Establishing Mutual Fund Company in the Philippines

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Establishing Mutual Fund Company in the Philippines

  1. 1. 4 TA ` 87~ YCO Ora _ a 1 % MUR hwastment Management A Feasibility Report for the Asian Development Bank
  2. 2. 1 August, 1988 AN o ESTABLISHING A MUTUAL FUND COMPANY IN THE PHILIPPINES A Feasibility Report for the Asian Development Bank This report has been prepared by Jardine Fleming Holdings Ltd and Russell & Co. Inc. solely for the use of the As ian Development Bank. It may not be disclosed Asian Development Bank. or copied in whole or in part to any other person without the prior written consent of the interviews, research, and analyses carried out by Jardine Fleming Holdings Ltd The information, opinions, and recommendations contained herein are based on and Russell & Co. Inc. and to be best of their knowledge and belief the information contained in this report is correct at the date hereof. Jardine Fleming Holdings Ltd and Russell & Co. Inc. accept no liability for any errors or omissions of fact or opinion expressed or implied herein.
  3. 3. TABLE OF CONTENTS IL PRINCIPAL ABBREVIATIONS 2 III EXECUTIVE SUMMARY 3 Approach ToThe Assignmenc 3 Key Reoanmardations 4 A. Establish a Fund Management Company 5 B. Improve the Trading Systems of The Securities Exchanges 7 C. Upgrade the Securities and Exchange Cammimion 8 D. A on S to Encourage The Issuance of More 9 E. Agree on an Action Programme for Implementation of Key Recommendations 10 Criteria For Foreign Fund Manages »...»»...._»..» » » »»-.»- » » » 10 Concluding Canments 11 IV. PAST OPERATIONS OF MUTUAL FUNDS .................................................................................................................................................... 12 V. REASONS FOR THE THINNESS OF THE STOCK MARKETS 15 Strict listing Requirements 16 Ifigh Issue Costa 16 Limited Availability of Informatiot 17 Need for Public Incentives 18 Unattractiveness of the Equity Markets As an Investment Alteaiative 19 Inadequate Regulaticns 19 Shortfall in the Supply of Stacks.» 19 VL OVERVIEW OF THE STOCK MARKET TRADING SYSTEMS 22 Stock Clearing Procedures 22 Domestic Transactions 22 Cornptteasatim 24 Unification of Stock Exchanges 24 VU. STATUS OF THE SEC 26 Existing Structure and Responsibilities 27 Recommendations 27 Existing Organisation and Structure 28 Systems 28 Financial Resources 28 Human Resources 28 Current and Future Rolea 29 VIIL REVIEW OF RELEVANT SECURITIES REGULATIONS 31 Mutual Fund Regulations 31 Establishment Procedure 31 Capital Structure 32 Management Company 32 Investment Advises 33 Custodian, 33 Operation 33 Investment Activities 33 Conflict of Interest 34 Reports and Disclosure 34 Stock Exchange Listing Taxation 35 Common Trust Regulations 36 General Provisions and Financial Requirements 36 The Trust Plan 37 IX. SCOPE OF THE FUND MANAGEMENT COMPANY 40 Retail Savings 41 Institutional Savings 42 Closed-End Equity Fund 42 Venture Capital Fund 43 Fixed-Incernne Fund 44 Retail Fund 44 X. CRITERIA FOR FOREIGN FUND MANAGER 47 XL ACTION PROGRAMME FOR THE ASIAN DEVELOPMENT BANK 48 Fund Management Company 48 Securities Trading Systems 49 Securities and Exchange Commission 49 Issuance of Equity 50 Concluding Remarks 51 All queries on this document should be directed to: John R. Style Richard E. Radez Regional Corporate Development President Jardine Fleming Holdings Limited Russell & Company Incorporated Connaught Centre 30 Rockefeller Plaza 47th Floor Suite 1936 Hong Kong New York, New York 10112 Telephone: (852) 5-843-8888 Telephone: (212) 245-4640 Telex: 75608 FLEDG Telex: 271259 RUSL UR Facsimile: (852) 5-810-1694 Facsimile: (212) 262-4093
  4. 4. II. PRINCIPAL ABBREVIATIONS Throughout this Feasibility report, the following abbreviations shall, unless otherwise indicated, have the meanings set opposite them: ADB - the Asian Development Bank ICA - Investment Companies Act 1960 PLDT - Philippine Long Distance Telephone Company RSA - Revised Securities Act 1982 SEC - Securities and Exchange Commission "U.S. $" and "$" - the United States dollar. Throughout this document, unless otherwise stated, the following exchange rate shall apply: U.S. $100 = P 20.85. The Philippine peso is not a freely convertible currency. page 2
  5. 5. II. PRINCIPAL ABBREVIATIONS Throughout this Feasibility report, the following abbreviations shall, unless otherwise indicated, have the meanings set opposite them: ADB - the Asian Development Bank ICA - Investment Companies Act 1960 PLDT - Philippine Long Distance Telephone Company RSA - Revised Securities Act 1982 SEC - Securities and Exchange Commission "U.S. $" and "$" - the United States dollar. Throughout this document, unless otherwise stated, the following exchange rate shall apply: U.S. $100 = P 20.85. The Philippine peso is not a freely convertible currency. page 2
  6. 6. III. EXECUTIVE SUMMARY This report responds to contract CAS/S/87-229 dated 11 November 1987 to examine the feasibility of establishing a viable mutual fund in the Philippines (see Appendix XII-A for a request for proposal). As discussed in greater detail in this report, we recommend the establishment of a fund management company. Ultimately, this company will manage a group of mutual funds rather than a single mutual fund. The viability of the fund management company and its group of funds will be very dependent upon the actions of the Asian Development Bank (ADB) and the Government of the Philippines to give substance to our other three recommendations. These deal with the upgrading of the Securities and Exchange Commission (SEC), the strengthening of the underlying stock exchange systems to trade stocks and the enactment of certain measures to encourage companies to issue more equity. Approach To The Assignment The assignment was jointly undertaken by Jardine Fleming Holdings Limited of Hong Kong and Russell & Company Incorporated of New York. Jardine Fleming, established in 1970, was the first merchant bank in Hong Kong and now provides a complete range of investment banking services in the Far East, including investment management, corporate finance, banking, broking and foreign exchange. Jardine Fleming has total funds under management of U.S. $4.9 billion. One of these funds is the JF Philippine Trust which was launched in 1974. Russell & Company provides advisory, research and finance services to a limited number of private firms and financial institutions wishing to do business in Asia. Russell & Company clients include: • CP Ventures - a leading Australian venture capital firm • Rockefeller & Co., Inc. - the Rockefeller Family's investment management firm • Asian Development Bank • Royal Trust Asia Ltd. - the Hong Kong arm of the Royal Trust Group. To undertake this assignment, Jardine Fleming and Russell & Company fielded a team of experts to cover: • Securities Regulation • Group of Funds Management • Public Fund Management • Securities Administration • Philippine Corporate Finance • Securities Market Development page 3
  7. 7. Exhibit I Organizations Interviewed in Manila Type of Organization Names Securities Industry Anscor Hagedorn Securities Barcelon, Roxas Securities Belson Securities First Pacific Securities Investment Underwriting Services Makati Stock Exchange Manila International Futures Exchange Manila Stock Exchange Financial Community Barclays Bank CityTrust Development Bank of the Philippines Far East Bank and Trust Company Hambrecht & Quist The Hongkong and Shanghai Banking Corporation Land Bank of the Philippines Lincoln Philippine Life Insurance Co. The Philippine American Life Insurance Co. Philippine National Bank Private Development Corporation of the Philippines Business Community C. Virata & Associates Centre for Research and Communications Jardine Davies MMA Consultants Mondragon International Philippines Murray Fisher Group SKR Managers & Advisers SyCip, Gorres, Velayo & Co. (SGV) Legal Community Angara, Abello, Concepcion, Regala & Cruz San Jose, Enriquez, Lacas, Santos & Borge SyCip, Salazar, Hernandez & Gatmaitan Government Organizations Armed Forces Retirement System Asset Privatization Trust Central Bank of the Philippines Department of Finance Office of the President Securities and Exchange Commission Social Security System International Organizations Asian Development Bank British Embassy International Finance Corporation The World Bank
