Stronger, transparent capital market seen

A trader talks on his phone in front of an electronic board showing a downtrend in trading at the Philippine Stock Exchange on June 29 after Greece closed its banks and imposed capital controls. AP

In the early 1990s, President Ramos forced the two rival local stock exchanges—the Makati and Manila bourses—to merge. It was a shotgun wedding that over the years created a more efficient unified house that we now know as the Philippine Stock Exchange (PSE).

These days, the economic managers of the Aquino administration are pushing for another major consolidation in capital market infrastructure—one that seeks to marry two separate trading platforms for different asset classes. The unification of the stock and bond markets, they believe, will boost volumes and unlock huge savings in maintaining and continuously enhancing financial market architecture. After all, while local markets have gone a long way in the last two decades as far as expanding volumes and improving governance systems are concerned, they still have a lot of catching up to do when pitted against regional peers.

Pretty soon, this dream of a consolidated capital market infrastructure will finally be realized. In the next few weeks, the PSE is set to formalize its acquisition of the controlling stake in Philippine Dealing Systems Holdings Corp. (PDS Group) after making an offer to shareholders to sell their shares. The majority of the shareholders have already agreed to sell their shares to the PSE, including the banks. Even the Singapore Exchange Ltd. (SGX)—previously torn between supporting the Philippines’ capital market reforms and making a more decent profit out of its investment in PDS—is expected to give in.

PDS Group is the holding firm for fixed-income trading platform Philippine Dealing and Exchange Corp. (PDEx), Philippine Depositary and Trust Corp. (PDTC) and Philippine Securities Settlement Corp.

Selling shareholders

The PSE earlier signed a deal to buy the 28.91-percent stake held by the Bankers Association of the Philippines (BAP) and some member-banks in PDS, raising its interest to nearly 50 percent.

“We’re doing this for national interest. We want a common platform so when the Asean (Association of Southeast Asian Nation) gates open, we will be efficient. If you look at Singapore, which is probably the benchmark, it has a single platform for everything,” said Lorenzo Tan, president of BAP and Rizal Commercial Banking Corp.

The local bourse also launched a general offer to other shareholders of PDS. Most recently, San Miguel Corp. and another minority investor agreed to sell a 4-percent interest, giving the PSE a 54-percent control at this time.

For its part, SGX owns about 20 percent of PDS while other shareholders are: Tata Consulting (8 percent), Computershare Technology (8 percent), Philippine American Life and General Insurance Co. (4 percent), Financial Executives Institute of the Philippines (1.54 percent), Investment Houses Association of the Philippines (1.12 percent) and Social Security System (1.54 percent).

As the BAP has already committed to sell its shares, SGX becomes the single biggest investor and deciding factor on whether the PSE will get a simple majority or 67 percent of PDS. It had been reported that SGX was lukewarm to the PSE’s offer due to pricing issues as a third-party audit commissioned by the BAP previously estimated the value of PDS at more than P4 billion.

Under corporate laws, the approval of 67 percent of shareholders is needed for a merger to happen. PSE sources are confident the exchange will get all the votes needed to effect a merger and that even SGX will accept the offer. But even without the SGX shares, the parties have committed to proceed with the transaction.

PSE has offered to buy out other shareholders at an enterprise valuation of P2.25 billion, which is based on a multiple of 10 times PDS’ earnings for 2013 and 2014. The offer is also priced at twice the book value of PDS.

Profitable operations

“We’re in the final stages already. By July, I know they want our approval so they have to get the requirements in,” Securities and Exchange Commission Chair Teresita Herbosa said.

The expectation is that the PSE will be able to “economize” and make the consolidated operations profitable.

“After consolidating their operations in the first six months to one year, they will still be separated but they will have common operations already,” Herbosa said. “I think the depository will be continued,” Herbosa said, referring to the operations of PDTC.

This depository unit of PDTC accounts for about 70 to 80 percent of the PDS’ net income. This unit also serves the depository requirements of the PSE.

From the point of view of the PSE, the depository business under PDTC is the immediate motivation for proceeding with this acquisition despite a pending legal challenge to the government securities (GS) trading business run by PDEx.

If Finance Secretary Cesar Purisima did not push for the PSE-PDS merger, the local bourse would have to set up its own depository system, consequently taking away PDS’ bread and butter.

PSE president Hans Sicat earlier explained: “For the PSE, the most important short-term function that we need to bring into the exchange is the depository function—the function of electronically keeping securities in the electronic vaults of the company. Clearly, it is not only a revenue enhancer for the PSE but it will also finally enable us to pursue a number of other new products.”

Challenges

To recall, PDEx, along with the BAP and the financial regulators, is facing a lawsuit for allegedly perpetrating a monopoly in GS trading. Sen. Aquilino Pimentel Jr., former congressman Luis Villafuerte, former budget secretary Benjamin Diokno and former national treasurers Norma Lasala and Caridad Valdehuesa filed the petition against PDEx at the Supreme Court in September 2013, initially disrupting the PSE-PDS merger discussions.

To allow discussions to proceed independent of the outcome of the case against PDEx, about 30 percent of the PSE’s payment to the sellers will be put in escrow pending the resolution of the legal case. In case the critics of PDEx win, the GS side of the business will simply be carved out of the consolidation and the PSE will claw back the commensurate amount of that put in escrow.

Of the fixed income trading business under PDEx, GS trading accounts for about 80 percent while private corporate bonds and other debt paper account for the rest.

One challenge for the PSE will be to make the fixed income trading platform at PDEx a real working exchange. The expectation is that by phasing PDS into the PSE infrastructure, bond trading—whether of GS or private issuances—will migrate from over-the-counter (OTC) to real-time trading.

For many years, PDEx has struggled to gain acceptance among bank treasurers, many of whom believe that it does not add value to them. The PDEx platform has been described as a mere mapping operation where OTC trades get reported to PDEx through a dealing platform, which banks pay for and whose fees are in turn passed on directly to investors.

The PSE may thus find the same sort of resistance from bankers, especially as the BAP will cease to be a shareholder of PDS. What will compel banks to use the unified platform in lieu of the OTC market that they had been accustomed to? Although only 30 percent of PDS’ business is attributed to PDEx and much less to GS trading alone, it is still a sizeable chunk that the PSE can’t afford to go to waste.

Synergy

Another challenge is aligning the corporate governance standards of the broker-dealer community with the banks even if they will no longer have any economic interest in the unified platform. Sicat, however, said the parties have been working on a corporate governance framework for the country’s unified capital market infrastructure.

Overall, the unification is seen to result in a stronger, deeper, more transparent capital market infrastructure under the PSE. Whether or not GS trading will end up as part of this infrastructure, the PSE takes comfort in the fact that private corporate bond issuances have grown through the years, thus complementing the bourse for equities.

“In a market that’s small like the Philippines, I don’t think it’s a bad thing. There are some obvious synergies that they can use, to lower overheads. There are advantages to it. They can share the trading platform There are different products, obviously, but there could be a point where it can be interesting because there could be hybrid products that will be easier to deal with when you’re talking to the same entity,” BPI Capital chief operating officer Reginaldo Anthony Cariaso said.