,008) Cash and cash equivalents ...... ¥ 303,399 ¥ 488,865 $ 2,446,766

97 CONSOLIDATED FINANCIAL STATEMENTS

Trading assets and liabilities - Trading assets and liabilities, including cash securities and financial derivatives for trading pur- pose held by the securities subsidiaries are recorded on a trade date basis at market value or fair value. Revenues and expenses related to trading securities transactions are recorded on a trade date basis. Unrealized gains or losses from financial derivatives such as futures, options and swaps transactions are reflected as net gain on trading in the accompanying consolidated state- ments of operations. Cash securities owned for non-trading purpose, shown in the accompanying consolidated balance sheets as "Investment securities", and operational investment securities are discussed below.

Investment securities - Effective April 1, 2000, the Company and consolidated subsidiaries adopted the new Japanese account- ing standard on accounting for financial instruments ("Opinion Concerning Establishment of Accounting Standard for Financial Instruments" (the "Standard for Financial Instruments") issued by the Business Accounting Deliberation Council on January 22, 1999).

In accordance with the Standard for Financial Instruments, at April 1, 2000 the Company and consolidated subsidiaries exam- ined the intent of holding each security and classified those securities as (a) securities held for trading purposes, (b) debt securi- ties intended to be held to maturity ("held-to-maturity debt securities"), (c) equity securities issued by subsidiaries and affiliated companies, and (d) for all other securities not classified in any of the above categories ("available-for-sale securities").

Trading assets and liabilities held by securities companies have been stated at fair market value as mentioned above. Effective April 1, 2000, the Company and domestic consolidated subsidiaries other than securities companies adopted the mark-to-mar- ket accounting for these securities. Held-to-maturity debt securities are stated at amortized cost. Equity securities issued by subsidiaries and affiliated companies are stated at moving-average cost. Available-for-sale securities (including operational investment securities) with fair market value are stated at fair market value. Realized gains and losses on sale of such securities are computed using the moving-average cost. Unrealized gains and losses on these securities are reported, net of applicable income taxes, as a separate component of the shareholders’ equity.

Debt securities with no fair market value are stated at the amortized cost, net of the amount considered not collectible.

Other securities with no fair value are stated at the moving-average cost.

If the market value of held-to-maturity debt securities, equity securities issued by subsidiaries and affiliated companies and available-for-sale securities declines significantly, such securities are stated at fair market value and the difference between fair market value and the carrying amount is recognized as loss in the period of the decline. If the fair market value of equity secu- rities issued by subsidiaries and affiliated companies is not readily available, such securities should be written down to net asset value in the event net asset value is significantly declines. Unrealized losses on these securities are reported in the consolidated statements of operations.

Hedging transaction - The Standard for Financial Instruments, effective from the year ended March 31, 2001, requires to state derivative financial instruments at fair value and to recognize changes in the fair value as gains or losses unless derivative financial instruments are used for hedging purposes. Valuation gains or losses on hedging instruments are mainly deferred as assets or liabilities until the gains or losses on underlying hedged instruments are realized. Interests received or paid on interest swap for hedging are accrued without marking-to-market, premium or discount on forward foreign exchange contact for hedg- ing is allocated to each fiscal term without marking-to-market. There was no effect on the accompanying consolidated finan- cial statements for 2001, except for disclosure in Note 9.

98 Collateralized short-term financing agreements - Collateralized short-term financing agreements consist of securities purchased under agreements to resell or securities sold under agreements to repurchase ("Repurchase transactions"), securities borrowed or loaned and Buy or Sell Gensaki which have been accounted for as financing transactions. Repurchase transactions are traded in overseas subsidiaries and recorded at their contractual amounts. Securities borrowed or loaned are recorded at the amount of cash collateral advanced or received. Buy or Sell Gensaki represents a form of securities purchased under resale agreements or securities sold under repurchase agreements originated in Japan. Gensaki transactions have been accounted for in the same manner as financing transactions in accordance with the amendment of the Securities and Exchange Law of Japan.

Provision for doubtful accounts - In accordance with the Standard for Financial Instruments, provision for doubtful accounts of domestic consolidated subsidiaries is provided on the estimated historical deterioration rate for normal loans, and the allowance specifically assessed for doubtful and failed loans. Overseas consolidated subsidiaries provide specifically assessed amounts.

Effect of adoption of the Standard for Financial Instruments - As a result of the adoption of the Standard for Financial Instruments, in the year ended March 31, 2001, operating income decreased by ¥741 million ($5,976 thousand) and income before income taxes and minority interests increased by ¥12,923 million ($104,218 thousand) compared with what would have been recorded under the previous accounting standard.

Property and equipment - Property and equipment are stated at cost. Depreciation is computed principally by the declining balance method over estimated useful lives as stipulated by corporate tax regulations. Depreciation for buildings purchased in Japan after April 1, 1998 is computed by the straight-line method.

Bonuses - The Company and domestic consolidated subsidiaries follow the Japanese practice of paying bonuses to employees in June and December. Accrued employees' bonuses represent liabilities estimated as of the balance sheet date. Bonuses to directors, which are subject to approval at the shareholders' meeting, are accounted for as an appropriation of retained earn- ings.

Retirement benefits for employees - Effective April 1, 2000, the Company and most domestic consolidated subsidiaries adopted the new accounting standard, "Opinion on Setting Accounting Standard for Employees' Severance and Pension Benefits" (the "Standard for Employees' Severance and Pension Benefits"), issued by the Business Accounting Deliberation Council on June 16, 1998.

As a result of the adoption of the Standard for Employees' Severance and Pension Benefits, in the year ended March 31, 2001, severance and pension benefit expense increased by ¥213 million ($1,718 thousand), operating income and income before income taxes and minority interests decreased by ¥213 million ($1,718 thousand) compared with what would have been recorded under the previous accounting standard.

The Company and most domestic consolidated subsidiaries have established an unfunded pension plan that allows a retiring employee to select between receiving retirement benefits each year or at a lump sum upon retirement by employees under their retirement benefit rule. The amount of retirement benefits to be paid for each plan is calculated principally based on the annual basic portion which is a fixed amount depending on the rank of each employees, and the annual performance portion which can be derived from a table based on each employees' rank and evaluation at a fixed amount.

Also the Company and most domestic subsidiaries are members of the plan which is an industry-wide multiemployer contrib- utory welfare pension plan administered by Securities Companies' Welfare Pension Fund.