  8. 8. • Private Equity Investment • Mutual Fund Marketing • Unit Trust Administration • Securities Computer Operations. This team has spent in excess of six man-months on the assignment. It has conducted more than sixty interviews of executives of the organisations shown in Exhibit I on the facing page. A detailed summary of individuals interviewed in Manila forms Appendix XII-B. During the assignment, each expert reviewed a wide number of written documents on the Philippine securities markets, the most important of which include: • A CAPITAL MARKET STUDY OF THE PHILIPPINES by Nomura Research Institute dated 22 February 1985. • DEVELOPING THE CAPITAL MARKETS OF THE PHILIPPINES by Terrence Reilly of Curtis, Mallet - Prevost, Colt & Mosle dated 14 March 1987. • TOWARDS A DEVELOPMENT OF THE PHILIPPINES CAPITAL MARKETS by University of the Philippines Business Research Foundation dated 2 October 1986. • REPUBLIC OF THE PHILIPPINES REVISED SECURITIES ACT OF 1982, INVESTMENT COMPANIES ACT 1960, and the associated Philippine securities regulations. These interviews, research and analyses form the basis for our key recommendations. We wish to emphasise that whenever references are made in this report to shortcomings and deficiencies in various governmental departments and agencies, it must always be borne in mind that the problems identified are not attributable to the existing management and staff. In fact, it is to their credit that these governmental departments and agencies, in particular the Securities and Exchange Commission, have not broken down totally, given that they have been deprived of adequate resources over many years. Key Recommendations We have four key recommendations: • Establish a fund management company to set up and manage a group of funds, the first being a closed-end fund that will invest primarily in equities. • Improve the underlying trading systems of the securities exchanges so that securities can be easily and confidently traded. • Upgrade the SEC so it can play a major proactive role in securities regulation and development of the capital market. • Agree steps to be undertaken by the Government of the Philippines to encourage companies to issue more equity via public offerings. page 4
  9. 9. All four of these key recommendations should be implemented via an action programme that will be agreed after appropriate policy dialogues, between the ADB and relevant departments and agencies of the Government of the Philippines. The ADB should be prepared to support this action programme with technical assistance grants. Depending upon the dimensions of the programme, it may also be appropriate to involve other international aid organisations, such as the World Bank, in its implementation. Each recommendation and the action plan are addressed separately. A. Establish a Fund Management Company We recommend that a fund management company be incorporated to manage a group or "family" of funds, each of which will be tailored to the specific needs or priorities of differing types of investors and managed by fund managers with relevant experience in each particular field. To ensure that the investing public has confidence in the fund management company and its products, the financial standing and integrity of the shareholders should be unimpeachable. To this end, we recommend that the fund management company be structured as a joint venture with the following possible shareholdings: Shareholder$ Eauity Foreign Fund Manager 40.00% Asian Development Bank 5.00% Quasi-government Bank 5.00% Major Filipino Financial Institutions 50.00% 100.00% Our reasoning for recommending such a shareholder structure is that: • An international fund management company will contribute the proven investment skills and expertise required to ensure the long term viability of mutual funds. • The Asian Development Bank's involvement will contribute significantly to investor confidence and provide on-going support to the development of the capital markets. • A quasi-government banking, institution will provide a link between government policy makers controlling the privatisation programme and the private sector capital markets. • Major Filipino financial institutions will have the required levels of integrity and financial standing in addition to providing a nationwide network of offices. The foreign fund manager, in addition to taking equity, will manage the mutual funds floated by the fund management company on a remuneration/incentive commission basis. This will ensure professional management of the fund management company. The association of quasi-governmental organisations such as the Development Bank of the Philippines and major Filipino financial institutions will give the fund management company added image and credibility, and greater access not only to the authorities - indispensable at this stage of Philippine capital market development - page 5
  10. 10. 0 - COMMENCE Exhqhst II • - COMPLETE Timing of Action A -IMPLEMENT Programme 1988 1988 1989 1989 1989 3rd Qtr 4th Qtr 1st Qtr 2nd Qtr 3rd Qtr 1 FUND MANAGEMENT COMPANY: Establish a fund management company to set up and manage a group of funds, the first being a closed end fund that will invest mainly in equities. g new >mutna fund rules and gu ati (consultant working with SEC). Commence • Review fiscal policy and its impact on mutual funds and investors (consultant working with SEC). Publish new mutual fund rules and regulations. • Commence drafting a unified mutual fund/unit trust code (consultant working with SEC). management etc...) and timing of launch of first "authorised" Agree on structure (spon egal framework, capitalisation, fund managementcompany (SEC working with ADB and first sponsor). SECURITIES AND EXCHANGE COMMISSION: Upgrade the SEC so that it can play a major proactive role in securities and devel- opment of the capital market. Study SEC organisation,'structure, computer systems. finan- to fulfill adequately its current and future roles(' cial and human resources, in order that they may be upgraded ultan working with SEC' and ADB). • Second SEC staff members to regional financial institution for training in administration of mutual funds (SEC and ADB). Formulate a transaction levy to increase financial resources • Implement programme to upgrade quality of existing staff/ available to SEC (SEC and ADB)_ recruit new staff with specialist skills. SECURITIES TRADING SYSTEMS: Improve underlying trading systems of securities exchanges so that securities can be easily and confidently traded. Develop plan to computerise a unified stock exchange (SEC,' • Develop computer systems for stock clearing and settlements stock exchanges. ADB>au d ce sultant) ,> (stock exchanges and systems consultants) Agree on timetable fist a erger;cf. tarsi a an Makai: ' tack exchanges (SEC and stock;cxchanges . • Computerise STD systems at Central Bank to expedite repa- triation of forex (CB and systems analysts). I SSUANCE OF EQUITY: Agree on steps to be undertaken by Government of the Philippines to encourage companies to issue more equity via public offerings. Develop and comment i reposing "Oh, dent" lending tint its on • Initiate public offerings as part of privatisation programme. commercial banks (SEC and Central Bank) Agree on Debt/Equity ratios to be met by companies raising international debt under Government guarantees (ADB, IFC,: SEC and Central Bank). • Review conditions under which Philippine subsidiaries of multinational corporations might raise equity in the local stock markets (consultant working with ADB).
