IT was a somber Christmas party for Philippine Stock Exchange (PSE) officials. No one died, and the market exhibited the optimism brought by the season. But there, indeed, was a funeral that day: for the PSE’s hopes of merging with the operator of the bond market.
In late-December last year, the Securities and Exchange Commission (SEC) wrote the PSE, essentially asking it to shut up and stop making further statements to the media on the PSE’s planned merger with the Philippine Dealing System Holdings Corp. (PDS), a company that owns the bond-exchange platform of the Philippine Dealing & Exchange Corp (PDEx).
It was the SEC’s opening salvo that hinted the market regulator would eventually reject the deal the PSE has been working on for nearly three years.
Come Easter Monday, nary a whimper of hope was heard: The SEC announced the decision it is not giving permission for the PSE to buy the PDS. That decision threw out the window all goodwill earned from the stock-exchange officials’ dealings with several firms over the past years.
These dealings began in 2013, when the PSE started inking agreements with several minority owners of the PDS to sell their holdings to the stock-exchange operator. The whole shebang was valued at about P2.25 billion. The idea to merge the two exchange platform, hence, became germinal.
The merger was reported to receive a green light from the Department of Finance, which only recently was tasked to oversee the operations of the SEC.
Over those three years, the PSE was able to convince the Bankers’ Association of the Philippines (BAP) and the Singapore Exchange to sell their respective shareholdings in the PDS.
The PSE officials then moved on to other minority holders, which the PSE has little convincing effort to do, since two of the larger shareholders have already given the green light.
The premise is simple, as explained by PSE President and CEO Hans B. Sicat. According to him, the equities exchange will acquire the bonds exchange and merge the two, since many bourses in the Asean region have their equities and bond-trading platform housed in one roof.
Aside from the regional practice, the PSE’s other goal for the merger is to offer more products that can be traded in its platform, which has long been limited to equities. The PSE wanted to further deepen the country’s capital markets, which have been lagging behind the top five Southeast Asian counterparts.
Genesis
THE PSE may have successfully launched its exchange-traded fund (ETF) in December 2014, but that has been limited to just one company. Global market jitters early last year were blamed for spooking other players from participating in the ETF.
An ETF is an open-end investment company that continuously issues and redeems its shares of stock in creation units in exchange for the delivery of a basket of securities representing an index. The ETF endeavors to track the performance of that index.
In the PSE’s case, the ETF created by a unit of First Metro Investment Corp. tracks the movement of the benchmark 30-company PSE index.
The ETF, however, came as a consolation following the PSE’s earlier bitter exchange with government agencies, mainly the Bureau of Internal Revenue, on the real-estate investment trust (Reit) products.
The country’s Reit law was enacted in 2009, under the Arroyo administration. The law aimed mainly to promote the development of the capital market; broaden the participation of the public in the ownership of real estate in the Philippines; and use the capital market as an instrument to help fund and develop infrastructure projects.
The law was designed to recycle real-estate assets by placing them in another Reit company in which the public can invest into by purchasing shares. The shares of the company can also be traded at the PSE.
The implementing rules and regulations of the law, however, were crafted by the economic team of President Aquino. The President’s team placed stringent tax measures on the recycling of assets, souring the entire Reit program entirely.
So far, none has applied for the Reit, citing such measures, mainly taxation issues, as prohibitive.
Longevity
WHEN the PDS was incorporated in the late 1990s, it was viewed as a trading platform for the capital markets and owned by the financial community.
Other PDS subsidiaries include the Philippine Depository and Trust Corp. (PDTC), the Philippine Securities Settlement Corp. and the PDS Academy for Market Development Corp.
Sicat said that during its project life, the PDS may have made some income, but it wasn’t able to give dividends to the owners.
“The PSE is the only natural buyer for any of the stakeholders who would like to exit,” Sicat said. “In the whole period of the PDS project life, I think, it’s a project that unfortunately was not able to deliver dividends, although, operationally, they’re now making money.”
“But the question, of course, as a shareholder is how long are you going to hang on in the business,” he added.
The PSE holds 21 percent of shareholdings in the PDS. Other owners of the PDS include the BAP, at 28.9 percent; Singapore Exchange Ltd., 20 percent; Tata Consultancy Services Asia, 8 percent; The Philippine American Life and General Insurance Co., 4 percent; San Miguel Corp., 4 percent; Financial Executive Institute of the Philippines, 3.1 percent; Social Security System, 1.5 percent; Investment House Association of the Philippines, 1.1 percent; and Golden Astra Capital, 0.4 percent.
“We are also the natural operator of the group, given the fact that we are the only other exchange in the country,” Sicat said. “Compared to any other potential buyer, we are the only ones who really know how to operate an exchange.”
In just a few years, trading at the bond exchange became much larger than its equities counterpart.
As the PSE’s value turnover in 2011 was less than P2 trillion, the PDS already rose to more than P4 trillion.
The PDS turnover reached as high as close to P6 trillion in 2013, went down to P4.5 trillion in 2014 and to P3.5 trillion last year. The PSE, meanwhile, was stuck at its P2-trillion level since 2013.