99 CONSOLIDATED FINANCIAL STATEMENTS

Income taxes - In 1999, the Company and certain consolidated subsidiaries have early adopted tax effect accounting in accor- dance with the new standards, which were mandatory for the year beginning after April 1, 1999 in Japan. Deferred taxes are recorded for the future tax consequences of events that have been recognized in the consolidated financial statements or tax returns, based upon enacted tax laws and rates, including an appropriate provision for taxes on undistributed earnings of sub- sidiaries and affiliates. The prior years' effect before 1999 of this new accounting has been recorded in retained earnings as of April 1, 1998, as explained in Note 18.

Translation of foreign currencies - Effective April 1, 2000, the Company and domestic consolidated subsidiaries adopted the new accounting standard, "Accounting Standards for Effects of Changes in Foreign Exchange Rates" amended by "Opinions on Revision of Accounting Standards for Effects of Changes in Foreign Exchange Rates" (the "Standards for Effect of Changes in Foreign Exchange Rates"), issued by the Business Accounting Deliberation Council on October 22, 1999.

In accordance with the Standards for Effect of Changes in Foreign Exchange Rates, the Company and domestic consolidated subsidiaries translate foreign currency assets and liabilities in foreign currencies into yen at year-end exchange rates. There was no material effect due to the amendment.

Translation of foreign currency financial statements - Financial statements of foreign subsidiaries are translated into yen on the basis of the year-end rates for assets and liabilities except that retained earnings are translated at historical rates. The average rates for the years are used for translation of income and expenses.

Translation adjustment - Due to the adoption of the Standards for Effect of Changes in Foreign Exchange Rates, translation adjustment is reported in the shareholders' equity. The prior year's amount, which was included in assets has not been reclassi- fied to conform to the 2001 presentation.

Net income (loss) per share - Net income (loss) per share of common stock is based on the average number of shares of com- mon stock outstanding during the period.

Diluted net income per share is computed based on the average number of shares of common stock outstanding plus the num- ber of shares of common stock that would have been issued had the outstanding convertible bonds been converted as of year- end.

4. Significant differences between accounting policies followed by the Company and domestic subsidiaries and International Accounting Standards The accompanying consolidated financial statements are prepared in conformity with accounting principles generally accepted in Japan. Differences from IAS include the following.

Securities in custody - As described in Note 11, "Securities in custody" is presented as an asset in the consolidated balance sheets with a contra account entitled "Securities borrowed and deposited by customers" as a liability.

100 Investment securities - On 2001 Japanese accounting standards require that marketable equity and all debt securities held for investment should be classified, according to management's intent, into one of the following categories: securities held for trading purposes, held-to-maturity debt securities, equity securities issued by subsidiaries and affiliate companies, or available- for-sale securities. Available-for-sale securities should be marked-to-market, with the resulting unrealized gain or loss recorded directly to a separate component of equity until realized, at which time the gain or loss is recorded in income. Held-to-matu- rity debt securities should be carried at amortized cost.

Impairment of assets - Japanese accounting standards do not require revaluation of property and equipment, which is required by IAS 36.

Statutory reserves - As described in Note 19, the Securities and Exchange Law of Japan requires a securities company to main- tain certain special purpose reserves which are not liabilities or contingent losses as described in IAS 10.

5. Margin transactions Margin transactions at March 31, 2001 and 2000 consisted of the following:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Assets: Loans receivable from customers ...... ¥ 88,171 ¥ 308,327 $ 711,056 Cash deposits as collateral for securities borrowed from securities finance companies ...... 140,121 85,302 1,130,009 ¥ 228,292 ¥ 393,629 $ 1,841,065

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Liabilities: Loans from securities finance companies ...... ¥ 14,453 ¥ 24,916 $ 116,556 Proceeds of securities sold for customers’ accounts ...... 15,319 28,702 123,541 ¥ 29,772 ¥ 53,618 $ 240,097

Loans receivable from customers are stated at amounts equal to the purchase prices of the relevant securities and are collateral- ized by customers' securities and customers' deposits of cash or securities. Proceeds of securities sold for customers' accounts were stated at the sales prices of the relevant securities on the respective transaction dates.

101 CONSOLIDATED FINANCIAL STATEMENTS

6. Collateralized short-term financing agreements Collateralized short-term financing agreements are accounted for in accordance with the "Uniform Accounting Standards of Securities Companies" (set by the board of directors of the Japan Securities Dealers' Association, November 14, 1974), based on Japanese Institute of Certified Public Accountants Auditing Committee Report No.17 "Auditing and Accounting Treatment regarding Application of Accounting Standards for Financial Instruments to Securities Companies" dated July 6, 2000, although the Standard for Financial Instruments is introduced this fiscal year.

Collateralized short-term financing agreements at March 31, 2001 and 2000 consisted of the following:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Assets: Securities borrowed...... ¥ 1,629,394 ¥ 351,710 $ 13,140,274 Securities purchased under agreements to resell...... 882,876 1,016,409 7,119,968 Buy Gensaki ...... 217,451 24,100 1,753,637 ¥ 2,729,721 ¥ 1,392,219 $ 22,013,879 Liabilities: Securities loaned ...... ¥ 1,716,006 ¥ 411,182 $ 13,838,758 Securities sold under agreements to repurchase ...... 793,276 883,468 6,397,387 Sell Gensaki ...... 741,938 1,123,837 5,983,371 ¥ 3,251,220 ¥ 2,418,487 $ 26,219,516

7. Trading assets and trading liabilities Trading assets and trading liabilities at March 31, 2001 and 2000 consisted of the following:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Trading assets: Corporate shares ...... ¥ 347,285 ¥ 249,537 $ 2,800,686 Government, corporate and other bonds...... 2,102,608 2,239,353 16,956,516 Beneficiary certificates...... 2,231 9,764 17,992 Commercial paper, certificates of deposits and others ...... 60,956 238,215 491,581 Option transactions...... 43,022 12,407 346,952 Futures transactions ...... 8,826 2,275 71,177 Swap agreements...... 264,067 108,071 2,129,572 Other derivatives ...... 29 0 234 Operational investment securities ...... 47,456 44,173 382,710 Other inventories ...... 8,016 24,073 64,645 ¥ 2,884,496 ¥ 2,927,868 $ 23,262,065

102 Thousands of Millions of yen U.S. dollars 2001 2000 2001 Trading liabilities: Corporate shares ...... ¥ 93,339 ¥ 84,662 $ 752,734 Government, corporate and other bonds...... 1,016,189 1,032,657 8,195,073 Commercial paper, certificates of deposits and others ...... _ 120 _ Option transactions...... 40,049 10,592 322,976 Futures transactions ...... 8,329 8,795 67,169 Swap agreements...... 254,455 97,412 2,052,056 Other derivatives...... 9 60 73 ¥ 1,412,370 ¥ 1,234,298 $ 11,390,081

Operational investment securities represent shares and bonds including various investments in partnerships of small and medium-sized companies which are expected to go public in the future.