  11. 11. but also to the stocks of enterprises such as the Manila Hotel which the Government of the Philippines wants to privatise. We further recommend that the ADB work with the relevant Filipino authorities to incorporate and authorise the fund management company as soon as possible. The subsequent development and performance of the fund management company can be closely monitored over the next three years and be used as a model when formulating upgraded legislation to regulate the mutual fund industry. Further fund management companies can be authorised by the SEC when market conditions are considered suitable. A suggested timetable for the preliminary stages of the recommended action plan is set out in Exhibit II on the facing page. Provided the timetable is adhered to, the SEC, with technical assistance from the ADB, should be able to commence simultaneously : - • the upgrading of rules and regulations governing the mutual fund industry and the protection of investors • the upgrading of its existing organisational structure and resources • the incorporation of the recommended fund management company There are several key factors that will determine the types of funds that the proposed fund management company should launch and the timing of the launches: • There simply are not enough. equities available in the Philippine stock markets to make a traditional mutual fund viable. There are only about 10 stocks of investment grade with adequate liquidity. Consequently, the first priority is to help develop a greater supply of publicly available equities in future years. • It will take 18 months at least, probably longer, to put in place at the SEC the bare minimum of resources and expertise needed to regulate mutual funds offered to the public. • Presently, the investment appetite of the Filipino public is largely limited to short-term, money-market instruments. With the exception of a very small segment of wealthy individuals, most Filipinos have not seen their savings recover from the economic downturn of the mid-1980's. Consequently, people do not want to risk whatever small savings they have been able to accumulate by investing in equities. Given these constraints, we recommend that the first fund offered by the new fund management company be a closed-end fund that will invest primarily in: • Convertibles, warrants and/or preferred stock of publicly quoted companies • Initial public offerings of equities • Secondary equity offerings by publicly quoted companies • Significant minority positions in private companies that will ultimately go public • Leveraged buyouts, management buyouts and company reconstructions that will also go public in due course. page 6
  12. 12. This fund will increase the investment appetite for equities by acting as an institutional investor that is willing to purchase a broader and more sophisticated range of securities. These investments will be warehoused in the fund until such time as it is profitable to sell them off on the secondary market. In turn, this will increase the supply of investment grade stocks available to public investors, both institutional and retail. The initial size of this fund should be between U.S. $25 million and U.S. $50 million if it is to have any significant impact on broadening and deepening the Philippine equity markets. The second fund should be a small venture capital fund of about U.S. $10 million. We are confident that there is a pool of capable management available to identify and manage these new venture companies. This fund will also contribute to the broadening of the equity market by developing companies that will be ready to go public in three to six years time. The third fund should be a fixed-income fund targeted at small to medium-sized financial institutions. Because of their size, these institutions cannot afford in-house professionals to invest their liquidity. This fixed-income fund might be a: • Money market fund targeted at smaller banks and "thrifts". Historically, these institutions have had to place their liquidity with larger banks at a rate disadvantage. • Medium-term bond fund targeted at smaller life insurance companies. These institutions are unlikely to have the investment evaluation skills needed to analyse higher yielding but potentially riskier bonds issued by private companies. The fourth fund might be an equity or fixed-income fund for small retail investors. However, it is our strong belief that the launch of an equity mutual fund targeted at small retail investors should be delayed until such time as the stockmarket has been "broadened and deepened." A mutual fund, launched prematurely, will face problems identical to those encountered in the 1960's and 1970's (see Section IV) and will run a high risk of failure, the consequence of which will be the retardation of the mutual fund industry by another fifteen years. The timing of the launch of a fixed income fund will be determined by the continuing recovery of personal income and savings. B. Improve the Trading Systems of The Securities Exchanges Considerable work needs to be done to improve the underlying trading systems of the securities exchanges if securities are to be easily and confidently traded. At present, the systems and procedures of the Manila and Makati Stock Exchanges are totally inadequate to handle a high volume of stock trading, much less to ensure that the rights of investors are protected adequately. It takes, on average, approximately fifty days to clear a domestic stock trade on these exchanges (i.e. the time taken from the date of trade to the date of receipt of physical certificates by a custodian bank). While the time required for each step in the clearing process is documented in greater detail in Section VI, there is a major bottleneck in the transfer agent's capability to process and release new stock certificates to the stock clearing house. Stock clearing takes even longer for a foreign investor. In average trading volumes, it normally takes, at best, fifteen and on average, thirty days for foreigners to obtain approval from the Central Bank to repatriate their foreign currency. In addition, it is page 7
  13. 13. not uncommon for up to eight letters of assignment to be outstanding for a single certificate. Further, there is no central depository system to hold the shares after they have been cleared. In terms of the efficiency of the stock exchanges and the brokerage houses, there is a general lack of computerisation. Furthermore, there is no automated reporting system to disseminate price information from the floor of the exchanges to the brokerage community, both domestic and foreign. The ADB should take a major role in assisting the stock exchanges to computerise and modernise their trading and price reporting systems. This will involve undoubtedly the review of trading systems employed by other securities exchanges in the Pacific region, particularly those in Taiwan, Hong Kong and, perhaps, New Zealand. Specific implementation projects will then flow from this review. C. Upgrade the Securities and Exchange Commission One of the contributory factors to past problems within the securities markets, including the past failures of the Filipino mutual fund industry, was the lack of specialist expertise of those involved in monitoring and regulating the market. In particular, if the SEC is to fulfill its fundamental role in the securities market, it is essential that its staff not only has a full knowledge of the relevant laws, rules and regulations but also has sufficient experience and perspective of its particular fields of responsibility to be able to implement them. Professionalism of the SEC is the key to the development of the securities industry as a whole. Again, we wish to emphasise that wherever references are made to the SEC's shortcomings it must always be borne in mind that the shortcomings identified are not attributable to the existing SEC management or its staff. In fact, it is to its credit that the SEC, deprived of adequate resources over many years, has not broken down totally. Our review indicates that there is insufficient staff within the SEC to cope with the current demands imposed upon it and certainly there is a very significant lack of depth of specialist knowledge in various fields. The current legislation and regulations have been established by Government (presumably having taken advice from specific outside professional advisers and practitioners). If the development of the mutual fund industry is to be encouraged even on the basis of the existing regulatory structure, it will be essential for specialist expertise in the following areas: - • data collection, statistics compilation, information distribution and storage (including computerisation) • establishment of detailed regulations for registration and approval of those within the industry and monitoring due compliance on an on-going basis. 19 reviewing local and foreign regulations and policies as they affect the changing requirements of the securities industry. • production of detailed financial and market analysis reports. Experience in these fields will involve legal, accounting, computer, legal drafting, statistical and administrative skills. At the present time, mutual fund activity is very limited and accordingly the opportunity (and indeed the necessity) within the Philippines to gain the necessary experience is equally limited. It is our view that there is a significant shortage of page 8
