In recent years the Philippine capital markets have performed well. The benchmark index has quadrupled since the global financial crisis in 2008 on a combination of good policy, strong economic growth, healthy inflows of foreign investment and low international interest rates. In 2016, however, market performance was mixed as the country held elections and the new administration settled in. The benchmark index fell, while the number of new initial public offerings (IPOs) was relatively small with demand on the light side. However, the expectation is that the new administration will be supportive of the markets and push through reforms that have been stalled due to bureaucratic disagreements.
Impressive Run
The year 1927 saw the first capital market open in the Philippines, with the launch of the Manila Stock Exchange (MSE). This was joined in 1963 by the Makati Stock Exchange. In 1992 the two merged, with the present Philippine Stock Exchange (PSE) the result. Equities depository functions are performed by the Philippine Depository & Trust Corporation, which is the central depository founded in 1995. Meanwhile, the Securities Clearing Corporation of the Philippines conducts clearing and settlement functions. The main market regulator, the Securities and Exchange Commission (SEC), dates back to 1936, when it was brought in to tame the excesses of the MSE. The SEC was reorganised in 1975 and then expanded in 1981, before taking its present form in 2000 in accordance with the Securities Regulation Code, which was also passed in that year. In 2003 the PSE itself was listed and trades T+3 for equities with shares immobilised.
Like many countries in the region, the market was hit hard in the 1997-98 Asian financial crisis, with the PSE index (PSEi) not reaching its 1997 highs again for approximately a decade. The 2008 global financial crisis brought about a new wave of market volatility, but the PSEi was better insulated against externalities, and the index rose from about 2000 points to above 8000 with an all-time high of 8127.48 recorded in April 2015.
Challenges
Momentum started to stall as the country headed into the 2016 election. Stocks then rallied just ahead of and immediately after the election, but declined again after President Rodrigo Duterte was inaugurated and introduced a number of controversial policies; although the index did hit its highest point in 2016 on July 20, by the end of 2016 the index was under 7000. One perhaps surprising challenge for the market has been the health of the financial system. With interest rates low and high levels of liquidity, issuers have had little incentive to turn to capital markets. Compared with bank financing, equity can be relatively expensive. The market is also relatively poorly engaged and has not reached the same popularity found in other markets. Only 1% of the Philippine population has invested in shares – despite having a growing middle class with disposable income – compared with a third of Singaporeans. “It is still a bank-dominated funding market,” Vicente Felizmenio, director of the Market Regulation Department at the SEC, told OBG. “Especially with the low interest rates and high levels of liquidity.”
The domestic market capitalisation of the PSE was $239.9bn at end-2016. It is substantially larger than the Taipei Exchange ($86.1bn), the Ho Chi Minh Stock Exchange ($67bn) and the Colombo Stock Exchange ($18.6bn), but smaller than regional heavyweights like Bursa Malaysia (MYX), the Stock Exchange of Thailand (SET) and the Indonesia Stock Exchange, which had market capitalisations of $363.1bn, $437.3bn and $433.8bn, respectively, at the end of the year.
Reforms In The Works
Over the longer term, the markets are looking up. Investors have noted that the new president has vowed to maintain supportive macroeconomic policies, and that he will make efforts to improve the competitiveness of the country. Consumer spending is forecast to rise and tax reform should help overall business sentiment. By the end of 2016 the general consensus was that while some of the political uncertainty and controversial policies of the new administration had affected the economy, it was fundamentally strong and would remain so in the coming year. Market participants have noted a number of policies that could lead to significant outperformance under the new administration. In particular, President Duterte’s commitment to infrastructure spending is getting considerable attention. It is not only expected to boost the economy, but also introduce new capital market products and new shares on the exchange.
Infrastructure Rules
The PSE has been working for some time on rules for the introduction of securities issued by infrastructure project vehicles – a structure common in South-east Asia. At present, six exchanges and exchange operators in the Asia-Pacific region have special programmes for the listing of infrastructure companies: the Australian Securities Exchange (ASX), the MYX, Hong Kong Exchange (HKEx), the Japan Exchange Group (JPX), the SET and the Taiwan Stock Exchange (TAIEx). The PSE is looking to emulate the rules adopted by the MYX, the HKEx, the SET and the TAIEx. The characteristic common to all infrastructure listing rules is the adjustment to profitability requirements, allowing companies to list with either no record of profits or a shorter record than for regular listings. For the JPX, the rule is one year of profits; the MYX requires two years; while on the ASX no profit is required for infrastructure companies. The concession period for most projects must be at least 15 years, and there is usually a minimum project cost.