8. Investment securities Cost/amortized cost and market value of held-to-maturity debt securities as of March 31, 2001 consisted of the following:

Millions of yen

Cost/ Market Difference Amortized cost Value Government bonds, local government bonds, etc...... ¥ 2,020 ¥ 2,031 ¥ 11

Thousands of U.S. dollars

Cost/ Market Difference Amortized cost Value Government bonds, local government bonds, etc...... $ 16,289 $ 16,383 $ 94

103 CONSOLIDATED FINANCIAL STATEMENTS

Cost and market value of available-for-sale securities as of March 31, 2001 consisted of the following:

Millions of yen

Cost Market value Difference Corporate shares ...... ¥ 112,645 ¥ 147,064 ¥ 34,419 Government, corporate and other bonds ...... 10 10 0 Other ...... 22,782 18,925 (3,857) ¥ 135,437 ¥ 165,999 ¥ 30,562

Thousands of U.S. dollars

Cost Market value Difference Corporate shares ...... $ 908,427 $ 1,186,000 $ 277,573 Government, corporate and other bonds ...... 81 81 0 Other ...... 183,726 152,621 (31,105) $ 1,092,234 $ 1,338,702 $ 246,468

Securities with no fair market value as of March 31, 2001 consisted of the following:

Thousands Millions of yen of U.S. Dollars Corporate shares...... ¥ 24,213 $ 195,266 Government, corporate and other bonds ...... 7,394 59,629 Other ...... 99,879 805,476 ¥ 131,486 $ 1,060,371

In addition to the above, securities of non-consolidated and affiliated companies amounting to ¥27,402 million ($220,985 thousand) were included in investment securities at March 31, 2001.

Investment securities at March 31, 2000 consisted of the following:

Millions of yen Corporate shares ...... ¥ 191,238 Government, corporate and other bonds ...... 21,950 Other...... 72,161 ¥ 285,349

104 At March 31, 2000, net unrealized gains of investment securities which have a quoted market price on a settlement date basis were as follows:

Millions of yen

Book Market Unrealized value value Gain Corporate shares ...... ¥ 119,492 ¥ 190,052 ¥ 70,560 Other ...... 29,687 30,243 556 ¥ 149,179 ¥ 220,295 ¥ 71,116

9. Derivatives for non-trading purposes Net unrealized gains/(losses) of derivatives for non-trading purposes at March 31, 2001 (excluding hedging transactions) con- sisted of the following:

Millions of yen

Contract Market Unrealized amount value Gains/(Losses) March 31, 2001: Interest rate swap ...... ¥ 86 ¥ (1) ¥ (1) Currency swap ...... 342 0 0

Thousands of U.S. dollars

Contract Market Unrealized amount value Gains/(Losses) March 31, 2001: Interest rate swap ...... $ 694 $ (8) $ (8) Currency swap ...... 2,758 0 0

Net unrealized gains of derivatives for non-trading purposes derived from hedging transactions at March 31, 2000 were included in figures below, due that hedge accounting had not been effective in 2000.

Millions of yen

Contract Market Unrealized amount value Gains March 31, 2000: Interest rate swap ...... ¥ 94,067 ¥ 2,457 ¥ 2,329 Currency swap ...... 8,107 1,399 1,329

105 CONSOLIDATED FINANCIAL STATEMENTS

10. Risk management information The two domestic securities subsidiaries, Daiwa Securities Co. Ltd. and Daiwa Securities SMBC ("Securities subsidiaries"), enter into transactions involving trading assets and liabilities to meet customer needs, and for its proprietary trading activities, as a broker and an end-user. These trading assets and liabilities include (1) cash securities such as stocks and bonds, (2) finan- cial derivatives traded on exchanges such as futures and options based on stock price indices, bonds and interest rates, and (3) financial derivatives traded over the counter such as currency and interest rate swaps, foreign exchange forward contracts, bonds with options, currency options, forward rate agreements and OTC equity derivatives.

The principal risks inherent in trading in these markets are market risk and credit risk. Market risk represents the potential for loss from changes in the value of financial instruments due to price and interest rate fluctuations in the markets. As to market risk, Securities subsidiaries determine the balance of risk and profit or loss on each instrument and use a value-at-risk method to manage this risk. Credit risk represents the potential for loss arising from the failure of the counter-party in a transaction to fulfill its terms and conditions. Securities subsidiaries assess the credit risk of their counter-parties applying internal credit rat- ing and monitor their exposure by measuring notional principal and credit exposure.

Daiwa Securities SMBC has established five risk management principles: Active management participation, system of internal supervision, sound management by risk limit setting, risk management assuming emergency and transparency in risk manage- ment process. By ensuring these five principles, Daiwa Securities SMBC expects that risks associated with trading activities are well controlled within a range that the management is willing to assume.

11. Securities in custody Securities in custody at March 31, 2001 and 2000 consisted of the following:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Securities borrowed for less than one year ...... ¥ 1,219,711 ¥ 1,335,084 $ 9,836,379 Securities deposited by customers as collateral mainly for margin and futures transactions ...... 336,461 485,821 2,713,395 ¥ 1,556,172 ¥ 1,820,905 $ 12,549,774

Securities in custody account is presented as an asset in the consolidated balance sheets. A contra account entitled "Securities borrowed and deposited by customers" is presented as a liability. Securities in custody are stated at market value on the respec- tive dates when such borrowings or deposits were made.

106 12. Pledged assets At March 31, 2001, short-term borrowings amounting to ¥40,590 million ($327,338 thousand), securities borrowed amount- ing to ¥226 million ($1,825 thousand) and long-term debt amounting to ¥36,048 million ($290,713 thousand) were secured by the following assets:

Thousands of Millions of Yen U.S. dollars Trading assets ...... ¥ 23,933 $ 193,010 Securities in custody ...... 6,361 51,298 Property and equipment ...... 140,194 1,130,599 Investment Securities ...... 4,485 36,168 Other ...... 4,875 39,315 ¥ 179,848 $ 1,450,390

The following securities were deposited with stock exchanges as guarantee for stock index and bond future contracts, etc. as of March 31, 2001: Thousands of Millions of Yen U.S. dollars Trading assets ...... ¥ 57,858 $ 466,601 Investment securities...... 41,497 334,652 ¥ 99,355 $ 801,253

The following securities were deposited as guarantee for swap transactions and other derivatives as of March 31, 2001:

Thousands of Millions of Yen U.S. dollars Cash and time deposits...... ¥ 17,554 $ 141,566 Securities in custody ...... 7,000 56,452 ¥ 24,554 $ 198,018 These amounts were stated at book value at the balance sheet date.