  14. 14. Exhibit III DEBT-EQUITY RATIOS OF TOP 1000 COMPANIES Type of Company 1981 1982 1983 1984 1985 1986 Agriculture, fishing 2.40 2.15 4.18 3.73 5.81 4.32 Construction 3.49 4.15 2.40 2.86 2.83 2.97 Electricity, gas, and 1.32 1.42 1.97 2.47 1.70 1.27 water Manufacturing 2.17 2.13 2.43 2.81 2.13 2.20 Mining and quarrying 2.09 3.47 4.26 4.53 5.70 12.49 Services 1.67 1.78 1.12 1.61 1.40 0.75 Transportation, 3.16 3.69 6.50 3.38 1.04 1.19 communication Wholesale and retail 3.92 3.97 3.79 3.73 2.47 2.64 Trade Financing, real estate 5.75 9.86 10.36 10.28 12.33 8.28 Total 4.64 4.66 5.03 5.38 1.68 3.96 Total (excluding 2.40 2.33 2.71 2.87 2.29 2.39 financing) Sources: Business Day, Top 1,000 Corporations in the Philippines Best 1,000 Corporation - Mahal Kong Philipinas Foundation
  15. 15. personnel with the necessary experience and expertise both generally within the industry and particularly within the SEC. The development of the industry and the regulations relating thereto, as recommended in this report, will make the requirement for experienced and expert skills more essential.The recommendations made elsewhere in this report cannot be fully effective unless and until the SEC has upgraded the quality of existing staff and has recruited new officers with specialist skills and experience. As an initial step in this process, we recommend that the ADB work with the SEC to develop plans for updating the existing Philippine regulatory framework, initiate a staff training programme and formulate a programme to increase the budgetary allocation available to the SEC from sources such as a transaction levy. The preparation of these plans probably should include visits to regulatory bodies in the United States, the United Kingdom, Hong Kong and perhaps Australia. Once these plans have been formulated, the ADB should assist the SEC to increase the experience and expertise of its staff. This exercise should have two dimensions. The first is to recruit regulatory personnel from other countries to Manila on short term contracts to work as consultants with relevant departments within the SEC. Such individuals might still be with a regulatory body such as the Securities and Exchange Commission in the United States or they might be retired personnel from either public or private sectors elsewhere with relevant securities regulatory experience. The second is to assist the SEC to develop to the point where it can implement independently its full responsibilities, including the upgrading of its monitoring and enforcement duties. This, in turn, will have a side benefit of requiring the Philippine securities industry as a whole to raise its own standards in order to comply with upgraded rules and regulations. Strong and effective regulation by the SEC will be a major step in improving confidence in the Philippine securities market. D. Agree on Steps to Encourage The Issuance of More Equity A key element in ensuring the viability of the first three recommendations is for the ADB and the Government of the Philippines to agree on steps to encourage companies to issue more equity via public offerings on the Philippine stock market. There is universal agreement that the private sector would be strengthened if Filipino companies issued more equity and thereby built stronger financial foundations. The Top 1,000 Companies are thought to be substantially overleveraged (see Exhibit III on the facing page). The SEC, however, does not yet have the institutional resources necessary to take the initiative to encourage the issue of more equity or to monitor the development of the capital market. The same holds true with certain Government organisations which are involved with its privatisation policies. To this end, we recommend that the ADB and the Government of the Philippines agree on action necessary to encourage companies to issue more equity. Such action could include, inter alia: • The imposition on commercial banks of "prudent" ratios to limit the amounts they can lend to overleveraged companies. The ultimate objective of these controls is to ensure that companies broaden their equity bases. The "prudent" limits should be introduced over a two to three year period, be closely monitored and strictly enforced. page 9
  16. 16. Exhibit IV Elements in Action Programme Securities & Fund Management Securities Trading Exchange Issuance of Area Company Systems Commission Equity Key Establish a fund I mprove the underlying Upgrade the SEC so it Agree on steps to be Recommendation management company to trading systems of the can play a major undertaken by the set up and manage a securities exchanges so proactive role in Government of the group of funds, the first that securities can be securities regulation and Philippines to encourage being a closed-end fund easily and confidently development of the companies to issue more that will invest primarily traded. capital market equity via public i n equities. offerings Key Elements in • Publish a new mutual • Agree on a timetable • Study the SEC's • Develop and impose Action fund code for the Manila and organization and "prudent" lending Programme Makati Stock structure, its limits on commercial • Establish rules Exchanges to merge computer systems, banks relating to the financial and human operation of mutual • Develop Computer resources so they can • Agree on fund management systems for stock be upgraded to meet debt-to-equity ratios companies clearing and i ts current and future to be met by settlement roles Philippine companies • Review fiscal policy raising international as it impacts mutual • Computerise the • Recruit experienced debt under a funds and their funds transfer regulatory staff from Government i nvestors system at the Central other countries to guarantee Bank for repatriation spend 12 to 24 • Agree on structure of foreign exchange months at the SEC to • I nitiate public (sponsors, legal assist in staff offerings as part of framework, • Develop a plan to training t he privatisation capitalization, and computerise the programme management) and unified stock • Set in motion a ti ming of the exchange programme to l aunching of the first upgrade the quality fund management of existing staff and company to be t o recruit new staff li censed with specialist skills • Analyse conditions • Formulate a under which transaction levy to Philippine i ncrease financial subsidiaries of resources available multinational to the SEC corporations might raise equity in the l ocal stock markets
