Time to trade: New regulations are making the markets safer

Markets in the Philippines have been performing well for a number of years. The country’s benchmark stock index was up 63% in 2009, 38% in 2010, 4% in 2011 and 33% in 2012. Among Asian equity markets, the Philippine Stock Exchange (PSE) was the second best performer in 2012 ( just behind Thailand, with a 35.8% gain). It hit 38 all-time records that year, broke 6000 for the first time in January 2013, 6500 in February and 7000 in April. Philippine stocks have very much left their past behind them, having broken through highs set in both 1997 and 2007.

THE NEXT STEPS: The challenge now is to build on this strong foundation, further developing the systems, institutions and regulations that will guarantee the market’s continued success going forward. “Basic elements of a stock exchange should have been in place for years; now we are getting it done,” Mark Visda, head of the corporate planning and research department at the PSE, told OBG.

It is vitally important for the Philippines to have markets and institutions that follow best practice. With international investors increasingly wary and competition coming in as the ASEAN Economic Community (AEC) forms, the country will face considerable challenges for a number of years; capital flows are expected to remain volatile and regional banks and securities companies may begin to become more active locally as barriers drop. Some analysts believe that the Philippines, given its balanced growth and the relative dearth of economic bubbles, is one of the best-positioned countries in the region to weather the possible flight of hot money.

Nevertheless, the country is being tested and the current state and future development of its markets infrastructure and regulations are vital if it is going to be resilient to inevitable shocks. The PSE index fell 22% from its May 2013 high as foreigners began to retreat from the emerging markets following indications of higher growth and higher interest rates in the US, and more pressure to this end is expected.

HISTORY: The PSE was established in 1992 from the merger of the Manila Stock Exchange (founded 1927) and the Makati Stock Exchange (founded 1963). The Securities and Exchange Commission (SEC) was established in 1936 and has a broad remit. It is not only in charge of preventing fraud and manipulation in the market, but it also oversees a wide variety of related laws and decrees, including the Corporation Code, the Partnership Law, the Investment Company Act and the Foreign Investments Act.

The Commonwealth Act 83, which created the SEC, was replaced in 1983 with the Revised Securities Act, which called for more detailed disclosure. Considerable reform has also been undertaken at the exchange. The PSE was made self-regulatory in 1998, five independent directors were added in 2001 under Republic Act (RA) 8799, and it was listed in 2003. A trading system from NYSE Euronext Technology was introduced in 2010, replacing a system in use since 1993 (MakTrade). The new NSC V900 platform is 10 times faster than the old system and highly scalable.

The market trades T+3 for equities (and T+0 to T+2 for other securities) and has two depositories. The Philippine Depository & Trust Corporation (PDTC) handles equities traded on the PSE and bonds traded on the Fixed Income Exchange, an electronic platform created in 2005. The Bureau of the Treasury acts as depository for government securities. The country has a real-time gross settlement system called PhilPaSS, which was introduced in 2002 and is based on the model at the European Central Bank. It utilises SWIFT formats and is said to be highly efficient, though according to HSBC, payments from custodian banks to their counterparties are still handled by cheque. The Securities Clearing Corporation of the Philippines acts as a central counterparty and the market is primarily scripless, with shares immobilised at PDTC. Government bonds are dematerialised.

SMALL BUT GROWING: The Philippines has one of the smallest markets in the region. Capitalisation was about $231bn at the end of June 2013, according to the World Federation of Exchanges. That compares with capitalisations of $400bn in Thailand, $478bn in Indonesia, $490bn in Malaysia and $752bn in Singapore. In terms of the market’s make up, the PSE has 253 listed companies, compared with Indonesia’s 472, Thailand’s 569 and Malaysia’s 909. The situation is much the same in the bond market. According to Asia Bonds Online, the Philippines had $85.18bn of government bonds outstanding as of March 2013 and $13.04bn of corporate bonds, for a total of $98.22bn. That compares with Indonesia’s $118.62bn, Thailand’s $294.45bn and Malaysia’s $321.94bn.

SIZE DOESN’T MATTER: Despite their small size, markets in the Philippines are quickly growing. In 2012, a record P219.07bn ($5.27bn) in capital was raised on the PSE, up from P107.50bn ($2.59bn) in 2011. Five companies went public, selling P24bn ($578m) in stock. The new listings comprised D&L Industries, GT Capital Holdings, East West Banking, Calata Corp and Coal Asia Holdings. Two companies – Rockwell Land and Yehey! – were listed via introduction, and a total P195bn ($4.7bn) was raised via private placements (P50.38bn, or $1.2bn), stock rights offerings (P52.07bn, or $1.25bn) and follow-on offerings (P92.64bn, or $2.23bn). Total capital of all PSE-listed firms ended the year up 25.7% from 2011.

