Yulo’s six goals
Jose Luis Yulo, the new president of the Philippine Stock Exchange (PSE), has a dream. Over the next few years, he wants to boost the number of Philippine-listed companies from 221 to 500, establish a bond market, set up a new board to list small and medium-sized firms, extend share ownership to the middle classes through mutual funds and expand the exchange’s reach from the capital to the provinces.
The new exchange chief, in office since June, has one other strong desire. He wants the regulatory competition, confusion and internal political wrangling that have dogged the exchange for the past few years to come to an end. If history is any guide, his first five goals may be easier to achieve than the last.
Yulo takes over at the PSE at a time when it is poised to catch up with other exchanges in south-east Asia. Most of the region’s stock markets are now moving beyond emerging-markets status, offering more sophisticated products and upgrading to fully computerized dealing and settlement. Bonds, futures and options, mutual funds and even securitization are all on the agenda of the capital markets in the region.
Fortunately, Yulo has a marketing background. Formerly president of the Philippine chamber of commerce and of a state-owned trading company, he also has banking experience. He believes there is a lot of scope for improvement. “Discussions on making the exchange competitive have been very positive,” he says.
Considerable progress has already been made. Capitalized at $76 billion, the PSE’s daily turnover has now reached $75 million. The exchange has almost 200 broker members; the 30 or more foreign firms now set up in Manila account for at least half of trading and sometimes as much as 70%. Standards of research and analysis are rising to a level that resembles sister exchanges in the region. A central depository has been established and 80% of trading is now scripless, with the rest expected to come into line by the end of this year. An average of 13 IPOs a year have been launched since reforms began and a start has been made in introducing more professionalism into the offices of the many small local brokers.
It was not always so. Because it is the second-oldest exchange in Asia after Japan, set up during the US colonial period, the PSE’s structure, practices and regulatory arrangements were all established in an earlier era. Until recently they were out of tune with modern financial markets. Disclosure was poor and insider trading rampant. Settlement was chaotic and slow.
Reform started earlier this decade when two separate stock exchanges were unified in a new building located in the Ortigas area, a neutral location well away from the two old exchanges’ patches in Makati and central Manila. Under the presidency of Eduardo de los Angeles, a range of reforms were introduced and, aided by a government privatization programme, the exchange blossomed.
Foreign funds started to flow in and a few foreign brokers set up shop. But progress was stymied by settlement problems, along with constant battles between the exchange and the Securities and Exchange Commission (SEC), the body charged with regulatory functions, and another long-standing institution in need of reform. The removal of SEC chairman Rosario Lopez last year, and her replacement with US-educated lawyer Perfecto Yasay – now appointed to a seven-year term – has cleared the way for progress on the regulatory front.
Perhaps the biggest impetus in internationalizing the market and improving its practices has come from the growth in the Philippine economy under the Ramos administration, which took office in 1992. The country has moved quickly from the poorest performer in south-east Asia to become an emerging-market tiger. The turnaround in the macroeconomy has boosted corporate earnings and improved the market’s image. As a result, foreign institutional money has started to flow in.
Although this means the PSE is now affected by developments on Wall Street – as are the region’s other exchanges – the increase in foreign involvement is leading to a more professional approach by listed companies as well as brokers.
But barriers to further development remain. Take new issues. Under the old rules, when a company issued new stock the shares were not distributed by its underwriters but by the PSE itself, which allocated the equity to its members. If the IPO did well, the brokers sat on the stock. If it did poorly, they sent it back to the issuer. Local brokers have put up strong resistance to any change to this cushy system, but a combined effort by the PSE and the SEC is making progress.
“Now, it’s agreed that 50% of a new issue will be distributed by the underwriters and the other 50% by the PSE, with all exchange members receiving an equal allocation,” says Yulo. “We want to improve this further, first by allocating a percentage of the issue for small investors and then by bringing in a book-building process.”
The current system is a major disincentive to issuers, who have given the changes strong support. “We want to change the system to improve due diligence and professionalism at the brokers,” says Yasay of the SEC, who last year ordered an audit of brokers suspected of disobeying the rules. He expects that the new system will also improve the quality of IPOs.
Regulatory concerns are also delaying the development of a bond market and the growth of the mutual-fund industry. Roman Azanza, a director of Crosby Securities and head of the capital market development council, a body which has spearheaded reform proposals from the start, believes that changes needed to jump-start the bond market will not come in before the end of next year, after the presidential election.
