Progress being made, but concerns remain about local markets’ readiness for integration
Second of three parts
ONE of the bright spots in a Philippine economy which is not unreasonably regarded as having a lot of potential is its financial market environment. A stable, conservatively regulated banking sector, a tightly controlled currency, and growing bond and equity markets—the latter having been at times the world’s top performer in terms of growth— all suggest that the country should be well-prepared for the integration of Asean capital markets.
There is some basis for that conclusion. The Philippine Stock Exchange index (PSEi) has been climbing steadily for six years; in the first part of 2013, it surpassed the 7,000-point level, and the index has already inched its way past 8,000 this year. Trading activity is on the rise as well, with the PSE reporting this week that first quarter trading volume increased by 40 percent year-on-year.
While the Philippine stock market’s pace slackened a bit through 2014—an outcome of the sensitivity to external influences described in the previous installment of this special report on Monday—it is still outperforming the rest of the region by a wide margin.
According to a fairly recent (February 20) regional assessment by London-based FTSE, year-to-date returns for the FTSE ASEAN Philippines All-Share Index are 8.8 percent; for 12 months, the index has returned 25.7 percent. The only other major regional market to come close to that performance is Thailand; year-to-date and 12-month returns for the FTSE SET All-Share index are 6.5 percent and 25.5 percent, respectively.
Over on the bond market side, growth has not been as spectacular, primarily because government issues overwhelmingly outnumber corporate issues; at the end of 2014, according to last month’s installment of the Asian Development Bank’s Asian Bond Monitor, government securities accounted for 83.7 percent of outstanding issues in the Philippine Dealing and Exchange (PDEx).
Activity, however, has been increasing, particularly on the corporate side; in comments at a recent business forum, Philippine Dealing System (PDS) president Cesar Crisol noted that trading volume at the PDEx had increased by nearly 14 percent in 2014, from $40.34 billion in 2013 to almost $46 billion at the end of last year. And while government securities still dominate the market, corporate debt issuances are growing at a much faster pace, expanding by 28.5 percent in 2014 compared to a modest 2 percent growth in government issues.
Even though the Philippine equity and fixed-income markets are considered good investments, they are still very much “developing economy” financial markets – relatively small in terms of number of participants, overall valuation, and range of products, and relatively illiquid. Both markets lack, or are only in the early stages of developing features that are commonplace in more developed markets, features that are necessary, according to most experts, to facilitate the market-to-market linkages the regional integration plan envisions. Furthermore, the shortcomings of Philippine markets are emblematic of the issues facing other regional markets; examining the local situation provides some insight as to the current state and necessary direction of the integration effort.
According to Satoshi Shimizu, senior economist for the Japan Research Institute’s Center for Pacific Business Studies, regional stock and bond markets suffer from several common problems. “Increases in the numbers of issuers and investors, human resource development, the development of financial products, the development of market infrastructure, systems and regulations, and the improvement of liquidity in secondary markets,” are improvements that are needed in virtually every Asean market with the exception of Singapore, Satoshi explained, adding, “The expansion of domestic investors will also be extremely important from the perspective of coping with capital flows.”
Attracting more investors to the Philippine stock market has been difficult because of its illiquidity, which is partly the result of limited rules on public flotation. A plan by the Securities and Exchange Commission (SEC) that was pursued for a time last year would have incrementally raised the public float requirement from its current 10 percent – a rule that only began to be vigorously enforced in the latter part of 2012 – to 20 percent by the end of next year, but it was shelved in November last year at the behest of the PSE, which is seeking to add more listed companies before further tightening the public float rule.
That presents a bit of a paradox; having liberal public float rules from a lister’s perspective should help to encourage more listings, because new listed companies are assured that they will not be devolving much control to public shareholders. But because public float rules require such a small percentage of a listed company’s stock to be available for daily trade, the illiquidity of the market persists by limiting the number of potential buyers. And because the illiquidity persists, the advantages of looser public float rules in boosting the number of listed issues seem to be lost; in 2014, the PSE saw 7 new listings, while Indonesia by comparison had 30.
The limited public float may also have an impact in limiting investment products in the stock market. Derivatives, which are a staple of more developed markets, are largely just an idea here at this point; at present, the PSE offers only one exchange-traded fund (ETF), which has produced moderate returns but failed to attract much interest from investors.
The lack of derivative instruments contributes to the market’s illiquidity because derivatives such as ETFs – which are not tied to a single company, but are index-based – are often an entry point for new investors, particularly foreign investors, who may not feel they are sufficiently familiar with individual listed companies, or who wish to invest in the market as a whole instead of specific issuers.
Bond market development needed
As was explained briefly in Monday’s first installment of this special report, the limited number of issuers is also a problem for the Philippine fixed-income market. According to PDS president Crisol, the market is missing opportunities for growth because of the small number of corporate issuers; although that number is increasing, the implication is that the local bond market has quite a lot of ground to make up to move into a competitive position. As Crisol pointed out, there are only 31 corporate issuers in the PDEx; in Malaysia, by contrast, there are 234.
Where the opportunity is being missed by potential issuing companies, in Crisol’s view, is in the advantageous makeup of the local market’s investment base; about 70 percent of current outstanding corporate issues are held by retail investors, as opposed to typically more conservative institutional or corporate customers.
Like the stock market, the local bond market is also handicapped to some extent by limited product offerings, as Crisol explained. He described the secondary market as being underdeveloped, the evidence for that being the significant lack of liquidity in the secondary market, which has in turn contributed to higher spreads than for original issuances – something which tends to further reduce the market’s attractiveness. The absence of a repurchase market – the development of which has become a priority for PDS, particularly as the local integration with the PSE proceeds – is also regarded as a serious problem, as it represents an entire class of investments that are simply not available yet.
Although market stakeholders are at least cautiously optimistic about the prospects for a more open market investment environment, there is a great deal of concern that reforms are not moving fast enough.
“In general, I believe that the Philippine markets, bonds and equities alike, are optimistic about the Asean integration,” said Mark Valino, a former deputy in PSE’s department of market education and now a professor at the University of Sto. Tomas College of Commerce. “Emerging markets, most from the Asean by number, are on the fund managers’ radars at this point.”
However, Valino explained, “Regulators are preparing for it, but not fully. As well as technology infrastructure, we need local legal structure in place – BIR, SEC, BSP, and so on.” The implication is that the regulatory structure has a long way to go, an assertion Crisol implicitly made as well, pointing that tax reforms, such as removing the tax on transfers between taxable and non-taxable investors (for example, a transfer between a bank investor and a government investor such as a pension fund), are needed to encourage more market activity.
Despite expressing some concern over the pace of reforms, Valino is upbeat about the prospects for market improvements. “The efforts to be part of it [the Asean integration]are very much evident,” among market stakeholders and regulatory agencies, Valino said.
Significantly, the results of preparations in other Asean markets have become a focus for local market players seeking some direction in getting ready for integrated markets, according to Valino. Because other Asean markets have many of the same problems as the Philippine markets, the speed and effectiveness of reforms elsewhere can be a good guide to what needs to be accomplished here. In the final installment of this special report on Friday some of the initiatives being taken by Philippine markets to prepare for integration as well as analysts’ outlook on how successful the regional-level effort may be this year will be highlighted.