  17. 17. • Any company seeking international debt finance that would be guaranteed by the Philippine Government and/or extended by the World Bank, the International Finance Corporation or the ADB should also be required to meet a designated debt-to-equity ratio. If the loan proposed will result in the designated debt-to-equity ratio being exceeded, then the company concerned should be required to offer "compensating equity" to the public via the Philippine stock markets. An example that immediately comes to mind is the recent International Finance Corporation loan extended to the Philippine Long Distance Telephone Company. There was universal agreement among senior Philippine Government officials that the PLDT should increase its equity base but there was no institutional mechanism for addressing this issue. • Public offerings should be considered as part of the privatisation programme. Initially, these public offerings should start with smaller entities such as the Manila Hotel. There is no reason why the Manila Hotel could not be a publicly owned company. The Singapore Stock Exchange, for example, has several publicly owned hotels quoted on it. A smaller initial public offering of this sort can also serve as a useful "dress rehearsal" for the larger public offerings that will be associated with the privatisation of companies such as Philippine Airlines and the Philippine National Oil Company. E. Agree on an Action Programme for Implementation of Key Recommendations A critical element in ensuring the viability of our four key recommendations is for the ADB and relevant departments and agencies of the Philippine Government to agree an action programme to implement these recommendations. Exhibit IV on the facing page summarises the specific elements that might be contained in such an action programme. These elements are discussed in different sections of this report and they are discussed in greater detail in Section X'I. After appropriate policy dialogues with the Government of the Philippines, the ADB should be able to identify priorities for the elements in the action programme, lay out a timetable for its implementation and designate Philippine governmental agencies that will be responsible for implementing specific elements of the programme. The ADB should be prepared to support this action programme with technical assistance grants. Depending upon the ultimate dimensions of this action programme, it may also be appropriate to involve other international aid organisations, such as the World Bank, in its implementation. Criteria For Foreign Fund Manager We believe that there are five key criteria for the ultimate selection of a foreign manager for the proposed fund management company: • Established corporate finance skills that can be applied in the management of the closed-end equity and venture capital funds. • Management experience in operating and administering a retail financial services organisation that specialises in personalised marketing to retail customers and the subsequent investment management of their funds. • A major presence in Asia to ensure that personnel with the requisite expertise and experience is readily available for secondment to the fund management company. page 10
  18. 18. • A proven track record in the management of mutual funds in the Asia/Pacific region. • A depth of knowledge of and experience in the Philippines. In considering any candidates, the ADB will also have to discuss them with the Government of the Philippines. For instance, the Government may feel that certain candidates might have conflicts of interest vis-a-vis the ongoing reschedulings of their outstanding loans to the Philippines. Concluding Comments Viewed realistically, our report indicates that the evolution of a broadly based capital market in the Philippines will take at least five to ten years. To ensure success, it is essential that the development process is carefully monitored and, if necessary, guided. We believe that there is a very real risk of failure unless there is constant supervision. Ultimately, such supervision and direction will come from a domestic Philippine Government agency such as the SEC and from an integrated stock market. However, we cannot envisage the SEC being professionally equipped to fulfill this role independently for at least three to five years. Consequently, it will be necessary for the ADB to take the lead by assisting with supervision and direction in the near term. If the market conditions and regulatory framework currently prevailing remain unaltered, we do not believe that the fund management company and the associated group of funds recommended in this report will be viable. Even if a minimum of the infrastructure requirements are met, we still are doubtful that the fund management company will be viable. In our opinion, there is no alternative other than for the Philippine Government, assisted by the ADB, to embark upon a broadly based capital market development programme that may take anywhere from five to ten years to reach fruition, given relative political stability. page 1 1
  19. 19. ExhibitV Philippine Mutual Funds Remarks Now Current on Original Date Management T. A./ Date of New Management T. A./ Portfolio Current Name Created Type Company Custodian. Change Name Company Custodian Value Status Ayala 17/7/74 Close Ayala Bank of the November 1986 SM Far East Bank Treasurer of P115.42M Capital Fund Inc. I nvestment Philippine (thru series of Fund (partly) and SM Fund, NAV per stock Management. I slands purchases at the I nc. Henry Sy I nc. unit at i ncreased I nc. stock exchange together with P1.490 as from P75M April-July 1986) officers of SM at to P200M. Fund, Inc. 30/10/87 Listing of additional shares on 6/1/88 Pacific June Open Pacific Fund Great Pacific Life Rizal P10.1 M Not Fund 1969 Fund (controller's Commercial (P6.6M available for Management office) Banking secs., new Co. (dissolved Corporation P3.5M subscription i n early 1984) fixed-in- but existing come) plan P27.66 holders per unit as may at i ncrease 06/01/88 their holdings Trinity 22/8/69 Open Trin-Invest Philippine PDCP subsidiary Land Bank Peso 3.8M Awaiting Shares Management Banking Corp. since 1979 of the SEC I nc. Services, Inc. Philippines guidelines (subsidiary of from 10/87 to PDCP) reactivate marketing effort Philippine 31/4/74 Close BANPEB Cres- Far East Liquidated I nvest- Mgmt. Corp. cent Int'l Bank & i n 1983 ment Co. (joint venture Fund Trust of Bancom (Luxem- Company Devpt. Corp., bourg) FEBTC, Anselmo Trinidad & Co. Filipinas 6/12/57 Open I nvestment Far East, 30/6/62 I n 1976, Mutual Planning Corp. Philbanking converted into a the Fund of the financial co. company Philippines (NAV of the fund was was P8.5M converted when it was into a converted) develop- ment corporation Source: Jardine Fleming/RusseIl interviews and research
  20. 20. IV. PAST OPERATIONS OF MUTUAL FUNDS The concept of mutual funds was introduced to the Philippines from the United States in the late 1950's when the Filipinas Mutual Fund (FMF) was launched on December 6, 1957. Three other mutual funds followed suit twelve years later, namely the Pacific Fund, Trinity Shares and Crescent International Fund. The last mutual fund, the Ayala Fund, was created in 1974. Exhibit V on the facing page shows the background details of each of these funds. Ultimately, each of these mutual funds was unsuccessful. FMF was launched in the middle of a bull market, its promotional and marketing efforts attracting considerable public interest. With a nationwide sales force ranging between 8,000 to 10,000 agents selling its shares, either by outright purchase or through a monthly instalment scheme marketed as a private investment plan, FMF at its height had some 70,000 investors and a net asset value of approximately Pesos 14 million in 1960. Having grown rapidly in a rising market, FMF encountered serious problems when investors, concerned about the volatility of the stock market and the value of their investments, attempted to redeem their holdings. In effect, there was a run by FMF investors similar to a run on a bank. FMF was unable to liquidate its stock market holdings rapidly enough to meet the redemption requirements of its investors. Consequently, its share price collapsed. A combination of factors led to the failure of FMF. The most important of these were: • Cost to investor. For those who acquired shares through outright purchase, a front-end load or commission of 8% was deducted from the value of their investment. In addition, annual management fees in the region of 1.5% per annum were also charged by the fund managers. Investors acquiring FMF shares through monthly installments under the private investment plan suffered considerable dilution of the actual investment value of their contributions. As much as 50% was lost in the first year through deductions by fund managers for selling commissions and associated costs. As the initial euphoria created by a rising stock market and high-profile marketing subsided, investors began to realise that the cost of entry into the stock market through FMF was inordinately high. • High administrative costs. FMFs administrative costs became excessive because the majority of its 70,000 investors were usually paying only 10 to 15 Pesos per month (equivalent to about Pesos 100 per month now). • Absence of regulatory control. Lack of legislation, codes of conduct or guidelines issued by the Philippine Government to control the marketing and administration of mutual funds resulted in many abuses Many unsophisticated retail investors were lured into purchasing FMF shares by extravagant promises made by, at best, hastily and partially trained salesmen whose sole motivation was to obtain their sales commissions. Although FMF did set up a training programme, it was never able to educate fully the 8,000 to 10,000 agents who, at one stage, were selling FMF shares. The professionalism of the sales force was page 1 2