“We’ve done several studies on how to get the bond market going,” he says. “The main problems are the need to end capital-gains tax on profits, and to stop imposing a documentary stamp tax. These measures cut too heavily into dealers’ margins. We’ve also established a basis for clearance and settlement and looked at the question of credit rating.”
Currently the Philippine bond market consists largely of three-month treasury bills and some long-term commercial paper. There is no secondary-market trading. The result is that most Philippine corporates prefer the international debt markets, with blue chips like Philippine Long Distance Telephone, Ayala Land and several banks issuing yankees and Eurobonds.
A bond dealers’ club is to be set up under the direction of Romeo Bernardo, a former senior official at the ministry of finance. But an effort to include a number of tax changes in the tax-reform programme now going through congress was unsuccessful. Senate legislators ruled that a separate bill would be necessary. The need to ensure that the new measures are revenue-neutral has also held up progress, as tax records are not available.
Changes to the mutual-fund industry are likely to move much faster, as the removal of the main constraint – double taxation – has been included in the tax-reform bill, which should be passed in December.
The development of mutual funds is expected to make a big impact on the exchange, where they make up only 0.03% of market capitalization, compared with 27% in Malaysia and 19% in Thailand. An increase to 5% would inject an additional $4 billion into the stock market.
There are eight mutual funds at present, the largest of which has only Ps800 million ($30 million) under management. Discussion of mutual-fund rules has also drawn in local pension funds, which probably have around $8 billion under management. Proposals have been mooted to transform the national social-security system into something resembling the innovative schemes pioneered in Chile, but concrete plans have yet to emerge.
According to Azanza, changes in the regulations are also running into problems at the central bank, where officials are concerned about distribution of mutual funds through banks. “There was a mutual-fund scandal in the Philippines in the 1950s, and the central bank remembers it,” Azanza says. “The [central] bank is worried that people will believe that fund growth is guaranteed if they buy it from a bank. If the banks are banned from selling mutual funds, this will stunt the growth of the industry. Nobody has a better distribution system than the banks.”
He points out that banks already sell instruments called common trust funds, which are not guaranteed. These funds are allowed to invest in equities, but most of their portfolio must be placed in treasury bills or commercial paper. Bank time deposits in the Philippines yield only around 6%, not a competitive rate compared with government bills.
Officials at the IMF also strongly back the development of the mutual-fund industry to help increase the Philippines’ savings rate – only 20% of GDP compared with the 35% average achieved by neighbouring countries.
“There’s enormous potential here,” says a senior official. “The central bank is concerned that savers understand the risks, following the big losses experienced in the fly-by-night operation in the 1950s. It’s also concerned about not creating loopholes where banks can avoid reserve requirements through their mutual-fund activities, and about how to measure these funds so that monetary aggregates are not distorted.”
But the IMF believes that even if these issues are not cleared up, other institutions such as insurance companies and independent financial companies can distribute mutual funds. Pressure from the banks, keen to get into this new business, may decide the issue.
Azanza’s development council is now tackling the issues involved in the next new area to be developed: mortgage securitization. This has been spurred on by a recent successful securitization of Philippine mortgage loans by Citibank. As with his efforts to invigorate the bond markets, he faces a daunting task.
“The market is basically socialized housing. Historically, developers approached a government body, the National Home Mortgage Finance Corporation, to get financing for mortgages on the properties they wanted to sell. People didn’t keep up the payments – the delinquency rate was 60% – because the lenders didn’t bother collecting the money! These are garbage loans which can’t be securitized.”
That old system has been stopped and home-owners now pay their loans through banks. For better-class homes, banks themselves are now lending, but using different rates and criteria. “Portfolios can’t be liquefied without a history and without the technology,” says Azanza. “The first challenge is to standardize the industry.”
Meanwhile at the PSE, Yulo holds out hope that the argument that has created the most noise and controversy in the capital market – the disagreements over regulation of trading between brokers on the PSE and the bureaucrats at the SEC – can be resolved. This issue provides a flow of juicy stories for the local financial press, doing the exchange’s international reputation no favours.
“A lot of the rows over regulation are domestic politics – a bit overblown,” says one foreign broker. “It’s good that they’re trying to clean up practices like insider trading and conflict of interest, but they need to be aware of the international image of the market. If the SEC says all the players are crooked, that doesn’t do anybody much good.”
