Daiwa Securities Group, Japan's No. 2 brokerage, is set to post sluggish results for the July-September quarter as volatile financial markets hit trading profits and the flow of equity deals dried up.

Industry leader Nomura Holdings Inc. and No. 3 player Nikko Cordial Corp have already given estimates for their quarterly earnings, putting the spotlight on Daiwa as the sector begins reporting this week.

Japanese brokers have faced a weak stock market as the U.S. mortgage crisis rocked confidence, a sharp slowdown in equity financing, extremely volatile trading conditions and a new regulation that has depressed sales of investment trusts.

Nikko last month projected a 47 percent quarter-on-quarter fall in pre-tax recurring profit while Nomura last week forecast a 40-60 billion yen pre-tax loss due to losses on U.S. home mortgage-backed securities and charges to cut U.S. jobs.

JP Morgan analyst Natsumu Tsujino expects a drop in Daiwa's quarterly profit. She says both Daiwa and Nomura likely suffered declines in trading profits as interest rate and currency markets swung wildly, and that both companies saw little in the way of banking deals.

In that sense it is a very bad environment, she said.

Stock-broking commissions are expected to have fallen as the benchmark Nikkei average slipped 7 percent during the quarter and daily average trading value on the Tokyo Stock Exchange dropped about 1 percent to 3.03 trillion yen.

Investment banking also tailed off.

Equity finance deals in Japan fell nearly 70 percent from a year earlier to $4.7 billion in the July-September quarter while mergers and acquisitions (M&A) involving Japanese firms held steady at about $23 billion, according to data compiler Thomson Financial.

Deutsche Securities analyst Tatsuo Majima said M&A could pick up in the second half but warned that Japanese companies would remain wary of issuing stock as they are not confident they can justify share dilution with an acceptable level of profit growth.

Japanese companies have to consolidate. There is no other road to take. M&A deals will likely grow but my expectations for equity finance are low, Majima said.

Majima said Daiwa's earnings will look much better than Nomura's in the second quarter in large part because it has not taken on the risky positions that got Nomura in trouble.

When the financial markets move in a big way as they have recently, Daiwa doesn't make a lot of money but it doesn't lose a lot either. It will look a lot better than Nomura in the second quarter.

JP Morgan's Tsujino expects Daiwa's group recurring profit, which is pre-tax and excludes extraordinary items, to total 38.7 billion yen, down 28 percent from the prior quarter and a decline of 6 percent year-on-year.

Credit Suisse is more pessimistic, forecasting profit to roughly halve to 26 billion yen, although Deutsche Securities reckons Daiwa will almost be able to match the first quarter with a profit of 50.5 billion yen.

Majima says sales of investment trusts, which have become important earnings drivers for brokers, will probably recover from December after two more sluggish months in October and November due in part to a new financial instruments law.

The law, which came into effect last month, requires financial institutions to explain the risks of investment trusts to investors. Coupled with a downturn in global stocks and a firmer yen, the regulation has dented sales.

For the full year to March 2008, Nomura is expected to post an 11 percent rise in pre-tax profit to 356 billion yen, according to the average estimate of 6 analysts polled by Reuters Estimates.

Daiwa's recurring profit is seen up 3 percent at 201.4 billion yen and Nikko's profit is expected to increase about 25 percent to 125.3 billion yen.