13. The Company’s transactions with related parties The Company has several related companies as explained below, which were less than 5% directly owned companies and whose financial statements were not consolidated into the accompanying consolidated financial statements for 1999. In the normal course of its operations, the Company leases most of its office space from The Daiwa Real Estate Co., Ltd. ("DRE") and receives research and data processing services from Daiwa Institute of Research Ltd. ("DIR").

In these reporting periods, the Company provided financial assistance to the related companies. In 1999, the Company recorded ¥115,800 million in the aggregate to Daiwa Finance Co. Ltd. ("DFC") which issues mortgage securities, Nippon Investment & Finance Co. Ltd. ("NIF") which invests in venture capital, and Daiwa Sanko Co., Ltd. ("Sanko"), which engages in trading with office equipment and electric parts (See Note 26). The Company paid ¥57,600 million in 1999 and ¥58,200 million in 2000 in the aggregate to these companies. On April 1, 2000, DFC merged NIF and changed its name to NIF Ventures Co., Ltd.

107 CONSOLIDATED FINANCIAL STATEMENTS

Significant transactions with these companies for ended March 31, 1999 were as follows:

Millions of yen Selling, general and administrative expenses : Rental expenses paid to DRE ...... ¥ 21,044 Research and data processing fees paid to DIR...... 23,011 Financial assistance expense to : DFC ...... 82,000 NIF ...... 24,000 Sanko...... 9,800

As described in Note 3, all of these related companies have been consolidated and significant account balances and transactions with these companies at and for the years ended March 31, 2001 and 2000 have been eliminated.

In addition, a statutory auditor of the Company is also the president of the Taiyo Mutual Life Insurance Co. The significant acoount balances with the Taiyo Mutual Life Insurance Co. at March 31, 2001 were long-term loans receiveable amounting to ¥5,000 million ($40,323 thousand), short-term borrowings amounting to ¥5,000 million ($40,323 thousand), and long-term debt amounting to ¥20,000 million ($161,290 thousand).

14. Lease transactions Financial leases that do not transfer ownership to lessees ("non-capitalized finance leases") are not capitalized and are accounted for in the same manner as operating leases. Certain related information at March 31, 2001 and 2000 are summa- rized as follows:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Total assets under non-capitalized finance leases ...... ¥ 21,906 ¥ 29,425 $ 176,661 Accumulated depreciation...... 12,886 16,775 103,919 Future lease payments of non-capitalized leases ...... 9,335 13,506 75,282 Due within one year ...... 4,011 4,882 32,347 Future lease payments of operating leases ...... 14,941 15,174 120,492 Due within one year ...... 2,018 1,582 16,274

15. Payables to customers Payables to customers at March 31, 2001 and 2000 consisted of the following:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Cash received for customers' accounts on trading ...... ¥ 88,721 ¥ 98,323 $ 715,492 Cash deposits received from customers mainly for margin and futures transactions...... 89,283 84,266 720,024 Other ...... 10,566 1,827 85,210 ¥ 188,570 ¥ 184,416 $ 1,520,726

108 16. Bank borrowings and long-term debt As is customary in Japan, in the case of unsecured bank borrowings, security must be given under certain conditions if requested by a lending bank, and such bank has the right to offset cash deposited with it against any debt or obligation that becomes due and, in the case of default and certain other specified events, against all debts payable to the bank. No such request has been made and no such right has been exercised.

Long-term debt at March 31, 2001 and 2000, consisted of the following:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Bond payable in yen: 1.4% due 2005...... ¥ 100,000 ¥ _ $ 806,452 Convertible bonds payable in yen, convertible into common stock at ¥3,035.90 per share: 1.5% due 2002 ...... 19,440 19,440 156,774 Convertible bonds payable in yen, convertible into common stock at ¥2,367.00 per share: 1.4% due 2003 ...... 36,269 36,269 292,492 1.4% due 2000 ...... _ 38,662 _ Convertible bond payable in yen, convertible into common stock at ¥1,094.00 per share: 0.5% due 2006 ...... 79,986 79,988 645,048 Bond with warrants: 1.37% due 2004 ...... 8,400 _ 67,742 Notes payable in yen issued by a subsidiaries: Series of notes with various rates and maturities from 1999 through 2002 ...... 2,978 3,098 24,016 5.0% subordinated due 2005 ...... 993 1,033 8,008 2.0% Euro-yen bond due 2002...... 80,000 80,000 645,161 Medium-term notes in yen issued by subsidiaries, with various rates and maturities through 2011 ...... 77,600 _ 625,806 Euro medium-term notes (authorized $5,000 million) issued by subsidiaries, with various rates and maturities through 2008 ...... 34,574 56,466 278,823 Yen subordinated loan due 2004 ...... 40,000 40,000 322,581 Borrowings from financial institutions ...... 118,300 331,760 954,032 Other...... 299 1,617 2,412 ¥ 598,839 ¥ 688,333 $ 4,829,347

The conversion prices shown above are subject to adjustment in certain circumstances.

At March 31, 2001, the number of shares of common stock issuable upon full conversion of outstanding convertible bonds and warrants was 101,055 thousand shares in aggregate.

109 CONSOLIDATED FINANCIAL STATEMENTS

The aggregate annual maturities of long-term debt as of March 31, 2001 are as follows:

Thousands of Year ending March 31 Millions of yen U.S. dollars 2002 ...... ¥ 18,170 $ 146,533 2003 ...... 136,498 1,100,791 2004 ...... 114,414 922,695 2005 ...... 56,054 452,051 2006 ...... 112,270 905,401 2007 and thereafter ...... 161,433 1,301,876

17. Retirement benefits Employees - The Company and domestic subsidiaries have unfunded lump-sum benefit plans for employees.

Under the terms of the lump-sum benefit plan, eligible employees are entitled, under most circumstances upon reaching mandatory retirement age or earlier voluntary termination, to a lump-sum benefit payment. The amount of retirement bene- fits to be paid is reduced by the benefits payable under the pension plan.

On March 31, 1999, the Company and a domestic consolidated subsidiary canceled all their employees' retirement benefit plans, both unfunded and funded, and liquidated their plan assets in order to pay an amount to entitled employees which would be required if they involuntarily terminated their employment in the course of shifting to the holding company struc- ture. The Company and the subsidiary recorded liquidation losses of employees' pension plans of ¥12,806 million in earnings for the year then ended (See Note 26).

On March 31, 2000, certain domestic consolidated subsidiaries also canceled all their employees' retirement benefit plans, both unfunded and funded, in a similar manner as the Company did in prior year. Those subsidiaries included payables of the retirement benefits to entitled employees in other current liabilities in the consolidated balance sheet as of March 31, 2000, and recorded liquidation losses of employees' pension plans of ¥3,171 million in earnings for the year then ended. (See Note 26).