The division of responsiblity for regulating different areas of the stock market has not yet been formally defined. Since last year the stock exchange has been able to regulate itself, passing on any cases of wrongdoing it finds to the SEC, as the outside regulator. But the two bodies have disagreed about how best to protect investors and about who is entitled to authorize what.
The dispute shows up clearly in the long-running saga of a proposed IPO for a real-estate company, known as the Pali land case. The IPO prospectus listed as assets of the company land which allegedly had once belonged to the late president Ferdinand Marcos, and which was sequestered by a body set up after Marcos was deposed to restore his ill-gotten gains to the nation.
When the company applied for approval to list, the SEC approved the listing on the basis that the company had fully disclosed the history of the assets. The PSE however denied the company permission to go to market on the basis that its job was to protect investors. The issue went to court, where the SEC initially won backing for its view that the enforcement of disclosure laws was the best protection for investors. The case still drags on, with the PSE claiming that the SEC has no authority to order a listing.
Other issues have arisen since. Earlier this year a senior broker at SBC Warburg resigned after allegations that he had been trading on his own account and using techniques which went against the rules. The SEC then banned all broking employees from trading on their own account, provoking an immediate outcry. “This is a ridiculous rule,” says a foreign broker. “It will lead only to salesmen hiding trades. You can’t change a culture overnight.”
Yulo also believes the ban is unwise. “Trading on own accounts is allowed in other countries. We think the ban may have been an over-reaction to a press furore and we’ve made representations to the SEC over it.” The SEC has yet to decide whether to drop or moderate the ban.
The SEC is also concerned about the PSE’s ability to regulate itself efficiently. Attention focuses on the make-up of the governing board and the power of the PSE’s compliance department. When self-regulation was granted late last year, the board of the PSE was staffed wholly by broker-members, and the compliance department needed the permission of the board to investigate a broker-member for any suspected wrongdoing.
As part of the self-regulatory move, the PSE now has three non-broker governors, including Yulo himself. The chairman of the PSE is Wilson Sy, a leading broker believed to have a strong influence in the market.
The behaviour of local brokers has long been an issue and in May it exploded publicly. Local political columnist Ninez Cacho Olivarez held a press conference to accuse her broker of cheating her, implicating four other firms as well. Cacho Olivarez claimed that she had given her broker, Jose Maximo Cuaycong, then working at local brokerage Abacus Securities, more than Ps7 million in cash and scrip to invest in the market.
He claimed to have invested her funds through Abacas and three other firms, including two Indonesian joint ventures, Dharmala Securities and Lippo Securities. Cuaycong worked briefly for Dharmala Securities until he was fired last year, since when he has kept a low profile. The broker was dealing on the columnist’s behalf through his own accounts, and all four brokers told Cacho Olivarez that they had no liability for her funds. She is filing a court action against him and has demanded an investigation by the Philippine senate.
The PSE compliance department investigated the allegations and found that the trader may have defrauded the four brokerages. But it found no evidence that Cacho Olivarez had been defrauded. The trader has since been banned and a report forwarded to the SEC.
The incident prompted further concern at the SEC about the PSE’s compliance department. The SEC wants the compliance department to be detached from the PSE and made independent from the president’s authority.
The department now requires the president’s permission to investigate a broker, an improvement over the previous requirement that it get permission from the whole board.
Yulo disagrees. “This new idea would make the head of the compliance department more independent than the PSE president,” he says. “Who is to have the authority? Investigators and auditors must report to someone senior.”
He proposes a system whereby if there are unusual trading movements on the exchange, the PSE launches an immediate inquiry, imposes sanctions if necessary and then reports to the SEC. The compliance department would also investigate outside complaints and conduct audits of listed companies and brokers.
“I want to clarify the areas of authority in investigations,” Yulo says. “I think the PSE should do the initial investigation, and then hand the job on to the SEC for further investigation. The SEC after all is the only body that can send people to jail.”
Further debate also seems likely about the make-up of the PSE board. The SEC now thinks the non-broker members should be increased to five, while Azanza at the capital market development council goes even further. “At the moment the exchange is very democratic – one member one vote,” he says. “But there are no foreign brokers on the board of governors, although they account for the majority of trading and are the most professional.”
He believes that the board should be made up of five qualified outsiders, five big brokers, foreign and local, with a global clientele and five small brokers elected by all the members. The board should then appoint professional management for the exchange. “At the moment the exchange is incestuous; it acts in its own interests,” he says.
