PSE-PDS merger: Engagement on the rocks

TWO YEARS ago, the Philippine Stock Exchange (PSE) and the Philippine Dealing Systems Holdings Corp. (PDS) group got together to discuss the creation of a unified capital market infrastructure in the country. Consolidating the trading platforms in the country was seen in line with global best practices and market structure—a transparent and efficient bourse with central clearing and settlement facilities across multiple asset classes.

Markets in other parts of Southeast Asia, Hong Kong, Korea and Japan each has an exchange that operates both equities and fixed income securities trading.

After a year of discussions, the PSE was able to sign a share purchase agreement with the Bankers Association of the Philippines (BAP) and other shareholders of PDS, which 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., effectively raising its stake in PDS to more than 67 percent subject to closing conditions.

The closure of the deal, however, was tied to the approval by the Securities and Exchange Commission (SEC) of PSE’s exemptive relief from the 20 percent limit of ownership in the unified exchange. The SEC subsequently raised a string of concerns on the proposed acquisition, including issues on monopoly, hefty depository fees and governance structures.

In a 17-page strongly worded letter penned by SEC market and securities regulation department director Vicente Graciano Felizmenio Jr. dated Nov. 27, when the deadline to close the deal to buy out other PDS shareholders lapsed, the corporate watchdog said it could not make a determination whether the ownership or control of PDS would adversely affect PDS’ ability to operate for public interest. It cited the absence of sufficient information on the PSE’s plans.

One key concern highlighted by the SEC letter, a copy of which was obtained by the Inquirer, was that the acquisition of shares in PDS could lead to “monopoly and restraint in trade” once a single entity emerged. The letter said it was only prudent for the commission to exercise “utmost care, detail and attention” to this proposal pursuant to the passage of the Philippine Competition Act.

To recall, Congress passed in mid-2015 the Philippine Competition Act that prohibits mergers and acquisitions weeding out competition, fixing of prices during auctions or biddings, and agreements limiting or controlling production, markets and investments.

Concerns on profitability

The SEC also questioned the high depository fees charged by the PDTC, which the regulator noted was in violation of previous commitment to charge lower depository fees proposed by the Securities Clearing Corp. of the Philippines (SCCP). The SEC letter noted it previously approved PSE’s application to set up its own depository system due to claims it can afford to lower the fees.

“The Commission hopes to see a reduction in the transactional costs in both exchanges and understands how a merger of the exchanges could lead to that. The PSE, however, has not presented any detailed and time-bound commitments to lowering transactional costs. Neither has it identified clear operational steps that would result to this decrease in costs,” the letter said.

The SEC letter even took note of the PSE’s “unusually high” profits versus regional peers, citing a return on assets of 27.6 percent in 2014 versus a regional average of 12.2 percent.

“We have yet to see commitment from the PSE to translate these profits to economic benefits for the market as a whole, in the form of either a meaningful reduction in fees or significant investments in capital assets—not just for themselves. Thus, aside from the high profits, the PSE has also recorded extremely high dividend payout ratios over the past years,” the letter said.

The acquisition of the PDS group meant PSE would already become more profitable, it added. “We believe that there is a lot of room for the consolidated group to pass on these economic benefits to market stakeholders (such as issuers and investors) through the lessening of fees, which cause friction in the free market.”

The PSE was also asked to give further clarification on how to unify processes given that the PSE and PDEx were currently using different clearing and settlement models.   The SEC also said the local bourse should “crystallize” its financial market infrastructure stability plan post consolidation and demonstrate how this would minimize attendant risks.

Governance structures

The SEC also asked the PSE to clarify governance structures in the consolidated entity. “The commission will need comfort that there will be sufficient and well represented fixed income market expertise in the governance of the consolidated entity. There needs to be assurances that decision-making at the highest levels of the consolidated entity take into consideration the needs of both the equity and fixed income markets and are responsive to the interests of all stakeholders,” the letter said.

The SEC also wanted the PSE to commit to a timetable as to when it would be able to comply with the 20 percent industry limit. The SEC’s impression was that the PSE had no intention of complying with the industry ownership limit and that what it actually sought was “permanent and unconditional” exemption from this provision.

The SEC also wanted the PSE to submit more information on the acquisition, including intentions, copies of the sale and purchase agreement, resulting voting structure for the two exchanges and method and criteria used to determine value and price. It also wanted details on other financial contributions and future organizational arrangements.

Taking note of three trading halts in August 2015, the SEC said PSE’s application should also provide for sufficient mitigation of any systemic risks.

“The Commission would need to have assurances that the PSE indeed has a clear vision for this market,” the letter said. “We cannot overlook the fact that the Philippine fixed income market has a central role in the movement of capital in the financial system, perhaps even having more systemic importance than the stock market.”

The PSE was given until Jan. 26, 2016 to clarify certain items about the P2.25-billion PDS deal.

No monopoly

On the other hand, the PSE remained hopeful that its request for exemptive relief to own at least two-thirds of PDS would be approved.

“We believe we have provided our responses to all the major concerns brought up by the SEC, but we will provide them supplemental information to facilitate our application for exemptive relief,” PSE president and CEO Hans Sicat said.

On the question of monopoly, Sicat says the Philippine regulatory framework does not prohibit the setting up of a new exchange even with the PSE’s planned acquisition of PDS.

“We believe though that we cannot afford to look at ourselves as operating in a vacuum. For one, the PSE has never had the monopoly in providing access to capital. Companies can choose to raise funds not just from the stock market but from banks or from issuing commercial papers. In the same manner, investors can choose to invest in various instruments, be it deposits, real estate or the equities market,” Sicat said.

“But even if we were to confine it from a strictly equities market standpoint, stock markets are now globalized and this is a reality that will not change. Companies and investors can easily venture in different markets outside. Given today’s financial market ecosystem, the relevant market is not just the domestic market but the regional, if not global market,” Sicat said.

The PSE would thus have to be stronger and bigger to be competitive in a global environment, Sicat said. He said the acquisition of PDS was very much in line with such goal.

On depository fees, Sicat said the PSE had made representations to the SEC on how the acquisition would benefit investors. “We hope the SEC can look at our proposal favorably on this item.”

Sicat said the PSE was mindful of the need for continuity in the fixed income market during the process of integrating with the PDS.