Initial public offering (IPO) activity, however, started to stall in 2013 due to concerns about the state of the global markets. Robinsons Retail Group, which has 35 department stores and 71 supermarkets in the country, launched its IPO in mid-October with shares priced toward the lower end of its range, given market conditions. Despite this, the IPO was oversubscribed and expected to earn $650m, making it the country’s largest-ever IPO. Earlier in the year, Travellers International Hotel Group delayed its IPO from its original July 19 target to October, where it priced its shares lower than initially expected and was oversubscribed. The money will be used for the expansion of Resorts World Manila, an integrated tourism complex near Terminal 3 of Ninoy Aquino International Airport that offers gaming. Also in July, Harbour Star Shipping Services, a tugboat operator, decided to delay its IPO. Its offer was instead listed in October at a discounted price. All told, 2013 has been a record year for IPOs, with $1.35bn raised as of late October.

INVESTOR INTEREST: As the market expands, the investor base is also widening. In 2012 the number of retail accounts grew 5.9% to 506,761, according to the PSE, with active accounts rising 9.8% to 163,807 (while the number of institutional accounts fell 28.5% to 19,089). Of the retail investors, 75.4% were in Manila. The number of online stock investors rose 48% in 2012, with 86% of those accounts active. However, trade via online platforms was only 6.7% of total turnover (minus block trades).

Inclusiveness in the stock market is a concern for the government and the exchange. Participation, at less than 1% of the total population, is seen as far too low, and the hope is to increase the number of retail investors to promote more healthy and liquid trading. In early 2013, the PSE introduced PSET radex, a platform that can be onsold by brokers to clients so they can trade shares, monitor their accounts and access information on companies.

OWNERSHIP LIMITS: The market is relatively open to foreign investment, but the country does restrict equity ownership in certain areas. A number of industries are totally closed, including mass media, small retail, fishing in the country’s territorial waters or the exclusive economic zones and small-scale mining. Other sectors have foreign investment limits ranging from 20% to 40%, including everything from advertising to utilities. A 60% limit is placed on SEC-regulated investment companies and investment houses. Another list limits foreign investment to 40% in companies associated with the defence industry, that are very small, or that are in businesses that are sensitive, in terms of public morals, such as gaming.

Foreign ownership limits have created some controversy in recent years, and the issue is not yet completely settled. In 2012 the Supreme Court ruled that the shareholding structure of Philippine Long Distance Telephone (PLDT) violated the prohibition on foreigners owning more than 40% of a utility, a limit which is in the country’s 1987 constitution. It was claimed in the suit that as much as 81% of PLDT’s shares were held by non-Filipinos following the sale of company stock in 2007 to Hong Kong’s First Pacific Group. To work around the limits and to make their structure constitutional, the company sold 150m voting preferred shares to a trust that it 99% owns. This solution may not hold, however. It is now being argued that since PLDT is itself foreign controlled, the trust is also a foreign entity and thus does not dilute the non-Filipino shareholding percentage.

FOREIGN ACTIVITY: Foreign brokers are particularly active on the exchange. According to the PSE, they dominated in 2012, when the top 10 brokers were Deutsche Regis Partners, UBS Securities Philippines, CLSA Philippines, Maybank ATR Kim Eng Securities, Macquarie Capital Securities, Philippine Equity Partners, COL Financial Group, DBP-DAIWA Securities, SMBC Philippines, JP Morgan Securities Philippines and SB Equities. Of these, Philippine Equity Partners, COL Financial Group and SB Equities are local.

In the first six months of 2013, the top five brokers were UBS (with 12.81% of the trading), Deutsche (12.09%), CLSA (8.13%), Maybank (7.78%) and Macquarie (6.38%). UBS was also the number one underwriter in the first half of 2013, with a full 62% of the business. Foreign buying was also strong. In 2012, non-Filipinos purchased P109.9bn ($2.6bn) worth of local shares, up from P56.52bn ($1.36bn) in 2011. And foreign investors have been active traders. In early 2013, they accounted for 49% of the turnover on the PSE.

KEY REFORMS: Many of the improvements being undertaken at the exchange and by the regulators centre around compliance, transparency and inclusiveness. This is in line with current trends; under President Benigno Aquino III, the emphasis in the Philippines has been on achieving greater openness and addressing institutional weaknesses, and the PSE and the SEC have been focused on relevant reforms.

To those ends, the Capital Markets Integrity Corporation (CMIC) was provisionally formed in 2011 and then made operational as a self-regulatory organisation in 2012. It took over the responsibilities of the PSE’s market regulation division and is tasked with being the independent audit, compliance and surveillance arm of the exchange. In early 2012 the CMIC introduced the Total Market Surveillance (TMS) system, which tracks activity in the market and works to detect unusual trading. It can handle 1m transactions per day and utilises advanced software technology. The system was built in cooperation with the Korea Exchange, which also assisted in the development another system. The PSE Electronic Disclosure Generation Technology allows corporate announcements and other related listed-company information to be accessed and integrated real-time into existing electronic platforms. The old Online Disclosure System delivered PDF documents, which needed to be manually stripped of data that can then be input for publication or analytical work.