There is no doubt that the exchange needs a steady hand and a period of stability. Apart from the continuing scandals in the broking community, the professional staff are only now beginning to recover from the brief period in office of Yulo’s predecessor, Vitalino Nanagas. A former senior officer at Citibank, Nanagas was appointed late last year to take over from reforming president De los Angeles, who returned to his former law practice and to his work as publisher of an influential daily Manila newspaper.
Within a few months Nanagas had demonstrated a leadership style which antagonized the professional staff on the exchange. In a highly-publicized demonstration outside the PSE headquarters, they called for his dismissal. Their complaints included allegations that he had appointed cronies, inexperienced in relevant financial matters, to highly-paid jobs at the exchange. Lower-paid but experienced people resigned amid outrage over expensive perks such as luxury cars for the new recruits.
Compliance officers, already smarting at their low pay, alleged that Nanagas had whitewashed investigations into stock manipulation by important members of the exchange. Eventually the board of governors replaced him. The straw that broke the camel’s back appears to have been a plan to place an expensive advertisement in The European newspaper. For his part, Nanagas claims that his removal was prompted by brokers’ objections to his plans for market reform.
His downfall demonstrates how much personalities and personal style still affect politics and business in the Philippines. “You can’t behave in an autocratic style like this any more with staff,” says a senior local broker. “On the other hand, the president of the exchange has to take into account the views of the members. Even Eduardo de Los Angeles, a highly-respected and very nice man, made enemies when he was at the exchange.”
Yulo is keen to restore good relations with the staff, bringing in only one former associate, who has set up a new media and communications department, and promoting others, especially those with professional qualifications. To institutionalize professionalism he plans to apply for ISO9000 certification, which will involve codifying rules precisely and remove opportunities for arguments.
He will also work towards resolving the regulatory conundrum, hoping that the “Two Ys” – himself and Yasay at the SEC – can tackle and finalize the remaining issues. Yulo is so positive that progress is possible that he plans to take the PSE on a roadshow to New York at the end of the year to sell its merits to US investors. “People are talking about the mechanics of change now, not the principle. After three years of reform there may be a more mature way of thinking,” he says. By the end of the year it should be clear if that judgement is correct.
Banks rush in to property
Filipino banks say their property lending is not out of control. But with some of the industrial companies they lend to making more profit from land deals than their core business, a lot of money is flowing indirectly into property. Are the banks dangerously exposed?
Just a year ago, bankers, brokers and especially foreign investors were desperate for somebody to put up some decent new office buildings in Manila. Virtually nothing was available on the market with good communications, well-organized space and adequate parking, even at the highest rental levels. Staff were crammed into 10 or 15-year-old Makati offices, with computer and telephone cables snaking across the floor. Setting up a dealing room was a nightmare.
Within a year their dreams came true as Manila property developers rushed to meet the demand. Spurred on by very strong investment figures and hopes that the Philippines would become even more attractive when Hong Kong was handed over to China, developers broke ground for new office blocks in existing business districts and started pre-selling for several giant new commercial and residential developments.
But concerns that the property market is now overheating have coincided with a wider financial crisis. Even before the Philippine peso came under attack in the wake of the flotation of the Thai baht, bankers had completed a detailed investigation not only of the property market, but also of Philippine banks’ exposure to property lending. Their verdict was that there was no need for panic, but that a slowdown would be no bad thing.
The governor of the central bank Gabriel Singson plays down the problem. “Bank lending to property amounts to 10.9% of total loans,” he says. “I know people think this is not credible because there are so many new buildings. But many property developers are financing developments through equity capital raised in the stock market, rather than through bank borrowing. They are also pre-selling condominiums, with down-payments of 25% and the rest over two years. Some of the bigger developments are financed by big foreign investors bringing money from outside.”
But pessimists are concerned that the level of property lending is higher than central bank estimates, because many industrial companies are also getting into the property business. “Some power companies are making more money out of property than power,” said one broker. “If you lend to them, how do you classify the loan?”
In May, Singson revealed the extent of his true concerns over the problem by announcing measures restricting property loans to 20% of banks’ total assets. Property or land held as collateral could account for only 60% of the total for other loans, down from 70%.
This action to cut banks’ exposure to property followed concerns that stock of property-related companies was over-priced. The jitters focused on persistent rumours about two companies owned by entrepreneur Andrew Tan, both aggressively involved in property.
In April this year, the Philippine bourse fell 10% in a week. With a total of 15 tower blocks worth $1.5 billion either on the drawing board or under construction, Tan’s Megaworld Properties and Empire East Land Holdings looked risky. Their prices fell 30%.