On May 30, 2016 the PSE released the first draft of the regulations for infrastructure vehicles in the wake of a series of meetings and discussions involving the SEC, the Asian Development Bank (ADB), and local and foreign stakeholders. Under the rules, potential listings would have to be pursuing a “national project” awarded under Republic Act 6957. The project must be ongoing at the time of listing and be planned to continue for at least 15 years. The minimum size is P5bn ($100m), and a one-year lock-up period for principal investors was suggested. In November 2016 the SEC approved the new rules with all the basic elements of the PSE proposal intact. The hope is that the new rules will allow for larger transactions, which are necessary for the country to bridge its sizeable infrastructure deficit and allow for more players to compete in the space. As it stands now, most infrastructure tenders are dominated by the country’s major conglomerates, companies with ready access to the massive bank financing needed. With markets ready and able to play a role in fundraising, smaller companies may be able to bid.
Reits Are Here
The other major change in the works is the introduction of real estate investment trusts (REITs) to the market. The REIT Act of 2009 was designed to deepen capital markets and broaden the ownership of real estate, but the process has encountered problems and no transactions had been completed as of February 2017. The product was stalled on two issues; taxation and the total minimum float required. Under the strict schedule for public ownership set out by the Bureau of Internal Revenue, REITs would have to be 40% owned by the public after two years and 67% within three years – levels deemed unacceptable to issuers with large real estate portfolios. Philippine REITs were also required to pay 12% value-added tax on the transfer of assets to the new vehicle. The new administration views the project positively and has been working on reviving it. However, officials have expressed concern that the tax bureau has implemented overly strict laws that reduce the competitiveness of REITs when compared to regional markets. It is their view that the country should be focused less on the issue of revenue loss, and instead consider the benefits that will come to the economy with the introduction of the REIT structure. By the end of 2016 it seemed that changes were set to be implemented in the near future. The SEC will be recommending a lower public float level at the offering time, with an understanding that it could be increased at a later date. The SEC is also developing amendments to the regulations so the structure will be more attractive to issuers. It is estimated that over $3bn worth of assets are ready to be listed under the REIT structure. Companies are already beginning to prepare their real estate assets in anticipation of upcoming changes in the law. Possible issuers include Century Properties, Megaworld, Ayala Land and the SM Group.
International Standards
Improving capital markets has become a high priority for the country, especially with ASEAN financial integration on the horizon. The Philippine markets are looking to strengthen and become more sophisticated in order to successfully compete with counterparts in the regional grouping. International assistance is being provided for relevant reforms, and changes are being planned and implemented to get markets closer in line with international standards. In late 2016 the ADB loaned the Philippines $600m, partially to prepare market conditions for long-term financing. In June 2016 the SEC raised the minimum float for companies offering shares from 10% to 15% with plans to potentially raise the minimum for all listed companies, not just IPOs. A 10% requirement was imposed in 2011, and the plan was to get the minimum to 25% by increasing the level by 5 percentage points a year. However, due to underperforming markets and significant volatility, the regulatory body decided to hold back on the increases until a future date.
The Capital Market Development Council, a public-private partnership that recommends reforms for the financial sector, is proposing to exempt related companies undergoing mergers from paying the capital gains tax. This has the potential to increase mergers and acquisitions activity, and allow for companies to effectively restructure without running the risk of a heavy tax burden. Other changes on the books include reducing personal and corporate income taxes. The new administration has suggested that the stock transaction tax be doubled from 0.5% to 1%, in lieu of the capital gains tax. Most other exchanges in the region charge more competitive rates ranging from roughly 0.1% to 0.5%. This has caused concerns for the PSE and stakeholders. According to the SEC, an increase up to 1% could have a negative impact on trading, making the Philippines less attractive to investors.
Regulating Conflicts
Although the Philippines has one of Asia’s oldest stock exchanges, the PSE still lags behind regional players in part because of limitations provided by legacy Philippine laws. It is not uncommon for those charged with assuring safety and stability to have different views from those who want to promote development; but in the Philippines the two sides have had particularly challenging moments. The SEC is in an especially strong position given the memories of the 1997-98 Asian financial crisis and the relatively good performance of the country’s equity markets post-2008. However, as the PSE plans to move forward, there is need for compromise from both organisations. “The market can enjoy more investment options if not for constraints prescribed by law. Several rules and regulations need to be amended to be more responsive to the ever-changing capital markets landscape,” Hans Sicat, CEO of the PSE, told OBG.
For its part, the SEC says that it is open to innovation and is working on a number of fronts to support new options. It wants to be creative and responsive without endangering investors or contributing to systemic risk. At the end of 2016 it was actively developing rules for crowdfunding and looking for ways to offer some protection from scammers without unduly burdening entrepreneurs. It is also involved in developing a framework for the introduction of derivative securities.
