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There is a creeping feeling of unease taking root in Tokyo’s investment banking and hedge fund circles, punctuated at increasingly regular intervals with the false bonhomie and back-slapping of farewell bashes for departing staff.

There’s no shortage of rumours washing around the hangouts frequented by Tokyo’s financial community. It’s hard to pin down exact figures, though, because nobody official is talking - officially.

But FT Alphaville has collected enough “Dear All, I’ll be relocating to xxxx…” emails and accounts of dismissals and relocation orders to come to a clear conclusion: While we know that key investment banks, from UBS and Merrill Lynch to Citigroup and Morgan Stanley, are downsizing worldwide, their Japan operations, which typically number 1,300 to 2,000 people each, are taking a fair amount of the pain.

Clearly, the slow “hollowing-out” of Tokyo’s financial community over the past year has accelerated in the past few months and in some cases, has led to radical cuts in both expat and Japanese domestic staff at key investment banks, hedge funds and other financial institutions.

While some analysts have been talking up the Tokyo stock market and its relative resilience at a time when markets elsewhere are looking shaky, it all seems too little, too late, as staffing decisions taken weeks or months earlier by financial institutions kick in.

Oh the irony of it all, observed one expat broker, commenting: “You know when the big guys like Goldman and Lehman cut their small cap teams that we’ve reached the bottom - you have to think, it’s got to be upwards from here”.

For now, small caps - once a nice little money-earner for the securities houses - have indeed fallen out of favour, particularly at the two US investment banks, which recently let go of mainly Japanese staff on their teams. Merrill Lynch, also, has downsized its small cap team as well as pruned here and there.

But that is small fry for the big investment banks, who are trying to downsize as discreetly as possible in Japan, where labour laws don’t make it easy. That is particularly difficult when you’re relocating or dismissing middle to senior managers, as Morgan Stanley, Lehman and UBS - among others - are finding out.

Merrill’s Tokyo operation is actually among the least affected, having cut only about 20 people out of its 1,300 or so employees on the institutional side, as part of a programme to cut 4,000 jobs globally.

Morgan Stanley leads the pack in terms of sheer numbers of staff being made redundant or being relocated. The head-slashing at its smart office in Tokyo’s inner west - particularly in its once-mighty property operations, encompassing its property investment division and securitisation departments - has been widely described as a “blood-bath”. Bloomberg reported last month that job cuts in its property securitisation division had reached about 65 people. But asked on Thursday about rumours that cuts across the board had now surpassed 120 people within the last four months, a spokesman said: “A lot of people are speculating out there [about such numbers] but it’s not correct.” We say, speak to any of the survivors.

The pain is also spreading through UBS’s Tokyo operations, where among the more prominent casualties was the head of equity sales, who departed this month, along with more junior staff. Lehman, meanwhile, appears to be cutting selectively, while continuing to hire in other departments so overall, according to a spokesman, the numbers are slightly up, year on year, at about 1,400 people.
Over at Nikko Citigroup, “you can smell the fear”, said one insider, as Citi takes some tough decisions in the wake of its triangular merger to meld the unwieldy structures of Citi and of Nikko Cordial, Japan’s number three securities firm, in which it previously held a stake.

The downsizing has been steady and painful, encompassing most of the combined groups many tentacles across retail banking, broking, asset management and investment banking with at least two “culls” so far, according to Nikko Citi people. Ironically, said one insider, it is staff on the Citi side of the operation who are most vulnerable, due to extra protection which is apparently enjoyed by staff on the Nikko Cordial side under the terms of the triangular merger agreement.

On the general issue of cutting staff in Japan, as foreign institutions well know, it is both onerous and often very costly to dismiss employees under Japanese labour laws. So in many cases, it is simply easier to either dismiss or relocate the expats, or reassign locals to positions such as chief pencil-sharpener. Japan lacks the “constructive dismissal” laws that are in place in many western countries, so you can bet there’ll be no shortage of nice, sharp pencils in many of these investment banks from now on.

We have to devote a few words to the hedge funds, some of which are reeling from a recent run of bad bets on Japan-related investment, or are turning tail and moving staff out of Japan - many to Singapore - due to tougher regulations brought in last year and increasing scrutiny from Japan’s financial authorities.

Collectively, Japan-focused hedge funds turned in a dismal performance last year - losing a combined $10.9bn in 2007, through poor performance and after $7.7bn of investor redemptions, according to Eurekahedge, the industry data provider. And Japan-based staff are bearing the brunt of it.

Just this week, Odey Asset Management became the latest asset manager to shut its Japan hedge fund after a dismal performance and investor withdrawals saw it plummet from a peak of $1.2bn (£608m) to less than $40m of assets in just two years.

One of the most significant hedge-fund shrinkages in Japan is that of Whitney, which conducts business as Japan Advisory in Tokyo and has seen the departure of at least eight senior people - a significant portion of its Japan-based staff - in the past months.

The list goes on, but for now we’ll end with the sorry tale of KBC Securities, which is now locked in fierce negotiations with staff and unions over its effort to lay off at least 15 staff - having relocated a clutch of others to Hong Kong.

But that is the subject of our next post.

Related links:

– Hollowing out, KBC Japan-style (2)
– The truth about Tokyo