The property market now looks safe. Within weeks of the April fall in equity prices the market rebounded and there are some signs that speculative fever may be abating. Most of the major listed companies are not thought to be at immediate risk. Ayala Land, one of the biggest and longest-established developers, has delayed building three new tower blocks. Metro Pacific, the Philippine property and communications company which is developing the giant Fort Bonifacio project on a former military base in central Manila, announced in August that first-half profits had risen 46% to Ps574 million ($20 million) from Ps393 million last year. The company said payments made by buyers who bought lots in the project had held up strongly.
Manuel Villar, president of C&P Homes, believes that the middle and low-cost homes market remains very healthy, with a considerable backlog of demand. “It’s the upscale market that is cyclical,” he says. “If there is demand, everybody wants to put up office buildings, condominiums and industrial estates, but when you start seeing a glut, people will stop building until demand catches up with supply.”
For now, demand and supply are still in balance in the office sector, property agents say, with occupancy rates at new buildings in the Makati business district holding up well at 98%, down from 99% two years ago. The current building boom is expected to produce a 20% vacancy rate – but in three years’ time. The middle-class housing sector, where supply has still not met demand, is unlikely to be affected by a downturn.
In the past few years the Philippine banking system has performed well, as the country enjoyed stable economic growth and sensible policies for the first time in many years. Profit growth in the banking sector has been in the 30% to 40% range. Loan growth has averaged 30% over the past five years, accelerating to 50% up to the end of last year.
But the surge seems to have peaked. In the first quarter of this year, total bank assets grew to Ps2,058 billion, a year-on-year growth rate of 34%. Savings and mortgage banks’ assets grew 32%, while commercial banks’ assets were up 37%. Philippine banks have maintained capital-adequacy ratios of at least 10% with some at 17% levels, well above the international minimum. Average return on asset levels are at 2% or more and return on equity 20%.
But earlier this year analysts detected several danger signals. The rise in loan growth to 50% would inevitably reduce the quality of borrowers, pointing to a growth in problem loans in the future. Already, loan-to-deposit ratios have risen to over 100%. With more competition in the market, spreads and margins are likely to fall, lowering profitability.
Other observers see less cause for concern. “You have to remember that the Philippines is coming from a very low base,” says Keith Craig, managing director of WI Carr Securities. “If you look at lending as a proportion of GDP, the Philippine rate has gone from 22% to 57% since 1992, still the lowest in Asia. For neighbouring Asean countries, the average rate has risen from 50% to 90%. In Thailand and Malaysia, it’s over 100%. Philippine credit expansion is only at the levels we saw in Thailand in the late 1980s.”
One area where analysts have found echoes of Thailand is the increase in offshore borrowing by banks, which exposes them to potential difficulty with the devaluation of the peso.
Lending in foreign currency as a percentage of total lending at Philippine banks has risen from just over 15% in early 1994 to 28% in April this year. More than 40% of lending growth was accounted for by loans backed by foreign currency deposit units (FCDUs), which are believed to amount to around $11 billion.
But the central bank is sure these loans present no serious risk. “All FCDU loans must have foreign-exchange cover,” Singson says. “Most of them, about 60%, are to exporters with earnings in foreign exchange. Foreign oil companies also borrow dollars, but now that the price of oil is deregulated these companies can raise prices to cover any shortfall in peso earnings.”
The same applies to public utilities like Philippine Long Distance Telephone, which is a large foreign borrower, but which has the right to adjust its bills to cover foreign-currency fluctuations.
The central bank also requires banks with foreign-exchange exposure to have 30% of cover in liquid form, such as government securities, as a further safeguard.
Unique among south-east Asian countries, the Philippines has one other cushion against both economic slowdown and further depreciation of the peso – its army of overseas workers. They remit more than $5 billion to the country every year, a major capital inflow for a country with total export earnings of $25 billion. The remittances not only underpin family incomes, but also finance home purchases and big-ticket items such as cars and electrical goods.
This stable, inflation-proof flow of funds has proved a boon to the retail sector, prompting the construction of larger shopping malls, bigger chains of convenience stores and a more extensive network of duty-free shopping facilities than are found in many other countries in the region.
With foreign-based Filipinos now responding to a government campaign to “bring back a friend” on their annual holiday, spending has been further boosted. Overseas workers give the Philippines a hidden advantage that many other south east Asian countries, buffeted by plummeting currencies and higher interest rates, will envy from afar.
