Philippines’ capital markets inch forward

The Philippines is on a roll – finally.

Southeast Asia’s fifth-largest economy is doing fine. The IMF expects economic output to expand by 6.7% this year and 6.8% in 2019, the current account deficit is narrowing and a series of tax reforms, the first of which was passed in December 2017, aims to cut inequality, boost consumption and pay for much-needed new infrastructure.

But the Philippines has a problem. Look beyond the macro figures to the financial markets and the lustre starts to fade. The capital markets are a mess and a muddle, lacking weight, depth and scale.

The total stock market capitalization of the companies listed on the Philippine Stock Exchange (PSE) in early September was $257 billion, trailing leading regional bourses in Malaysia ($438 billion), Indonesia ($482 billion), Thailand ($552 billion) and Singapore ($767 billion).

The country’s debt markets are shallow, even by the standards of southeast Asia, a region with its own capital market challenges. The total amount of outstanding debt securities in the Philippines at the end of 2017 was $136.4 billion, according to data from the Bank for International Settlements; again, it trails its regional peers, including Malaysia ($370 billion in total debt securities outstanding) and Singapore ($412 billion).

The Philippines boasts a smattering of top-tier firms, including SM Prime Holdings, Ayala Corporation and BDO Unibank, all of which made it onto the latest Forbes Global 2,000 list. But they rarely come to the markets, preferring in the main to lean on domestic lenders when in need of funds.

And the country lacks a deep well of ambitious, smaller firms that in other markets might view a stock market listing as the obvious way to raise capital and expand their physical and digital horizons.

This helps to explain why, since the start of the decade, just 39 initial public offerings have been completed in the Philippines, worth $5.2 billion in total, against 155 worth $23.6 billion in Malaysia, and 185 worth $30.2 billion in Singapore.

Michael De Guzman, country head Philippines and head of Philippines coverage for investment banking and capital markets at Credit Suisse, says: “While it is a relatively small stock exchange with low trading volumes right now, in the years to come we are optimistic that this capital market will become stronger and more liquid as the economy continues to grow, new products such as Reits [real estate investment trusts] are issued, the debt market deepens further and more IPOs take place.”

There are already signs of change. Over the last 12 months, regulators have taken decisive steps to transform the country’s stodgy capital markets. In January this year, the PSE won approval from regulators to introduce short selling for the first time, allowing investors to hedge risk while, in theory, spurring trading activity and boosting market liquidity.

Then there is the Reit market, which has been in a state of flux for years. When Gloria Macapagal Arroyo, the president at the time, passed a Reit Law in 2009, the aim was clear. Leading property developers would convert portions of their holdings into real estate investment trusts and then list the vehicles on the PSE. At a stroke, this would add to the stock of first-class residential and commercial property, while allowing local and foreign investors to invest in and profit from a liquid new asset class.

But it didn’t work out that way. The law got off to the worst of possible starts. Property developers complained that the government’s primary aim seemed to be to protect its tax revenue streams instead of focusing on unlocking hidden value and adding depth to the capital markets. They pushed back against the imposition of a 12% value added tax on the transfer of property to a Reit structure – even in cases where the transfer was supposedly a tax-free exchange.

Nor did they like the requirement that at least two thirds of any Reit had to be publicly listed.

“For some companies, property is their crown jewels and they prefer to maintain majority control,” says Reginaldo Cariaso, president of BPI Capital, the investment banking division of Bank of the Philippine Islands. “This is one of the main reasons why the Reit market has not taken off so far.”

Little wonder that, as of September, there are still no real estate investment trusts listed on the PSE. 

However, there are signs of a change. Last December’s pro-business tax reform, the first in a series of rule changes aimed at boosting growth and raising government revenues, removed the 12% VAT charge on property transfers.

The current administration of president Rodrigo Duterte is also keen to reach a compromise over how Reits are structured and owned.

“This is likely to result in more flexibility in ownership,” adds Cariaso.

Even if the law is amended, as is widely expected, few bankers think the sector will shoot off the blocks.

“We will see the Reits market take off, but it will take two or three years for it to really get going,” says one investment banker.

SM Prime, the largest listed company by market capitalization, is widely expected to be the first to dip its toes into the water. Jeanette Yutan, JPMorgan’s head of Philippines research, reckons the commercial property firm, which owns 27 shopping malls around the country, has about $13 billion of the $20 billion-worth of real estate assets that are suitable for packaging and listing in a Reit.

Credit Suisse’s de Guzman expects the real estate market, particularly in the greater Manila area, to take off over the next few years, as a new generation takes the reins at real estate firms or property-led conglomerates and considers ways to raise capital by spinning off and listing Reits.

De Guzman says: “As the large Philippines companies that are currently tightly controlled by family groups continue to expand, and as their capital expenditure programmes grow to billions of dollars every year, they are expected to release more liquidity to secure the required capital to meet their funding needs, including possibly listing more of their subsidiaries.”

Another saga that has hobbled the development of the capital markets is slowly limping toward resolution. Even in a market like the Philippines, where administrations regularly set out to, say, shake up the macro-economy or the financial markets, only to fall short and pass on the problem to their successors, this is an odd one.

For years, the PSE sought to gain outright control of the Philippine Dealing System (PDS), the official exchange for trading fixed-income instruments and data, government securities and foreign exchange. The aim was simple: to unify the equity and debt markets, to take them both to the next level.

A PSE-led takeover-cum-merger, crucially, has had the backing of successive administrations. Talks aimed at unifying the two bourses began in 2013, supervised by the former finance secretary Cesar Purisima.