The CMIC’s counterpart at the SEC is the Investor Protection and Surveillance Department, which monitors the market on a daily basis, receives anonymous tips and gathers information about any alleged violations from the CMIC. In the spirit of promoting transparency and fairness, the SEC has been using its powers – which extend undertaking to criminal prosecutions – to make the markets more efficient and equitable. At the end of 2012, for example, the commission announced that it was conducting nine investigations, six of which involved market manipulation while the other three were insider trading.

The SEC is even seeking to expand its powers. In April 2013, SEC chairwoman Teresita Herbosa said that a proposed amendment to the Securities Regulation Code is the “disgorgement of profits”. Anyone found to have gained from illegal or unethical activities will be required to pay back those profits plus interest.

ILLEGAL ACTIVITIES: Under RA 8799, or the Securities Regulation Code, a long list of activities are prohibited, including: “painting the tape”, which involves making transactions to create the appearance that there is price movement in a stock; “marking the close”, which is making trades at the end of the day to influence a stock’s closing price; collusion between the buyer and the seller to match prices; artificially pumping up prices and then selling into the rising market; sales in which there is no real change in ownership; disseminating false information; and taking advantage of a shortage of securities.

The 1999 BW Resources scandal, which involved an 18,000% increase in the stock price of the company, was never successfully prosecuted; it took a decade to get a judgment and the defendant had fled the country before he could be charged. But times have changed and newer cases may be more successful. When the shares of Calata, an agricultural input supplier, were listed in May 2012, the price rose from P7 ($0.17) to almost P24 ($0.58) and then back to P8 ($0.19) in the span of less than three weeks. By that time, the TMS was up and running and the CMIC announced that it found clear evidence of manipulation. In late 2012 the SEC sued 13 individuals for the manipulation of Calata stock shares.

Additionally, the first and only criminal conviction so far under Securities Regulation Code was achieved in early 2013. The Regional Trial Court of Makati City ruled against Francisco Borromeo, the former head of a local brokerage house, for seven violations of RA 8799. He was convicted of selling client shares without their consent, buying shares with dummy accounts and of failure to deliver the proceeds of the sale of client shares. As a result of the conviction, Borromeo was fined some P2.1m ($50,600).

MORE EFFICIENT: Aside from battling securities violations, the exchange and the SEC have been implementing a number of reforms in recent years to make the market more efficient and more promising for investors. At the beginning of 2012, the Amended Rule on Minimum Public Ownership became effective, requiring all listed companies to maintain at least a 10% public float (which includes individuals with less than 10% of the total shares, mutual funds, the social security fund and pension funds, but excluding Treasury shares). The Bureau of Internal Revenue (BIR) has noted that public shares traded in listed companies enjoy preferential tax rates and that this is not fair if the company is not truly public.

In July 2013, the SEC approved Exchange-Traded Funds (ETFs) rules with the expectation of allowing these vehicles on the PSE by the end of the year. The first two sections (A and B) on listing and disclosure were approved in March. Part C, which covers market making, was settled in July. The exchange hopes that the introduction of ETFs will offer investors more opportunities. To this end, the PSE has been actively working to educate the public about them, running seminars and conferences and providing incentives to encourage the trading of the instruments, such as waiving transaction fees for market makers when they handle ETF transactions. The ETF rules seek to achieve a high level of transparency and investor protection and follow the International Organisation of Securities Commissions guidelines on ETF regulation. ETFs in the Philippines will need minimum paid-up capital of P250m ($6m) and a public float of 10%, but the lock-up periods and track records required for normal IPOs will not apply (though fund managers should have two years experience).

REITS: Real Estate Investment Trusts (REITs) have also been promoted, but with little success. The REIT Act, passed in late 2009 and implemented in July 2011, established a framework for these investment vehicles. REITs in the Philippines are required to distribute 90% of their income as dividends, have paid up capital of P500m ($12m) and have at least one-third of their shares in public hands. They are allowed to invest in Philippine real estate, income-generating foreign real estate, debt securities and listed shares, cash and government bonds, and they benefit from a number of tax breaks.

However, REITs have so far not been very popular; none were launched as of mid-2013. Despite tax incentives, such as a special 1% withholding tax rate, potential issuers see the burden as still too high. They cite the fact that a REIT has to pay a 12% value-added tax (VAT) on asset transfers and 30% corporate income tax, along with the fact that the public shareholding must reach two-thirds over a three-year period.

The sector is trying to convince the BIR that eliminating certain taxes on REITs would be in the best interest of everyone, arguing that the establishment of REITs would generate considerable economic activity, and because of that they should be VAT exempt. The authorities, however, see potential for abuse if groups with small public floats are allowed to make investments without paying the tax.

OUTLOOK: Despite some dips caused by exogenous factors, 2013 has been a good year for the PSE, and efforts to expand the investor base and the instruments on offer should support continued expansion.

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The Report: The Philippines 2014

Capital Markets chapter from The Report: The Philippines 2014

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