  21. 21. further suspect because people sensed that each salesman really only had a small group of family and friends to sell to. Once this limited market had been saturated, the sales agents had neither the skills nor the experience required to develop new clients on a "cold calling" basis. • Volatility of the stock market. Investor confidence was seriously undermined by dramatic fluctuations in the stock markets. Any adverse movement in stock prices in the Philippines usually triggers a rush to liquidate, resulting in further sharp price declines. A mutual fund, in particular, would be unlikely to liquidate its own holdings fast enough to meet the subsequent surge of redemptions. In the case of FMF, very few investors were sufficiently wealthy to be able to sustain losses without hardship. For those who had. transferred the bulk of their savings into FMF shares, any downward movement in share values precipitated panic selling. • Narrow character of the stock market. The paucity of investment grade stocks inevitably resulted in the prices of these securities being driven even higher by the inflow of funds seeking quality investments. As these stocks became "overbought", buying attention switched to second and third liners and, in some cases, to more speculative issues. When selling pressure replaced active buying and FMF sought to raise cash to meet redemptions, the market for lower-grade stocks evaporated, leaving FMF with no choice but to liquidate its holdings of blue chips and marketable second liners. Consequently, the residual portfolio was reduced to unmarketable low-grade stocks with the result that the remaining investors became "locked in". Faced with an inability to remain a viable open-ended mutual fund, FMF was converted into a finance company, Filipinas Mutual Finance, in June 1962. Eventually, FMF became a development corporation in 1976. By 1969, interest in mutual funds was again rekindled and three new funds were launched: Pacific, Trinity and Crescent International. The Crescent International Fund was registered in Luxembourg and sold to international investors. The three funds enjoyed the boom in the Philippine stock markets but became, like FMF, victims of the market's volatility. They encountered a bear market, the fall of which was too fast for them to meet redemptions. In the process, many smaller investors were again seriously "burned" and effectively lost the value of their investments. With the exception of the Trinity Mutual Fund, which today comprises a mere 900 investors and a net asset value of Pesos 3.8 million, the other funds were closed. The last Filipino mutual fund was launched in July 1974 when the Ayala Group introduced the closed-end "Ayala Fund". This was well managed and properly structured. However, even the Ayala Fund suffered from the same extremely limited range of investment grade quoted issues and fell prey to the same problems that other mutual funds had encountered in a bear market. Rather than close the fund, Ayala decided to withdraw. The fund management and effective ownership was transferred to the Shoemart Group and the name changed to "SM Fund". The SM Fund is quoted an both the Manila and the Makati Stock Exchanges and has recently increased its capital stock from Pesos 75 million to 200 million. However, the SM Fund can no longer be considered a mutual fund in the generally accepted sense. Its composition and control are now closely linked to the corporate interests of the Shoemart Group and Sy family, the controlling stockholders of Shoemart. page 1 3
  22. 22. When reviewing the performance of mutual funds in the Philippines over the past thirty years, it is clearly evident that the majority of the retail investors who invested in them had little or no basic understanding of the workings of capital markets. Essentially, they are people in the middle or lower-middle income categories whose investment/savings strategy is historically inclined to short-term deposits with local banking or savings institutions. Their only exposure to "longer term" investment is almost exclusively limited to pre- need schemes such as memorial or education plans and life insurance. Their lack of investment acumen makes them particularly vulnerable to plausible and well presented sales pitches by, at best, over enthusiastic and, at worst, unscrupulous salesmen. These unsophisticated investors invariably purchase mutual fund shares after the market has risen and then get caught when the market declines. Falls experienced in a bear market in the Philippines are, more often than not, too fast to meet redemptions. The consequence of the failure of these five mutual funds is that today they have a very speculative image with virtually all Filipinos. This "casino" image, coupled with the lack of investors' sophistication, a volatile and narrowly based stock market, escalating administrative costs, insufficient regulatory control and a strong bias toward short-term money market instruments, remains a major obstacle to the successful re-introduction of equity-oriented mutual funds sold to retail investors. page 14
  23. 23. Exhibit VI Manila Stock Exchange Composite Index (Year-End) 1980 1981 1982 1983 1984 1985 1986 1987 Source: Manila Stock Exchange
  24. 24. V. REASONS FOR THE THINNESS OF THE STOCK MARKETS Even though the Philippine stock markets have risen eightfold since their low point in 1984 (see Exhibit VI on the facing page), they still remain thin equity markets. Out of a total of 129 companies listed on the Manila Stock Exchange, there are only 13 actively traded. These are: Exhibit VII Actively Traded Philippine Stocks Major Blue Chip Good Second Liners San Miguel Sime Darby P.L.D.T. Soriano Corp. Commercial/Industrial Globe-Mackay Ayala Corp. Philex Apex Benguet Mining Atlas* Lepanto* Oriental Petroleum & Minerals Phil. Overseas Drilling Oil Exploration * - Atlas and Lepanto are designated as second liners in that Atlas is currently overgeared and both Atlas and Lepanto have passed dividends in recent years. As Exhibit VIII on the next facing page illustrates, the remaining volume is concentrated on third liners on the "Big Board" and speculative stocks on the "Small Board". Even within the most heavily traded shares, only a small portion of the total shares is actually available for the investing public to buy. San Miguel Corporation has 31% of its shares that are freely available for purchase. Ayala Corporation has 11%. The remaining shares are "locked up" in the hands of the founding family or in the hands of friends (see Appendix XIID). The ADB asked us to examine certain areas to assess whether they were reasons contributing to the thinness of the stock markets. These areas and our assessment of them are: Discriminatory Fiscal Treatment of Capital Market Assets We do not believe that the fiscal treatment of capital market assets vis-a-vis bank deposits and the lack of fiscal and other incentives for companies to go public is so serious as to be a major impediment to the development of the securities markets. In fact, there are two major fiscal incentives that should make it attractive for companies to go public: a. Inheritance Tax is higher on equity holdings in private companies. page 15