“We wanted to build a more efficient single exchange, with equities and fixed income under one roof,” says an individual close to him.

Purisima and his team “nearly got the deal over the line in 2015”, the individual says. The PSE bought 21% of the PDS in July of that year, making it the second-largest shareholder behind the Bankers Association of the Philippines (BAP), with a 28.9% stake, and on a par with Singapore Exchange, which also owns 21%.

Other minority shareholders include local software firm Whistler Technologies, Indian IT firm Tata Consultancy Services and conglomerate San Miguel Corporation.

When the PSE then secured approval from its shareholders to boost its stake in the fixed-income bourse to 72%, it looked like a done deal. In October 2015, the PSE said it expected to control as much as 95% of the merged trading platform once it got final approval from the Securities and Exchange Commission (SEC).

But then the process stalled. A successful merger was contingent on the PSE solving one crucial problem. Together, its 184 broker-members owned 27.9% of the stock exchange, and SEC laws said that no industry group could collectively own more than 20%. The PSE wanted to buy the PDS outright and the SEC would only allow that to happen if these reforms went ahead.

The PSE tried everything. It begged the regulator to ignore the shares held by 52 dormant traders whose trading rights had been revoked, which would have cut broker ownership to a little under 24%.

Nothing doing, said the SEC.

In March 2018, the PSE completed a P2.9 billion ($54 million) rights offering, selling 11.5 million new shares at P252 apiece. But that still left the brokers controlling 21.71% of the bourse.

“This was an important step – it wasn’t the regulator being pedantic,” says the source close to Purisima. “We felt it was important to dilute the power of the brokers and to cut the number who sat on the PDS’s board. There were too many conflicts of interest in terms of policing insider trading and maintaining a high level of governance. The brokers wanted to keep the exchange to themselves and to continue to profit in ways that are considered illegal in other countries.”

When Carlos Dominguez replaced Purisima as finance secretary in July 2016, he set out in the hope of reviving the merger and making it work.

“When I came into office, the PSE’s executive team came to see me and told me they still wanted to buy” the fixed income bourse, Dominguez tells Asiamoney in Manila. “I said, OK, but the 20% broker-ownership limit remains. After 18 months had gone by and they still hadn’t done anything, I said to myself: ‘What’s wrong with those guys’? It’s a club, and they don’t want to step on each other’s toes.”

Eventually, an irked Dominguez says he just “gave up waiting”. In January this year, he was quoted by local media as saying the development of the onshore capital markets was being “slowed down by the PSE’s inability to be compliant with the law”, adding: “The Duterte administration will no longer tolerate private institutions thwarting the goal of achieving a robust and inclusive financial system.”

The nation’s finance chief needed an answer, and he was convinced the PDS wasn’t going to find it for him.

“The current [leadership is] not doing its job,” he says. “They are owned by the banks, so it’s not in their interests to have an active bond market. The public weren’t being served well, and the government’s goals weren’t being met.”

Whether or not this is so is a moot point. True, the Philippines banking association is the platform’s largest shareholder, and, yes, the chairman of the board of PDS Group is Nestor Tan, who also happens to be president and chief executive of the country’s largest lender, BDO Unibank. But the board is also well stocked with executives from beyond the banking world, including Lay Chew Chng, chief financial officer of Singapore Exchange, and Joseph Pineda, deputy CFO at San Miguel.

But something had to give. The last thing Dominguez wanted was to hand the same rotten problem over to his successor. His solution, when it came, was both sage and supple-minded. He would get Land Bank of the Philippines to buy out PDS Group’s largest investors, consolidate its shareholding, then list the trading platform on the Philippine Stock Exchange where it would be properly managed and governed – and owned by local and foreign institutional investors.

It’s a plan with many merits. LandBank is a powerful lending institution that serves the needs of important industries, including farming and fishing. As well as being owned by the government, and the fourth-largest domestic bank by assets, its chairman is none other than finance secretary Carlos Dominguez.

In March, the state lender offered to buy 66.67% of PDS for P1.5 billion, at P360 a share. By July, LandBank president and chief executive Alex Buenaventura said 43% of the trading platform’s shareholders had agreed to the offer, including the PSE, which is set to sell its entire stake having ruled out the option of making a counter-offer. Dominguez stated firmly that LandBank will not be a long-term owner of the debt bourse.

“It’s a stop-gap,” he said. “It will come in, clean it up, and list it on the Philippine Stock Exchange.”

Will all of this happen? The government has thrown its weight behind a project that, while not wholly ideal, is a thoughtful and logical solution to a problem that has irked successive administrations.

That’s not to say that it won’t fail: at the time of writing in early September, it is six months since the LandBank solution was proposed, and no agreement has yet been reached. A binding contract might be signed before this story is published – or deliberations may continue to run for many months more. Nothing ever happens easily or overnight in the Philippines, as its champions and critics alike will attest.

Long term, of course, the aim is to transform this fast-growing country’s capital markets. Every year, a scattering of IPOs and corporate bonds pepper the market. Some are chunky; few make the eyes pop wide. Compared with the other large southeast Asian economies, the Philippines equity and debt markets are shallow and illiquid, packed only with the usual gang of powerful conglomerates.

More debt sales and IPOs and, in time, the introduction of new asset classes such as real estate investment trusts, is the way forward.

“Non-performing loans are low right now because the economy is doing well,” says a former senior government official, now retired. “One day, they’ll rise again, banks will struggle, and the government will have to step in and help them. By then, we will need to have a good, growing, functioning bond market in place. Is the current plan the only way to go about it? No, but it’s still a good plan.”