As explained in Note 3, effective April 1, 2000, the Company and most of domestic consolidated subsidiaries adopted the Standard for Employees' Severance and Pension Benefits, under which allowance and expenses for severance and pension ben- efits are determined based on the amounts obtained by actuarial calculations.

Retirement benefits as of March 31, 2001 consisted of the following:

Thousands of Millions of Yen U.S. dollars Projected benefit obligation...... ¥ 16,635 $ 134,153 Less : pension assets...... (8,273) (66,718) Less : unrecognized actuarial differences ...... (838) (6,758) Retirement benefits...... ¥ 7,524 $ 60,677

110 Included in the consolidated statement of income for the year ended March 31, 2001 is severance and pension benefit expense comprising of the following:

Thousands of Millions of Yen U.S. dollars Service costs...... ¥ 5,099 $ 41,121 Contribution to multiemployer's pension plan ...... 2,080 16,774 Interest cost on projected benefit obligation ...... 289 2,331 Expected return on plan assets...... (285) (2,298) Amortization of actuarial differences ...... 209 1,685 Allowance for severance and pension benefits ...... ¥ 7,392 $ 59,613

The discount rate and the rate of expected return on plan assets used by the Company are 1.5-3.0% and 1.5-3.0%, respec- tively. The estimated amount of all retirement benefits to be paid at the future retirement date is allocated equally to each service year using the estimated number of total service years. Actuarial differences are recognized as expenses using the declin- ing-balance method over 5 years from 2001.

Directors - In 1999, the Company and a domestic consolidated subsidiary changed their accounting method to provide for directors' retirement benefits on an accrual basis from expensing at the time of payment as described in Note 2.

Directors' retirement benefits of ¥1,889 million ($15,234 thousand) and ¥1,536 million were included in "Retirement bene- fits" in the accompanying consolidated balance sheets as of March 31, 2001 and 2000, respectively.

Multiemployers’ pension plan - The Company and certain of domestic consolidated subsidiaries are members of a multiem- ployers' pension plan that is an industry-wide multiemployer contributory welfare pension plan administered by the Securities Companies' Welfare Pension Fund. The funded pension plan has faced the problems arising from the decreasing members and continuing low interest rates. The Company and consolidated subsidiaries' liability is calculated, based on the difference between its projected benefit obligation and its fair value of the plan assets as of March 31, 2000. Provision for the multiem- ployers' pension plan was charged to income (Note 26) and reported in the consolidated balance sheets as "Multiemployers' pension plan" as of March 31, 2001 and 2000.

111 CONSOLIDATED FINANCIAL STATEMENTS

18. Income taxes In 1999 the Company and certain domestic consolidated subsidiaries early adopted tax effect accounting in accordance with the new standards as described in Note 3. With regard to the cumulative effect on prior years of adopting tax effect account- ing, net loss for the year ended March 31, 1999 decreased by ¥78,952 million and retained earnings as at March 31, 1999 increased by ¥3,017 million as presented in the accompanying consolidated statements of shareholders' equity.

The normal effective statutory income tax rate in Japan arising out of the aggregation of corporate, enterprise and inhabitants taxes was approximately 42%, 42% and 48% for 2001, 2000 and 1999, respectively. Foreign subsidiaries are subject to income taxes of the countries in which they operate.

Details of deferred tax assets and liabilities at March 31, 2001 and 2000 are as follows:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Deferred tax assets: Net operating losses...... ¥ 71,909 ¥ 62,337 $ 579,911 Write-off of goodwill ...... 52,585 69,973 424,073 Provision for the multiemployers’ pension plan...... 12,127 11,194 97,798 Other ...... 36,228 34,584 292,161 Gross deferred tax assets ...... 172,849 178,088 1,393,943 Less-Valuation allowance ...... (78,840) 62,595) (635,806) Total deferred tax assets ...... 94,009 115,493 758,138 Deferred tax liabilities ...... 16,880 1,955 136,130 Net deferred tax assets...... ¥ 77,129 ¥ 113,538 $ 622,008

The Company and certain subsidiaries recorded a valuation allowance to reflect the estimated amount of deferred tax assets that will not be realized.

112 The deferred tax assets and liabilities at March 31, 2001 and 2000 may be attributed to current amount and non-current amount as follows:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Deferred tax assets : Current ...... ¥ 8,833 ¥ 15,463 $ 71,234 Non-current ...... 83,367 98,075 672,314 Total deferred tax assets ...... ¥ 92,200 ¥ 113,538 $ 743,548 Deferred tax liabilities : Current ...... ¥ 1,836 ¥ _ $ 14,806 Non-current ...... 13,235 _ 106,734 Total deferred tax liabilities ...... ¥ 15,071 ¥ _ $ 121,540

A reconciliation of the difference between the normal effective statutory tax rate and the effective income tax rate reflected in the accompanying consolidated statements of operations for the year ended March 31, 2000 was as follows:

2000 Normal effective statutory tax rate ...... 42.0% Valuation allowance for deferred income tax assets ...... 11.5 Lower tax rate applicable to income of foreign subsidiaries ...... (2.0) Other, net...... (5.4) Effective income tax rate...... 46.1%

There was no significant difference between the normal effective statutory tax rate and the effective income tax rate reflected in the accompanying consolidated statements of operations for the year ended March 31, 2001.

19. Statutory reserves Statutory reserves at March 31, 2001 and 2000 consisted of the following:

Thousands of Millions of yen U.S. dollars 2001 2000 2001 Reserve for securities and financial futures transaction liabilities ...... ¥ 1,975 ¥ 981 $ 15,927

The Securities and Exchange Law of Japan requires a securities company to set aside a reserve in proportion to its securities transactions and other related trading to cover possible customer losses incurred by default of the securities company on securi- ties transactions.

113 CONSOLIDATED FINANCIAL STATEMENTS

20. Contingent liabilities At March 31, 2001, the Company and its consolidated subsidiaries were contingently liable as guarantors of loans and lease deposits amounting to ¥6,773 million ($54,665 thousand).

21. Shareholders’ equity The Commercial Code of Japan allows a company to retire a portion of its outstanding shares upon approval of the sharehold- ers at the annual general shareholders' meeting. On December 8, 1997, the directors' meeting passed a resolution to enable the Company to purchase and retire outstanding shares up to a maximum aggregate acquisition cost of ¥25,000 million. In 1999, the Company purchased and retired shares having a market value of ¥1,970 million. As a result of such share acquisi- tions, retained earnings as of March 31, 1999 decreased by ¥1,970 million, and the number of issued and outstanding shares decreased by 3,832 thousand shares.