  25. 25. ExhibitVIll Manila Stock Exchange (shares traded in billion pesos) Volume of 10 most actively traded listed companies 19.3 Volume of second-line companies and speculative issues 8.36 2.07 1.56 0.72 0.65 1982 1984 1980 1981 1982 1983 Atlas 446,397 Philex 73,731 Semirara Coa 124,581 Philex 626,925 Philex 199,441 Atlas 59,167 Banco Filipino 84,476 San Miguel 508,559 San Miguel 143,731 Oriental Pet. 54,105 Atlas 67,460 Atlas 223,035 Lepanto 141,228 Lepanto 43,162 Oriental Pet. 60,532 Precision 119,939 Oriental Pet. 139,999 Apex 41,428 Philex 56,386 Lepanto 119,902 Apex 118,691 San Miguel 35,526 San Miguel 46,630 PLOT 111,976 I nterport 101,558 PLOT 26,857 Phil O'seas 31,168 Benguet 36,947 Benguet 61,406 Trans-Asia 22,343 Lepanto 28,324 Oriental Pet. 21,383 Phil O'seas 61,171 Stanford 22,090 Metropolis De 27,500 Phil O'seas 20,142 1st Phil Hldg 44,723 1st Phil Hldg 18,757 Trans-Asia 24,550 BF Homes 16,182 1,458,345 70% 408,166 1,804,989 53% 1,804,989 53% Tot turnover P2.07 B Tot turnover P0.614 B Tot turnover P0.724 8 Tot turnover P3.4 B 1984 1985 1986 1987 Philex 161,725 Philex 131,118 San Miguel 1,089,004 Philex 2,712,748 Atlas 91,888 San Miguel 44,491 Philex 999,871 Lepanto 2,634,921 PLDT 51,517 Phil Cocoa 36,739 PLDT 511,828 San Miguel 2,137,253 San Miguel 38,178 Globe Macka • 32,572 Lepanto 354,869 Atlas 1,508,423 Fil. Synth 26,000 PLDT 22,179 Globe Macka 203,162 Apex 1,180,448 Benguet 23,707 Lepanto 19,508 Atlas 199,804 Phil O'seas 1,108,346 Lepanto 21,660 Atlas 17,619 Benguet 143,300 Oriental Pet. 1,107,545 Prec. Elec. 16,398 Benguet 10,255 A. Soriano 111,129 PLOT 867,969 Globe Macka • 13,265 Oriental Pet. 8,307 Sime Darby 107,197 Trans-Asia 737,524 Oriental Pet. 11,868 I nsular Bank 6,409 Oriental Pet. 70,400 A. Soriano 559,571 456,225 70% 329,197 21% 3,790,562 4596 14,554,748 75% Tot turnover P0.649 B Tot turnover P1,557.2 B Tot turnover P8,362.2 B Tot turnover P19,265.713 Source: Manila Stock Exchange
  26. 26. b. Capital Gains Tax is minimal con the disposal of shares in publicly quoted companies. Strict Listing Requirements We do not consider that existing formalities, in themselves, constitute an obstruction to the listing of securities. Neither the disclosure conditions nor the documentary requirements are unduly onerous. The published form of Listing Agreement sets out ongoing obligations of a listed company, the requirements of which are straight- forward. We did note, however, that the exchanges may require additional information from companies in support of listing applications. The exchanges also reserve the right, at their discretion, to suspend dealings of listed securities. An unreasonable exercise of these rights would naturally act as a strong deterrent to any company seeking a listing. Nevertheless, any less detailed disclosure requirements would be detrimental to the development of a more sophisticated securities market. There is, however, an additional safeguard for investors. Before any securities can be listed on the exchanges, they must first be registered with and receive the approval of the SEC before their listing and sale to the public. In its application to the SEC, each company must provide extensive, detailed information which includes all the information required by a Listing Agreement. Approval by the SEC is a precondition to an application to the exchanges for a listing and, although the exchanges review applications independently of the SEC (and may require such additional information as they think fit), they are able to rely on the details filed in the company's Registration Statement as approved by the SEC. High Issue Costs As discussed in the paragraphs above, the listing requirements and procedures of the exchanges are not unduly cumbersome. There are, however, areas for improvement. Provided a company has completed the application correctly (together with all necessary supporting documentation) and is able to satisfy any additional enquiries, we estimate that the exchanges, acting through the Joint Listing Committee, would be able to approve the listing within four to six weeks. As mentioned above, the relative lack of detailed information required by the exchanges is balanced by the more extensive details to be filed with the SEC under the provisions of the RSA. The SEC has the power to require any additional information or documentation as it deems necessary in the public interest and in order to protect the interests of investors. For the same reasons, the SEC may either reject applications or impose such conditions on registration as it thinks fit. It is estimated that the registration of securities and the approval for sale to the public would take sixty to ninety days provided the papers were in order. While we would not favour any reduction in the information required by the SEC, we would recommend a review of SEC internal procedures in order to reduce the time taken for the determination of an application. The fees charged by the exchanges for the initial listing (max. Pesos 42,000 - including both exchanges) and the annual fee (Pesos 10,000 per exchange) are reasonable. There is a maximum fee of 0.10% payable to the SEC on initial filing based on the maximum aggregate price at which the securities are to be offered. In addition, there are the inevitable printing costs and fees of lawyers, accountants and other professional advisers. The fees to be paid to the underwriters are conventionally limited to a maximum of 5%. However, the current trend is for a listing to be sponsored by selected groups of brokers from each exchange who negotiate their fees independently with the issuing company. The SEC, in giving its approval to the sale page 1 b
  27. 27. of the securities, may impose the maximum amount of remuneration or commission to be paid in connection with the sale (or offer for sale) of the securities. Provided the SEC imposes reasonable limits and ensures compliance, the costs of new issues are not unduly high when compared with the costs of an issue on an exchange in another jurisdiction. The costs may, however, be significantly higher than those for raising capital through banking institutions. Limited Availability of Information Theoretically, any member of the public may have access to the audited annual and unaudited semi-annual accounts of companies whose shares are registered with the SEC under the RSA. The SEC will not release to the public the annual accounts of other corporations unless there are exceptional circumstances. Our research reveals that even for the former category neither the SEC nor the exchanges have taken steps to ensure that these companies produce accounts with sufficient data to enable others to measure their true trading performance or to assess, with any confidence, the strength of their balance sheets. It is our experience that Filipino companies, be they privately or publicly owned, are extremely reluctant to publish or even discuss details of their current and prospective activities with anyone unconnected with the company. It is, therefore, highly improbable that they will create pressure themselves for stricter disclosure requirements. It is a fundamental criterion for the development of the securities market, however, that companies disclose sufficient information in their accounts for investors to assess realistically their true financial condition. The current situation will only be improved by a strong lead from the SEC. Neither the brokers nor other institutions involved in the securities markets have developed research facilities capable of producing and disseminating detailed company analyses. It is unclear if this is a direct result of the lack of sufficient financial information or their perception that research material is neither necessary nor required. If the former, they should be encouraged to voice their opinions in support of the changes necessary to provide fuller disclosure by companies. If the latter, they should be persuaded to the view that a more active securities market will be to their obvious benefit and that this can be assisted substantially by the publication of up-to-date detailed research material. As stated above, the information required to be contained in published accounts is insufficient and, in the absence of effective compliance controls from the SEC, there is the possibility that a failure by a company to file its accounts might go undetected. Not only is a strong lead required from the SEC but also we would recommend that the Accounting Standards Council be consulted in the development of improved disclosure requirements for published accounts. Existing financial reporting requirements are inadequate. Insufficient information is available for analysts to assess with any degree of confidence the past and projected trading performance of individual corporations or the strength of their balance sheets. The accounting profession must be encouraged to adopt and comply with stricter accounting standards. page 17