Conrado Bate, president and CEO of COL Financial Group Inc., said the country’s capital markets are concerned more on the issue of making the bond market much open to individual investors, rather than having the two platforms merged.
COL is one of the leading stock-brokerage firms in the Philippines that focus on individual investors.
“Make the bond market open to retail investors. That is what we want to happen, whether there is a merger or the fixed-income market continues to operate separately,” Bate said.
Scenarios
PRIOR to the SEC’s rejection, SEC Commissioner Ephyro Luis Amatong, who handled the case, told reporters the agency only needed to answer the question: “Are the Philippine capital markets better off with the two exchanges integrated, or are they better off apart?”
“To answer this question, we have to run scenarios. Among the things that are being considered, which is more favorable to capital-market development?” he said.
“There are advantages: lower cost, making the exchanges more efficient. If you combine them, would they be able to provide better services, if not, why would we combine them? What’s in it for us anyway?” the commissioner said.
The correspondences between the SEC and the PSE on its plan to acquire the PDS started in April 27 last year, with the stock exchange informing the regulator of its plan for the first time.
The agency replied a month later, but it already focused on its concerns on monopoly of the industry, which could be bad for the public. There were also several questions, including on the concrete details on how the PSE plans to operate the two platforms.
Several letters went back and forth the SEC and the PSE. The latter, however, already wanted to consummate the deal the PSE forged with the stockholders of the PDS. Sicat’s team submitted its proposed business plan to the SEC on January 26. Months later, the SEC held a news conference, wherein officials said the regulator was not satisfied with the bourse’s reply on how to operate the two platforms.
Furthermore, the regulators questioned the reliability of the PSE’s own trading platform, especially after a series of trading halts last year. The SEC’s poking further tested the patience of many PSE officials.
The SEC maintained it cannot give the PSE the go signal for a merger, as there remains the specter of monopoly.
Rules
ANY move to a monopoly is currently held in check by the Securities and Regulation Code (SRC), which placed a 20-percent limit on the ownership of exchanges and exchange controllers, such as the PDEx and the PDTC.
Section 33.2 (c) states that: “Where the Exchange is organized as a stock corporation, that no person may beneficially own or control, directly or indirectly, more than five percent (5%) of the voting rights of the Exchange and no industry or business group may beneficially own or control, directly or indirectly, more than twenty percent (20 percent) of the voting rights of the Exchange: Provided, however, that the Commission may adopt rules, regulations or issue an order, upon application, exempting an applicant from this prohibition where it finds that such ownership or control will not negatively impact on the Exchange’s ability to effectively operate in the public interest.”
With the ruling, the PSE needs to secure an “exemptive” relief from the SEC to assume 100-percent ownership of the PDS, and also be exempted from the prescribed composition of the PDS board of directors under Section 33.2 (g) of the SRC.
SEC Chairman Teresita J. Herbosa said the law mandates that ownership be distributed, so that no entity could dominate the others. The PSE was, in effect, asking for exemption for these provisions, Herbosa explained.
“In Supreme Court decisions and guidelines, you have to have a very, very good reason to be entitled to the exemption,” she said.
According to the SEC, during the deliberations on the SRC, legislators observed that the PSE was controlled by a group of small brokers. Some lawmakers went as far as saying such group has a vested interest in maintaining the status quo.
With such view, the legislative body placed industry ownership limit to 20 percent and individual ownership to 5 percent.
The current structure of the PSE begs to be reviewed to confirm or debunk such view.
Other shareholders composed of both individual and companies control 49.28 percent of the PSE. Other owners include First Resources Management Corp. (11.76 percent), SMC Retirement (10.3 percent), BDO Unibank Inc. (9.09 percent), Government Service Insurance System (9.09 percent), Lucky Securities (5.34 percent) and Papa Securities Inc. (5.14 percent).
The SEC said that, for it to give its exemptive relief to the PSE, the bourse needs to provide a comprehensive information on how such consolidation will happen and what the structure will look like after the merger.
According to the proposed structure after the merger of the two platforms, the PSE will become the 100-percent owner of both the trading exchanges for the bond and the equities markets and all other subsidiaries.
What the SEC envisions in its ownership structure is that both PSE and PDS shareholders should own the two exchanges and all other units under it.
Commitments
THE SEC claimed the PSE and PDS had only just convened a joint working group to iron out the details of the transaction and nothing more.
“They have not been able to provide the SEC with clear and detailed time-bound plans and commitments for the consolidated equity and fixed-income markets,” the agency said.
“The larger fear here is that the PSE does not appear to fully appreciate the central importance of the fixed-income market in financial intermediation and does not have a concrete plan on how to develop and manage such a market going forward.”
The SEC further said the PSE also failed to convince them that there are benefits to the merger, such as lower fees to be imposed to the trading public when the two trading platforms are housed together. Currently, the PSE and PDEx use different clearing platforms.
The PSE, meanwhile, promised a marginal decrease of .001 percent in depository fees, which the SEC called as “tokenistic commitment.” The PSE also did not give a commitment that it will hold on to the current fees when the merger transpired, according to the SEC.