The shareholders of the Company approved a stock incentive plan on June 25, 1998. The plan provides for the issuance of up to 6,000 thousand shares in the form of options to directors and key employees. On March 30, 1999, options were awarded to those who were with Daiwa Securities Co. Ltd. listed as the grantees at the time of the shareholders' meeting, and at the time of grants were either (1) Directors or (2) General Managers, Deputy General Managers or Assistant General Managers under the plan. The options may be exercised during the period from July 1, 2000 until June 20, 2003, and the exercise price is ¥667 ($5).

The Company is authorized to issue 4,000,000 thousand shares of common stock and 100,000 thousand shares of preferred stock on approval of the shareholders' meeting held on June 25, 1998. Contents of preferred shareholders' right are (1) pre- ferred shareholder shall not have any voting rights at a shareholders' meeting, (2) no share consolidation nor share split shall be made with respect to preferred shareholders, (3) the Company shall not grant to the preferred shareholders pre-emptive rights to subscribe for new shares or rights to subscribe for convertible bonds or bonds with warrants to subscribe for new shares. At present the Company has not yet issued any preferred stock.

22. Capital adequacy requirements In Japan, the securities company is subject to risk-based capital adequacy rules established and administered by the Financial Services Agency. Securities subsidiaries report their capital adequacy ratio as defined pursuant to these rules. The authorities will take certain administrative measures if such ratio declines below 140%. Capital adequacy ratios of Daiwa Securities Co. Ltd. were 251.3% (unaudited) and 262.7% (unaudited) for 2001 and 2000, respectively, and of Daiwa Securities SMBC were 364.7% (unaudited) and 507.4% (unaudited) for 2001 and 2000, respectively.

23. Segment information The Company and consolidated subsidiaries operate predominantly in a single industry segment. The Company and consoli- dated subsidiaries' primary business activities include (1) trading in securities, (2) brokerage of securities, (3) underwriting and distribution of securities and (4) other business related to securities transactions.

A summary of revenues by geographic area for the three years ended March 31, 2001 and a summary of total assets by geo- graphic area for the two years ended March 31, 2001 were as follows:

114 Millions of yen

Asia & Elimination Japan America Europe Oceania or unallocated Consolidated Year ended March 31, 2001: Revenues: Outside customer ...... ¥ 488,512 ¥ 198,304 ¥ 23,644 ¥ 7,651 ¥ – ¥ 718,111 Inter-area ...... 15,529 (370) 138 117 (15,414) – Total ...... 504,041 197,934 23,782 7,768 (15,414) 718,111 Operating expenses...... 330,498 186,780 18,990 6,703 (4,725) 538,246 Operating income ...... ¥ 173,543 ¥ 11,154 ¥ 4,792 ¥ 1,065 ¥ (10,689) ¥ 179,865

At March 31, 2001: Total assets by Geographic area...... ¥ 7,104,229 ¥ 1,817,111 ¥ 572,243 ¥ 76,507 ¥ (319,867) ¥ 9,250,223

Year ended March 31, 2000: Revenues: Outside customer ...... ¥ 528,090 ¥ 85,359 ¥ 31,969 ¥ 9,232 ¥ – ¥ 654,650 Inter-area ...... 17,703 (516) (1,960) (454) (14,773) – Total ...... 545,793 84,843 30,009 8,778 (14,773) 654,650 Operating expenses...... 325,440 82,305 23,878 7,227 (11,130) 427,720 Operating income ...... ¥ 220,353 ¥ 2,538 ¥ 6,131 ¥ 1,551 ¥ (3,643) ¥ 226,930

At March 31, 2000: Total assets by Geographic area...... ¥ 7,807,069 ¥ 709,836 ¥ 339,697 ¥ 57,810 ¥ (400,199) ¥ 8,514,213

Year ended March 31, 1999: Revenues: Outside Customer ...... ¥ 247,423 ¥ 103,781 ¥ (3,705) ¥ 7,462 ¥ – ¥ 354,961 Inter-area ...... 16,295 418 (181) 151 (16,683) – Total ...... 263,718 104,199 (3,886) 7,613 (16,683) 354,961 Operating expenses...... 245,957 146,191 54,097 10,603 (13,321) 443,527 Operating income (loss) ...... ¥ 17,761 ¥ (41,992) ¥ (57,983) ¥ (2,990) ¥ (3,362) ¥ (88,566)

115 CONSOLIDATED FINANCIAL STATEMENTS

Thousands of U.S. dollars

Asia & Elimination Japan America Europe Oceania or unallocated Consolidated Year ended March 31, 2001: Revenues: Outside Customer ...... $ 3,939,614 $ 1,599,226 $ 190,677 $ 61,702 $ – $ 5,791,219 Inter-area ...... 125,234 (2,983) 1,113 944 (124,308) – Total ...... 4,064,848 1,596,243 191,790 62,646 (124,308) 5,791,219 Operating Expenses ...... 2,665,308 1,506,291 153,145 54,056 (38,106) 4,340,694 Operating Income ...... $ 1,399,540 $ 89,952 $ 38,645 $ 8,590 $ (86,202) $ 1,450,525

At March 31, 2001: Total assets by Geographic area...... $ 57,292,170 $ 14,654,121 $ 4,614,863 $ 616,992 $ (2,579,573) $ 74,598,573

Geographic overseas revenues for the three years ended March 31, 2001 were as follows:

Millions of yen

America Europe Asia & Oceania Total Year ended March 31, 2001: Overseas revenue ...... ¥ 188,739 ¥ 22,045 ¥ 7,631 ¥ 218,415 Total revenue ...... 718,111 % of total revenue ...... 26.2% 3.1% 1.1% 30.4%

Year ended March 31, 2000: Overseas revenue ...... ¥ 79,516 ¥ 23,668 ¥ 10,529 ¥ 113,713 Total revenue ...... 654,650 % of total revenue ...... 12.2% 3.6% 1.6% 17.4%

Year ended March 31, 1999: Overseas revenue ...... ¥ 136,128 ¥ 16,148 ¥ 8,592 ¥ 160,868 Total revenue ...... 354,961 % of total revenue ...... 38.4% 4.5% 2.4% 45.3%

Thousands of U.S. dollars

America Europe Asia & Oceania Total Year ended March 31, 2001: Overseas revenue ...... $ 1,522,089 $ 177,782 $ 61,540 $ 1,761,411 Total revenue ...... 5,791,219 % of total revenue ...... 26.2% 3.1% 1.1% 30.4%

116 24. Commissions Commissions derived from each department for the year ended March 31, 2001 and 2000 were as follow:

Millions of yen

Equity Fixed Income (Bond) Asset Management Investment Banking Others Total Year ended March 31, 2001: Brokerage ...... ¥ 82,231 ¥ 642 ¥ 8 ¥ – ¥ – ¥ 82,881 Underwriting ...... – – – 38,859 – 38,859 Distribution ...... – – 37,510 2,099 – 39,609 Other ...... 2,620 3,084 70,421 7,137 10,093 93,355 ¥ 84,851 ¥ 3,726 ¥ 107,939 ¥ 48,095 ¥ 10,093 ¥ 254,704

Millions of yen

Equity Fixed Income (Bond) Asset Management Investment Banking Others Total Year ended March 31, 2000: Brokerage ...... ¥ 145,968 ¥ 1,488 ¥ 7 ¥ – ¥ 13 ¥ 147,476 Underwriting ...... – – – 34,887 – 34,887 Distribution ...... – – 86,764 1,439 – 88,203 Other ...... 2,876 3,395 70,431 7,218 9,630 93,550 ¥ 148,844 ¥ 4,883 ¥ 157,202 ¥ 43,544 ¥ 9,643 ¥ 364,116

Thousands of U.S. dollars

Equity Fixed Income (Bond) Asset Management Investment Banking Others Total Year ended March 31, 2001: Brokerage ...... $ 663,154 $ 5,177 $ 65 $ – $ – $ 668,396 Underwriting ...... – – – 313,379 – 313,379 Distribution ...... – – 302,500 16,927 – 319,427 Other ...... 21,129 24,871 567,912 57,556 81,395 752,863 $ 684,283 $ 30,048 $ 870,477 $ 387,862 $ 81,395 $ 2,054,065

Commissions earned for the year ended March 31, 1999 consisted of the following:

Millions of yen Brokerage ...... ¥ 68,986 Underwriting ...... 24,917 Distribution ...... 37,330 Other ...... 54,217 ¥ 185,450

117 CONSOLIDATED FINANCIAL STATEMENTS

25. Selling, general and administrative expenses Major elements of selling, general and administrative expenses for the three years ended March 31, 2001, 2000 and 1999 are summarized as follows:

Thousands of Millions of yen U.S. dollars 2001 2000 1999 2001 Employees’ compensation and benefits...... ¥ 140,426 ¥ 140,648 ¥ 126,890 $ 1,132,469 Commissions and floor brokerage...... 20,785 9,816 12,950 167,621 Communications ...... 12,926 15,896 17,118 104,242 Occupancy and rental...... 38,663 40,787 49,910 311,798 Data processing and office supplies...... 17,367 20,874 30,614 140,056 Taxes other than income taxes ...... 7,554 7,312 9,211 60,919 Depreciation...... 15,495 14,780 8,535 124,960 Other ...... 33,732 37,385 15,857 272,032 ¥ 286,948 ¥ 287,498 ¥ 271,085 $ 2,314,097

118 26. Other income (expenses) Details of “Other, net” in the consolidated statements of operations for the three years ended March 31, 2001 were as follows:

Thousands of Millions of yen U.S. dollars 2001 2000 1999 2001 Gains on sales of investment securities ...... ¥ 2,004 ¥ 16,755 ¥ 1,921 $ 16,161 Write-off of securities ...... (4,750) (4,104) (1,200) (38,306) Valuation losses of investment securities ...... – (1,659) (8,760) – Financial assistance to related companies (note 13) ...... – – (115,800) – Valuation losses related to fixed assets...... (227) (2,489) (15,873) (1,831) Losses on disposal and sale of fixed assets ...... (2,751) (6,693) – (22,185) Losses on sale of loan receivables...... (1,519) – – (12,250) Expenses for liquidation of related companies...... – (12,418) – _ Losses related to foundation of domestic subsidiaries ...... – (15,493) – _ Cumulative effect of an accounting change (notes 2 and 17) ...... – – (1,034) – Liquidation losses of employees’ retirement plans (note 17) ...... – (3,171) (12,806) _ Provision for multiemployers’ pension plans (note 17) ...... – (28,443) – _ Restructuring of overseas business...... – – (6,176) – Expenses for the holding company structure...... – – (2,562) – Losses on restructuring of property and equipment...... – – (2,268) – Provision for doubtful accounts ...... (2,942) (30,603) (1,904) (23,726) Equity in earnings (losses) of affiliated companies...... 761 (551) 1 6,137 Other ...... (2,832) (2,691) 606 (22,839) ¥ (12,256) ¥ (91,560) ¥ (165,855) $ (98,839)

Valuation losses related to fixed assets for 1999 were derived from updated development appraisal of the investment property called Daiwa Europe House ("DEH") held by Daiwa Europe Property plc. ("DEP"), a consolidated subsidiary. DEP has been in the course of completing the constructing of DEH, the original intention having been that Daiwa Securities SMBC Europe Limited ("DEL"), a consolidated subsidiary would occupy the property once the work was completed. A decision was taken by DEL in 1999 not to move into DEH, and DEP changed the purpose of holding of the building to commercial usage. Due to the change of the purpose of holding the property, DEP had the land and building appraised according to the local accounting standard and recorded a valuation loss in the amount of ¥20,137 million for the year ended March 31, 1999. In this connection, DEL also reversed the reserve for relocation to DEH in the amount of ¥4,264 million for the same period.

Valuation losses related to fixed assets for 2001 and 2000 were derived from appraisal of the golf club membership.

Losses related to foundation of domestic subsidiaries for 2000 consisted of write-off of goodwill of ¥8,000 million, non- deductible consumption taxes derived from goodwill of ¥4,359 million and expenses for starting costs of ¥3,134 million.

119 CONSOLIDATED FINANCIAL STATEMENTS

27. Subsequent events Appropriation of retained earnings - Under the Commercial Code of Japan, a plan for appropriation of retained earnings pro- posed by the Board of Directors must be approved at a shareholders' meeting to be held within three months after the end of the fiscal year. The appropriation of retained earnings for the year ended March 31, 2001 was approved by the shareholders' meeting held on June 27, 2001 as follows:

Thousands of Millions of yen U.S. dollars Cash dividends (¥13 ($0.1) per share) ...... ¥ 17,265 $ 139,234 Bonuses to directors...... 135 1,089

120 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders and the Board of Directors of Daiwa Securities Group Inc.:

We have audited the accompanying consolidated balance sheets of Daiwa Securities Group Inc. (formerly “Daiwa Securities Co. Ltd.”, a Japanese corporation) and subsidiaries as of March 31, 2001 and 2000, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended March 31, 2001, expressed in yen. Our audits were made in accordance with generally accepted auditing standards in Japan and, accordingly, included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances.

In our opinion, the consolidated financial statements referred to above present fairly the consolidated financial position of Daiwa Securities Group Inc. and subsidiaries as of March 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 2001, in conformity with accounting principles generally accepted in Japan which were applied on a consistent basis.