The SEC recognises the need for these instruments, especially as interest rates in the US rise. In late 2016 the Money Market Association of the Philippines (MART) applied to become recognised as the country’s third self-regulatory organisation (SRO) in order to act as a nexus for the trading of overnight index swaps. The proposed instruments would be peso-denominated and could thus provide additional alternative avenues for investors seeking to better manage and reduce risks.
Exchange Merger
The merger of the PSE and the Philippine Dealing and Exchange (PDEx), a fixed-income trading platform, has been in discussion for some time. Under the planned merger, the PSE would buy 100% of Philippine Dealing System Holdings – up from its current 21% share. The deal has been in the works since 2013 and has been valued at an estimated P2.25bn ($45m).
Regulators, however, have expressed mixed reactions to the transaction, mainly due to concerns it would create a monopoly with the potential to harm public interest. Further issues involve the PSE not being able to clearly identify how the merger would benefit the market, despite saying that the combination would bring synergies. An estimated 10% reduction in depository fees was not considered to be enough to compel a waiver to allow for the transaction.
However, some officials are focusing on the possible positive impacts on the market. In 2016 the SEC admitted that it saw the merits of the transaction, for many of the reasons argued by the exchanges themselves, indicating common ground. “The SEC would like to see the merger of the exchanges,” the SEC’s Felizmenio told OBG. “It would be a great benefit to investors and the markets, making access easier and simpler.” Implementing such a merger will not be a straightforward process, however. As the SEC is an independent commission under the Department of Finance, it cannot be pressured directly. The exchanges will also have to contend with anti-monopoly regulator, the Philippine Competition Commission. The PSE and the PDEx signed a memorandum of agreement based on updated terms, and the expectation is that this new arrangement will be seen as acceptable to the SEC.
Stronger Together
ASEAN integration has had little effect on the Philippines’ capital markets so far. While the ASEAN Economic Community (AEC) has been in existence since 2015, it has not impacted trading or investment on the PSE. The technical and legal realities of a single market, not to mention the potential economic impact of it, are slowing progress. The ASEAN Trading Link is one example of how AEC cooperation in the markets has faced practical difficulties. While Singapore, Malaysia and Thailand integrated have with the cross-border arrangement, others, including the Philippines, have not followed suit.
The delay has been due in part to fears that local brokers would lose business to their international counterparts. The PSE also wants to be better prepared, introducing more products in order to be competitive with regional markets. The exchange notes that certain regulations stand in the way of joining, such as the requirement that all shares traded in the Philippines be registered there. It has been suggested that rather than waiting for the harmonisation of rules, which could take years, the Philippines should simply mutually recognise the shares of other exchanges on a bilateral basis, as has been done elsewhere in the ASEAN region. Ultimately though, the regional experiment runs up against difficulties faced in many parts of the world. While trading stocks across borders can be done easily – even without any sort of agreements or mechanisms in place – it is the clearing of settlement and depository elements of the value chain that are the real challenges. Regionalising such functions requires a complete rewriting of domestic laws and a certain loss of control. Such an all encompassing process could take a significant time.
Bond Market Balance
The bond market has been a relative bright spot in the Philippines. While equities and the currency faced uncertainty in the early days of the new administration, bonds held steady, and credit default swaps indicated concerns over failure were low.
Some uneasiness has been expressed about the bond market in the Philippines in the short and medium terms, however. While the country’s economic fundamentals are seen as strong, the issuing of debt by the government to finance its infrastructure plans has put some pressure on yields. The funding needs of the private sector are also likely to expand given the outlook for economic growth and the need for more investment. Total bond issuance by the Bureau of the Treasury is expected to reach P465bn ($9.8bn) in 2017, 30% higher than in 2016. Meanwhile, in 2016 the Bank of the Philippine Islands (BPI) launched a set of bond-related indexes in order to better track the performance of the bond and equity markets.
For the fixed-income market going into 2017, major initiatives for the PDEx include project bonds and dollar-denominated securities. Outstanding government bonds as of end-2016 were P3.98trn ($84.2bn), while outstanding corporate bonds totalled P891bn ($18.8bn). Year-to-date corporate bond listings as of mid-April 2017 came to P61bn ($1.3bn). OUTLOOK: The Philippine markets are in need of innovation and product development. To provide the necessary investment opportunities and to be competitive, derivative securities and REITs are being considered by regulators and the exchange. The merger of the PSE and the PDEx might also bode well for the country, and a strategic foreign investor would be worth considering. Longer term, the Philippines has to figure out how to work regionally. No market in ASEAN is large enough to go it alone over the long term. This reality should compel some action on the part of the exchanges and their regulators, and increased cooperation is likely.
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