  28. 28. Unattractiveness of the Equity Markets As an Investment Alternative Ultimately, investors, both retail and institutional, buy equities because they believe they offer superior returns (in the form of capital appreciation and dividend yields) over other investment alternatives. Exhibit IX on the facing page shows the post-tax returns of alternative investments in the financial markets in the Philippines since 1983. Equities have not been attractive investments when compared to other alternatives. The outstanding feature of the Philippine financial markets during this period has been the very high level of interest rates. There was a strongly inverted yield curve during 1983 and 1984. At present, the cost of 30-day money has dropped to approximately 14%. However, the Government deficit is expected to increase during 1988, thereby increasing pressure on interest rates. In such an investment climate, the only sensible thing for the smaller investor to do is to invest his money in short-term, fixed-income instruments. We believe that this is the major reason why investors have not found the equity market to be an attractive investment alternative. If accepted, this reasoning has important consequences for certain Government actions that have been proposed. Specifically, while the strong bias remains towards debt rather than equity finance, there is little point in the Government offering tax or fiscal incentives to try to attract capital to the stock market. Such incentives might make stocks marginally more attractive, but the benefits of these incentives will be more than offset by the attraction of high interest rates. Until the yield curve moves substantially downward, Philippine investors will be reluctant to convert their excess liquidity into capital market investments, be they equities, fixed interest notes or bonds. I nadequate Regulations As Robert Fell, Chief Executive of the Stock Exchange of Hong Kong, recently pointed out, "supervision of securities listings plays a key role in maintaining the integrity of a stock market. The settlement system and the surveillance of exchange members' conduct also contributes to an equity market in which people feel safe to invest." Put another way, if investors perceive an equity market as being unsafe (i.e., controlled by insider trading and speculative stock manipulation), they simply will not invest their money in equities. Unfortunately, the regulation of both Filipino stock exchanges has not been as strong and as effective as it should have been. There was a general consensus among those we interviewed that the local stock exchanges were unsafe markets in which to invest one's accumulated capital. We believe that the fundamental reason for this attitude is that the regulatory apparatus, primarily the SEC, has inadequate resources to fulfill effectively its role of supervision and regulation. Until this state of affairs is remedied, investors will remain reluctant to put their capital at risk in the Philippine Stock markets. This is why one of our key recommendations focuses upon the strengthening of the SEC. This topic is discussed in greater detail in Section VII. Shortfall in the Supply of Stocks Owners of private companies and the management of public companies sell equities via the stock markets for one fundamental reason: they believe they are getting an attractive price for their equity. If the owner of equity can obtain a price multiple of page 19
  29. 29. ExhibitX DEBT-EQUITY RATIOS OF TOP 1000 COMPANIES Type of Company 1981 1982 1983 1984 1985 1986 Agriculture, fishing 2.40 2.15 4.18 3.73 5.81 4.32 Construction 3.49 4.15 2.40 2.86 2.83 2.97 Electricity, gas, and 1.32 1.42 1.97 2.47 1.70 1.27 water Manufacturing 2.17 2.13 2.43 2.81 2.13 2.20 Mining and quarrying 2.09 3.47 4.26 4.53 5.70 12.49 Services 1.67 1.78 1.12 1.61 1.40 0.75 Transportation, 3.16 3.69 6.50 3.38 1.04 1.19 communication Wholesale and retail 3.92 3.97 3.79 3.73 2.47 2.64 Trade Financing, real estate 5.75 9.86 10.36 10.28 12.33 8.28 Total 4.64 4.66 5.03 5.38 1.68 3.96 Total (excluding 2.40 2.33 2.71 2.87 2.29 2.39 financing) Sources: Business Day, Top 1,000 Corporations in the Philippines Best 1,000 Corporation - Mahal Kong Philipinas Foundation
  30. 30. Need for Public Incentives Again, we see no need, at present, for incentives for the public to invest in securities. The fundamental problem is that a substantial majority of the Philippine public does not have sufficient disposable income to engage in any sort of savings activity at all. In one interview, an interviewee estimated that 98% of the Philippine public is unable to participate in a meaningful savings programme. Tax cuts or other fiscal incentives will not, in themselves, correct this situation. A stronger domestic economy, more widespread employment and sustainable economic growth are the fundamental factors that will increase the savings available for more of the public to be able to invest in securities. Generally, the small minority of Filipinos who have savings available to invest in securities have found post-tax returns of alternative investments to be more attractive. When there is an inverted yield curve with short-term interest rates reaching 40% per annum at one point, rational investors would never invest in securities. Instead, they would do what people have done: purchase short-term money market instruments and stay liquid. During our interviews, executives gave us many other reasons for the thinness of the stock markets. The most frequently mentioned reasons included: • The founding family does not want to lose control (even though the company may already be publicly listed). • They do not want outsiders prying into their business affairs. • Filipinos want to keep a good thing "in the family". • Public companies have to answer to more people and to disclose more financial information to the public, particularly the Bureau of Inland Revenue. • The board of a public company becomes more conservative. • Public companies lose the entrepreneurial spirit that built them in the first instance. A further reason, mentioned only once, concerned the insider trading case associated with Lepanto mining. This case has lingered, unresolved, with the SEC for over ten years. One interviewee thought this unresolved case may have had a chilling effect upon the appetite of private companies to go public. While all these reasons have some degree of validity, they and others like them have not prevented private companies in other Asian countries from going public during the past fifteen years. In fact, virtually all of the initial public offerings in Hong Kong during the past fifteen years have been those of previously privately owned, family- controlled companies. Instead, we believe that the reasons for the thinness of the Manila stock markets are more complex. Basically, we have divided these reasons into three categories: • Unattractiveness of the equity markets as an investment alternative • Regulatory shortcomings • Shortage of stocks. page 1 8
  31. 31. Exhibit IX Post-Tax Returns of Alternative Investments 1983 1984 1985 1986 Pre-Tax Post-Tax Pre-Tax Post-Tax Pre-Tax Post-Tax Pre-Tax Post-Tax Return Return Return Return Return Return Return Return 1. Money Market Paper 16.90 14.37 27.20 23.12 20.98 17.83 13.58 11.20 2. Gov't Securities 14.54 12.36 37.90 32.33 27.05 22.99 16.04 13.23 3. Stocks a. Commercial 15.60 13.27 11.52 9.79 9.06 7.70 3.57 3.21 b. Mining 5.48 4.66 6.41 5.45 9.51 8.08 4.45 4.01 4. Savings Deposits 9.70 8.25 9.85 8.37 10.84 9.21 8.62 7.11 5. Time Deposits 15.30 13.00 24.16 20.53 21.83 18.56 14.77 12.19 Source: Annual Reports of Makati and Manila Stock Exchanges, Central Bank Annual Reports, Top 1,000 Companies Note: Witholding Tax: 1985 - 15%; 1985 - 17.5% Dividend Tax: 10% Stock returns based on selected C-I and Mining Issues. Source: Jardine Fleming/Russell research and analysis

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