Also, in our opinion, the U.S. dollar amounts in the accompanying consolidated financial statements have been translated from yen on the basis set forth in Note 1.

Tokyo, Japan

June 27, 2001

STATEMENT ON ACCOUNTING PRINCIPLES AND AUDITING STANDARDS

This statement is to remind users that accounting principles and auditing standards and their application in practice may vary among nations and therefore could affect, possibly materially, the reported financial position and results of operations. The accompanying financial statements are prepared based on accounting principles generally accepted in Japan, and the auditing standards and their appli- cation in practice are those generally accepted in Japan. Accordingly, the accompanying financial statements and the auditors’ report presented above are for users familiar with Japanese accounting principles, auditing standards and their application in practice.

121 THE DAIWA SECURITIES GROUP (all addresses in japan)

Daiwa Securities Group Inc. Daiwa Asset Daiwa SB Investments Ltd. The Daiwa Real 6-4 Otemachi 2-chome Management Co. Ltd. 7-9 Nihonbashi 2-chome Estate Co., Ltd Chiyoda-ku, Tokyo 100-8101 10-5 Nihonbashi Chuo-ku, Tokyo 103-0027 1-9 Nihonbashi Tel: 81-3-3243-2100 Kayabacho 2-chome Tel: 81-3-3243-2915 Kayabacho 1-chome Chuo-ku, Tokyo 103-0025 Chuo-ku, Tokyo 103-0025 Daiwa Securities Co. Ltd. Daiwa Securities Business Tel: 81-3-3665-5501 Tel: 81-3-5695-2111 6-4 Otemachi 2-chome Center Co., Ltd. NIF Ventures Co., Ltd. Chiyoda-ku, Tokyo 100-8101 Daiwa Institute of 3-2 Toyo 2-chome 2-1 Kyobashi 1-chome Tel: 81-3-3243-2111 Research Ltd. Koto-ku, Tokyo 135-0016 Chuo-ku, Tokyo 104-0031 Daiwa-Soken Building Tel: 81-3-5633-6100 Daiwa Securities SMBC Tel: 81-3-5201-1515 15-6 Fuyuki Co. Ltd. Koto-ku, Tokyo 135-8460 3-5 Yaesu 1-chome Tel: 81-3-5620-5100 Chuo-ku, Tokyo 103-8289 Tel: 81-3-3243-2211

122 OVERSEAS DIRECTORY

Daiwa Securities SMBC Daiwa Securities SMBC Daiwa Securities SMBC Daiwa Securities Trust & Europe Limited Hong Kong Limited Co. Ltd. Banking (Europe) plc Head Office Level 26, One Pacific Place Seoul Branch Head Office 5 King William Street 88 Queensway, Hong Kong DITC Building 6th Floor 5 King William Street London EC4N 7AX, U.K. Tel: 852-2525-0121 #27-3 Youido-dong London EC4N 7JB, U.K. Yongdungpo-gu, Seoul Tel: 44-20-7320-8000 Tel: 44-20-7597-8000 Daiwa Securities SMBC Republic of Korea Singapore Limited Dublin Branch Frankfurt Branch Tel: 82-2-787-9100 6 Shenton Way #26-08 Level 2, Block 3 Trianon Building DBS Building Tower Two Beijing Office Harcourt Centre Mainzer Landstrasse 16 Singapore 068809 International Building 2103 Harcourt Road 60325 Frankfurt am Main Republic of Singapore Jianguo Menwai Dajie 19 Dublin 2, Ireland Federal Republic of Germany Tel: 65-220-3666 Beijing, People’s Republic of Tel: 353-1-478-3700 Tel: 49-69-717080 China Daiwa Securities Paris Branch Daiwa Securities SMBC Tel: 86-10-6500-6688 America Inc. 112 Avenue Kléber Australia Limited Shanghai Office Financial Square, 32 Old Slip 75116 Paris, France Level 48, Nauru House 38th Floor, HSBC Tower New York, NY 10005, U.S.A. Tel: 33-1-56-26-22-00 80 Collins Street, Melbourne 101 Yin Cheng East Road Tel: 1-212-612-7000 Victoria 3000, Australia Geneva Branch Pudong New Area Tel: 61-3-9280-1300 Daiwa Securities 50 Rue du Rhône Shanghai, People’s Republic of Trust Company P.O. Box 3198 Daiwa Securities SMBC - China One Evertrust Plaza 1211 Geneva 3, Switzerland Cathay Co., Ltd. Tel: 86-21-6841-3333 Jersey City, NJ 07302, U.S.A. Tel: 41-22-818-74-00 200 Keelung Road, 14th Floor Tel: 1-201-333-7300 Section 1 Milan Branch Taipei, Taiwan R.O.C. Via Senato 14/16, Tel: 886-2-2723-9698 20121 Milan, Italy Tel: 39-02-763271 DBP-Daiwa Securities SMBC Philippines, Inc. Spain Branch Citibank Tower 18th Floor Jose Ortega y Gasset 20, 8741 Paseo de Roxas 7th Floor, Madrid 28006, Salcedo Village, Makati City Spain Republic of the Philippines Tel: 34-91-529-9800 Tel: 632-813-7344

Middle East Branch The Tower Bahrain Commercial Complex, 7th Floor P.O. Box 30069 Manama, Bahrain Tel: 973-534452

123 CORPORATE DATA

Daiwa Securities Group Inc. Shares of Preferred Stock Head Office Authorized 6-4 Otemachi 2-chome 100,000 thousand shares Chiyoda-ku, Tokyo 100-8101 Issued and Outstanding Japan 0 shares Tel: 81-3-3243-2100 Number of Shareholders Telex: J22411 94,656 (as of March 31, 2001) Internet Home Page Address Independent Public Accountants http://www.ir.daiwa.co.jp/ Asahi & Co. Date of Founding Stock Exchange listings May 1, 1902 Tokyo, Osaka, Nagoya, London, Paris, Frankfurt, Brussels Commencement of Operations Transfer Agent and Registrar April 26, 1999 The Chuo Mitsui Trust and Banking Company, Limited Shares of Common Stock 8-4 Izumi 2-chome Authorized Suginami-ku, Tokyo 168-0063 4,000,000 thousand shares Japan Issued and Outstanding Stock Transfer Agency Dept. 1,331,735 thousand shares (as of March 31, 2001) Tel: 81-3-3323-7111

For further information, please contact:

Daiwa Securities Group Inc.

Investor Relations Department Tel: 81-3-3243-3841 Fax: 81-3-3242-0955 Email: [email protected]

This annual report has been printed on recycled paper

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