“The PSE would then be a de facto monopoly owner of all the exchanges in the country,” Herbosa said. “This would significantly reduce any incentives to lower costs or improve quality on their part. This is a fear that the SEC takes seriously.”
The SEC also likened the proposed merger to the same deal involving the combination of Deutsche Boerse AG—Germany’s stock exchange—and the London Stock Exchange Group Plc. The two bourses gave regulators details, such as forecast financials for the combined entity, cost savings per annum per cost center, costs of the integration, undertakings for reduction of trading, clearing and information fees and undertakings not to raise these fees, among others.
The SEC claimed the PSE failed to provide them these details.
The deal involving the German and British stock exchanges is still ongoing and securing regulatory approvals.
On the other hand, the PSE’s share purchase agreement with the BAP also includes a five-year non-compete clause, another fear that the SEC raised.
“Banks are largest players in the bond market. Should the quality of PDS deteriorate or experience trading glitches, as the PSE has three times in August 2015, a very significant market player is constrained from setting up an alternative market,” the SEC said. “Not only has the PSE not provided safeguards to mitigate the risks of a monopoly, it put up even more barriers to competition and to setting up contingencies.”
Unsurprising
THE PSE, meanwhile, was naturally appalled with the decision of the SEC.
“I would say, however, it was a bit surprising [with] the manner they have done it and maybe the process, wherein they mention everything to the press and gave us the official answer by [facsimile] three hours later,” Sicat said.
“On a personal note, I think its a bit surprising with the PowerPoint [slide presentation] or press release that they’ve started to add some adjectives or name-calling about the PSE,” Sicat said. “While they are entitled to their conclusions, it’s also quite obvious to us.”
He explained the presentation “intentionally either glossed over some of the facts or decided not to tell you [reporters] a lot of the issues.”
“As a professional who has been in the capital market for close to 30 years, I think that’s not the right way to do things.”
Herbosa, however, said the regulator’s move doesn’t necessarily mean it is closing the doors on the PSE’s plan to merge with PDS.
“We could not just justify their current submission,” she said. “We will consider it [if the PSE resubmits].”
Sicat said one of their options was to appeal the SEC’s decision since their earlier deals with the owners of the PDS cannot be completed until it secures regulatory approval. The PSE may also wait for the next government to come in as it can be a fresh start for the PSE efforts to combine the two trading platforms.
He said the PSE may make a move during the third or fourth quarter of the year and wait for the dust to settle.
“The general ideology is that an exchange and a capital market need to be full service operators. And this is where we have a major difference in opinion, as the operating cost of an exchange is very high,” Sicat said. “Whether you have high volumes or low volumes [of trade], the operating cost remains high. The only way you can decrease that high operating cost is to have a menu of products and services.”
Sicat said the PSE may also develop its own bond-exchange platform, raising the possibility of poaching the very same companies that do business with PDS and possibly killing the very organization that it also partly owns.
“We are not afraid of competition either. But whether we go that route and say that is something we want to do will cause two or three years of difficulty for both exchanges,” Sicat said, adding that there are no legal issues that would impede them from have their own bond-exchange platform.
Repercussions
SOME camps view the SEC’s decision as having repercussions in the effort of the Philippines to connect with other exchanges in the region.
These efforts are seen in the country’s engagement with the Asean+3 Multi-Currency Bond Issuance Framework. Shortened as Ambif, this framework is an Asian Development Bank initiative that allows participants to offer local currency cross-border bonds. The Philippines want to become part of that maiden issuance.
“The acquisition [of PSE of PDS] is not a precondition for the Philippines to pursue inclusion in efforts for integration,” the SEC said, however.
The PDS has also entered into regional links and agreements with the Bond Pricing Agency of Malaysia to make available their bond pricing and information services through a link to each other’s web sites. The PDS is also active and is part of the working groups in the Ambif.
Still, the SEC maintained the PSE is failing to identify current and ongoing agreements with Asean counterparts.
The Asean+3 include the 10-member Asean countries plus Japan, South Korea and China.
Sicat, however, said cross-border equities trading is far different from the bond trading in the region.
“The SEC had been telling us to connect to the [Asean] trading link, but how can we do so when there are several constraints,” Sicat said. “One is that the SEC requires any shares that will be sold in the Philippines to be registered locally.”
Sicat used an Internet sale through the Asean link as an example, citing a scenario wherein a Filipino wants to buy Singtel shares of Singapore.
Sicat said such sale, if consummated, under the present regulations, would be a violation of the SEC’s rules since Singtel is not registered in the Philippines.
Thailand, Singapore and Malaysia—all Asean top member-countries—have already forged a mutual recognition agreement, and buy and sell shares with one another.
“In other words, these countries are now doing mutual recognition, similar to a bilateral or multilateral agreement,” he said. “These countries have relied on their respective regulator’s counterparts.”
With the soured relationship of the two organizations that were supposed to deepen the country’s capital market, it would take more time for the Philippines to have vibrant trading floors that offer various products.
Image credits: AP/Aaron Favila